Telstra Corporation's (TLSYY) CEO Andy Penn on Q2 2017 Results - Earnings Call Transcript

| About: Telstra Corporation (TLSYY)

Telstra Corporation Limited (OTCPK:TLSYY) Q2 2017 Results Earnings Conference Call February 15, 2017 5:15 PM ET

Executives

Peter Kopanidis - Head, IR

Andy Penn - CEO

Warwick Bray - CFO

Analysts

Fraser McLeish - Credit Suisse

Raymond Tong - Evans & Partners

Eric Choi - UBS

Sameer Chopra - Bank of America Merrill Lynch

Eric Pan - J.P. Morgan

Craig Wong-Pan - DB

Roger Samuel - CLSA

Ian Martin - New Street Research

Andrew Levy - Macquarie

Nick Harris - Morgans

Brian Hahn - Morningstar

Peter Kopanidis

My name is Peter Kopanidis, I’m Telstra’s Head of Investor Relations. On behalf of Telstra, I welcome you all to webcast of our 2017 Half Year Results Presentation. As an important symbol of respect, it is our custom at significant Telstra events to acknowledge Australia’s First People. Today therefore, I’d like to acknowledge that we meet the traditional owners of the land on which we meet, the Wurundjeri people of the Kulin nation and pay my respects to their elders, both past and present. After presentations from our CEO, Andy Penn, and our CFO, Warwick Bray, we’ll be taking questions from investors and analysts.

With that, I’ll now hand over to our CEO, Andy Penn. Good morning, Andy.

Andy Penn

Well, thank very much, Peter, and good morning, everybody, and welcome to our results briefing for the half year ended the 31st of December 2016.

Our vision is to be a world-class technology company that empowers people to connect. This means, we need to keep bringing world-class technology innovation to the market, technology innovation in our network, and technology innovation in the applications and services our customers use on the network, and there is no better example of this than the new Telstra Nighthawk M1, this is a mobile hotspot device.

Aside from being cutting edge technology in its own right, it is a great example of the transformative products and services that we are offering our customers today, products that are consistent with our brand promise to create better ways to empower people to thrive in a connected world, created in partnership with Qualcomm, Netgear and Ericsson, this device is currently the fastest mobile device in the world. It is capable of delivering an incredible 1 gigabit per second download speed.

To put that into perspective, it enables our customers to download HD movies in three minutes, or one hour episodes of their favorite TV show, in around 16 seconds. It can even charge your smartphone. Our substantial and sustained investment in our mobile network means that we are one of the only few operators in the world with the speed and breadth of coverage to enable our customers to truly make use of a device like this with its amazing capability. The Nighthawk M1 was launched earlier this week to Telstra customers.

Let me now turn to the business of today.

This morning, Warwick and I will provide an overview of our half year results. I will cover the key highlights and Warwick will then take you through the results in detail. Following that, I will provide you with an update on our progress against the three pillars of our strategy. I will also comment on the progress that we have made on our $3 billion capital investment program. Warwick and I will then be happy to take your questions.

Before I start though, I would like to give you a sense of the market dynamics that we experienced in the first half. There is no doubt the competitive intensity in the industry has increased. During the half, we saw data volumes continue to increase and competition in pricing across fixed, bundles, mobile, data and IP. There has also been an acceleration in the rollout of the nbn which we have previously reported will negatively impact our EBITDA by $2 to $3 billion over the longer term.

It is significant that we were able to continue to increase customer numbers in mobiles, in retail fixed plans and data and IP despite the competitive pressures in the market and by very solid progress on our cost reduction program to mitigate the impact of these economic headwinds.

Turning then to the results. On a guidance, total income was up 0.7% and was lower than last year whilst EBITDA was 1.7% higher. Adjusting for recent regulatory impacts including MTAS and the FAD decisions, total income and EBITDA were up 2.2% and 2.4% respectively. Reported EBITDA decreased 1.6% to $5.2 billion and net profit after tax reduced to $1.8 billion including planned restructuring costs. The Board has declared a fully franked dividend of 15.5 cents per share, which is equivalent of the 2016 interim dividend.

Importantly, we continued to attract new customers during the half, adding 200,000 net new retail mobile services. We now provide 17.4 million mobile services including 7.6 million postpaid handheld retail customer services, an increase of 79,000 in postpaid in the period. Retail fixed bundle growth during the half was strong with 124,000 new bundles customers, which means we now have 2.8 million customers on a bundled broadband plan. Retail fixed broadband customers were up 90,000. We performed well in nbn, adding 292,000 new services, reaching a market share of 51%. And IP MAN services were up 18.9%.

Our GES business continued to grow strongly and we were particularly pleased with the performance in cloud and in Industry Solutions where revenue was up 56.1%, driven by commercial works for nbn. NAS continued to deliver EBITDA margin improvement, up 6 percentage points through operational leverage, standardized offerings, and a lower cost global delivery model. GES also received a number of key industry awards including from Cisco, Microsoft and from Frost & Sullivan, the Service Provider of the Year for Excellence in Enterprise Collaboration, Enterprise Mobility Managed Services & Hosted Customer Contact services.

In productivity, we are seeing benefits flow through to the bottom line through reductions in fixed costs. Underlying core fixed costs declined $92 million or 2.6% in the half. This was ahead of our target to reduce fixed costs by more than 2% per annum.

Warwick will provide you more details on our productivity program in a moment.

In October, we completed the $1.25 billion off-market share buyback, which was heavily subscribed, and in December a $250 million on-market share buyback. In July, we refreshed our brand with a focus on being more human and developing an emotional connection with our customers by demonstrating how innovation and technology can help people and businesses thrive. Since launch, we have seen positive trends in relation to brand consideration and perception measures, and we have been recognized as Australia’s most valuable brand and among the world’s top 100 most valuable brands for the second year in a row.

Data usage on our network continued to grow strongly. In the 12 months to December 2016, traffic over our mobile network increased 39%, traffic on our fixed network, including nbn grew 51% and traffic on the Telstra Air network increased tenfold.

Disappointingly, and despite these improvements, our Strategic Net Promoter Score was 8

points lower than the same period last year, largely due to the impact of the network disruptions that we saw in the first half of calendar 2016. We are working hard to regain our customers’ confidence here.

As we announced in November, our aspiration is to improve both strategic and episode NPS by three to six points per annum so we have more work to do. Encouragingly though, Consumer NPS improved in the second half of the calendar year compared to the first half, and we also saw some positive trends in Episode NPS.

We have a clear strategy to differentiate our products through the speed, coverage and reliability of our networks, and through innovative product design and new customer experiences, including access to media content. The up to $3 billion of incremental capital expenditure we announced last year will drive further improvements in our customer experience. The investment will reinforce our market differentiation over the longer term, deliver significant customer benefits, together with associated revenue uplift, improve capital efficiency and further

reduce operating costs. Our total capital expenditure for the half was 16% of sales revenue or $2.1 billion. Our full year guidance for CapEx to sales remains at 18% as we ramp up the strategic investment program in the second half of the year.

In November, we communicated to the market our intention to conduct a strategic review of capital allocation over a 6 to 12-month period. The review takes into account the nbn payments and is addressing our balance sheet structure and settings, our debt profile, longer term CapEx requirements post the rollout of the nbn and investment decisions including M&A criteria. It is also considering returns to shareholders including dividends, buybacks and other forms of return. Since November, we have been consulting with shareholders, and we will continue to do so as we investigate how we optimize the value from the recurring nbn payments and any other changes that we need to make to our capital management framework.

Overriding and consistent feedback from shareholders to-date highlights the importance of retaining a strong balance sheet, particularly through the nbn transition period and against the backdrop of a more competitive operating environment. We have already communicated our intention to retain balance sheet settings consistent with an A band credit rating and this position remains unchanged. The capital allocation review is ongoing and we will communicate further with the market in due course.

Before handing over to Warwick, I will just make a couple of comments on mobile roaming.

Over many years, Telstra has invested heavily in regional Australia. We will continue to do so if the current regulatory settings remain in place. Our customers across Australia highly value the superior quality and coverage of our network. In November I outlined our plans that would see more than $1 billion of investment directed towards regional and rural Australia over the next four to five years. Imposing regulatory roaming would remove the business case for this investment. There’s no doubt that it would be unambiguously bad for regional Australia.

Any regulation that removes the ability to differentiate on the basis of coverage will inevitably see private investment by all carriers redirected away from remoter parts of our country. This is not just Telstra’s investment but also substantial proposed investment by the industry and co-investment in regional and remote mobile infrastructure. One of our competitors has barely invested in regional infrastructure, just 24 base stations in the black spots programs compared to our 577. They clearly have no intention of investing and will have no incentive to do so in the future if roaming is regulated.

They say, we have had an unfair advantage. That is rubbish. The fact is we have invested billions of shareholders money since privatization to build the largest and best network in Australia for our customers. They have chosen not to do so despite being one of the world’s largest and best capitalized companies in the world. This is why the ACCC has received an unprecedented amount of feedback from regional Australians and the overwhelming majority said regulated roaming was not worth the risk to investment. We will continue to work constructively with the ACCC and with regional stakeholders to ensure the current regulatory settings remain in place and regional Australia continues to benefit from investment in leading-edge mobile communications.

Thank you. And now, let me now hand over to Warwick who’ll take you through the numbers in more detail.

Warwick Bray

Thank you, Andy, and good morning, everybody.

The presentation this morning breaks down as: First, the overall results and performance against prior periods and guidance; second, product performance; third, our expenses and productivity; fourth, an update on our main balance sheet movements and our capital position; and finally, some comments on guidance for FY17.

Firstly, let me take you through the overall performance of the business.

On a reported basis, including the impact of restructuring costs and regulatory decisions, income was down 0.7% to $13.7 billion; EBITDA was down 1.6% to $5.2 billion; and net profit after tax was down 16.4% to $1.8 billion; basic EPS was down 14% to 14.8 cents.

On a guidance basis, income was the same as reported and EBITDA was up 1.7%. And excluding the MTAS and FAD regulatory decisions, income was up 2.2% and EBITDA was up 2.4%.

The reported numbers for the half include the effects of restructuring costs which reduced EBITDA by $165 million; and regulatory pricing decisions, which decreased income by $400 million and reduced EBITDA by $38 million.

The guidance basis removes the restructuring costs. I’ll comment on full year guidance at the end of this session.

We have reported an increase in depreciation and amortization of 10.7%. This was mostly due to

ongoing investment in business software assets with shorter useful lives. D&A will also increase as a result of our strategic CapEx announced in August 2016 of up to $3 billion over the next three years. Net finance costs decreased 18.4%, mostly due to the refinancing of debt at lower rates and $32 million of favorable net non-cash gains associated with our derivative financial hedge instruments. Income tax was broadly flat. Income tax expense was in line with cash tax paid. Effective tax rate on continuing operations increased to 32.8%. We expect the effective tax rate over time to revert closer to the statutory rate.

We now move to our other main financial measures.

This half, our CapEx was broadly flat at $2.1 billion including increased investment in our mobile network. Our CapEx to sales ratio was up 0.8 points to 16%. We expect increased CapEx in the second half of this year, consistent with our full year guidance of approximately 18%.

On a guidance basis, excluding restructuring costs in the half and in year M&A, free cash flow was $1.6 billion. The largest factor for the free cash flow reduction from $1.9 billion to $1.6 billion was that the first half of FY16 included cash flows from Autohome trading.

The Board has declared a fully franked interim dividend of 15.5 cents per share. Return on equity and return on invested capital remain well above our costs of capital. Return on equity decreased by 4.9 points, mostly due to reduced earnings and increased equity from the profit on sale

of Autohome. Return on invested capital decreased by 1.8 points mostly due to reduced earnings. Our future ratios will continue to be influenced by the changing mix in our major products.

Turning to income performance within our product framework.

Overall, we saw a decline in reported income of 0.7% to $13.7 billion. Our recurring core income decline was 3.4% or $453 million. Excluding an impact from the implementation of the MTAS and FAD decisions, our core income declined 0.4%. Mobile was down $125 million or 2.4% on the first half of FY16. Fixed was down $181 million or 5.2%, data and IP was down $48 million or 3.4%. Recurring NBN DA was up $26 million or 14%. NAS continued its double-digit rate of growth, up $225 million or 18%. Global connectivity was down $12 million or 1.7%, however, on a constant currency basis, income was up 2.6%.

Outside our recurring core income, one-off NBN DA receipts and hardware connection revenue was up $370 million; and new business was down $16 million due to the Telstra Software Group, where the focus is on consolidating operations.

Turning to product EBITDA performance.

Overall, we saw an increase in EBITDA on a guidance basis up 1.7% to $5.4 billion. Our recurring core was down a $194 million. The influence of the nbn this half was approximately $152 million and we expect the recurring impact of nbn to grow to $2 billion to $3 billion per annum over the course of the nbn network rollout. Outside recurring nbn impacts, the remaining core was down $42 million. We see some encouraging trends in the half and sequentially, we’ll go through this on the next slide.

One-off NBN DA EBITDA and nbn costs to connect was up $279 million in line with the nbn rollout. This included $348 million of increased one-off NBN DA income including retraining; partly offset by $56 million of increased net nbn costs to connect and $13 million of one-off DA costs.

New business EBITDA was up $3 million. Telstra Health has moved from acquisition phase to an integration phase, with a focus on new solutions with our existing assets. Across the Telstra Software Group, we have rationalized operations for future growth.

Turning to recurring core product EBITDA performance in detail

This table now further expands the EBITDA performance of our core business. Working from the bottom, the difference between the reported EBITDA figure of $5.189 billion and the recurring core of $4.94 billion is the nbn one-off, new growth businesses and guidance adjustments.

Turning to our recurring core, EBITDA was down $194 million, or as identified on the last slide, down $42 million excluding the recurring impact from nbn. This is included some encouraging trends. Mobile was down $63 million. However, sequentially, mobile service revenue has increased, which is one of our indicators of success. NAS was up $90 million, exceeding the $76 million decline in Data and IP. Global connectivity was up $13 million or 16.4% on a constant currency basis.

Turning to the product performance in detail starting with mobile.

We have seen some encouraging signs of stabilization of revenue, ARPU and margin in the last half. These signs can be seen sequentially, so we’re showing three halves on this chart.

For the half, mobile revenue was down 8.7%, or 2.4% excluding MTAS. We achieved mobile services growth of 0.3% sequentially against the second half of FY16. And we are starting to see our way through postpaid handheld ARPU declines and have continued SIO momentum in the half. During the half, we added 200,000 retail mobile services, including 79,000 postpaid handheld customers, to bring our total subscriber base to 17.4 million.

Postpaid handheld ARPU excluding MRO, although down 2.6% on the first half of FY16, has been stabilizing against the second half of FY16. Encouragingly, we continue to see customer migration to higher minimum monthly commitment plans and the quality of revenue improving. This minimum monthly commitment growth was offset by lower out of bundle revenue and a higher mix of BYO plans.

Postpaid mobile churn continues to be low by international standards. Churn in this half decreased on the second half of FY16 excluding an impact from the closure of our 2G network in December.

We are encouraged by our prepaid handheld revenues which increased 1.4% with 39,000 unique

users added in the half. Prepaid ARPU has also returned to sequential growth against the second half of FY16 with increased voice and data recharges.

Mobile broadband revenue fell 14.7% due to a decline in ARPU and prepaid unique users. This

largely reflects the mix shift from old legacy plans to newer plans at a lower ARPU; and increased sharing of data through mobile handsets as mobile data inclusions have grown and are shareable.

Machine to machine revenue grew 13.3%, with 130,000 M2M SIOs added in the half. We continue to see growth in M2M with new Internet of Things solutions being implemented in verticals such as logistics.

Mobile hardware revenue decreased 4.4%, largely due to lower volumes. Our hardware margin improved due to reduced handset subsidies. The mobile EBITDA margin increased 2 points to 41%. Excluding the margin accretive impact from MTAS, mobile margins were broadly flat on PCP. Compared to the first half of FY17, mobile margins in the second half of FY16 benefited from the timing of roaming credits and lower hardware revenue.

Turning to our fixed performance.

Our strategy in fixed is to continue to provide customers with simple, flexible, and high value bundle plans together with unique inclusions like Telstra Air, Telstra TV, and more capable home internet devices. This strategy has led to continued strong SIO performance.

Fixed data revenue grew 1.8%. Our retail subscribers grew 90,000 in the half. Fixed data revenue was impacted by wholesale and the FAD regulatory decision. Excluding this FAD impact, fixed data revenue grew by 2.4%. Fixed data growth was also impacted by competitive conditions.

The fixed voice revenue decline was contained to single-digits. Retail fixed voice customer line loss was contained with continued focus on retention in our save cells and proactive migration of home-phone-only customers to new bundled plans with broadband and Wi-Fi. The fixed voice ARPU decline of 4.8% was broadly in line with the prior corresponding period.

Our bundled products are performing well. We added 124,000 retail bundled customers in the half. 85% of our retail broadband customer base are now on a bundled plan, many of which are on our entertainment offers.

Demand for our nbn services continues. During the half we added 292,000 nbn connections bringing total nbn connections to 792,000, or a 51% share ex-satellite. We now have 636,000 bundle and 52,000 data only connections. The number of registered customers on Telstra Air increased by over 400,000 in the half. We now have over 1.5 million customers activated on Telstra Air since launching in June 2015.

The fixed voice margin fell by 4 points, and fixed data margin fell by 7 points. Fixed margins were negatively affected by one-off costs of connecting customers to the nbn, and the ongoing nbn network costs. Excluding nbn related items and regulatory FAD impacts, fixed margins were broadly consistent with the prior corresponding period.

We continue to focus on reducing costs in our fixed portfolio by developing digital platforms in sales and self-service functionality. Fixed other revenue decreased by 3.8%, largely due to the FAD decision for Fixed Line Services implemented 1st November 2015.

Turning to data and IP.

Data and IP revenue declined 3.4% ex-FAD, largely due to increased competitive pressure and a

decline in the domestic market. We continued to perform well against the market with customers

embracing our complementary NAS products; and Next IP network flexibility, scalability and security. While we are achieving volume and connection growth in IP access, price competition is continuing. IP access declined 1% reflecting these yield trends. Within IP access, IP MAN revenue was up 1%, with SIOs up 18.9%, reflecting customer wins and demand for IP value added services. ISDN declined 10.6% due to accelerated migration to IP access, unified communications, fixed data and nbn products. Our EBITDA margin of 59% was impacted by yield pressures in the IP market.

Now, turning to Network Applications and Services, or NAS.

We continue to be encouraged by our NAS performance. In the first half, we again achieved double-digit revenue growth and expanded margins. We achieved revenue growth across business and GES customers including growth from commercial works and cloud services. Revenue growth across managed network services, unified communications and integrated services was impacted by the achievement of delivery milestones on large contracts in the prior corresponding period that were not repeated this half. Excluding these delivery milestones, managed network services annuity revenue growth was achieved in security services; and the continued success and growth post integration of our Bridgepoint and O2 Networks acquisitions.

Unified communications declined 1.5%. However, excluding the delivery milestones on large contracts, annuity revenue growth was achieved through increased IP telephony SIOs and across Cisco unified communications products.

Cloud revenue grew by 41% due to increased consulting professional services and key acquisitions, including Readify and K-Cloud. Industry Solutions revenue growth of 56% was principally due to increased nbn commercial works, other commercial works and professional media solutions through Telstra Broadcast Services. The NAS EBITDA margin improved 6 points through operational leverage, scalable standardized offerings and a lower cost delivery model.

Turning to global connectivity.

Global connectivity represents our international GES business. On this slide, we have identified our global sales revenue from across our previous fixed, data & IP and NAS product revenues to be consistent with our overall product framework we represented at our August results.

Global connectivity revenue increased 2.6% in local currency with customers responding positively to the combination of the Pacnet network and the Telstra brand. Growth in Australian dollars was negatively impacted by currency appreciation.

Fixed voice decline was marginal as yield pressure has been mitigated by targeted volume growth. Data and IP revenue growth in local currency was achieved in Internet and Ethernet services, to a large extent due to over-the-top customers. NAS revenue grew due to the launch of a suite of managed network services and unified communications. The Global connectivity margin improved by 2 points with EBITDA up 16.4% in local currency due to continued delivery of synergies from the Pacnet acquisition and productivity. We are encouraged with the progress of the Pacnet integration and expect to deliver the recurring annual synergy benefits of

A$65 million ahead of schedule.

Turning to media and firstly Foxtel.

Foxtel’s revenue in the half decreased by 2% with a decline in total subscribers due to the wind down of T-Box and the announced closure of Presto. A major marketing push to formally launch the new Foxtel Play pricing is planned in coming months. Foxtel’s total closing subscribers were more than 2.8 million, with closing broadcast cable and satellite subscribers flat compared to the prior year period. Whilst there was some increase in underlying churn, majority of the increased churn was due to use of no fixed-term contract offers in FY16. EBITDA decreased by 14.3% to $372 million, mostly due to lower revenue and increased investment in programming. There was no distribution received from Foxtel in the half and cable access revenue was down 12.1% to $51 million.

Now, moving to our other media assets.

Telstra Media achieved strong revenue growth due to Foxtel from Telstra and Telstra TV. In the half, we continued our strategy to bundle media with core fixed products. Foxtel from Telstra revenue grew by 11.4% to $390 million, with net subscribers up 88,000 over the last 12 months. Foxtel from Telstra subscribers declined 3,000 in the last six months due to churn on our prior year promotional offer. We had 622,000 Telstra TV devices in market. Telstra TV is now the fastest growing streaming device in Australia, contributing to majority of growth in other media revenue. Other media revenue was up by 19.1% including IPTV revenue growth, partly offset by a reduction in legacy mobile download services. Our media strategy has moved from direct media revenue towards differentiation and bundling content, such as AFL and NRL, across Telstra’s core products.

Turning to income from the NBN Definitive Agreements or DA.

During the half we recognized NBN DA related income of $1.057 billion, up 66.2%. This included strong growth from the PSAA and ISA ownership receipts, which were up $304 million and $40 million respectively, in line with the progress of the nbn rollout and migration. PSAA and ownership receipts will be influenced by the timing of the nbn rollout; and the timing of related cash flows will vary between periods.

Revenue from the Commonwealth Agreements decreased 23.7%, mostly due to the timing of income recognition from the Telstra Universal Service Obligation Performance Agreement. Recurring ISA revenue from ducts, racks and backhaul was up 14.0% to $212 million. These receipts reflect nbn co ongoing use of our infrastructure. nbn commercial works income related to the sale of assets was $79 million. We have separated this from ISA ownership receipts to provide additional clarity on the composition of NBN DA income. In addition to NBN DA income, we also received nbn commercial works revenue in NAS of $311 million.

Turning from our product performance, let me take you through our expenses and productivity.

On a guidance basis, excluding mostly restructuring costs, our operating expenses decreased 2.2% or $184 million. On a reported basis, operating expenses decreased 0.1% or $12 million. We are pleased by this result. We are on track to deliver against our cost ambitions announced in November that is a more than 2% annual year-on-year reduction in net underlying core fixed costs.

Going through each of our four cost categories in turn. First, our core sales costs decreased $240 million or 6.3%. Excluding the benefit from reduced interconnect costs due to MTAS, core sales costs grew by 3.5%. Overall, we saw an increase in efficiency of our core sales costs.

Second, on underlying basis, our core fixed costs declined $92 million or 2.6%, exceeding our more than 2% annual year-on-year target. This means that the results of our cost productivity programs more than offset inflation and reinvestment. We remain committed to reducing core fixed costs on an underlying basis by more than $1 billion over the next five years to offset up to one third to one half of the $2 billion to $3 billion negative impact of the nbn. Outside of our underlying core fixed costs, NAS labor and corporate increased by $76 million. This included increased nbn commercial works and recurring DA costs; increased NAS labor on large contracts; offset by lower global connectivity and corporate costs.

Third, new business costs declined by $19 million due to cost management and FX impacts. These costs supported Telstra Health and the Telstra Software Group.

Fourth, within one-off NBN DA and costs to connect, we reduced the average net cost per nbn

connection by around 35%. This nbn unit cost reduction is critical for the future. One-off NBN DA and costs to connect increased by $91 million in line with the nbn rollout.

Turning to some of the more detailed capital and balance sheet movements.

Overall, our balance sheet remains strong. Gross debt remained consistent with June 2016 with no new long-term debt issuance in the first half of FY17. Liquidity decreased in the first half of FY17, mostly reflecting the payment of dividend and buybacks. Our closing FY16 liquidity included the proceeds from the sale of Autohome. Our average debt maturity has decreased to 4.3 years from 4.8 years at the full year. Finance costs on an accounting basis were down 18.4%, mostly due to a reduction in average gross borrowing costs from 5.6% to 5.4%, and a net non-cash favorable movement in remeasurements. The reduction in gross borrowing costs reflects the ongoing benefit of lower cost term debt issuance and the favorable impact from lower market rates on the floating component of our portfolio. Gearing increased to 50.4% including reduced liquidity following the cash received from the sale of Autohome and subsequent capital management program. Our financial parameters remain at the conservative end of our comfort zones. Our comfort zones will remain unchanged during the period of our capital allocation review.

Finally, turning to guidance.

Today, we are reconfirming our guidance. For FY17, we expect mid to high-single digit income growth and low to mid-single digit EBITDA growth. We expect to spend CapEx of approximately 18% of sales and free cash flow to be in the range of $3.5 billion to $4 billion.

Our first half income growth was influenced by lower hardware revenue than we expected. Given this, we expect that full year FY17 income growth will be at the bottom end of our mid to high single digit range.

In the second half of FY17, we expect that income growth will improve from factors such as MTAS impacts in the first half dropping out of the comparison in the second half; and the nbn rollout is expected to accelerate in accordance with the nbn Corporate Plan. As is usually the case, the basis on which we provided guidance is detailed in the slide footnote.

Thank you. I will now ask Andy back to provide a strategic update.

Andy Penn

Thanks, Warwick.

Last year, we announced that we had refined our strategy around three pillars, delivering brilliant customer experiences; driving value and growth from the core; and building new growth businesses close to the core.

In support of our strategy, we also have three critical strategic enablers, investing in the networks of the future; digitizing our business; and building the culture and capabilities that we will need to be successful.

It is against the first two of these where our $3 billion of incremental investment is focused. I will now comment on recent progress in each of the three pillars and on our strategy as well as the Strategic Investment program.

Firstly, delivering brilliant customer experiences. This is undoubtedly our most important strategic imperative. That is why it is disappointing that our strategic NPS declined 8 points compared to December 2015. As I mentioned before, the drop has been primarily driven by the impact of the network outages, particularly on our larger customers. We are confident that the sentiment of our corporate customers is recovering and should reflect in our NPS results in the coming half.

Encouragingly, we have seen positive trends in both strategic NPS and episode NPS for our

Consumer customers during the last six months underpinned by a number of customer focused

initiatives. Notwithstanding this, there is no doubt that we still have much to do to deliver a better experience for our customers, and there are too many instances that I know of where we let our customers down.

When we announced our refined strategy in November, we said that we would be relentless in

delivering customer experience improvements. And we have a broad range of initiatives aimed at delivering seamless, simple and integrated interactions for customers and eliminating pain points. Progress in the half included providing our customers with a better network experience, not only through more coverage and faster speeds as I will talk about later, but also through new devices.

The Telstra Gateway Frontier is a cutting edge fixed line modem that has a built in mobile 4G chip set. It is an example which brings together Telstra’s mobile and fixed networks in one device to connect our customers quickly and keep them connected, even if their fixed line is unavailable. We have introduced new systems to give customers greater flexibility and choice for hardware deliveries. We have simplified self install for our ADSL customers making the connection process much easier as well as increasing ADSL speeds for our customers. We have also focused on creating more value for our mobile customers with Go Mobile Swap and My Business Lease plans which provide customers with regular and cost-effective ways of actually upgrading their smartphones.

There are now 622,000 Telstra TV devices in the market, a six-month increase of 322,000, making it the fastest growing streaming device in Australia. We are seeing very strong activation and usage rates and we plan to launch the next Telstra TV later in the year. Excitingly, it will have a built-in free to air tuner and customers will no longer have to toggle between input sources and enjoying all of their viewing through Telstra TV. It will also have the ability to receive 4K content. The next generation of the Telstra TV device will deliver more content at higher quality while using less data. Most importantly, this device will be exclusive for Telstra broadband customers, and continue to be part of the Why Telstra? story, when our customers make the decision to choose us.

We have further extended our mobile content differentiation by offering live streaming of all AFL, NRL and Netball games data free and included with all mobile plans. We have made it easier for customers to understand what is important by simplifying previously lengthy terms and conditions. We have also simplified our International Roaming Day Pass pricing to two zones and we have improved protection for customers from the unwelcome surprise of additional charges from premium third party providers by introducing a double opt in process. Notwithstanding these improvements, we recognize that we have work to do to consistently deliver a high quality customer experience.

The second pillar of our strategy is to drive value and growth from our core business. Progress in mobiles in the half saw us add 79,000 retail postpaid services and 39,000 retail prepaid unique users. New initiatives included the introduction of the new Pixel smartphone through an exclusive partnership with Google. The Pixel has proven to be a very popular device with our

customers, exceeding our initial expectations.

We are also pleased with the popularity of Telstra Air which continues to provide Wi-Fi access through more than 750,000 hotspots nationally including more than 4,700 public hotspots. Broadband customers can also take their home data allowance overseas with them via 19 million hotspots globally. The number of activated customers on Telstra Air increased by over 400,000 in the half, with now 1.5 million of our customers taking advantage of the service.

Turning to fixed.

We saw an additional 90,000 net new retail broadband customers with 292,000 new nbn connections and 124,000 new retail bundle customers. Our new home internet bundle customers now have a significant boost in streaming speeds and stronger Wi-Fi signals. On nbn, our market share excluding satellite grew to 51% and we are seeing strong demand from customers as the rollout scales up. 78% of nbn customers are now connecting via self-install kits. Our challenger internet brand Belong continues to grow with 120,000 customers now, of which more 50,000 are connected to the nbn.

In data and IP. We launched a Data Centre Interconnect product which allows customers to connect to 30 data centers globally with a range of bandwidths and latency on offer and flexible contract options. Our acquisition of K Kloud and Readify has reinforced our credentials as the leading provider of enterprise Microsoft products in Australia. It has brought more than 250 specialist enterprise software developers into our business.

As Warwick mentioned, we also saw an EBITDA margin improvement of 6 percentage points

in NAS business during the period. It reflects the fact that our product and contract mix has continued to evolve and mature, and we have achieved operational efficiencies through increased scale and automating more of our service delivery.

Productivity is critical to driving value from our core business and we continue to implement our plan to achieve at least $1 billion in net productivity over the next five years. Key initiatives in the period have included automating and scheduling and dispatch process for customer appointments, removing manual steps for business and enterprise sales and improving turnaround times for customers by 60%. We have also removed older plans from Telstra’s IT systems which has improved average system response time for customer orders. Underlying core fixed costs reduced by 2.6% or $92 million in the half, ahead of the annual target to reduce by more than 2% per annum.

In terms of network coverage, we now offer 4G coverage to over 98% of the population through 6,400 4G sites. This is bringing faster speeds and a better mobile browsing experience to more customers. Telstra has also built out additional network infrastructure 4GX, which has doubled peak network speeds for up to 75% of our customers who experience speeds of up to 300 megabits per second. In addition, 36 new mobile base stations were constructed in the half through the first round of the Mobile Blackspots Program bringing our total of blackspot sites to around 100. We will be rolling out a further 329 mobile blackspots in the coming period from round 1 of the program and on top of this, we successfully won a further 148 mobile base stations under round 2, which was announced late last year.

In the half, we successfully decommissioned our 24-year old 2G network with immediate cost benefits across the power and lifecycle maintenance. Importantly though, this shutdown frees up valuable spectrum and infrastructure that will be reused for the rollout of new technologies, including 5G.

Our third strategic pillar is to build new growth businesses close to the core. This is about realizing new opportunities for the future that leverage our core strengths. In Telstra Health we continue to focus on integrating the technology capabilities that we have acquired and using them to deliver new services. These capabilities are being used to deliver the National Cancer Screening Register for the Federal Government where we are creating a single electronic record for bowel and cervical cancer screening for millions of Australians.

In addition to this important project, we have secured some other important health customer wins during the period, a contract with the Western Australia Government for an information system to support healthcare delivery in remote and regional areas; Epworth HealthCare will be rolling out our Patient Flow Manager solution at their main hospital in Melbourne; and our joint venture, Fred IT has entered into a partnership with Sigma Pharmaceuticals, to deliver a cloud-based pharmacy software solution.

Smart Home is another exciting opportunity for us. Our Smart Home offer is now in the market including ‘Watch and monitor’ and ‘Automation and Energy’ products. There has been strong interest from consumers with approximately 1,200 visits per day to the Telstra Smart Home content online.

As the complexity of home networks increases, our technology experts continue to provide personal support to our customers. We now have around 265,000 Platinum customers, representing 32% growth in the last six months. We average over 12,000 interactions with customers per week via the Platinum Help Desk and at our 357 Tech Bars around the country.

Turning to small and medium business opportunities.

The Neto eCommerce platform is well-positioned as 300,000 small businesses customers are forecast to establish an online presence by 2020. We believe the opportunity for growth in NAS products in the small and medium business market will be significant in the future as we have seen in large enterprise and government customers.

Telstra Ventures continues to invest in world class innovation which is strategically relevant to us. During the first half, Telstra Ventures invested in three U.S.-based companies, AttackIQ, a leading cyber-defense platform delivering continuous security validation to customers; Headspin, a mobile app testing and performance management platform; and NS1, a next generation DNS for application developers.

Turning to Ooyala.

Intelligent video is a critically important capability in a world where we are seeing massive growth in the amount of media that is distributed over an IP network. However, the dynamics of this market have changed and we have a remediation plan for Ooyala which is aimed to reposition the company in the sector.

In our global business, we have also made progress. We will outperform our plans for the integration of Pacnet and will achieve the previously announced run rate target of $65 million of synergies by end of 2017 financial year, one year ahead of schedule.

The integration of Telstra and Pacnet has fueled some key customer wins, a $243 million contract with DFAT covering 160 sites; IPVPN services to 281 sites across the Asia-Pacific for a food and agriculture multinational; and broadcast services for 47 international Women’s Tennis Association tournaments.

We also strengthened our in-country presence. Our joint venture in China continues to perform well and we are investing in the business to enhance our unique proposition to this market. Our joint venture in Indonesia, Telkomtelstra, now has more than 7,000 Managed Network Services sites under contract.

I wanted to return to now to our strategic investment program and our plans to invest up to $3 billion between 2017 and 2019.

The investment program has three key objectives. Firstly to build the networks for the future, including reinforcing our network differentiation; secondly, digitizing our business and particularly the interactions between Telstra and our customers; and thirdly, delivering seamless, simple and integrated customer experiences.

We provided details of these investments at our Investor Day in November, and work has

commenced on each of these programs. While we are still at an early stage, I would like to provide some examples of the quick wins that we’re seeing in the program.

As I showcased earlier, we launched the world’s first Gigabit LTE network and device. This is

technology that delivers world-leading speeds and gives us good insight into 5G technologies, net speeds and customer experiences. We have improved ADSL speeds for more than 500,000 customers.

In digitization, we rolled out the first tranche of digital capabilities in a new stack that meant we could retire 21 legacy applications. We are also building our foundational capabilities through a cross company approach on Agile/DevOps methodologies. And to further improve the customer experience in nbn, we deployed a new solution for our agents which consolidates nine previous agent interfaces into one, which is expected to reduce average customer handling times and improve customer first time resolution.

Let me summarize then, before we take your questions.

We have made good progress in the half. We achieved strong growth in new customers across their portfolios and we also achieved progress on our productivity program. Whilst the competitive dynamics and the acceleration of the nbn rollout have had an economic impact, we are nonetheless pleased with the overall resilience of the business. We continue to execute in a changing environment and we are moving forward with our plans to incrementally invest up to $3 billion in the network for the future and to digitize our core business to transform the experience we provide customers. We remain in a very strong capital position and we have been active in our capital management with the execution of off and on-market buybacks and our capital allocation review.

Many thanks for being with us this morning. Before I hand over to Peter to moderate the Q&A part, I would just like to acknowledge and thank all of our employees for their continued hard work and support, and most importantly for their commitment to serve our customers. Thank you.

Question-and-Answer Session

A - Peter Kopanidis

Thanks, Andy. We will open up to questions on the phone line. The first question comes from Fraser McLeish from Credit Suisse.

Fraser McLeish

Hi. Thanks very much, just a couple for me. Just, Warwick, on the mobile margins, obviously have been bouncing around a little bit for various reasons. But that kind of 41% reported in the half, do you see that as kind of the underlying margin we should think about the second half and beyond? That’s the first one. And just secondly, just on the 311 million from nbn commercial works in NAS. Can you just remind us of the profile of that going forward and maybe give us some idea, I mean is that similar to normal NAS margins, or is that the higher or lower? And finally, just on the $79 million in nbn, the sale of assets, is that a one-off or should we expect to more of that going forward? Thanks.

Warwick Bray

Yes. So, firstly on the mobile EBITDA, the difference between this half and the prior corresponding period, the first half of 2016 in percentage terms is almost exactly explained by NPAT, [ph] so nothing going on underneath. The difference between and the previous sequential period is explained by -- so firstly, there was a one-off roaming benefit in first half 2016 that we -- sorry, in second half of financial year 2016, that we wouldn’t expect to be repeated that. And the second thing that’s going on the percentage of EBITDA margin is as the proportion of our revenues in mobile that pertain to value-added services like stay connected, some of the great hosted MDM that we fell in enterprise and some of the value-added service on machine-to-machine as the proportion of services go up, they’re profitable, but they’re not quite as profitable as the main business. So that has some impact on the percentage EBITDA margin. Relative to any other comments that we’ve made before about the mobile EBITDA margin, there is no change to those previous comments.

The second question was about the commercial works that include in NAS. If you look at the 6-point improvement in NAS, we typically are really pleased with that. So, it’s 8% EBITDA margin from negative a few years ago. The nbn commercial works have almost no impact on that improvement in margin. Improvement in margin is coming from some operational leverage, and also where we were doing customized solutions, they’re now able to industrialize them. And so, it’s those two things and just lower cost delivery models has led to that expansion in margins. And I don’t think we’ve added -- I won’t give any more guidance on the timing of the nbn commercial works over and above what we said about the three big contracts publically. And then just finally, on the one-off aspects of the nbn, where they relate to the beginning definitive agreement, we would expect them to continue in line with what we said before.

Fraser McLeish

So, does that $79 million sale of assets, is that something we’ll see again or is that a one-off.

Warwick Bray

So, most of that pertains to the nbn commercial works. So, you should sort of think of the nbn commercial works in a lump, based on what we’ve previously talked, and we haven’t breaking that down further.

Fraser McLeish

Okay. So, we’re likely to see that number again, as long as the commercial works continue or a number of similar…?

Warwick Bray


Yes. I’m not going to breakdown the nbn commercial works into some components, but you will expect some of it to continue. Yes.

Andy Penn

Yes. I mean, quite as we’re saying, the commercial works are ongoing. So, we expect to continue to receive the economic benefit of that.

Peter Kopanidis

The next question comes from Raymond Tong of Evans & Partners.

Raymond Tong

Good morning, Andy; good morning, Warwick. Just a couple of questions, firstly [Technical Difficulty]

Andy Penn

Maybe not.

Raymond Tong


…negative drivers and whether you’re seeing….

Andy Penn

Raymond, can you ask that again? Sorry. Raymond, you’re cutting out. If you don’t mind, can you start again? Sorry.

Raymond Tong

Can you hear me now?

Andy Penn

Yes.

Raymond Tong

So, just on postpaid ARPU firstly. Can you maybe talk about some of the drags that have been sort of the negative drivers over the last 12 to 18 months; whether you’re seeing some of those abating by the tactical discounting, access data, [ph] and also as far as the MRO as well? That’s the first question. And just the second question, the fixed data ARPU declines have accelerated. Can you maybe talk through the drivers based on what you’re seeing going forward?

Warwick Bray

Yes. So, just on mobile and I’d speak to postpaid handset ARPU and I’ll refer to the table on slide 14. And what we see there is that there was a decline in mobile ARPU from the first half of 2016 to the second half of 2016 from $69 to $67.82. And you can see, it’s been more stable in second half 2016 to first half 2017. And when we look beneath that, we gave some color on this at the Investor Day in November. The period that I just referred to refers to four quarters. And in the first of those four quarters, we saw the ARPU decline continuing. But, we’ve been pleased with the stabilization in the last three of those quarters. Digging underneath that, what we’re seeing is more strength in consumer. And some of the challenges that we have seen in consumer, we’re seeing in business at the moment. Within consumer, the tactical discounting that I referred to a year and six months ago, has decreased. So, we’ve managed to get on top that. We’re very pleased with the MMC increase, and that has continued. Another factor that’s going on is that there is a higher proportion of our base is BYO in this half and higher than we’ve seen before.

If you want sort of like a one word answer on mobile postpaid handheld, it would be a story of stabilization in the last three quarters. And look, in terms of fixed, the question was about fixed data ARPU?

Raymond Tong

Yes, that’s right.

Warwick Bray

Yes. So, look, in the overall fixed business, we’re very pleased with our performance in terms of size, so it’s 51% share on the nbn. And we’ve added another 90,000 retail fixed broadband SIOs, very strong performance in bundles but ARPU has been impacted by the competitive conditions. That’s right. And that’s part of the reason why the fixed data growth excluding FAD was in the mid-2s percent.

Peter Kopanidis

Okay. Next question comes from Eric Choi from UBS.

Eric Choi

I just had three questions. First one was just on mobile margins. So, obviously the FX impact was flat, but presumably that would have included the benefit from a folding [ph] in hardware revenues as well. So, just wondering what the mobile service line did in the first half? Second question is just on free cash flow. So, on a reported basis, free cash flows went back to 500 million but there wasn’t much year-on-year moving impact on CapEx and EBITDA I think went back slightly, just confirming why there was such a big capital movement, is that all MRO and nbn receipts related? And then, just last one on the dividend. Obviously, you’re paying over 100% payout ratio in the first half. And you said before, there were short term fluctuations in the EPS. So, just wondering how prepared you are to do sort of over 100% payout ratio on a full year basis?

Warwick Bray

So, I’ll do the first two of those. Starting with the free cash flow, on a reported basis -- and the reported basis for free cash flow is continuing and discontinued. So that includes Autohome in there and restructuring. And so, you need to take that into account when you look in the difference between the free cash flow this year and the prior corresponding period. Working capital has gone up. And the biggest reason for working capital going up is the nbn. And so, we receive the PSAA payments quarterly and they are paid in arrears. So, it’s important to adjust for the Autohome and restructuring, and then you see that the free cash flow -- the efficiency of that hasn’t changed all that much.

In terms of mobile margins, there’s various factors going on and there wasn’t much of a difference in the hardware margin on PCP. There’s more factors going on than just the revenue. And in terms of the services managing year-on-year that was after adjusting for MTAS, there wasn’t much movement there. And then, the effects on the -- the sequential effects were the same as what I’ve said before. I’ll hand over to Andy to talk about dividend.

Andy Penn

I think that the main point on the dividend is really obviously the Board looks through the cycle in terms of making its dividend decisions, the most important thing ultimately in relation to dividend is how we continue to improve the performance of the business. Obviously to mitigate the offsetting impacts of the negative headwind that comes from the nbn as we previously reported as the nbn rolls out, it’ll have a $2 billion to $3 million negative impact on EBITDA. And of course against, we are obviously looking to grow our mobile’s business, we’ve got to build a vibrant reseller business in nbn where you need to continue to grow and expand the margins in NAS business, productivity, and achieve sale in our new growth businesses. And that’s ultimately what will determine the dividend going forward.

Peter Kopanidis

Next question comes from Sameer Chopra from Bank of America Merrill Lynch.

Sameer Chopra

Just a follow-up to Eric’s question on working capital. Working capital was down $600 million, maybe down about $3 billion, there is an adverse capital headwind of $3 billion over the last five years. And I was wondering if you could talk about what initiatives you have [technical difficulty] quite significant. The second one is, Andy, you spent quite a lot of time on the call talk about sales and a lot of these other new initiatives. Could you give us a view around what is EBITDA that you would look to get out of some of the new businesses over the medium term?

Warwick Bray

Yes. On the working capital, that is something that we do spend quite some time on. And so the first -- the biggest increase that we are seeing on working capital over the last year has been the nbn PSAA and that will rise as the nbn rises, and it will -- the construction rises and as the nbn concludes, that will naturally go down. The second biggest area for the increasing working capital is MRO. And so, part of the reason for that increase is we’ve moved from the subsidy model to the MRO model. The subsidy model has no effect on the balance sheet whereas the MRO does, one thing if we went through our complete base from subsidy to MRO over that time. The second is handset prices went up considerably over that last five-year period. In terms of the future, what we are seeing is two effects -- actually three effect, were they to continue, would change that trajectory. And the first is the move from MRO to a leasing approach; the second is increasing BYO mix; and the third is, we didn’t see in the last -- in the Christmas that’s just finished, we didn’t see increase in handset that we have in many of the previous years.

Andy Penn

Thanks, Warwick. And just, to your second question, Sameer, really around the new businesses, I mean, I think first point to make is this is an investment in building new growth businesses, which are close to the core of our business and leverage some of our core capabilities. In terms of the impact currently on the financials of the company, so I think in the half, it was about minus $86 million negative EBITDA impact as a consequence of the investment in these businesses, so sort of upto -- roughly double that for the full year. We would expect to improve on that position as we move forward and as we do the integration and we really start to see these businesses track up in terms of performance.

Realistically, if one puts them in the context of Telstra, they are not going to be material additions to economic EBITDA pre-2020. But our aspiration with them really is to 2020 and beyond is actually to build new profit growth for the company through these areas. And in that regard, we’ve obviously got work to do in terms of -- for example on health, on integrating the businesses that we have acquired, building out the tech that we need to underpin them. But we are getting some really interesting new business opportunities through the things that I’ve mentioned such as the cancer registries, such as the remote healthcare provisioning, western Australia what we’re doing in pharmacy. So, I can’t put a forecast on them, but they’re sort of looking to be material post-2020 and improve the drag on EBITDA between now and then.

Peter Kopanidis

Next question comes from Eric Pan with J.P. Morgan.

Eric Pan

Good morning, guys. Thanks for taking my questions. Maybe just going back on the mobile ARPU. You’re saying that postpaid ARPU has stabilized in the past three quarters. Would that result come through potentially in the second half of the year where [technical difficulty]? And then similarly on the mobile broadband ARPU, it declined significantly this period. Can you just give us some color on what’s driving that and that if we can see some sort of stabilization in the future?

Warwick Bray

Yes. So, I won’t give specific guidance on postpaid handheld. What I would say is that we are working our way through areas of postpaid handheld that must end, as referenced, what has held postpaid handheld back over the last few halves has been excess data that we are working our way through and excess voice, and we are a lot of our way through both of those. In terms of your second question, in terms of mobile broadband, we’re seeing -- it’s a complex product, it’s prepaid and postpaid and within that there are dongles and cellular Wi-Fi and connected tablets. And so, in some of those areas, we are seeing growth. In prepaid mobile broadband, that’s where a lot of the decline is. And what we are seeing there is customers who previously had prepaid mobile broadband are more likely to be tethering with their handset. And so, it is a big opportunity for us in there to revise the category and that’s what the challenge for us.

Eric Pan

Right. Speaking of tethering, do you guys have plans to monetize the Telstra Air asset? If not, when the free use of it cut into the potential toll free [ph] mobile data update?

Warwick Bray

Yes. So, clearly, I’m pleased with Telstra Air, and it’s a really important part of Telstra, particularly for our fixed network. And so, when you look at the 51% share that was achieved on the national broadband network and when you look at the 90,000 retail fixed data customers, and so a lot of that is down to the great story we can tell our customers. So, if you take our fixed broadband services, you can use all those hotspots around Australia and data around the world. And so that’s the business model for Telstra Air. And we do look a lot at whether or not, the use of Telstra Air cuts into our mobile network, and we don’t see -- after extensive studies, we don’t see signs of cannibalization there.

Eric Pan

Got it. And lastly, if I could, NAS grew nicely in the half, but global connectivity only grew only 6.6%[ph] in local currency. Can you help us think about how we should think about the potential growth on this segment going forward, especially given its important in offsetting the nbn headwind?

Andy Penn

I think the growth opportunities in the international connectivity and also the NAS that goes with it, is very significant. As you saw, w had a number of significant customer wins with DFAT, with the one I mentioned across the Asia Pacific region, which was a company like I mentioned multinational, and in some others actually as well. And we are seeing strong tight capital there, IPVPN license opportunity in China as people see the benefit of what’s going with a foreign company in terms of data center and clear ability in China. We’ve just actually just appointed one of our key executives to spearhead the further acceleration of that to be based in Singapore, David Burns who’s heading up to the Singapore at the moment. So, as is there is always, there is obviously a long-term play. But we think that as businesses look to technology, the improved productivity, so I look as migration as migration in the business to the cloud in Asia is a very strong offering that we have.

Peter Kopanidis

Next question comes from Craig Wong-Pan from DB.

Craig Wong-Pan

Good morning. First question is just on the guidance. Can you give your guidance range to the total income -- talk about hitting the lower end of that range. But on the EBITDA, the cash flow guidance, you retained that range. Could you just talk through some of the positive impacts that could enable you to achieve in likeness of the top end or within that range or hitting the lower end of that total income guidance?

Second question on D&A, just given this step up in the D&A in period. as you carry more CapEx in the second half, can you give us any kind of detail on where D&A could get to? And then thirdly on the tax rate, you mentioned that that [indiscernible] rate over time. Can you indicate what the timeframe that would be?

Warwick Bray

Yes. Firstly on the guidance, the reason why income moved and the EBITDA and free cash flow did not. Firstly, the mobile hardware, there were various effects going on in there. The net-net was a top effect we saw, it was about EBITDA neutral and it was actually slightly free cash flow positive. And the second thing that’s going on -- that was the basically the majority of the rates for us clarifying guidance. Other areas which were a bit less than expectations came with offsetting directly variable costs. And third thing is we have done -- we continue to be pleased by the progress of our productivity, which offset some of the income to EBITDA.

Second one in terms of D&A, yes, so, in the half that’s just finished, the biggest raise and sort of step up in D&A was more and more of our CapEx spend is going on categories that can be defined as software. And those software categories have lower working lives. And so that causes D&A to go up. And we’d expect that effect to continue in the future, as well as that of course we’ve got the impact of step up in CapEx, 18% CapEx to sales over the next three years, which will feed through into depreciation.

I think the tax rate has been within a couple of percentage points of our statutory tax rate over the last number of halves. It’s been sort of in the high 20s, in the 29%. But there is a series of issues cause it to go over. As an example, some of them are timing issues and we would expect that our tax rate will revert to the statutory tax rate. But it will go plus or minus a point around that statutory tax rate from half to half.

Peter Kopanidis

Next question is from Roger Samuel from CLSA.

Roger Samuel

I’ve got a couple of questions. First on just on mobile backhaul. And we’ve seen that NBN CO has started trailing mobile backhaul services for Vodafone last week. I am just wondering if there is any risk to Telstra in the longer term, and also in the context of the domestic roaming enquiry as well, I am just interested in your view on this.

Andy Penn

Roger, you say you had two questions…

Roger Samuel

Yes. The other one is just a housekeeping one. In terms of nbn services, do you recognize the voice component of nbn services in fixed voice, or is it all in fixed data? And how do you allocate the voice component between the two, fixed voice and fixed data, for nbn?

Andy Penn

Sure, thanks. Roger, it’s Andy. Look, on your point about mobile backhaul and interplay with mobile roaming, I think that by far the most significant point is really around mobile roaming where you heard me make some comments this morning. We’ve invested very significantly over a long period of time to have a network with greater coverage, better speeds, and a better quality network. And so, therefore, we think that it’s critical that mobile roaming isn’t declared, because it will have a very significant negative impact on region Australia. I don’t think -- I mean from a backhaul perspective, we’ve basically run fiber backhaul to pretty much all of our base stations a long time ago, that was a massive investment. And our customers have seen the benefit of it.

And of course, it is at the moment, basically, there is facilities access in place from a regulated point of view where operators can see backhaul from each other, and can actually seek access to put their access equipment on each other’s sites and that actually happens on hundreds of sites today. So, I don’t think the nbn backhaul development thing really changes anything in that dynamic. But we obviously are very concerned to make sure that people understand the implications of mobile roaming, because it will be a bad decision for the industry, a bad decision for region Australia. And so, hence, we’re working with the ACCC to try and mitigate the risk if that happens. And then on the fixed voice, the housekeeping point, I think Warwick can comment specifically on the methodology, but yes, we do allocate the -- between voice and fixed is the answer.

Warwick Bray

And we do that on the traditional ADSL network, when we sell a bundle, we allocate between voice and data there, and the principles remain the same on the nbn.

Peter Kopanidis

Next question comes from Ian Martin of New Street Research.

Ian Martin

I have three questions, if you wouldn’t mind. First, with the nbn recurring revenue, up 14% to $212 million, I think you side noted that that’s function of the nbn market. nbn has more than doubled over the last year, and then we’re looking for long-term revenue here of about $1 billion. So, I wonder what is holding up the growth in that recurring revenue spend. Secondly, just [indiscernible] and a big jump in the second half, you guys said at one extent, I think you guided [indiscernible] new start growth to start backhaul. And thirdly, Andy, you have fixed and [indiscernible] rounding issue, not the time issue. The other side we see the deflation will be some kind of commercial arrangement further, I just wonder if there’s any prospect to that.

Andy Penn

In relation to the recurring nbn timings, I think as you’re aware and as you pointed out, actually we said that over time once the nbn is fully rolled out, they will increase to about $1 billion dollar and then increase in inflation thereafter for the term of the contracts, which run for more than 30 years. And essentially those timings are for access and usage of our core infrastructure network. So, the big fiber backhaul -- the big fiber rings around the country, access to our exchanges, the tips and ducts. And so, there is enormous amount of infrastructure and we obviously need to keep investing and maintaining that infrastructure. Because nbn is really only acquiring the last what we call metaphorically, the last mile of infrastructure. So, essentially downstream is the farther points of interconnect around the country.

Now, because it’s the different aspects of that, the big fiber backbone rings we put in place at the beginning, and essentially nbn required access to those early on in the program. Notwithstanding, the fact that they haven’t fully rolled out if that makes sense. And so, as the risk of the rollout, which is why hence the rates have increased, if you like, on those payments is less than the rate of roll-out, if I can put it that way. But ultimately, we do expect it to increase to roundabout $1 billion, and it should increase relatively minimally from here on in.

In terms of the CapEx in the second half of the year, in relation to the program, what I would say is that if you think about the program and the three component parts around networks of the future, digitization and ultimately delivering a brilliant customer experience much of the delivery in bringing customer experience is about the network and digitization, but there is another initiatives that we have in place in that bucket as well. But by far, the majority of investment is around the network investment in the early parts of the program. So, that’s the way we’ll see that in the second half of the year, and our expectation is we will meet that guidance. And in relation to…

Ian Martin

[Multiple Speakers] or some expansion of footprint as well?

Andy Penn

Well, there is obviously -- there is some expansion in footprint, absolutely. There is increased capacity within the network and then there some foundational investments in some of the stuff around software defined networking, network function virtualization which is actually about preparing for 5G and other networking business for the future. And then, finally, as regard to commercial arrangements, obviously, I couldn’t comment on anything specific in that regard. But, we have an active relationship with a number of MVNOs in Australia, and support them through our wholesale business. We’ve access to our network, and I think it’s indicative and in fact our other two main competitors have similar types of relationships, both with other companies and with themselves. And I think it’s indicative of the fact that there is a viable, and commercial, and working third-party market essentially for MVNOs in Australia.

Peter Kopanidis

Next question comes from Andrew Levy of Macquarie.

Andrew Levy

Three questions if I may. First is just on the total income guidance, and you pulled out the lower hardware revenue. Can you just give some context as to how the other divisions have performed against the plan, and what [technical difficulty] guidance? And second one is and it’s partly related, can you just talk through the impact on the labor financing [technical difficulty] for this year and going forward here, both the revenue and EBITDA perspective[technical difficulty] around that? And then, the third one is just, and apologies if I missed earlier. [technical difficulty] Could I just ask a little bit more color on the data and IP, supply and competition there, and what is in that [technical difficulty]? Thank you.

Warwick Bray

Just really start with the lease plan. Look, most important thing here is what it means for our customers. And so, those customers who don’t want handset down to risk their family at the end of the two years, means they get the economic benefit of that reused handset. And for us, the economics of a lease plan versus an MRO plan is hugely different as in big true economics, it will mean less working capital for us in the long-run if it becomes a larger proportion of our base.

In terms of the income, so the largest proportion of the income change in the first half relative to our expectations was mobile hardware. And so, in terms of mobile hardware, there were three reasons there. But there weren’t just many handsets, but then people are hanging onto their handsets for longer. And the other thing relative to our expectations is that in the previous second halves of the year, there have been stronger increases in handset prices than we saw in the second half of the year -- second calendar half of the year that’s just finished. Those effects are sort of different in the impact on our EBITDA and free cash flow. The net result was neutral on EBITDA and slightly favorable on free cash flow. And apart from that, any change in income relative to our expectations was pretty broadly across the business.

Andrew Levy

So, on the data and IP?

Warwick Bray

Yes. Look, in terms of data and IP, there was a small regulatory effect in there. It wasn’t the largest of the regulatory effects. But look, data and IP is a competitive market. We’re putting some great new products on top of the flexibility, scalability, and security of our mixed IP network. We’ve had some important wins there, so for instance our IP MAN SIOs are up 18.9%. We are in the environment where each time we renew a contract, we have to sell more for more. What we are saying that is mitigating the decline in data and IP is not only the benefits of our mixed IP network but also the complementary NAS business where we sell NAS with data and IP, we’re getting even better as hoped.

Andrew Levy

Just a follow-up, [technical difficulty] obviously deteriorated data and IP. Do we see stabilization at any part sooner or is there something…

Warwick Bray

The data and IP will have some effect from the nbn as well. When I talked about the long-term outlook for the business, one of the most important equations that we look at is whether the increase in the NAS EBITDA offsets the decrease in the data and IP EBITDA. And that equitation worked very solidly in our favor for the half that’s just finished.

Andy Penn

And I think I would add to, Andrew, we got some more generic comment around the results is, as I said at the beginning that there is no doubt that the competitive intensity in the market has increased, and that’s having an impact in terms of pricing and income. And ultimately, we’re not necessarily driving that. And so, how that plays out is a function of how the market plays out. What’s really important is how we respond, how we continue to add value to our customers, and how we continue to win new customers and retain customers. And I think our customer numbers, as Warwick has pointed out, whether it’s on IP MAN, up 18.9%; whether it’s on mobile; whether it’s retail fixed broadband; whether it’s on nbn; whether it’s on Telstra TV, all of those are showing very strong progress in the half. But there’re some economic headwinds driven by the competitive dynamics. And of course, also, the roll-out of nbn as we’ve previously communicated that, once it’s fully rolled out, has a negative impact on EBITDA of $2 billion to $3 billion.

The nbn recently quoted their rollout stats at the moment about -- they’re about a third of the way through, that’s from an activation or available for access rather perspective in terms of the number of mobile -- the number of nbn connections, which we’ve declared today is probably more like 20%, but that effectively remains, we’re 20% into that $2 billion to $3 billion, which obviously is $400 million to $600 million of EBITDA drag we’ve already basically accommodated in our financial performance. So, it’s how we respond to that and the competitive pressures, which really the management team is very focused on.

Peter Kopanidis

Eric Choi from UBS back for another question.

Eric Choi

I’ve a couple of follow-ups. The first one is just on restrictions that you might have at the nbn rollout. Can you just remind us if there is any remaining restriction preventing Telstra from promoting other [ph] product as a substitute for nbn? And also whether there’re any restrictions on Telstra marketing mobile broadband for nbn customers after you received that connection payment? And then, the second question is just final one on mobile churn. You’ve obviously said on an underlying basis postpaid churn down in the second half of 2016. But I just wanted to clarify, have you reclassified that second half 2016 churn number upwards, just because it looks a bit funny versus the 10.9 churn you reported at FY16? I mean, I guess related to this question is, I mean if you look at net add analysis, your postpaid sort of indexed or under-indexed opposite, but your churn also picked up, which implies that your growth has accelerated. So just wondering if you can kind of grow that basis, whether you’re still outpacing your existing postpaid?

Andy Penn

I’ll get Warwick to answer on the churn questions. On the nbn question, basically, we can obviously continue to compete in the mobile market. And that’s exactly what we will do. And so, there’s nothing stopping us from doing that. In terms of -- there’re some restrictions about us proactively seeking to ship people off of fixed phone to mobile, but that’s not -- disingenuously, but that’s absolutely not what we would intend to do. And we’ll just continue to compete in the nbn market and in the mobile market, which will complement each other. But I’ll get Warwick to comment on the churn on postpaid handheld.

Warwick Bray

Yes. So, just to give some overall color on it, where churn matters, we’re really pleased with what’s going on an underlying basis. And so, the heart of postpaid handheld is the upper end of consumer postpaid handheld, and we’re seeing that it’s being very steady. The difference between churn this half and churn in the previous sequential period, the reason why on the surface it’s slightly up, it was the closure of the 2G network. And so, there were some sales there that didn’t come across. And that -- if we adjust to that, it was slightly down in the previous sequential period, which remains strong relative to like world standards, but we didn’t reach that in the second half last year.

Peter Kopanidis

Next question comes from Raymond Ton from Evans & Partners.

Raymond Ton

I’ve got a couple of follow-up questions. Just firstly, can you detail bit more of the performance across each of the business segments, Telstra business, and GES seems to be under fair bit of pressure, revenues were down 4% and 5%? That’s the first one. And second one just, I think you stated your position on mobile roaming, if it does get declared, can you maybe talk through the potential downside risk to your mobile medium to long term? Thank you.

Andy Penn

Do you want to talk about the GES one and I’ll take the roaming one?

Warwick Bray

The story of our customer segments is the story of how the products, which I’ve talked about, translates across to them. So, we saw NAS -- growth in GES, but we saw data and IP under pressure. And within GES, I’ve talked about within the mobile business, we had stronger times in consumer, but in the GES business, mobile is -- if we take where mobile is most under pressure, it is in the GES business. There is a similar translation story to TV that -- NAS is a smaller proportion in TV, and so we’ve got -- we’re making great inroads within TV, but didn’t get as bigger benefit from NAS. And TV is in competition in data and IP. And then TV hasn’t had the full benefit of the strength we’re seeing in mobile and consumer. So, they would be -- those differences would be the main differences across the divisions, is how the products translate into the division.

Andy Penn

And on the mobile roaming question, Raymond, I mean the fundamental point is that one of our points of differentiation is the quality of our network and then ingredients to that, coverage of our network, if mobile roaming were to be declared, that point of differentiation would essentially be neutralized. And the way our business model works, as you know, I mean, customers do pay a small premium to be with Telstra because they want a better quality network, they want better coverage, and that includes metro as well as regional customers. So, customers come to us because they know when they go into regional Australia, they’re going to get coverage. And that is a really healthy dynamic for regional Australia because it means mobile customers are actually helping fund the infrastructure that is critical to regional Australia. And essentially if that’s eliminated, that dynamic will ultimately obviously be eliminated as well. And the obvious response has to be, we have to shift our focus and emphasis to our other points of differentiation. And it will comprise our ability to invest the CapEx as well into that part of the country. So, we’ll have to achieve savings in free cash flow through essentially lower CapEx, and we will have to redirect the CapEx that we’re spending into other areas of differentiation. And the disappointing thing for that would be, it will be regional Australia that is negatively impacted. Now, as I say, we’re sort of optimistic that such a decision wouldn’t be made, but that would be the -- essentially the consequences of decision, and how we would have to start thinking about responding, but we’re not going in, we’re optimistic that that won’t happen. But, obviously we’re pending receipt of the drop decision which I think is due at the end of March or sometime into April.

Peter Kopanidis

Next question comes from Nick Harris of Morgans.

Nick Harris

Just a question on the new business segment, maybe not going to give us any guidance on the outlook, but are you able to give us the guidance on quantum of capital you’ve got deployed in that particular segment, we can obviously then [indiscernible] R&Ds on the outlook and return the capital?

Andy Penn

I’m just looking at Warwick, I think we disclosed, the investment in riyal [ph] and investments [multiple speakers] I think we have disclosed them, it’s a couple of hundred million I know in health and about 500 million in intelligent video. The rest of which is sort of Smart Home, eCommerce solutions for small, medium business. They are relatively insignificant in the scheme of things at the moment.

Nick Harris

Are you looking at less than $1 billion volume?

Andy Penn

Yes.

Peter Kopanidis

Next question comes from Brian Hahn of Morningstar.

Brian Hahn

Andy, would you say the impact of nbn and greater competition has core Telstra on the hook or there is still accounts getting to floating rates? [Ph] And would this six months result force you to perhaps accelerate the productivity push or are you still happy with the current plan?

Andy Penn

Well, what I would say is that I think the performance has been strong in the period because we have continued to grow customer numbers, new customers, retained customers and gained share in a number of segments. So, ultimately that’s what’s critically important. I mean obviously, the economics of the competitive dynamics of the market are going to be what they’re going to be. And obviously what’s critical for us is that we compete very effectively in the context of that. And so, the second aspect which is the rollout of the nbn, we are very aware of what the rollout is and we are aware very aware as nbn shared with us what the timing of that is, and we’ve already shared with the market very clearly what the economic impact of that is, which is material. I mean, our EBITDA in the aggregate is somewhere in the order of $10.5 billion last year as a company, and this is $2 billion to $3 billion. So, we are talking about quarter of our overall EBITDA. And as I mentioned before, we are sort of roughly 20% into that. So, we’ve already committed a fair bit of that drag that.

But obviously how we respond through the areas I mentioned through growing our business, growing mobiles, delivering a vibrant reseller business in nbn, continue to grow and expand NAS business and productivity, all part of the mix as to how we mitigate the impact of those dynamic. So, that’s just how the market has played out. But I think against the background of that, results in customer numbers and also the financial results hold up well in the context of those market pressures.

Peter Kopanidis

Next question comes from Craig Wong-Pan from Deutsche Bank.

Craig Wong-Pan

Just one question on your strategic NPS score that’s down 8 points, so I just want to understand, how we should think about that? Is it like a leading indicator that we think of some of the operators [ph] think that negative impact comes in the future period or do you think that that’s sort of reduction in the NPS score is largely already reflected in the results you’ve delivered today?

Andy Penn

So, the first thing I should say is that delivering a brilliant customer experience and servicing our customers is our single most important priority and objective, and nobody would be more disappointed than I am that we’ve had a minus 8 movement in NPS. And whenever we let down any single customer, that’s a massive disappointment for me.

Strategic NPS is and -- we measure, sorry, strategic NPS, and we measure episode NPS and both of those actually are integrated into the remuneration system. And 40% of everybody’s variable remuneration in the company is dependent on us achieving the targets that we set ourselves, which as I said in November three to six-point improvement.

Episode NPS is essentially very sort of direct in the sense it’s looking at billing experiences, move experiences, new order experiences, services experiences where strategic NPS is a more of a generic one. So, I think the more lead indicator is really episode NPS; strategic NPS is a more sort of generic sentiment at a points of time. And it’s perhaps not surprising that at the point of time when we did the surveys, which was between June and December of last year, the customers felt disappointed and frustrated about the impacts of the network interruptions. But episode NPS actually is flat half -- sorry, yes half year on half year. And so, I think the episode NPS -- and we are seeing some positive sort of signs there and positive movement, and also in strategic NPS in consumers, I mentioned in the second half of the year.

So, I think that I would be the first -- we have absolutely got more to do to continue to improve the service we provide to our customers. But there is no doubt that the most significant contributor to that impact was the consequence of the network interruptions, we had in the first half of last calendar year.

Peter Kopanidis

Last question from this session is from Eric Pan of J.P. Morgan.

Eric Pan

So, maybe a little bit on the fixed side, fixed data accrual was little weaker than expected, which is surprising since nbn plans price higher than ADSL plan. What portion of your nbn adds are coming through the long brands versus the Telstra channel, can you give us some color on what is going on there?

Warwick Bray

Yes. So, on the fixed data ARPU, look, we’re pleased with ARPU on both the traditional and on the nbn, the long was 50,000 plus. So, all the nbn sales that we added, the long was 50,000 across nbn and traditional sales. It wasn’t the bulk of the SIOs. And what I would say on fixed data is that there was some regulatory impact, I think that was about 1%, but underlying was more competitive.

Eric Pan

And then, just lastly on the mobile side. When you guys eventually look rollout 5G, do you have the options to market it against nbn or are you restricted from doing that?

Andy Penn

We got a question a little bit earlier which is sort of similar and basically the bottom line is, we can complete -- we will compete in the mobiles market, and we will compete in the fixed market. We’re committed and we are very intimately involved in the setting of the global standards to 5G. So, we will be absolutely at the leading edge of rolling out 5G. At a practical level, most of the global industry now anticipating will get a global set of great standards on 5G until roundabout 2019. But we are doing a lot of innovation in the meantime around 4G, its broadcast over LTE, Wi-Fi, Voice over LTE. And so, we will continue to compete very hard on mobiles and in the fixed as well. So, we have no restrictions in that regard.

Eric Pan

Got it. Thank you.

Peter Kopanidis

Thank you for joining us for our webcast for 2017 half year results. That concludes this morning’s presentation. There will be a short break. And I’ll then handover to my colleague, Jason, who will moderate the media Q&A. Thank you for your attendance.

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