FORM 20-F
Table of Contents

As filed with the Securities and Exchange Commission on March 1, 2007

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 


Form 20-F

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

Commission file number 001-14540

 


Deutsche Telekom AG

(Exact Name of Registrant as Specified in its Charter)

Federal Republic of Germany

(Jurisdiction of Incorporation or Organization)

Friedrich-Ebert-Allee 140, 53113 Bonn, Germany

(Address of Registrant’s Principal Executive Offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

American Depositary Shares, each representing

one Ordinary Share

  New York Stock Exchange
Ordinary Shares, no par value   New York Stock Exchange*

Securities registered or to be registered pursuant to

Section 12(g) of the Act:

NONE

(Title of Class)

Securities for which there is a reporting obligation pursuant to

Section 15(d) of the Act:

NONE

(Title of Class)

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

Ordinary Shares, no par value: 4,361,119,250 (as of December 31, 2006)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes    x    No    ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes    ¨    No    x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes    x    No    ¨

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

 

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

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

Item 17    ¨    Item 18    x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes    ¨    No    x

*Not for trading, but only in connection with the registration of American Depositary Shares.

 



Table of Contents

TABLE OF CONTENTS

 

          Page
PART I   

Item 1.

  

Identity of Directors, Senior Management and Advisors

   4

Item 2.

  

Offer Statistics and Expected Timetable

   4

Item 3.

  

Key Information

   4
  

Selected Financial Data

   4
  

Risk Factors

   7

Item 4.

  

Information on the Company

   15
  

Introduction

   15
  

Historical Background

   15
  

Organizational Structure

   16
  

Segment Revenue Breakdown

   17
  

Description of Business

   18
  

Mobile Communications

   18
  

Broadband/Fixed Network

   29
  

Business Customers

   44
  

Group Headquarters and Shared Services

   53
  

Innovation Management (Research and Development)

   56
  

Acquisitions and Divestitures

   58
  

Regulation

   59
  

Description of Property, Plant and Equipment

   76

Item 4A.

  

Unresolved Staff Comments

   77

Item 5.

  

Operating and Financial Review and Prospects

   78
  

Management Overview

   78
  

Critical Accounting Estimates

   87
  

Consolidated Results of Operations

   90
  

Segment Analysis

   97
  

Mobile Communications

   98
  

Broadband/Fixed Network

   112
  

Business Customers

   124
  

Group Headquarters and Shared Services

   129
  

Liquidity and Capital Resources

   131
  

Reconciling Differences between IFRS and U.S. GAAP

   141
  

Recently Issued IASB Pronouncements

   145
  

New U.S. GAAP Accounting Pronouncements

   147

Item 6.

  

Directors, Senior Management and Employees

   149
  

General

   149
  

Supervisory Board

   150
  

Management Board

   156
  

Compensation

   158
  

Share Ownership

   168
  

Employees and Labor Relations

   170

Item 7.

  

Major Shareholders and Related Party Transactions

   175
  

Major Shareholders

   175
  

Related Party Transactions

   176

Item 8.

  

Financial Information

   179
  

Consolidated Financial Statements

   179
  

Export Sales

   179
  

Legal Proceedings

   179

 

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          Page
  

Dividend Policy

   190
  

Significant Changes

   190

Item 9.

  

The Offer and Listing

   191
  

Trading Markets

   191

Item 10.

  

Additional Information

   194
  

Articles of Incorporation

   194
  

Significant Differences in Corporate Governance Practices

   200
  

Other Matters

   203
  

Exchange Controls

   204
  

Taxation

   204
  

German Taxation

   205
  

U.S. Taxation and U.S.-German Double Taxation Agreement of August 29, 1989

   206
  

Documents on Display

   209

Item 11.

  

Quantitative and Qualitative Disclosures about Market Risk

   210
  

Risk Identification and Analysis

   210
  

Foreign Exchange Rate Risk

   210
  

Interest Rate Risk

   211
  

Changes in Market Risk Exposure in 2006 Compared to 2005

   212

Item 12.

  

Description of Securities Other than Equity Securities

   212
PART II   

Item 13.

  

Defaults, Dividend Arrearages and Delinquencies

   213

Item 14.

  

Material Modifications to the Rights of Security Holders and Use of Proceeds

   213

Item 15.

  

Controls and Procedures

   213

Item 16A.

  

Audit Committee Financial Expert

   215

Item 16B.

  

Code of Ethics

   215

Item 16C.

  

Principal Accountant Fees and Services

   216

Item 16D.

  

Exemptions from the Listing Standards for Audit Committees

   217

Item 16E.

  

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

   218
PART III   

Item 17.

  

Financial Statements

   219

Item 18.

  

Financial Statements

   219
  

Report of Independent Registered Public Accounting Firms as of December 31, 2006 and 2005 and for the three years ended December 31, 2006

   F-2
  

Consolidated Income Statement for the three years ended December 31, 2006

   F-3
  

Consolidated Balance Sheet as of December 31, 2006 and 2005

   F-4
  

Consolidated Cash Flow Statement for the three years ended December 31, 2006

   F-5
  

Consolidated Statement of Recognized Income and Expense for the three years ended December 31, 2006

   F-6
  

Notes to the Consolidated Financial Statements

   F-7

Item 19.

  

Exhibits

   219

 

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DEFINED TERMS

Deutsche Telekom AG is a private stock corporation organized under the laws of the Federal Republic of Germany (the “Federal Republic”). As used in this annual report on Form 20-F (“Annual Report”), unless the context otherwise requires, the term “Deutsche Telekom” refers to Deutsche Telekom AG and the terms “we,” “us,” “our” and “group” refer to Deutsche Telekom and, as applicable, Deutsche Telekom and its direct and indirect subsidiaries as a group.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Unless otherwise indicated, the financial information contained in this Annual Report has been prepared in accordance with the requirements of the International Financial Reporting Standards, issued by the International Accounting Standards Board (IASB), and as adopted by the European Union (E.U.) as of the date of the financial statements included in this Annual Report, as well as with the regulations under commercial law set forth in Section 315a (1) HGB (Handelsgesetzbuch, the “German Commercial Code”). All International Financial Reporting Standards issued by the IASB, effective at the time of preparing the consolidated financial statements and applied by Deutsche Telekom, have been adopted for use in the E.U. by the European Commission. The consolidated financial statements of Deutsche Telekom also comply with International Financial Reporting Standards as published by the IASB. Therefore, there are no differences and a reconciliation between International Financial Reporting Standards as adopted by the E.U. (“E.U. GAAP”) and International Financial Reporting Standards as published by the IASB is not needed. E.U. GAAP and International Financial Reporting Standards as published by the IASB are referred to hereafter, collectively, as “IFRS”. IFRS differs in certain significant respects from U.S. generally accepted accounting principles (“U.S. GAAP”). For a discussion of the principal differences between IFRS and U.S. GAAP, as they relate to us and our consolidated subsidiaries, and a reconciliation of net profit and total shareholders’ equity to U.S. GAAP, see “Item 5. Operating and Financial Review and Prospects—Reconciling Differences between IFRS and U.S. GAAP” and notes (50) and (51) to our consolidated financial statements for the years ended December 31, 2006, 2005 and 2004, included in this Annual Report.

FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. Forward-looking statements are statements that are not historical facts. Examples of forward-looking statements include statements concerning:

 

   

plans, objectives and expectations relating to future operations, products and services;

 

   

our prospective share of new and existing markets;

 

   

plans, objectives and expectations for our cost savings and workforce reduction programs and the impact of other significant strategic or business initiatives, including acquisitions, dispositions and business combinations, and our network upgrade and expansion initiatives;

 

   

the potential impact of regulatory actions on our financial condition and operations;

 

   

the possible outcomes and effects of litigation, investigations, contested regulatory proceedings and other disputes;

 

   

future general telecommunications sector and macroeconomic growth rates; and

 

   

our future revenues, expenditures and performance.

Forward-looking statements generally are identified by the words “expect,” “anticipate,” “believe,” “intend,” “estimate,” “aim,” “plan,” “will,” “will continue,” “seek,” “outlook,” “guidance” and similar expressions. The “Risk Factors” discussion in Item 3, the “Management Overview” discussion in Item 5 and the “Quantitative and Qualitative Disclosures About Market Risk” discussion in Item 11, in particular, contain numerous forward-looking statements, although such statements also appear elsewhere in this Annual Report.

Forward-looking statements are based on current plans, estimates and projections. You should consider them with caution. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any forward-looking statement in light of new information or future events, although we

 

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intend to continue to meet our ongoing disclosure obligations under the U.S. securities laws (such as our obligations to file annual reports on Form 20-F and reports on Form 6-K) and under other applicable laws. Forward-looking statements involve inherent risks and uncertainties, most of which are difficult to predict and are generally beyond our control. We caution you that a number of important factors could cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. These factors include, among other factors:

 

   

the level of demand for telecommunications services in the markets we serve, particularly for wireless telecommunications services, access lines, traffic and new higher-value products and services;

 

   

competitive forces, including pricing pressures, technological developments and alternative routing developments, all of which affect our ability to gain or retain market share and revenues in the face of competition from existing and new market entrants;

 

   

the effects of our price reduction measures and our customer acquisition and retention initiatives, particularly in the fixed-line voice telephony business, the mobile telecommunications business and our interconnection businesses;

 

   

the effects of industry consolidation on the markets in which we operate, particularly with respect to our mobile and leased lines businesses;

 

   

the success of new business, operating and financial initiatives, many of which involve substantial start-up costs and are untested, and of new systems and applications, particularly with regard to the integration of service offerings;

 

   

our ability to achieve cost savings and realize productivity improvements, particularly with respect to our workforce-reduction initiatives, while at the same time enhancing customer service quality;

 

   

our ability to attract and retain qualified personnel, particularly in view of our cost reduction efforts;

 

   

regulatory developments and changes, including with respect to the levels of tariffs, terms of interconnection, customer access and international settlement arrangements, as well as with respect to a European Union challenge to German legislation concerning our new high-speed fiber-optic network build-out in Germany;

 

   

our ability to secure and retain the licenses needed to offer new and existing services and the cost of these licenses and related network infrastructure build-outs, particularly with respect to advanced services;

 

   

the outcome of litigation, disputes and investigations in which we are involved or may become involved;

 

   

risks and uncertainties relating to the benefits anticipated from our international expansion, including in the United States;

 

   

risks and costs associated with integrating our acquired businesses and with selling or combining businesses or other assets;

 

   

the progress of our domestic and international investments, joint ventures and alliances;

 

   

concerns over health risks associated with the use of wireless mobile devices and other health and safety risks related to radio frequency emissions;

 

   

the availability, terms and deployment of capital, particularly in view of our debt refinancing needs, actions of the rating agencies and the impact of regulatory and competitive developments on our capital outlays;

 

   

the level of demand in the market for our debt obligations, and for the debt obligations of our subsidiaries and associated companies, and our shares, as well as for assets that we may decide to sell, which may affect our financing and acquisition strategies;

 

   

risks of infrastructure failures or damage due to external factors, including natural disasters, intentional wrongdoing, sabotage, acts of terrorism or similar events;

 

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the effects of foreign exchange rate fluctuations, particularly in connection with subsidiaries operating outside the euro zone; and

 

   

changes in general economic conditions, government and regulatory policies, new legislation and business conditions in the markets in which we and our subsidiaries and associated companies operate.

Certain of these factors are discussed in more detail elsewhere in this Annual Report, including, without limitation, in Item 3, Item 4 and Item 5. We caution investors that the foregoing list of important factors is not exhaustive. When reviewing forward-looking statements contained in this document, investors and others should carefully consider the foregoing factors as well as other uncertainties and events and their potential impact on our operations and businesses.

Certain information in this Annual Report has been provided by external sources. Due to the rapid changes in our industry, it is possible that some of this information is no longer accurate. Assessments of market share in particular involve the use of information released or estimated by regulatory authorities, our competitors, third parties or us.

World Wide Web addresses contained in this Annual Report are for explanatory purposes only and they (and the content contained therein) do not form a part of, and are not incorporated by reference into, this Annual Report.

 

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PART I

ITEM 1. Identity of Directors, Senior Management and Advisors

Not applicable.

ITEM 2. Offer Statistics and Expected Timetable

Not applicable.

ITEM 3. Key Information

SELECTED FINANCIAL DATA

The following table presents selected consolidated financial and operating information. This selected consolidated financial and operating information should be read together with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and the notes thereto that are included elsewhere in this Annual Report.

The selected consolidated financial information as of and for each of the four years ended December 31, 2003, through 2006, are extracted or derived from our consolidated financial statements and the notes thereto, which have been audited by Ernst & Young AG Wirtschaftsprüfungsgesellschaft Steuerberatungsgesellschaft (“E&Y”) and PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft (“PwC”), for the periods ended and at December 31, 2006, 2005, 2004 and 2003. Periods prior to 2003 (except required U.S. GAAP information) have not been presented as such financial information was prepared in accordance with German GAAP and, pursuant to SEC Release 33-8567, “First-Time Application of International Financial Reporting Standards,” is not required to be included because it is not comparable to the IFRS information provided below.

 

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Selected Consolidated Financial Data of the Deutsche Telekom Group

 

    

% Change

2006/2005(1)(2)

    2006     2005     2004     2003     2002  
          

(billions of €, except as

otherwise indicated)

 

Income Statement Data

            

Net revenues

   2.9     61.3     59.6     57.3     55.6     n.a.  

Domestic

   (5.0 )   32.4     34.2     34.7     34.4     n.a.  

International

   13.6     28.9     25.4     22.6     21.2     n.a.  

Profit from operations

   (30.6 )   5.3     7.6     6.3     8.3     n.a.  

Net profit

   (43.4 )   3.2     5.6     1.6     2.1     n.a.  

Balance Sheet Data

            

Total assets(3)

   1.3     130.2     128.5     125.5     136.2     n.a.  

Total financial liabilities (in accordance with the consolidated balance sheet)

   (0.5 )   46.5     46.7     51.1     64.1     n.a.  

Shareholders’ equity(3)

   2.2     49.7     48.6     45.5     43.5     n.a.  

Cash Flow Data(4)

            

Net cash from operating activities

   (5.4 )   14.2     15.0     16.7     15.1     n.a.  

Net cash used in investing activities

   (42.0 )   (14.3 )   (10.1 )   (4.5 )   (2.3 )   n.a.  

Net cash used in financing activities

   74.4     (2.1 )   (8.0 )   (12.9 )   (5.8 )   n.a.  

U.S. GAAP Data

            

Net profit

   (39.5 )   3.2     5.3     2.3     2.9     (22.0 )

Shareholders’ equity

   2.4     52.7     51.5     47.5     45.0     45.4  

Total assets

   0.8     134.4     133.2     137.2     145.9     149.4  

Ratios and Selected Data

            

Additions to intangible assets (including goodwill) and property, plant and equipment

   20.9     13.4     11.1     6.6     7.6     n.a.  

Capital expenditures(4)

   27.4     11.8     9.3     6.4     6.4     n.a.  

Equity ratio (%)(3)(5)

   0.3     35.8     35.5     34.2     31.9     n.a.  

Number of employees averaged over the year (full-time employees excluding trainees) (thousands)

   1.6     248     244     248     251     n.a.  

Revenues per employee (thousands of euro)(6)

   1.1     246.9     244.3     231.7     221.3     n.a.  

Earnings per share/ADS in accordance with IFRS—basic and diluted (euro)(7)

   (43.5 )   0.74     1.31     0.39     0.50     n.a.  

Earnings per share/ADS in accordance with U.S. GAAP—basic (euro)(7)

   (41.4 )   0.75     1.28     0.56     0.70     (5.31 )

Earnings per share/ADS in accordance with U.S. GAAP—diluted (euro)(7)

   (41.3 )   0.74     1.26     0.55     0.70     (5.31 )

Dividend per share/ADS (euro)(7)(8)

   0.0     0.72     0.72     0.62          

Dividend per share/ADS (U.S. dollar)(7)(8)(9)

   0.0     0.90     0.91     0.80          

n.a.—not applicable.

(1) Percentage change based on figures expressed in millions.
(2) In this table, increases in the size of negative numbers are expressed in percentage terms with negative percentage amounts, and decreases in the size of negative numbers are expressed with positive percentage amounts.
(3) As of December 31, 2006, we voluntarily changed our accounting policies relating to provisions for pensions as permitted under IAS 19.93A, which allows for actuarial gains and losses to be recognized directly under retained earnings in shareholders’ equity. We believe that fully recognizing actuarial gains and losses when they occur results in a better presentation of the financial position in the balance sheet. The corresponding prior-year comparatives have been adjusted as follows: reduction in consolidated shareholders’ equity - 2005: EUR 983 million, 2004: EUR 291 million, 2003: EUR 224 million; increase in provisions for pensions - 2005: 1,571 million, 2004: EUR 479 million, 2003: EUR 368 million; increase in deferred tax assets - 2005: EUR 588 million, 2004: EUR 188 million, 2003: EUR 144 million. For more information please see note (29) to the consolidated financial statements.
(4) In accordance with the statement of cash flows.
(5) The ratio equals total stockholders’ equity divided by total assets. Amounts proposed as dividends are treated as short-term debt rather than as equity for purposes of the calculation of this ratio.
(6) Calculated on the basis of the average number of employees for the year, excluding trainees, apprentices and student interns.

 

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(7) “ADS” refers to the Deutsche Telekom American Depositary Shares traded on the New York Stock Exchange (“NYSE”). One ADS corresponds in economic terms to one ordinary share of Deutsche Telekom AG.
(8) Dividends per share are presented on the basis of the year in respect of which they are declared, not the year in which they are paid. The proposed 2006 dividend per share amounts are subject to approval by the shareholders at the annual shareholders’ meeting.
(9) Dividend amounts have been translated into U.S. dollars (using Moneyline Telerate) for the relevant dividend payment date, which occurred during the second quarter of the following year, except for the 2006 amount, which has been translated using the applicable rate on December 29, 2006. As a result, the actual U.S. dollar amount at the time of payment may vary from the amount shown here.

Exchange Rates

Unless otherwise indicated, all amounts in this Annual Report are expressed in euros.

As used in this document, “euro,” “EUR” or “€” means the single unified currency that was introduced in the Federal Republic and ten other participating Member States of the European Union on January 1, 1999. “U.S. dollar,” “USD” or “$” means the lawful currency of the United States. “British pound sterling” or “GBP” means the lawful currency of the United Kingdom. As used in this document, the term “noon buying rate” refers to the rate of exchange for euros, expressed in U.S. dollars per euro, in the City of New York for cable transfers payable in foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes, as required by Section 522 of the U.S. Tariff Act of 1930, as amended. Unless otherwise stated, conversions of euros into U.S. dollars have been made at the rate of EUR 1.00 to USD 1.3197, which was the noon buying rate on December 29, 2006.

Amounts appearing in this report that have been translated into euros from other currencies have been translated in accordance with the principles described in the notes to the consolidated financial statements, under “Summary of Accounting policies—Currency translation.”

So that you may more easily ascertain how the trends in our financial results might have appeared had they been expressed in U.S. dollars, the following table shows, for the periods indicated, the average, high, low and period-end, noon buying rates for euros, expressed in U.S. dollars per EUR 1.00:

 

Year or Month

   Average(1)    High    Low    Period-End
          (in $ per €)     

2002

   0.9495    1.0485    0.8594    1.0485

2003

   1.1411    1.2597    1.0361    1.2597

2004

   1.2478    1.3625    1.1801    1.3538

2005

   1.2400    1.3476    1.1667    1.1842

2006

   1.2661    1.3327    1.1860    1.3197

2006

           

September

      1.2833    1.2648    1.2687

October

      1.2773    1.2502    1.2773

November

      1.3261    1.2705    1.3261

December

      1.3327    1.3073    1.3197

2007

           

January

      1.3286    1.2904    1.2998

February

      1.3246    1.2933    1.3230

(1) The average of the noon buying rates on the last business day of each month during the relevant period.

On February 28, 2007, the noon buying rate was USD 1.3230 per EUR 1.00.

Our shares trade on the German stock exchanges, including the Frankfurt Stock Exchange, in euros. Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the euro price of the shares on the German stock exchanges and, as a result, are likely to affect the market price of our ADSs on the New York Stock Exchange. When we declare cash dividends, they are declared in euros, and exchange rate fluctuations affect the U.S. dollar amounts you would receive if you are a holder of American Depositary Receipts (ADRs) evidencing ADSs upon conversion of cash dividends on the shares represented by your ADSs.

 

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RISK FACTORS

In addition to the other information contained in this Annual Report, investors in our securities should carefully consider the risks described below. Our financial condition or results of operations, or the trading prices of our securities, could be materially adversely affected by any of these risks.

The following discussion contains a number of forward-looking statements. Please refer to the “Forward-Looking Statements” discussion at the front of this Annual Report for cautionary information.

An economic downturn, a substantial slowdown in economic growth or deterioration in consumer spending could adversely affect our customers’ purchases of our products and services in each of our strategic business areas, which could have a negative impact on our operating results and financial condition.

Our business depends to a large degree on general economic conditions in Germany, Western and Eastern Europe and the United States. If economic growth in the countries in which we conduct business deteriorates in 2007, this could have an adverse effect on the level of demand by our individual customers for our products and services and the willingness of our business customers to invest in information and communications technology (ICT). This could, in turn, jeopardize the attainment of our growth targets, such as those relating to multimedia services in mobile telecommunications, or those relating to broadband products and services based on digital subscriber line (DSL) technology.

Because we operate in heavily regulated business environments, decisions that regulatory authorities impose on us restrict flexibility in managing our business and may force us to offer services to competitors, or reduce the prices we charge for our products and services, either of which could have a material negative impact on our revenues, profits and market shares.

Unlike many of our competitors, we are subject to strict regulation in many market segments in Germany and Central and Eastern Europe, particularly in areas of the fixed-line network business of our Broadband/Fixed Network strategic business area. Government agencies regularly intervene in the offerings and in the pricing of our products and services. Regulation can impede our ability to grow and to react to the initiatives of competitors and technological change.

The European Commission currently reviews the markets, which are or should be subject to sector specific regulation under the framework on telecommunications regulation. Except for a minor decrease of regulatory activity in retail markets, we do not believe that a significant reduction of sector-specific regulation in general will occur. On the contrary, as a result of this review by the European Commission, the scope of regulation may be expanded by the European Union or national regulatory authorities, which could have negative effects on our business and pricing flexibility and, as a result, could affect our ability to generate revenue and profit.

Access and price regulation applies primarily to telecommunications services that are considered to involve an operator with “significant market power.” We have been designated an operator with significant market power in most fixed-line markets in which we operate, including in Germany, Hungary, Slovakia and Croatia. The German telecommunications regulatory framework implemented by the Federal Network Agency (Bundesnetzagentur) has an especially significant impact on our business. So far, we have been exempted from regulation on the basis of a loss of significant market power in markets of relatively minor importance only, such as the market for foreign long-distance calls in fixed-line networks.

The German parliament amended the Telecommunications Act in 2006. These amendments primarily strengthened customer protection rules, such as obligations to announce prices for premium voice call services before a call is made. This could have an adverse effect on our future revenues and entail additional operating costs.

Additionally, since we are offering mobile and fixed-line triple-play services (high-speed Internet access, communications services and entertainment offerings), media regulation may become increasingly important to our business. This regulation might restrict our ability to provide media services, including the delivery of content, and could also result in additional costs for technical implementation measures needed to comply with increased regulation.

 

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Broadband/Fixed Network

We believe that, for the foreseeable future, the Federal Network Agency is likely to consider us as a provider with significant market power in various German markets for public voice telephony services in the fixed-line network and in other markets, including most of those in which we held monopoly rights in the past. As a result, we expect that the strict regulatory provisions of the Telecommunications Act relating to providers with significant market power will be applied to our activities in those markets. Considering that in many markets our competitors are unlikely to gain significant market power in the near future, we expect that we will have to compete in important markets with providers not subject to these regulatory obligations. Therefore, these competitors may have more flexibility than we have in terms of the types of services offered and customers served, pricing and the granting of network access.

The Federal Network Agency has not shown any sign that it will refrain from regulating previously unregulated or emerging markets. On the contrary, the Federal Network Agency appears prepared to extend regulation into previously unregulated markets. For example, we have been required to offer an Internet Protocol (IP) Bitstream Access product in the wholesale-market, which will be regulated in terms of price, possibly below the current prices for Resale DSL. Additionally, we may be forced to offer unbundled broadband access to competitors as soon as T-Com introduces its own all IP-product after April 2007. Unbundled broadband access for our competitors would expand competition in the access business, currently focused on metropolitan areas, to all regions in Germany. These regulatory measures could have a material adverse effect on our market shares, revenues and profits.

Regulatory authorities may choose to classify our entry into new markets as extensions of our existing services and subject such new business to regulation instead of considering it an unregulated new product offering. For example, “T-Home”, our triple-play product which was launched in October 2006, using DSL technology over a new high-speed fiber-optic network (VDSL), was initially introduced with a reduced connection speed (25 Mbit/s instead of 50 Mbit/s) and no interactive features. It could be viewed by the Federal Network Agency as an extension of our double-play service offering and not a new market, which could subject our T-Home offering to extensive regulation.

Our fixed-line subsidiaries in Central and Eastern Europe are subject to regulatory provisions and risks that are similar to those affecting our fixed-line operations in Germany. The business impact of increased regulation on our subsidiaries in Central and Eastern Europe will depend on the way in which national regulatory authorities use their powers, and the extent to which our competitors take advantage of regulatory decisions designed to foster increased competition.

Further market analysis procedures under the E.U. regulatory framework will be carried out in Hungary and Slovakia in 2007, which could eventually lead to reductions in the prices we may charge to customers for wholesale and retail services. These developments could also contribute to a loss of our market share in these countries. Our Central and Eastern European subsidiaries might also be required to adjust their product offerings on the wholesale and retail levels in furtherance of competition in the fixed-line network. This could have a material adverse effect on their market shares, revenues and profits.

Mobile Communications

Our mobile telecommunications operations are supervised by regulatory authorities in the countries in which we operate. We expect a tightening of regulatory control in the area of mobile telecommunications, with a probable negative effect on pricing and revenues, as a result of a reduction in international roaming charges for the wholesale and retail market, call termination charges and also possible access regulation in some markets. The E.U. regulatory framework considers international wholesale roaming, call termination and access, and origination as separate markets. On this basis, national regulatory authorities in the European Union are required to carry out market investigations and, if necessary, define regulatory remedies in those markets in accordance with E.U. directives.

On February 10, 2005, the E.U. Commission opened formal proceedings in Germany against, among others, T-Mobile Deutschland and T-Mobile International. The E.U. Commission alleged that T-Mobile Deutschland

 

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had been charging excessive wholesale roaming tariffs for calls of foreign visitors in its network during the period from 1997 to 2003. Should the E.U. Commission decide to uphold its preliminary findings, it may impose significant fines on T-Mobile. A decision is expected in the first half of 2007.

Despite attempts by operators to avert regulatory intervention by voluntarily reducing prices, on July 12, 2006, the E.U. Commission submitted a proposal to regulate international roaming tariffs for wholesale and retail customers on the basis of a capped pricing system. The implementation of this regulation, which is expected during 2007, would have immediate effect in E.U. member states and therefore not require further transposition into national law. A further reduction of roaming tariffs will have an adverse affect on T-Mobile’s revenues.

Mobile call termination charges are subject to regulatory measures in T-Mobile’s markets and can have a significant effect on revenues. On November 8, 2006, the Federal Network Agency published a decision lowering termination charges in Germany until November 30, 2007. Although the announced reduction of termination rates was expected, further reductions may occur. In the UK, Ofcom recently proposed extending price controls for termination rates through March 2011. Ofcom is expected to reach a final decision in March 2007. In Austria, the purchase of tele.ring Telekom Service GmbH (“tele.ring”) by T-Mobile Austria has resulted in a demand to reduce termination rates by carriers with whom interconnection arrangements currently exist and proceedings to compel such reduction were initiated in July 2006.

Our telecommunications systems and operations in the United States are regulated primarily by the U.S. Federal Communications Commission (FCC) and by various other federal, state and local governmental bodies. These and other governmental agencies may also exercise jurisdiction over mobile telecommunications operators. Some U.S. states have taken actions to regulate various aspects of wireless operations including customer billing, termination of service arrangements and advertising. Any of those agencies could adopt regulations or take other actions that could adversely affect our business. If we fail to comply with applicable regulations, we may be subject to sanctions, which may have an adverse effect on our mobile telecommunications business in the United States.

For further information regarding the matters discussed above and other aspects of the regulatory environments to which our businesses are subject, see “Item 4. Information on the Company—Regulation” and “Item 8. Financial Information—Legal Proceedings.”

We face intense competition in all areas of our business, which could lead to reduced prices for our products and services and a decrease in market share in certain service areas, thereby having an adverse effect on our revenues and net profit.

Broadband/Fixed Network

In Germany, and to a lesser extent in Eastern Europe, fixed-line network voice telephony service revenues and prices have been declining in recent years, primarily due to intense competition and adverse decisions imposed by the Federal Network Agency, and also due to customers’ substitution of mobile telecommunications and Voice over Internet Protocol (VoIP) services for fixed-line usage.

Due to intense competition from mobile operators, fixed line carriers and cable operators, we continued to lose market share in 2006. We expect a further increase in competition due to a change in mobile operators’ focus from pure mobile services towards fixed-line offerings and cable operators’ product bundles for telephone and broadband access lines, which are increasingly offered in more regions throughout Germany. Furthermore, regulatory actions by the Federal Network Agency as well as the increasing quality and acceptance of VoIP services will increase pressure on our market shares, revenues and margins.

Additional local and regional network operators are expanding their presence to include other major cities and regions. In the future, we could face even fiercer competition and lose further market share if our competitors were to combine their businesses.

Existing mobile substitution effects are intensified as a result of the proliferation of mobile virtual network operators (MVNO). Reduced prices for mobile telecommunications services (e.g., on the basis of lower flat rates

 

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without call-based charges and regulatory decisions regarding mobile telephony termination rates) could increase pricing pressure on our fixed-line services. Furthermore, mobile operators are increasingly engaging in reselling DSL product bundles provided by other fixed-line operators, and this continues to have an adverse effect on our fixed-line network revenues.

The German and European markets for Internet access and portal services, especially within the broadband market, have been, and will continue to be, highly competitive. Prices for broadband flat rates have been steadily declining. Broadband/Fixed Network’s future competitive position will be affected by pricing, network speed and reliability, services offered, customer support and its ability to be technologically adept and innovative. The regulatory environment can also exert a significant influence on the level of competition. We expect that our competitors will continue to pursue new broadband customers aggressively. In the market for portal services and content, competition is also intense due to low barriers to entry.

Part of the challenge for our Broadband/Fixed Network strategic business area will be to improve its reputation for customer service while implementing cost-saving measures. If we do not improve our customer service sustainably, there is a risk that we might not stop our continuing loss of customers.

Each of these developments is expected to continue to erode our market shares and to decrease our revenues and profit margins. For more information, see “Item 4. Information on the Company—Description of Business—Broadband/Fixed Network” and “Item 4. Information on the Company—Regulation.”

Mobile Communications

During 2004 and 2005, consolidation in the wireless telecommunications sector in the United States dramatically changed the competitive landscape. Each of T-Mobile USA’s three remaining national competitors—Verizon Communications, Inc. (“Verizon”), Cingular Wireless LLC (“Cingular”) and Sprint/Nextel Corporation (“Sprint/Nextel”)—are significantly larger than T-Mobile USA. Their scale could afford them significant structural and competitive advantages in this market. This situation presents a long-term challenge to T-Mobile USA to effectively compete in pricing, products, coverage and the introduction of new technologies and services. Intense competition from various regional operators also exists. Since T-Mobile USA is a significant contributor to our overall revenue and customer growth, a slowdown or decline in the business of T-Mobile USA could have a material adverse effect on the attainment of the growth targets of our group as a whole.

Competition in the European mobile telecommunications markets has increased and can be expected to increase in the future. Increasing competition results, in part, from the entry into the market of low cost carriers, such as MVNOs, which use the networks of other operators at volume discounts, and from market consolidation. If prices for mobile telecommunications services decline more than anticipated and this decline is not compensated for by higher usage, T-Mobile may not achieve its objectives. In addition, mobile network operators’ expansion of product offerings into the fixed-line sector may result in a competitive disadvantage for T-Mobile in countries in which T-Mobile offers only mobile communications services. Moreover, technologies such as WLAN, DSL, WiMax and VoIP, which can be used with existing hardware and platforms, could result in the diversion of voice and data traffic from T-Mobile’s network, which could lead to significant price and revenue reductions.

As European markets have become increasingly saturated, the focus of competition has been shifting from customer acquisition to customer retention, and increasing the quality and value of existing customers. Accordingly, if we are unable to offer increased quality and better value to our customers, our market share and revenues may not grow as we have anticipated in our growth plans.

For more information, see “Item 4. Information on the Company—Description of Business—Mobile Communications.”

Business Customers

Our Business Customers strategic business area, operated through T-Systems Business Services GmbH and T-Systems Enterprise Services GmbH (collectively, “T-Systems”), is a provider of solutions covering the entire ICT value chain. It is subject to risks associated with the general and regional economies of its customers and the

 

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willingness and ability of its customers to invest in information and communications technology services and products. The ICT market is shaped by long sales cycles, severe competition and declining prices. The result is downward pressure on revenues and margins.

The international growth potential of T-Systems may be constrained by its limited brand recognition in some national markets, at least compared to that of competitors who may be more established there, particularly as this relates to maintaining and increasing business with multinational companies outside of Germany. If various sales initiatives introduced by T-Systems are not successful, T-Systems may lose market share to its competitors.

For more information, see “Item 4. Information on the Company—Description of Business—Business Customers.”

We may realize neither the expected level of demand for our products and services, nor the expected level or timing of revenues generated by those products and services, as a result of lack of market acceptance, technological change or delays from suppliers, which could adversely affect our cash flows.

There is a risk that we will not succeed in making customers sufficiently aware of existing and future value-added services or in creating customer acceptance of these services at the prices we would want to charge. There is also a risk that we will not identify trends correctly, or that we will not be able to bring new services to market as quickly or price-competitively as our competitors. These risks exist, in particular, with respect to our anticipated future growth drivers in the mobile telecommunications area (e.g., mobile data services provided via Universal Mobile Telecommunications System (UMTS or “3G”) or other advanced technologies) and in the fixed-line telecommunications area (e.g., triple-play services). Some of our investments to develop future products and services may involve substantial cash outlays with no certainty of market acceptance or regulatory non-interference. Accordingly, there is a risk that the return on our investments, in particular in UMTS licenses and network infrastructure may be negatively affected, which could result in significant write-downs of the value of our UMTS or other licenses or other network-related investments.

In October 2006, we launched “T-Home” to offer triple-play services to our customers in Germany. “Triple-play” refers to the interaction between high-speed Internet access, communications services and entertainment offerings. As “T-Home” was launched with reduced features, the market acceptance for these new products and services could be negatively impacted. Furthermore, the comprehensive free TV offering in Germany could reduce our customers’ willingness to pay for additional channels. This could also have an adverse effect on our pricing models, revenues and profit margins.

Further, as a result of rapid technological progress, and the trend towards technological convergence, there is a danger that new and established information and telecommunications technologies or products may not only fail to complement one another, but in some cases may even substitute for one another. An example of this is VoIP, a technology that is already established in the business customer market. VoIP has now reached the consumer market as well and, as a technology that competes directly with traditional fixed-line telephony services, has the potential to reduce our market share and revenues in our fixed-line business. The introduction of mobile handsets with VoIP functionality may also adversely affect our pricing structures and market share in our mobile voice telephony business. If we do not appropriately anticipate the demand for new technologies, and adapt our strategies and cost structures accordingly, we may be unable to compete effectively, with the result that our business activities, financial condition and results may suffer.

For more information, see “Item 4. Information on the Company—Description of Business.”

Failure to achieve our planned reduction and restructuring of personnel could negatively affect our financial objectives and profitability.

We announced an extensive staff restructuring program for our operations in Germany in November 2005, under which a total of approximately 32,000 employees will leave the group by 2008. Some of these employees will leave us as part of the sale of the Vivento business lines and others through voluntary early retirement and other voluntary measures. By the end of 2006, the group had already realized approximately one-third of these planned staff reductions.

 

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On December 1, 2006, approximately 600 employees were transferred to the walter Telemedien Group in connection with the transfer of certain Vivento calling center operations. The planned further sale of Vivento’s business lines is dependent on, among other things, finding suitable buyers and achieving certain financial objectives.

However, the successful realization of our ongoing staff reduction program depends on a range of factors that are beyond our control, such as the continued successful sale of our Vivento operating businesses (call center and technology maintenance businesses), general developments in the labor market and the demand for our retrained labor force and the level of acceptance of the various severance offers and other voluntary reduction measures, e.g., early retirement programs. If the planned staff reduction targets are not achieved, this would have a negative effect on our operating expenses and profitability.

Additionally, we are planning various measures to make customer service more efficient and to orient it more closely towards customer needs. We plan to transfer a significant number of employees into three dedicated businesses—our T-Service initiative. All three units will remain completely in the group’s ownership. The objectives of the T-Service initiative are to increase productivity and service levels, while at the same time increasing cost efficiencies. The success of these measures will largely depend on the extent to which the unions and the works councils will cooperate constructively with management in the realization of these plans.

For more information, see “Item 4. Information on the Company—Description of Business—Group Headquarters and Shared Services” and “Item 6. Directors, Senior Management and Employees—Employees and Labor Relations—Other Employees.”

Alleged health risks of wireless communications devices have led to litigation affecting T-Mobile, and could lead to decreased wireless communications usage or increased difficulty in obtaining sites for base stations and, thus, adversely affect the financial condition and results of operations of our mobile telecommunications services business.

Media reports have suggested that radio frequency emissions from wireless mobile devices and cell sites may raise various health concerns, including cancer, and may interfere with various electronic medical devices, including hearing aids and pacemakers. Research and studies are ongoing. The World Health Organization has declared that, on the basis of current scientific knowledge, there are no known adverse effects on health below the international threshold standards, nor is it expecting any serious dangers to arise in the future—although it does recommend continued research due to the ongoing scientific uncertainty. We cannot be certain that medical research in the future will dismiss any and all links between radio-frequency emissions and health risks.

Whether or not such research or studies conclude there is a link between radio-frequency emissions and health, popular concerns about radio-frequency emissions may discourage the use of wireless mobile devices and may result in significant restrictions on both the location and operation of cell sites, either or both of which could have a material adverse effect on our or T-Mobile’s results of operations.

T-Mobile USA is subject to current and potential litigation relating to these health concerns. Several amended class action lawsuits have been filed in the United States against T-Mobile USA and several other wireless-service operators and wireless-telephone manufacturers, asserting products liability, breach of warranty and other claims relating to radio-frequency transmissions to and from wireless mobile devices. The complaints seek substantial monetary damages as well as injunctive relief. The defense of these lawsuits may divert management’s attention, and T-Mobile USA may be required to pay significant awards or settlements and incur significant expenses in defending these lawsuits.

We do not know whether legislators, regulators or private litigants will refrain from taking other actions adverse to us, based on the purported health-related risks associated with radio-frequency emissions. Any such litigation, legislation or adverse actions may result in additional costs and loss of revenues in our Mobile Communications strategic business area.

For more information, see “Item 8. Financial Information—Legal Proceedings.”

 

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System failures due to natural or man-made disruptions could result in reduced user traffic and reduced revenues and could harm our reputation and results.

Our technical infrastructure (including our network infrastructure for fixed-line network services and mobile telecommunications services) may be damaged or disrupted by fire, lightning, flooding and other calamities, technology failures, human error, terrorist attacks, hacker attacks and malicious actions, and other similar events. We attempt to mitigate these risks by employing a large number of measures, including backup systems and protective systems such as firewalls, virus scanners, and building security. We cannot, however, be certain that these measures will be effective under all circumstances and that disruptions or damage will not occur. Damage or disruption to our infrastructure may result in reduced user traffic and revenues, increased costs, and damage to our reputation.

To reach our goals of additional cost cutting and further improvements in our competitiveness, we plan to develop and implement a comprehensive IP-platform that would support both fixed-line and mobile telephony services. This means that the traditional PSTN-platform will be completely replaced by an IP-based system. Upon implementing this joint IP-platform, we will be subject to risks inherent to all IT systems connected to the Internet, such as hacker attacks and “spam calls.” These risks could lead to a temporary interruption of our IT resources and, as a result, impair the performance of our technical infrastructure.

Shortcomings in our supply and procurement process could negatively affect our product portfolio, revenues and profits.

As a fully integrated ICT service provider, we cooperate with a wide range of different suppliers for technical components and assemblies, as well as for software and other goods and information important to the conduct of our business. Although we do not believe that we are materially dependent on any single supplier, disruptions in our chain of supply could negatively affect our product portfolio, cost structure, revenues and profits. We take a variety of measures to shelter ourselves from these risks, but we cannot be sure that these measures will be effective under all circumstances.

We are continuously involved in disputes and litigation with regulators, competitors and other parties. The ultimate outcome of such legal proceedings is generally uncertain. When finally concluded, they may have a material adverse effect on our results of operations and financial condition.

We are subject to numerous risks relating to legal and regulatory proceedings, in which we are currently a party or which could develop in the future. Litigation and regulatory proceedings are inherently unpredictable. Legal or regulatory proceedings in which we are or come to be involved (or settlements thereof) may have a material adverse effect on our results of operations or financial condition. For information concerning some of the litigation in which we are involved, including with respect to Polska Telefonia Cyfrowa (“PTC”) and Toll Collect, see “Item 8. Financial Information—Legal Proceedings.” For information concerning our regulatory environment, see “Item 4. Information on the Company—Regulation.”

Future sales of our shares by the Federal Republic or KfW Bankengruppe (“KfW”) may adversely affect the trading prices of our shares and ADSs.

Continuing its privatization policy, the Federal Republic (which owns, together with KfW, approximately 31.7% of our outstanding shares) has announced that it intends to further reduce its holdings of equity interests in the future, including shares in Deutsche Telekom AG. The reduction in the Federal Republic’s direct or indirect holdings may involve KfW. For shareholders, there is a danger that the market offering of a significant volume of our shares by either the Federal Republic or KfW, or speculation to this effect on the markets, could have a negative impact on the price of our shares and ADSs.

On April 24, 2006, the Blackstone Group purchased 191.7 million of our shares from KfW. KfW agreed with Blackstone to a one year lock-up with respect to further sales of KfW’s Deutsche Telekom shares. In return, Blackstone agreed with KfW to a two-year lock-up of its Deutsche Telekom shares. Despite these contractual terms, market speculation regarding purchases of a large number of our shares by additional large private-equity

 

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investors or a potential sale of shares currently held by Blackstone, could have negative effects on the volatility of our share price. We are not a party to these agreements and have no right to enforce the lock-up restrictions. In addition, lock-up agreements may be waived by the parties thereto.

Exchange-rate and interest-rate risks have had, and may continue to have, an adverse effect on our revenue development.

We are exposed to currency risks related to our international business activities. Generally, our Central Treasury hedges currency risks that may have a negative impact on our cash flows, although there can be no guarantee that our hedging strategies will succeed. Currency risks may have a negative impact on our results of operations when amounts in local currencies are translated into euros, particularly in connection with U.S. dollar- and British pound sterling-denominated results.

For more information with respect to the impact of exchange rates and currency translation, see “Item 5. Operating and Financial Review and Prospects—Consolidated Results of Operations.”

We are also exposed to interest-rate risks, primarily in the euro, U.S. dollar and British pound sterling currencies. Interest-rate risks arise as a result of fluctuations in interest rates affecting the level of interest payments due on indebtedness at variable rates in each of these currencies. Once per year, our Management Board specifies ratios of fixed and variable debt in these three currencies. Our Central Treasury then takes measures, using derivative instruments and other measures, to implement the interest-risk management decisions of the Management Board.

For more information about our hedging activities and interest-rate and market risks, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

Developments in the telecommunications sector have resulted, and may in the future result, in substantial write-downs of the carrying value of certain of our assets.

We review on a regular basis the value of each of our subsidiaries and their assets. In addition to our regular annual impairment reviews, whenever indications exist that goodwill, intangible assets or fixed assets may be impaired due to changes in the economic, regulatory, business or political environment, we consider the necessity of performing certain valuation tests, which may result in impairment charges. The recognition of impairments of tangible, intangible and financial assets could cause us to take large, non-cash charges against net profit, which could lead to a reduction in the trading price of our shares and ADSs. For more information, see “Item 5. Operating and Financial Review and Prospects—Critical Accounting Estimates.”

 

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ITEM 4. Information on the Company

INTRODUCTION

The legal and commercial name of our company is Deutsche Telekom AG. We are a private stock corporation organized under German law. Our registered office is located at Friedrich-Ebert-Allee 140, 53113 Bonn, Germany, and its telephone number is +49 (228) 181-0. Our agent for service of process in the United States is Deutsche Telekom, Inc., 600 Lexington Avenue, New York, NY 10022.

HISTORICAL BACKGROUND

The provision of public telecommunications services in Germany was long a state monopoly, as formerly provided in the constitution of the Federal Republic. In 1989, the Federal Republic began to transform the postal, telephone and telegraph services administered by the former monopoly provider of such services into market-oriented businesses, and divided the former monopoly into three distinct entities along their lines of business, one of which was our predecessor, Deutsche Bundespost Telekom. At the same time, the Federal Republic also began the liberalization of the German telecommunications market. We were transformed into a private stock corporation effective January 1, 1995.

The operation of networks (including cable networks) for all telecommunications services, other than public fixed-line voice telephony, was opened to competition in Germany on August 1, 1996, when the new legal framework for the regulation of the telecommunications sector in Germany—the Telecommunications Act—became effective. As required by the Telecommunications Act, and mandated by the directives of the E.U. Commission, the telecommunications sector in Germany was further liberalized on January 1, 1998, through the opening of the public fixed-line voice telephony services to competition.

Since then, we have faced intense competition and have been required, among other things, to offer competitors access to our fixed-line network at regulated interconnection rates. For more information on the regulatory effects on competition in our fixed-line business, see “—Regulation.”

Other important events in the development of our business have included:

 

   

the formation of the new strategic business areas, Broadband/Fixed Network, Business Customers and Mobile Communications as of January 1, 2005, as an evolution from our previous structure, to better serve evolving customer needs;

 

   

the 2005 acquisition of Global System for Mobile Communications (GSM) networks in California and Nevada in the United States from Cingular for USD 2.5 billion, and the related dissolution of our network-sharing joint venture with Cingular;

 

   

the full divestment of shareholdings in the Russian mobile telecommunications operator, Mobile TeleSystems OJSC (“MTS”), in 2005 following reductions of our shareholdings in 2003 and 2004;

 

   

the acquisition of a 76.5% majority interest in Crnogorski Telekom a.d. (“Crnogorski Telekom”) in Montenegro through our Hungarian subsidiary, Magyar Telekom, in 2005;

 

   

the acquisition in 2006 of the Austrian mobile telecommunications operator, tele.ring, for a purchase price of EUR 1.3 billion;

 

   

the acquisition in 2006 of gedas AG (“gedas”) (a subsidiary of Volkswagen AG), an IT service provider primarily focused on the automotive and manufacturing industries, for a purchase price of EUR 0.3 billion;

 

   

the completion of the merger of T-Online International AG with and into Deutsche Telekom AG in June 2006;

 

   

the acquisition of additional shares in PTC and the full consolidation as of November 1, 2006;

 

   

the acquisition in November 2006 by T-Mobile USA of 120 additional spectrum licenses in the United States for data and voice services for a total purchase price of USD 4.2 billion, or EUR 3.3 billion; and

 

   

the launch of new broadband products and services, which combine DSL telephone, Internet and TV/video (triple-play services) based on T-Com’s new high-speed VDSL network.

Additional information regarding the foregoing events and developments is contained throughout this Item 4.

 

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ORGANIZATIONAL STRUCTURE

As described below, our group is organized into three strategic business areas, Mobile Communications, Broadband/Fixed Network and Business Customers, with strategic and cross-divisional management functions prepared by Group Headquarters and Shared Services.

 

   

Mobile Communications offers digital mobile voice and data services to consumers and business customers and also sells hardware and other terminal devices in connection with the services offered. In addition, services are sold to resellers and other companies that buy network services and market them independently to third parties.

 

   

Broadband/Fixed Network offers consumers and small business customers state-of-the-art infrastructure for traditional fixed-network services, broadband Internet access, and multimedia services. Broadband/Fixed Network also does business with national and international network operators and with resellers, and provides upstream telecommunications services for our other strategic business areas.

 

   

Business Customers offers its customers a full range of ICT services and is divided into two business units. T-Systems Enterprise Services supports multinational corporations and large public authorities, and T-Systems Business Services serves around 160,000 large and medium-sized enterprises.

The following table shows the significant subsidiaries that we owned, directly or indirectly, as of December 31, 2006. The revenues of these companies, together with Deutsche Telekom AG, account for more than 90% of the group’s revenues.

 

Name of Company

  

%

Held

T-Mobile Deutschland GmbH (“T-Mobile Deutschland”)(1), Germany

   100.00

T-Mobile USA, Inc. (“T-Mobile USA”)(2), United States

   100.00

T-Mobile Holdings Ltd. (“T-Mobile UK”)(2), United Kingdom

   100.00

T-Mobile Austria Holding GmbH (“T-Mobile Austria”)(3), Austria

   100.00

T-Mobile Netherlands Holding B.V. (“T-Mobile Netherlands”)(2) Netherlands

   100.00

T-Mobile Czech Republic a.s. (“T-Mobile Czech Republic”)(4) Czech Republic

   60.77

T-Systems Enterprise Services GmbH (“Enterprise Services”) Germany

   100.00

T-Systems Business Services GmbH (“Business Services”), Germany

   100.00

T-Systems GEI GmbH (“T-Systems GEI”), Germany(5)

   100.00

GMG Generalmietgesellschaft mbH (“GMG”), Germany

   100.00

DeTeImmobilien, Deutsche Telekom Immobilien und Service GmbH (“DeTeImmobilien”), Germany

   100.00

Magyar Telekom Telecommunications Public Limited Company (“Magyar Telekom”)(6) Hungary

   59.21

Slovak Telekom, a.s. (“Slovak Telekom”), Slovakia

   51.00

HT-Hrvatske telekomunikacije d.d. (“T-Hrvatski Telekom”), Croatia

   51.00

(1) Indirect shareholding via T-Mobile International AG & Co. KG
(2) Indirect shareholding via T-Mobile Global Holding GmbH
(3) Indirect shareholding via T-Mobile Global Holding Nr. 2 GmbH
(4) Indirect shareholding via CMobil B.V. (“CMobil”)
(5) Indirect shareholding via T-Systems Enterprise Services GmbH
(6) Indirect shareholding via MagyarCom Holding GmbH

A list of our subsidiaries as of December 31, 2006, is filed as Exhibit 8.1 to this Annual Report.

 

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SEGMENT REVENUE BREAKDOWN

The following table presents total revenues (the sum of external (net) revenues and intersegment revenues), net revenues and intersegment revenues of our segments for the years indicated. For more information regarding our revenues on a segment basis, see “Item 5. Operating and Financial Review and Prospects—Segment Analysis.”

 

    For the years ended December 31,  
    2006     2005     2004  
   

Net

Revenues

  %  

Inter-

Segment

Revenues

   

Total

Revenues

   

Net

Revenues

  %  

Inter-

Segment

Revenues

   

Total

Revenues

   

Net

Revenues

  %  

Inter-

Segment

Revenues

   

Total

Revenues

 
    (millions of € except percentages)  

Mobile Comunications

  31,308   51.0   732     32,040     28,531   47.9   921     29,452     25,450   44.4   1,077     26,527  

Broadband/ Fixed Network

  20,635   33.6   4,050     24,685     21,731   36.5   4,304     26,035     22,397   39.1   4,615     27,012  

Business Customers

  9,061   14.8   3,560     12,621     9,058   15.2   3,792     12,850     9,246   16.1   3,716     12,962  

Group Headquarters and Shared Services

  343   0.6   3,331     3,674     284   0.4   3,221     3,505     260   0.4   3,266     3,526  

Reconciliation

      (11,673 )   (11,673 )       (12,238 )   (12,238 )       (12,674 )   (12,674 )
                                                           

Group

  61,347   100.0       61,347     59,604   100.0       59,604     57,353   100.0       57,353  

 

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DESCRIPTION OF BUSINESS

Mobile Communications

Principal Activities

The principal services offered by our Mobile Communications strategic business area, through T-Mobile, are digital mobile telephony services based on the mobile telecommunications technology known as GSM, and non-voice services such as SMS (short message service), MMS (multimedia messaging services) and other data services to residential and business customers based on CSD (circuit switched data), GPRS (general packet radio service) and UMTS technologies. T-Mobile also operates numerous W-LAN HotSpots. T-Mobile offers international roaming services for GSM, GPRS, UMTS and W-LAN to its customers through a large number of international roaming agreements with third-party operators, which allow customers to access mobile services while outside their home network service area. T-Mobile also sells mobile devices to customers in conjunction with its service offerings.

Mobile voice and data services are offered both on a prepay basis and on a contract basis. Customers purchase contract services on the basis of fixed monthly fees, and pay time-based airtime and per-message fees. Some contract service offerings include a limited amount of airtime, data volume or messages in the monthly fee. Prepay services are purchased on the basis of monetary increments that are recorded on the customers’ SIM (subscriber identity module) card and then deducted, based on airtime or messaging usage fees, as the cards are used. W-LAN services are sold on both a monthly subscription basis and through various usage-based plans.

Usage fees can vary according to the tariff plan selected by the customer, the day and time when a call is made, the destination of the call, the location where the call originates and, in some cases, other terms applicable to the tariff plan, and whether the called party is also a customer of the same network.

Global Branding and Alliances

In 2006, we re-branded Mobimak in Macedonia as T-Mobile Macedonia and Monet in Montenegro as T-Mobile Crna Gora.

T-Mobile was a founding member of the “FreeMove” alliance, together with Telefónica in Spain, TIM Italia S.p.A. in Italy and Orange S.A. in France. The alliance aims to make mobile services more widely available and seamless in all countries in which alliance members operate, by cooperating in several key areas, including the development of joint services related to roaming, voice and data, and the development and purchasing of mobile devices. The European Commission required Telefonica to leave the alliance in 2006 following Telefonica’s acquisition of O2 plc. Telia Sonera AB joined the alliance in March 2006.

New Services

T-Mobile’s strategy is to offer an integrated portfolio of voice and data services to its customers, using the most appropriate technologies available depending on local market conditions.

The coverage in all of our markets is based on GSM network technology. GPRS and EDGE technologies are employed to increase the data capacity of the GSM network. EDGE is currently commercially available in the United States, Germany, Hungary and the Czech Republic. In urban and suburban areas in Europe with a higher demand for data capacity, this technology is supplemented by UMTS-FDD (Frequency Division Duplex) technology. The network is fully integrated and allows a seamless user experience for voice and data services.

In 2006, all of our markets in Europe with UMTS-FDD coverage areas have been upgraded to support HSDPA (High-Speed Downlink Packet Access) technology, which enables data rates of up to 3.6 Mbit/s. Based on its newly acquired spectrum, T-Mobile USA plans to offer its first commercial services based on UMTS-FDD technology in the second half of 2007.

In addition, T-Mobile offers mobile broadband data services through its W-LAN HotSpots in Europe and in the United States. The integration of the W-LAN HotSpots and the mobile networks enables our customers to use data services regardless of the access technology used.

 

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To date, T-Mobile has met or exceeded all regulatory obligations with respect to its UMTS and other license requirements in the United Kingdom, Germany, Austria, the Netherlands, the Czech Republic, Hungary, Croatia, Poland, the United States and Slovakia. For more information regarding regulatory obligations, and for further details with respect to rollout requirements and network sharing, see “—Regulation.”

Principal Markets

Our principal mobile telecommunications markets are in the United States, Germany, the United Kingdom, Poland, Hungary, the Netherlands, the Czech Republic, Austria, Croatia, Slovakia, Macedonia and Montenegro.

T-Mobile counts its customers by the number of SIM cards activated and not churned. Since the beginning of 2006, T-Mobile has included in its customer totals the SIM cards with which machines can communicate automatically with one another (“M2M cards”). T-Mobile’s mobile telecommunications subsidiaries count contract customers as customers for the length of their contracts, and count prepay customers as customers as long as they continue to use our services, and then for a prescribed period thereafter, which differs according to the particular market. Generally, at the end of this period, or in the case of payment default or voluntary disconnection, the customers are cancelled or “churned.” The churn rate for any given period represents the number of customers whose service was discontinued during that period, expressed as a percentage of the average number of customers during the period, based on beginning and period-end figures. Our competitors may calculate their churn rates using methods different from ours. In addition, because we use different calculation methodologies in different jurisdictions, our own churn figures are not comparable across all of our national operations.

United States

Through T-Mobile USA, T-Mobile offers mobile telecommunications services to individual and business customers in the United States. At December 31, 2006, T-Mobile USA had approximately 25.0 million customers, compared to approximately 21.7 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 21.2 million, or 85%, were contract customers, compared to approximately 18.4 million, or 85%, at December 31, 2005, and approximately 3.8 million were prepay customers at December 31, 2006, compared to approximately 3.3 million at December 31, 2005.

T-Mobile USA’s average churn rate for 2006 was 2.9% per month, approximately the same as in 2005. The contract customer churn rate decreased slightly to 2.2% in 2006, from 2.3% in 2005. Competitive differences, differences in features and services due to the use of multiple wireless technologies, and general differences in consumer behavior between the United States and Europe factor into the higher industry churn rates in the United States compared to Europe. However, the churn rate of our U.S. operations is higher than the U.S. industry average, due in part to the higher proportion of prepay customers in T-Mobile USA’s customer base relative to most of its U.S. competitors. Prepay customers in the United States typically churn at substantially higher rates than contract customers. T-Mobile USA initiated two-year service contracts for new customers begining in the second quarter of 2006, consistent with plans offered by the other large U.S. national carriers. The introduction of these longer term contracts is expected to have a beneficial impact on customer churn in 2007.

On August 9, 2006, the FCC commenced Auction No. 66 (“Auction 66”), offering 90 MHz of Advanced Wireless Services (AWS) spectrum in the 1700 MHz and 2100 MHz frequency bands across the United States. The auction was concluded on September 18, 2006. The FCC sold 1,087 AWS licenses to 104 bidding entities, raising USD 13.7 billion for the U.S. government. A wholly-owned subsidiary of T-Mobile USA was the most active participant in the auction, winning bids for a total of 120 licenses for USD 4.182 billion, which amount was paid in 2006. The licenses were awarded to T-Mobile USA by the FCC on November 29, 2006. The cost for T-Mobile USA per MHz of spectrum acquired in this auction per person of covered population was USD 0.63. With this additional spectrum, T-Mobile USA more than doubled its average spectrum position in the top 100 U.S. markets from 25.9 MHz to 52.2 MHz.

On January 5, 2005, T-Mobile USA and Cingular terminated their network-sharing joint venture (GSM Facilities LLC, “GSM Facilities”), and T-Mobile USA acquired 100% ownership of the shared-network assets in

 

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California, Nevada and New York City, plus additional wireless spectrum in California and Nevada. The following are key elements of the transaction:

 

   

Upon the dissolution of GSM Facilities, the New York City wireless network was distributed to T-Mobile USA, and the California and Nevada network to Cingular;

 

   

T-Mobile USA acquired 100% ownership of the California and Nevada wireless network immediately after the dissolution of GSM Facilities;

 

   

T-Mobile USA acquired 10 MHz of spectrum from Cingular in each of the San Francisco, Sacramento and Las Vegas Basic Trading Areas (BTAs) for USD 180 million. T-Mobile USA also acquired an option to purchase from Cingular an additional 10 MHz of spectrum in each of the Los Angeles and San Diego BTAs, under certain circumstances, effective two years after the initial closing of the transaction. In February 2007, the company elected to exercise the option with respect to San Diego only;

 

   

T-Mobile USA agreed to provide network services to Cingular in parts of California, Nevada and the New York City metropolitan area under a wholesale arrangement during a four-year transition period following the dissolution of GSM Facilities. Cingular is obligated to pay a minimum of USD 1.2 billion over the four-year period for these services, based on network usage;

 

   

T-Mobile USA and Cingular agreed to exchange spectrum previously used in the operation of GSM Facilities, such that each party retains 50% of such spectrum in each market;

 

   

As agreed, T-Mobile USA gave up 10 MHz of spectrum in the New York City BTA to Cingular, and T-Mobile USA received 5 MHz of spectrum from Cingular in each of the nine BTAs in the California/Nevada market on January 7, 2007; and

 

   

Amendment of the existing roaming agreement between the parties provides for a nationwide agreement.

T-Mobile USA has an ownership interest in Cook Inlet/VS GSM VII PCS Holdings, LLC, a joint venture that is managed and controlled by Cook Inlet Voice and Data Services, Inc. (“Cook Inlet”), which in turn is the sole member of Cook Inlet/VS GSM VII PCS, LLC (“CIVS VII”). CIVS VII participated in the 2005 spectrum auction (“Auction 58”) conducted by the FCC for certain Personal Communications Services (PCS) 1900 MHz licenses. Bidding for approximately one-half of the auctioned licenses was restricted to entities with revenues and assets below certain established thresholds (“Designated Entities”), while the remaining licenses were open to all bidders. Although T-Mobile USA did not qualify as a Designated Entity, CIVS VII did, and it bid on both restricted and non-restricted licenses in Auction 58. At the conclusion of Auction 58, CIVS VII was high bidder for 36 licenses in various metropolitan markets across the United States for a total of USD 255 million (subject to a reduction of up to approximately USD 20 million in bidding credits, which bidding credits may be lost in whole or in part if control of such licenses is transferred before certain predetermined minimum holding periods to a non-Designated Entity). These licenses were granted by the FCC to CIVS VII in June 2005. At the end of 2006, T-Mobile USA held an approximately 66% equity interest in CIVS VII. Although Cook Inlet manages CIVS VII, the consent of T-Mobile USA is required for certain actions undertaken by the joint venture.

Germany

Through T-Mobile Deutschland, T-Mobile offers mobile telecommunications services to individual and business customers in Germany. At December 31, 2006, T-Mobile Deutschland had approximately 31.4 million customers, including approximately 0.5 million M2M cards in use in machine-to-machine applications that were counted as customers for the first time in 2006. There were approximately 29.5 million customers at December 31, 2005, not including M2M cards in use. Of the total customers at December 31, 2006, approximately 15.1 million were contract customers, compared to approximately 14.3 million at December 31, 2005. T-Mobile Deutschland had approximately 16.3 million prepay customers at December 31, 2006, compared to approximately 15.2 million at December 31, 2005.

T-Mobile Deutschland’s total average churn rate for 2006 was 1.6% per month, compared to an average churn rate of 1.5% per month in 2005, due to an increase in the prepay churn rate. The average contract customer

 

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churn rate was 1.2% per month in 2006, which remained unchanged compared to 2005. The average prepay churn rate during 2006 was 2.0% per month, compared to the average prepay churn rate of 1.8% per month during 2005, which was primarily a result of increased competition. In general, a contract customer of T-Mobile Deutschland is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfil contractual obligations. T-Mobile Deutschland’s prepay churn policy generally states that in the 12 months following activation, a customer can originate calls/data traffic and receive data or voice communication (“phone time”). In the following 92 days, the customer can only receive data and voice communication (“message time”) and originate only SMS traffic. After these approximately 15 months, the prepay customer is churned, unless the prepay account was topped-up during the approximately 15-month period. In that case, if a EUR 15 top-up credit is added to the account, the customer gets 215 days of phone time and 92 days of message time. With EUR 30 and EUR 50 top-up credits, the phone time period is again 12 months plus 92 days message time. For two prepaid tariffs, the churn policy is different than described above. For these special tariffs, phone time for standard top-ups of EUR 15, EUR 30 and EUR 50 is 92 days followed by 92 days messaging time.

United Kingdom

T-Mobile UK offers mobile telecommunications services to individual and business customers in the United Kingdom. At December 31, 2006, T-Mobile UK had approximately 16.9 million customers, compared to approximately 17.2 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 3.7 million were contract customers, compared to approximately 3.4 million at December 31, 2005, and approximately 13.2 million were prepay customers at December 31, 2006, compared to approximately 13.7 million at December 31, 2005. Beginning January 1, 2006, T-Mobile UK has counted its wholesale customers as either contract or prepay customers. Until December 31, 2005, T-Mobile UK counted all of its wholesale customers as contract customers.

Of the total number of T-Mobile UK customers at December 31, 2006 and 2005, approximately 5.3 million and 6.2 million, respectively, were customers of Virgin Mobile Telecoms Limited (“Virgin Mobile”), which is a MVNO. All Virgin Mobile customers currently use T-Mobile UK prepaid technology and are therefore reported as prepay customers. Virgin Mobile reports to T-Mobile UK the number of customers using a churn policy, whereby a customer is churned after a period of 180 days of inactivity. As a virtual network operator, Virgin Mobile purchases airtime minutes and basic mobile services from T-Mobile UK and resells these minutes and services under the “Virgin Mobile” brand name. Until January 2004, Virgin Mobile had been a joint venture between T-Mobile UK and the Virgin Group. At that time, T-Mobile UK sold its 50% equity stake in Virgin Mobile to the Virgin Group and received a payment of GBP 50 million (approximately EUR 75 million) in exchange for waiving its right to participate in any initial public offering of Virgin Mobile. Additionally, T-Mobile UK and Virgin Mobile concluded a telecommunications supply agreement granting Virgin Mobile use of T-Mobile UK’s mobile telecommunications network for a further ten years. In 2006, NTL Incorporated acquired Virgin Mobile Holdings (UK) plc, the parent company of Virgin Mobile. This acquisition has not had a significant impact on the telecommunications supply agreement between T-Mobile UK and Virgin Mobile.

During 2006, T-Mobile UK’s average monthly churn rate (not including Virgin Mobile customers) was 3.3%, compared to 3.1% in 2005. The increase in churn was predominantly caused by a significant increase in T-Mobile UK’s prepay churn rate of 3.8% per month in 2006, compared to 3.1% per month in 2005. This increase is caused by an increase in the inactive prepay subscriber base and the loss of wholesale subscribers due to competiton. The contract churn rate decreased to 2.1% per month in 2006, compared to 2.9% per month in 2005, due to attractive retention offers for T-Mobile UK’s contract customers.

Generally, a contract customer of T-Mobile UK is churned either after the voluntary termination upon the lapse of a contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. A prepay customer in the United Kingdom is churned after a period of 180 days of inactivity (i.e., the customer has neither originated nor received a voice or data communication in that period).

 

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Poland

T-Mobile holds a 97% interest in PTC. Since November 1, 2006, PTC has been fully consolidated in the results of T-Mobile. At December 31, 2006, PTC had approximately 12.2 million customers, of which approximately 4.5 million were contract customers and approximately 7.7 million were prepay customers.

In general, a contract customer of PTC is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfil contractual obligations. PTC’s prepay churn policy generally states that a customer can originate calls/data traffic and receive data or voice communication during his validity period, which depends on the tariffs and can be up to 12 months (account validity). This validity period can be extended by top-up credits. If a customer exceeds the account validity date, he will stay in a grace period of either 3 or 12 months depending on his tariff, in which the customer can only receive voice or data communication. If the prepay account has not been topped up during this grace period, the customer is churned.

For information regarding a dispute concerning our investment in PTC, including challenges to our ownership of PTC shares, see “Item 8. Financial Information—Legal Proceedings.”

Hungary

Through T-Mobile Hungary (formerly Westel Mobil Távközési Rt., which was re-named T-Mobile Hungary Ltd. in May 2004), T-Mobile offers mobile telecommunications services to individual and business customers in Hungary. Our interest in T-Mobile Hungary is held through a 59% interest in Magyar Telekom.

At December 31, 2006, T-Mobile Hungary had approximately 4.4 million customers, compared to approximately 4.2 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 1.5 million were contract customers, compared to approximately 1.3 million at December 31, 2005. T-Mobile Hungary had approximately 2.9 million prepay customers at December 31, 2006, approximately the same number as it had at December 31, 2005.

T-Mobile Hungary’s average churn rate during 2006 was 1.5% per month, which is approximately the same as in 2005. The average contract churn rate decreased, from 0.9% per month in 2005 to 0.8% per month in 2006, primarily as a result of various customer retention campaigns in 2006. The corresponding prepay customer churn rate was 1.8% per month, which is approximately the same as in 2005. Generally, a contract customer of T-Mobile Hungary is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. In the absence of re-charging, a prepay customer is churned after a period of 12 to 16 months depending on the amount charged on the prepay card.

The Netherlands

Through T-Mobile Netherlands, T-Mobile offers mobile telecommunications services to individual and business customers in the Netherlands.

At December 31, 2006, T-Mobile Netherlands had approximately 2.6 million customers, compared to approximately 2.3 million customers at December 31, 2005. This increase is mainly a result of growth in both contract and prepay customers. At the end of 2006, approximately 1.3 million customers were contract customers and approximately 1.2 million were prepay customers, compared to approximately 1.2 million contract customers and approximately 1.1 million prepay customer at the end of 2005.

The average churn rate for 2006 was 2.8% per month, compared to an average churn rate of 3.1% per month in 2005, due to a decrease in the contract churn rate, which was partially offset by an increase in the prepay churn rate. The average contract churn rate decreased from 2.2% per month in 2005 to 1.5% per month in 2006 due to attractive retention offers to contract customers. The average prepay churn rate increased from 4.0% per month in 2005 to 4.2% per month in 2006 due to increased competition in the Dutch market. In general, a contract customer of T-Mobile Netherlands is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. If a prepay

 

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customer has neither originated nor received a voice or non-voice activity (or received only SMS/MMS messages) for a period of 180 days, the customer is churned and removed from the customer base, provided the customer’s account has not been re-charged during that period.

Czech Republic

Through T-Mobile Czech Republic, T-Mobile offers mobile telecommunications services to individual and business customers in the Czech Republic. T-Mobile’s equity interest in T-Mobile Czech Republic is held through its wholly-owned subsidiary, CMobil, which owns approximately 61% of T-Mobile Czech Republic.

At December 31, 2006, T-Mobile Czech Republic had approximately 5.0 million customers, compared to approximately 4.6 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 1.8 million were contract customers, compared to approximately 1.3 million at December 31, 2005. T-Mobile Czech Republic had approximately 3.2 million prepay customers at December 31, 2006, compared to approximately 3.3 million prepay customers at December 31, 2005.

T-Mobile Czech Republic’s average churn rate increased during 2006, from 1.1% per month in 2005, to 1.4% per month in 2006, primarily due to an increase of the prepay churn rate. The average contract churn rate during 2006 was 0.7% per month, compared to the average contract churn rate of 0.6% per month during 2005. The average prepay churn rate during 2006 was 1.7% per month, compared to the average prepay churn rate of 1.3% per month during 2005, which was driven by a higher number of customers who were acquired with special time limited offers. Generally, a contract customer is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. In the absence of re-charging, a prepay customer is churned 30 days after completing a period of 12 months without charged voice or data communications activity.

Austria

Through T-Mobile Austria, T-Mobile offers mobile telecommunications services to individual and business customers in Austria. On April 28, 2006, T-Mobile Austria acquired tele.ring. At December 31, 2006, T-Mobile Austria had approximately 3.2 million mobile customers (including approximately 1.0 million tele.ring customers). Of the total customers at December 31, 2006, approximately 2.0 million were contract customers (including approximately 0.8 million tele.ring customers) and approximately 1.2 million were prepay customers (including approximately 0.2 million tele.ring customers).

T-Mobile Austria’s acquisition of tele.ring is subject to certain conditions imposed by the European Commission and the Austrian Telekom-Control-Kommission. The main conditions are the sale of certain sites and UMTS frequencies to smaller competitors in order to strengthen their market and competitive positions. T-Mobile Austria will sell redundant sites not being used after the merger of the two networks. On September 23, 2006, T-Mobile Austria and tele.ring legally merged.

T-Mobile Austria’s average churn rate during 2006 slightly increased to 1.9% per month (tele.ring’s average churn rate was 2.3% per month during 2006), as compared to the average churn rate of 1.8% per month during 2005. The average churn rate for contract customers during 2006 remained unchanged at 1.3% per month compared to 2005 (tele.ring’s average contract churn rate was 1.5% per month during 2006). In general, a contract customer is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations.

Since the beginning of December 2004, T-Mobile Austria has generally churned prepay customers if they had 12 months and six weeks without any account movements (e.g., account top-up or outgoing traffic) and six months without incoming voice calls longer than one minute. Tele.ring generally churns prepay customers after three months without any account movements.

Croatia

Through T-Mobile Hrvatska d.o.o. (“T-Mobile Croatia”), T-Mobile offers mobile telecommunications services to individual and business customers in Croatia. Deutsche Telekom’s equity interest in T-Mobile Croatia is held through its 51% equity interest in T-Hrvatski Telekom, which owns 100% of T-Mobile Croatia’s share capital.

 

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At December 31, 2006, T-Mobile Croatia had approximately 2.2 million customers, compared to approximately 1.9 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 0.6 million were contract customers, compared to approximately 0.4 million at December 31, 2005. T-Mobile Croatia had approximately 1.6 million prepay customers at December 31, 2006, compared to approximately 1.5 million at December 31, 2005.

T-Mobile Croatia’s average monthly churn rate during 2006 was 1.1%, compared to 1.0% in 2005. The average contract churn rate was 1.1% per month in 2006, which remained unchanged, compared to 2005. The average prepay churn rate during 2006 was 1.1% per month, compared to 1.0% per month in 2005. In general, a contract customer is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. Until December 2005, a prepay customer was churned after a period of 90 days without re-charging. In December 2005, T-Mobile Croatia changed its churn policy to churn a prepay customer after a period of 270 days without re-charging, which is in line with its competitors.

Slovakia

Through T-Mobile Slovensko, T-Mobile offers mobile telecommunications services to individual and business customers in Slovakia. T-Mobile Slovensko has been fully consolidated since the beginning of 2005. Prior to 2005, we did not fully consolidate T-Mobile Slovensko as we were not in a control position, due to certain minority holder rights. Deutsche Telekom’s equity interest in T-Mobile Slovensko is held through its 51% equity interest in Slovak Telekom, a.s., which owns 100% of T-Mobile Slovensko’s share capital.

At December 31, 2006, T-Mobile Slovensko had approximately 2.2 million customers, compared to approximately 2.0 million at December 31, 2005. Of the total customers at December 31, 2006, approximately 1.0 million were contract customers, compared to approximately 0.8 million at December 31, 2005. T-Mobile Slovensko had approximately 1.2 million prepay customers at December 31, 2006, which is approximately the same number of prepay customers it had at December 31, 2005.

T-Mobile Slovensko’s average churn rate during 2006 was 1.6% per month, which represents a decrease from 1.9% in 2005. The average contract churn rate decreased, from 1.3% per month in 2005 to 1.0% per month in 2006, primarily due to intensive retention campaigns. The average prepay churn rate decreased, from 2.3% per month in 2005 to 2.0% per month in 2006, primarily due to the discontinuation in 2006 of a promotion providing prepaid SIM cards to customers on a trial basis in comparison with 2005.

Generally, a contract customer is churned either after the voluntary termination upon the lapse of his contract or after forced contract termination due to the customer’s failure to fulfill contractual obligations. A prepay customer is churned after a period of 12 months without re-charging calculated from the last use, or if the prepay account is overdrawn.

Macedonia

In Macedonia, T-Mobile offers mobile telecommunications services through T-Mobile Macedonia. T-Mobile Macedonia is a wholly-owned subsidiary of A.D. Makdonski Telekom unikacii (“MakTel”), which is majority owned by Magyar Telekom.

At December 31, 2006, T-Mobile Macedonia had approximately 0.9 million customers, which is approximately the same number of customers it had at December 31, 2005.

Montenegro

In Montenegro, T-Mobile offers mobile telecommunications services through T-Mobile Crna Gora (Montenegro). All of the share capital of T-Mobile Crna Gora (Montenegro) is held by Crnogorski Telekom, which is majority owned by Magyar Telekom.

 

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At December 31, 2006, T-Mobile Crna Gora (Montenegro) had approximately 0.3 million customers, compared to 0.2 million customers at December 31, 2005.

Seasonality

T-Mobile’s business in each of its principal markets is affected by seasonal factors, with a general increase in sales of products and services occurring during the fourth calendar quarter, due to holiday purchases. As a result, T-Mobile’s performance during the fourth quarter can have a significant influence on its performance for the full year.

Suppliers

T-Mobile purchases IT and network components, as well as mobile devices for purposes of resale, from a number of different suppliers.

T-Mobile believes that it has reduced its technological risks and the risk of delays in the supply of equipment and other technologies, both by contracting with multiple suppliers having significant market share in the network infrastructure and mobile device businesses, and by negotiating contractual penalties to be enforced in the event a supplier does not meet its obligations with respect to timeliness and quality. However, these penalty provisions may not fully mitigate the harm to our business caused by any such contractual breaches.

Marketing and Sales

Each of T-Mobile’s principal subsidiaries uses its own combination of direct and indirect distribution channels to market its products and services to its customers. In each of T-Mobile’s principal markets, T-Mobile markets its products and services to retail customers through its own network of direct-retail outlets, which are continuously being expanded. In Germany, these direct retail outlets (T-Punkt shops) are operated by a separate affiliated company for the entire Deutsche Telekom group. Further direct-sales channels include a direct-sales force dedicated to business customers, sales through customer service and the T-Mobile Web sites, which are used for customer-relationship management as well as for sales transactions. In addition, third-party distributors, who typically market the products and services of multiple mobile network operators, play a significant role in distribution. Our mobile telecommunications subsidiaries use a variety of incentives to encourage third-party vendors to sell T-Mobile products and services, such as payment of associated marketing expenses and offering special commissions.

Mobile telecommunications resellers and MVNOs are also an important distribution channel for T-Mobile products and services, especially in Germany and the United Kingdom. Mobile telecommunications resellers purchase network access at wholesale rates, and mobile devices at a discount, from network operators, resell packaged services and mobile devices under their own brands through their own distribution channels, charge their customers at rates that they set independently and provide customer service and technical support.

T-Mobile provides its customers with access to T-Mobile specific and third-party content services as well as to the open Internet. Content provided to customers is either for free, in which case the customer only has to pay the normal connection charges to view the content, or it is premium content, where a customer pays a specific charge through the customer’s mobile telephone bill to access the content.

Since 2005, T-Mobile, through its “web’n walk” product, offers its customers mobile open access to the Internet on mobile phones. T-Mobile believes that this strategy is superior to the offers of its competitors, who determine the content access for its customers.

Dependence on Patents, Licenses and Industrial, Commercial or Financial Contracts

T-Mobile owns a large number of registered patents and generally has a number of patent applications outstanding at any given time for technical innovations in the area of mobile telecommunications applications, as a consequence of its development activities. Patent protection activity is focused on countries with T-Mobile operations. We do not believe that T-Mobile is dependent on any one patent or group of patents.

 

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To enable us to offer mobile telecommunications services in the different jurisdictions in which we operate, we require, and therefore are dependent on, telecommunications licenses from the relevant authorities in each of these jurisdictions. For further information, see “—Regulation.”

We do not believe that T-Mobile is dependent on any third-party industrial, commercial or financial contracts.

Competition

General

Competition in the mobile telecommunications market is generally intense and conducted on the basis of price, subscription options and range of services offered, offers of subsidized mobile devices, coverage, innovation and quality of service.

In the past, competition in the European mobile telecommunications market was conducted at the national level. Increasingly, however, competition in this market is being conducted on a more international basis, as Europe-wide services are being introduced.

In Western Europe, the rate of mobile telephone penetration is quite high. As a result, T-Mobile expects that the growth in the number of T-Mobile customers in these markets will be significantly lower than in past years, and that the focus of competition will continue to shift from customer acquisition to customer retention, and to increasing average revenues per user by stimulating demand for voice usage and new data products and services. T-Mobile believes that, as competition intensifies in its European markets, customer terminal equipment subsidies will be reduced and competition will focus more on the service revenue market rather than on numbers of customers.

The global mobile telecommunications industry has been undergoing consolidation in recent years, which may increase competitive pressure, and we expect that this will continue in the coming years.

In addition, new technologies, whether introduced by us or by others, can be expected to draw customers from existing technologies, including our customers. The competitive dynamics of the mobile telecommunications industry, therefore, could change in ways that we cannot predict which could adversely affect our results of operations and, thus, our financial position.

United States

T-Mobile USA faces intense competition in the U.S. mobile telecommunications market from the three other large national mobile providers, Verizon, Cingular and Sprint/Nextel, and from various regional operators. These four large national carriers are estimated to represent approximately 85% of the total U.S. mobile telephony customer base as of September 30, 2006. T-Mobile USA’s customer market share, measured against the other large nation-wide operators, was approximately 13% at September 30, 2006, which was the same at December 31, 2005. Most of these competitors or their predecessors had been operating in the U.S. mobile telecommunications market for a considerable time prior to the entry of T-Mobile USA’s predecessors into the U.S. market.

Verizon, Cingular and Sprint/Nextel together represent approximately 74% of the total U.S. mobile telephony market in terms of customers as of September 30, 2006. These companies have potential advantages of size and scale that could allow them to deliver services in a more cost-efficient manner and thereby negatively affect T-Mobile USA’s competitive position.

The U.S. mobile telecommunications market is quite different in a number of respects from the European mobile telecommunications markets. For example, there is no single communications standard. In addition, licenses to provide wireless services cover numerous localities, rather than the entire nation. It can therefore be difficult for network operators to obtain the spectrum needed in some localities to expand customer bases, upgrade the quality of service and add new services, particularly in densely populated urban areas. Low population density in other areas can cause problems with network efficiency and result in large geographic areas with no or limited coverage. For these and other reasons, including the extremely high penetration level of

 

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reliable, low cost, fixed-line telephony services, penetration levels for mobile telephony services in the United States are generally lower than penetration levels in Western European countries. As a result, mobile telecommunications operators in the U.S. market generally continue to invest heavily in order to encourage and capture growth in customer numbers.

Usage and pricing practices in the U.S. mobile market also differ significantly from those typically seen in European markets. Average voice usage per customer per month is generally much higher in the United States than in Europe. Contract pricing in the United States is typically in the form of a fixed monthly charge at various price points for specified bundles of features and services, which permit usage up to prescribed limits with no incremental charges. Usage in excess of the limits results in incremental charges. Prepay usage is generally priced solely on a usage basis. Typically, both inbound and outbound usage counts against the contract usage limits, and both are subject to incremental charges for excess contract usage and prepaid usage. Monthly average revenue per user (ARPU) is typically higher in the United States than in Europe. However, average revenue per minute of use is substantially lower in the United States than in Europe.

The differences between the U.S. and European mobile telephony markets result in different competitive pressures in these markets. In the United States, coverage is a key competitive factor, as is the perceived value of bundles of minutes, features and services at the most popular price points. To the extent that the competitive environment requires us to decrease prices, or increase our service and product offerings, our revenues could decline, our costs could increase and our customer retention could be adversely affected.

Germany

In Germany, T-Mobile Deutschland faces intense competition from mobile network operators Vodafone, E-Plus and O2. We believe that T-Mobile Deutschland maintained its market leadership position, in terms of number of customers, at September 30, 2006, but its smaller competitors, O2 and E-Plus, gained ground compared to 2005.

T-Mobile believes that T-Mobile Deutschland had a customer market share of approximately 37% at September 30, 2006, while Vodafone had a customer market share of approximately 36%, E-Plus had a customer market share of approximately 15% and O2 had a customer market share of approximately 13%. T-Mobile believes that the overall penetration rate in the German mobile telecommunications market was approximately 100% at September 30, 2006.

In the retail market, in addition to competition from other network operators, T-Mobile Deutschland faces significant competition from resellers. T-Mobile expects that, in the short term, the multi-brand strategy of E-Plus, as well as the market entry of existing and potentially new resellers will significantly affect mobile telephony prices and attract customers from the other existing mobile operators.

United Kingdom

In the United Kingdom, T-Mobile UK faces intense competition, principally from Vodafone, O2 and Orange. In addition, T-Mobile UK faces competition from “3” (a brand name of Hutchison 3G UK Limited). T-Mobile believes that T-Mobile UK’s customer market share, which includes customers of Virgin Mobile, decreased to approximately 24% as of September 30, 2006, compared to approximately 25% in 2005. Virgin Mobile has changed its customer base definition and as a result, its subscriber base decreased at the beginning of 2006. T-Mobile believes that the penetration rate in the UK mobile telecommunications market was approximately 114% at September 30, 2006.

In the retail market, in addition to competition from other mobile network operators, T-Mobile UK faces significant competition from resellers, as well as from other MVNOs.

Poland

In Poland, PTC faces competition from Polkomtel and Centertel. T-Mobile believes that PTC’s customer market share was approximately 34% at September 30, 2006 and that the penetration rate in the Polish mobile telecommunications market was approximately 90% at September 30, 2006.

 

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Hungary

In Hungary, T-Mobile Hungary faces competition from Pannon GSM and Vodafone Hungary. T-Mobile believes that T-Mobile Hungary’s customer market share was approximately 45% as of September 30, 2006, approximately the same market share as in 2005, Pannon GSM had a market share of approximately 34%, compared to 33% in 2005, and Vodafone Hungary had a market share of approximately 21% in 2006, compared to approximately 22% in 2005. T-Mobile believes that the penetration rate in the Hungarian mobile telecommunications market was approximately 93% at September 30, 2006.

The Netherlands

In the Netherlands, T-Mobile Netherlands faces intense competition from KPN Mobile (including Telfort), Vodafone and Orange. T-Mobile believes that T-Mobile Netherlands’ customer market share was approximately 15% as of September 30, 2006, compared to approximately 14% in 2005, while KPN Mobile (including Telfort), Vodafone and Orange had a market share of approximately 50%, 23% and 12%, respectively, in 2006, compared to approximately 50%, 24% and 12%, respectively, in 2005. T-Mobile believes that the penetration rate in the Dutch mobile telecommunications market was approximately 103% at September 30, 2006.

In the Dutch retail market, in addition to competition from the mobile network operators mentioned above, T-Mobile Netherlands competes with an increasing number of MVNOs.

Czech Republic

In the Czech Republic, T-Mobile Czech Republic faces competition from Telefónica O2 Czech Republic (formerly Eurotel Praha) and Vodafone Czech Republic (formerly Oskar Mobil). T-Mobile believes that T-Mobile Czech Republic’s customer market share was approximately 41% at September 30, 2006, compared to approximately 41% in 2005, Telefónica O2 Czech Republic had approximately 40%, compared to approximately 41% in 2005, and Vodafone Czech Republic had approximately 19%, compared to approximately 19% in 2005. We believe that the penetration rate in the Czech mobile telecommunications market was approximately 116% at September 30, 2006.

Austria

In Austria, T-Mobile Austria primarily faces competition from mobilkom austria, ONE and “3”. T-Mobile believes that T-Mobile Austria’s customer market share after the consolidation of tele.ring was approximately 35% at September 30, 2006, and the customer market shares of mobilkom austria, ONE and “3” were approximately 39%, 22% and 4%, respectively. T-Mobile believes that the penetration rate in the Austrian mobile telecommunications market was approximately 110% at September 30, 2006.

Croatia

In Croatia, T-Mobile Croatia faces competition from VIPnet and Tele2. T-Mobile believes that T-Mobile Croatia’s customer market share was approximately 50% as of September 30, 2006, compared to approximately 52% in 2005. T-Mobile believes that the penetration rate in the Croatian mobile telecommunications market was approximately 93% at September 30, 2006.

Slovakia

In Slovakia, T-Mobile Slovensko faces competition from Orange. T-Mobile believes that T-Mobile Slovensko’s customer market share was approximately 45% as of September 30, 2006, compared to approximately 45% in 2005. T-Mobile believes that the penetration rate in the Slovak mobile telecommunications market was approximately 87% at September 30, 2006.

Macedonia

In Macedonia, T-Mobile Macedonica faces competition from Cosmofon AD. T-Mobile believes that T-Mobile Macedonia’s customer market share was approximately 67% at September 30, 2006, compared to approximately 70% at September 30, 2005. T-Mobile believes that the penetration rate in the Macedonian mobile telecommunications market was approximately 66% at September 30, 2006.

 

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Montenegro

In Montenegro, T-Mobile Crna Gora (Montenegro) faces competition from ProMonte. T-Mobile believes that T-Mobile Crna Gora’s customer market share was approximately 36% as of September 30, 2006, compared to approximately 40% in 2005.

Broadband/Fixed Network

The Broadband/Fixed Network strategic business area offers consumers and small business customers state-of-the-art infrastructure for traditional fixed-network services, broadband Internet access, and customer-oriented multimedia services. Broadband/Fixed Network also provides services to national and international network operators and resellers, and provides products and services for Deutsche Telekom’s other strategic business areas.

The merger of T-Online International AG into Deutsche Telekom AG, which had been approved by shareholders in 2005, did not become immediately effective due to lawsuits filed by some T-Online shareholders. However, with the final ruling of the Federal Court of Justice (Bundesgerichtshof), the merger became effective when it was entered in the commercial registers on June 6, 2006. With the entry of the merger in the commercial registers, T-Online shareholders became Deutsche Telekom AG shareholders. Following the merger, T-Online no longer reports as a separate legal entity. However, Deutsche Telekom still employs the T-Online brand for most of Broadband/Fixed Network’s mass market IP-based services in Germany. For more information relating to the merger, see “Item 5. Operating and Financial Review and Prospects—Management Overview” and “Item 8. Financial Information—Legal Proceedings.”

The merger of T-Online into Deutsche Telekom has enabled the Broadband/Fixed Network strategic business area to achieve improved structural as well as product and service efficiencies. Customers now receive fully integrated products and services from a single source, which previously were provided separately by T-Com and T-Online. Additionally, a new, simplified and integrated portfolio of rates and services was introduced in September 2006. The new portfolio, called “3x3 Complete Packages” (3x3 Komplettpakete), includes a variety of flat rates and services for telephony, surfing the Internet and Internet television in an assortment of combinations. These product offerings are marketed as basic telephony services (“single-play”), telephony and high-speed Internet access (“double-play”) and high-speed Internet access, communications services and entertainment offerings (“triple-play”). Triple-play, also marketed as “T-Home,” was launched in October 2006.

Principal Activities

The Broadband/Fixed Network strategic business area operates one of the largest fixed-line networks in Europe in terms of the number of lines provided. Broadband/Fixed Network also operates one of the largest Internet Service Providers (“ISPs”) in Europe in terms of subscribers and revenues. Broadband/Fixed Network reports its domestic and international operations separately. The Scout24 group is included within domestic operations since its parent company has its registered office in Germany. The principal activities of the Broadband/Fixed Network strategic business area include:

 

   

Network communications services, consisting of network access products (excluding broadband) and calling services;

 

   

Wholesale services, for domestic and international customers, including voice services, IP services, network and access services (Resale DSL and the unbundled local loop) and solutions;

 

   

IP/Internet products and services (mainly marketed to retail customers under the T-Online brand name), including broadband access, VoIP, ISP access-related services, video-on-demand, triple-play services, digital distribution platforms for games (marketed as Gamesload), software (marketed as Softwareload) and music (marketed as Musicload);

 

   

Data communications services and solutions provided through the Business Customers strategic business area to small- and medium-sized enterprises, including products based on IP, which include intranet and extranet solutions, as well as leased lines;

 

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Value-added services (special purpose telephony services), including toll-free services and public payphones;

 

   

Other services, including publishing services, customer retention programs, installation and maintenance services;

 

   

Terminal equipment for telecommunications, including the distribution of T-Com’s own brand as well as the brands of leading telecommunications and IT manufacturers;

 

   

Fixed-line network services, wholesale services, IP/Internet services and multimedia services (radio and television) in certain countries in Eastern Europe, through its subsidiaries Magyar Telekom (Hungary), Slovak Telekom (Slovakia) and T-Hrvatski Telekom (Croatia); and

 

   

IP/Internet services in Western Europe provided through T-Online Spain (marketed as “Ya.com”) and T-Online France (marketed as “Club Internet”).

Most of Broadband/Fixed Network’s revenues in 2006 were derived from fixed-line network communications services provided within Germany, primarily in the form of access and calling services revenues. For more information, see “Item 5. Operating and Financial Review and Prospects—Segment Analysis—Broadband/Fixed Network.”

The following table reflects the number of broadband and narrowband access lines in operation supported by our Broadband/Fixed Network strategic business area:

 

     As of
December 31,
2006
   As of
December 31,
2005
  

%

Change
December 31,
2006/
December 31,
2005

    As of
December 31,
2004
  

%

Change
December 31,
2005/
December 31,
2004

 
     (millions, except where indicated)  

Broadband(1)

             

Lines (total)(2)

   11.7    8.6    36.9     6.1    41.5  

Domestic(3)

   10.3    7.9    29.8     5.8    36.9  

of which: resale(4)

   3.2    1.6    n.m.     0.2    n.m.  

International(5)

   1.4    0.6    n.m.     0.3    n.m.  

Broadband rates (total)(6)

   8.0    5.5    45.5     3.8    45.6  

of which: domestic

   6.3    4.5    41.2     3.2    38.0  

Narrowband(1)

             

Lines (total)(2)

   39.0    41.2    (5.5 )   42.8    (3.7 )

Domestic(7)

   33.2    35.2    (5.8 )   36.8    (4.1 )

Standard analog lines

   24.2    25.5    (5.2 )   26.4    (3.3 )

ISDN lines

   9.0    9.8    (7.5 )   10.4    (6.1 )

International (Eastern Europe only)

   5.8    6.0    (3.9 )   6.1    (1.0 )

Magyar Telekom(8)

   3.0    3.2    (5.7 )   3.2    (0.4 )

Slovak Telekom

   1.2    1.2    (2.3 )   1.2    (3.9 )

T-Hrvatski Telekom

   1.6    1.7    (1.7 )   1.7    (0.1 )

Narrowband rates (total)(6)

   3.2    4.4    (27.2 )   5.4    (19.1 )

Internet customers with a billing relationship (total)(9)(10)

   16.6    15.2    8.8     14.5    5.1  

n.m.—not meaningful

Table includes broadband and narrowband lines (Germany plus Eastern and Western Europe). Eastern Europe includes Magyar Telekom, T-Hrvatski Telekom and Slovak Telekom; Western Europe includes T-Online Spain and T-Online France.

 

(1) The total was calculated on the basis of precise figures and rounded to millions. Percentages have been calculated on the basis of precise figures.
(2) Lines in operation.
(3) Broadband lines excluding lines for internal use.

 

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(4) Definition of resale: sale of broadband lines based on DSL technology to alternative providers outside the Deutsche Telekom group.
(5) Western Europe includes only broadband lines on Broadband/Fixed Network’s own network.
(6) Represents customers with an ISP billing relationship (“ISP customers”) in Germany, Eastern and Western Europe. These amounts include PAYG customers of Magyar Telekom.
(7) Telephone lines excluding internal use and public payphones, including wholesale services.
(8) Narrowband lines for December 31, 2006, encompass customer relationships for Magyar Telekom’s subsidiary MakTel and Crnogorski Telekom (formerly Telekom Montenegro). Prior-year comparatives have not been adjusted.
(9) Total calculated on the basis of customers (broadband and narrowband rates) in Germany, Western and Eastern Europe with a billing relationship and pay as you go customers (those customers who do not have a rate plan with a monthly basic charge).
(10) Figures include T-Hrvatski Telekom’s subsidiary Iskon Internet d.d. since June 2006.

During 2006, the number of Broadband/Fixed Network’s narrowband lines in Germany decreased at a greater rate than expected. This is primarily due to increased competition from alternative fixed-network providers with fully integrated bundled packages, as well as fixed-to-mobile substitution. The loss of narrowband customers also occurs in connection with customers’ initial acquisition of a broadband line. Additionally, since the merger of T-Online with Deutsche Telekom was not effective until June 2006, the Broadband/Fixed Network strategic business area had only limited capacity to act in the market with the integrated product offerings.

In Germany, the number of Broadband/Fixed Network narrowband lines decreased by 2.0 million or 5.8% to 33.2 million in 2006. Broadband/Fixed Network’s estimated market share for narrowband lines declined from 94.9% in 2004 to 91.3% in 2005 to 86.9% in 2006 based on information from the Federal Network Agency’s 2006 annual report. Although not as significant as the factors mentioned above, substitution by cable network operators also contributed to this decline.

Broadband/Fixed Network intends to pursue new business opportunities, and expects to continue its growth in the broadband area and to increase the number of broadband lines in operation through the offering of more competitive rate plans, including flat-rate plans, and new products and services. Broadband/Fixed Network also intends to introduce non-access related broadband services. In addition, the Broadband/Fixed Network strategic business area is focusing on defending its market share in its core businesses by stabilizing narrowband access lines and reducing the loss of call minutes.

Broadband services allow customers to access the Internet and Internet-related services at significantly higher speeds than traditional dial-up services. Broadband is used to refer to ADSL (asymmetric digital subscriber line), ADSL2 and ADSL2+ (more advanced ADSL technology) and VDSL (very high-speed digital subscriber line) technologies, for which the downstream data rate is greater than 128 Kbit/s. For more information, see “—Operations in Germany—IP/Internet Services—Broadband Access” below.

The broadband market continued to grow during 2006. Falling prices for services provided by Internet service providers (ISPs), and competitively priced bundled broadband access, voice and ISP product offerings by fixed-network operators, were factors in the continued growth of the broadband market.

The total number of broadband lines in operation in Germany provided by Broadband/Fixed Network increased by 2.4 million, or 29.8%, from 7.9 million at December 31, 2005 to 10.3 million at December 31, 2006. This increase was primarily due to an increase in the number of Resale DSL lines sold to alternative providers from 1.6 million at December 31, 2005 to 3.2 million at December 31, 2006. This incease was also due to an increase in the rate of growth of retail DSL customers in Germany, especially in the fourth quarter after Broadband/Fixed Network’s initial introduction of bundled offerings providing broadband access, voice and ISP products. We expect the number of retail and Resale DSL lines in operation provided by Broadband/Fixed Network to continue to increase in conjunction with the overall increase in the market for broadband connections in Germany.

With approximately 16.6 million ISP customers as of December 31, 2006, Broadband/Fixed Network is one of the largest European ISPs, based on both revenues and number of customers. Compared to December 31, 2005, Broadband/Fixed Network’s ISP customers increased by approximately 1.4 million. The total number of customers with broadband rates increased by 2.5 million, or 45.5%, from 5.5 million as of December 31, 2005 to 8.0 million at the end of 2006. The increase in ISP customers with broadband rates was partially offset by a decrease in ISP customers with narrowband rates. Customers with narrowband rates decreased by 1.2 million, or 27.2%, from 4.4 million as of December 31, 2005 to 3.2 million at the end of 2006, primarily due to customer

 

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migration from narrowband rates to broadband rates. In Germany, the number of customers with broadband rates increased 41.2%, from 4.5 million as of December 31, 2005 to 6.3 million as of December 31, 2006. International operations posted a 63.4% increase in the number of customers with broadband rates as of December 31, 2006, compared to December 31, 2005. The growth internationally is primarily due to attractive products and rate offerings in Eastern and Western Europe. The comparatively low market penetration rates in Eastern Europe provide for continuing growth opportunities.

Broadband/Fixed Network expects that market share in narrowband access lines and the prices for narrowband products will continue to decrease due to fixed-to-mobile substitution, competition from other fixed- line operators and an increase in sales of broadband products in connection with increased use of IP-based networks. Broadband/Fixed Network also expects that the adoption of IP-based networks by fixed-line operators will lead to the obsolescence of PSTN networks in the medium term. This should contribute to a loss in narrowband access lines, which we belive will be accompanied by a smaller increase in the number of broadband lines in operation and related demand for products by ISP customers.

We expect that the new 3x3 Complete Packages integrated product and rate portfolio, which was introduced in September 2006, will contribute to increased use of broadband lines and ISP products by our customers. These new integrated offers were accepted by 3.6 million customers as of December 31, 2006. The integrated broadband access, ISP and VoIP features available from Broadband/Fixed Network in conjunction with the new service initiatives are expected to increase customer satisfaction and loyalty.

Operations in Germany

Network Infrastructure

Broadband/Fixed Network’s present network infrastructure is comprised of access and transmission networks and service platforms.

Broadband/Fixed Network has been investing in modern network infrastructure technologies since 2005, which will form the basis of its next generation network (NGN). The development of Broadband/Fixed Network’s NGN is a long-term objective and necessitates the implementation and integration of network enhancement technologies, as well as other technologies. NGN technologies are currently being integrated into the existing network infrastructure and will replace elements of the existing network, such as asynchronous transfer mode (ATM) and Synchronous Digital Hierarchy (SDH), as well as platforms such as the public switched telephone network (PSTN). The network infrastructure will integrate existing constituent IP platforms into a single IP architecture and will benefit from the performance advantages offered by high-speed network structures. The overall design concept of T-Com’s migration to a NGN based network is based on several key principles. For instance, introduction of leading-edge NGN technologies on all network layers denotes a move towards a layered architecture, a shift from circuit (i.e., voice based) to packet technologies (i.e., IP-based), and utilization of ethernet and passive optical network technologies. An NGN approach results in a reduction in an assortment of technologies and platforms through its utilization of a leaner infrastructure, as well as in a reduction in resources needed to operate the network. Therefore, implementation of NGN technologies increases the efficiency and innovation potential of the existing network. Implementation of the NGN will result in the replacement of certain service platforms in the mid- to long-term, including our PSTN.

Access Network

Broadband/Fixed Network offers ICT access for individual customers, very small business customers and other carriers. Typically a customer has access to Broadband/Fixed Network’s network by means of a copper cable that runs from Broadband/Fixed Network’s transmission network to the customer’s home or office. The portion of the access network that connects the transmission network to the customer is commonly referred to as the “last mile” or “local loop.” Broadband/Fixed Network began to significantly upgrade its access network in 2005 through implementation of the NGN enabling access technologies, such as VDSL high-speed access technology. The implementation of VDSL beyond the initial ten more densely populated metropolitan areas was temporarily suspended in 2006 due to concerns surrounding regulatory developments. Broadband/Fixed Network intends to continue to pursue the build-out of its network but expects that this will occur more slowly than originally anticipated.

 

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Broadband/Fixed Network also intends to continue to upgrade its broadband-access network by expanding the use of ADSL2+ technology. ADSL2+ will enable customers to realize access speeds of up to 20 Mbit/s. The ADSL2+ technology will be provided to approximately 700 smaller cities and less densely populated urban areas in Germany.

For more information regarding network-access regulation, see “—Regulation—German Telecommunications Regulation—Interconnection.”

Transmission Network

Broadband/Fixed Network’s transmission network consists of fiber-optic cables enhanced with Wavelength Division Multiplexing (WDM) and SDH technologies, as well as other network components. WDM uses wavelengths of light to increase the capacity of fiber-optic cables, thereby allowing multiple communication channels. This allows Broadband/Fixed Network to increase the capacity of its transmission network without having to use additional fiber-optic cable. SDH is an international high-speed transmission standard, which improves network management and increases the reliability of fiber-optic networks. During 2006, Broadband/Fixed Network began to reduce its investment in SDH significantly due to the planned gradual upgrade to NGN enabling technologies. Broadband/Fixed Network plans to extend further its use of WDM and other network enhancement technologies based on the demands of its customers and in conjunction with our ongoing broadband strategy.

Service Platforms

Broadband/Fixed Network uses its service platforms to enable the provision of voice, data and other value-added services to its customers. Broadband/Fixed Network’s service platforms include IP-based and ATM technologies, which permit the high-quality transmission of large amounts of data (e.g., VoIP, text, audio and video). These platforms allow Broadband/Fixed Network to deliver a wide range of products and services to individual and business customers. The products and services delivered on these service platforms include browser access to the World Wide Web and virtual private networks (VPNs). Server connections to the World Wide Web are also employed in Broadband/Fixed Network’s service platforms.

Network Communication Services

Network Access Products

Broadband/Fixed Network offers network access to its individual and business customers through a variety of access-line packages, which generally include a fixed monthly payment and a variable component based on traffic volume. These access-line packages may contain standard analog-line access or digital-line access, the latter of which is also known as Integrated Services Digital Network (ISDN) access lines. In addition, both types of access lines are a prerequisite for broadband access and can be enhanced by increasing their bandwidth capacity through the use of DSL technology as described below under “—IP/Internet Services.”

Narrowband Access

T-Net Access

Broadband/Fixed Network’s standard access voice products are marketed under the brand name “T-Net” and permit the customer to use a single telecommunications channel for voice, data or facsimile transmission at speeds of up to 56 Kbit/s. The following table shows the number of T-Net access lines in operation, excluding public payphones, as of December 31 for each of the periods presented:

 

Year

  

T-Net Access

Lines

2004

   26.4 million

2005

   25.5 million

2006

   24.2 million

 

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The number of T-Net access lines in operation has continued to decrease from 2004 to 2006. Broadband/Fixed Network expects this trend to continue in the future. Competition, due to regulatorily mandated unbundling of the PSTN and DSL access lines in 2008, and conversion of the network to the NGN, are expected to be significant factors in this decrease.

T-ISDN Access

Broadband/Fixed Network’s ISDN access products are marketed under the brand name “T-ISDN” and permit a single customer access line to be used simultaneously to provide multiple products and services, including voice, data and facsimile transmission at 64 Kbit/s, which can be increased to 128 Kbit/s using channel bundling. Compared to regular voice telephone lines, ISDN technology provides connections with faster transmission speeds and increases Broadband/Fixed Network’s network usage rates.

Broadband/Fixed Network offers two types of T-ISDN access lines: basic and primary. Basic T-ISDN access lines provide two telecommunications channels per access line and are offered to individual as well as business customers. Primary T-ISDN access lines provide 30 telecommunications channels per access line and are offered mainly to business customers. The following table shows the number of ISDN access lines and channels in operation as of December 31 for each of the periods presented:

 

     ISDN Access Lines(1)     

Year

   Basic    Primary    Total ISDN
Channels(2)

2004

   10.4 million    97,000    23.9 million

2005

   9.8 million    93,000    22.5 million

2006

   9.1 million    89,000    20.9 million

(1) ISDN lines including internal use and public payphones, including wholesale services.
(2) Calculations of Total ISDN Channels based on actual figures.

The number of basic T-ISDN access lines decreased in 2006 compared to 2005, primarily as a result of increased competition, especially from new integrated voice and Internet products, and saturation of the ISDN market. Another factor in the decrease in the number of T-ISDN access lines was the migration of T-DSL customers, who had been using T-ISDN access lines in conjunction with broadband service, to T-Net access lines after April 1, 2004. This migration occurred after Broadband/Fixed Network increased the price of T-DSL when purchased in combination with T-ISDN, and reduced the price of T-DSL when purchased in combination with T-Net. Broadband/Fixed Network expects this trend to continue.

Broadband/Fixed Network expects the number of narrowband access lines in operation to continue to decrease in the future due to increased competition, fixed-to-mobile substitution and increased acceptance of VoIP.

Calling Services

T-Net and T-ISDN permit comprehensive local, regional and international calling services, and dial-up Internet access, and offer customers many of the same services, such as three-way calling, call-waiting and caller ID. T-ISDN also offers several features not available to T-Net customers, including a second connection channel, which allows the customer to have three separate telephone numbers to use the telephone, send or receive faxes and use the Internet simultaneously.

In 2006, Broadband/Fixed Network’s competitors continued to make considerable inroads into the calling services market, primarily as a result of regulatory decisions favoring increased competition in the fixed-line area. Competitors have introduced their own infrastructure and continue to make investments in interconnection points to benefit from favorable pricing conditions. The decrease in the number of Broadband/Fixed Network’s call minutes in Germany continued in 2006, due to loss of access lines to these competitors, fixed-to-mobile substitution and increased acceptance of VoIP. Broadband/Fixed Network’s call plans with a flat-rate component, which were initially introduced in 2005 and expanded and improved in 2006, have led to an increase in call minutes by customers through those plans.

 

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To counter some of these competitive challenges, Broadband/Fixed Network introduced several different rate plans, designed to provide customers with reduced per-call rates for an additional monthly fee. These new rate plans were designed to better meet the demands of specific customer segments, compared to Broadband/Fixed Network’s existing rate plans. Broadband/Fixed Network believes that there is a trend towards including and increasing flat-rate components in rate plans. In addition, in October 2006, Broadband/Fixed Network completed the introduction of its new 3x3 Complete Packages product portfolio, which offers customers a choice of three different levels of single-play, double-play and triple-play. Broadband/Fixed Network expects calling minutes with respect to the newly introduced flat rate plans to increase. However, overall, Broadband/Fixed Network expects calling minutes and revenues in the future to decrease due to continued loss of narrowband access lines, continued fixed-to-mobile substitution and the increased acceptance of VoIP.

Wholesale Services

Through its wholesale services business, Broadband/Fixed Network provides products and services to other domestic carriers and service providers, as well as to other members of the Deutsche Telekom group, in accordance with regulatory guidelines stipulated by the Federal Network Agency. Within Wholesale Services, International Carrier Sales & Solutions (ICSS), is responsible for the international wholesale business. ICSS’ services and solutions are sold globally under the Deutsche Telekom brand. Wholesale products and services provided to third-party and Deutsche Telekom group customers include the following:

Domestic Services

Interconnection services

Broadband/Fixed Network’s interconnection services primarily consist of call origination and the transit and termination of switched voice traffic. The terms under which Broadband/Fixed Network interconnects its telephone network with the networks of other domestic carriers and service providers are either bilaterally negotiated or imposed by the Federal Network Agency. At December 31, 2006, Broadband/Fixed Network had 135 interconnection arrangements. Bilateral interconnection agreements existed with 88 of these carriers, while the remaining carrier interconnections were implemented on the basis of an interconnection order from the Federal Network Agency. The Federal Network Agency mandated price reductions on interconnection prices valid from June 1, 2006 until November 30, 2008.

IP services

Broadband/Fixed Network provides Internet transport services for broadband and narrowband service providers (“virtual ISP services”) as well as transport services for carrier interconnection. In addition, Broadband/Fixed Network offers nationwide access through its IP backbone and regional IP access to broadband IP providers. Broadband/Fixed Network also provides scalable narrowband and broadband Internet transport services to ISPs (“OnlineConnect”), which allow ISPs to expand their Internet platforms in line with customer demand.

Access services

Demand for services enabling other telecommunications operators to offer their own end-customer telephone and Internet services continued to increase in 2006. The trend of telecommunications operators leasing access to the local loop to enable themselves to supply their customers with telephone and Internet services, using Broadband/Fixed Network’s network infrastructure continued to increase significantly to 4.7 million lines in 2006 from 3.3 million in 2005 and 2.0 million lines in 2004. Unbundled local loop access is available to competitors in high bitrate (typically DSL capable) and low bitrate (typically not DSL capable) variants. Due to competitors increasing investment in their own network infrastructure, including co-location facilites and exchanges, in Germany, Broadband/Fixed Network expects that the demand for access in the unbundled local loop will increase in the future.

Furthermore, since July 2004, Broadband/Fixed Network has offered a Resale DSL product, i.e., the sale of broadband access lines to competitors. This enables third-party operators to offer an integrated service combining

 

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access- and IP services to their retail customers under their own brands. The current maximum transmission speed offered to Resale DSL customers is 16 Mbit/s. Resale DSL continued to increase significantly in 2006 to 3.2 million, from 1.6 million in 2005 and 0.2 million in 2004.

Network Services

Broadband/Fixed Network offers leased lines with transmission speeds ranging from 64 Kbit/s to 2.5 Gbit/s, which are tailored to fit the specific needs of carriers and mobile network operators. These leased lines can be used both for the transmission of data and for voice traffic. Broadband/Fixed Network also offers Carrier Services Networks, which combine leased lines with network management services.

International Services

ICSS provides international wholesale customers, typically other fixed-line carriers and mobile operators, ISPs, application service providers (ASPs) and content providers, with worldwide direct access to Deutsche Telekom’s international telecommunications network. ICSS’ main focus is the transfer of outgoing international voice and data traffic from Germany to carriers in other countries for termination in their networks, and the provision of carrier termination and transit services for calls that originate outside of Germany and are routed through our network for termination in Germany or a third country. During 2006, ICSS managed total worldwide voice traffic of more than 13.8 billion minutes, providing connections to more than 190 countries worldwide. In addition, ICSS also manages the exchange of international IP traffic between carriers, which is necessary in order to allow carriers to offer Internet access and content to their retail customers. Other services provided by ICSS include “Carrier Managed Network Solutions,” which are IP-based VPNs for carriers serving the corporate market, and a comprehensive set of mobile solutions.

IP/Internet Services

Broadband/Fixed Network’s integrated broadband strategy includes new offerings for voice, Internet and entertainment services. Broadband/Fixed Network believes that broadband growth in Germany, particularly in the retail market, is largely dependent on the successful introduction and acceptance of double-play and triple-play products and services. Substantially all of the operating activities conducted under the T-Online brand are included in IP/Internet services, which also includes Broadband/Fixed Network’s retail DSL activities.

In 2006, Broadband/Fixed Network continued to develop its portfolio to include new innovative broadband services. The new high-speed VDSL network, which Broadband/Fixed Network began to roll out in 2005, provides bandwidths of up to 50 Mbit/s. In conjunction with this roll out, Broadband/Fixed Network continued to develop new markets in which it will be possible to offer innovative services. In March 2005, Broadband/Fixed Network launched its VoIP broadband telephony service. VoIP technology offers Internet users an affordable option of telephoning via the Internet. Since the beginning of November 2005, Broadband/Fixed Network has been offering a VoIP flat-rate. In 2006, the portfolio of access services was broadened with rate offerings that include Internet access and DSL telephony that can be selected for all available access line speeds. In May 2006, Broadband/Fixed Network launched the T-DSL 16000 product line primarily for data-intensive applications.

In October 2006, Broadband/Fixed Network launched its first triple-play product “T-Home,” consisting of highspeed-Internet access, telephony and Internet Protocol TV (IPTV). This product evolved from “T-Online Vision,” introduced in 2003, which allowed broadband services (mainly video-on-demand) to be accessed through a television set. As part of the launch of IPTV via the new high-speed network, Broadband/Fixed Network has concluded agreements with 130 broadcasters in Germany. Since August 2006, Broadband/Fixed Network has been offering transmissions of soccer matches of the first and second Bundesliga divisions in cooperation with the pay-TV channel Premiere.

In the entertainment area, the existing video-on-demand portfolio is being continually expanded, with a film library of over 1,300 titles from all genres, including 600 Hollywood productions. Broadband/Fixed Network offers “Musicload”, one of the leading German online-music download portals based on the number of downloads. With the introduction of “Gamesload” in August 2005 and “Softwareload” in November 2006, Broadband/Fixed Network established two other digital distribution platforms for entertainment and downloading of software on the Internet.

 

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Scout24 is a group of leading European online marketplaces and an established online classified service. Scout24 provides a broad range of sector specific marketplaces: AutoScout24, ElectronicScout24, FinanceScout24, FriendScout24, ImmobilienScout24 (real estate), JobScout24 and TravelScout24.

Broadband Access

Broadband/Fixed Network typically offers broadband access based on ADSL technology, which combines a high-speed data download transmission speed with a lower upload transmission speed, primarily to its individual customers. Broadband/Fixed Network also offers synchronous DSL (SDSL) technology to its business customers, which permits high-speed data transmission speeds in both directions. Since 2003, SDSL has been available throughout Germany under the “T-DSL Business” brand name. Broadband/Fixed Network provides T-Net and T-ISDN access lines, enhanced by means of DSL technology, to its individual and business customers at a fixed monthly fee. In the future, it is anticipated that Broadband/Fixed Network will offer DSL on a stand-alone basis, enabling customers to substitute broadband access for narrowband access. In addition, Broadband/Fixed Network expects the number of broadband lines in operation to increase in the near future. Broadband/Fixed Network markets broadband access lines to its retail customers under the T-Online brand name.

The number of broadband access lines provided by Broadband/Fixed Network continued to increase in 2006, and Broadband/Fixed Network expects that demand for high-bandwidth services will result in continued growth in the number of broadband access lines in operation in the future.

To access the Internet, however, in addition to obtaining a broadband access line, individual customers also require a contract with an Internet Service Provider (ISP), such as Broadband/Fixed Network’s T-Online branded ISP service. Since the merger of T-Online into Deutsche Telekom, Broadband/Fixed Network has offered integrated services, such as 3x3 Complete Packages, which include ISP services, Internet access and telephony services.

Data Communications

Broadband/Fixed Network’s full portfolio of data communications solutions, which is also offered by the Business Customers strategic business area, includes the following products and services:

 

   

Telekom Design Networks, which combine data and voice communications products to meet the specific needs of business customers and other carriers. A wide range of additional services (e.g., consulting, project management, design and re-design of customer networks) are integrated into TDN contracts. These components form the basis for a customized system solution, which can then be adjusted, based on changing client requirements and new technologies;

 

   

Leased lines, which are trunk lines offering high levels of security and pre-defined bandwidths, for the construction and operation of corporate networks. Broadband/Fixed Network offers leased lines under the brand names “SFV” (Standardfestverbindung) and “DDV” (Datendirektverbindung);

 

   

Virtual Private Network products, which connect customer sites within a closed network, and include standard solutions as well as individually tailored services for ATM- or IP-based networks. VPN products provide high-speed transmission rates and increased security standards. VoIP solutions have been offered as part of Broadband/Fixed Network’s data communication products (e.g., as part of an IP network) to business customers since 2003;

 

   

Ethernet products, primarily under the brand names “DDV-M Ethernet 100” and “High-Speed Ethernet,” which provide Broadband/Fixed Network’s business customers with innovative, low-priced “plug-and-play” solutions, and which connect customer sites using worldwide Ethernet standards and feature high transmission speeds (up to 1Gbit/s);

 

   

Internet solutions and IP-related services, primarily provided through the CompanyConnect and “IP-Transit” products;

 

   

CompanyConnect includes a broadband Internet connection and is targeted at medium- and large-sized companies. This product includes guaranteed bandwidths, from 256 Kbit/s to 155 Mbit/s, and fixed IP addresses;

 

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IP-Transit offers bandwidths from 2 Mbit/s to 2.5 Gbit/s and provides worldwide Internet connectivity using multiple connections to different providers simultaneously. Based on this technology, customers can achieve very high system stability and independence from a single ISP. IP-Transit is mainly marketed by Broadband/Fixed Network, in cooperation with T-Systems, to wholesale services customers and large-sized companies; and

 

   

Dedicated customer lines: Broadband/Fixed Network’s dedicated customer line product offers business customers connections between two customer networks (located up to 50 kilometers apart) with transmission speeds of up to one Gbit/s.

Value-Added Services

Broadband/Fixed Network offers a range of value-added telephone services for individual and business customers. These services include toll-free numbers and shared-cost numbers for customer-relationship management, directory-assistance numbers, the provision and administration of directory databases and public payphones. Broadband/Fixed Network’s premium-rate services (which use the 0190 and 0900 exchanges) enable information and entertainment packages to be sold and billed automatically by telephone or via the Internet.

Broadband/Fixed Network provides contact-routing solutions to our customers. Through its product, “T-VoteCall,” Broadband/Fixed Network provides media broadcasting companies (largely television and radio stations) with the ability to catalogue and switch customer calls to pre-defined locations. This service enables media broadcasters to increase customer participation in their program offerings as well as to measure audience loyalty.

Broadband/Fixed Network’s new products in the directory-assistance sector include a telephone number search service via SMS text, and a directory-search service based on telephone numbers.

Terminal Equipment

Through its terminal equipment business, Broadband/Fixed Network distributes, for purchase or lease, an extensive range of third-party and Broadband/Fixed Network’s own-brand telecommunications equipment. Products range from individual telephone sets and facsimile machines, targeted at individual customers, to more complex telephones, private branch exchanges (PBXs) and complex network systems (including broadband-access devices), targeted at business customers.

Other Services

Other services includes publishing, support services and the sale of products and services through Broadband/Fixed Network’s T-Punkt outlets. Publishing services include the sale of marketing and advertising services to small- and medium-sized companies via Broadband/Fixed Network’s telephone directories. The telephone directories (e.g., DasTelefonbuch, GelbeSeiten, DasÖrtliche) are edited and published in a variety of formats (including print, CD-ROM, online and a version for mobile devices) in cooperation with local publishers. Broadband/Fixed Network receives most of its publishing revenues from advertisements contained in these directories. In recent years, this business has been subject to increasing pressure from competition especially from online services. For information regarding legal proceedings relating to directory services, see “Item 8. Financial Information—Legal Proceedings.”

Support services include installation, maintenance, hotline, customer consulting, training and software installation services, which are provided on a standardized basis and, for business customers, on a customized basis.

Sales Channels

Broadband/Fixed Network offers its products and services through a broad range of third-party distributors, as well as direct and indirect sales channels. Broadband/Fixed Network’s direct distribution channel includes its “T-Punkt” retail outlets, direct sales forces dedicated to either business or retail customers, and online ordering via the Internet. In addition, Broadband/Fixed Network provides toll-free numbers that allow customers to obtain

 

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information about, and place orders for, its various products and services. Broadband/Fixed Network maintains separate sales units for direct sales to individuals and businesses, domestic carrier services and services offered to network operators and service providers.

Most of Broadband/Fixed Network’s terminal equipment sales occur through its T-Punkt outlets, which offer an extensive product portfolio, including T-ISDN and T-DSL business products, and products and services from T-Mobile and third-party vendors. Broadband/Fixed Network receives commissions on its sales of products and services provided by other Deutsche Telekom business units. At December 31, 2006, Broadband/Fixed Network had 586 T-Punkt outlets in Germany, of which 104 were business outlets. T-Punkt business outlets offer more products and services targeted to businesses (e.g., tailored telecommunications solutions for combined voice and data usage).

International Operations

Broadband/Fixed Network operates primarily in the fixed-line and ISP business areas in Eastern Europe and primarily in the ISP business area in Western Europe. The majority of the business activities of our Eastern European subsidiaries, except for mobile telecommunication, are included in the Broadband/Fixed Network’s results of operations. Commencing in January 2007, the shared services and headquarters functions of Magyar Telekom are reported under Group Headquarters and Shared Services.

Eastern Europe

Broadband/Fixed Network provides fixed-line network services, wholesale services, IP/Internet services and multimedia services (radio and television) in certain countries in Eastern Europe, through its subsidiaries Magyar Telekom (Hungary), Slovak Telekom (Slovakia) and T-Hrvatski Telekom (Croatia). As an integrated telecommunications provider, Broadband/Fixed Network intends to systematically market triple-play and quadruple-play (which includes mobile communications in addition to triple-play services) packages in certain markets served by these subsidiaries.

Magyar Telekom

Broadband/Fixed Network holds a 59.35% equity interest in Magyar Telekom, the leading full-service telecommunications service provider in terms of customers and revenues in the Republic of Hungary. Magyar Telekom offers telecommunications services, such as fixed-line services, wholesale services, IP/Internet services and other services such as IT-system integration, IT-consulting and cable television to individual and business customers throughout most of Hungary. Magyar Telekom’s 51% stake in MakTel, the incumbent fixed-line carrier in the Republic of Macedonia, increased to 56.7% after MakTel purchased 10% of its own shares in the Macedonian government auction in June 2006. In addition, Magyar Telekom has a stake of 76.5% in Crnogorski Telekom (formerly Telekom Crne Gore (Montenegro)), which provides fixed-line and Internet services in the Republic of Montenegro.

Magyar Telekom offers a broad range of fixed-line services, including narrowband access products, broadband access products and calling services. Magyar Telekom also offers ICT solutions to support business processes or fully manage the complete operation of customer business processes. During 2006, a Hungarian cable television network operator further strengthened its position in the Hungarian fixed-line market, offering cable TV, cable broadband Internet and voice over cable services. In response to this competitive pressure, call-by-call and preselection competitors and mobile substitution, Magyar Telekom commenced promoting several flat-rate tariff packages and DSL offers and launched the first IPTV offering in Hungary in November 2006.

Under the “T-Online Hungary” brand name, Magyar Telekom maintained its leading position among ISPs in the Hungarian market based on the number of customers, with market shares in the local dial-up market of approximately 39% in 2006, and 42% in 2005 and 2004. The number of broadband access lines provided by Magyar Telekom continued to increase in 2006. The number of customers with broadband rates at Magyar Telekom (including MakTel & Crnogorski Telekom) increased from 260,000 at December 31, 2005 to 437,000 at December 31, 2006.

 

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Magyar Telekom’s multimedia and broadcasting services business primarily consists of its cable television business. The number of Magyar Telekom’s cable television customers increased from 404,000 in 2005 to 414,000 in 2006.

In line with its Value Creation Program announced in August 2004, Magyar Telekom further strengthened its competencies in the IT-network and system integration fields through several smaller strategic acquisitions during 2006. Through these acquisitions, Magyar Telekom expanded its competencies in the areas of outsourcing, ICT solutions, systems integration and software development and implementation.

Magyar Telekom’s international strategy is to provide international network and carrier services in southeastern Europe by expanding its presence in the region. Accordingly, Magyar Telekom entered the Romanian market in July 2004, the Bulgarian market in September 2004, and the Ukrainian market in August 2005, and currently offers wholesale services in each of these markets. Capitalizing on its experience in these markets, Magyar Telekom has expanded its activities as an alternative carrier and Internet service provider in southeastern Europe.

Magyar Telekom controls MakTel, currently the sole fixed-line operator in Macedonia. MakTel’s exclusive right to offer fixed-line telecommunications services in Macedonia expired at the end of 2004. Since then, competition has intensified in the international telecommunications and Internet services segments.

Effective March 31, 2005, Magyar Telekom acquired the government of Montenegro’s 51.1% share of Crnogorski Telekom and has consolidated its results since this date. Magyar Telekom also acquired an additional 21.9% of Crnogorski Telekom’s shares from minority shareholders. On May 24, 2005, through a public tender, Magyar Telekom acquired an additional 3.5% stake in Crnogorski Telekom, increasing Magyar Telekom’s total stake to 76.5%. The total purchase price of these transactions was EUR 140.5 million.

T-Hrvatski Telekom

Broadband/Fixed Network owns a 51% equity interest in T-Hrvatski Telekom, the leading full-service telecommunications provider in the Republic of Croatia in terms of revenues. T-Hrvatski Telekom offers access and local, long-distance and international fixed-line telephone services, data communications services, IP/Internet services (formerly online services) and wholesale services.

T-Hrvatski Telekom introduced entertainment services with the launch of IPTV in September 2006. T-Hrvatski Telekom also operates a digitalized fixed-line telecommunications network. Since mid-2005, particularly in the fixed-line voice telephony business, T-Hrvatski Telekom has been confronted by increasing competition. In addition to preselection, mobile substitution is the main competitive challenge in Croatia.

In 2006, the number of T-Hrvatski Telekom’s narrowband access lines in operation decreased slightly compared to 2005 and 2004. However, the number of its broadband access lines in operation more than doubled to 216,000 at December 31, 2006, from 101,000 at December 31, 2005 and 22,000 at December 31, 2004.

T-Hrvatski Telekom’s IP/Internet business is the largest Croatian ISP in terms of revenues, and its market share at the end of 2006, based on revenues, was approximately 75%. The number of T-Hrvatski Telekom’s online customers increased by 39% to approximately 973,000 in 2006, compared to 2005. Broadband/Fixed Network expects that T-Hrvatski Telekom’s online business will be positively affected by customers’ substitution of broadband access services for standard dial-up access, which is expected to continue to increase in the future.

Slovak Telekom

In 2000, Broadband/Fixed Network acquired a 51% equity interest in the then state-owned Slovenské telekomunikácie a.s. On January 15, 2004, Slovenské telekomunikácie a.s. changed its name to “Slovak Telecom a.s.,” and on March 8, 2006, was rebranded “Slovak Telekom.” As part of this rebranding strategy, the T-Brands were introduced in Slovakia. Slovak Telekom is a leading full-service telecommunications provider in the Slovak Republic.

 

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Slovak Telekom offers access and local, long-distance and international fixed-line telephone services, data communications services, wholesale services, IP/Internet services and distribution and broadcast of radio and television signals.

In December 2006, Slovak Telekom introduced new competitive entertainment services with the launch of IPTV and triple-play. Slovak Telekom believes that triple-play is expected to be one of the main drivers for the success of Slovak Telekom’s broadband business. Through its online portal “T-Station,” Slovak Telekom also offers games-on-demand, music-on-demand and video-on-demand.

Slovak Telekom’s total number of narrowband access lines decreased in 2006, primarily due to mobile substitution. The decrease in access lines, however, slowed in 2006 to 2.3% compared to 2005, primarily due to the introduction of optional calling plans with a flat rate component. In 2005, Slovak Telekom’s total number of narrowband access lines decreased by 3.9% compared to 2004.

The number of broadband access lines in operation in Slovak Telekom’s network continued to increase in 2006. The number of broadband access lines in operation at December 31, 2006 was 182,000 compared to 104,000 at December 31, 2005, and 38,000 at December 31, 2004.

As of December 31, 2006, Slovak Telekom’s online customer base increased to approximately 222,000 customers, a 34% increase compared to 2005. The number of Internet customers using broadband services doubled to 162,000 customers at December 31, 2006. Slovak Telekom believes that the development of high-bandwidth Internet services in Slovakia will encourage customer migration from narrowband to broadband access.

Western Europe

Through its subsidiaries and associated companies, Broadband/Fixed Network also conducts operations in Western Europe outside of Germany, primarily broadband-based access and Internet-related services for individual customers in France and Spain.

T-Online France, operating under the commercial brand “Club Internet,” has continued to develop its Internet business beyond simple access services. After the introduction of a fully unbundled product in 2005, whereby the complete customer relationship for fixed telephony and Internet access products was taken over by Club Internet, triple-play products were introduced in August 2006. This first triple-play product includes more than 40 free and 100 pay TV channels. It is the first of its kind in France based on the Microsoft TV software platform. The product has been enhanced by a hard disk in the set top box which allows the user to record programs, and by video-on-demand functionality.

Broadband/Fixed Network intends to further strengthen T-Online France’s competitive position with the introduction of a fully IP-based network, allowing coverage of more than 40% of the residents in France. As of December 31, 2006, more than 420 co-location sites had already been unbundled. The unbundling of co-location sites enables T-Online France to offer its own products and provides pricing flexibility in operating its own network. T-Online France believes that it will be able to achieve greater degrees of freedom in product design (e.g., innovation and quality of services) and product pricing, thereby allowing it to bring to the market innovations, including additional triple-play products.

T-Online Spain, operating under the brand names “Ya.com” for the retail market and “Albura” for the wholesale market, has also commenced offering services beyond Internet access. In 2005, T-Online Spain launched voice telephony services under its Ya.com brand name and increased the bandwidth capability of up to 20 Mbit/s for its broadband customers.

As in France, Broadband/Fixed Network intends to increase its competitiveness in Spain through the roll-out of its own IP-based network. The acquisition of Albura in 2005 has formed the basis for this network, which is currently being expanded and upgraded. A contract for the use of a third-party backbone is in place and, as of December 31, 2006, more than 305 co-location sites have already been accessed.

 

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During 2006, Broadband/Fixed Network’s customers with a broadband rate increased from approximately 635,000 customers at the end of 2005 to approximately 921,000 at December 31, 2006. T-Online Spain and T-Online France both capitalized on the expansion of the broadband markets in their respective countries to increase their customer bases.

Seasonality

Broadband/Fixed Network’s businesses are not materially affected by seasonal variations.

Suppliers

The principal types of equipment purchased by Broadband/Fixed Network are network components, such as switching systems; transmission systems; access network components; and customer premises equipment, such as telephones, fax machines, broadband modems and similar items. Although we do not believe Broadband/Fixed Network is dependent on any single supplier due to its multiple-supplier strategy, there may be occasions when a particular product from a particular supplier is delayed or back-ordered. Broadband/Fixed Network’s major suppliers are Siemens AG, Deutsche Post AG, Alcatel SEL AG, Grey Global Group (MEDIACOM), AVM Computersysteme, Cisco Systems Inc., Corning Cable Systems GmbH & Co. KG, Lucent Technologies Network Systems GmbH and IBM.

Dependence on Patents, Licenses, Customers or Industrial, Commercial or Financial Contracts

We do not believe that Broadband/Fixed Network is dependent on any patent or other intellectual property rights. For a description of patent infringement litigation relating to ATM technology that is relevant to Broadband/Fixed Network’s business, see “Item 8. Financial Information—Legal Proceedings—Other Proceedings.” We also do not believe that Broadband/Fixed Network is dependent on any individual third-party customer or on any industrial, commercial or financial contract.

Competition

Broadband/Fixed Network faces intense competition, based primarily on price in the market for fixed-line network voice telephony, from other fixed-line carriers and mobile operators. In recent years, this competition has intensified, especially in the narrowband and broadband access markets as well as in the market for ISP products and services. In particular, competition through bundled offers from other fixed-line carriers has intensified. The introduction of attractively priced triple-play services packages to customers by Broadband/Fixed Network and other fixed-line carriers as well as cable operators is evidence of this increase in competition. We expect that competition from cable operators and VoIP will also continue to increase. Depending on the degree to which alternative technologies, such as VoIP, cable broadband and the Internet, gain market acceptance, the usage of Broadband/Fixed Network’s PSTN network will be adversely affected.

A number of competitors in Germany have indicated that they are either considering investing or intend to invest in their own high-speed networks, for instance by developing VDSL access networks, in order to pursue their own triple-play strategies. To date, only one competitor has confirmed this intention. Given the significant competitive advantage that such high-speed networks offer in the broadband access market, Broadband/Fixed Network expects that other competitors will eventually follow suit and invest in their own networks in order to compete with Broadband/Fixed Network.

National network operators, such as Arcor AG & Co. KG and local network operators, such as HanseNet Telekommunikation GmbH (“HanseNet”), Versatel AG and NetCologne Gesellschaft für Telekommunikation mbH, have also made substantial investments in local network infrastructure and compete with Broadband/Fixed Network in major urban centers throughout Germany.

Competition from local network operators, on the basis of leased lines (unbundled local loop) or the competitor’s own infrastructure, is increasing, particularly from entities owned by large European telecommunications companies, such as HanseNet (a subsidiary of Telecom Italia).

 

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The impact of mobile substitution on Broadband/Fixed Network is also increasing, in part because of the increased market entry of MVNOs, i.e., companies with aggressive pricing policies that buy mobile network services and market them independently to third parties. Furthermore, as prices for mobile telephony decline, local and other calling services, as well as access services, face increasing competition from mobile telephone operators, due to mobile substitution.

It is also possible that cable operators may increase their market share by offering attractive triple-play services.

Accordingly, we believe that we continue to be exposed to the risk of further market share losses and falling margins.

Competition in the fixed-line network segment in Eastern Europe also increased. The growing number of competitors offering call-by-call and, more recently, carrier pre-selection services to consumers has led to increased competition, especially in Hungary, in which mobile substitution was also a significant factor. Increased mobile substitution also affected the Slovakian market. In addition, competition in Hungary and Slovakia is also expected to increase as cable network operators in those countries upgrade their networks to offer double-play and triple-play services. Competition in Croatia is expected to increase following the award of additional fixed-line network licenses.

In 2005, Broadband/Fixed Network offered VoIP services in Germany for the first time to retail customers. VoIP services can compete with traditional voice telephony, both in the network access services business and in the various calling services markets. VoIP network access services offerings and customer acceptance have increased in 2006. In addition, VoIP services also has substantial competitive potential in the calling services markets.

Prices for DSL access, ISP services and voice communications in the fixed-line network decreased significantly in Germany in 2006, primarily due to increased competition and technological progress, as well as mobile substitution. The increased use of bundled packages (including calling plans) with a flat-rate component and a decrease in the overall prices for these packages by our competitors have intensified the downward pricing pressure on our own products, services and pricing packages. These factors, combined with the continued implementation of government policies intended to foster greater competition, are expected to yield similar trends in the future.

Effect of Regulatory Decisions

In the markets for international, long-distance and local calling services in Germany, the level of competition we face is influenced by the fact that we are required to permit other telecommunications companies to interconnect with our fixed-line network and for access to the unbundled local loop at rates determined by the Federal Network Agency. As a result, decisions of the Federal Network Agency regarding the rates that we are permitted to charge for interconnection and for access to the unbundled local loop have had, and will continue to have, a significant impact on the strength of Broadband/Fixed Network’s competition in the market for fixed-line network voice telephony as well as on Broadband/Fixed Network’s revenues and profit. For a more detailed discussion of regulatory decisions and other competitive factors affecting Broadband/Fixed Network’s business, see “—Regulation” and “Item 8. Financial Information—Legal Proceedings.”

Other Fields of Business Activity

Although Broadband/Fixed Network does not manufacture its own equipment, it does re-sell telecommunications equipment provided by other companies under its own brand. The terminal equipment sector is characterized by falling prices, low margins, rapid technological innovation and intense competition. The basis for competition in this field is primarily price. Broadband/Fixed Network’s most significant competitors in this area are Siemens AG, Alcatel, Koninklijke Philips Electronics N.V. and Tenovis GmbH & Co. KG. Most of these competitors are also suppliers to Broadband/Fixed Network.

Apart from broadband-related developments, Broadband/Fixed Network believes that future innovations will be increasingly focused on the convergence between fixed-line and mobile telecommunications networks. In

 

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addition to its launch of the T-Box (single answering service for calls to the fixed-line number and the mobile number) in October 2005, Broadband/Fixed Network has introduced other convergence products. Broadband/Fixed Network believes that these and other such products could play an important role in the process of converging multimedia, telecommunications and related products and services.

Business Customers

The Business Customers strategic business area provides, through T-Systems, ICT services worldwide, primarily to German and international companies, non-profit organizations and governmental agencies. T-Systems is also responsible for servicing all of the Deutsche Telekom group’s business customers.

In 2006, T-Systems acquired gedas for a purchase price of EUR 0.3 billion from Volkswagen AG. The transaction was completed on March 31, 2006. A major component of this transaction is an agreement with Volkswagen for the provision of IT services valued at EUR 2.5 billion over a term of seven years. With this acquisition, Business Customers intends to reinforce its future position in the automotive sector, a key market for IT service providers.

Principal Activities

T-Systems uses advanced information technology and its telecommunications expertise to provide ICT infrastructure and tailored ICT solutions to its customers and, in some instances, takes over complete business processes as part of these solutions. T-Systems supports its customers through its global telecommunications network and through its IT infrastructure network, which connects more than twenty countries worldwide.

Although the majority of T-Systems’ customers are headquartered in Germany, as of December 31, 2006, approximately 14.8% of T-Systems’ 56,397 employees provided services from locations outside Germany. The increase in the total number of employees from 2005 is primarily due to the acquisition of gedas. T-Systems’ primary markets are in Western Europe, but T-Systems serves its multinational customers globally through its delivery organizations.

A major step in implementing its growth strategy was the acquisition of gedas. By doing so, T-Systems has established itself as the second largest global IT provider in the automotive industry in terms of revenue. Additionally, the acquisition of gedas, which represents a significant portion of T-Systems’ international revenues (approximately 73% of revenues outside Germany), has strengthened T-Systems’ global presence, particularly in the automotive sector.

In 2006, German-based operations contributed approximately 83.4 % of T-Systems’ total revenues. For the year ended December 31, 2006, T-Systems’ Business Services business unit generated approximately 34.4% of T-Systems’ total revenues, and its Enterprise Services business unit contributed approximately 65.6% of its total revenues. Total revenues include intersegment revenues from other Deutsche Telekom group companies and affiliates. For more information, see “Item 5. Operating and Financial Review and Prospects—Segment Analysis—Business Customers.”

 

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Business Model

Since January 1, 2005, T-Systems’ activities have been organized through two main business units: Enterprise Services and Business Services, each of which is described in more detail below. The following graphic illustrates this business model:

LOGO


* Services provided for service units of both Enterprise Services and Business Services.

Business Services

Business Services is responsible for approximately 160,000 large-, medium- and small-sized business customers. The Sales & Service Management service unit primarily services customers on a personalized and customized basis. The Marketing & Product Management unit designs services for customers on a standardized, non-customized basis. Business Services is also responsible for the delivery of telecommunications services to all business customers of both Business Services and Enterprise Services through its Telecommunications Operations (TC Operations) service unit.

Business Services’ Sales & Service Management service unit addresses its customers’ needs via four sales channels: large enterprises, medium enterprises, small enterprises and health care organizations. Sales & Service Management is responsible for managing the customer relationships of the Business Services business unit.

Business Services’ Marketing & Product Management service unit is responsible for product management, pricing and distribution of telecommunications offerings for all Business Services customers. Marketing & Product Management is responsible for the lifecycle management of products and solutions and for the costs of all purchased inputs relating to customer offerings. Marketing & Product Management is also responsible for innovation management, marketing control, management of purchased inputs and the regulatory compliance of products and services.

 

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TC Operations is responsible for planning, building and operating T-Systems’ global telecommunications service-generating platforms and its customers’ LAN and WAN networks. Additionally, TC Operations carries out the delivery functions of Business Services (as described in more detail below). TC Operations is also responsible for quality and process management, as well as external procurement of telecommunications services for the group.

Enterprise Services

Enterprise Services serves T-Systems’ largest customers (approximately 130 multinational corporations and large public institutions) through its dedicated Sales & Service Management service unit. In 2006, Enterprise Services became responsible for servicing certain large customers of Business Services. Enterprise Services is also responsible for the non-German T-Systems subsidaries. In addition, Enterprise Services also delivers information technology services, through its Systems Integration and IT Operations service units, for business customers of both Business Services and Enterprise Services.

Enterprise Services’ Sales & Service Management service unit provides services through six vertical market segments, called “Industry Lines,” which reflect T-Systems’ key customer accounts. Sales & Service Management is responsible for managing the customer relationships of the Enterprise Services business unit.

Enterprise Services’ Sales & Service Management is organized along six defined Industry Lines, as follows:

 

   

“Telecommunications, Media & Utilities”—Includes other network operators and companies offering fixed-line, mobile and Internet telecommunications services, as well as media, ISP and utilities companies. T-Systems provides outsourcing services and other IT systems, such as customer relationship management, customer care, call center and billing systems.

 

   

“Automotive”Includes automobile manufacturers and companies in the automotive industry, including suppliers.

 

   

“Manufacturing”—Includes manufacturers of components for the aircraft, electronics, aerospace, defense, high-tech, mechanical engineering, chemical, pharmaceutical and consumer goods industries. T-Systems provides supply chain management, product life-cycle management and IT and telecommunications outsourcing services.

 

   

“Services”—Includes the services industry, such as telematics, insurance, travel, transport, logistics, professional, wholesale distribution and retail. T-Systems develops a variety of solutions, including sales support systems, billing solutions, portals for direct sales via the Internet, Internet-based reservation and booking systems, and tracking and data management systems.

 

   

“Finance”—Includes banks and insurance companies. T-Systems develops a variety of solutions, including industry specific sales support systems and electronic banking solutions.

 

   

“Public”—Includes government agencies, state pension funds, the armed forces of the Federal Republic, research and teaching institutions and international organizations. T-Systems enables public entities (such as federal ministries and state agencies) to establish innovative business processes, such as services to individuals through the Internet and the management of data and voice networks.

IT Operations carries out the delivery functions of Enterprise Services (as described in more detail below). IT Operations provides ICT solutions to support business processes or takes over full responsibility for the operation of entire business processes of a customer. Accordingly, this service unit supplies customers with workstations, service and maintenance functions, operates data centers, and provides systems and applications necessary to support or completely take over a customer’s operations.

Systems Integration develops, integrates and manages customized ICT solutions for customers, including industry specific, as well as industry independent, solutions. Customer solutions include ICT solution consulting, software and platform development, migration services, systems integration and application management.

 

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Media & Broadcast

Media & Broadcast is the leading provider of broadcast infrastructure services in Germany and one of the leading in Europe in terms of revenue. Media & Broadcast primarily provides terrestrial television and radio network broadcast services, which include the planning, installation, maintenance, troubleshooting and operation of terrestrial television and radio transmission equipment. Media & Broadcast is responsible for the entire value chain (e.g., sales, projects, services) and offers these services to public and commercial broadcasters and television production companies.

Detecon

Detecon offers its customers integrated management and technology consulting. Detecon operates worldwide and focuses on consulting for the telecommunications market. Detecon markets its services separately from the Business Services and Enterprise Services business units.

Service Offerings Portfolio

A significant recent trend in the IT and telecommunications markets is the emergence of a combined ICT market, which is driven primarily by customer requirements and technological advances. The primary advantages of this combined market are more effective and efficient solutions and incident management in complex IT and telecommunications infrastructures, including one single service agreement for all ICT services.

It is the goal of T-Systems to become a European-based ICT leader for multi-national companies, and an ICT leader for mid-market companies in Germany. T-Systems is in the process of aligning its operations to provide combined IT and telecommunications services more effectively, through optimized service management, and solutions development. In this regard, T-Systems is reshaping its service offerings, particularly within three value enhancing service levels:

 

   

“ICT Infrastructure”—Includes the sale of hardware with related basic support services and capacity or connectivity, in combination with communications technology-related applications and value added services.

 

   

“Horizontal processes and applications”—Includes standard business applications on platforms run by T-Systems, provided and operated for various customers (application provisioning and operations), application lifecycle management (i.e., end-to-end operational responsibility for an application), application development and system integration and Business Process Outsourcing (i.e., complete end-to-end management of business processes including human or asset resources outsourced to T-Systems).

 

   

“Vertical processes and solutions”— In addition to its horizontal processes and applications which apply to all industries, T-Systems offers industry specific solutions or vertical solutions for different industries. The automotive, public and telecommunications industries are served completely, whereas banking, aerospace, and travel, transport and logistics industries are served with selected industry-specific solutions.

In addition, T-Systems provides consulting and digital security services, which are included in each of the above service levels.

Business Services

Business Services offers a comprehensive portfolio of telecommunications services to its customers and those of Enterprise Services. Given the convergence of the telecommunications and IT markets, Business Services has enlarged its portfolio by offering IT Services and has positioned itself as an ICT provider for the German middle market. The Business Services product and services portfolio includes:

 

   

Voice Services—consisting of telephone lines and calling services, including VPN as well as mobile voice access;

 

   

Voice Equipment—telecommunications equipment available for sale or lease;

 

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Data communication services—consisting of traditional data connections (e.g., leased link services, VPN transport services based on Frame Relay and ATM technologies) and IP solutions based on modern IP technologies, including VoIP;

 

   

Local Area Network (LAN) solutions—LAN and W-LAN hardware for sale or lease, as well as the implementation and operation of related solutions;

 

   

Mobile solutions—access solutions and integration services, including customer-requested solutions relating to digital transmission of content, such as universal secure access and mobile office solutions;

 

   

IT infrastructure services—solutions for improving IT-infrastructure (e.g., desktop management);

 

   

IT business solutions—design, implementation and management of applications;

 

   

Business Process Outsourcing—assumption of responsibility for complete business processes (e.g., billing solutions, human resources); and

 

   

Digital Security Services—including antivirus, firewall and encryption services.

Sales & Service Management

Sales & Service Management is the “single face to the customer” for Business Services and is responsible for all customer-relevant tasks, including product positioning in the German market, sales proposals, customer acquisition and retention, order management, implementation and service management.

To support quality customer service throughout Germany, the sales force is organized regionally. Due to the vast range of customers and their different needs and requirements, Sales & Service Management is separated into five sales channels:

 

   

large enterprises and multi-national corporations that require customized solutions;

 

   

medium enterprises that require the integration of multiple products;

 

   

small enterprises that require standardized products;

 

   

public, which addresses solutions specific to public authorities; and

 

   

health care, which addresses solutions specific to the health care industry.

Prior January 1, 2007, solutions specific to public authorities and health care were serviced by a single sales channel.

Contracts relating to the Sales & Services Management distribution channels have an average duration of approximately three years. Voice services provided are billed on a per-minute basis, while data services are billed in terms of the volume of bandwidth provided each month. Customers taking advantage of leased-line services pay an initial connection fee, based on the type of line leased, and thereafter pay monthly subscription charges based on the line’s capacity (narrowband or broadband), the length of the line (point-to-point connection) and the duration of the lease.

Sales & Service Management’s assets mainly consist of telecommunications and network equipment as well as transmission equipment (71%), intangible assets (14%) and assets under construction (12%).

Marketing & Product Management

Business Services’ Marketing & Product Management service unit is responsible for developing telecommunications and IT offerings for large, medium- and small-sized companies, as well as for the health care market and public authorities. Marketing & Product Management is also responsible for the lifecycle and portfolio management of products and solutions, as well as innovation management, marketing, communications, product profitability and the regulatory compliance of products and services.

 

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Telecommunications Operations

Telecommunications Operations, as part of T-Systems Business Services business unit, manages the development, construction and operation of T-Systems’ German and international service platforms, based on transport capacity leased primarily from T-Com and, to a lesser extent, from other providers.

T-Systems’ service platforms include:

 

   

IP MPLS—delivers advanced IP services and features, including VPNs for business customers;

 

   

ATM/Frame Relay—used as transport technologies through which specific services in customer networks are offered;

 

   

VoIP—T-Systems uses an international IP-based voice platform and is upgrading this platform currently with new voice products for business customers;

 

   

Managed Leased Line Systems—provides transport capacity with less than 2 Mbit/s in Germany; and

 

   

Remote dial-in platforms—designed to give mobile and non-permanent users an easy and secure access to their companies’ Intranet through private dial and secure Internet access technologies.

Approximately 80% of TC Operations’ assets are comprised of technical facilities mainly consisting of active network equipment and approximately 12% are comprised of intangible assets mainly consisting of software licenses with the remaining 8% comprised of furniture and fixtures as well as assets under construction.

Media & Broadcast

Media & Broadcast has a comprehensive service portfolio, which includes television and radio networks, and satellite services. The service portfolio covers the whole broadcast value chain except for the content production and the post-production process. Media & Broadcast is the largest broadcast network operator and broadcast service operator in Germany in terms of revenues and has an outstanding expertise in systems-equipment technology and digital broadcasting transmitters. Its customers comprise national public and commercial broadcasters, television production companies and international broadcasters. In Europe, T-Systems is one of the leading providers of broadcast services in terms of revenues. As of December 31, 2006, T-Systems’ broadcast network in Germany comprised more than 5,900 analog television and radio transmitters, and approximately 250 digital television and radio transmitters.

Many of these services are delivered via T-Systems’ own infrastructure. Media & Broadcast’s main service, and its primary source of revenues, is television and radio network services, which include the planning, installation, monitoring, maintenance, troubleshooting and operation of terrestrial television and radio transmission equipment. T-Systems’ television and radio transmission infrastructure is the basis for the nationwide, wireless provision of television and radio programming. Its customers include both commercial and public radio and television organizations, including the two leading German public television channels, ARD and ZDF.

Media & Broadcast transmits television and radio programs within the framework of customer-specific contracts. Contract criteria include effective radiated power, quality, and “availability” (reliability of operations and downtime). Customers pay for Media & Broadcast services corresponding to their use of the services offered. Most contracts have an average duration of four to six years. In addition, Media & Broadcast provides links between multiple television and radio studios, and recording facilities, enabling the efficient exchange of television and radio content. Services include temporary transmission lines and outside broadcast units (such as for live news reporting, sports coverage and open-air concerts), as well as permanent television and radio transmission links.

Media & Broadcast’s satellite services include the marketing and delivery of satellite capacity, and the provision and operation of uplinks and downlinks. Contractual relationships are generally of a long-term nature (up to 10 years). For satellite capacity, T-Systems’ normal practice is to conclude contracts for the entire useful life of the satellites concerned. T-Systems provides leased satellite capacity primarily to the major European satellite network operators, Eutelsat and SES Astra.

 

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Enterprise Services—IT Operations and Systems Integration

Systems Integration

Systems Integration (SI) provides advice and assistance for a company’s entire “plan-build-run” lifecycle and employs approximately 14,000 employees worldwide (of which approximately 3,000 are employed outside Germany). Through its ICT solutions, SI increases the flexibility of its customers’ business processes. Its primary focus is on consulting (e.g., solution design), IT projects (e.g., solution implementation, along with development projects, including software and platform development, re-engineering and migration) and application lifecycle management. The focal points of SI’s business model are:

 

   

“Industrialization”—relates to the introduction of uniform processes, methods and tools and enhancing the re-usability of modular solutions. It is also defined by the maintenance of low-cost structures at production sites. For this reason, T-Systems has established sourcing platforms in India, Russia, Hungary and Brazil in order to provide offshore programming support.

 

   

“Internationalization”—through SI, an international network of people and organizations has been established to provide sales and services to international customers by offering them tailored, efficient solutions and service components.

 

   

“Focusing”—SI focuses its marketing and sales activities on specific industries to help it achieve greater market and existing customer penetration.

Detecon International GmbH (“Detecon”), T-Systems’ wholly-owned subsidiary, offers customers comprehensive management and technology consulting services worldwide. Detecon focuses on providing services to software and hardware suppliers of telecommunication systems, and to carriers and other service providers as well as to other industries that use such systems.

IT Operations

IT Operations is responsible for providing services relating to customer IT infrastructure, including computing services, desktop services, application services and telecommunications services. IT Operations’ services are offered to new and existing customers through Enterprise Services’ Sales & Service Management service unit.

IT Operations provides the personnel, servers and infrastructure necessary to operate the IT functions of T-Systems’ customers. IT Operations is represented in a large number of locations throughout Germany and the world. As of December 31, 2006, IT Operations had a total of more than 17,000 employees, of whom approximately 70% were based in Germany.

IT Operations comprises three main service lines: Desktop Services & Solutions, Computing Services & Solutions and Business Process Outsourcing. Desktop Services & Solutions delivers, operates and maintains desktop systems for customers, while Computing Services & Solutions operates data centers for customers and manages the systems and applications which run in these data centers. Business Process Outsourcing operates solutions that support customers’ business processes, taking “end-to-end” responsibility for those processes.

Desktop Services & Solutions

The Desktop Services & Solutions service line is responsible for the development and implementation of complete office systems solutions with wide-ranging responsibility for IT infrastructure. Other core services include stand-alone office systems solutions, including desktop operations, call-center and help-desk services, as well as the operation of computing services infrastructure, consulting and IT design. These services may include sales or leasing contracts relating to desktop computer hardware supplied by third parties. Through Desktop Services & Solutions, T-Systems provides cost-effective desktop services primarily to large customers. Such services cover the entire lifecycle of the workstations provided to the customer, and also include the remote configuration, troubleshooting and debugging of software running on workstations serviced through Desktop Services & Solutions.

 

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Through Desktop Services & Solutions, IT Operations also ensures the proper operation of the workstations and services hardware and software products provided. As of December 31, 2006, more than 1,300,000 workstations were serviced through Desktop Services & Solutions. Help-desk services are primarily provided through the Services Office platform and the Call Center Platform Management (CCPM) services. The Services Office platform supports one of the largest and most sophisticated Microsoft Exchange applications worldwide, with more than 300,000 mailboxes as well as file, fax and SMS services. CCPM includes services that are required for the smooth operation of a call-center platform.

In general, desktop services contracts have an average duration of two years. Customers pay for managed desktop services based on contractually agreed service levels. These agreements describe quantities of goods (i.e., the number of computers leased and maintained) as well as customer-specific availability and quality requirements for the services provided.

Computing Services & Solutions

Computing Services & Solutions provides customers with the ability to outsource their entire IT operations. The services offered include the operation of data centers, application management, user support and network management. Other services offered include the installation, operation and administration of central computer systems (mainframes), open computer systems (e.g., UNIX, Windows NT), data center infrastructure services and business applications, on behalf of its customers.

Generally, contracts involving computing services have an average duration of four years or more. Customers pay for computing services based on contractually agreed service levels. These agreements describe the quantity, quality and extent of services to be provided.

Business Process Outsourcing

Business Process Outsourcing targets the following markets:

 

   

Human Resources Solutions, including payroll accounting and travel expense management services, human resources support and time management;

 

   

Billing Services for telecommunication companies, media companies and utilities, which involves settlement and collection services, from the collection and processing of data to the generation of invoices and billing;

 

   

Finance & Accounting Services, which includes the processing of accounting-related business transactions according to national and international accounting standards;

 

   

Managed Document Services, which include archiving, printing and mailing, as well as electronic data exchange; and

 

   

Accounts Receivable Management/Debt Management for business customers, which includes credit rating checks, address investigation and other services.

Seasonality

The revenues of the Business Customers strategic business area are not materially affected by seasonal variations. However, its revenues may be subject to quarterly fluctuations depending on sales cycles (currently ranging between six and 18 months) and the purchasing patterns and resources of its customers, which are subject to general economic conditions and, therefore, difficult to predict. Accordingly, revenues received in a particular quarter may not be indicative of future revenues to be received in any subsequent quarter.

Suppliers

The principal goods and services purchased by T-Systems are computer hardware for client servers and mainframes, operating systems and applications software, network capacity, network services, telecommunications network components and IT consulting services. Business Customers manages the risks in

 

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the supplier relationships, as well as the risks associated with quality and cost considerations, on behalf of its customers. We do not believe that Business Customers is dependent on any single supplier.

Dependence on Intellectual Property

We do not believe that the Business Customers strategic business area is dependent on any individual patents, licenses or industrial, commercial or financial contracts. However, Business Customers is subject to third-party software licenses in connection with the services it provides to its customers. Any breach, violation or misuse of third-party software licenses could result in additional costs with respect to the particular projects that are the subject of such licenses.

Dependence on Material Contracts

Business Customers intends to become less dependent on internal customers (i.e., other Deutsche Telekom group companies) and to improve its market position with respect to external customers. In 2006, the other Deutsche Telekom group companies accounted for approximately 28.2% of Business Customers’ total revenues, compared to 29.5% in 2005 and 28.7% in 2004. No other customer accounted for a significant portion of Business Customers’ total revenues in 2006.

Competition

T-Systems operates in markets that are subject to intense competitive pressures, and the overall market has been characterized by consolidation and increased concentration during the past year. T-Systems faces a significant number of competitors, ranging in size from large IT and telecommunications providers to an increasing number of relatively small, rapidly growing and highly specialized organizations. T-Systems believes that its combination of service, performance, quality, reliability and price are important factors in maintaining a strong competitive position.

T-Systems holds different market positions (based on total revenues) in different regions of the world. In Germany, T-Systems was the market leader in 2005 in the IT and telecommunications areas. In Western Europe, T-Systems was one of the five largest vendors in 2005, together with IBM Global Services, Accenture, CapGemini, and HP Services with respect to IT services including intersegment revenues of T-Systems, and one of the four largest companies, together with BT Global Services, France Télécom and Telefónica, in the telecommunications industry. Globally, T-Systems ranked among the top 20 IT and telecommunications companies. T-Systems’ global IT competitors include IBM Global Services, EDS, Fujitsu Services, HP Services, Accenture, CSC, Atos Origin and Capgemini. In the telecommunications area, T-Systems competes globally with AT&T, VerizonBusiness, NTT, France Télécom and BT Global Services. The ICT market has been characterized by consolidation.

Competition in the telecommunications markets in which T-Systems competes is very intense, both in Germany and globally. The market is characterized by substitution of legacy services (voice and data) by IP and mobile services and by strong pricing pressures. The competitive landscape over the past several years has been characterized by market participants attempting to reduce their indebtedness and increase their profitability through strategic refocusing and concentration on IP services and fixed-mobile convergence solutions. T-Systems expects this strategic refocusing to continue in 2007 and therefore expects similarly fierce competition.

Competition is also intense in the information technology area. The current market is characterized by strong pricing pressures, reduced customer IT budgets and prolonged customer sales cycles. As a result of these competitive pressures, many companies, including T-Systems, are attempting to maintain or expand market share through improved productivity, cost-cutting and efficiency measures. This situation has also led to a consolidation in the IT sector, which T-Systems expects to continue for the foreseeable future. In addition, T-Systems expects that the global IT services markets recovery will continue in 2007, but competition will likely remain intense.

 

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We believe that T-Systems can compete effectively, largely due to its strategy of providing comprehensive solutions (planning, building and operating) to its customers’ needs across a broad spectrum of ICT activities. Offering substantial industry specific expertise, T-Systems believes it can respond to customers’ requirements, acting as a full-service telecommunications and IT provider, effectively and efficiently supporting its ICT customers.

Toll Collect

In connection with a project to create and operate an innovative system for the collection of toll charges for the use by heavy vehicles of the German highway system, we entered into an agreement dated September 2002 (together with all amendments thereto, the “operating agreement”) with an agency of the Federal Republic, DaimlerChrysler Financial Services AG (“DaimlerChrysler Services”) and Compagnie Financiere et Industrielle des Autoroutes S.A. (“Cofiroute”). We refer to this project as the “Toll Collect project.” The partners are responsible for the development of the toll collection system, which has been built and operated by the joint venture Toll Collect GmbH (“Toll Collect”). DaimlerChrysler Services and we each hold a 45% stake in Toll Collect, with the remaining 10% being held by Cofiroute. Our investments in the Toll Collect project include our equity interests therein, which are recognized in our consolidated financial statements using the equity method of accounting, and certain financial guarantees.

Commencement of operations of the toll collection system was originally planned for August 31, 2003. On February 29, 2004, the parties agreed to begin operations with on board units with slightly less than full technical performance no later than January 1, 2005 (Phase 1), which obligation was satisfied. On January 1, 2006, following issuance of the preliminary operating permit, the toll collection system began to operate with full technical performance as specified in the operating agreement (Phase 2). To date, Toll Collect has not received the final operating permit as the parties are not in agreement with respect to certain contractual requirements relating to the grant of the operating permit. The operating agreement can be terminated by the Federal Republic if the final operating permit has not been granted within one year following issuance of the preliminary operating permit. Therefore, the Federal Republic may claim that it is entitled to terminate the operating agreement. Such right to terminate expires within six months. We have not received any indication that the Federal Republic intends to terminate the operating agreement. However, in December 2006, Toll Collect initiated an arbitration proceeding seeking a determination that the Federal Republic’s basis for denying the issuance of the final operating permit is unfounded and claiming that additional remuneration is due to Toll Collect in accordance with the operating agreement.

The Federal Republic has initiated arbitration proceedings against DaimlerChrysler Services, Deutsche Telekom AG and the consortium. The Federal Republic is claiming damages resulting from the delay in the commencement of operations and contractual penalties in an aggregate amount of approximately EUR 5.2 billion plus interest. We filed our defense statement on June 30, 2006. Although the outcome of arbitration proceedings is difficult to predict, we believe that these claims are unsustainable and we are contesting the Federal Republic’s claims vigorously. For more information, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Liquidity—Contractual Obligations and Other Commitments” and “Item 8. Financial Information—Legal Proceedings.”

Group Headquarters and Shared Services

General

Group Headquarters and Shared Services performs strategic and cross-divisional management functions for the Deutsche Telekom group. Group Headquarters functions include those performed by many of our central departments, such as treasury, legal, accounting and human resources. Operating functions not directly related to the core businesses of our strategic business areas are considered shared services functions. These functions also include, among others, the management and servicing of our real estate portfolio (primarily within Germany), fleet management and Vivento. Although many of the Group Headquarters and Shared Services functions are legally part of Deutsche Telekom AG, we manage Group Headquarters and Shared Services as though it were a separate legal entity.

 

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Principal Activities

The real estate unit is, based on total and net revenues, the largest shared service within Group Headquarters and Shared Services. The real estate unit is responsible for managing our real estate portfolio, renting commercial real estate and providing facility management services for our group, primarily in Germany. Our real estate operations are conducted through various subsidiaries and affiliates and include:

 

   

the internal and external group leasing and rental business;

 

   

the power supply and air conditioning solutions business related to our telecommunications facilities;

 

   

facility management services;

 

   

real estate management for Magyar Telekom and Slovak Telekom (since June 2006), as well as third parties in Hungary and Slovakia; and

 

   

the operation, management and servicing of our radio transmission sites, such as our radio towers and transmitter masts in Germany (primarily used in mobile, radio and satellite communications, as well as for television broadcasting).

In April 2006, we reduced our stake in Sireo Real Estate Asset Management GmbH from 51% to 25.1%. However, Sireo will continue to oversee the management and disposition of our real estate portfolio and plans to expand its operations and business with third parties. For more information about our real estate portfolio and management activities, see “—Description of Property, Plant and Equipment—Network Infrastructure—Real Estate.”

Vivento was established in 2002 with the goal of efficiently implementing our staff restructuring measures in a socially responsible manner. Through Vivento, displaced workers are retrained and equipped with new employment qualifications for permanent redeployment within the Deutsche Telekom group or with external employers, or for project and temporary assignments. In addition to individual placements, Vivento staffs major projects and workforce-intensive operations and services. To create further employment opportunities, Vivento operates its own business lines. At the beginning of 2004, Vivento commenced providing call-center services primarily to some of our group companies and, to a lesser extent, third parties. These call center operations consist of a portion of the former call center operations of T-Com, as well as those of Vivento Customer Services GmbH, which was established in the first quarter of 2004.

Vivento Customer Services GmbH provides customer-relationship services, including call-center and back-office services, within the group as well as to third parties. Vivento Customer Services operates 14 sites throughout Germany and, as of December 31, 2006, employed approximately 2,500 people. In addition, approximately 200 people from Vivento were employed by Vivento Customer Services on a contract or temporary basis as of that date. In July 2004, Vivento set up a further business line by establishing Vivento Technical Services GmbH, which offers installation and after-sales services in the field of technical infrastructure within and outside the group. As of December 31, 2006, Vivento Technical Services had approximately 2,000 employees, and a further 400 were temporary staff from Vivento.

As of December 1, 2006, we completed the transfer of five call centers of Vivento Customer Services, including an aggregate of approximately 600 employees of Vivento Customer Services, to Walter Tele Medien-Gruppe. In connection with our personnel reduction measures announced in 2005, we plan to divest further activities of our Vivento business lines.

On June 22, 2006, the German Federal Administrative Court declared the transfer of civil servants to Vivento not legally permissible. As a result, no further transfers of civil servants to Vivento will be made until an appropriate legal basis is created. The situation for the civil servants already transferred will remain unchanged—they will stay at Vivento and will continue to be given temporary employment or a new permanent position inside or outside the group. The transfers already made to date are legally valid because the transfer process was completed under existing law. For more information, see “Item 6. Directors, Senior Management and Employees—Employees and Labor Relations.”

 

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During 2006, approximately 2,700 of our employees were transferred to Vivento. Through December 31, 2006, a total of approximately 36,800 employees have been transferred to Vivento since its creation. Approximately 68% of these employees were transferred from T-Com, both as part of T-Com’s program to increase its efficiency, and through the transfer of some T-Com operations to the Vivento business lines. The remaining transferred employees either were apprentices who had finished their professional training within the group, but had not obtained full-time employment, or came from the other Deutsche Telekom strategic business areas.

At December 31, 2006, a total of approximately 23,300 employees had left Vivento since its formation, of which 4,400 left during 2006. About 70% of these employees were external placements. As of December 31, 2006, approximately 13,500 employees were in Vivento, of which approximately 700 were permanent staff, 7,200 were employees of the Vivento business lines and approximately 5,600 were engaged on a temporary or contract basis within or outside of the group.

The following table provides information regarding Vivento’s employee structure and movements for the periods presented:

 

     2006(1)    2005(1)    2004(1)

Number of employees transferred to Vivento

   2,700    2,400    12,100

Number of employees that have left Vivento

   4,400    6,100    9,100

Total number of employees in Vivento as of year-end

   13,500    15,300    19,000

of which: Operational staff of Vivento

   700    700    700

of which: Number of employees in business lines

   7,200    7,200    4,600
 
  (1) Figures have been rounded to nearest 100.

Our fleet management company, DeTeFleetServices GmbH (“DeTeFleetServices”), provides fleet management and mobility services, with approximately 43,000 vehicles provided to our group companies and affiliates within Germany. DeTeFleetServices also generates net revenues from third parties through its sale of used fleet vehicles and, to a limited extent, through fleet management services to third parties. The majority of third party customers are former affiliates of Deutsche Telekom AG that were sold.

The Central Treasury department is primarily responsible for cash management, investments in securities, leasing arrangements and the refinancing of indebtedness through a variety of financial arrangements, including, among other things, bank loans and other credit arrangements. Furthermore, this unit is responsible for the issuance of debt in the international capital markets, the handling of payments and clearing transactions, and foreign exchange and hedging activities. For more information, see “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources” and “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

T-Venture Holding GmbH (“T-Venture”) is also included in Group Headquarters and Shared Services. T-Venture’s mission is to scout new products, technologies and services and to acquire access to them on our behalf. Accordingly, a central corporate fund has been established for this purpose, in addition to the individual investments that can be made by our strategic business areas.

The Telekom Training unit is responsible for providing professional training and qualification services for our employees within Germany. This unit also provided training for approximately 10,300 apprentices during 2006.

Group Headquarters and Shared Services also includes the establishment and maintenance of international intellectual property rights for the Deutsche Telekom group, including the T-Com, T-Mobile, T-Online and T-Systems brands.

Apart from our facility management operation in Hungary and Slovakia, Group Headquarters and Shared Services has only limited international activities, as most of our international operations have been transferred to our strategic business areas, and our non-core assets have been divested.

 

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INNOVATION MANAGEMENT (RESEARCH AND DEVELOPMENT)

Innovation Strategy

Our innovation strategy focuses on customers and their current and future requirements that we expect to have the greatest impact on our company in the coming years. In 2006, we continued to concentrate our research activities based on the “5i” strategy, which comprises the following five focus fields, reflecting our strategic innovation portfolio and development priorities:

 

   

Inherent Security—offers our customers network-related security solutions.

 

   

Intuitive Usability—seeks to make complicated services and functions more user friendly.

 

   

Intelligent Access—offers customers the best service available without requiring the user to manually select the network services and access.

 

   

Integrated Communication—promotes the appropriate connection and interaction of many tasks and devices to one another.

 

   

Infrastructure Development—creates the technological basis needed to meet bandwidth, mobility and security requirements in a cost-effective manner for our group and its customers.

Systematic analysis and tracking of future customer needs helps us focus our research and development (R&D) efforts on the topics and technologies that are most relevant to our customers. Key innovation and performance indicators and processes enable us to evaluate and provide quality assurance throughout the group. Execution strategies and the timing of the introduction of products to the market are subject to group-wide contribution and effort. The major topics of innovation the group will concentrate on in 2007 and the future are IPTV, mobile Internet and ICT services. In addition, we are exploring the potential for fixed-mobile convergence products and for innovative business ideas such as IP value-added services.

Research & Development

In addition to modifying our R&D efforts from a technology-oriented focus to a customer-oriented focus in 2003, we combined the central departments “Technology & Platforms” and “Innovation” in 2005 to harmonize and closely coordinate our strategies for developing new applications and products, as well as network platforms. Our innovation activities are currently managed by the realigned “Innovation, Research & Development” central department, which is responsible for innovation strategy, innovation management across the group, innovation marketing, group-wide research and development and corporate venture capital. Innovation, Research & Development focuses primarily on issues that are relevant to all strategic business areas and on new technologies that are expected to be launched or ready for the market in two to five years. The strategic business areas are primarily responsible for product innovations that are close to market launch, i.e., within a development lead time of up to 24 months.

In addition to the Innovation, Research & Development central department, Deutsche Telekom Laboratories and T-Venture support the implementation of our innovation strategy. Deutsche Telekom Laboratories acts as a central research and development unit. T-Venture, a venture capital company, finances and supports innovative new companies in the telecommunications and IT sectors.

Deutsche Telekom Laboratories

Launched in 2005, Deutsche Telekom Laboratories established itself as a central research and development institute and as an international science institution. Deutsche Telekom Laboratories is divided into the Innovation Development Laboratory and the Strategic Research Laboratory. Both areas are organized to support the transfer of knowledge and findings from academic research into product design with our strategic business areas.

The Innovation Development Laboratory has assumed the role of general contractor for applied research and development. On the basis of the five innovation areas described above, it manages our R&D portfolio. It

 

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develops and assesses innovative ideas, implements test environments, assists with demonstrations and prototypes, and develops business models. It then transfers results to the strategic business areas for further review and development.

The Strategic Research Laboratory carries out long-term, applied fundamental and technology research and provides important basic insights for the development of innovative products and solutions. To achieve this, the Berlin Technical University and Deutsche Telekom have set up four fields of research at the university, each under an endowed chair.

Research and Development Expenditures

In 2006, our expenditures on experimental, explorative, and pre-production research and development were EUR 0.2 billion (2005: EUR 0.2 billion; 2004: EUR 0.2 billion). Typical research and development activities included the development of new data-transmission processes and innovative telecommunications products. In 2006, investment in internally developed intangible assets amounted to EUR 0.3 billion, an increase of EUR 0.1 billion compared to 2005 and 2004. This investment related primarily to the development and adaptation of internally developed software, as well as software platforms and architectures, with the aim of improving processes for the provision and operation of services and products. As in previous years, the vast majority of this amount was attributable to the Broadband/Fixed Network and Mobile Communications strategic business areas.

Intellectual Property

In 2006, we filed 557 patent applications worldwide. Management of our intellectual property portfolio is based on strict cost/benefit considerations. The portfolio is reviewed on a regular basis and those intellectual property rights that are no longer relevant are eliminated. This led to a reduction of the number of inventions, patent applications, patents, utility models and design models held to 5,663 as of December 31, 2006 (2005: 6,686; 2004: 5,991).

 

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ACQUISITIONS AND DIVESTITURES

The following table presents each of the principal acquisitions and divestitures made by us during our last three fiscal years:

 

Year   

Segment(1)

  

Event

   Amount  
               (billions of €)  
2006    Mobile Communications   

Purchase of shares in PTC(2)

   (0.6 )
2006    Business Customers   

Purchase of shares in gedas

   (0.3 )
2006    Mobile Communications   

Purchase of shares in tele.ring

   (1.3 )
2006    Broadband/Fixed Network   

Exchange of shares of Deutsche Telekom AG for shares of T-Online International AG(3)

   (0.8 )
2006    GHS   

Sales of real estate

   0.4  
2005    Broadband/Fixed Network   

Purchase of shares in Crnogorski Telekom

   (0.1 )
2005    GHS   

Sales of shares in DeASat S.A.

   0.1  
2005    Mobile Communications   

Purchase of shares in CMobil

   (0.1 )
2005    GHS   

Sale of real estate

   0.2  
2005    GHS   

Sales of shares in Intelsat, Ltd.

   0.1  
2005    Mobile Communications   

Sale of remaining shares in MTS

   1.2  
2005    Broadband/Fixed Network   

Purchase of additional shares of T-Online International AG

   (1.8 )
2005    Broadband/Fixed Network   

Sale of shares in comdirect bank AG (“comdirect bank”)

   0.2  
2004    Broadband/Fixed Network   

Purchase of remaining shares in EuroTel Bratislava a.s.

   (0.3 )
2004    Mobile Communications   

Sale of shares in MTS

   1.3  
2004    GHS   

Sales of real estate

   0.3  
2004    GHS   

Sale of shares in SES Global S.A.

   0.6  
2004    Broadband/Fixed Network   

Acquisition of the Scout24 Holding GmbH

   (0.2 )
2004    Broadband/Fixed Network   

Acquisition of Stonebridge Communications A.D.

   (0.1 )

(1) Reflects our reorganized business structure as of January 1, 2005.
(2) Further payments relating to the acquisition of PTC shares from Elektrim will be required to be made as determined by a Vienna arbitration tribunal. For more information on PTC, see “Item 8. Financial Information—Legal Proceedings” and “Notes to the Consolidated Financial Statements—Summary of accounting policies—Business combinations.”
(3) In June 2006, we issued 62.7 million of our shares in exchange for the remaining shares of T-Online in connection with the completion of the merger of T-Online International AG into Deutsche Telekom AG, which shares had a fair value of EUR 0.8 billion. In August 2006, we repurchased 62.7 million of our shares in the market, which shares were retired to avoid dilution as a result of the issuance of shares in connection with the merger.

 

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REGULATION

Overview

Our operations worldwide, as well as those of our subsidiaries and affiliates, are subject to sector-specific telecommunications regulations and general competition law, as well as a variety of other regulations. The extent to which telecommunications regulations apply to us depends largely on the nature of our activities in a particular country, with the conduct of traditional fixed-line telephony services usually being subject to the most extensive regulation. Regulations can have a very direct and material effect on our overall business, particularly in jurisdictions that favor regulatory intervention.

General Licensing Requirements

To provide services and to operate our networks, either general authorizations or licenses are required from regulatory authorities in countries in which we operate. In member states of the European Union (“E.U. Member States”), the operation of fixed networks and the provision of public voice telephony services in the fixed network require notification to, or registration with, regulatory authorities. Further, the public voice telephony services of our Croatian subsidiary, T-Hrvatski Telekom, require a license.

Licensing procedures also apply to our mobile network operations with respect to radio frequencies. The duration of any particular license or spectrum usage right depends on the legal framework in the relevant country. Most countries limit the duration of licenses or usage rights, which are generally renewable, to between three and thirty years.

The E.U. Regulatory Framework

Between 1989 and 2001, the European Union introduced a number of liberalization and harmonization directives as well as recommendations regarding open and efficient access to, and the use of, public telecommunications networks and services. These were intended to open monopolistic markets and to harmonize technical interfaces, usage conditions, and mandatory minimum service standards for all fixed-line users and to provide a general framework for tariffs throughout the European Union. At the end of 1999, the E.U. Commission initiated a review of the E.U. telecommunications regulatory framework, focusing on the development of competition in the telecommunications sector and the increasing convergence of media, telecommunications and information technology. In 2002, the European Union adopted several legislative measures, which included a general framework directive and four specific directives regarding the following topics (collectively constituting the “E.U. Framework”):

 

   

access to, and interconnection of, electronic communications networks;

 

   

mandatory minimum service standards for all users (universal service obligations) and users’ rights;

 

   

authorization and licensing regimes;

 

   

telecommunications data protection; and

 

   

a regulatory framework for radio spectrum policy in the European Union.

The directives are, among other things, intended to:

 

   

establish the rights, responsibilities, decision-making powers and procedures of the national regulatory authority (“NRA”) in each E.U. Member State and the E.U. Commission;

 

   

identify specific policy objectives that NRAs must achieve in carrying out their responsibilities; and

 

   

provide that operators with significant market power in defined electronic communications markets can be subject to certain obligations.

Since the most significant part of our business is undertaken in the European Union, our operations are to a large extent subject to the E.U. Framework on telecommunications regulation. E.U. Member States are required to enact E.U. legislation in their domestic law and to take E.U. legislation into account when applying domestic

 

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law. In each E.U. Member State, a NRA is responsible for enforcing the national telecommunications laws that are based on the E.U. Framework. NRAs generally have significant powers under their relevant telecommunications acts, including the authority to impose network access and interconnection obligations, and to approve or review the charges and general business terms and conditions of providers with “significant market power”. In general, a company can be considered to have significant market power if its share of a particular market exceeds 40%. NRAs also have the authority to assign wireless spectrum and supervise frequencies and to impose universal service obligations.

The E.U. Commission supervises the NRAs and formally and informally influences their decisions in order to ensure the harmonized application of the E.U. Framework throughout the European Union. Companies can challenge decisions of the relevant NRA before national courts. Such legal proceedings can lead to a decision by the European Court of Justice, which is the ultimate authority on the correct application of E.U. legislation.

The E.U. Framework is also important in some countries that are not yet part of the European Union, but which are expected to be in the future, such as Croatia. Those countries are already adapting their telecommunications legislation to the E.U. Framework.

Special Requirements Applicable to Providers with Significant Market Power

The most significant impact on our business stems from the E.U. Framework’s special requirements applicable to providers with significant market power. Obligations in relation to network access, price setting, separate accounting for interconnection services, publication, and non-discrimination, can be imposed on those operators that are designated by the relevant NRA as having significant market power in an electronic communications market. Such determinations are based on E.U. guidelines and E.U. competition case law. We have been designated as having significant market power primarily in most fixed-line markets in which we operate, as well as in mobile voice call termination markets.

In particular, the NRA may subject providers with significant market power, and their affiliates, to the following rules and obligations:

 

   

The prior approval or retroactive review of charges, insofar as such charges and conditions relate to a market in which the provider holds significant market power.

 

   

The obligation to offer other companies unbundled special network access (including interconnection) as well as access to certain services and facilities on a non-discriminatory basis.

In addition, providers with significant market power can be obliged to maintain segregated accounting systems with regard to access services. This obligation is intended to allow for transparency with respect to various telecommunications services in order to prevent, among other things, the cross-subsidization of services. In this regard, the NRA may specify the structure of a provider’s internal accounting for particular telecommunications services, which can increase costs of compliance.

Under the E.U. Framework, the E.U. Commission periodically issues a market “recommendation,” which is a list of telecommunications markets that it considers susceptible to sector-specific regulation. NRAs must take this list of markets into account when defining the markets that are to be analyzed for the existence of competitive restraints. If a NRA finds that a market is not competitive, it establishes which providers have significant market power in this market and may impose certain measures prescribed by statute.

In February 2003, the E.U. Commission issued its first recommendation, which related to the retail markets for fixed-line public telephone service and leased lines, as well as the wholesale markets for the unbundled local loop, fixed-network interconnection, leased lines, broadband access, mobile voice call termination, mobile access and call origination, international roaming, and broadcasting transmission services. We have been designated as an operator with significant market power in almost all of these markets in Germany.

NRAs may analyze additional markets not included in the E.U. recommendation if justified by special national circumstances. NRAs are required to conduct market analyses on all communications markets included in the E.U. Commission’s recommendation, as well as those that the NRAs have decided to include within the

 

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scope of sector-specific regulation in agreement with the E.U. Commission. All NRA market analyses are subject to the supervision of the E.U. Commission and can be challenged if the E.U. Commission does not agree with the NRA’s findings.

In addition to the recommendation, there is a separate E.U. regulation on unbundled access to the local loop, which became effective in January 2001. It contains the obligations to provide full unbundled access to copper-paired wire lines as well as unbundled access to the high-frequency spectrum of those lines (line-sharing). Unbundling has led to a considerable loss of our market share.

Additional E.U. legislation that may materially affect our business is discussed in the subsequent sections on broadband/fixed-network regulation and mobile communications regulation.

Legislative Developments

Under the E.U. Framework, the E.U. Commission must regularly review its market recommendation. The first review of the E.U. recommendation is currently ongoing, but the draft of the next recommendation appears to somewhat limit the number of markets in which obligations are imposed on operators with significant market power. In particular, most retail markets are expected to be removed from the list of markets that are susceptible to telecommunications regulation. However, the most important market relating to retail access to the fixed telephone network is expected to remain subject to such regulation. We expect the new recommendation to come into force in mid-2007.

In addition, the entire E.U. Framework is subject to a review currently in progress. Any changes to the framework would become effective following their transposition into national law. So far, the E.U. Commission has signaled that only minor changes to the regulatory framework will be considered. Whether the regulatory framework will increase or decrease the regulatory burden on us will depend on the changes being adopted by the European Union, the manner in which revised directives are subsequently implemented in the E.U. Member States, and how the revised regulatory framework will be applied by the respective NRAs.

Infringement Proceedings Against Germany

In October 2004, the E.U. Commission launched an infringement proceeding against Germany concerning provisions of the Telecommunications Act in connection with wholesale network access, including interconnection. The E.U. Commission’s concern was that the Federal Network Agency lacked the full flexibility required by the E.U. Framework with respect to its authority to issue decisions regarding the imposition of obligations on operators found to have significant market power in the field of wholesale network access and interconnection. Consequently, the infringement procedure could also lead to more flexibility for the Federal Network Agency to refrain from imposing cost-oriented prices where an access obligation had been imposed on an operator with significant market power. After the Telecommunications Act was recently amended in order to comply with the E.U. Commission’s request, it is currently uncertain whether this infringement proceeding will be continued.

In April 2005, the E.U. Commission launched a further infringement proceeding against Germany, criticizing a provision of the Telecommunications Act that does not allow for the imposition of the obligation to offer carrier pre-selection and call-by-call-selection when there is effective competition between services supplied by mobile network operators and by mobile service providers at the retail level. The E.U. Commission is also concerned that, according to the Telecommunications Act, the Federal Network Agency can regulate the rates that operators with significant market power charge for retail telecommunications services, but does not provide for the flexibility of imposing less intrusive obligations. It further argues that the Telecommunications Act does not provide enough flexibility for the Federal Network Agency to decide how to apply price regulation (for example, whether to approve tariffs in advance or retroactively). After the recent amendment of the Telecommunications Act, it is currently uncertain whether this infringement proceeding will be continued.

 

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Media Regulation

Although regulation of broadcast media and media content has not materially affected our business, as traditional telecommunications services and media services increasingly converge through products such as triple-play, media regulation may become increasingly important to our business. For example, in Germany we currently offer IPTV to our high-speed broadband customers as well as mobile TV services to customers of T-Mobile Deutschland. Although there are several regulations related to media services and platforms, the introduction of a notification obligation and a possible license requirement for broadcasting platforms are being discussed by the German state governments. These discussions could result in regulations relating to the selection of broadcasting programs transmitted over such platforms, and the contractual conditions for such transmission.

Other E.U. regulation requires TV set top boxes to have either no encryption technology or a common scrambling algorithm. The set top boxes we use for our German IPTV services rely on a special digital rights management technology that might not be entirely compatible with the common scrambling algorithm. However, the Federal Network Agency has granted us a preliminary exemption from this regulation until July 2007, and the recently amended Telecommunications Act now explicitly allows for further exemptions. If the current legislation is ultimately determined to apply to our set top boxes, this could result in our set top boxes not being in compliance with the legal requirements. Modification of the current digital rights management technology could prove costly and some features of our IPTV service may be discontinued.

Competition Law

The European Union’s competition rules have the force of law in all E.U. Member States. The main principles of the E.U. competition rules are set forth in Articles 81 and 82 of the European Community Treaty (“E.C. Treaty”) and in the E.U. Merger Regulation (the “Merger Regulation”). In general, the E.C. Treaty prohibits “concerted practices” and all agreements that may affect trade between Member States and which restrict, or are intended to restrict, competition within the European Union, and prohibits any abuse of a dominant position within the common market of the European Union, or any substantial part of it, that may affect trade between Member States. The E.U. Commission enforces these rules in cooperation with the national competition authorities, which may also directly enforce the competition rules of the E.C. Treaty. In addition, the national courts have jurisdiction over alleged violations of E.U. competition law.

The Merger Regulation requires that all mergers, acquisitions and joint ventures involving participants meeting certain turnover thresholds are to be submitted to the E.U. Commission for review, rather than to the national competition authorities. Under the amended Merger Regulation, concentrations will be prohibited if they significantly impede effective competition in the common European market, or a substantial part of it, in particular as a result of the creation or strengthening of a dominant position.

In addition, all E.U. Member States (and other jurisdictions in which we operate, such as the United States) have legislation in place which is substantially similar to the E.U. competition rules. Thus, in markets where we are dominant, our ability to practice business freely and to establish our own prices can be restricted. Moreover, our opportunities to cooperate with other companies, or to enhance our business by fully or partially acquiring other businesses, can also be limited. In Germany, the authority responsible for the application of competition law is the Federal Cartel Office (Bundeskartellamt). For information regarding specific competition cases in which we are involved, see “Item 8. Financial Information—Legal Proceedings.”

German Telecommunications Regulation

Since the most substantial part of our business is located in Germany, German telecommunications regulation has an especially significant impact on our business. As in all E.U. Member States, German telecommunications regulation is based on the E.U. Framework. German telecommunications regulation is mainly derived from the Telekommunikationsgesetz (the “Telecommunications Act”).

We believe that, for the foreseeable future, the Federal Network Agency is likely to view us as a provider with significant market power in various German markets for public voice telephony services in the fixed

 

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network and in other markets, including most of those in which we held monopoly rights in the past. Additionally, in 2006, we were determined to be a provider with significant market power in the German market for mobile voice call termination for the first time. As a result, we expect that the strict regulatory provisions of the Telecommunications Act relating to providers with significant market power will be applied to our activities in those markets. Considering that in many markets our competitors are unlikely to gain significant market power in the near future, we expect that we will have to compete in important markets with providers not subject to those regulatory obligations. Therefore, these competitors may have more flexibility than we have in terms of the selection of services offered and customers served, pricing and the granting of network access.

Pricing

Under the Telecommunications Act, tariffs for telecommunications access services offered by providers with significant market power and their affiliates can be subject to price regulation, insofar as the tariffs relate to a market in which significant market power has been determined to exist. Other tariffs are essentially unregulated. The tariffs of all providers in Germany are, however, subject to generally applicable E.U. and German laws, including competition law and consumer protection rules. In addition, tariffs for universal services must be set at an “affordable price.” For more information, see “—General Network Access—Universal Services.”

The Telecommunications Act distinguishes between tariffs that require prior regulatory approval and those that are subject to retroactive review. Generally, wholesale pricing requires prior approval, whereas retail pricing is subject to retroactive review. Nevertheless, at present, we are required to disclose most retail pricing measures concerning our fixed telephony network to the Federal Network Agency two months before they become effective, which enables the Federal Network Agency to undertake a preliminary evaluation with respect to whether our prices comply with rules prohibiting abuse of significant market power. This requirement restricts our flexibility to react quickly to competition in the retail markets for fixed telephony.

General Network Access

Every operator of a public telecommunications network, irrespective of its market position, is obligated, upon request, to make an interconnection offer to other network operators for interconnection with its network. If the parties cannot agree on the terms and conditions of such interconnection, upon application by one of the parties, the Federal Network Agency can compel an operator that controls access to end users to allow interconnection to its network and can impose other access obligations.

Treatment of New Markets

The German government has recently introduced in the Telecommunications Act a rule concerning “new” telecommunications markets, which provides that access and price regulations concerning operators with significant market power will, in general, not be applicable to new markets. The purpose of this rule is ostensibly to encourage telecommunications providers to invest in new infrastructure and services. An effect of this new rule could be that our new high-speed fiber-optic broadband access platform will not be regulated. We currently operate this new platform in ten metropolitan areas and started with the roll out in further cities. However, the regulatory treatment of these networks will ultimately depend on the interpretation of the new rule by the Federal Network Agency. Additionally, the E.U. Commission regards the new market rule as contradicting the E.U. Framework and has announced that it will initiate an infringement proceeding against Germany. Under the E.U. Framework, the E.U. Commission can initiate infringement proceedings against an E.U. Member State if it is convinced that the E.U. Member State has not correctly transposed the rules of the E.U. Framework into national law and is thus in breach of the E.U. Treaty. This proceeding will be ultimately decided by the European Court of Justice and is expected to take up to three years. Our further investment in high-speed fiber access in other German cities will depend not only on customer demand but also on the regulatory environment. If our new network is ultimately regulated in disregard of the new market rule, this may affect our decisions with respect to further investments in planned new infrastructures or other products.

 

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Universal Services

The Telecommunications Act includes provisions to ensure the availability of certain basic telecommunications services (“universal services”) throughout Germany. Universal services comprise public fixed-line network voice telephony with certain ISDN features, directory services, telephone books, public pay phones and certain categories of transmission lines. These services must be universally available to all customers at a price determined by the Federal Network Agency to be an “affordable price.” We currently provide the universal services specified by the Telecommunications Act voluntarily and without compensation.

Customer Protection

The customer protection rules, which apply to all providers of telecommunications services, have been expanded in the latest amendment of the Telecommunications Act. The expanded obligations largely promote greater price transparency for customers. We expect that certain value added services, such as premium voice call services, will be negatively affected.

Data Retention

The German Government has published a draft bill on data retention for law enforcement purposes. This legislation is intended to implement E.U. directives which came into force in 2006. The new requirements may result in additional investment and recurring annual costs for us, depending on the final wording of the national legislation. At present, it is unclear to what extent those costs will be compensated by the state.

Interconnection

Fixed-Fixed Interconnection

Since January 2002, there has been an “element-based” interconnection tariff system in Germany. Under this system, the tariff for transmission of traffic is based on the number and type of network elements used in transmission, and not on the distance over which the traffic is transmitted. The Federal Network Agency determined our previous interconnection pricing levels in November 2003. These tariffs were valid from December 1, 2003, to May 31, 2006. Compared to the previous period, the tariffs were reduced by the Federal Network Agency by 9.5%. Some carriers have initiated legal proceedings against the decision of the Federal Network Agency in order to lower the tariffs further. These proceedings are still pending.

On April 13, 2006, the Federal Network Agency decided on new fixed-fixed interconnection charges valid from June 1, 2006 until November 30, 2008. The charges were again reduced by approximately 10%. The Federal Network Agency justified this price reduction by not considering the costs of certain switches in the PSTN-network that it believes are not efficient based on the number of users. On September 5, 2006, we initiated legal proceedings to obtain injunctive relief. This action was dismissed by the court on December 20, 2006. Some competitors also initiated legal proceedings in order to lower the tariffs further. The proceedings are still pending. In the meantime, the reduced charges have taken effect.

Pursuant to a Regulatory Order published on October 5, 2005, Deutsche Telekom is considered a provider with significant market power in the three interconnection services markets and, consequently, we are obligated to provide interconnection and conveyance services, and we are required to grant, for interconnection purposes, co-location rights to our competitors. Co-location rights give a competitor the right to share certain physical premises with us. In addition, we are also obligated to allow our competitors to interconnect directly with other carriers within our co-location rooms and to share their transmission paths. The rates we may charge for such interconnection and conveyance services, as well as for granting co-location rights, remain subject to the prior approval of the Federal Network Agency. On November 4, 2005, we initiated legal proceedings against the obligation to allow our competitors to interconnect directly with other carriers within our co-location rooms. These proceedings are still pending.

Local Loop Access

After concluding the market analysis procedures required by the Telecommunications Act, the Federal Network Agency published a Regulatory Order for access to the local loop in April 2005, which confirmed that

 

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we were considered to have significant market power in this market. Accordingly, although we have offered unbundled local loop access since 1998, this decision confirmed that we are still obligated to offer such access to other carriers. By allowing competitors to connect to customer access lines within our local networks, unbundling of the local loop allows our competitors to gain direct access to customers without having to build local networks of their own. In this way, competitors are able to use our customer access lines to offer a wide range of local services directly to customers.

We are involved in a number of pending legal proceedings regarding recent decisions of the Federal Network Agency that concern access charges relating to the local loop, and which have resulted in severe reductions in our charges for such access. We believe that the Federal Network Agency did not take into account a number of our costs that were justifiable costs for these services, and that if it had done so, our permitted local loop access charges would have been higher. For more information, see “Item 8. Financial Information—Legal Proceedings—Proceedings Against Decisions of the Federal Network Agency.”

On April 29, 2005, the Federal Network Agency reduced the monthly line rental charges we are allowed to charge our competitors, from EUR 11.80 to EUR 10.65. These charges are valid for the period from April 1, 2005 to March 31, 2007. On January 19, 2007, we applied for a new monthly fee of EUR 12.03. The Federal Network Agency is expected to make a determination with respect to this application on or prior to March 31, 2007. On August 3, 2005, the Federal Network Agency also decided to reduce the one-time activation (takeover of an existing line) charge for subscriber line rental we are allowed to charge our competitors by approximately 10%, to EUR 45.61 for the most common type of subscriber line (copper wire pair with high bit-rate use). The corresponding cancellation charges have been reduced as well. In cases in which a customer switches to another carrier, or returns to us, the charges were reduced to EUR 5.80 (approximately 71% lower than before). These amended activation and cancellation charges are valid until June 30, 2007. Due to the importance of customer line rental to our wholesale business, these reductions will have negative effects on the revenues of our T-Com business.

Since January 2001, we have been offering line sharing (i.e., using a single access line for multiple purposes, including sharing access with competitors) in accordance with E.U. requirements. On August 3, 2005, the Federal Network Agency reduced the monthly line sharing charges from EUR 2.43 to EUR 2.31. This decision was based on a finding of a decrease in overhead costs and a rejection of certain cost-allocation factors. Further, the Federal Network Agency decided on the one-time activation charges for the provision of line sharing, which will be reduced to EUR 51.43. Another reduction concerns the one-time cancellation charges for line sharing, which were lowered to EUR 10.48 and EUR 51.22, respectively (with/without switching the end customer’s access to another carrier using line sharing). The amended tariffs are valid until June 30, 2007.

With the Regulatory Ordinance of April 20, 2005, the Federal Network Agency imposed on us the obligation to submit a reference offer of unbundled services to our competitors. This reference offer provides for penalties and extended possibilities of cooperation with carriers in the context of co-location. Since this reference offer is still under regulatory examination, we do not know for the time being to what extent the Federal Network Agency will accept our proposals or impose further regulatory measures upon us.

In October 2006, a competitor initiated proceedings with the Federal Network Agency relating to access to cable ducts, fiber and co-location within the street cabinets. We believe that these proceedings were withdrawn in February 2007 as a result of the pending Federal Network Agency’s market analysis, which will likely address this subject. This market analysis is expected to commence in March 2007, and will likely not be concluded until the end of 2007.

Broadband Access—Bitstream

In the market analysis for wholesale broadband access services, we were determined as having significant market power and, therefore this market will be subject to regulation described below. The Federal Network Agency divides the broadband wholesale services market into separate IP-Bitstream Access and ATM-Bitstream Access markets.

 

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IP Bitstream

For the IP-Bitstream Access market, the Federal Network Agency issued a regulatory order in September 2006. According to the order, we are obliged to offer IP broadband access to our competitors and the rates are subject to prior approval by the Federal Network Agency. We are obliged to make a reference offer for broadband access, which we published on December 13, 2006, and that now has to be discussed with the Federal Network Agency and our competitors.

We have been offering Bitstream Access on a voluntary basis since August 2004. These products combine DSL resale products with additional wholesale IP transport services and enable ISPs and network operators without their own infrastructure to transport broadband traffic between end-customers and the IP networks of our competitors. Therefore, we believe there is no need for regulation in this area. Nevertheless, the Federal Network Agency did not accept our voluntary offer and imposed on us the additional regulatory measures described below.

The market analysis for IP Bitstream access includes the new VDSL network to the extent that it is compatible with other bitstream access products. The Federal Network Agency stated that it can only decide which VDSL-based bitstream products are not compatible once the VDSL network is operational and end-user products are being offered. Although discussions regarding the regulation of the VDSL network are still ongoing, we are hopeful that products based on this new network will be classified as new or emerging markets, in which case no access obligations will be imposed on us. We expect a decision to be made on the basis of the amended Telecommunications Act that, in general will not apply to these new markets. However, no assurance can be given that this will be the case. For more information, see “—General Network Access—Treatment of New Markets.”

Furthermore, the discussion about the regulation of an unbundled DSL product is still ongoing. Under the Telecommunications Act, the Federal Network Agency can impose on us the obligation to offer unbundled broadband access to our competitors. This could also include the obligation to unbundle a wholesale DSL product from the existing telephone lines. This issue is still open, and we expect that it will be resolved during 2007. The resolution of this issue depends on the discussions with the Federal Network Agency and our competitors in regulatory procedures we expect for this year. If we are obligated to offer such an unbundled broadband access, we expect increased competition in rural areas with the possible consequence of customer losses in those areas.

ATM Bitstream

We will also be obliged to provide ATM Bitstream Access, the prices for which will be subject to retroactive approval of the Federal Network Agency. We do not expect a final regulatory order to be issued before March 2007. The final order will oblige us to publish a reference offer for ATM broadband access in the middle of 2007. As a result of this regulation, retroactive regulation of prices will likely lead to the reduction of our ATM rates.

Broadband Access—DSL Resale

Besides unbundled local loop access and line sharing, we offer our Resale DSL product to our competitors on a voluntary basis. This Resale DSL product is part of our above-mentioned Bitstream Access offer. At the end of 2005, the Resale DSL agreements we had concluded since August 1, 2004 were examined by the Federal Network Agency. The Federal Network Agency investigated whether we had abused our dominant position by levying rates that were only 11.5% lower than our retail price for DSL. In June 2006, the Federal Network Agency closed these proceedings after we announced that we would offer an increased discount of 20% below the DSL retail price.

Since August 2006, we have offered our Wholesale DSL product, which departs from the retail-minus-20% pricing formula of Resale DSL in favor of fixed prices for bandwidths of 1, 2, 6 and 16 Mbit/s. This has resulted in considerable price reductions compared to the Resale DSL product. Most ISPs have therefore already switched

 

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from Resale DSL to Wholesale DSL. Other competitors, however, have submitted complaints to the Federal Network Agency alleging that our competitors offering DSL access on the basis of carrier line sharing or unbundled local loop provided by us cannot match the low prices offered by Wholesale DSL. They allege that we are engaging in price dumping or predatory pricing because the prices we are charging for Wholesale DSL are lower than the costs for a competitor offering a product based on carrier line sharing. In addition, they allege that there is no “consistency” between the prices charged for carrier line sharing, unbundled local loop and Wholesale DSL. We were informed that the Federal Network Agency has decided not to open a proceeding at this time, but it may do so in the future.

Retail Regulation

On June 23, 2006, the Federal Network Agency imposed on us the obligation to disclose to it any retail pricing measures within the markets for access to the public telephone network, as well as the markets for publicly available local and national telephone services provided, at a fixed location for residential and non-residential customers, including VoIP services, two months before they become effective. However, this obligation generally does not apply to bundled products containing regulated and non-regulated services if the obligation has been met regarding the regulated components of the bundle, the regulated components are still offered unaltered on a stand-alone basis, and the difference between the price of the bundle and the sum of the prices of the regulated components is at least equal to the costs of the non-regulated components. Within the first two weeks after the relevant disclosure has been made, the Federal Network Agency is required to check if the planned rates are clearly not compatible with section 28 of the Telecommunications Act. If so, the Federal Network Agency must, within a period of two weeks of notice of the measure, prohibit introduction of the rates until such time as it has completed its examination. However, even if the Federal Network Agency does not prohibit introduction, the rates can only become effective two months after disclosure. Therefore, in general, the obligation delays our ability to react quickly to market changes.

On December 20, 2006, the Federal Network Agency published a draft of the market analysis for publicly available local and national telephone services to mobile networks provided at a fixed location for residential and non-residential customers, including VoIP services. The national consultation ended on February 2, 2007. In the draft market analysis, the Federal Network Agency designates Deutsche Telekom as a provider with significant market power. Should this designation become effective, any retail pricing measures within that market will be subject to ex-post regulation. Moreover, it is possible that the Federal Network Agency will impose on us the obligation to disclose to it our retail pricing measures two months before they become effective.

The Federal Network Agency still does not classify VoIP as a “publicly available telephone service,” which would imply an emergency services obligation. However, with the further development of VoIP, and the increasing use of this nomadic service, the Federal Network Agency has requested all market participants to submit proposals for a technical solution to the emergency services problem.

The broadband access tariffs, as well as the broadband and narrowband service tariffs, that we offer to retail customers under our T-Online brand are not subject to regulation under the Telecommunications Act. However, these tariffs are indirectly affected by the regulation of wholesale tariffs for these services and will be taken into account by the Federal Network Agency in a review undertaken as part of a retroactive procedure if they form part of a product bundle that contains regulated components. Moreover, sector-specific regulation may be extended in the future to the broadband services market, which will depend on the results of the Federal Network Agency’s current market analysis procedures.

Central and Eastern European Telecommunications Regulation

Our subsidiaries in Hungary and Slovakia are subject to the same E.U. Framework as our fixed-line products and services in Germany. We also operate fixed-line and mobile networks in Croatia, Macedonia and Montenegro. These countries are also orientating their regulatory frameworks towards the E.U. Framework. Therefore, all of our subsidiaries in Central and Eastern Europe are generally exposed to a set of regulatory risks similar to those in Germany described above. Additional significant regulatory matters affecting specific subsidiaries are discussed below.

 

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Hungary

Although some competition within the fixed-line network has existed in Hungary for several years, Magyar Telekom still possesses substantial market share in many telecommunications markets within Hungary. As expected, the Hungarian NRA has found Magyar Telekom to be an operator with significant market power in a large number of the markets currently subject to regulation, including subscriber lines and calling services.

We expect that continuing wholesale market regulation will have a negative impact on Magyar Telekom’s margins due to regular wholesale price reductions following E.U. trends. Currently, Magyar Telekom has to comply with wholesale obligations regarding call origination and termination, unbundling, local and national bitstream access and price regulation for the termination of wholesale leased lines. As in previous years, Magyar Telekom also remains under the obligation to submit its reference offers for interconnection and unbundling to the Hungarian NRA for prior approval.

The Hungarian Competition Authority completed its investigation of the bundling of PSTN and DSL lines of the Hungarian incumbent operators, and concluded that Magyar Telecom’s DSL offering constitutes unjustified product bundling. If Magyar Telekom introduces an unbundled DSL product within 90 days (i.e., by April 8, 2007), the Hungarian competition authority will not impose any fine or obligation. Such offer is planned to be introduced in the first quarter of 2007.

In addition, the Hungarian NRA has launched a public discussion about the necessity of a wholesale line rental product, which, if introduced, would provide additional opportunity for some competitors to broaden their customer base at the expense of Magyar Telekom’s market share. The outcome of these discussions is still uncertain.

Competition has been further facilitated by number portability, which was introduced for the fixed network on January 1, 2004, and which has effectively led to a net loss of approximately 5% of lines for Magyar Telekom.

As competition between Magyar Telekom and cable television providers for telephony, Internet access and television services becomes more intense, Magyar Telekom expects to be increasingly affected by the disparity of regulatory burdens between services provided over the fixed-line telephony network and those provided over cable networks. Unlike Magyar Telekom, cable network providers are currently not subject to any wholesale obligations.

Moreover, with respect to competition within the fixed-line network, Magyar Telekom is required to pay other incumbent PSTN operators in Hungary call termination rates that are 40-50% higher than the regulated rates Magyar Telekom is allowed to charge competitors. The NRA plans to further balance this inequality gradually to the level justified by economies of scale.

Slovakia

The Slovak NRA determined that Slovak Telekom is designated as an operator with significant market power in most of the designated fixed-line markets in which it operates. As a result, Slovak Telekom is required to publish reference offers for unbundling of the local loop, interconnection, terminating parts of leased lines and market of broadcasting transmission, keep separate accounts, and comply with obligations regarding transparency and non-discrimination in the markets for unbundled local loops, call termination and origination, terminating parts of leased lines and broadcasting transmission. Furthermore, Slovak Telekom is obliged to offer carrier selection and carrier preselection and to follow a prescribed calculation methodology for the pricing of calling services. We expect that the market analysis procedure will continue until the beginning of 2007, and we expect that additional regulatory obligations will be imposed on Slovak Telekom as the market analyses continue. Such obligations will include, among other things, a requirement to modify Slovak Telekom’s existing wholesale broadband access products or prices and wholesale leased line products.

 

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Croatia

T-Hrvatski Telekom has been designated as an operator with significant market power in the interconnection market, the market for public voice services in the fixed-line network, the market for leased lines, and the market for transmission of voice, sound, data, documents, pictures and other services. As a result, the Croatian NRA is empowered to, among other things, regulate network access and interconnection with respect to these markets.

Macedonia and Montenegro

Our subsidiaries in Macedonia and Montenegro are, to varying degrees, increasingly subject to similar regulatory actions as are applicable to our other European subsidiaries. As these countries continue to align their telecommunications regulatory regimes with the E.U. Framework, we expect that operations in these countries will become increasingly subject to similar levels of regulatory intervention.

Mobile Regulation

United States

Our U.S. mobile operations, provided through T-Mobile USA, are regulated by the FCC and by various other Federal, state and local governmental bodies. The FCC has authority to regulate “rates and entry” by Commercial Mobile Radio Service (“CMRS”) operators, while the states have authority to regulate “other terms and conditions” of CMRS. The FCC has refrained from regulating rates charged by CMRS operators. However, under its authority to license CMRS operators to serve the public, the FCC has imposed a number of requirements on operators including rules for providing emergency 911 services, number portability and support for lawful electronic surveillance. In addition, there are conditions on AWS licenses, which were granted on November 29, 2006, requiring T-Mobile USA to build-out or put the spectrum to use within the initial 15-year license term. If substantial use of the spectrum has not commenced by the end of this period, the licenses could be forfeited at that time.

In addition, depending upon how they are resolved, certain proceedings currently pending at the federal and state levels could impose costs and other burdens on T-Mobile USA. These include:

 

   

Local Exchange Carrier/CMRS interconnection: FCC rules require local exchange carriers to provide CMRS operators interconnection within a reasonable time after it is requested, unless such interconnection is not technically feasible or not economically reasonable. Interconnection allows the completion of calls between wireless and fixed-line phones. FCC intercarrier compensation rules provide a framework for determining the levels of reciprocal compensation (for traffic originating or terminating in a local area) and access charges (for non-local traffic). In 2001, the FCC embarked on a wide-ranging examination of intercarrier compensation methodologies, which may result in substantial modification of its interconnection rules. The FCC adopted a further notice of proposed rulemaking on these issues in February 2005, which remains pending and the FCC is currently considering proposals from a group of state regulators on reforming the intercarrier compensation regime. We cannot predict when or if the FCC will act to overhaul the existing intercarrier compensation regime, but we anticipate that the FCC may take action on certain aspects of intercarrier compensation in 2007, which could impose additional costs on T-Mobile USA.

 

   

Special Access: High capacity circuits used by CMRS operators for transporting traffic between cell sites and local exchange carrier switching facilities is supplied in large part by the local exchange carriers. The FCC initiated a proceeding to reform special access provisioning in 2005. Since then the issue has been raised in recently concluded and pending local exchange carrier or interexchange carrier merger proceedings, although broad rules applicable to all local exchange carriers have yet to be established. In light of public comments and a report issued by the Government Accountability Office, the FCC imposed reporting, non-discrimination, and limited pricing relief conditions on the wireline companies involved in recent mergers. However, the Chairman of the FCC has specifically stated that such merger conditions are

 

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not indicative of what type of regulation the FCC may ultimately impose in this area. Special access costs are an increasingly large portion of T-Mobile USA’s annual operating expenditures, and the inability to secure special access circuits on cost-based and nondiscriminatory terms could become a significant issue in the future.

 

   

CALEA: The Communications Assistance for Law Enforcement Act (CALEA) requires a telecommunications carrier to ensure that its equipment, facilities, or services are capable of enabling the government to intercept communications and access call-identifying information when lawfully authorized. CMRS operators are covered by CALEA. In addition, T-Mobile is subject to an agreement with the U.S. Federal Bureau of Investigation and Department of Justice, which imposes on us certain operational and other requirements designed to ensure that we can effectively respond to, and implement, such wiretap and other information requests by U.S. law enforcement agencies. In August 2005, the FCC ruled that CALEA applied to facilities-based broadband Internet access providers, as well as to interconnected VoIP services, and established a compliance deadline of May 14, 2007. This order potentially could apply to T-Mobile USA’s Internet access and WiFi services. In May 2006, the FCC decided, as required by CALEA, that it would rely on industry standard setting bodies to define the technical requirements for meeting the new CALEA obligations. These obligations could necessitate significant network modifications in the future in order to comply with the assistance capability requirements of CALEA.

 

   

Customer Proprietary Network Information (CPNI)/Consumer issues: The FCC has set forth rules for the treatment of CPNI. Due to recent privacy concerns raised by the activities of parties that through fraudulent schemes seek to obtain and sell customer call information, the FCC has initiated an investigation of the top five wireless carriers (including T-Mobile USA) and the top five fixed-line carriers concerning the treatment of customer call records under the FCC’s current CPNI requirements. Additionally, the FCC has initiated a rulemaking to consider making certain prospective changes to the carrier processes for handling CPNI. Proposed rules by the FCC include mandating customer-set passwords for online account access and for access to certain types of CPNI over the phone requiring carriers to coordinate with law enforcement in the event of unauthorized disclosures, and providing notice to customers of certain changes to their account. The U.S. Congress is also examining the issue of CPNI and is considering imposing stricter safeguards upon all telecommunications carriers and VoIP providers. These developments may require significant alterations to T-Mobile USA’s systems and practices and, therefore, have the potential to impose significant additional financial and administrative costs on the company. 

 

   

Regulation on the state and local level: Some states, through their respective public utility commissions and legislatures, or through other means, have taken, or are seeking to take, actions to regulate various aspects of wireless operations, including customer billing, termination of service arrangements, advertising, the filing of “informational” tariffs and certification of operations. These developments have significantly affected, or have the potential to significantly affect, T-Mobile USA’s business practices with respect to many aspects of the carrier-customer relationship, including solicitations, marketing, activations, billing and customer care. At the local level, wireless facilities typically are also subject to zoning and land use regulation, and may be subject to fees for use of public rights-of-way. T-Mobile USA’s access to additional sites to install wireless facilities is a key component of its ability to continue to deploy wireless services in an effective manner.

Operations in the European Union

Our operations within the European Union are subject to rules established by the EU regulatory framework (see “—The E.U. Regulatory Framework”). Under these rules, NRAs have been mandated to analyze three mobile communication markets in order to determine whether regulatory remedies must be imposed:

 

   

Access and call origination: Market analysis procedures have been initiated or completed by all NRAs in the European Union, but no NRA has thus far found reason to impose regulatory remedies.

 

   

Call termination in mobile networks: Various remedies imposed by the NRAs are described by country below.

 

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Wholesale international roaming: Market analysis procedures have been initiated or completed by most NRAs in the EU. These activities have been coordinated by the European Regulators Group (ERG), which has been set up by the E.U. Commission in order to advise and assist with the consolidation of the E.U. internal market for electronic communications networks and services. In 2005, the ERG published a common position and established a framework for the analyses to be conducted by the national regulators. None of the NRAs has found operators to have significant market power in the relevant market.

On February 20, 2006, the E.U. Commission announced that, in light of the inability of NRAs to impose regulatory remedies, it had begun work on an E.U. regulation on international roaming charges. In July 2006, a proposal was submitted to the European Parliament and the Council of the European Union, under which international roaming charges would be linked to average European termination rates. Wholesale charges would be capped at twice the average European termination rate for calls within the visited country and three times the average European termination rate for calls to another E.U. Member State. At the retail level a ceiling would be set at 130% of the wholesale rate. A maximum price would be set for receiving calls at the level of the average European termination rate plus a margin of 30%. On June 1, 2006, T-Mobile, together with other leading mobile operators, announced that this group of companies representing almost 200 million mobile customers in Europe would voluntarily reduce their roaming charge by approximately 50%. Nevertheless, the E.U. Commission continues to press for adoption of such regulations, which would have significant consequences for T-Mobile’s revenues.

Germany

On November 8, 2006, the Federal Network Agency finalized the market analysis procedure for the mobile call termination market and decided that T-Mobile Deutschland has to reduce the termination rate charges from EUR 0.11 per minute to EUR 0.0878 per minute. This decision is valid from November 23, 2006 until November 30, 2007 and also applies to Vodafone. E-Plus and O2 are required to lower their mobile termination rates to EUR 0.0994 per minute (from EUR 0.124 per minute) for the same time period. A new decision of the Federal Network Agency in 2007 may lead to a further reduction of termination rates after November 30, 2007.

T-Mobile Deutschland appealed to the Administrative Court of Cologne the Federal Network Agency’s general decision to regulate termination rates and the regulation establishing the actual tariff level. For more information, see “Item 8. Financial Information—Legal Proceedings.”

The Federal Network Agency recently announced the tender of additional spectrum in 2008. It is expected that, in the course of this auction, spectrum capacity in different bands will be made available to market participants, including UMTS extension bands (190 MHz of spectrum in the 2.6 GHz band) as well as UMTS spectrum that was already allocated in 2000, but later returned to the Federal Network Agency. It is currently unclear under what conditions the allocation will take place. We do not expect the auction to be as competitive or expensive as the auction in 2000.

Pursuant to the 2004 amendments to the Telecommunications Act, new regulatory fees will, in the future, be imposed based on the revenues of respective telecommunications companies. This provision may have a disproportionate effect on large companies, such as Deutsche Telekom, and may have a material adverse effect on our results of operations. The details on how these new regulatory fees will be calculated have not yet been determined and will be promulgated in a separate ordinance, which is expected to become effective during 2007.

Consumer protection obligations in the revised Telecommunications Act came into force in February 2007, some of which have an implementation period of six months. These obligations will have a considerable negative impact on T-Mobile Deutschland, in particular, by requiring prices for premium voice call services to be announced before a call is made.

On July 11, 2001, the E.U. Commission issued a press release confirming that E.U. Commission inspectors and officials from national competition authorities had started carrying out simultaneous inspections at the premises of nine European mobile communications operators located in the United Kingdom and Germany. Our subsidiaries T-Mobile Deutschland and T-Mobile UK were among the companies inspected. The E.U. Commission asserted that an E.U.-wide sector inquiry had established serious competition concerns regarding

 

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pricing practices for mobile roaming services, which warranted further investigations, particularly in the United Kingdom and Germany. The E.U. Commission statement indicated that the inspections in the United Kingdom and Germany were to ascertain whether there had been consumer price-fixing by mobile operators in these countries. The statement further indicated that the inspections were intended to verify whether German operators had illegally fixed the wholesale prices they charge to other operators, and whether these prices are excessive or discriminatory. The E.U. Commission had initially focused its inquiry on the U.K. operators, resulting in a number of further requests for information. On July 26, 2004, the E.U. Commission announced that it had sent a statement of objections to Vodafone and O2 in the United Kingdom, but not to T-Mobile UK or Orange UK. We therefore believe that it is unlikely that the E.U. Commission will open formal proceedings against T-Mobile UK. However, on February 10, 2005, the E.U. Commission opened formal proceedings relating to T-Mobile operations in Germany. The E.U. Commission alleged that T-Mobile Deutschland has been abusing its dominant position in the market for wholesale roaming services by charging excessive tariffs for calls of foreign visitors in its network during the period from 1997 to 2003. T-Mobile has rejected these allegations as being unfounded. Should the E.U. Commission decide to uphold its preliminary findings, it could impose significant fines on T-Mobile. A decision is expected in the first half of 2007.

United Kingdom

T-Mobile UK does not have any obligation to provide national roaming to third parties. However, in 2003 the predecessor to the Office of Communications (Ofcom), Oftel, undertook a consultation on proposals to require T-Mobile UK and all other GSM operators to offer GSM national roaming if requested by the new UMTS mobile operator “3”. All U.K. GSM licensees objected to this proposal. Ofcom issued a consultation in 2004 on whether it has the power to impose such a condition if it is needed, and proposed guidelines to be applied if it is required to determine a national roaming agreement. The mobile operator 3 is seeking the continuation of this condition, despite having selected a new national roaming provider by auction. Ofcom is expected to reach a decision in 2007.

Ofcom is planning to release a number of spectrum bands to the market in 2007 and 2008 some of which may be used for competing mobile services. It has proposed that spectrum will be auctioned on a technology and service neutral basis. Ofcom is currently preparing seven spectrum award processes and has either issued consultations or held workshops on each of these awards. Ofcom is not currently proposing to limit the use of such spectrum. In addition, T-Mobile UK and the other U.K. GSM operators may be able to change the use of their current GSM spectrum after 2007, e.g., to use it for UMTS services, but the terms on which they may be able to do so are not yet clear.

T-Mobile is currently regulated on its average price for call termination, which expires on March 31, 2007. In September 2006, Ofcom published a consultation proposal for regulation of call termination rates over the period from April 2007 to March 2011. Ofcom is expected to reach a final decision in the first half of 2007.

The Netherlands

Following investigations by the Dutch NRA and competition authority into mobile call termination tariffs, all Dutch licensed mobile telecommunications operators voluntarily agreed to amend their call termination tariffs from January 1, 2004 to December 1, 2006. Under this agreement, the Dutch mobile operators may not exceed certain flat-rate and per-minute tariffs in accordance with a specific schedule. These tariffs are currently in effect until new tariffs, either self-imposed or regulatorily mandated, are applied. As a result of these voluntary decreases, the Dutch competition authority formally ceased its investigation into alleged excessive pricing. The Dutch NRA previously decided to adhere to these voluntarily set tariffs until December 1, 2005 and has since adopted the voluntary tariffs in its own policy recommendations under the former regulatory framework. Challenges by fixed-line operators to the Dutch NRA’s adaptation of these voluntary decreases have been denied by the Trade and Industry Appeals Tribunal.

In its decision regarding the analysis of the market for call termination under the current regulatory framework, the Dutch NRA decided that voice call-termination tariffs should be decreased to reflect the actual cost of such termination by July 1, 2008, with such decreases being introduced incrementally, beginning on

 

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July 1, 2006. However, this decision has been annulled by the Trade and Industry Appeals Tribunal. As a consequence, the Dutch NRA is currently preparing a new decision, which is expected to be similar to the existing decision and will enter into force on July 1, 2007.

According to a decision by the Dutch competition authority on September 27, 2004, T-Mobile Netherlands was fined EUR 14.8 million for its alleged involvement in an anti-competitive scheme regarding dealer commissions, carried out together with the four other Dutch mobile telecommunications operators. After T-Mobile Netherlands and the other affected companies filed an appeal of this decision on a variety of grounds, the Court of Rotterdam granted an appeal based on various substantive grounds while at the same time denying various other grounds for appeal. Both the Dutch competition authority and a selection of the affected companies, including T-Mobile Netherlands, have subsequently appealed the Court of Rotterdam’s decision.

Czech Republic

The Czech NRA designated all three mobile operators in the Czech Republic (i.e., T-Mobile Czech Republic, Telefonica O2 Czech Republic and Vodafone Czech Republic) as having significant market power in the market for mobile call termination and imposed regulatory remedies on them including price regulation of mobile termination charges. These remedies, effective since July 1, 2006, resulted in a decrease in mobile termination charges by 4% compared to the price level determined by the Czech NRA in March 2005.

On September 25, 2006, T-Mobile Czech Republic and Vodafone Czech Republic announced that they have entered into discussions on the sharing and development of mobile network infrastructure. These discussions are undertaken in close consultation with the competent regulatory authorities.

Austria

Based on its decision of October 27, 2004, the Austrian NRA published its final decision concerning the mobile termination rates of all network operators including T-Mobile Austria in December 2005. In this procedure, Mobilkom Austria was found to have the lowest network costs (2005: EUR 0.0679/min). Therefore, Mobilkom will be the benchmark for all other network operators and Mobilkom’s network costs in 2005 are currently the target value to be reached by the mobile termination rates of all mobile network operators by the end of 2008 at the latest. As a result, a “glidepath” applies, in which the mobile termination rates of the mobile network operators are reduced between EUR 0.01/min and EUR 0.0183/min every six months until the target value is reached. This target value will be reviewed by the Austrian NRA every two years. The Austrian NRA is currently calculating the network costs of all mobile network operators to determine the actual benchmark level for a regulation of mobile termination rates beginning with 2007. A decision of the Austrian NRA in this respect is expected in the first half of 2007 and the resulting benchmark level will replace the current target value of EUR 0.0679/min.

In light of our purchase of tele.ring, competitors have filed an application requesting an additional decrease of T-Mobile Austria’s mobile termination rates. Accordingly, T-Mobile Austria’s mobile termination rates could be lowered even further. A decision of the Austrian NRA is expected in the first half of 2007.

Hungary

T-Mobile Hungary is currently subject to regulatory obligations regarding the termination of calls into its network. On January 24, 2005, the Hungarian NRA designated T-Mobile Hungary, Vodafone and Pannon GSM as having significant market power in the wholesale market for call termination on mobile networks, and required each of these companies to grant access to specific network facilities, act in a transparent and non-discriminatory manner, and maintain long-run incremental cost-based mobile termination rates and accounting separation. T-Mobile Hungary and Vodafone filed suit against the decision. The court of first instance materially amended the decision in some parts including provisions related to termination rates. The case is currently pending at second instance due to appeals by all parties.

On July 25, 2005, the Hungarian NRA imposed specific reductions of termination rates on all three mobile network operators. Beginning retroactively from May 2005, the three mobile network operators were to apply

 

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average termination fees based on an international benchmark calculation. All three mobile network operators appealed the decisions of the Hungarian NRA at the City Court in Budapest. The court rejected Pannon’s claim, while T-Mobile Hungary’s and Vodafone’s suits are still pending. The Hungarian NRA imposed a fine of approximately EUR 600,000 on T-Mobile Hungary for not complying with its July 25, 2005 decision while the proceedings took place. T-Mobile Hungary filed a suit against the fine, and won the case at first instance. The case was appealed by the regulator and is currently pending.

On October 2, 2006, the Hungarian NRA issued its new market analysis decision regarding the mobile voice termination market. According to this decision, the Hungarian NRA designated T-Mobile Hungary, Vodafone and Pannon GSM as having significant market power, amended the obligations set out in its 2005 decision and stated that it planned to further reduce mobile termination rates. All three mobile operators filed suit against the October 2006 decision.

On December 20, 2006, the Hungarian NRA delivered its decisions on the mobile termination fees applicable from February 2, 2007. The rates are identical to those forecast in the 2006 market analysis decision and will result in a decrease in termination rates in 2007, with additional decreases in 2008 and 2009. Each of the decisions of the Hungarian NRA to decrease termination rates has been challenged by all mobile operators in court.

Slovakia

On July 12, 2006, the Slovak NRA imposed certain obligations on T-Mobile Slovensko relating to the voice-call termination market, namely transparency, non-discrimination, accounting separation and network access. However, the Slovak NRA did not impose the obligation of cost-orientation of termination tariffs, which means that the wholesale prices for termination in the network of T-Mobile Slovensko are not currently regulated. An additional obligation of cost-oriented termination tariffs, similar to most other EU Member States, may be imposed in the future, which could lead to further tariff reductions. T-Mobile Slovensko filed an appeal with the Slovak Supreme Court in August 2006, where it sought to reverse the Slovak NRA’s decision. The case is pending.

On November 27, 2006, T-Mobile Slovensko signed a national roaming agreement with Telefónica O2 Slovakia, which enables Telefónica O2 Slovakia to provide its services partly through the network of T-Mobile Slovensko.

Poland

In July 2006, three mobile operators in Poland, including PTC, were designated as having significant market power in the call termination market and, as a result, regulatory obligations relating to provision of access, non-discrimination, transparency and cost orientation were imposed on them. These three mobile operators appealed the decisions of the Polish NRA and the claims are still pending. On September 25, 2006, PTC fulfilled these regulatory obligations and published new mobile termination rates calculated on a cost basis and information regarding the provision of access and submitted this information to the Polish NRA. New mobile termination rates became effective from October 15, 2006. Although the Polish NRA accepted the reduction of mobile termination rates proposed by all mobile operators, the Polish NRA’s objective is a further reduction of mobile termination rates in order to reach a level equal to the benchmark of the average of the three lowest mobile termination rates in the European Union by the end of 2007. The Polish NRA has already initiated a proceeding in order to assess the charges applied by the operators and requested additional cost information in January 2007. The proceeding is still pending and a decision is not expected before the end of March 2007.

In April 2006, the Polish NRA began a national consultation process and notified its draft decision to the European Commission that designated three mobile operators, including PTC, as having significant market power in the market for access and call origination and imposing related regulatory obligations on them. However, the draft decision was withdrawn in May 2006 from the European Commission. The Polish NRA is preparing a new decision, which is expected to be consulted and re-notified to the European Commission in the first half of 2007. The Polish NRA may find that these three mobile operators have significant market power and impose regulatory obligations again. No obgliations have yet been imposed on PTC.

 

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Tele2 requested to be admitted as a MVNO to PTC’s network. As a commercial agreement could not be reached, Tele2 approached the Polish NRA, which initiated an administrative proceeding against PTC in May 2006. This proceeding is still pending. PTC claims that such a proceeding is contrary to the European legal framework and, in July 2006, submitted a complaint on infringement of EU Law to the European Commission.

In 2004, PTC was granted spectrum in the 3.6-3.8 GHz range (WiMax frequencies). In July 2006, the Polish NRA started proceedings aimed at revoking the WiMax spectrum rights on the basis that PTC had not started commercial use of the frequencies. In its decision of October 12, 2006, the Polish NRA decided not to withdraw the WiMax frequencies. However, proceedings to revoke the spectrum rights may be initiated in the future.

Other European operations

Croatia

Since September 2004, T-Mobile Croatia has been designated as having significant market power in the interconnection market and in the market for public voice services in mobile networks (the analysis was repeated in 2005, and started again in 2006). As a result, interconnection prices have to be determined in line with the principles of transparency and cost-orientation, based on the actual costs of the services provided, including a reasonable rate of return on investment. A reference interconnection offer, which includes prices and terms of interconnection, has to be approved by the Croatian NRA. Moreover, non-discrimination, cost accounting and accounting separation obligations have also been imposed.

Macedonia

The services provided by mobile network operators in Macedonia are not currently subject to price regulation. A tender for entrance of a third mobile network operator is ongoing, and tender documentation envisages significant market power status and domestic roaming obligation for the existing mobile operators. Therefore, the Macedonian NRA is collecting retail and wholesale market data in connection with its market analysis. Depending on the outcome and findings of this market analysis, regulatory obligations may be imposed, including those relating to wholesale pricing and domestic roaming.

On February 12, 2007, the Macedonian competition authority started proceedings against T-Mobile Macedonia to determine whether it holds a dominant position in the market for call completion within the T-Mobile Macedonia network and a possible misuse of this position in connection with the provision of voice mail services.

 

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DESCRIPTION OF PROPERTY, PLANT AND EQUIPMENT

Network Infrastructure

As a result of substantial investments in telecommunications and cable networks since the early 1990s, Broadband/Fixed Network believes that its fixed-line network in Germany is one of the most technologically advanced networks in the world, with full-digital switching and nearly 100% digital transmission capability. Advanced VDSL, ADSL2+, ATM and WDM technologies are incorporated in this network, which not only provide much faster voice and data transmission, but also improved network management and network reliability.

During 2006, Broadband/Fixed Network continued to expand its use of NGN enabling high-speed access and transmission network technologies. In particular, Broadband/Fixed Network plans to continue to increase incorporating ADSL2+ technology and VDSL technology in-line with the demands of its customers and in conjunction with its ongoing broadband strategy. Moreover, in addition to its announced efforts to increase broadband access speeds, Broadband/Fixed Network intends to continue to increase the use of innovative technologies like Outdoor DSLAM and Gigabit Ethernet to provide IPTV and high-speed access at speeds up to 25 Mbit/s. NGN technologies increase the efficiency of, and potential to offer new services using the existing network.

As of December 31, 2006, Broadband/Fixed Network’s PSTN in Germany consisted of approximately 7,900 local networks connected by a long-distance transmission network. Broadband/Fixed Network’s IP platform, the basis for various services offered to individual customers (especially access to the Internet) and business customers (e.g., VPNs and connection of servers to the World Wide Web), consisted of numerous locations primarily linked through router technology.

The following table provides information on the length of the copper and fiber-optic cables contained in Broadband/Fixed Network’s access and transmission networks in Germany at December 31, 2006, and each of the two prior years:

 

     Length in km

        Year        

   Copper Cable    Fiber-Optic Cable

2004

   1.485 million    0.197 million

2005

   1.480 million    0.206 million

2006

   1.485 million    0.216 million

For more information about Broadband/Fixed Network’s network infrastructure, see “—Description of Business—Broadband/Fixed Network.”

Cable Transmission Infrastructure

Broadband/Fixed Network’s global transmission infrastructure consists of underground and submarine cables, which directly link the German national telecommunications network to numerous other telecommunications service providers worldwide. In addition, Broadband/Fixed Network holds interests in numerous fiber-optic submarine and terrestrial cable networks worldwide. Restoration contracts with other cable operators and telecommunications carriers have been created to prevent network failures from affecting network availability. Broadband/Fixed Network’s domestic telecommunications network is connected to submarine cables via various “landing points,” five of which are located in Germany.

Computing Services & Solutions (CSS)

CSS possesses the server equipment, software tools and expertise employed in the operation of the computer network infrastructure described above. As of December 31, 2006, CSS’ global mainframe systems performance had a combined total computing power of 136,375 millions of instructions per second (MIPS), compared to 123,386 MIPS as of December 31, 2005.

T-Systems’ mainframe computing equipment in Germany and Switzerland (more than 80% of T-Systems’ total worldwide computing power) is based on a leasing contract with IBM. T-Systems only purchases the

 

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computing capacity actually required, according to a flexible, demand-driven business agreement. In addition to these mainframe systems, as of December 31, 2006, a total of 33,037 servers (most of which are owned by T-Systems) were operated worldwide, in particular in Europe.

Mobile Network Infrastructure

At December 31, 2006, the network infrastructure of our mobile telecommunications business consisted of approximately 80,000 base station cells in Europe and approximately 37,000 base station cells in the United States.

Real Estate

Our German real estate portfolio consists of approximately 10,300 properties, which comprise a total site area of approximately 39 million square meters. The total net floor space of these properties is approximately 9.2 million square meters. In addition, we have leased approximately 3.9 million square meters. Most of this area is used for telecommunications installations, research centers, service outlets, computer centers and offices. Area and sites used for our radio transmission facilities are not itemized in square meters and therefore are not included in these numbers.

We manage and service our German real estate portfolio through various subsidiaries and affiliates.

The real estate portfolio of our consolidated group had a book value of EUR 10.2 billion at December 31, 2006, including radio transmission properties and real estate assets of our foreign subsidiaries. Approximately 66% of this amount (EUR 6.7 billion) relates to properties held directly by Deutsche Telekom AG on an unconsolidated basis. The remaining 34% is mostly held through our Mobile Communications strategic business area and our Central and Eastern European subsidiaries.

To improve operational efficiencies and dispose of non-core assets, we have continued to monetize certain of our real estate assets. In 2006, we entered into agreements for the sale of properties in the aggregate amount of EUR 411 million. Of the EUR 407 million in proceeds we received in 2006, EUR 74 million related to properties transferred in 2006 and EUR 333 million related to transactions in 2005 and prior years. The properties we sold in 2006 comprised approximately 3.4 million square meters of land area and approximately 0.5 million square meters of lettable floor space. We leased back a relatively small portion of this. Although we will incur rent expense related to the leased-back area, we will achieve a reduction in interest payments and other costs related to the properties sold. In 2007, we plan to continue with our portfolio adjustment strategy and with disposals of properties.

Our radio transmission sites in Germany, including towers, masts and rooftops, are owned or leased by various subsidiaries. Our subsidiaries manage these radio transmission sites and the related technical infrastructure facilities to provide antenna space for T-Mobile, T-Com and T-Systems in Germany. These subsidiaries also offer these services to third-party radio-network operators. Our subsidiaries currently manage approximately 25,700 radio transmission sites, of which approximately 3,400 are located on Deutsche Telekom AG property. Approximately 23,200 of these transmission sites are owned by our subsidiaries, whereas the remaining 2,500 are owned by third-parties. In addition, we own and operate approximately 19 radio transmission sites for AM, short- and long-wave radio transmission.

ITEM 4A. Unresolved Staff Comments

Not applicable.

 

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ITEM 5. Operating and Financial Review and Prospects

You should read the following discussion in conjunction with our annual consolidated financial statements, including the notes to those financial statements, which appear elsewhere in this Annual Report. Our financial statements have been prepared in accordance with IFRS, which differs in certain significant respects from U.S. GAAP. For a discussion of the principal differences between IFRS and U.S. GAAP, as they relate to us, and a reconciliation of net profit and total shareholders’ equity to U.S. GAAP, see “—Reconciling Differences between IFRS and U.S. GAAP” and notes (50) and (51) to the consolidated financial statements.

The strategies and expectations referred to in the following discussions are considered forward-looking statements and may be strongly influenced or changed by shifts in market conditions, new initiatives we implement and other factors. We cannot provide assurance that the strategies and expectations referred to in these discussions will come to fruition. Forward-looking statements are based on current plans, estimates and projections, and therefore, you should not place too much reliance on them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any forward-looking statements in light of new information or future events. Forward-looking statements involve inherent risks and uncertainties, most of which are difficult to predict and are generally beyond our control. We caution you that a number of important factors could cause actual results or outcomes to materially differ from those expressed in, or implied by, the forward-looking statements. Please refer to “Forward-Looking Statements” and “Item 3. Key Information—Risk Factors” for descriptions of some of the factors relevant to these discussions and other forward-looking statements in this Annual Report.

MANAGEMENT OVERVIEW

Management of our company provides the following discussion and analysis to present an overview of our financial condition, operating performance and prospects from management’s perspective.

The 2006 financial year was difficult. Although we recorded growth in our international businesses, particularly in the United States, our domestic market in Germany was characterized by more intense competition and continued unfavorable regulatory oversight. As a consequence, we lost large numbers of customers and a great deal of revenues in our fixed network business. Revenues and margins in the German mobile communications market were also impacted by a dramatic decline in prices.

As a result of these trends, we have instituted a course of action to demonstrate to our customers that we are still the best choice for telecommunications products and services, and also to maintain the confidence of our shareholders. In this regard, we launched new calling plans in the second half of 2006, which are beginning to show positive results. Although we have a lot of hard work ahead of us, we are determined to strengthen our group’s position in all markets, not only by improving our customer service capabilities.

We will continue to focus on improving our competitiveness in Germany, growth abroad in the mobile communications area, mobile internet and further development of integrated communications and IT solutions. Additionally, we intend to set the standard for customer care in our industry, to be the most highly regarded service company in our industry and to achieve a competitive edge through leadership in innovation.

The following paragraphs highlight several recent important developments relating to our group.

Net revenues and net profit

In 2006, the telecommunications industry was marked by rapid technological change and intense competition. For us, revenue development was driven by two opposing trends: growth in our international markets, particularly in the United States; and slower growth rates, as well as more rapidly falling prices, in the domestic telecommunications market.

Total net revenues increased by 2.9% to EUR 61.3 billion in 2006 as compared to 2005. The contribution to net revenues generated internationally was EUR 28.9 billion, or 47.1%. This increase in the development of international revenues was mainly the result of continued customer growth at T-Mobile USA. Total net revenues

 

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contributed by subsidiaries acquired in 2006 (primarily tele.ring, gedas and PTC) amounted to EUR 1.2 billion. Domestic revenue, in contrast, declined from EUR 34.2 billion in 2005 to EUR 32.4 billion in 2006, primarily as a result of strong competitive and price pressures.

Net profit in 2006 decreased by EUR 2.4 billion to EUR 3.2 billion as compared to 2005. This decrease was primarily due to lower operating income as a result of the decrease in domestic revenues and higher expenses for staff-related measures. Additionally, increased losses from financial activities could not be completely offset by an income tax benefit.

Closer interaction between the various areas of the group to improve service quality, innovative performance and efficiency

Our Board of Management responsibilities are distributed across six Board departments. In addition to the central management areas assigned to each of the chairman of the Board of Management, the Board member responsible for Finance, and the Board member responsible for Human Resources, three new Board departments were established in December 2006 that combine business area-specific and Group-wide tasks: the Business Customers and Production Board department; the T-Com, Sales and Service Board department and the T-Mobile, Product Development and Product Innovation Board department.

Proposed dividend

Our Management Board and Supervisory Board are proposing a dividend of EUR 0.72 for each Deutsche Telekom share carrying dividend rights. This proposal is subject to approval by our shareholders at the 2006 annual general shareholders’ meeting to be held on May 3, 2007.

The group’s growth driver remained the Mobile Communications strategic business area

In 2006, the Mobile Communications strategic business area was again the group’s main growth driver. Despite decreased revenues in Germany and Hungary, the T-Mobile group substantially increased both its revenues and its customer base.

T-Mobile USA was again the most successful T-Mobile company with 3.4 million net customer additions. T-Mobile USA had a total of 25 million customers at the end of the year. T-Mobile Deutschland recorded 1.4 million net customer additions, increasing its customer base to a total of 31.4 million as of December 31, 2006. This success is mainly due to intensive marketing activities to win customers. In the United Kingdom, T-Mobile UK (including Virgin Mobile) recorded approximately 0.9 million net customer additions. New calling plans also contributed significantly to this increase. Customer numbers at T-Mobile Czech Republic and T-Mobile Netherlands also developed positively. In Austria, the number of customers increased significantly as a result of the acquisition of tele.ring, which contributed 1.0 million to the total customer increase of 1.1 million. Cumulatively, the Eastern European mobile communications companies in Hungary, Slovakia, Croatia, Macedonia and Montenegro accounted for appreciable growth of 0.8 million customers to a total of over 10 million mobile customers as of December 31, 2006. PTC in Poland, which has been fully consolidated since November 1, 2006, added 12.2 million customers to our total customer base. For information regarding a dispute concerning our investment in PTC, including challenges to our ownership of PTC shares, see “Item 8. Financial Information—Legal Proceedings.”

Additionally, T-Mobile USA took part in a spectrum auction held by the FCC in the United States (Auction 66) and purchased additional spectrum for EUR 3.3 billion. This spectrum acquisition will form the foundation for expanding its customer base in the U.S. market and introducing innovative products based on new technologies. The roll-out of the 3G network commenced in 2006, with most of the work scheduled to be completed in 2007 and 2008.

 

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Despite fierce competition in the fixed-line communication market the Broadband/Fixed Network strategic business area achieved strong broadband growth

Business developments in the Broadband/Fixed Network strategic business area continued to be subjected to offsetting effects. Growth continued in the broadband market, which could not fully compensate for the continued decrease in the number of narrowband access lines and call minutes.

The number of broadband lines in Germany and abroad (including Eastern and Western Europe) increased by 36% to 11.7 million in 2006 as compared to 8.6 million in 2005. In Germany, the number of broadband customers also increased as a consequence of price plans and integrated all-inclusive offers of voice telephony, broadband Internet and TV entertainment (single, double, and triple-play packages offered as 3x3 Complete Packages) and new service offerings. A total of 10.3 million DSL lines provided by T-Com were in operation in Germany at the end of 2006, an increase of 2.4 million, as compared with 7.9 million at the end of 2005.

Nevertheless, competition in the broadband market continued to intensify in 2006. A consequence of this was a considerable drop in prices for ISP rates and, towards the end of the year, for 3x3 Complete Packages (including broadband lines).

T-Com benefited from the overall broadband market growth, in particular in its third-party DSL resale activities. The number of DSL resale lines increased in 2006 by 1.6 million to 3.2 million as compared to 2005.

Since the merger of T-Online International AG into Deutsche Telekom AG was completed in June 2006, the Broadband/Fixed Network strategic business area was able to offer fully integrated packages for voice and Internet communications. Following the launch of the 3x3 Complete Packages in mid-September, T-Com gained 563,000 new broadband customers in the fourth quarter of 2006, which represents the highest quarterly growth in DSL to date. With the new rates, T-Com has succeeded in winning over formerly pure voice telephony or narrowband Internet customers to broadband technology.

T-Com entered the triple-play age in Germany in August 2006. Through T-Com’s VDSL network, customers in ten German metropolitan areas now receive top-quality voice communications, Internet access, and IPTV through a single broadband line. In time for the start of the soccer season, T-Com opened the doors to the new world of multimedia applications by launching “Bundesliga on Premiere powered by T-Com,” the IPTV broadcast of Bundesliga soccer games by pay TV operator Premiere. The second half of 2006 saw the introduction of the first triple-play packages on the market—not only in Germany, but also in Eastern and Western Europe. In Western Europe, the launch of triple-play products in France and the further expansion of its proprietary infrastructure helped T-Com to capitalize on the growth of this broadband market as well. In 2006, the number of broadband lines in operation in our own networks in Western Europe increased from 73,000 to 445,000, and in Eastern Europe from 568,000 to 992,000. In total, the number of broadband lines we operated outside Germany more than doubled to 1.4 million as of the end of 2006 as compared to 2005.

Additionally, the total number of DSL rate customers in 2006 increased by 45% to a total of 8.0 million. Compared with 2005, the DSL rate customer base in Germany grew by 1.8 million to 6.3 million as of the end of 2006. T-Com recorded strong growth in the fourth quarter in particular after introducing the 3x3 Complete Packages. Overall, T-Com attracted more ISP rate customers than broadband lines customers, which represents an improvement in the customer base.

In the verticals sector—the consumer brands that are specifically targeted at young growth markets—Musicload continued its trend as one of the leading providers of online music downloads. In September 2006, Musicload launched a new subscription model that gives customers access to more than 1.8 million music tracks for a flat monthly charge. For many users, the subscription solution represents an attractive alternative to purchasing music on the Internet. Gamesload’s offering now includes more than 440 downloadable games and over 120 games in the flat rate offering. Musicload and Gamesload are among the leading German online platforms in their respective target markets. In November 2006, T-Com launched Softwareload, a new download portal for software programs. Softwareload provides a selection of more than 17,000 titles covering a broad range of software applications.

 

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The number of narrowband lines in Germany and abroad decreased by 5.3% to 39.0 million during 2006 as compared to 41.2 million as of the end of 2005. In Germany, the number of narrowband lines decreased by 5.7% to 33.2 million in 2006 as compared to 35.2 million as of the end of 2005. The decrease in narrowband lines are primarily due to customer churn in favor of fixed-network competitors, as well as increasing substitution by mobile communications and by cable network operators. The total number of T-ISDN lines decreased disproportionately in 2006 by 8.2% to 9.0 million as compared to 9.8 million as of the end of 2005, due, in part, to DSL customers switching from T-ISDN to an analog T-Net line.

The development of call minutes in Germany experienced contrasting trends in 2006. By successfully marketing calling plans, T-Com increased customer loyalty in terms of the proportion of T-Com’s call minutes for all call types (local, national, international, and fixed-to-mobile) in relation to the total minutes generated on T-Com’s PSTN network. The number of calling plan customers (including PSTN rate options from the new 3x3 Complete Packages and VoIP flat rates) was 16.5 million at the end of 2006, representing a penetration rate of almost 50% of total narrowband lines. However, despite the positive development of customer retention in terms of call minutes, the absolute number of call minutes in T-Com’s network continues to decline, due to the ongoing loss of lines and the effects of substitution.

Business with resellers (wholesale services) also saw diverging trends in 2006. The interconnection business declined due to increasing direct network interconnection between competitors and due the loss of market shares to call-by-call providers. This contrasted with sharp increases in unbundled subscriber lines to 4.7 million in 2006 as compared to 3.3 million in 2005 and in DSL resale lines to 3.2 million in 2006 as compared to 1.6 million in 2005. Overall, business in the area of wholesale services continued to be subjected to considerable regulatory intervention. Moreover, price reductions for subscriber lines, interconnection calls, and DSL resale products, due to competitive pressures and regulatory decisions, had a negative impact on the wholesale services business.

Business Customers strategic business area increases the level of new orders despite difficult market environment

In the reporting year, the Business Customers strategic business area was exposed to increasingly intense competition, continued consolidation, as well as a huge decline in prices in the traditional telecommunications business. Nevertheless, the level of new orders increased due to the signing of new contracts.

Business development was influenced by the decline in revenues from the telecommunications services business for both multinational business customers in the Enterprise Services business unit and medium-sized customers in the Business Services unit. Furthermore, new agreements for services for PC workstation systems within the group had a negative impact on the revenue development due to lower prices and volumes.

Primarily as a result of the consolidation of gedas in 2006, international business developed very positively. Additionally, the volume of business conducted with companies outside the group was stabilized and remained at the prior-year level. Primary factors for this development included business with services for PC workstations and the development and integration of software systems in the Enterprise Services unit. The Business Services unit, which also serves small and medium-sized enterprises, continues to lead the German market and was able to increase its market share for IT Business.

Group strategy

Vision

We want to make personal and social networking easier for customers. This is based on broadband leadership using the most advanced technologies and being the most highly regarded service company. To accomplish these goals, we will concentrate on four main areas:

 

   

Improved competitiveness in Germany

 

   

Growth abroad with mobile communications

 

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Mobilization of the Internet

 

   

Further development of integrated communications and IT solutions

Achieving the goal of being the “most highly regarded service company” will be pivotal to sustaining success through differentiation in the face of markets characterized by intense price competition. We intend to reinforce the service concept deep in our corporate culture.

Market Environment

Our markets and competitive environment continue to present substantial challenges for us. This is partly due to volatile conditions prevailing in certain markets and a largely unfavourable regulatory environment. While the European consumer market and even the mobile communications market are showing increasing signs of saturation, it is also possible to identify growth areas, such as broadband, mobile Internet and the mobile communications market in the United States.

Previously separated markets and technologies are continuing to converge. One of the driving forces behind this development is the Internet Protocol (IP), a technology used to send and receive data in high-performance broadband networks. Convergence involves both opportunities and risks for our group. As an integrated provider of telecommunications services, we have the opportunity to shape this transformation of the industry. However, technological innovation resulting in the rapid substitution of one communication technology for another poses a major risk for us. An increasing number of providers have, and will continue to, enter the telecommunications market, including some with business models and technologies that may have serious implications for us, such as the growing range of Internet-based communications technologies, including VoIP.

During 2006, we implemented a range of key measures that have contributed to the group’s strategic positioning for the future. The merger of T-Online into Deutsche Telekom, which was successfully completed in June 2006, has already substantially improved the range of offerings to customers. By acquiring further spectrum rights in the United States through Auction 66, we have commenced improving and expanding our footprint in the United States and hope to increase market share as well. In the Business Customers segment, we further reinforced our core competence as a service provider for ICT by expanding our expertise in the automotive industry through the acquisition of gedas from Volkswagen.

Innovation

In addition, we succeeded in successfully introducing a series of innovations in various markets. The introduction of IPTV in Germany represents a further milestone for our positioning in the broadband services market. With the recent introduction in the mobile communications market of HSDPA, an enhanced bandwidth mobile network, mobile broadband is now possible. Additionally, the successful implementation of customer relationship management systems across business areas means that we are now able to tailor integrated offerings to the requirements of our customers more efficiently and effectively. Increasing customer satisfaction will yield improved customer loyalty, which, in turn, will help achieve the group’s financial goals in the future.

Domestic Consumer Market

In Germany’s consumer market, our group is facing intense competition both in the wireless and the broadband and fixed-line market, each characterized by enormous price pressure and accelerated focus on market share gains to increase revenue growth in the face of market saturation.

We will focus on defending our profitability in our domestic market through efficiency initiatives and other measures aimed at stabilizing our market position.

Offerings

We intend to defend and stabilize our market position with innovative bundled products, such as “Telekom-Vorteil” and attractive calling plans, including flat-rate plans such as “Max” from T-Mobile Germany. Furthermore, we will seek to share significantly in the continued growth of the broadband market. With our IPTV

 

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offering, T-Home, and the ongoing roll-out of our high-speed broadband network (e.g., via VDSL to 50 German cities), we are offering differentiated and competitive products to the market. Nevertheless, customer acceptance of those offerings will develop over time and will need to be accompanied by substantial marketing activities. In order to strengthen our market position and harmonize product development activities in our group, we are in the process of establishing a cross-business product development function.

Sales and Services

It is crucial to provide not just first-class products at attractive prices, but also high-quality customer service to create differentiation potential in the face of price pressure. To professionalize our service, we will broaden our own T-Punkt shop network in Germany. During 2007, we intend to continue to increase the number of T-Punkt shops by adding 200 outlets to our existing 600 outlets. We also intend to increase the sales staff in our T-Punkt network by about 1,500 to enhance the quality of service to our customers.

In addition, we will utilize our integrated customer relationship management approach to offer customers compelling and relevant solutions to better fit their needs. This will enable us to increase customer loyalty among existing customers and to attract new customers using an overarching sales channel management.

To foster this integrated approach, we have established, as of January 2007, a joint go-to-market approach with responsibility for sales and service in Germany allocated to our new sales and service Board department. This integrated approach will be further complemented by an effort to increase the efficiency and effectiveness of our service units in Germany. In this regard, we plan to establish three dedicated business units that will focus on technical infrastructure services, technical customer service and call centers. The “T-Service” project will be led by the new sales and service Board department. Our aim in establishing these three new businesses is to align our cost structures over time with prevailing market conditions, enhance the quality of service delivered to our customers and to improve the productivity and expertise of our employees in those units.

International Consumer Market

Outside of Germany, our goal is to systematically grow our market share in terms of revenues. Particular emphasis will be placed on customer service and attractive offers. As an integrated telecommunications provider in Hungary, Croatia, and Slovakia, we will systematically market triple-play and quadruple-play packages in these markets. Triple-play combines voice telephony, broadband Internet access, and TV-based entertainment services, and quadruple-play adds a mobile communications component. Triple-play has been introduced by Magyar Telekom in Hungary, as well as in Croatia by Hrvatski Telekom and in Slovakia by Slovak Telekom.

In the United States, the mobile communications market as a whole is still experiencing strong subscriber growth, which means that the principal challenge for us is to grow faster than the rest of the market and increase our market share while maintaining a relatively stable average revenue per user. The success of T-Mobile USA to date is attributable in large measure to the quality of its customer care, which was ranked highest among the five largest wireless service providers in the U.S. by J.D. Powers and Associates in 2006 for the fifth consecutive time. Now that we have acquired additional spectrum through Auction 66 with more than doubling our spectrum capacity in the top100 markets in the United States, we plan to deploy this spectrum through a focused network build-out and to introduce innovative products and services such as “MyFaves.” The network roll-out commenced in the fourth quarter of 2006 and will continue until 2009.

Business Market

In the business customer market, we will defend our market share in the area of telecommunications and further expand in the large and medium-sized customer markets. At the same time, we will introduce offers of standardized IT services and solutions for the mid-market and expand the IT outsourcing business with existing and new key accounts. The steps taken to expand these markets include, strategic pricing measures and the rapid expansion of IP services. On the production side, we will consolidate the platforms to increase efficiency. Systematically aligning production architecture and business processes will put us in an excellent position in the

 

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business customer market to service this area with a competitive portfolio of integrated IT and telecommunications solutions. This applies to horizontal solutions for specific parts in the value chain and also to industry-specific solutions, such as the automotive industry and the public sector.

Our strategies may, of course, be adapted and changed to respond to opportunities and changing conditions. As reported in past years, we may embark on capital expenditure programs and pursue aquisitions, joint ventures, dispositions or combinations of businesses where we perceive real opportunity for profitable growth, cost savings or other benefits for our group. Transactions may be conducted using newly issued shares of Deutsche Telekom or shares of our affiliates, cash or a combination of cash and shares, and may individually or in the aggregate be material to us. As in the past, discussions with third parties in this regard may be commenced, on-going or discontinued at any time or from time to time.

Outlook(1)

Growth in our international markets is expected to continue, particularly in the key markets of the United States and the United Kingdom. Developments in our domestic markets are still dominated by extremely intense competition and price erosion in the telecommunications market as a whole, and for consumer DSL and business voice telephony, as well as for mobile communciations.

We are responding to the challenges of rapid technological changes and strong competition in the telecommunications industry with specific measures to ensure the long-term sustainability of customer relationships and thus revenue and profit. In particular, we believe that the sustainable improvement of our service culture toward customers and investments in future product areas, as well as simplified price structures, will safeguard our customer relationships and, as a consequence, will show positive effects on revenue development. Additional cost reductions, achieved with the help of increased rationalization investments, such as in new, more cost-efficient IP-based networks, will result in cost efficiencies designed to ensure the long-term sustainability of cash flows. These measures will also assist us in pursuing our goal of continuing to offer our shareholders an attractive dividend. The immense changes in our market environments—in particular rapid technological changes—are forcing us to adjust our workforce structure by eliminating jobs in a socially responsible way. The workforce reduction will be implemented using voluntary measures such as partial retirement arrangements, severance payments and early retirement.

Mobile Communications

The Mobile Communications strategic business area will continue to be the growth engine of the group. The further development of the strategic business area will again be driven in particular by the U.S. market, which is recording relatively high customer growth rates. For Europe, despite strong price pressure, we expect to be able

 


(1) This Outlook discussion contains forward-looking statements that reflect management’s current views with respect to future events. Words such as “expect,” “anticipate,” “believe,” “intend,” “may,” “could,” “estimate,” “aim,” “goal,” “plan,” “project,” “should,” “will,” “seek,” “outlook” or similar expressions generally identify forward-looking statements. Statements with regard to future revenues, earnings or operating profitability are forward-looking statements. You should consider forward-looking statements with caution. They are subject to risks and uncertainties, most of which are difficult to predict and are often beyond our control. The risks and uncertainties include those described in the sections “Forward-Looking Statements” and “Risk Factors” of this Annual Report. Please read those sections when considering this Outlook discussion. Among the other relevant factors that might influence our ability to achieve our objectives are: the progress of our workforce reduction initiative and the impact of other significant strategic or business initiatives, including acquisitions, dispositions and business combinations. In addition, stronger than expected competition, technological change, legal proceedings and regulatory developments, among other factors, may have a material adverse effect on costs and revenue development. If these or other risks and uncertainties materialize, or if the assumptions underlying any of these statements prove incorrect, our actual performance may materially differ from the performance expressed or implied by such statements. We can offer no assurance that our estimates or expectations will be achieved. We do not assume any obligation to update forward-looking statements to take new information or future events into account or otherwise, although we intend to continue to meet our ongoing disclosure obligations under the U.S. securities laws (such as our obligations to file annual reports on Form 20-F and reports on Form 6-K) and under other applicable laws.

 

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to expand our market share, primarily through higher usage on the part of our customers. An important growth contributor is expected to be the offer of advanced mobile data services, especially an enhanced web’n’walk offering with new equipment at attractive rates.

Based on these assumptions, we expect a positive total revenue development in the Mobile Communications strategic business area. However, regulatory decisions and the further development of the U.S. dollar and British pound sterling exchange rates may have a negative effect on T-Mobile’s revenue development.

The group’s capital expenditure activities in 2007 will continue to focus on its mobile communications business. In Europe, key areas will include improvements in the quality of the existing GSM networks and the further expansion of our UMTS networks. In the United States, we are enhancing network quality and network coverage and focusing on the rapid roll-out and launch of 3G mobile communications networks and products in order to ensure growth in customer numbers and revenues. For more information, see “—Liquidity and Capital Resources—Capital Expenditures and Investments—Capital Expenditures.”

Broadband/Fixed Network

In the DSL business, we will defend our market share and expect a significant increase in the number of access lines. Additionally, we want to further establish our triple-play products offered under T-Home. A major element of this strategy will be the expansion of our high-speed Internet infrastructure, provided that such an investment is economically viable given the regulatory environment in the medium term. Aside from the VDSL roll-out, investments in 2007 will focus on expanding the DSL and IP networks and on maintaining and extending the existing network infrastructure. For more information, See “—Liquidity and Capital Resources—Capital Expenditures and Investments—Capital Expenditures.”

In 2007, the traditional fixed-line network business will continue to be negatively affected by competition-induced market share losses, fixed-mobile substitution, price cuts due to regulatory requirements, and market-related price erosion. With a quality and service campaign, Broadband/Fixed Network will focus in 2007 on safeguarding and defending the core voice and access business, and on expanding its broadband business with new, innovative products. We are also preparing to migrate the old PSTN environment to the new IP-based environment and thereby introduce an innovative, competitive IP connection that will facilitate many additional functions for customers, such as video telephony.

Based on these assumptions, we expect the negative trend in total revenues for the Broadband/Fixed Network strategic business area to continue.

To make our service function more efficient and to optimize its alignment with customer needs, we are currently planning, a large service initiative, T-Service, which will involve the transfer of certain of the business activities of Broadband/Fixed Network’s existing call centers, technical infrastructure and technical customer service into three distinct businesses. The objectives of the T-Service initiative are to increase productivity and service levels, while at the same time increasing cost-efficiencies. A significant number of employees in Germany are to participate in this project during 2007. These measures will allow us to focus on the quality of our service under conditions that reflect realistic market conditions. The goal is to maintain our competitiveness in the long term, while safeguarding jobs both in the group and particularly in Germany. The group also aims to systematically align working conditions and remuneration systems with market levels and to increase productivity.

Business Customers

The Business Services unit will focus on safeguarding its telecommunications business in a hotly contested market. In our telecommunications core business, we will focus on winning back customers. This strategy will be accompanied by efforts to expand areas such as LAN solutions, i.e., network solutions for connecting workstations at a company’s site. The Business Services unit is expecting growth in its IT business. The goal in this area is to substantially intensify our cooperation in particular with small- and medium-sized enterprises. Capital expenditures will be guided by the technical integration of the IT environment and the introduction of value-added services.

 

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In the Enterprise Services unit, we plan to expand our market share in the telecommunications business through integrated IT and telecommunications sales activities. In the IT business, we intend to grow primarily by expanding outsourcing activities, in particular through large-scale contracts and continued business process outsourcing with a focus on the Automotive (global), Public (Germany, the United Kingdom, Spain), and Telecommunications (Germany and Western Europe) industry lines. We are planning to increase capital expenditures also in Enterprise Services, particularly through the assumption of assets in conjunction with business process outsourcing. For more information, See “—Liquidity and Capital Resources—Capital Expenditures and Investments—Capital Expenditures.”

Based on these assumptions, we currently expect total revenues in the Business Customers strategic business area to remain stable.

 

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CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements prepared in accordance with IFRS as adopted by the European Union, and the reconciliation of our consolidated financial statements from IFRS to U.S. GAAP, are dependent upon and sensitive to accounting methods, assumptions and estimates that we use as bases for the preparation of our consolidated financial statements and reconciliation. We have identified the following critical accounting estimates and related assumptions and uncertainties inherent in our accounting policies that we believe are essential to an understanding of the underlying financial reporting risks, and the effect that these accounting estimates, assumptions and uncertainties have on our consolidated financial statements under IFRS and our reconciled U.S. GAAP financial information.

Accounting for property, plant and equipment, and intangible assets involves the use of estimates for determining fair value at the acquisition date, in particular, in the case of assets acquired in a business combination. The expected useful lives and residual values of these assets must be estimated. The determination of the fair values of assets, as well as of the useful lives and residual values of the assets is based on management’s judgment.

The determination of impairments of property, plant and equipment, and intangible assets involves the use of estimates that include, but are not limited to, the cause, timing and amount of the impairment. Impairment is based on a large number of factors, such as changes in current competitive conditions, expectations of growth in the telecommunications industry, changes in regulatory environment, increased cost of capital, changes in the future availability of financing, technological obsolescence, discontinuance of services, current replacement costs, prices paid in comparable transactions and other changes in circumstances that indicate an impairment exists. The determination of recoverable amounts and fair values are typically based on discounted cash flow methodologies that incorporate reasonable market assumptions. The identification of impairment indicators, the estimation of future cash flows and the determination of fair values of assets (or groups of assets) requires management to make significant judgments concerning the identification and validation of impairment indicators, expected cash flows, applicable discount rates, useful lives and residual values. For example, the estimation of cash flows underlying the fair values of our mobile businesses takes into consideration the continued investment in network infrastructure required to generate future revenue through the offering of new data products and services, for which only limited historical information on customer demand may be available. If the expected demand for these products and services does not materialize, our revenues and cash flows may not develop in accordance with our business model, which may lead to write-downs of investments to their fair values.

Under U.S. GAAP, the recoverability of assets that are held and used is measured by comparing the sum of the future undiscounted cash flows derived from an asset (or a group of assets) to their carrying value. If the carrying value of the asset (or the group of assets) exceeds the sum of the future undiscounted cash flows, an impairment is considered to exist. If an impairment is considered to exist on the basis of undiscounted cash flows, the impairment charge is measured using an estimation of the assets’ fair value. Reversal of previously recognized impairment losses is not permitted.

The determination of the recoverable amount of a cash-generating unit (under IFRS) or the fair value of an asset group or a reporting unit (under U.S. GAAP) involves the use of estimates by management. Methods used to determine the fair value less costs to sell (under IFRS) or fair value of an asset group (under U.S. GAAP), include discounted cash flow methodologies and models based on quoted stock market prices. Key assumptions on which management has based its determination of fair value include ARPU (monthly average revenue per user), subscriber acquisition and retention costs, churn rates, capital expenditures and market share. These estimates can have a material impact on fair value under both IFRS and U.S. GAAP and the amount of any goodwill write-down.

Financial assets include equity investments in foreign telecommunications service providers that are principally engaged in the mobile, fixed-line network, Internet and data communications businesses, some of which are publicly traded and have highly volatile share prices. Generally, an impairment charge is recorded, in accordance with IFRS, when an investment’s carrying amount exceeds the present value of its estimated future cash flows, and, in accordance with U.S. GAAP, when a decline in fair value is considered to be other than

 

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temporary. The calculation of the present value of estimated future cash flows and the determination of whether an impairment is other than temporary involves judgments and relies heavily on assessments by management regarding the future development and prospects of the investee company. In determining value, quoted market prices are used, if available, or other valuation methodologies. To determine whether an impairment is other than temporary, we consider the ability and intent to hold the investment for a reasonable period of time to ascertain whether a forecasted recovery of fair value exceeds the carrying amount, including an assessment of factors such as the length of time and magnitude of the excess of carrying value over market value, the forecasted results of the investee company, the regional economic environment and state of the industry. Future adverse changes in market conditions, particularly a downturn in the telecommunications industry, or poor operating results could result in losses or an inability to recover the carrying amount of the investment, which could result in impairment charges.

Management maintains an allowance for doubtful accounts to account for estimated losses resulting from the inability of customers to make required payments. When evaluating the adequacy of an allowance for doubtful accounts, management bases its estimates on the aging of accounts receivable balances and historical write-off experience, customer credit worthiness and changes in customer payment terms. If the financial condition of customers were to deteriorate, actual write-offs might be higher than currently expected.

Income taxes are estimated for each of the jurisdictions in which we operate and involve a specific calculation of the expected actual income tax exposure for each taxable item and an assessment of temporary differences resulting from the different treatment of certain items for IFRS consolidated financial and tax reporting purposes. Any temporary differences will result in the recognition of deferred tax assets or liabilities in the consolidated financial statements. Management judgment is required for the calculation of current and deferred taxes. Deferred tax assets are recognized to the extent that their utilization is probable. The utilization of deferred tax assets will depend on whether it is possible to generate sufficient taxable income, based on applicable tax category and jurisdiction, taking into account any restrictions relating to the loss-carryforward period. Various factors are used to assess the probability of the future utilization of deferred tax assets, including future reversals of existing taxable temporary differences, past operating results, operational plans, loss-carryforward periods, and tax planning strategies. If actual results differ from these estimates or if these estimates must be adjusted in future periods, the financial position, results of operations and cash flows may be affected. In the event of a change in the assessment of future utilization of deferred tax assets, the recognized deferred tax assets must be increased or decreased, as the case may be, and recognized in profit and loss. As a result, the effect of downturns or upturns in our businesses on our net profit or loss can be magnified by the resultant effects on our deferred tax assets.

Pension obligations for benefits to non-civil servants are generally satisfied by plans that are classified and accounted for as defined benefit plans. Pension benefit costs for non-civil servants are determined in accordance with actuarial procedures, which rely on assumptions including discount rates, life expectancies and, to a limited extent, expected return on plan assets. Estimations of the expected return on plan assets have a limited impact on pension costs because the amount of funded plan assets is small in relation to the outstanding pension obligations. Other key assumptions affecting pension costs are based, in part, on actuarial valuations, including discount rates used to calculate the amount of the pension obligation. In order to determine the discount rate, we determine an appropriate yield curve based on the spot rates of the rate of return of more than 500 high-quality European corporate bonds with a rating of “AA” as reported by Bloomberg L.P. Since our defined pension obligations are denominated predominantly in euro, this yield curve provides the basis for the discount rate. We determine the discount rate on the weighted average timing (duration) of the our defined benefit payments. The duration of our defined benefit payments is approximately 15 years. The assumptions concerning the expected return on plan assets are determined on a uniform basis, considering long-term historical returns, asset allocation and future estimates of long-term investment returns. In the event that further changes in assumptions are required with respect to discount rates and expected returns on invested assets, the future amounts of the pension benefit costs may be materially affected.

We exercise considerable judgment in determining and recognizing provisions and the exposure to contingent liabilities related to pending litigation and other outstanding claims subject to negotiated settlements,

 

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mediation, arbitration or government regulation, as well as other contingent liabilities. Judgments are necessary in assessing the likelihood that a pending claim will succeed, or if a liability will arise, and with respect to quantification of the possible range of final settlements. Provisions are recorded for liabilities when losses are considered probable and can be reasonably estimated. Because of the inherent uncertainties in making such judgments, actual losses may be different from the originally estimated provision. Significant estimates are involved in the determination of provisions related to taxes, environmental liabilities, our workforce adjustment initiative and litigation risks. These estimates are subject to change as new information becomes available, primarily with the support of internal specialists or outside consultants, such as actuaries or legal counsel. Adjustments to loss provisions may significantly affect future operating results.

We are obligated under the Federal Posts and Telecommunications Agency Reorganization Act (Gesetz zur Reorganisation der Bundesanstalt für Post und Telekommunikation Deutsche Bundespost) to pay for our share of any operating cost shortfalls in income of the Civil Service Health Insurance Fund (Postbeamtenkrankenkasse) and benefits to be paid. The Civil Service Health Insurance Fund provides healthcare and medical benefits for its members and their dependents, who are civil servants employed by or retired from Deutsche Telekom, Deutsche Post AG and Deutsche Postbank AG. Since January 1, 1995, participation in the Civil Service Health Insurance Fund was closed to new members. The insurance premiums collected by the Civil Service Health Insurance Fund may not exceed the insurance premiums imposed by alternative private health insurance enterprises for comparable insurance benefits, and, therefore, do not reflect the changing composition of ages of the participants in the fund. We recognize a provision in the amount of the actuarially determined present value of our share in the fund’s future deficit, using a discount rate and making assumptions about life expectancies and projections for contributions and future increases in general health care costs in Germany. Since the calculation of these provisions involves long-term projections over periods of more than 50 years, the present value of the liability may be significantly impacted by even small variations in the underlying assumptions.

Revenue recognition for customer activation fees

Broadband/Fixed Network’s T-Com business unit and Mobile Communications receive installation and activation revenues from new customers. These revenues (and related costs limited to the amount of deferred revenues) are deferred and amortized over the expected duration of the customer relationship. The estimation of the expected average duration of the relationship is based on historical customer turnover. If management’s estimates are revised, material differences may result in the amount and timing of revenues recognized for a given period.

Revenue recognition for long-term service contracts

Business Customers conducts a portion of its business under long-term contracts with customers. We account for certain long-term service contracts based on proportional performance, recognizing revenues as performance of a contract progresses. Factors affecting estimates of contract progress may include total contract costs, remaining costs to completion, total contract revenues, contract risks and other judgments. Estimates relating to long-term contracts are subject to regular reviews and are adjusted as necessary.

Revenue recognition for multiple-element arrangements

The framework of the Emerging Issues Task Force Issue (EITF) No. 00-21 was adopted to account for multiple-element arrangements under IFRS, in accordance with International Accounting Standard (IAS) 8.12, issued by the IASB, as well as under U.S. GAAP. EITF 00-21 requires that arrangements involving the delivery of bundled products or services be separated into individual units of accounting, each with its own separate earnings process. Total arrangement consideration relating to the bundled contract is allocated among the different units based on their relative fair values (i.e., the relative fair value of each of the accounting units to the aggregated fair value of the bundled deliverables). The determination of fair values is complex because some of the elements are price sensitive and, thus, volatile in a competitive marketplace. Revisions to the estimates of these relative fair values may significantly affect the allocation of total arrangement consideration among the different accounting units, and may therefore affect future operating results.

 

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CONSOLIDATED RESULTS OF OPERATIONS

The following table presents information concerning our consolidated income statements for the periods indicated:

 

     For the years ended December 31,  
           2006                 2005(1)                 2004(1)        
     (millions of €)  

Net revenues

   61,347     59,604     57,353  

Cost of sales

   (34,755 )   (31,862 )   (31,544 )

Gross profit

   26,592     27,742     25,809  

Selling expenses

   (16,410 )   (14,683 )   (12,870 )

General and administrative expenses

   (5,264 )   (4,210 )   (4,476 )

Other operating income

   1,257     2,408     1,718  

Other operating expenses

   (888 )   (3,635 )   (3,916 )

Profit from operations

   5,287     7,622     6,265  

Finance costs

   (2,540 )   (2,401 )   (3,280 )

Share of profit (loss) of associates and joint ventures accounted for using the equity method

   24     214     945  

Other financial income (expense)

   (167 )   784     (360 )

Loss from financial activities

   (2,683 )   (1,403 )   (2,695 )
                  

Profit before income taxes

   2,604     6,219     3,570  

Income taxes

   970     (198 )   (1,552 )

Profit after income taxes

   3,574     6,021     2,018  

Profit attributable to minority interests

   409     432     424  
                  

Net profit (profit attributable to equity holders of the parent)

   3,165     5,589     1,594  
                  

(1) Amounts reflect immaterial adjustments due to a change in accounting policy relating to IAS 19.93A. For more information, see note (29) to the consolidated financial statements.

Net Revenues

In 2006, our net revenues increased by EUR 1,743 million, or 2.9%, to EUR 61,347 million, compared with 2005. This increase was primarily due to the positive development of net revenues in the Mobile Communications strategic business area, which increased 9.7% year-on-year. In contrast, net revenues in the Broadband/Fixed Network strategic business area decreased 5.0%. In the Business Customers strategic business area, net revenues remained at the same level as in the previous year.

The increase in net revenues in 2006 also included effects relating to acquisitions by the group in the amount of EUR 1.2 billion (primarily the acquisition of gedas (EUR 495 million), PTC (EUR 299 million), and tele.ring (EUR 296 million)) and by the accelerated recognition of deferred revenue in the amount of EUR 201 million relating to a change in customer retention periods at Broadband/Fixed Network. The increase was offset, in part, by exchange rate effects totaling EUR 200 million, primarily from the translation of U.S. dollars to euros.

We generated consolidated net revenues of EUR 59,604 million in 2005, an increase of 3.9%, compared to EUR 57,353 million to 2004. Net revenues from Broadband/Fixed Network decreased by 3.0%, primarily due to a decrease in narrowband and calling charge minute net revenues, which was not completely offset by the increase in broadband net revenues. Mobile Communications net revenues increased by 12.1% due to further customer growth, in particular at T-Mobile USA. Business Customers net revenues declined by 2.0%, largely as a result of ongoing competition in the market and the continued reduction in prices of traditional telecommunications services. The full consolidation of T-Mobile Slovensko and Telekom Montenegro in 2005 and positive exchange rate effects also contributed to the increase in the group’s net revenues.

 

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For more information on our net revenue development and trends, see “ —Segment Analysis.”

Cost of Sales

Our cost of sales comprises the aggregate cost of products and services delivered. In addition to directly attributable costs, such as direct material and labor costs, it also includes indirect costs, such as depreciation and amortization.

Cost of sales increased by EUR 2,893 million, or 9.1%, in 2006 to EUR 34,755 million, compared with EUR 31,862 million in 2005. In addition to higher expenditures in connection with the personnel reduction initiative, the increase in the cost of sales was due primarily to customer growth in the Mobile Communications strategic business area. However, cost of sales in the Broadband/Fixed Network strategic business area was down slightly compared to 2005.

Cost of sales increased by EUR 318 million in 2005 to EUR 31,862 million, compared with EUR 31,544 million in 2004. However, compared to our growth in revenues during 2005, our cost of sales increased at a slower pace. In addition to the increase in cost of sales as a result of increased sales volume, cost of sales in 2005 was affected by higher amortization expense for UMTS licenses (EUR 345 million), and increased depreciation expense in connection with the acquisition of the mobile networks in California, Nevada and New York. This increase was offset, in part, by a significant decrease in impairment losses on mobile telecommunications licenses (FCC licenses) in the United States of EUR 1,220 million.

Selling Expenses

Our selling expenses include all expenses for activities that do not directly increase the value of our products or services, but help to secure sales. Selling costs generally include all expenses relating to the sales (e.g., commissions), advertising and marketing departments and other sales promotion activities.

Selling expenses increased by EUR 1,727 million, or 11.8%, in 2006, compared to 2005. In addition to higher expenditures relating to the personnel reduction initiative, this increase is predominantly attributable to higher commission and marketing expenses in the Mobile Communications and Broadband/Fixed Network strategic business areas, which increased mainly as a result of customer growth at T-Mobile USA, and intensified advertising for new calling plans and major sponsored events.

The increase in selling expenses of EUR 1,813 million to EUR 14,683 million in 2005, compared with EUR 12,870 million in 2004, was primarily due to the increase in selling expenses at T-Mobile USA resulting from the growth in the number of T-Mobile stores, as well as to higher customer acquisition costs, and to an increase in marketing and selling expenses in the Broadband/Fixed Network strategic business area in connection with our broadband initiative.

General and Administrative Expenses

Our general and administrative expenses generally include all costs attributable to the core administrative functions that are not directly attributable to production or selling activities.

General and administrative expenses increased by EUR 1,054 million, or 25.0%, in 2006, compared to 2005, with the largest increases attributable to Group Headquarters and Shared Services and Mobile Communications. Overall, this increase is primarily due to higher expenses relating to the personnel reduction initiative.

General and administrative expenses decreased by EUR 266 million to EUR 4,210 million in 2005, compared with EUR 4,476 million in 2004. The decrease in general and administrative expenses was primarily due to decreases at Group Headquarters and Shared Services (due, in part, to the reduction of provisions related to other taxes) and at Business Customers (mainly due to cost efficiencies, partly offset by increased restructuring costs). However, general and administrative costs increased at Broadband/Fixed Network, in particular at T-Com, as a result of increased costs for apprentices and social costs related to employees.

 

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Other Operating Income

Other operating income consists of reversals of provisions (if not allocated to functional costs), income from transfer of costs and gains from disposals. Miscellaneous other operating income encompasses a variety of income items for which the individually recognized amounts are not material.

In 2006, other operating income decreased by EUR 1,151 million to EUR 1,257 million compared to 2005, primarily as a result of the non-recurrence of a reversal of provisions in 2005 relating to the new arrangements for the financing of the Civil Service Health Insurance Fund, which accounted for EUR 783 million of the increase in other operating income in 2005.

In 2005, the increase in other operating income (EUR 690 million), compared to 2004, was mainly due to higher income from a reversal of provisions. Effective in December 2005, a new arrangement was established by the Federal Republic relating to the cost contribution to the Civil Service Health Insurance Fund. The new arrangements for the financing of the Civil Service Health Insurance Fund resulted in a reversal totaling EUR 783 million. For further information, see “Item 6. Directors, Senior Management and Employees—Employees and Labor Relations—Civil Servants.”

Other Operating Expenses

Other operating expenses consist of impairment of goodwill, additions to provisions (if not allocated to functional costs) and losses on disposals. Miscellaneous other operating expenses encompass a variety of expense items for which the individually recognized amounts are not material.

In 2006, other operating expenses decreased by EUR 2,747 million compared to 2005. This was mainly due to reduced goodwill impairment losses. In 2005, goodwill impairment losses recognized as expenses totaled EUR 1,920 million relating mainly to T-Mobile UK (EUR 1,917 million) compared with EUR 10 million in 2006.

In 2005, the decrease in other operating expenses of EUR 281 million was primarily the result of offsetting effects. The decrease (EUR 514 million) in goodwill impairment losses, relating mainly to T-Mobile UK EUR 1,917 million in 2005 and EUR 2,225 million in 2004), was offset, in part, by an increase in miscellaneous other expenses of EUR 263 million, primarily related to personnel adjustment and restructuring measures.

Profit from Operations

Profit from operations decreased by EUR 2,335 million 2006, compared to 2005, primarily due to higher cost of sales, selling expenses and general and administrative expenses and lower other operating income, offset in part, by lower other operating expenses. The details are described in the individual items set forth above and in personnel costs, depreciation, amortization and impairment losses set forth below.

Profit from operations increased by EUR 1,357 million in 2005, compared to 2004, primarily as a result of increased revenues and other operating income, as well as decreased general and administrative expenses and other operating expenses, offset, in part, by increased selling expenses and cost of sales. The details are described in the individual items set forth above and in personnel costs, depreciation, amortization and impairment losses set forth below.

 

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Loss from Financial Activities

The following table presents information concerning our loss from financial activities:

 

     For the years ended December 31,  
     2006     2005(1)     2004(1)     2006/2005     2005/2004  
     (millions of €)     (% change)  

Finance costs

          

Interest income

   297     398     377     (25.4 )   5.6  

Interest expense

   (2,837 )   (2,799 )   (3,657 )   (1.4 )   23.5  
   (2,540 )   (2,401 )   (3,280 )   (5.8 )   26.8  

Share of profit of associates and joint ventures accounted for using the equity method

   24     214     945     (88.8 )   (77.4 )

Other financial income (expense)

   (167 )   784     (360 )   n.m.     n.m.  
                      

Loss from financial activities

   (2,683 )   (1,403 )   (2,695 )   (91.2 )   47.9  
                      

n.m.—not meaningful
(1) Amounts reflect immaterial adjustments due to a change in accounting policy relating to IAS 19.93A. For more information, see note (29) to the consolidated financial statements.

Finance costs

Finance costs increased by EUR 139 million in 2006 as compared to 2005. This was primarily due to a positive effect in the second quarter of 2005 that resulted from an adjustment to the book value of financial liabilities to reflect the changes in the present value of the estimated future payments. The changes in the estimated future payments were triggered by a downward adjustment in interest rates relating to these financial liabilities following an upgrade of our credit rating by rating agencies.

Our finance costs decreased by EUR 879 million in 2005 to EUR 2,401 million as compared to 2004 primarily due to a reduction of financial liabilities and an improvement in our credit ratings which resulted in better interest rates on certain existing indebtedness.

The effective weighted average interest rate applicable to our outstanding indebtedness related to bonds and debentures was 6.2% in 2006, 6.5% in 2005 and 6.8% in 2004. The effective weighted average interest rate applicable to our outstanding indebtedness related to bank liabilities was 6.6% in 2006, 6.1% in 2005 and 6.5% in 2004. Some of our debt instruments have provisions that could cause the interest rate on such investments to increase upon the occurrence of certain downgrades in our long-term unsecured debt ratings. For more information, see “—Liquidity and Capital Resources—Capital Resources.”

Share of profit of associates and joint ventures accounted for using the equity method

The share of profit of associates and joint ventures accounted for using the equity method declined by EUR 190 million in 2006 as compared to 2005, primarily due to lower profits from associates and joint ventures. In addition, the profit generated by PTC was only included through the end of October 2006. PTC has been fully consolidated since November 1, 2006.

The share of profit of associates and joint ventures accounted for using the equity method in 2005 reflected the gain on our sale of shares in comdirect bank amounting to EUR 62 million. In 2004, the share of profit of associates and joint ventures accounted for using the equity method reflected the gain on the sale of shares in MTS amounting to EUR 972 million, which was partially offset by losses incurred in connection with Toll Collect.

Other financial income (expense)

Other financial income (expense) decreased by EUR 951 million in 2006, compared to 2005. In 2005, other financial income (expense) included the gain on the sale of our remaining shares in MTS (EUR 976 million). In

 

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2006, this decrease was offset, in part, by the proceeds from the sale of Celcom in 2003, which were received in the first quarter of 2006 (EUR 196 million).

Other financial income (expense) improved by EUR 1,144 million in 2005, compared to 2004, primarily due to the sale of our remaining shares in MTS (EUR 976 million) in 2005.

Personnel costs

The following table provides a breakdown of the personnel costs included in the functional cost line items (cost of sales, selling expenses, general and administrative expenses and other operating expenses):

 

     For the years ended
December 31,
 
     2006     2005     2004  
     (millions of €)  

Wages and salaries

   (13,436 )   (11,436 )   (10,411 )

Social security contributions and expenses for pension plans and benefits:

      

Social security costs

   (1,598 )   (1,520 )   (1,482 )

Expenses for pension plans

   (1,351 )   (1,129 )   (1,195 )

Expenses for benefits

   (157 )   (169 )   (254 )
                  

Personnel costs

   (16,542 )   (14,254 )   (13,342 )
                  

In 2006, the expenses related to the personnel reduction initiative totaled EUR 2,852 million. These expenses relate primarily to voluntary redundancy and severance payments (EUR 676 million) and to the early retirement arrangements for civil servants (EUR 1,800 million). In 2005, expenses for other personnel reduction measures amounted to approximately EUR 1,210 million, mainly attributable to provisions for voluntary redundancy and severance payments for salaried employees in the context of the staff restructuring program announced in the fourth quarter of 2005. The personnel expenses in 2005 and 2006 related primarily to the staff reduction program announced in the fourth quarter of 2005. In addition, they include expenses for Altersteilzeit (partial retirement, termination benefit) and expenses for staff reduction programs at the international subsidiaries.

In addition, the increase in personnel costs in 2006 compared to 2005 is attributable to the first-time consolidation of gedas in the Business Customers strategic business area, collectively agreed increases in wages and salaries, and increased staff levels and exchange rate effects at T-Mobile USA.

Number of employees (average for the year)

 

     For the years ended December 31,
     2006    2005    2004

Number of Employees

        

Civil servants

   42,969    46,525    48,536

Non-civil servants

   205,511    197,501    199,023
              

Deutsche Telekom group

   248,480    244,026    247,559
              

Trainees and student interns

   10,346    10,019    10,146

The increase in the annual average headcount is attributable in particular to the first-time consolidation of gedas in the first quarter of 2006, and PTC in the fourth quarter of 2006. In addition, there was a significant increase in headcount at T-Mobile USA.

 

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Depreciation, Amortization and Impairment Losses

The following table provides a breakdown of the depreciation, amortization and impairment losses contained in the functional cost line items (cost of sales, selling expenses, general and administrative expenses and other operating expenses):

 

     For the years ended
December 31,
 
     2006     2005     2004  
     (millions of €)  

Amortization and impairment of intangible assets

   (2,840 )   (4,427 )   (5,461 )

of which: impairment of goodwill

   (10 )   (1,920 )   (2,434 )

of which: amortization and impairment of mobile telecommunications licenses

   (994 )   (951 )   (1,824 )

Depreciation and impairment of property, plant and equipment

   (8,194 )   (8,070 )   (7,666 )
                  

Total depreciation, amortization and impairment losses

   (11,034 )   (12,497 )   (13,127 )
                  

The amortization and impairment of intangible assets relates mainly to mobile telecommunications licences, software licences and goodwill. The decrease of EUR 1,587 million is attributable in particular to the absence in 2006 of impairment of goodwill for T-Mobile UK of EUR 1,917 million applied in 2005. This decrease was offset in part, by amortization amounts relating to the first-time consolidation of tele.ring and PTC in the Mobile Communications strategic business area, consisting mainly of amortization on the capitalized customer base and brand names totaling EUR 274 million.

The depreciation and impairment of property, plant and equipment increased in 2006 by EUR 124 million. The increase was largely the result of higher depreciation of technical equipment and machinery relating to additional operating equipment in connection with the network expansion at T-Mobile USA, which led to a higher depreciation base.

The decrease in amortization and impairment of intangible assets in 2005, of EUR 1,034 million, primarily resulted from a reduction in goodwill impairment losses at T-Mobile UK (2005: EUR 1,917 million; 2004: EUR 2,225 million), and the non-recurrence in 2005 of goodwill impairment losses at Slovak Telekom (EUR 203 million), compared with 2004.

Additionally, in 2004, an impairment loss of EUR 1,250 million was recorded in connection with our U.S. mobile telecommunications licenses relating to the winding up of GSM Facilities, the network joint venture between T-Mobile USA and Cingular. In 2005, in addition to the impairment losses at T-Mobile UK, there was an increase in the amortization of UMTS licenses (EUR 345 million) as a result of the effect of a full year of amortization charges that had commenced with the start of commercial operations using our UMTS licenses in Germany and the United Kingdom in the second and third quarters of 2004, respectively. Amortization of other intangible assets recognized at T-Mobile USA increased in 2005, by EUR 285 million, mainly due to the wholesale agreement on minutes of use between T-Mobile USA and Cingular.

Depreciation and impairment of property, plant and equipment also increased in 2005, by EUR 404 million, primarily as a result of an increase in depreciation related to the acquisition of the GSM Facilities networks in California, Nevada and New York in the first quarter of 2005.

For more information relating to our intangible assets, see note (21) to the consolidated financial statements.

 

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The following table provides a breakdown of impairment losses:

 

    

For the years ended

December 31,

 
         2006             2005             2004      
     (millions of €)  

Intangible assets

   (123 )   (1,958 )   (3,710 )

of which: goodwill

   (10 )   (1,920 )   (2,434 )

of which: U.S. mobile telecommunications licenses

   (33 )   (30 )   (1,250 )

Property, plant and equipment

   (287 )   (248 )   (158 )

of which: land and buildings

   (228 )   (233 )   (106 )

of which: technical equipment and machinery

   (13 )   (7 )   (45 )

of which: other equipment, operating and office equipment

   (26 )   (5 )   (5 )

of which: advance payments and construction in progress

   (20 )   (3 )   (2 )
                  

Total impairment losses

   (410 )   (2,206 )   (3,868 )
                  

The impairment losses on land and buildings mainly result from the fair value measurement of land and buildings held for sale and are reported in other operating expenses.

Profit before Income Taxes

In 2006, profit before income taxes decreased by EUR 3,615 million, to EUR 2,604 million compared with 2005, mainly due to decreased profit from operations and increased loss from financial activities. The non-recurrence of large-scale goodwill impairment charges in 2006 helped support pre-tax profitability.

In 2005, profit before income taxes increased by EUR 2,649 million, to EUR 6,219 million compared with 2004, mainly due to increased profit from operations and decreased loss from financial activities.

Income Taxes

 

     For the years ended December 31,  
     2006     2005(1)    2004(1)    2006/2005    2005/2004  
     (millions of €)    (% change)  

Income taxes

   (970 )   198    1,552    n.m.    (87.2 )

n.m.—not meaningful

(1) Amounts reflect immaterial adjustments due to a change in accounting policy relating to IAS 19.93A. For more information, see note (29) to the consolidated financial statements.

In general, the amount of income taxes we recognize is a function of our profit before income taxes and the various income tax rates applicable to profit before income taxes, and the recognition or non-recognition of deferred income taxes. However, the income tax expense recorded on our financial statements is not necessarily reflective of the actual income taxes we paid.

Income taxes changed from an expense of EUR 198 million in 2005 to an income tax benefit of EUR 970 million in 2006, a difference of EUR 1,168 million. As described below, in both 2006 and 2005, we recorded previously unrecognized deferred tax assets resulting in an income tax benefit of EUR 1.2 billion and EUR 2.2 billion, respectively. In comparison to 2005, however, the level of earnings decreased significantly in 2006. This decreased level of earnings resulted in a considerably lower income tax expense which, when combined with the income tax benefit, resulted in a net tax benefit of EUR 970 million.

Our effective income tax rate (income taxes as a percentage of profit before income taxes) was approximately (37)% in 2006, 3% in 2005 and 43% in 2004. The German statutory income tax rate applicable to us was approximately 39% in 2006, 2005 and 2004. This statutory income tax rate includes corporate income tax of 25%, a solidarity surcharge on corporate income tax (Solidaritätszuschlag) levied at 5.5% on corporate income tax, and trade tax at an average German national rate.

Our profit before income taxes was EUR 2,604 million in 2006, EUR 6,219 million in 2005 and EUR 3,570 million in 2004. Profit before income taxes in each of these years included transactions that significantly affected profit before income taxes with no, or a disproportionately small, impact on income taxes recorded.

 

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With regard to the deferred tax asset mentioned above, based on an assessment of all available evidence, we determined in the third quarter of 2006, that it had become probable that EUR 1.2 billion of the previously unrecognized deferred tax assets at T-Mobile USA relating primarily to federal income tax net operating loss carryforwards was realizable. For purposes of this assessment, we reviewed forecasts in relation to actual results and expected trends in the industry. The realization of the previously unrecognized deferred tax assets provided for a corresponding income tax benefit. These effects were partially offset by the write-off of deferred tax assets amounting to EUR 0.2 billion due to negative developments in current operating income at three of our foreign subsidiaries.

In addition, in the second quarter of 2006 we agreed with the German tax authorities on the application of a provision of trade tax law regarding certain capital losses incurred in previous years. As a result of this agreement, we were able to release a provision for income taxes totaling EUR 0.4 billion.

In 2005, income taxes decreased from EUR 1,552 million to EUR 198 million, a decline of EUR 1,354 million compared to 2004. In 2005 we recorded previously unrecognized deferred tax assets resulting in an income tax benefit of EUR 2,176 million. Recording this deferred tax asset more than offset the increase in income taxes resulting from our increased level of earnings during the year.

Profit before income taxes in 2005 included capital gains on our sale of MTS shares, amounting to EUR 1.0 billion, only 5% of which was taxable. Additionally, profit before income taxes was reduced by a goodwill impairment of EUR 1.9 billion, which we recognized in 2005, primarily relating to T-Mobile UK. Because the goodwill impairments were not deductible for income tax purposes and did not affect deferred income taxes, income tax expense was not reduced by the recognition of the impairment loss. Income tax expense recorded in 2005 was offset by the recording of previously unrecognized deferred tax assets at T-Mobile USA (EUR 2,176 million).

Our profit before income taxes in 2004 included capital gains on the sale of MTS shares, amounting to EUR 1.0 billion, only 5% of which was taxable. Additionally, profit before income taxes was reduced by the recognition of goodwill impairment losses of EUR 2.4 billion in 2004. Income tax expense was not reduced by the impairment losses recognized in 2004.

Net profit

In 2006, our net profit decreased to EUR 3,165 million from EUR 5,589 million in 2005, primarily as a result of the factors set forth above.

In 2005, we increased our net profit to EUR 5,589 million, from EUR 1,594 million in 2004, primarily as a result of the factors set forth above.

SEGMENT ANALYSIS

The following table presents total revenues (the sum of external (net) revenues and intersegment revenues), net revenues and intersegment revenues of our segments for the years indicated.

 

    For the years ended December 31,  
    2006     2005     2004  
   

Net

Revenues

 

Inter-

Segment

Revenues

   

Total

Revenues

   

Net

Revenues

 

Inter-

Segment

Revenues

   

Total

Revenues

   

Net

Revenues

 

Inter-

Segment

Revenues

   

Total

Revenues

 
    (millions of €)  

Mobile Communications

  31,308   732     32,040     28,531   921     29,452     25,450   1,077     26,527  

Broadband/Fixed Network

  20,635   4,050     24,685     21,731   4,304     26,035     22,397   4,615     27,012  

Business Customers

  9,061   3,560     12,621     9,058   3,792     12,850     9,246   3,716     12,962  

Group Headquarters and Shared Services

  343   3,331     3,674     284   3,221     3,505     260   3,266     3,526  

Reconciliation

    (11,673 )   (11,673 )     (12,238 )   (12,238 )     (12,674 )   (12,674 )
                                               

Group

  61,347       61,347     59,604       59,604     57,353       57,353  
                                               

 

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Beginning in January 2007, the shared services and headquarters function of Magyar Telekom is reported under Group Headquarters and Shared Services. Similarly, the operational business activities of Magyar Telekom is reported separately as part of the respective strategic business areas to which they relate.

Mobile Communications

The following table presents selected financial information concerning Mobile Communications:

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Net revenues

   31,308    28,531    25,450    9.7     12.1  

Inter-segment revenues

   732    921    1,077    (20.5 )   (14.5 )

Total revenues

   32,040    29,452    26,527    8.8     11.0  

Profit before income taxes

   3,845    3,520    1,602    9.2     n.m.  

n.m.—not meaningful

Net Revenues

Net revenues from our Mobile Communications strategic business area, which consist of revenues from customers outside of the Deutsche Telekom group, increased by EUR 2,777 million, or 9.7%, to EUR 31,308 million in 2006, from EUR 28,531 million in 2005. This increase was primarily attributable to continued growth in numbers of customers, and to the first-time consolidation of tele.ring as of April 28, 2006 and PTC as of November 1, 2006. Mobile Communications counts its customers by the number of SIM cards activated and not churned. The aggregate number of Mobile Communications customers increased by 22.9%, from 86.6 million in 2005 to 106.4 million (including 6.2 million in 2005 and 5.3 million in 2006 from the Virgin Mobile MVNO). This increase in customers was mainly a result of the first-time consolidation of PTC and strong customer growth in the United States, and to a lesser extent, customer growth in Europe and the first time consolidation of tele.ring.

Net revenues increased by EUR 3,081 million, or 12.1%, to EUR 28,531 million in 2005, from EUR 25,450 million in 2004. This increase was primarily attributable to continued growth in numbers of customers, and to the first-time consolidation of T-Mobile Slovensko. The aggregate number of Mobile Communications customers increased by 14.7%, from 75.5 million in 2004 to 86.6 million in 2005 (including 5.0 million customers in 2004 and 6.2 million in 2005 from the Virgin Mobile MVNO). This increase in customers was mainly a result of strong customer growth in the United States, and to a lesser extent, customer growth in Europe and the first-time consolidation of T-Mobile Slovensko.

In Germany, the United Kingdom, Hungary, Austria, the Czech Republic, the Netherlands and Poland, the rate of mobile telephone penetration is quite high. As a result, Mobile Communications expects that the growth in the number of its customers in these markets will be significantly lower than in past years, and the focus of competition will continue to shift from customer acquisition to customer retention, and to increasing ARPU by stimulating demand for voice usage and new data products and services to offset expected industry price decreases.

Total Revenues

Total revenues include both net revenues from external customers and revenues from other entities within the Deutsche Telekom group. The most significant component of Mobile Communications’ inter-segment revenues relates to revenues received from the Broadband/Fixed Network strategic business area for terminating calls on our mobile network in Germany that originate from T-Com’s fixed-line network in Germany.

Total revenues are mainly comprised of service revenues. Service revenues are comprised of revenues generated by customers for services (i.e., voice services, including incoming and outgoing calls, and data services) plus roaming revenues, monthly charges, and revenues from visitor roaming.

Revenues from mobile termination fees are primarily generated in our operations outside of the United States. Reduced mobile termination fees, as agreed with or determined by the regulatory authorities, in Germany,

 

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the United Kingdom, the Czech Republic, as well as Hungary, the Netherlands, Austria and Slovakia, negatively affected Mobile Communications’ total revenues in 2006. These decreased mobile termination fees will continue to have a negative impact on Mobile Communications’ total revenues in 2007 and beyond. Mobile Communications believes that mobile termination fees will further decrease in its markets in the future.

The following table reflects the number of Mobile Communications customers by subsidiary:

 

     As of December 31,

Subsidiary

   2006    2005    2004    2006/2005(1)     2005/2004(1)
     (millions)    (% change)

T-Mobile USA

   25.0    21.7    17.3    15.2     25.4

T-Mobile Deutschland

   31.4    29.5    27.5    6.4     7.2

T-Mobile UK(2)

   16.9    17.2    15.7    (1.7 )   9.6

T-Mobile Hungary

   4.4    4.2    4.0    4.8     5.0

T-Mobile Netherlands

   2.6    2.3    2.3    13.0     0.0

T-Mobile Czech Republic

   5.0    4.6    4.4    8.7     4.5

T-Mobile Austria(3)

   3.2    2.1    2.0    52.4     5.0

T-Mobile Hrvatska (Croatia)

   2.2    1.9    1.5    15.8     26.7

T-Mobile Slovensko (Slovakia)(4)

   2.2    2.0       10.0     n.a.

PTC(5)

   12.2          n.a.     n.a.

Other(6)

   1.3    1.1    0.8    18.2     37.5
                   

Total(1)

   106.4    86.6    75.5    22.9     14.7
                   

n.a.—not applicable

(1) Calculation of percentages and total numbers of customers have been based on actual figures.
(2) Includes Virgin Mobile customers of 5.3 million in 2006, 6.2 million in 2005 and 5.0 million in 2004.
(3) Includes tele.ring customers of 1.0 million in 2006 (consolidated as of April 28, 2006).
(4) Fully consolidated as of the first quarter of 2005.
(5) Fully consolidated as of November 1, 2006.
(6) Other includes T-Mobile Macedonia and T-Mobile Crna Gora (Montenegro). T-Mobile Crna Gora (Montenegro) was consolidated for the first time in the second quarter of 2005.

The figures in the table above represent the total numbers of contract and prepaid customers at year-end for the periods presented. The customer counting methodologies employed differ in some respects between national markets, so that the figures in the table above may not be directly comparable with one another. For more information relating to how we calculate our customer data, see “Item 4. Information on the Company—Description of Business—Mobile Communications.”

Mobile Communications expects that the number of customers in its Western European markets will not grow significantly in the future, as most of the mobile telecommunications markets in Western Europe are relatively mature and saturated. Mobile Communications expects that the number of its customers in the U.S. market will continue to increase in the future because that market has not yet reached saturation.

 

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Total Revenues by Geographic Area

The following table reflects Mobile Communications’ total revenues by geographic area:

 

     For the years ended December 31,  
     2006     2005     2004     2006/2005     2005/2004  
     (millions of €)     (% change)  

United States(1)

   13,628     11,887     9,278     14.6     28.1  

Germany(1)

   8,215     8,621     8,745     (4.7 )   (1.4 )

United Kingdom(1)

   4,494     4,153     4,344     8.2     (4.4 )

Hungary(1)

   1,050     1,090     1,049     (3.7 )   3.9  

The Netherlands(1)

   1,138     1,064     1,046     7.0     1.7  

Czech Republic(1)

   1,043     938     827     11.2     13.4  

Austria(1)(2)

   1,149     885     882     29.8     0.3  

Croatia(1)

   556     512     436     8.6     17.4  

Slovakia(1)(3)

   429     378         13.5     n.a.  

Poland(1)(4)

   305             n.a.     n.a.  

Other(1)(5)

   198     174     135     13.8     28.9  

Intra-segment revenues(6)

   (165 )   (250 )   (215 )   34.0     (16.3 )
                      

Total revenues

   32,040     29,452     26,527     8.8     11.0  
                      

n.a.—not applicable

(1) These amounts relate to each mobile subsidiary’s respective, separate financial statements (single-entity financial statements adjusted for uniform group accounting policies and reporting currency), without taking into consideration consolidation effects at the strategic business area level (which effects are included under “Intra-segment revenues” in the table) or at the group level.
(2) Includes tele.ring fully consolidated as of April 28, 2006.
(3) Fully consolidated as of the first quarter of 2005.
(4) Fully consolidated as of November 1, 2006.
(5) Other includes T-Mobile Macedonia and T-Mobile Crna Gora (Montenegro). T-Mobile Crna Gora (Montenegro) was consolidated for the first time in the second quarter of 2005.
(6) In addition to consolidation effects at the strategic business area level, “Intra-segment revenues” also includes revenues as defined under footnote (1) for the following subsidiaries: T-Mobile International UK (2006: EUR 66 million, 2005: EUR 83 million, 2004: EUR 90 million), T-Systems Traffic (2005: EUR 5 million, 2004: EUR 13 million) and Pro-M (2006: EUR 75 million; Pro-M was consolidated for the first time in the second quarter of 2006).

United States

 

     For the years ended December 31,
     2006    2005    2004    2006/2005     2005/2004
     (millions of €)    (% change)

Total revenues

   13,628    11,887    9,278    14.6     28.1

less Terminal equipment

   1,580    1,353    1,289    16.8     5.0

less Other

   815    1,010    224    (19.3 )   n.m.
                   

Service revenues

   11,233    9,524    7,765    17.9     22.7
                   

n.m.—not meaningful

Total revenues in the United States increased by EUR 1,741 million, or 14.6 %, to EUR 13,628 million in 2006, compared to EUR 11,887 million in 2005, primarily due to an increase in the average customer base in 2006. In local currency, total revenues increased even more on a percentage basis. The development of the U.S. dollar and the euro had a negative currency translation effect. Total revenues in the United States increased by EUR 2,609 million, or 28.1%, to EUR 11,887 million in 2005, compared to EUR 9,278 million in 2004, primarily due to an increase in the overall average customer base in 2005. In local currency, the total revenue increase was lower on a percentage basis as a result of currency translation effects.

Service revenues increased by EUR 1,709 million, or 17.9 %, to EUR 11,233 million in 2006, compared to EUR 9,524 million in 2005, mainly as a result of an increase in the average number of customers. However, non-voice service revenues increased at a greater rate than the increase in the average number of customers in

 

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2006, compared to 2005, due to increased customer acceptance of these services (such as higher usage and content for SMS or MMS). Service revenues increased by EUR 1,759 million, or 22.7%, to EUR 9,524 million in 2005, compared to EUR 7,765 million in 2004, mainly as a result of an increase in the average number of customers and non-voice service revenues.

Revenues from sales of terminal equipment increased by EUR 227 million, to EUR 1,580 million in 2006, compared to EUR 1,353 million in 2005, as a result of an 3.9% increase in gross customer additions and higher volumes of handset upgrade sales to existing customers. Revenues from sales of terminal equipment increased by EUR 64 million, to EUR 1,353 million in 2005, compared to EUR 1,289 million in 2004, as a result of a 13.6% increase in gross customer additions, which was partially offset by reduced costs from suppliers which were passed on to customers in 2005.

Other revenues decreased to EUR 815 million in 2006, compared to EUR 1,010 million in 2005. This decrease was primarily driven by lower network usage revenues from Cingular customers in California, Nevada and New York as Cingular customers transitioned to the Cingular network, pursuant to an agreement implemented in the first quarter of 2005. We expect a further decline in other revenues in 2007 as Cingular completes the transition of its customers to its own network. Other revenues increased to EUR 1,010 million in 2005, compared to EUR 224 million in 2004. This increase was primarily driven by network usage revenues from Cingular customers in connection with the agreement implemented at the beginning of 2005 referenced above.

For 2007, we expect further customer and revenue growth at T-Mobile USA, albeit at a slightly decreased pace, compared to previous years. However, revenue growth, as expressed in our reporting currency versus U.S. dollars, may be affected by unfavorable exchange rate developments between the euro and the U.S. dollar.

Germany

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   8,215    8,621    8,745    (4.7 )   (1.4 )

less Terminal equipment

   423    564    677    (25.0 )   (16.7 )

less Other

   357    300    411    19.0     (27.0 )
                   

Service revenues

   7,435    7,757    7,657    (4.2 )   1.3  
                   

Total revenues in Germany declined by EUR 406 million in 2006, or 4.7%, compared to 2005. This decline was primarily attributable to a decrease in service revenues and terminal equipment revenues, which was partially offset by an increase in other revenues. In 2005, total revenues declined by EUR 124 million in 2005, or 1.4%, compared to 2004. This decline was primarily attributable to reductions in other revenues and revenues from sales of terminal equipment, which was partially offset by an increase in service revenues.

Service revenues decreased by EUR 322 million, or 4.2%, to EUR 7,435 million in 2006, compared to EUR 7,757 million in 2005. This decrease was primarily attributable to lower voice revenues primarily as a result of lower prices due to competitive pressures. In 2005, service revenues increased by EUR 100 million, or 1.3%, to EUR 7,757 million, compared to EUR 7,657 million in 2004. This increase was primarily attributable to higher voice and non-voice revenues, as a result of an increased average customer base.

Revenues from sales of terminal equipment decreased by EUR 141 million, to EUR 423 million in 2006, compared to EUR 564 million in 2005, due to the sale of lower value terminal equipment and reduced costs from suppliers, which were passed on to customers, and higher discounts granted as part of customer acquisition and retention efforts. Revenues from sales of terminal equipment decreased by EUR 113 million, to EUR 564 million in 2005, compared to EUR 677 million in 2004, also due to reduced costs from suppliers, which were passed on to customers, and higher discounts granted as part of customer acquisition and retention.

Other revenues mainly consist of MVNO revenues, activation revenues and disconnection fees. MVNO revenues are generated from O2 traffic being routed through the T-Mobile Deutschland network. MVNO revenues accounted for 79% of total other revenues in 2006, compared to 85% in 2005 and 76% in 2004.

 

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Other revenues increased by EUR 57 million, to EUR 357 million in 2006, compared to 2005, primarily as a result of higher MVNO revenues due to higher voice usage of O2 customers being routed through T-Mobile Deutschland network. In 2005, other revenues decreased by EUR 111 million, to EUR 300 million, compared to 2004, primarily as a result of lower MVNO revenues due to the signing of a new national roaming agreement with O2 for lower per-minute prices.

United Kingdom

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   4,494    4,153    4,344    8.2     (4.4 )

less Terminal equipment

   289    384    403    (24.7 )   (4.7 )

less Other

   223    231    232    (3.5 )   (0.4 )
                   

Service revenues

   3,982    3,538    3,709    12.5     (4.6 )
                   

Total revenues in the United Kingdom increased by EUR 341 million, or 8.2%, to EUR 4,494 million in 2006, from EUR 4,153 million in 2005. This increase was predominantly due to an increase in service revenues, which was partly offset by lower terminal equipment revenues and other revenues. In 2005, total revenues decreased by EUR 191 million, or (4.4)%, to EUR 4,153 million, from EUR 4,344 million in 2004, due to a decrease in service revenues and terminal equipment revenues.

Service revenues increased by EUR 444 million, or 12.5%, to EUR 3,982 million in 2006, compared to EUR 3,538 million in 2005. This increase was mainly a result of growth in the T-Mobile UK customer base (excluding Virgin Mobile) due to increased customer acquisition efforts in 2006. Service revenues decreased by EUR 171 million, or 4.6%, to EUR 3,538 million in 2005, compared to EUR 3,709 million in 2004. This decrease was mainly a result of the reduction in mobile termination fees imposed by the U.K. telecommunication regulator in September 2004, and a result of lower voice usage per customer and a negative foreign exchange effect between the British pound sterling and the euro.

Revenues from sales of terminal equipment decreased in 2006, compared to 2005, mainly due to higher sales discounts and reduced average prices of mobile devices. Revenues from sales of terminal equipment decreased in 2005, compared to 2004, mainly due to reduced costs from suppliers, which were passed on to customers, and higher sales discounts.

Other revenues decreased by EUR 8 million, to EUR 223 million in 2006, compared to EUR 231 million in 2005 due to lower activation and disconnection fees. In 2005, total other revenues decreased slightly by EUR 1 million, to EUR 231 million, compared to EUR 232 million in 2004.

Poland

 

     For the years ended December 31,
     2006(1)    2005    2004    2006/2005    2005/2004
     (millions of €)    (% change)

Total revenues

   305          n.a.    n.a.

less Terminal equipment

   9          n.a.    n.a.

less Other

   3          n.a.    n.a.
                    

Service revenues

   293          n.a.    n.a.
                    

n.a.—not applicable
(1) Fully consolidated since November 1, 2006.

PTC was consolidated as of November 1, 2006. Total revenues contributed by PTC during 2006 amounted to EUR 305 million, of which service revenues amounted to EUR 293 million.

 

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Hungary

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   1,050    1,090    1,049    (3.7 )   3.9  

less Terminal equipment

   82    82    89    0.0     (7.9 )

less Other

   23    26    19    (11.5 )   36.8  
                   

Service revenues

   945    982    941    (3.8 )   4.4  
                   

Total revenues in Hungary decreased by EUR 40 million, or 3.7%, to EUR 1,050 million in 2006, compared to EUR 1,090 million in 2005. In local currency, total revenues increased. The development between the Hungarian forint and the euro resulted in a negative currency translation effect. The increase in total revenues in local currency was mainly related to an increase in service revenues. Total revenues increased by EUR 41 million, or 3.9%, to EUR 1,090 million in 2005, compared to EUR 1,049 million in 2004, mainly due to an increase in service revenues, primarily as a result of an increased average contract customer base.

Service revenues decreased by EUR 37 million to EUR 945 million in 2006. In local currency, service revenues increased. The development between the Hungarian forint and the euro had a negative currency translation effect. The increase in service revenues in local currency was mainly a result of an increased usage and increased average contract customer base, who tend to generate higher service revenues than prepay customers. Service revenues increased by EUR 41 million, to EUR 982 million in 2005, from EUR 941 million in 2004. This increase was due to a larger average contract customer base.

Revenues from sales of terminal equipment remained constant at EUR 82 million in 2006 as in 2005. Revenues from sales of terminal equipment decreased by EUR 7 million, to EUR 82 million in 2005, compared to EUR 89 million in 2004, primarily due to lower average sales prices of terminal equipment.

The Netherlands

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   1,138    1,064    1,046    7.0     1.7  

less Terminal equipment

   47    37    47    27.0     (21.3 )

less Other

   15    35    51    (57.1 )   (31.4 )
                   

Service revenues

   1,076    992    948    8.5     4.6  
                   

Total revenues in the Netherlands increased by EUR 74 million, or 7.0%, to EUR 1,138 million in 2006, compared to EUR 1,064 million in 2005. The increase in total revenues was mainly related to an increase in service revenues and terminal equipment revenues, partly offset by decreases in total other revenues. Total revenues in the Netherlands increased by EUR 18 million, or 1.7%, to EUR 1,064 million in 2005, compared to EUR 1,046 million in 2004. The increase in total revenues was mainly related to an increase in service revenues, partly offset by decreases in revenues from sales of terminal equipment and other revenues.

Service revenues increased by EUR 84 million, to EUR 1,076 million in 2006, compared to EUR 992 million in 2005, primarily due to a higher proportion of contract customers in the average customer base, who tend to generate higher service revenues than prepay customers. Service revenues increased by EUR 44 million, to EUR 992 million in 2005, compared to EUR 948 million in 2004, primarily due to a higher proportion of contract customers.

Other revenues mainly include other operating revenues. Other revenues decreased by EUR 20 million, or 57.1%, to EUR 15 million in 2006, compared to EUR 35 million in 2005, primarily due to a decrease in disconnection fees. In 2005 total other revenues decreased by EUR 16 million, or 31.4%, to EUR 35 million in 2005, compared to EUR 51 million in 2004, primarily due to a decrease in other operating revenues.

 

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Czech Republic

 

     For the years ended December 31,
     2006    2005    2004    2006/2005     2005/2004
     (millions of €)    (% change)

Total revenues

   1,043    938    827    11.2     13.4

less Terminal equipment

   43    52    40    (17.3 )   30.0

less Other

   9    18    14    (50.0 )   28.6
                   

Service revenues

   991    868    773    14.2     12.3
                   

Total revenues in the Czech Republic increased by EUR 105 million, or 11.2%, to EUR 1,043 million in 2006, compared to EUR 938 million in 2005. In local currency, total revenues also increased. The development of the Czech koruna and the euro had a positive currency translation effect. The increase in total revenues was mainly related to an increase in service revenues, as a result of having a larger customer base and positive currency translation effects. Total revenues increased by EUR 111 million, or 13.4%, to EUR 938 million in 2005, compared to EUR 827 million in 2004, also due to an increase in service revenues, as a result of a larger average customer base.

Service revenues increased by EUR 123 million in 2006, to EUR 991 million. This increase was mainly a result of an increased average customer base, which was partly offset by lower visitor roaming revenues. In 2005, service revenues increased by EUR 95 million, to EUR 868 million, from EUR 773 million in 2004. This increase was due to a larger average customer base and higher visitor roaming revenues.

Austria

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   1,149    885    882    29.8     0.3  

less Terminal equipment

   22    29    42    (24.1 )   (31.0 )

less Other

   37    22    20    68.2     10.0  
                   

Service revenues

   1,090    834    820    30.7     1.7  
                   

Total revenues in Austria increased by EUR 264 million in 2006, or 29.8%, to EUR 1,149 million, from EUR 885 million in 2005. This increase was primarily due to the consolidation of tele.ring as of April 2006, which contributed EUR 310 million to total revenues. In 2005, total revenues increased by EUR 3 million, or 0.3%, to EUR 885 million, from EUR 882 million in 2004. This increase was predominantly due to growth in service revenues, partly offset by a decrease in terminal equipment revenues.

Service revenues increased by EUR 256 million in 2006, to EUR 1,090 million. This increase was primarily due to the consolidation of tele.ring, which contributed EUR 277 million. This increase was partially offset by lower prices resulting from intense competition. In 2005, service revenues increased by EUR 14 million, to EUR 834 million. This increase was mainly to an increased average customer base and to a higher proportion of contract customers, who tend to generate higher service revenues than prepay customers.

Revenues from sales of terminal equipment decreased by EUR 7 million in 2006, from EUR 29 million in 2005 to EUR 22 million in 2006, due to higher mobile device subsidies. In 2005, revenues from sales of terminal equipment decreased by EUR 13 million, to EUR 29 million, compared to 2004, partly due to reduced costs from suppliers, which were passed on to customers.

Other revenues, primarily consisting of activation fees and other operating revenues, increased by EUR 15 million in 2006, or 68.2%, to EUR 37 million, from EUR 22 million in 2005. In 2005, other revenues increased by EUR 2 million, or 10%, to EUR 22 million, from EUR 20 million in 2004.

 

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Croatia

 

     For the years ended December 31,
     2006    2005    2004    2006/2005     2005/2004
     (millions of €)    (% change)

Total revenues

   556    512    436    8.6     17.4

less Terminal equipment

   28    25    21    12.0     19.0

less Other

   10    12    9    (16.7 )   33.3
                   

Service revenues

   518    475    406    9.1     17.0
                   

Total revenues in Croatia increased by EUR 44 million, or 8.6%, to EUR 556 million in 2006, compared to EUR 512 million in 2005. In local currency, total revenues also increased. The development between the Croatian kuna and the euro had a positive currency translation effect. The increase in total revenues was mainly related to an increase in service revenues and, to a lesser extent, to increases in revenues from sales of terminal equipment. In 2005, total revenues increased by EUR 76 million, or 17.4%, to EUR 512 million, compared to EUR 436 million in 2004, primarily due to increases in service revenues and, to a lesser extent, to increases in revenues from sales of terminal equipment and other revenues.

Service revenues increased by EUR 43 million to EUR 518 million in 2006. This increase was mainly a result of a larger customer base. In 2005, service revenues increased by EUR 69 million, to EUR 475 million, from EUR 406 million in 2004. This increase was due to an increased customer base and higher visitor roaming revenues.

Slovakia

 

     For the years ended December 31,
     2006    2005(1)    2004    2006/2005     2005/2004
     (millions of €)    (% change)

Total revenues

   429    378       13.5     n.a.

less Terminal equipment

   12    10       20.0     n.a.

less Other

   14    21       (33.3 )   n.a.
                   

Service revenues

   403    347       16.1     n.a.
                   

n.a.—not applicable
(1) Fully consolidated as of the first quarter of 2005.

Total revenues in Slovakia increased by EUR 51 million, or 13.5%, to EUR 429 million in 2006, compared to EUR 378 million in 2005. The development between the Slovak koruna and the euro had a positive currency translation effect. In local currency, revenues also increased, mainly related to an increase in service revenues as a result of a larger customer base.

Service revenues increased by EUR 56 million to EUR 403 million in 2006. In local currency, service revenues also increased mainly as a result of a larger customer base.

Revenues from sales of terminal equipment increased by EUR 2 million, to EUR 12 million in 2006, compared to EUR 10 million in 2005, due to an increase in number of mobile devices sold.

Macedonia

 

     For the years ended December 31,  
     2006    2005    2004    2006/2005     2005/2004  
     (millions of €)    (% change)  

Total revenues

   147    139    135    5.8     3.0  

less Terminal equipment

   6    7    9    (14.3 )   (22.2 )

less Other

   2    2    5    0.0     (60.0 )
                   

Service revenues

   139    130    121    6.9     7.4  
                   

 

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Total revenues in Macedonia increased by EUR 8 million, or, 5.8%, to EUR 147 million in 2006, compared to EUR 139 million in 2005. In local currency, total and service revenues also increased. The increase in total revenues was mainly related to increased service revenues, as a result of increased usage and a larger customer base. In 2005, total revenues increased by EUR 4 million to EUR 139 million, or 3.0%, from EUR 135 million in 2004.

Montenegro

 

     For the years ended December 31,
     2006    2005(1)    2004    2006/2005    2005/2004
     (millions of €)    (% change)

Total revenues

   51    35       45.7    n.a.

Less Terminal equipment

   2    1       100.0    n.a.

less Other

        </