Speech by Michael Beard, Tranz Rail MD, To AGM

Speech by Michael Beard, Managing Director

Address to Shareholders, 2000 Annual Meeting.

Parkroyal Hotel, Wellington, 10 October 2000, 3pm

A New Era in Transport

Good afternoon fellow shareholders of Tranz Rail, Ladies and Gentlemen. It is a pleasure to address you today in my new role as Managing Director of this Company.

I was more than delighted when, almost a year ago, I was approached about ‘a job’ in New Zealand.

Having spent much of my career providing transport services to New Zealand, the opportunity to lead one of New Zealand’s foremost transport companies was an intriguing prospect and one I was glad to accept.

I have come to Tranz Rail at a very exciting time in this company’s history. A time when the Company is at a crucial moment in its evolution.

Essentially, Tranz Rail has come to an end of an era. Over the last ten to fifteen years, Francis Small and his team have made tremendous gains in productivity and efficiency. They successfully turned around an inefficient, loss making operation into a profitable going concern.

But for at least the last two years the Board has realised that the traditional model of operating a railway is not sustainable. We need to find a new path – a new way of operating.

Why is this?

I do not need to tell you, our shareholders, that the returns you have been receiving from your investment in Tranz Rail have not been satisfactory.

The problem in a nutshell is that the returns from certain parts of the business do not warrant the amount of investment needed to sustain them. We need to refocus our capital expenditure on areas that will give you, our shareholders a good return. We need to prune the bush so that it grows fuller and bears richer fruit.

Tranz Rail is a horizontally and vertically integrated operation. This means we do almost everything needed to run a passenger and freight business under one roof.

We are also not just a transport company: through our two heavy engineering workshops we are a mechanical engineering company, through the maintenance and development of our track, bridges and structures we are a civil engineering company, through the operation of our shipping operations we run a shipping line; and through our signalling and communications activities we are a telecommunications company.

Trying to be everything to everybody takes a lot of resources in terms of management time, people, and capital expenditure. Each of these businesses is asset heavy, ultimately requiring a large amount of capital expenditure to sustain them. The amount of money needed to replace and upgrade the assets to remain competitive in the market is far in excess of the amount of free cash Tranz Rail has available to spend.

We are left with a structure that limits our ability to be flexible and take advantage of market opportunities as they arise. Our driving force has become the need to feed the beast. The need to service our huge asset base means we are faced with high fixed costs and high capital expenditure needs and a constant internal focus.

Furthermore, by being a jack of all trades we run the risk of being a master of none. Our portfolio of activities is too broad to allow for in-depth performance management.

Our driving force needs to be turned outwards towards the market – focusing on what we do best – providing transport services - letting the professionals from specialist companies do the rest.

Why do we need to do this? Because we are not meeting the needs of our three key stakeholders - our shareholders, our customers and our employees.

Company Vision

So how do we answer the needs of these 3 groups? How do we become the transport company that investors, customers and employees choose first?

We have set ourselves performance targets for each of these three groups which we think will go along way to satisfy their needs. Each of these targets is achievable.

The first affects you, our shareholders. We will aim to increase substantially profits, and the value of the stock, by the end of the forecast period, 2002.

For our customers we want to be 5 % better in terms of overall customer satisfaction than the best of our competitors, ultimately increasing market share by 20 % by the end of 2002.

We will focus on increasing market share in areas which are profitable for us, providing the services and products focused on our customers and measuring our success through their satisfaction ratings.

For our employees we want to reach a level of satisfaction that is in the top quartile all the companies in New Zealand. Creating an organisational culture that people want to work in and that attracts top level employees.

To achieve a safer workplace we must eliminate fatalities and we aim to reduce the Lost Time Injury rate by 50%.

How will we achieve these targets?

Firstly, we know we need to change. We need to narrow the focus of the Company both horizontally and vertically. We need to be flexible and responsive to the market. So we must divest ourselves of those parts of the business that are either unprofitable and asset heavy, reducing and shifting our cost structure from fixed to variable – with particular focus on reducing capital expenditure.

Changes in Organisation

The Company will become more focused with a smaller, more highly trained workforce employed directly by Tranz Rail focused exclusively on our main operations. There will be a scaling back of the Company’s marginalised businesses as the Company concentrates on expanding core profitable business. This will result in greater revenue and profit, enhanced capital utilisation, high service levels and an improved pricing structure.

The new structure reflects the possibility that many operational functions will be outsourced. Tranz Rail will provide core freight transport services only using outside suppliers to operate many services.

As you can see from this diagram, the Company will be organised around three complementary operating groups. We will basically be providing very focused rail services, multi modal, technology centred distribution services and interisland freight and passenger services.

The Rail Services Group will be a highly outsourced, lean and efficient railway that will service commodity and wholesale customers. It will be a virtual railway holding minimal assets.

The Distribution Services Group will focus on retail customers and provide value-added door to door multi-modal domestic and international distribution services. This group will be mode neutral – rail will be only be used if it is the most cost effective transport solution.

The Interislander Services Group will offer freight services to the other two groups as well as outside the Company.

The Company is considering the possibility of outsourcing some of the Companies operations. Outsourcing offers the Company a number of benefits. It allows us to concentrate on primary business by outsourcing functions that are not part of the core. This will potentially provide improved service levels by delivering a more focused service. It will enable Tranz Rail to concentrate on what we do best while at the same time benefitting by leveraging off the skill base of external suppliers in all other areas. It will also help us to make a step change in the Company’s culture.

Outsourcing is also a viable means of reducing and shifting costs from fixed to variable. It introduces a greater degree of flexibility allowing the Company to responding quickly to the changing requirements of the market.

At this stage the Company is investigating the range of outsourcing options available to see what options will best suit the different parts of the Company. We will be looking very carefully to see whether it makes sense to go down this route. Our criteria will include such things as the impact on the Company’s operating expenditure and cashflows and the level of service we will receive.

Outsourcing options may include contracting to third party operators with skills in related industries, assisting employees to set up their own businesses, and entering into joint ventures with other parties.

Initially we will be looking at outsourcing track, structures and signalling engineering and maintenance, rolling stock and locomotive engineering and maintenance and terminal operations. However, nothing is sacred and as we move towards a virtual transport company it is possible that other areas of the Company could be identified for outsourcing.

Management will be initially focused on these five key business drivers.

These are:

Focusing on core business
Optimising costs and improving asset productivity
Providing service excellence
Communicating Tranz Rail’s story
Improving safety performance
Let me explain each strategy in more detail.

Focusing on core business

Tranz Rail will focus activities around a profitable core freight business. Unproductive assets, customers and resources will be released and new, profitable customers and products will be developed with capital investment targeted at profitable business.

We will be offering new products focused on the freight. Rail services will focus on commodity/whole sale customers particularly coal, forestry, milk, third party containers, unit trains and corridor access. Rail transport is most suited to these type of business.

The growth area in transport is domestic and international distribution and we will put resource into developing this side of the business. The focus will be on LCL/LWL distribution, freight handling and warehousing and international freight forwarding.

We will offer both fast and conventional ferry services moving rail wagons and commercial vehicles as well as passengers and cars. A prime focus will be to restructure Cook Strait Operations to protect and improve the value of the franchise.

Already we are asking ourselves if we need to be in some businesses. We are carefully evaluating all areas of the Company identifying the areas that should be part of core business. If they do not have synergy with the rest of our business we will look at exiting them.

Discussions are in progress with the Auckland region about their desire to have greater control of the rail corridor in Auckland. The discussions are centred on selling or assigning parts of the network to Auckland. The terms of the agreement are still being discussed.

The focus on core profitable business means that unprofitable routes will be closed or the lease reassigned. Lines that do not give an economic return will be closed and the assets tied up in those areas will be reassigned to parts of the network that are profitable. This will in turn reduce operating costs and capital requirements going forward. We are actively reviewing a number of lines that give dubious returns including the Napier to Gisborne line and Rotorua branch line.

We understand there is a lot of concern surrounding the closure of branch lines. There are also reasons, other than commercial, to keep marginal lines operating. One such reason would be to reduce the environmental and safety effects of a large number of trucks on the road. It is entirely possible the government may consider it in the national or community interest to allocate funds to certain lines to ensure their viability. Tranz Rail would be open to such overtures.

Optimising Costs and Improving Asset Productivity

The second strategy is to improve asset productivity and further reduce costs.

This will be achieved through simplifying rail operations by standardising and rationalising assets.

Our rail operation will be centred on greater containerisation of general freight and the use of unit trains. This is made possible by focusing on wholesale and bulk commodity customers such as forestry, milk and coal.

By simplifying our operation around containerised general freight and unit trains we can dramatically reduce our asset requirements and improve asset utilisation.

Ownership of specialised equipment will be transferred to customers or, alternatively, it will only be provided by Tranz Rail against back to back long term contracts.

Along with the increased use of technology, the use of unit trains and containerised traffics means we will be able to largely eliminate shunting. This will have positive effects for safety performance and for reducing costs.

The outsourcing programme will also contribute to a reduction in assets and an improvement in costs.

We will not only be working simpler we will be working smarter as we continue workplace re-engineering. This will include an improved e-commerce and information technology capability as we do more and more of our business electronically.

The result will be improved speed to market and improved customer service. E commerce will also help reduce internal transaction costs as process duplication will be reduced.

Providing Service Excellence

Providing service of the highest quality is crucial if we are to meet the performance targets for each of our stakeholders.

An intense focus on service excellence is the essential so we can out a premium on quality products and services.

The ‘vital few’ elements of service excellence in a freight and distribution business are reliable, timely and safe carriage, timely and accurate documentation and clean, freight worthy equipment. It is vital to us to deliver the vital few!

The Company will adopt good management practises to achieve business excellence. We will subscribe to the New Zealand Business Excellence standards which are based on the Baldrige performance criteria developed in the United States. This framework will be applied to all parts of the business, and will enable us to measure our progress against very clear strategic objectives.

Improvements in Safety

The last year has been a difficult one in terms of safety. Five of our employees died in a space of 12 months, fatalities that should not have happened and that were heartbreaking for the families and work colleagues. For the Company this completely unacceptable and for me personally, it is appalling.

Tranz Rail has learnt from the outcome of this. We have moved rapidly to ensure that this will never happen again. A Ministerial Inquiry into Health and Safety at Tranz Rail examined our processes in detail. The result was a clear understanding of safety at Tranz Rail and what is being done to improve it.

We are committed to improving safety at Tranz Rail. We will be working closely with our staff and with their representatives to create a safe working environment.

I will be personally leading a proactive continuous programme that will include tough safety performance indicators and targets, a review of high risk work processes and the elimination of employees from those environments. We are also actively implementing the recommendations from the Rayner Report, the independent report on safety commissioned by Tranz Rail and the Ministerial Inquiry.

Safety is one of the key business drivers for our Company.

Communicating Tranz Rail’s Story

We are in for an exciting time. As we change the direction of the Company we will have a great story to tell about this Company. We want to create a Company where perceptions of excellence match the excellent reality.

We aim to create a Company that people want to work in, do business with or have in their communities.

And for you, most importantly, a company that you will want to invest in.

The best promotion for us is satisfied customers, employees and investors.

Profit Warning

Let me now inject a note of concern. We need you to know that the first quarter of the 2001 financial year will be negatively impacted by the huge leap in fuel prices.

Fuel costs this quarter are double the price they were this time last year. Although the Company is doing what it can do recover these costs through increased freight rates, fuel surcharges and energy efficient measures, the continuing adverse trend will mean the bottom line will be affected.

The first quarter will also be adversely impacted by some one-off costs associated with the change process described above.

We release our first quarter results on 25 October and we will be able to give you a clearer picture at that time.

Market Developments

We also have good news on the way.

The reason for making many of the changes I have outlined today is to establish an improved and closer relationship with key customers. In recent weeks we have been working with four major freight customers on new initiatives. As a result of that I expect to be in a position to announce the details of significant new business over the next few weeks.

We will also be inviting expressions of interest from the market to explore whether other companies may be interested in purchasing our long distance passenger service, Tranz Scenic, and our temperature-controlled freight services, Tranz Link Refrigerated.

Tranz Scenic operates eight tourist services including The TranzAlpine, the world renowned service between Christchurch and the West Coast, The Geyserland Express and The TranzCoastal.

Since 1993, the long distance passenger business has been significantly developed as an integral part of the New Zealand tourism industry. In 1997, it won New Zealand’s top tourism award for its innovative travel packages. However, tourism is not part of our primary business and the Tranz Scenic services might sit more comfortably with a specialist operator in the tourism field.

An information memorandum will be released to the market in the next two weeks seeking expressions of interest in the business.

Tranz Link Refrigerated was acquired in 1994 when the Company bought RFL Transport. It provides temperature-controlled freight services throughout New Zealand.

TLR is a multi-modal business comprising a specialist refrigerated truck fleet, Ice-Liner rail wagons and a number of chiller/freezer transit facilities that allow transfer between road and rail in climate-controlled conditions. The major facilities are in Auckland, Palmerston North and Christchurch.

Tranz Link Refrigerated is essentially a self-contained business that might generate more value as part of a specialist transport network. We will be evaluating any expressions of interest in it over the next couple of months

As you can see we are serious about our new direction – the above developments are the start – and there will be good news to come.

Conclusion

Tranz Rail will prove that rail is alive and well in the 21 century. We are already carrying more freight than at any other time in the history of the New Zealand rail network. We believe our new direction will continue to improve on this.

We are pruning the bush, so that it grows back bigger and better and healthier. You, our shareholders, will be the recipient of the fruit it will bear.

Our new direction pays homage to the spirit of New Zealand pioneers who built the railway that helped shape this nation of ours. Rail not only is surviving in the 21st century, it is evolving and in its new form will continue to contribute to the success of this country.

ENDS

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