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/SECOND AND FINAL ADD - TO211 - TELUS Corporation/7.8 Financial instruments; Commitments and contingent liabilities Financial instruments (Note 4 of the interim Consolidated financial statements) The Company's financial instruments consist of cash and temporary investments, accounts receivable, investments accounted for using the cost method, accounts payable, restructuring accounts payable, short-term obligations, long-term debt, interest rate swap agreements, share-based compensation cost hedges, as further discussed in Note 10(b)-(c) of the interim Consolidated financial statements, and foreign exchange hedges. Fair value: The carrying value of cash and temporary investments, accounts receivable, accounts payable, restructuring accounts payable and short-term obligations approximates their fair values due to the immediate or short-term maturity of these financial instruments. The carrying values of the Company's investments accounted for using the cost method would not exceed their fair values. The carrying value of short-term investments equals their fair value as they are classified as held for trading. The fair value is determined directly by reference to quoted market prices. The fair values of the Company's long-term debt are estimated based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same maturity as well as the use of discounted future cash flows using current rates for similar financial instruments subject to similar risks and maturities. The fair values of the Company's derivative financial instruments used to manage exposure to interest rate and currency risks are estimated similarly. The fair values of the Company's derivative financial instruments used to manage exposure to increases in compensation costs arising from certain forms of share-based compensation are estimated based upon fair value estimates of the related cash-settled equity forward agreements provided by the counterparty to the transactions. The effect of the adoption of comprehensive income on the Company's derivatives was to record them at their fair values rather than at their carrying amounts. The primary change was in derivatives classified as held for hedging and used to manage interest rate and currency risks associated with U.S. dollar denominated debt, as shown in the table below. As at ($ millions) June 30, 2007 ------------------------------------------------------------------------- Hedging item maximum maturity Notional Carrying Fair date amount amount value ------------------------------------------------------------------------- Liabilities Long-term debt Principal 4,806.9 5,154.4 Derivatives(1) classified as held for hedging and used to manage interest rate and currency risks associated with U.S. Dollar denominated debt - Derivative asset 2007 - - - Derivative liability - Current 2007 - - - Non-current 2011 2,950.5 1,081.8 1,081.8 - Interest payable 7.3 Net 1,089.1 1,089.1 Derivatives(1) used to manage interest rate risk associated with planned refinancing of debt maturing June 1, 2007 2007 $ - - - ------------------------------------------------------------------------- 5,896.0 6,243.5 ------------------------------------------------------------------------- ------------------------------------------------------------------------- December 31, 2006 ------------------------------------------------------------------------- Hedging item maximum maturity Notional Carrying Fair date amount amount value ------------------------------------------------------------------------- Liabilities Long-term debt Principal 4,908.2 5,535.9 Derivatives(1) classified as held for hedging and used to manage interest rate and currency risks associated with U.S. Dollar denominated debt - Derivative asset 2007 809.9 (40.4) - Derivative liability - Current 2007 673.4 165.8 - Non-current 2011 2,950.5 710.3 835.7 - Interest payable 6.3 Net 842.0 1,090.6 Derivatives(1) used to manage interest rate risk associated with planned refinancing of debt maturing June 1, 2007 2007 500.0 - 6.5 ------------------------------------------------------------------------- 5,750.2 6,633.0 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) Designated as cash flow hedging items. ------------------------------------------------------------------------- Commitments and contingent liabilities (Note 17 of the interim Consolidated financial statements) The Company's commitments and contingent liabilities have not changed significantly in the six-month period ended June 30, 2007. Changes to maturities of long-term debt as a result of financing activities in the first six months of 2007 were described in Section 7.3 above. On July 6, 2007, the CRTC issued Decision Telecom 2007-50, Use of deferral account to expand broadband services to certain rural and remote communities. In this decision, the CRTC approved the use of the deferral account for the purpose of expanding broadband services in a limited number of communities in British Columbia and Quebec. The Company is currently reviewing the implications of this decision in conjunction with its previously filed submission for use of the deferral account funds and, as directed by the CRTC, will file an update to the previously filed submission in September 2007. A number of claims and lawsuits seeking damages and other relief are pending against the Company. It is impossible at this time for the Company to predict with any certainty the outcome of such litigation. However, management is of the opinion, based upon legal assessment and information presently available, that it is unlikely that any liability, to the extent not provided for through insurance or otherwise, would be material in relation to the Company's Consolidated financial position, excepting the items enumerated in Note 17(c) of the interim Consolidated financial statements. 7.9 Outstanding share information The following is a summary of the outstanding shares for each class of equity at June 30, 2007 and at July 13, 2007. In addition, for July 13, 2007, the total number of outstanding and issuable shares is presented assuming full conversion of outstanding options as well as options not yet granted, but for which shares have been reserved. ------------------------------------------------------------------------- Class of equity security Common Non-Voting Total (millions of shares) Shares Shares shares ------------------------------------------------------------------------- Common equity Outstanding shares at June 30 and July 13, 2007 176.4 155.3 331.7(1) Options outstanding and issuable(2)(3) at July 13, 2007 0.5 16.3 16.8 ------------------------------------------------------------------------- Outstanding and issuable shares at July 13, 2007 176.9 171.6 348.5 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) For the purposes of calculating diluted earnings per share, the number of shares for the second quarter of 2007 was 336.9. (2) Assuming full conversion and ignoring exercise prices. (3) Not reduced for any options that may have been forfeited or expired in the period July 1 to July 13, 2007. ------------------------------------------------------------------------- 8. Critical accounting estimates and accounting policy developments 8.1 Critical accounting estimates TELUS' critical accounting estimates are described Section 8.1 of its 2006 Management's discussion and analysis. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 8.2 Accounting policy developments (Note 2 of the interim Consolidated financial statements) The interim Consolidated financial statements follow the same accounting policies and methods of their application as set out in Note 1 of TELUS' 2006 Consolidated financial statements for the year ended December 31, 2006, other than as set out below, including that certain of the comparative amounts have been reclassified to conform with the presentation adopted currently. Convergence with International Financial Reporting Standards In 2006, Canada's Accounting Standards Board ratified a strategic plan that will result in Canadian GAAP, as used by public companies, being converged with International Financial Reporting Standards over a transitional period currently expected to be complete by 2011. The precise timing of convergence will depend on an Accounting Standards Board progress review to be undertaken and released by March 31, 2008. Canadian GAAP will be converged with International Financial Reporting Standards through a combination of two methods: as current joint-convergence projects of the United States' Financial Accounting Standards Board and the International Accounting Standards Board are agreed upon, they will be adopted by Canada's Accounting Standards Board and may be introduced in Canada before the complete changeover to International Financial Reporting Standards; and standards not subject to a joint-convergence project will be exposed in an omnibus manner. As this convergence initiative is very much in its infancy, it would be premature to currently assess the impact of the initiative, if any, on the Company. Comprehensive income; recognition and measurement of financial instruments Commencing with the Company's 2007 fiscal year, the recommendations of the Canadian Institute of Chartered Accountants (CICA) for accounting for comprehensive income (CICA Handbook Section 1530), for the recognition and measurement of financial instruments (CICA Handbook Section 3855) and for hedges (CICA Handbook Section 3865) apply to the Company. Currently, the concept of comprehensive income for purposes of Canadian GAAP, in the Company's specific instance, is to include changes in shareholders' equity arising from unrealized changes in the values of financial instruments. The implementation and the application of Handbook Sections 1530, 3855 and 3865 were described in the Company's 2007 first quarter Management's discussion and analysis. See Note 2(b) of the interim Consolidated financial statements. Income taxes arising from partnership income In mid-2006, Canada's Accounting Standards Board's Emerging Issues Committee issued a Draft Abstract (D59) regarding the accounting for income taxes related to entities that consolidate partnership interests that have a different year end than the consolidating entity. The Company has applied the guidance therein contained through its 2006 year-end. In March 2007, the Emerging Issues Committee issued a revised Draft Abstract (RD59) which changed the approach to determination of the classification of future income taxes between current and non-current. In May 2007, the Emerging Issues Committee removed this issue from its agenda. Given the absence of specific guidance on the issue, the Company has adopted the policy of accounting for the current portion of the future income tax liability for partnerships to include the tax effect of differences between the accounting and tax bases of current assets and current liabilities and the tax on partnership income to be allocated during the next twelve months. The Company has retrospectively applied this policy, which has, in the Company's specific current instance, the net effect of increasing the current portion of future income tax liabilities. The consolidated balance sheet reclassification is as set out in Note 2(c) of the interim Consolidated financial statements. Financial instruments - disclosure and presentation Commencing with the Company's 2008 fiscal year, the new recommendations of the CICA for financial instrument disclosures and presentation (CICA Handbook Section 3862) will apply to the Company. The new recommendations will result in incremental disclosures, relative to those currently, with an emphasis on risks associated with both recognized and unrecognized financial instruments to which an entity is exposed during the period and at the balance sheet date, and how an entity manages those risks. The Company is assessing how it will be affected by these new recommendations. 9. Annual guidance for 2007 The following discussion is qualified in its entirety by the Caution regarding forward-looking statements at the beginning of Management's discussion and analysis. It is also qualified by Section 10: Risks and risk management of TELUS' 2006 annual and 2007 first quarter Management's discussion and analyses, as well as this report. The Company has revised its annual guidance for high-speed Internet net additions as a result of competitive activity and temporarily reduced order processing capability resulting from the billing and client care system conversion. See Section 10.3 Process Risks. Previous guidance Revised guidance and original Change for 2007 targets for 2007 ------------------------------------------------------------------------- Consolidated Revenues $9.175 to $9.175 to $9.275 billion $9.275 billion no change EBITDA(1) $3.725 to $3.725 to (as adjusted)(2) $3.825 billion $3.825 billion no change Earnings per share - basic (as adjusted)(3) $3.25 to $3.45 $3.25 to $3.45 no change Capital expenditures Approx. Approx. $1.75 billion $1.75 billion no change ------------------------------------------------------------------------- Wireline segment Revenue (external) $4.85 to $4.85 to $4.9 billion $4.9 billion no change EBITDA $1.775 to $1.775 to (as adjusted)(2) $1.825 billion $1.825 billion no change Capital expenditures Approx. Approx. $1.2 billion $1.2 billion no change High-speed Internet More than More than Approximately net additions 125,000 135,000 10,000 fewer ------------------------------------------------------------------------- Wireless segment Revenue (external) $4.325 to $4.325 to $4.375 billion $4.375 billion no change EBITDA $1.95 to $1.95 to (as adjusted)(2) $2.0 billion $2.0 billion no change Capital expenditures Approx. Approx. $550 million $550 million no change Wireless subscriber More than More than net additions 550,000 550,000 no change ------------------------------------------------------------------------- (1) See Section 11.1 Earnings before interest taxes depreciation and amortization (EBITDA) for the definition. (2) Excluding a cash-settled share option expense of approximately $180 million in 2007 for introducing the net-cash settlement feature, of which, approximately $155 million is in wireline and approximately $25 million is in wireless. (3) Excluding an after-tax charge per share of approximately $0.33 for introducing the net-cash settlement feature. ------------------------------------------------------------------------- The following key assumptions were made at the time the original targets for 2007 were announced in December 2006. Management believes the assumptions remain reasonable. ------------------------------------------------------------------------- Key assumption for 2007 targets Actual result for the year to-date ------------------------------------------------------------------------- Canadian real GDP growth of 2.7% The Conference Board of Canada recently (revised to 2.5%) issued a revised estimate of 2.5% for 2007 and 3.2% for 2008. Increased wireline competition Cable-TV competitors have begun to in both business and consumer market VoIP services to home office markets, particularly from type business in some communities, and cable-TV and VoIP companies have increased promotion of lower- price "light" services to residential households Forbearance for local retail Assumption unchanged. TELUS has filed wireline services in major forbearance applications following the urban markets by the second first quarter Federal Cabinet half of 2007 Order-in-Council that simplified the conditions for regulatory forbearance. On July 25, the CRTC granted TELUS local forbearance in Fort McMurray with additional rulings expected by early August. See Section 10.1 Regulatory No further price cap mandated The CRTC's decision on the parameters consumer price reductions for the next price cap period was announced on April 30, 2007 confirming this assumption. Canadian wireless industry TELUS' gross additions and net market penetration gain of additions in the first half of 2007 4.5 to five percentage points were consistent with this assumption TELUS would record approximately Restructuring costs are currently not $50 million of restructuring expected to exceed $35 million in 2007 expenses TELUS' statutory income tax Assumptions unchanged. See Section 5: rate is expected to be 33 to Consolidated results from operations - 34% with minimal cash tax Income taxes payments in 2007 A discount rate of 5.0% and Assumptions unchanged expected long-term average return of 7.25% for pension accounting Average TELUS shares Average shares outstanding were outstanding of 330 to 335.3 million in the first half of 335 million shares for the 2007, a decrease of about 3% from the full year same period in 2006 and within the range of the 2.5 to 4% reduction implied by the key assumption for the full year ------------------------------------------------------------------------- TELUS continues to have long-term policy guidelines for Net debt to total capitalization, Net debt to EBITDA and dividend payout, described in Section 7.4. The 2007 annual guidance is in compliance with these policy guidelines. 10. Risks and risk management The following are significant updates to the risks described in Section 10 of TELUS' 2006 annual and 2007 first quarter Management's discussions and analyses. 10.1 Regulatory The outcome of any existing or future regulatory reviews, proceedings, court appeals, Federal Cabinet appeals or other regulatory developments could have a material impact on TELUS' operating procedures, costs and revenues. Local forbearance On July 25, in Telecom Decision 2007-58, the CRTC granted forbearance for local residential services in Fort McMurray, Alberta. The CRTC had granted conditional forbearance for Fort McMurray, Alberta in March 2007 subject to achievement of certain competitor quality-of-service standards, which were met, on average, for the six-month period from December 2006 to May 2007. Forbearance decisions are expected for Victoria, Vancouver, Calgary and Edmonton by early August and for Rimouski later this year. TELUS has also applied for deregulation of regulated business phone services in phone exchanges covering 78 per cent of business lines in B.C. and Alberta, and 52 per cent in eastern Quebec.There can be no assurance that forbearance will be granted for any or all of the outstanding applications. Price cap regulation The CRTC issued Telecom Decision 2007-27 on April 30, 2007, setting the parameters for the price cap regulation effective June 1, 2007. The decision created a uniform price cap regime for TELUS across its incumbent territories in B.C., Alberta and Eastern Quebec and eliminated the deferral account on a go-forward basis. Constraints were removed for upward pricing of optional residential services, features and bundles. Flexibility was granted to increase basic residential services in rural high cost serving areas by the lesser of the annual inflation rate and five per cent with a corresponding reduction to the contribution subsidy paid and received. Flexibility to increase business rates was maintained at the overall annual inflation rate, with a maximum increase of 10% for individual rates. In addition, local payphone calls may be increased to a maximum of 50 cents per cash call ($1 per non-cash call) and rates remain frozen at existing levels for public safety and social services such as 911 and message relay service. Competitor services were largely unchanged by the price cap decision. Essential services In Telecom Decision 2007-46, the CRTC ruled that ILECs should not be required to implement Ethernet and high-speed Internet (ADSL) orders concerning competitor services until the CRTC issues a decision on review and vary applications filed by TELUS and certain other ILECs - such decision expected by the end of August 2007. In the essential services proceeding currently under way (Public Notice 2006-14), TELUS continues to argue that ADSL and Ethernet are not essential services and should not be unbundled. Quality-of-service rebate program - CRTC decisions on TELUS' exclusion applications In May, the CRTC released decisions on two of TELUS' exclusion applications for retail quality-of-service rate rebates. Decision 2007-29 addressed three adverse events from mid-July 2003 to December 2003: forest fires in the Interior of B.C. and South-western Alberta, a cable-cut in Vancouver and floods in the Lower Mainland of B.C. The CRTC granted that three retail quality-of-service measures could be excluded during these adverse event periods. The CRTC also directed TELUS to adjust three other quality-of- service measures to an average level measured in the six-month period preceding the adverse events and to implement applicable customer credits for the July 2002 to December 2003 rate adjustment period. In Decision 2007-30, the CRTC granted TELUS' exclusion application for severe flooding in Southern Alberta in June 2005, directing that TELUS exclude three retail quality-of- service measures for the months of June and July, similar to the February Decision 2007-14 for TELUS' exclusion application for competitor quality-of- service measures. In June, the CRTC granted relief from the competitor quality-of-service rate rebate program from November 2006 to January 2007 for the Lower Mainland of B.C. during a series of severe storms. In addition, under Telecom Decision CRTC 2007-40, the CRTC made provision such that TELUS can substitute the competitor quality-of-service results for the excluded periods with results from adjacent periods as part of applicable forbearance applications. In July, the CRTC acknowledged in Telecom Decisions 2007-52 and 2007-55 that the 2005 labour disruption qualified as an adverse event. The first of these two decisions granted relief from four of seven competitor quality-of- service indicators for the period of the actual disruption as well as the time required to return to normal operations (July 2005 through February 2006 inclusive). The second decision granted relief for all six retail quality-of- service indicators for applicable period between July 2005 through February 2006. TELUS has one remaining exclusion application before the CRTC for retail quality-of-service programs concerning the series of severe storms in the Lower Mainland of B.C. from November 2006 to January 2007. If the CRTC grants relief from the remaining outstanding exclusion application or future adverse events, any mandated quality-of-service rate rebates in the future would be reduced; however, there can be no assurance that relief will be granted. Wireless number portability (WNP) Phase one of WNP (sometimes referred to as local number portability, or LNP) was implemented successfully on March 14, 2007 in the majority of populated centres in Canada by Canadian wireless carriers, including TELUS. Implementation of WNP in remaining areas is mandated for September 2007. Experience from one full-quarter of WNP, indicates that it is a net contributor to increased subscriber loading for TELUS with inbound porting exceeding outbound porting, but WNP has also contributed to increased wireless customer retention costs (8.2% of network revenue in the second quarter of 2007 compared to 6.2% of network revenue in the same period in 2006) and increased subscriber churn (1.45% in the second quarter of 2007 compared to 1.30% in the same period in 2006). Subscriber churn and retention spending may be permanently higher in the future. WNP could also lead to an increase in migration of network access lines to wireless services, as well as present opportunities to TELUS to market more effectively in the business/enterprise market in Central Canada where TELUS has a lower market share than its competitors. There can be no assurance that this will be the case. Foreign-ownership restrictions TELUS and its subsidiaries are subject to the foreign ownership restrictions imposed by the Telecommunications Act, the Radiocommunication Act and the Broadcasting Act. In July 2007, the Minister of Industry and the Minister of Finance announced the creation of a Competition Review Panel to review Canadian competition and investment legislation: the Competition Act and the Investment Canada Act. As the Panel will report to the Minister of Industry by June 30, 2008, it is expected that any subsequent legislation changes would not be effective until late-2008 or 2009. TELUS has supported the relaxation of foreign ownership restrictions in the past, but believes that any such relaxation must be on an equal basis for broadcasting and telecommunications companies. 10.2 Human resources Collective bargaining at TELUS Quebec Two collective agreements between TELUS Quebec and the Syndicat des agents de maitrise de TELUS covering professional and supervisory team members in Quebec expired on March 31, 2007. The parties continue to negotiate to achieve a new collective agreement. 10.3 Process risks TELUS systems and processes could negatively impact financial results and customer service - Billing/revenue assurance and efficiency programs TELUS successfully converted all of its wireline consumer customers in Alberta to a new integrated billing and client care system in late-March 2007. The new system includes re-engineered processes for order entry, pre- qualification, service fulfillment and assurance, customer care, collections/credit, customer contract and information management. During the second quarter of 2007, initial system difficulties were experienced that reduced order processing capability, which caused increased installation backlogs and higher costs such as extra call centre resources in order to maintain service levels. The critical billing function performed as expected and call centre operations are expected to return to normal levels in future. There can be no assurance that this undertaking will not negatively impact, on an extended basis, TELUS' customer service levels, competitive position and financial results. Additional phases of development and conversion are planned over the next several years including a similar system conversion for B.C. consumers planned for the first half of 2008. There is no assurance that the B.C. conversion will be as successful as the Alberta conversion. This customer-focused project required extensive system development and, in itself, presents future implementation risks due to the complexity of the implementation task and resource constraints, as well as reliance on newly developed third party software code. Significant time delays in implementing new phases of this system, or system instability, could negatively impact TELUS' competitive ability to quickly and effectively launch new products, services and promotions; achieve and maintain a competitive cost structure; and deliver better information and analytics to management. 11. Reconciliation of non-GAAP measures and definition of key operating indicators 11.1 Earnings before interest taxes depreciation and amortization (EBITDA) TELUS has issued guidance on and reports EBITDA because it is a key measure used by management to evaluate performance of business units, segments and the Company. EBITDA is also utilized in measuring compliance with debt covenants - see Section 11.4 EBITDA excluding restructuring costs. EBITDA is a measure commonly reported and widely used by investors as an indicator of a company's operating performance and ability to incur and service debt, and as a valuation metric. The Company believes EBITDA assists investors in comparing a company's performance on a consistent basis without regard to depreciation and amortization, which are non-cash in nature and can vary significantly depending upon accounting methods or non-operating factors such as historical cost. EBITDA is not a calculation based on Canadian or U.S. GAAP and should not be considered an alternative to Operating income or Net income in measuring the Company's performance, nor should it be used as an exclusive measure of cash flow, because it does not consider the impact of working capital growth, capital expenditures, debt principal reductions and other sources and uses of cash, which are disclosed in the Consolidated statements of cash flows. Investors should carefully consider the specific items included in TELUS' computation of EBITDA. While EBITDA has been disclosed herein to permit a more complete comparative analysis of the Company's operating performance and debt servicing ability relative to other companies, investors should be cautioned that EBITDA as reported by TELUS may not be comparable in all instances to EBITDA as reported by other companies. The following is a reconciliation of EBITDA with Net income and Operating income. EBITDA (as adjusted) excludes a non-cash charge for introducing a net- cash settlement feature for share option awards granted prior to January 1, 2005. EBITDA (as adjusted) is regularly reported to the chief operating decision-maker and corresponds to the definition used in setting TELUS' 2007 EBITDA targets and revised guidance (see Section 9). ------------------------------------------------------------------------- Quarters Six-month periods ended June 30 ended June 30 ($ millions) 2007 2006 2007 2006 ------------------------------------------------------------------------- Net income 253.1 356.6 447.9 566.7 Other expense (income) 18.5 9.6 22.3 13.9 Financing costs 127.2 127.5 244.8 254.5 Income taxes 93.7 18.7 173.0 134.8 Non-controlling interest 1.3 2.6 2.8 4.7 ------------------------------------------------------------------------- Operating income 493.8 515.0 890.8 974.6 Depreciation 318.3 335.2 636.0 674.4 Amortization of intangible assets 72.5 46.9 122.1 110.8 ------------------------------------------------------------------------- EBITDA 884.6 897.1 1,648.9 1,759.8 Add back: Non-cash charge in 2007 for introducing a net-cash settlement feature for options granted prior to 2005 1.8 - 175.3 - ------------------------------------------------------------------------- EBITDA (as adjusted) 886.4 897.1 1,824.2 1,759.8 ------------------------------------------------------------------------- ------------------------------------------------------------------------- In addition to EBITDA, TELUS calculates EBITDA less capital expenditures as a simple proxy for cash flow in its two reportable segments. EBITDA less capital expenditures may be used for comparison to the reported results for other telecommunications companies over time and is subject to the potential comparability issues of EBITDA described above. ------------------------------------------------------------------------- Quarters Six-month periods ended June 30 ended June 30 ($ millions) 2007 2006 2007 2006 ------------------------------------------------------------------------- EBITDA 884.6 897.1 1,648.9 1,759.8 Capital expenditures (Capex) (481.8) (458.8) (863.7) (779.3) ------------------------------------------------------------------------- EBITDA less capital expenditures 402.8 438.3 785.2 980.5 Add back: Non-cash charge in 2007 for introducing a net-cash settlement feature for options granted prior to 2005 1.8 - 175.3 - ------------------------------------------------------------------------- EBITDA (as adjusted) less capital expenditures 404.6 438.3 960.5 980.5 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 11.2 Free cash flow The Company reports free cash flow because it is a key measure used by management to evaluate its performance. Free cash flow excludes certain working capital changes and other sources and uses of cash, which are disclosed in the Consolidated statements of cash flows. Free cash flow is not a calculation based on Canadian or U.S. GAAP and should not be considered an alternative to the Consolidated statements of cash flows. Free cash flow is a measure that can be used to gauge TELUS' performance over time. Investors should be cautioned that free cash flow as reported by TELUS may not be comparable in all instances to free cash flow as reported by other companies. While the closest GAAP measure is Cash provided by operating activities less Cash used by investing activities, free cash flow is considered relevant because it provides an indication of how much cash generated by operations is available after capital expenditures, but before proceeds from divested assets, and changes in certain working capital items (such as trade receivables, which can be significantly distorted by securitization changes that do not reflect operating results, and trade payables). The following reconciles free cash flow with Cash provided by operating activities less Cash used by investing activities: ------------------------------------------------------------------------- Quarters Six-month periods ended June 30 ended June 30 ($ millions) 2007 2006 2007 2006 ------------------------------------------------------------------------- Cash provided by operating activities 1,061.9 813.0 1,522.5 1,486.1 Cash (used) by investing activities (477.8) (486.1) (870.1) (802.2) ------------------------------------------------------------------------- 584.1 326.9 652.4 683.9 Net employee defined benefit plans expense 21.0 1.3 45.0 2.9 Employer contributions to employee defined benefit plans 14.7 45.0 48.6 75.5 Amortization of deferred gains on sale-leaseback of buildings, amortization of deferred charges and other, net (4.3) 7.3 4.8 (8.6) Reduction (increase) in securitized accounts receivable (350.0) (135.0) - (35.0) Non-cash working capital changes except changes in taxes, interest, and securitized accounts receivable, and other (99.8) (81.8) (114.7) 85.0 Acquisition - 19.5 - 19.5 Proceeds from the sale of property and other assets (1.3) (0.6) (1.3) (8.0) Other investing activities (2.7) 8.4 7.7 11.4 ------------------------------------------------------------------------- Free cash flow 161.7 191.0 642.5 826.6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The following shows management's calculation of free cash flow. ------------------------------------------------------------------------- Quarters Six-month periods ended June 30 ended June 30 ($ millions) 2007 2006 2007 2006 ------------------------------------------------------------------------- EBITDA 884.6 897.1 1,648.9 1,759.8 Restructuring costs net of cash payments (7.3) 19.0 (24.3) 3.4 Share-based compensation (8.9) 12.7 129.7 21.1 Donations and securitization fees included in Other expense (9.1) (7.6) (18.4) (12.1) Cash interest paid (218.5) (271.5) (242.1) (284.6) Cash interest received 5.6 0.8 7.5 23.3 Income taxes received (paid), less investment tax credits received that were previously recognized in either EBITDA or capital expenditures, and other (2.9) (0.7) 4.9 95.0 Capital expenditures (481.8) (458.8) (863.7) (779.3) ------------------------------------------------------------------------- Free cash flow 161.7 191.0 642.5 826.6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 11.3 Definition of key operating indicators These measures are industry metrics and are useful in assessing the operating performance of a wireless company. Average revenue per subscriber unit per month (ARPU) is calculated as Network revenue divided by the average number of subscriber units on the network during the period and expressed as a rate per month. Data ARPU is a component of ARPU, calculated on the same basis for revenues derived from services such as text messaging, mobile computing, personal digital assistance devices, Internet browser activity and pay-per-use downloads. Churn per month is calculated as the number of subscriber units disconnected during a given period divided by the average number of subscriber units on the network during the period, and expressed as a rate per month. A prepaid subscriber is disconnected when the subscriber has no usage for 90 days following expiry of the prepaid card. Cost of acquisition (COA) consists of the total of handset subsidies, commissions, and advertising and promotion expenses related to the initial subscriber acquisition during a given period. As defined, COA excludes costs to retain existing subscribers (retention spend). COA per gross subscriber addition is calculated as cost of acquisition divided by gross subscriber activations during the period. COA per gross subscriber addition to lifetime revenue is calculated as cost of acquisition for new subscribers divided by expected lifetime revenue of the subscriber base, expressed as a percentage. EBITDA excluding COA is a measure of operational profitability normalized for the period costs of adding new customers. COA was $150.4 million and $279.9 million, respectively, for the second quarter and first six months of 2007 as compared to $120.9 million and $238.8 million, respectively, for the same periods in 2006. Lifetime revenue per subscriber is calculated as ARPU divided by the churn per month. The metric provides a means of estimating the average total revenue expected from existing subscribers. Retention spend to Network revenue represents direct costs associated with marketing and promotional efforts aimed at the retention of the existing subscriber base divided by Network revenue. 11.4 Definition of liquidity and capital resource measures Dividend payout ratio is defined as the most recent quarterly dividend declared per share multiplied by four and divided by basic earnings per share for the 12-month trailing period. The target guideline for the annual dividend payout ratio on a prospective basis, rather than on a trailing basis, is 45 to 55% of sustainable net earnings. EBITDA - excluding restructuring costs is used in the calculation of Net debt to EBITDA and EBITDA interest coverage, consistent with the calculation of the Leverage Ratio and the Coverage Ratio in credit facility covenants. Restructuring costs were $28.3 million and $84.5 million, respectively, for the twelve-month periods ended June 30, 2007 and 2006. EBITDA - excluding restructuring costs interest coverage is defined as EBITDA excluding restructuring costs divided by Net interest cost. Historically, this measure is substantially the same as the Coverage Ratio covenant in TELUS' credit facilities. Interest coverage on long-term debt is calculated on a 12-month trailing basis as Net income before interest expense on long-term debt and income tax expense divided by interest expense on long-term debt. Interest expense on long-term debt for the 12-month trailing period ending June 30, 2006 includes losses on redemption of long-term debt. The 12-month periods ended June 30, 2007 and 2006 also include accruals for estimated costs to settle a lawsuit. Net debt is a non-GAAP measure whose nearest GAAP measure is the sum of Long-term debt and Current maturities of long-term debt, as reconciled below. Net debt is one component of a ratio used to determine compliance with debt covenants (refer to the description of Net debt to EBITDA below). ------------------------------------------------------------------------- As at As at As at June 30, Dec. 31, June 30, ($ millions) 2007 2006 2006 ------------------------------------------------------------------------- Long-term debt including current portion 4,806.9 4,908.2 4,708.3 Debt issuance costs netted against long-term debt 32.5 19.9 22.2 Deferred hedging liability, net 1,081.8 838.5 990.5 Accumulated other comprehensive income amounts arising from financial instruments used to manage interest rate and currency risks associated with U.S. Dollar denominated debt (179.3) - - ------------------------------------------------------------------------- Debt 5,741.9 5,766.6 5,721.0 Deduct Cash and temporary investments (2.2) 11.5 18.6 Add proceeds from securitized accounts receivable 500.0 500.0 535.0 Net debt 6,239.7 6,278.1 6,274.6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The deferred hedging liability in the table above relates to cross currency interest rate swaps that effectively convert principal repayments and interest obligations to Canadian dollar obligations, which at June 30, 2007, is in respect of the U.S. $1,925.0 million debenture maturing June 1, 2011. At December 31, 2006 and June 30, 2006, the deferred hedging liability was in respect of the 2011 debenture and the U.S. $1,166.5 million debenture that matured June 1, 2007. Management believes that Net debt is a useful measure because it incorporates the exchange rate impact of cross currency swaps put into place that fix the value of U.S. dollar-denominated debt, and because it represents the amount of long-term debt obligations that are not covered by available cash and temporary investments. Net debt to EBITDA - excluding restructuring costs is defined as Net debt as at the end of the period divided by the 12-month trailing EBITDA excluding restructuring costs. TELUS' guideline range for Net debt to EBITDA is from 1.5 to 2.0 times. Historically, Net debt to EBITDA - excluding restructuring costs is substantially the same as the Leverage Ratio covenant in TELUS' new credit facilities. Net debt to total capitalization provides a measure of the proportion of debt used in the Company's capital structure. The long-term target ratio for Net debt to total capitalization is 45 to 50%. Net interest cost is defined as Financing costs before gains on redemption and repayment of debt, calculated on a 12-month trailing basis. No gains on redemption and repayment of debt were recorded in the respective periods. Losses recorded on the redemption of long-term debt are included in net interest cost. Net interest costs for the 12-months ending June 30, 2007 and 2006 are equivalent to reported quarterly financing costs over those periods. Total capitalization - book value excludes Accumulated other comprehensive income and is calculated as follows. ------------------------------------------------------------------------- As at As at As at June 30, Dec. 31, June 30, ($ millions) 2007 2006 2006 ------------------------------------------------------------------------- Net debt 6,239.7 6,278.1 6,274.6 Non-controlling interests 22.1 23.6 25.3 Shareholders equity 6,614.8 6,928.1 6,839.1 Less: Accumulated other comprehensive income 125.8 - - ------------------------------------------------------------------------- Total capitalization - book value 13,002.4 13,229.8 13,139.0 ------------------------------------------------------------------------- ------------------------------------------------------------------------- TELUS Corporation CONTACT: PRNewswire - - 08/03/2007 |