TMCnet News
/SECOND AND FINAL ADD - TO346 - TELUS Corporation/10. Risks and risk management The following are significant updates to the risks described in Section 10 of TELUS' 2006 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 In March 2007, the CRTC issued Decision 2007-18 approving forbearance from regulation of local residential services in Fort McMurray, Alberta, subject to TELUS demonstrating that it has met 14 competitor quality-of-service criteria. On April 4, 2007, the Federal Government issued an Order-in-Council that varied the conditions for forbearance in CRTC's Decision 2006-15 Forbearance from regulation of retail local exchange services. Among other provisions, the Order-in-Council abolished the 25% market share loss threshold, but retained the requirement for incumbent local exchange carriers (ILECs) to meet each of nine competitor quality-of-service standards averaged over six months for all competitors (compared with the previous requirement to meet each of 14 quality-of-service standards for six consecutive months). The Order-in-Council also eliminated restrictions on winback activities and changed the definition of a local market from a broader local forbearance region to a local exchange. For business services, application for forbearance can now be made where there is a choice of facilities-based phone providers. For consumer services, application for forbearance can now be made in any retail local exchange market that has at least three competitors with their own infrastructure - typically the ILEC, a wireless carrier not affiliated with the ILEC and a cable-TV company offering VoIP services. The CRTC will have up to 120 days to issue a decision on a forbearance application and will give precedence initially to applications for the largest Canadian metropolitan areas, which for TELUS are Vancouver, Calgary and Edmonton. The Company expects to demonstrate that the conditions for forbearance have been met in many of the large centres in its incumbent territories and has filed forbearance applications for Victoria, Vancouver, Calgary, Edmonton and Rimouski. TELUS expects to have more flexibility in the marketing of products and services in forborne markets as a result these changes. Price cap regulation On March 14, 2007, the CRTC issued Telecom Decision CRTC 2007-15 denying Barrett Xplore Inc.'s application to review and vary the Commission's 2006 deferral account ruling that allowed TELUS to use deferral accounts funds for the expansion of broadband services for rural and remote areas. In February, the Federal Cabinet denied a related appeal by Barrett. The CRTC is expected move ahead with the examination of TELUS' broadband expansion proposal. However, the deferral account ruling continues to be subject to challenges in the Federal Court of Appeal by consumer groups and Bell Canada. The Company expects the Federal Court to hear the deferral account appeals launched by these parties (now unified into one proceeding) later this year. TELUS is intervening in the court appeal process to preserve its discretion to spend the deferral account funds on broadband expansion plans. On April 30, 2007, the CRTC issued its decision on the parameters in effect for the next price cap period beginning June 2007. The decision confirmed the Company's assumption of no further residential non-high cost serving area mandated price reductions. The Company continues to assess the overall impact of the Price Cap decision. 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. With the implementation of WNP in 2007, Canada is the second country in the world after the United States to offer complete number portability: wireless-to-wireless, wireless-to-wireline and wireline-to- wireless. WNP could lead to an increase in migration of network access lines to wireless services, increased wireless subscriber churn and/or additional customer retention costs for the Company, 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. Review of certain Phase II costing issues The CRTC initiated a proceeding (Public Notice 2007-4) in March 2007 to review cost calculation methods, referred to as Phase II costs, for regulated telecommunications services provided by ILECs and cable companies. The proceeding is expected to last until the fourth quarter of 2007, with a decision not expected until the first quarter of 2008. TELUS has proposed that Phase II costs continue to follow general principles of causality, that all forward looking costs need to be categorized appropriately, and that costs should based on individual company measurements. Unless the CRTC determines otherwise on all these proposals, the outcome of this proceeding would not be expected to have a material adverse impact on TELUS in the near term. Regulation of telecommunications wholesale services The CRTC initiated a proceeding (Public Notice 2006-14) in November 2006 to review the regulatory framework for telecommunications wholesale services. This proceeding is expected to last until the fourth quarter of 2007, with a decision not expected until the second quarter of 2008. TELUS has proposed that the regulatory framework for wholesale services should be revamped in order to align with the Governor in Council's Policy Direction to the CRTC. Unless the CRTC determines otherwise, the outcome of this proceeding would not be expected to have a material adverse impact on TELUS in the near-term. 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 converted a large number of wireline consumer customers in Alberta to new billing system in late-March 2007. Additional phases of development and conversion are planned over the next several years. The new system included re-engineered processes for order entry, pre-qualification, service fulfillment and assurance, customer care, collections/credit, customer contract and information management. This customer-focused project requires extensive system development and, in itself, presents implementation risks due to the complexity of the implementation task and resource constraints, as well as reliance on newly developed third party software code. There can be no assurance that this undertaking will not negatively impact, on a temporary or extended basis, TELUS' customer service levels, competitive position and financial results. As well, significant time delays in implementing 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 ended March 31 ($ millions) 2007 2006 ------------------------------------------------------------------------- Net income 194.8 210.1 Other expense (income) 3.8 4.3 Financing costs 117.6 127.0 Income taxes 79.3 116.1 Non-controlling interest 1.5 2.1 ------------------------------------------------------------------------- Operating income 397.0 459.6 Depreciation 317.7 339.2 Amortization of intangible assets 49.6 63.9 ------------------------------------------------------------------------- EBITDA 764.3 862.7 Add back: Non-cash charge in 2007 for introducing a net-cash settlement feature for options granted prior to 2005 173.5 - ------------------------------------------------------------------------- ------------------------------------------------------------------------- EBITDA (as adjusted) 937.8 862.7 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 and is subject to the potential comparability issues of EBITDA described above. EBITDA (as adjusted) less capital expenditures provides a basis for comparing the 2007 measure to 2006. ------------------------------------------------------------------------- Quarters ended March 31 ($ millions) 2007 2006 ------------------------------------------------------------------------- EBITDA 764.3 862.7 Capital expenditures (Capex) (381.9) (320.5) ------------------------------------------------------------------------- EBITDA less capital expenditures 382.4 542.2 Add back: Non-cash charge in 2007 for introducing a net-cash settlement feature for options granted prior to 2005 173.5 - ------------------------------------------------------------------------- ------------------------------------------------------------------------- EBITDA (as adjusted) less capital expenditures 555.9 542.2 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 ended March 31 ($ millions) 2007 2006 ------------------------------------------------------------------------- Cash provided by operating activities 460.6 673.1 Cash (used) by investing activities (392.3) (316.1) ------------------------------------------------------------------------- 68.3 357.0 Net employee defined benefit plans expense 24.0 1.6 Employer contributions to employee defined benefit plans 33.9 30.5 Amortization of deferred gains on sale-leaseback of buildings, amortization of deferred charges and other, net 9.1 (15.9) Reduction (increase) in securitized accounts receivable 350.0 100.0 Non-cash working capital changes except changes in taxes, interest, and securitized accounts receivable, and other (14.9) 166.8 Proceeds from the sale of property and other assets - (7.4) Other investing activities 10.4 3.0 ------------------------------------------------------------------------- Free cash flow 480.8 635.6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The following shows management's calculation of free cash flow. ------------------------------------------------------------------------- Quarters ended March 31 ($ millions) 2007 2006 ------------------------------------------------------------------------- EBITDA 764.3 862.7 Donations and securitization fees included in Other expense (9.3) (4.5) Restructuring costs net of cash payments (17.0) (15.6) Share-based compensation 138.6 8.4 Cash interest paid (23.6) (13.1) Cash interest received 1.9 22.5 Income taxes received (paid), less investment tax credits received that were previously recognized in either EBITDA or capital expenditures, and other 7.8 95.7 Capital expenditures (381.9) (320.5) ------------------------------------------------------------------------- Free cash flow 480.8 635.6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 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 $129.5 million and $117.9 million, respectively, for the first quarter of 2007 and 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 the subscriber base. 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 $55.8 million and $61.2 million, respectively, for the twelve-month periods ended March 31, 2007 and 2006. EBITDA - excluding restructuring costs interest coverage is defined as EBITDA excluding restructuring costs divided by Net interest cost. This measure is substantially the same as the Coverage Ratio covenant in TELUS' credit facilities. Funded debt, in general terms, is borrowed funds less cash on hand as defined in the Company's bank agreements. Interest coverage on long-term debt is calculated on a 12-month trailing basis as Net income before interest expense on long-term debt and income tax expense divided by interest expense on long-term debt. Interest expense on long-term debt for the 12-month trailing period ending March 31, 2006 includes losses on redemption of long-term debt. The 12-month periods ended March 31, 2007 and 2006 also include accruals for estimated costs to settle a lawsuit. Net debt is a non-GAAP measure whose nearest GAAP measure is the sum of Long-term debt and Current maturities of long-term debt, as reconciled below. Net debt is one component of a ratio used to determine compliance with debt covenants (refer to the description of Net debt to EBITDA below). ------------------------------------------------------------------------- As at As at As at March 31 Dec. 31 March 31 ($ millions) 2007 2006 2006 ------------------------------------------------------------------------- Long-term debt 5,664.1 4,908.2 4,566.8 Debt issuance costs netted against long-term debt 33.4 19.9 22.1 Deferred hedging liability, net 1,087.1 838.5 1,142.7 Accumulated other comprehensive income amounts arising from financial instruments used to manage interest rate and currency risks associated with U.S. Dollar denominated debt (222.0) - - ------------------------------------------------------------------------- Debt 6,562.6 5,766.6 5,731.6 Cash and temporary investments (534.0) 11.5 1.1 Securitized accounts receivable 150.0 500.0 400.0 ------------------------------------------------------------------------- Net debt 6,178.6 6,278.1 6,132.7 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 in respect of the U.S. $1,166.5 million debenture maturing June 1, 2007 and the U.S. $1,925.0 million debenture maturing June 1, 2011. Management believes that Net debt is a useful measure because it incorporates the exchange rate impact of cross currency swaps put into place that fix the value of U.S. dollar-denominated debt, and because it represents the amount of long-term debt obligations that are not covered by available cash and temporary investments. Net debt to EBITDA - excluding restructuring costs is defined as Net debt as at the end of the period divided by the 12-month trailing EBITDA excluding restructuring costs. TELUS' guideline range for Net debt to EBITDA is from 1.5 to 2.0 times. Historically, Net debt to EBITDA is substantially the same as the Leverage Ratio covenant in TELUS' new credit facilities. Net debt to total capitalization provides a measure of the proportion of debt used in the Company's capital structure. The long-term target ratio for Net debt to total capitalization is 45 to 50%. Net interest cost is defined as Financing costs before gains on redemption and repayment of debt, calculated on a 12-month trailing basis. No gains on redemption and repayment of debt were recorded in the respective periods. Losses recorded on the redemption of long-term debt are included in net interest cost. Net interest costs for the 12-months ending March 31, 2007 and 2006 are equivalent to reported quarterly financing costs over those periods. Total capitalization excludes Accumulated other comprehensive income, consistent with definitions in the Company's credit facilities. ------------------------------------------------------------------------- As at As at As at March 31 Dec. 31 March 31 ($ millions) 2007 2006 2006 ------------------------------------------------------------------------- Net debt 6,178.6 6,278.1 6,132.7 Non-controlling interests 25.1 23.6 27.7 Shareholders equity 6,630.4 6,928.1 6,794.3 Accumulated other comprehensive income 147.4 - - ------------------------------------------------------------------------- Total capitalization 12,981.5 13,229.8 12,954.7 ------------------------------------------------------------------------- ------------------------------------------------------------------------- TELUS Corporation CONTACT: PRNewswire - - 05/02/2007 |