management's discussion & analysis
management's discussion & analysis
7. liquidity and capital resources
7.1 Cash provided by operating activities
Cash provided by operating activities increased in 2004, when compared with 2003, principally due to improved operating profitability, lower payments under restructuring programs, the recovery of income taxes associated with settlement of tax matters (including interest income), and lower interest expense, partly offset by an increase in contributions to defined benefit plans.
- EBITDA increased by $274.8 million in 2004, when compared with 2003. EBITDA includes a non-cash share-based compensation expense of $23.8 million in 2004 ($nil in 2003) as a result of adopting the amended recommendations of the Canadian Institute of Chartered Accountants (CICA) for accounting for share-based compensation – see Accounting policy developments.
- Restructuring and workforce reduction payments decreased by $164.8 million in 2004, when compared with 2003. The decrease was primarily from winding down the 2001 to 2003 Operational Efficiency Program and lower associated payments, partly offset by payments under new restructuring initiatives.
- Income taxes received increased by $29.1 million as the cash recovery of income taxes and investment tax credits net of tax installments was $194.6 million in 2004, compared with $165.5 million in 2003.
- Interest paid decreased by $24.6 million in 2004, when compared with 2003, as a result of debt repayments.
- TELUS received $33.3 million from Verizon, recorded as a reduction of prepaid and deferred services. The $33.3 million was part of the $148.1 million (US $125 million) received when the independent Directors of TELUS agreed to facilitate the divestiture by Verizon of its entire 20.5% equity interest in TELUS.
- Non-cash working capital included changes in proceeds from securitized accounts receivable. In 2004, the Company made payments of $150 million to reduce securitized accounts receivables, compared with payments of $175 million in 2003.
Partly offsetting the above increases were:
- Employer contributions to employee defined benefit plans increased by $37.0 million, in 2004, when compared with 2003. The increase reflects updated actuarial valuations and the net acceleration of discretionary funding.
- A decrease in interest received of $14.3 million in 2004, when compared with 2003. Interest received in both years was primarily from the settlement of tax matters, as well as from interest earned on cash and temporary investments.
7.2 Cash used by investing activities
Cash used by investing activities increased in 2004, when compared with 2003, primarily as a result of increased capital expenditures. The Company also received proceeds of $27.6 million in 2004 from the sale of non-strategic assets, including several real estate properties. In 2003, the Company disposed of non-strategic properties and monetized an investment for total proceeds of $51.2 million. Funds used for other investing activities in 2004 included TELUS' purchase of ADCOM, Inc.
Communications segment ILEC capital expenditures increased by 7.3% to $826.4 million in 2004, when compared with 2003. The increase was due to significant investments in internal systems and processes, as well as investments in network infrastructure to improve customer service and network reliability, the development of new services, and the delivery of services to new customers. In addition, capital spending in early 2003 was constrained by the impact of the Operational Efficiency Program, which temporarily delayed certain projects. Expenditures for high-speed Internet facilities (or ADSL) were relatively flat at $95.7 million in 2004, consistent with more moderate subscriber growth.
Non-ILEC capital expenditures increased by 12.4% to $137.9 million in 2004, when compared with 2003. The increase in non- ILEC expenditures was primarily to support the Company's IP strategy and delivery of services to new customers, which included implementation of several large contracts.
The Communications segment capital expenditure intensity ratio was 19.8% in 2004, compared with 18.3% in 2003. Cash flow (EBITDA less capital expenditures) decreased by 11.2% to $984.1 million in 2004, when compared to 2003, mainly due to higher capital spending and increased restructuring charges.
- Mobility segment capital expenditures decreased by 1.4% in
2004 when compared with 2003. TELUS Mobility continued the
enhancement of digital wireless coverage and continued building
microwave facilities during 2004 aimed at reducing future leased
line transmission costs. Capital spending decreased from 2003
principally as a result of improved infrastructure equipment costs
and a stronger Canadian dollar.
Capital expenditure intensity for TELUS Mobility decreased to 12.5% in 2004 from 15.2% in 2003, due primarily to significant growth in Network revenues. As a result of continued strong growth in EBITDA and reduced capital expenditure intensity, Mobility generated cash flow (EBITDA less capital expenditures) of $787.5 million as compared with $455.5 million in 2003.
Consolidated cash flow (EBITDA less capital expenditures) increased by 13.3% to $1,771.6 million in 2004, when compared with 2003.
7.3 Cash used by financing activities
Cash used by financing activities decreased in 2004, when compared with 2003, due primarily to lower scheduled debt redemptions in 2004. Financing activities included the following:
- Proceeds from Common Shares and Non-Voting Shares issued increased by $62.2 million in 2004. Shares were issued from treasury under the employee share purchase plan and under share-based compensation plans in 2003 and 2004. In addition, 2004 proceeds included those from the exercise of warrants. Effective November 1, 2004, TELUS began to purchase employee share purchase plan shares in the market rather than issuing from treasury.
- In the fourth quarter of 2004, TELUS received $114.8 million from Verizon, part of the $148.1 million (US $125 million) received when the independent Directors of TELUS agreed to facilitate the divestiture by Verizon of its 20.5% equity interest in TELUS.
- Cash dividends paid to shareholders increased by $76.7 million in 2004, when compared with 2003. The increase in cash dividends paid was primarily due to remittance of the fourth quarter 2004 dividend on December 31, 2004, while the dividend for the fourth quarter of 2003 was remitted in January 2004. The increase in dividends paid was also due to the five-cent increase in the dividend declared and paid in the fourth quarter of 2004 and a larger number of Common Shares and Non-Voting Shares outstanding. Commencing with the dividend declared in the fourth quarter, TELUS began to purchase dividend reinvestment plan shares in the market rather than issuing from treasury and the previous 3% plan discount was eliminated.
Normal Course Issuer Bid to December 31, 2004
- TELUS' Normal Course Issuer Bid for the repurchase of its Common Shares and Non-Voting Shares was accepted by the Toronto Stock Exchange, and commenced December 20, 2004. The repurchase program enables TELUS to repurchase on the market, over a 12- month period, up to a maximum of 14.0 million Common Shares and 11.5 million Non-Voting Shares, representing approximately 7% of the issued and outstanding Common Shares and Non-Voting Shares. In December 2004, TELUS purchased for cancellation Common Shares and Non-Voting Shares for a total outlay of $78.0 million, of which $39.3 million was recorded as a reduction to share capital and $38.7 million, representing the amount in excess of book value, was recorded as a reduction to retained earnings. The maximum number of shares that can be repurchased in any 30-day period is 2% of the issued and outstanding shares of each class of shares.
- The redemption of all of the publicly held TELUS Communications Inc. Preference and Preferred Shares was completed by August 3, 2004 for an outlay of $72.8 million.
- Debt redemptions in 2004 included $189.5 million of TELUS Communications Inc. Series A Debentures and $20 million of TELUS Communications Inc. Medium-term Notes. The maximum outstanding bank facility balance of $34 million was repaid in full in the first quarter of 2004.
7.4 Liquidity and capital resource measures
The balance of Long-term Debt and Current maturities of Long-term Debt was $6,336.5 million as at December 31, 2004, a decrease of $494.4 million from December 31, 2003. The lower debt balance was due to redemptions and a $291.9 million decrease in the Canadian dollar value of U.S. dollar denominated Notes, as the Canadian dollar appreciated against the U.S. dollar by approximately 7.3% during 2004. TELUS' U.S. dollar debt is fully hedged, resulting in a corresponding increase of $291.9 million being recorded in the deferred hedging liability.
While the amount of utilized bank facilities decreased to $nil from $7.0 million one year earlier, TELUS converted $500 million of debt from a fixed rate to a floating rate basis during the first half of 2004, reducing the proportion of fixed rate debt. The net debt to total capitalization ratio measured at December 31, 2004 decreased, when compared with one year earlier, primarily as a result of debt repayments and increased common equity. The net debt to EBITDA ratio measured at December 31, 2004 improved significantly, when compared with one year earlier, as a result of debt reduction and an increase in 12-month trailing EBITDA (excluding restructuring).
The earnings coverage ratio improved significantly because of the improvement in income before interest and taxes and decreased interest on total debt. The EBITDA interest coverage ratio improved as a result of higher EBITDA (excluding restructuring) and lower interest costs, partly offset by lower interest income. The Free cash flow measure for the year ended December 31, 2004 increased, when compared with one year earlier, primarily because of improved EBITDA, higher tax recoveries, lower payments under restructuring programs and lower net interest payments, partly offset by increased capital expenditures.
As announced in October 2004, on a prospective basis, the Company has set a target guideline for the annual dividend payout ratio of 45 to 55% of net earnings. The annualized effective payout ratio of 20 cents per share per quarter is in the range of 43 to 48% based upon the annual 2005 targets for basic earnings per share of $1.65 to $1.85.
7.5 Credit facilities
The following are the credit facilities available to TELUS at December 31, 2004:
Including cash of $896.5 million and the credit facilities described in the table above, TELUS had unutilized available liquidity well in excess of $2.0 billion at December 31, 2004. TELUS' credit facilities contain customary covenants including a requirement that TELUS not permit its consolidated Leverage Ratio (Funded Debt to trailing 12-month EBITDA) to exceed 4.0:1 (approximately 2.1:1 at December 31, 2004) and not permit its consolidated Coverage Ratio (EBITDA to Interest Expense on a trailing 12-month basis) to be less than 2.0:1 (approximately 5.1:1 at December 31, 2004) at the end of any financial quarter. There are certain minor differences in the calculation of the Leverage Ratio and Coverage Ratio under the credit agreement as compared with the calculation of net debt to EBITDA and EBITDA interest coverage. The calculations are not expected to be materially different. The covenants are not impacted by revaluation of capital assets, intangible assets and goodwill for accounting purposes, and continued access to TELUS' credit facilities is not contingent on the maintenance by TELUS of a specific credit rating.
7.6 Accounts receivable sale
TELUS Communications Inc., a wholly owned subsidiary of TELUS, is able to sell an interest in certain of its receivables up to a maximum of $650 million and is required to maintain at least a BBB(low) credit rating by Dominion Bond Rating Service (DBRS), or the purchaser may require the sale program to be wound down. The necessary credit rating was exceeded by two levels at BBB(high) as of February 16, 2005. The proceeds of securitized receivables were $150 million at December 31, 2004, as compared with $300 million at December 31, 2003. It is necessary to retain a minimum of $150 million proceeds under this program to keep it active. Average proceeds from securitization were $181 million in 2004 and $453 million in 2003.
7.7 Credit ratings
On July 1, 2004, TELUS completed a reorganization affecting two wholly owned subsidiaries. TELUS Communications (Québec) Inc. (TCQ) transferred substantially all the assets and business of TCQ to TELUS Communications Inc. (TCI). Following this reorganization, DBRS upgraded the long-term credit ratings of the First Mortgage Bonds and Medium-term Notes assumed by TCI to BBB(high), matching other DBRS credit ratings for TCI.
In the fourth quarter of 2004, in response to the announcement that Verizon was selling all its TELUS Voting Shares and Non-Voting Shares, three of four rating agencies that cover TELUS issued updates or confirmations. Moody's Investors Service affirmed its Baa3 senior unsecured rating for TELUS Corporation and changed its outlook to positive from stable. DBRS confirmed its ratings for TELUS Corporation and TELUS Communications Inc. with a stable trend. Standard and Poor's (S&P) announced that its ratings were unchanged.
On February 10, 2005, S&P revised its outlook to 'positive' from 'stable' and affirmed its long-term corporate credit and senior unsecured ratings for TELUS and TCI. On February 17, 2005, DBRS again confirmed its ratings for TELUS Corporation and TELUS Communications Inc. with a stable trend.
TELUS has an objective to preserve access to capital markets at a reasonable cost by maintaining investment grade credit ratings and targeting improved credit ratings in the range of BBB+ to A–, or the equivalent, in future.
7.8 Off-balance sheet arrangements and contractual liabilities
Financial instruments (Note 4 of the Consolidated financial statements)
During the first half of 2004, the Company entered into two series of hedging relationships to which hedge accounting has been applied: one series of hedging relationships results in fixing the Company's compensation cost arising from a specific grant of restricted stock units, and the other series results in the notional conversion of $500 million of the 2006 (Canadian Dollar) Notes from a fixed interest rate of 7.5% to a floating interest rate based upon the three-month Bankers' Acceptance Canadian Dollar Offered Rate plus a spread. TELUS intends to hedge its exposure with respect to share-based compensation arrangements granted in 2005 using cash-settled equity forward transactions.
As at December 31, 2004, the Company had entered into foreign currency forward contracts that have the effect of fixing the exchange rates on US $48 million of fiscal 2005 purchase commitments; hedge accounting has been applied to these foreign currency forward contracts, all of which relate to the Mobility segment.
Fair value: The fair values of the Company's long-term debt and convertible debentures 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 value of the Company's debt at December 31, 2004 was estimated at $8,643.1 million ($8,698.8 million at December 31, 2003).
Commitments and contingent liabilities
(Note 16 of the Consolidated financial statements)
The Company has a number of commitments and contingent liabilities as quantified in the following table. For further information, refer to Note 16(c) of the Consolidated financial statements.
- The Company has $70.7 million in outstanding commitments for its restructuring programs as at December 31, 2004. In addition, the Company disclosed in its guidance for 2005 that it expected to record approximately $100 million of restructuring and employee reduction costs in 2005 in support of ongoing efficiency initiatives.
- In accordance with CRTC Price Cap Decisions 2002-34 and 2002-43, the Company defers a portion of revenues in a deferral account, which at December 31, 2004, was $128.7 million. Due to the Company's use of the liability method of accounting for the deferral account, the CRTC Decision 2005-6, in respect of the Competitor Digital Network Access (CDNA), does not currently affect the Company's income statement. The mechanism for disposing of the balance in this deferral account, other than as already approved by the CRTC in Decision 2005-6 and previous decisions, is currently the subject of a CRTC proceeding.
- On May 21, 2004, the Canada Industrial Relations Board (CIRB) declared TELE-MOBILE COMPANY and TELUS Communications Inc. a single employer for labour relations purposes. The CIRB also determined that TELUS Mobility's non-unionized team members, predominantly located in Ontario and Quebec, performing work similar to their unionized TELUS Mobility counterparts in Alberta and British Columbia, should be included in the bargaining unit represented by the Telecommunications Workers Union. The application to the Federal Court of Appeal for judicial review of Decision 278 was heard in October 2004 and the Court subsequently dismissed the appeal in a December 16, 2004 decision. On February 14, 2005, TELE-MOBILE COMPANY and TELUS Communications Inc. applied to the Supreme Court of Canada for leave to appeal the Federal Court of Appeal's December 16, 2004, decision. Should the ultimate operational and financial impacts of Decision 278 differ from management's assessments and assumptions, a material adjustment to the Company's financial position and the results of its operations could result.
Canadian GAAP requires the disclosure of certain types of guarantees and their maximum, undiscounted amounts. The maximum potential payments represent a worst-case scenario and do not necessarily reflect results expected by the Company. Guarantees requiring disclosure are those obligations that require payments contingent on specified types of future events; in the normal course of its operations, the Company enters into obligations which GAAP may consider to be guarantees. As defined by Canadian GAAP, guarantees subject to these disclosure guidelines do not include guarantees that relate to the future performance of the Company. As at December 31, 2004, the Company has no liability recorded in respect of performance guarantees, and $1.0 million (December 31, 2003 – $1.5 million) recorded in respect of lease guarantees. The maximum undiscounted guarantee amounts as at December 31, 2004, without regard for the likelihood of having to make such payment, were not significant.
In the normal course of operations, the Company may provide indemnification in conjunction with certain transactions. The term of these indemnification obligations range in duration and often are not explicitly defined. Where appropriate, an indemnification obligation is recorded as a liability. In many cases, there is no maximum limit on these indemnification obligations and the overall maximum amount of the obligations under such indemnification obligations cannot be reasonably estimated. Other than obligations recorded as liabilities at the time of the transaction, historically the Company has not made significant payments under these indemnifications.
In connection with its 2001 disposition of TELUS' directory business, the Company agreed to bear a proportionate share of the new owner's increased directory publication costs if the increased costs were to arise from a change in the applicable CRTC regulatory requirements. The Company's proportionate share would be 80% through May 2006, declining to 40% in the next five-year period and then to 15% in the final five years. As well, should the CRTC take any action which would result in the owner being prevented from carrying on the directory business as specified in the agreement, TELUS would indemnify the owner in respect of any losses that the owner incurred. At December 31, 2004, the Company has no liability recorded in respect of indemnification obligations.
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 items disclosed previously. See Note 16(f) of the Consolidated financial statements.
7.9 Related party transactions
(Note 20 of the Consolidated financial statements)
On November 30, 2004, Verizon and the Company entered into an agreement pursuant to which the Company's independent members of the Board of Directors agreed to facilitate the divestiture by Verizon of its 20.5% equity investment in the Company. Such agreement was necessary due to certain restrictive provisions in the Long Term Relationship Agreement, dated January 31, 1999, between Verizon and the Company. Such divestiture was effected by a public secondary offering of Verizon's entire equity interest in the Company on December 14, 2004; post divestiture, Verizon and the Company are no longer related parties for purposes of generally accepted accounting principles and Verizon no longer has a pre-emptive right to buy shares from treasury.
Pursuant to the agreement, and the amended agreement pursuant to which the Company acquires certain rights to Verizon's software, technology, services and other benefits, Verizon paid the Company $148.1 million (US $125 million). In conjunction with the divestiture, a number of agreements between Verizon and the Company were terminated or altered, including the amended and restated software and related technology and services agreement (SRT) pursuant to which the Company acquired certain rights to Verizon's software, technology, services and other benefits. The term of the SRT was extended to 2008. The Company will continue to have exclusive rights in Canada to specified Verizon trademarks, software and technology acquired prior to Verizon's divestiture of its investment in the Company and Verizon is required to continue to provide upgrade and support on the software and technology licensed to the Company. The annual fees payable by the Company under the SRT for the years 2005 to 2008 have been reduced from an aggregate of US $82 million to a nominal amount; Verizon and the Company remain committed to use each other's cross-border services where capabilities and customer requirements permit and the Company has been released from its obligation not to compete in the United States.
As of December 31, 2004, in aggregate, $312.1 million of specified software licences and a trademark licence have been acquired under the agreement and have been recorded as capital and other assets. These assets are valued at fair market value at the date of acquisition as determined by an arm's-length party's appraisal. The total commitment under the SRT was US $275 million (2003 – US $377 million) for the period 2001 to 2008 and the commitment remaining after December 31, 2004, as a result of the amendment, is a nominal amount (2003 – US $102 million).
7.10 Outstanding share information
The following is a summary of the outstanding shares for each class of equity at December 31, 2004 and at January 31, 2005. In addition, for January 31, 2005, the total number of outstanding and issuable shares is presented, assuming full conversion of convertible debentures, options and warrants.