TELUS

annual report 2004

management's discussion & analysis

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management's discussion & analysis
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9. looking forward to 2005

9.1 General outlook

Setting the stage for 2005 was significant consolidation activity in the Canadian telecommunications industry that took place in 2004 combined with the market introduction of new telecom services by new competitive entrants facilitated by new technologies such as voice over IP (VoIP).

In February, Manitoba Telecom Services (MTS) sold its equity position in Bell West to BCE. In March, MTS announced the acquisition of Allstream reorienting its out-of-region growth strategy from the West to national in order to compete directly with Bell in the Eastern Canadian business market. In November, BCE acquired the assets of 360networks to support growth in Western Canada and to access its tax losses. In the wireless sector, Rogers Communications Inc. acquired Microcell in November, which took the wireless sector from a four to a three facilities-based player market.

Rogers Communications also acquired U.S.-based AT&T Corporation's stake in Rogers Wireless and took the company private by purchasing the remaining minority interest. The move by U.S. companies to focus on their domestic operations and to sell their equity stakes in Canadian telecommunications companies continued late in the year with the sale of Verizon's 20.5% interest in TELUS through a large, public secondary offering.

These consolidation developments marked a year in which the underlying telecommunications market displayed general trends similar to recent years with the wireless sector driving strong revenue growth and increased equity value, while wireline growth and value generally remained soft.

The Canadian telecom industry generated revenues of approximately $32 billion in 2004, with Bell Canada and its affiliated regional telecommunications companies representing about 50% of the total. As the second largest full-service telecommunications provider in Canada, TELUS generated $7.6 billion in 2004, or about 24% of the total.

Overall revenue growth in the Canadian telecom market in 2004 was approximately 3%, somewhat higher than the growth experienced in 2003, but with continued weakness in wireline voice, data, wholesale and business markets. Wireline local voice was flat, data was down slightly but showed some growth late in the year, and long distance continued to decline. Wireless was the growth engine for the sector, with industry revenues approximately 18% higher. As a result, TELUS, which has strategically focused on both wireless and data, outperformed the industry with 6% consolidated revenue growth.

It is expected that 2005 will be another year of transition for the Canadian telecommunications industry. Incumbent carriers expect increased competition for local voice and long distance as cable-TV companies prepare to launch IP telephony using VoIP. Wireless companies are expected to continue to focus on growth through subscriber additions and increased revenue from expansion of data services.

Wireline

In 2005, the threat of VoIP to incumbent telecommunications companies is expected to emerge more strongly. In the past year, players such as Call-Net, Vonage, Primus and Navigata launched VoIP services in Canada for residential customers using other carriers' high-speed Internet infrastructure and facilities. Their impact has been somewhat muted with concerns over such issues as security and reliability. Cable-TV companies including Shaw Communications and Cogeco Cable have launched or announced plans to launch VoIP service offerings in 2005. They will use their own infrastructure to connect directly with customers and leverage their end-customer relationships and recognizable brands to market the service. The battle for the residential customer is expected to increasingly focus on the best bundled offerings of voice, Internet, TV/video and wireless that a company can deliver with reliability and superior customer service.

Residential access line growth will likely continue to be negatively impacted by the migration to wireless, decreases in second lines and substitution to cable-TV-based VoIP offerings. The market for long distance is likely to continue its declining trend, as VoIP providers introduce aggressively priced voice packages to entice customers to switch providers. Pending the outcome of a regulatory proceeding on the matter, incumbent telecoms are expected to react with their own VoIP offerings by continuing to introduce value bundles delivering enhanced functionality and convenience. TELUS is well positioned for these developments with its launch of the Future Friendly Home and a compelling set of fixed and mobile solutions for the residential customer, including the potential introduction of an IP-based TV service provided over TELUS' ADSL infrastructure.

At the end of 2004, the enterprise business market began showing signs of a modest rebound reflected by the resumption of data revenue growth. Voice and legacy data may continue to decline as in the past few years, but growth in business enhanced data service revenues should at least partially offset the trend, as small and medium business and enterprise clients look to upgrade legacy networks and equipment. Both these market segments are expected to adopt IP and managed services as a means to achieve operational savings, revenue generation and business innovation.

Canadian uptake for VoIP in the business market has been more subdued than anticipated. Most Canadian businesses consider VoIP as the next generation telecom solution and have been reluctant to adopt the new technology until it has been proven and matures. However, usage and adoption of VoIP is skewed towards the enterprise segment and it is expected that, by the end of 2005, approximately two-thirds of large businesses will be using some form of VoIP.

As customers migrate from legacy services to enhanced IP-based services, telecommunications providers anticipate pressure on overall wireline margins. The new products and services do not have the same profit margins as the legacy services and this transition will continue to pressure incumbent telephone companies' wireline EBITDA margins. Therefore, incumbent carriers are expected to continue to focus on operational cost efficiency and effective capital expenditure deployment to protect profitability and returns on investment.

Telecom providers are projected to migrate voice and data traffic to a single IP-based platform over the next several years, thereby achieving cost efficiencies while providing combined IP voice, data and video solutions. There will be a continued effort to look at the end-to-end delivery chain and fundamentally re-design the processes and systems associated with each element (ordering, provisioning, fulfillment, assurance, customer care, billing and collections) to improve productivity.

In 2005, the CRTC is expected to determine the VoIP regulatory rules for incumbent telecom companies and later in the year to commence proceedings on the regulatory framework for the next price cap period beginning in June 2006. The current CRTC price cap framework established in 2002, as well as recent decisions, continue to support the CRTC's facilities-based competition framework.

Wireless

In contrast to the mature wireline sector, wireless industry growth continued to be very strong, with Canadian wireless industry revenue and EBITDA increasing by 18% and 33%, respectively. Capital expenditure levels are generally stable as carriers leverage previous investments, resulting in strong cash flow improvement.

Wireless penetration in Canada increased to 47% of the population in 2004, and based on the worldwide trend toward penetration levels of 70% or more, there remains considerable growth potential for the Canadian industry. Approximately 1.6 million new subscribers were added in Canada during 2004 representing a penetration gain of 4.8 percentage points of Canada's total population. Subscriber growth is predicted to continue as the industry is expected to attain about 60% wireless penetration of the Canadian population by the end of 2007.

The Rogers Communications purchase of Microcell should have a positive impact on the wireless sector as the number of national network-based competitors is reduced from four to three. Over time, this structure is expected to lead to a number of benefits including, among other things, lower industry churn, improved cost of acquisition and competitive rationality. Potentially offsetting the consolidation of Microcell is the expected entry by Virgin Mobile into the market in a joint venture with Bell Mobility. Virgin is expected to increase the competitive intensity and sales in the prepaid and youth markets. In the business market, competition may intensify in Push To Talk (PTT) offerings as CDMA-based PTT is introduced by Bell Mobility, ending the exclusive position TELUS has enjoyed in this segment, particularly with its full featured Mike iDEN product. However, the wider introduction of CDMAbased PTT services could stimulate usage and demand for PTT services overall, and in the youth and consumer segments.

Wireless data is estimated to be approaching 3 to 5% of industry service revenues. Companies are expecting accelerated data usage as they continue to aggressively market wireless data services including text and picture messaging, powerful and popular BlackBerry devices from Research in Motion (RIM), mobile computing and wireless Internet access. In 2005, the introduction of video messaging services is also expected to boost wireless data demand. Data usage is expected to continue to drive subscriber growth and support ARPU for all operators in 2005.

TELUS' strategic focus on delivering national business services in data and IP, and its large exposure (41% of consolidated 2005 revenue guidance) to the fast-growing Canadian wireless market, position the Company for above-average growth in 2005 and beyond.

9.2 Financial and operating targets and issues for 2005

TELUS continues to have the following policy guidelines, which were announced previously:

The following targets for 2005 were announced publicly on December 17, 2004 and the Company has a practice of reaffirming or adjusting guidance on a quarterly basis.

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The 2005 targets reflect strong growth in both revenue and profitability, with the target range for consolidated earnings per share representing a 4 to 17% increase over 2004. With capital expenditures remaining near 2004 levels, TELUS expects to have another strong year of free cash flow of more than $1.2 billion in 2005. This bodes well for TELUS' ability to successfully overcome competitive pressures and continue to enhance shareholder value.

Communications segment EBITDA is expected to decline in the range of 3 to 5% in 2005, resulting from slightly lower wireline revenue and increased restructuring costs, partially offset by continued operating efficiencies. Excluding restructuring and workforce reduction costs, Communications segment EBITDA is expected to range between negative 2.5% and flat compared to that of 2004. Communications segment revenue growth in the non-incumbent territory in Central Canada is expected to increase 7 to 16%, while targeting positive EBITDA in 2005.

TELUS Mobility EBITDA is expected to increase by 18 to 23% driven by an approximate 14 to 16% increase in revenues, continued economies of scale, cost containment and expansion in wireless subscribers.

The double-digit earnings per share increase is not only being driven by higher consolidated operating profitability, but also by reduced depreciation due to improved capital efficiency in recent years and by lower financing costs as a consequence of lower debt levels, and potentially a lower number of shares outstanding. This significant growth in earnings per share is despite the fact that 2004 earnings included 21 cents of positive impacts from the settlement of tax matters (and related interest), which are not projected to reoccur in 2005.

Key assumptions and sensitivities for 2005 targets

Earnings per share, cash balances, net debt and common equity may be affected by purchases of up to 23.3 million additional TELUS shares under the Normal Course Issuer Bid.

For projection purposes, the following assumptions were made:

There is no assurance that these assumptions or the 2005 financial and operating targets and projections will turn out to be accurate.

9.3 Financing plan for 2005

TELUS has no significant amount of debt maturing in 2005, and the $150 million amount outstanding under its accounts receivable securitization program at the end of 2004 is the minimum required to maintain the program. TELUS' financing plan is to use the $896.5 million cash-on-hand at December 31, 2004 and free cash flow generated by its business operations in 2005 to: (i) pay dividends; (ii) repurchase TELUS Common Shares and Non-Voting Shares under the Normal Course Issuer Bid; and (iii) maintain cash-on-hand in anticipation of the maturation of $1.6 billion of 7.5% Canadian dollar TELUS Corporation Notes in June 2006. Consideration may also be given to redeeming debt or repurchases of debt in the open market. On February 16, 2005, TELUS announced its intention to redeem its $149.6 million of 6.75% convertible debentures at par on June 16, 2005.

TELUS also expects to maintain its current position of fully hedging its foreign exchange exposure for indebtedness. At the end of 2004, approximately 93% of TELUS' total debt was borrowed on a fixed-rate basis. The Company plans to renew its $800 million 364-day revolving facility in May 2005 and generally expects to maintain a minimum of $1 billion in unutilized liquidity.