management's discussion & analysis
management's discussion & analysis
10. risks and uncertainties
The following sections summarize the major risks and uncertainties that could affect TELUS' future business results going forward.
Increased competition may adversely affect market shares, volumes and pricing in certain TELUS business segments
Competition is expected to remain intense, not only in the traditional telephony and Internet markets, but also from new entrants looking to provide alternatives to traditional wireline voice access and long distance through the use of IP telephony, or VoIP. Technology substitution by wireless and e-mail services will also continue to put pressure on traditional wireline services. Competitors are expected to continue to focus on local access, data and IP services in the business market and high-speed Internet and wireless services across both the consumer and business markets, as these services offer the highest growth potential. Wireline long distance is experiencing negative revenue growth and voice local access continues to experience a gradual decline in network access lines, both of which are expected to accelerate in the future. Competitors remain intent on winning market share in both the business and residential local and long distance voice markets as a way to sell additional data, Internet and wireless services, particularly through various bundled service arrangements. From a technology perspective, to a large extent the industry as a whole is migrating to IP and an IP-based service delivery model. Transition from legacy voice infrastructure to IP telephony and from legacy data to multi-protocol label switching (MPLS) is expected to accelerate in 2005, and this may negatively affect pricing and margins on select services.
Wireline voice and data
While TELUS expects local, long distance and data competitors – ranging from traditional facility carriers, resellers, long distance dialaround and card providers – to continue to focus mainly on the business market in 2005, an increasing number of new and smaller competitors have already begun combining residential local, long distance and wireless services (typically through marketing alliances) into one bundled monthly rate or are offering VoIP alternatives. TELUS' competitors already offer varying arrays of long distance, local and advanced data/IP services and they are increasingly bundling long distance with price-discounted local access, wireless and advanced data, Web-based and e-commerce services, and other information technology services and support. As a result, TELUS also increasingly faces competition from Internet and information technology hardware, software and business process/consulting related companies.
Certain other TELUS competitors, having either built extensive local fibre-optic facilities throughout Western Canada over the past several years, or having acquired facility assets through acquisitions, are increasingly focusing on marketing and revenue generation, particularly in the small and medium-sized business market due to the size of this market, its concentrated geographic urban clustering and attractive margins. With the industry consolidation that took place in 2004, most of these competitors have sound financial strength and other resources. At the same time, competition remains strong in the large business market, where a small number of major customers can deliver a significant amount of revenue and, as a result, overall industry pricing remains very competitive, especially in the long distance and data markets.
Wireline Internet access
With a Western Canadian industry high-speed Internet penetration rate typically much higher than most other Canadian and international locations, industry growth for Internet service may slow more quickly than anticipated, resulting in reduced net additions for all industry competitors and posing a constraint on TELUS' ability to increase its share of total high-speed subscribers in the market. TELUS Communications is targeting 100,000 high-speed net additions in 2005, a reduction of 28,000 from what was achieved in 2004. Pricing for basic high-speed Internet access in TELUS' markets continues to be among the lowest anywhere, resulting in a constraint on revenue growth regardless of higher penetration rates.
Residential dial-up Internet access competition and growth have declined dramatically, in large part due to increased high-speed Internet availability and lower pricing. Losses of existing TELUS dial-up subscribers to high-speed services of competitors are mitigated by TELUS' efforts to transfer these customers to its own high-speed Internet service. However, there can be no assurance that the rate of loss of dial-up subscribers or market share retained by TELUS will be as expected, as TELUS will continue to face significant competition from cable-TV high-speed Internet services. TELUS could also experience high future rates of churn or subscriber deactivations if its current quality of service and competitive pricing are not maintained or improved.
Voice over Internet protocol (VoIP)
Internet telephony, also referred to as VoIP, continues to be a developing service that could negatively impact TELUS' local and long distance business over the next few years. While the technology has existed for some time, particularly for business customer premise equipment and IP Centrex services, it was not until 2004 that a number of new entrants launched services aimed at the residential and small business markets throughout Canada. In addition, next generation cable-TV modems currently being deployed by cable-TV companies will allow the cable-TV companies to begin offering VoIP over their cable networks.
Cable-TV companies in Canada have recently launched or reaffirmed their intention to begin offering VoIP telephony in 2005. TELUS also began developing its IP telephony initiative in the fall of 2001 and began the transition from circuit-based switching to IP in the summer of 2003. This presents an opportunity for new services, network simplification and cost reduction. However, there can be no assurance that the adoption of VoIP services in the market or provision of such services by TELUS would not cannibalize existing revenues. If significant VoIP competition develops, it could erode TELUS' existing market share of traditional local and long distance services and adversely affect future revenues and profitability.
Competition in the Canadian wireless market is expected to remain intense in 2005 in all regions of the country, including Western Canada. TELUS Mobility is targeting approximately 425,000 to 475,000 net subscriber additions in 2005, and there can be no assurance that it will achieve its objective given the level of competition and the possibility of declining growth rates in the Canadian wireless industry.
In 2004 Rogers Wireless acquired the smallest national wireless carrier, Microcell Telecommunications, to create the largest wireless carrier in Canada when measured by number of subscribers. This combination of the two GSM (Global System for Mobile Communications) carriers could give rise to increased scale efficiencies, which the new company could exploit to its advantage. There can be no assurance that TELUS will be able to compete as effectively against this larger rival as it did against the two companies separately.
With the entry of the Virgin Group to provide wireless services under the Virgin Mobile brand name on a resale basis from Bell Mobility, competition within the Canadian wireless market is expected to further intensify, particularly in the prepaid and youth segments. In addition, other competitors may offer wireless services regionally or nationally on a resale basis. This could lead to pricing pressures and higher costs of acquisition in the future, particularly in the prepaid market.
There is risk that increased competition could increase churn rates, cause marketing costs of acquisition per subscriber to be higher than otherwise, and lower the average revenue per subscriber. Aggressive advertising and innovative marketing approaches are expected to continue to be the norm. Certain competitors have offered unlimited local airtime packages in specific markets, subsidized low or zero-cost handsets, and/or lowered airtime prices, and may continue to do so. In addition, certain carriers have stated their intention to launch competitive Push To Talk products, which may compete directly with TELUS Mobility's Mike and CDMA Push To Talk services. (See technology) TELUS Mobility intends to manage these risks by continuing to focus on differentiated value-added services and profitable subscriber growth.
Bell Mobility entered Western Canada in the fall of 2001, built its own network and operational capabilities, and launched its own 1X data network in urban centres in Alberta and B.C. in the fall of 2002.
In addition, the roaming/resale agreements among TELUS Mobility, Bell Mobility and affiliates, and Aliant Telecom Wireless, first operationalized in mid-2002, allowed Bell Mobility to expand the availability and range of its wireless services to approximately 2.5 million incremental POPs throughout rural Alberta and B.C. This allowed Bell Mobility to expand into Western Canada earlier and more cost-effectively than if it had to wait to fully build out its own rural network coverage. The entry of Bell Mobility in these rural areas has increased the effective number of competitors to three (including TELUS) in these regions. Roaming/resale agreements have similarly allowed TELUS Mobility, on a reciprocal basis, to expand its PCS network coverage and distribution primarily in Central and Atlantic Canada by approximately 7.5 million people, generally served by two other competitors, bringing TELUS Mobility's national digital coverage and addressable market to 30.0 million. There can be no assurance that TELUS Mobility's marketing efforts will be as successful in the new markets as in existing coverage areas.
Wireless competition is also coming from new digital wireless technologies, which may be offered from both traditional and non-traditional sources, utilizing licensed and/or unlicensed spectrum, that deliver higher-speed data and Internet services over current and next generation wireless devices. Such availability may lead to increased re-subsidization costs related to the migration of existing subscribers to advanced feature handsets based on newer technologies. There can be no assurance that new services offered by TELUS Mobility will be available on time, or that TELUS Mobility will be able to charge incrementally for the services. (See Technology.)
Industry Canada concluded its initial auction for wireless spectrum in the 2.3 GHz and 3.5 GHz bands in February 2004 and recently concluded a re-auction for residual spectrum in these bands in January 2005. TELUS participated in both and obtained a number of licences. This spectrum is expected to be utilized primarily for services such as the provision of fixed wireless, which could be used as an alternative technology for delivering high-speed Internet and voice services. This could strengthen existing competitors or could result in new competitors formed by other successful bidders.
10.2 Economic fluctuations
Significant economic downturns or recessions may adversely impact TELUS
The Conference Board of Canada recently estimated Canadian real GDP growth in 2004 at 2.6%, down from 3.7% (annual rate) during the first half of 2004. During the fall of 2004, the Bank of Canada moved to reduce the amount of monetary stimulus in the economy by twice raising its target for overnight interest rates. Uncertainty concerning Canadian economic growth has increased and is related to concerns about the impact of higher oil prices on the world economy, the pace of expansion of emerging major market economies such as China and India, the current account imbalance in the United States, the removal of both monetary and fiscal stimulus in the North American economies, the appreciation of the Canadian dollar compared to the U.S. dollar, and geopolitical developments.
In an uncertain economy, residential and business telecommunications customers may delay new service purchases, reduce volumes of use and/or discontinue use of services. Significant economic downturns or recessions could adversely impact TELUS' profitability and free cash flow, realization of income tax losses carried forward, return on invested pension assets and associated pension expenses, and bad debt expense, and/or require the Company to record impairments to the carrying value of its assets, including, but not limited to, its intangible assets with indefinite lives (spectrum licences) and its goodwill. Impairments to the carrying value of assets would result in a charge to earnings and a reduction in shareholders' equity, but would not affect cash flow.
10.3 Financing and debt requirements
TELUS' business plans and growth could be negatively affected if existing financing is not sufficient
TELUS may finance future capital requirements with internally generated funds as well as, from time to time, borrowings under the unutilized portion of its bank facility or through the issuance of securities. In May 2004, new four-year term and 364-day bank facilities were established for $1.6 billion. Continued availability of the $800 million 364-day portion of the bank facility on a revolving basis is dependent on renewal of this portion of the facility on or prior to its maturity on May 6, 2005 on terms acceptable to TELUS. There can be no assurance that the 364-day portion of the bank facility will be renewed on terms acceptable to the Company. Failing such renewal, any amount drawn by TELUS on the 364-day portion of the facility that remains outstanding on May 6, 2005 will be available only for one year on a non-revolving basis. TELUS has not borrowed under and does not currently intend to borrow under the 364-day portion of the bank facility.
Disruptions in the capital markets, increased bank capitalization regulations, reduced lending to the telecom sector, or a reduced number of active Canadian chartered banks as a result of reduced activity or consolidation could reduce capital available for corporate credits such as TELUS.
On July 26, 2002, TELUS Communications Inc. (TCI), a wholly owned subsidiary of TELUS, entered into an agreement with an arm's length securitization trust under which it is able to sell an interest in certain of its trade receivables up to a maximum of $650 million. As at December 31, 2004, TCI had received aggregate cash proceeds of $150 million. Under the program, TCI is required to maintain at least a BBB(low) credit rating by Dominion Bond Rating Service. In the event this rating is not maintained, the Company may be required to wind down the program.
TELUS' financial policy is to target an optimal net debt to EBITDA ratio of less than or equal to 2.2 times (2.1 times as at December 31, 2004) and a net debt to total capitalization policy of approximately 45 to 50% (47.9% as at December 31, 2004) and to achieve over time debt credit ratings in the range of BBB+ to A–, or equivalent (split ratings of BBB and Baa3 as at February 16, 2005). A change in credit ratings could impact TELUS' cost of and access to capital. There can be no assurance that TELUS can maintain or improve current credit ratings.
While anticipated cash flow is expected to be sufficient to meet current requirements and remain in compliance with TELUS' financial policy, these intentions could constrain TELUS' ability to invest in its operations for future growth. There can be no assurance that TELUS will reduce its debt leverage or achieve its target credit ratings on a timely basis.
On October 29, 2004, TELUS announced its intention to repurchase under a Normal Course Issuer Bid up to 14,000,000 TELUS voting and up to 11,500,000 non-voting shares, representing approximately 7.1% of TELUS' issued and outstanding shares. TELUS expects to have sufficient cash flow to meet its financial policy objectives and to fund the repurchases of its shares. While there is no current plan to change the dividend payout rate, the TELUS Board reviews its dividend level quarterly based on a number of factors including a target dividend payout ratio guideline of 45 to 55% of net earnings, and there can be no assurance that a future change will not be implemented. TELUS expects to generate material free cash flow in 2005, which would be available to, amongst other things, repurchase or redeem debt (including convertible debentures) as well as to pay dividends to shareholders, repurchase shares and increase cash balances. However, if actual results are different from TELUS' expectations, there can be no assurance that TELUS will not need to change its financing plans, including its intention to redeem its convertible debentures, repurchase shares, or pay dividends according to the target payout guideline.
10.4 Tax matters
Income tax assets may not be realized as expected
The operations of TELUS are complex and related tax interpretations, regulations and legislation pertaining to TELUS' activities are continually subject to change. The Company has significant amounts of income taxes receivable, future income tax assets, including tax loss carry forwards, and future income tax liabilities. These amounts are based on estimates by TELUS management. Potential changes to either or both the amounts and the timing of the realization of such amounts can affect the determination of net income or realization of cash in future periods.
Timing surrounding the monetization or realization of future income tax assets is uncertain, since the timing is dependent on future earnings of the Company and other events. The amounts of future income tax assets and future income tax liabilities are also uncertain, since the amounts are based upon the substantially enacted future income tax rates in effect at the time, which can be changed by governments. The amount of future income tax assets is also based upon the Company's anticipated mix of revenues among the jurisdictions in which TELUS operates, which is also subject to future events.
The timing of the collection of income taxes receivable is substantially out of the control of the Company and is dependent on expected assessments, reassessments and other processes undertaken by the Canada Revenue Agency (CRA) and other provincial tax authorities. The attest-related activities of those authorities also affect the ultimate determination of the actual amounts of income taxes receivable, future income tax assets and future income tax liabilities. Therefore, there can be no assurance that income taxes will be sheltered as anticipated and/or the amount and timing of receipt or use of these assets will be as currently expected.
10.5 Human resources
The outcome of outstanding labour relations issues may result in unanticipated increased costs and/or reduced productivity
In 2000, TELUS commenced collective bargaining with the Telecommunications Workers Union (TWU), which represents approximately 11,500 employees, for a new collective agreement in both the Communications and Mobility business segments, replacing legacy agreements from BC TELECOM and Alberta-based TELUS. As a consequence of a January 28, 2004 decision of the Canada Industrial Relations Board (CIRB), the parties were placed into binding arbitration as a process to resolve outstanding bargaining issues. On February 16, 2004, TELUS filed an application with the CIRB for reconsideration of its decision with respect to binding arbitration. At the same time, TELUS also filed an appeal of the CIRB's decision with the Federal Court of Appeal. The appeal was stayed until the CIRB rendered its reconsideration decision. On April 8, 2004, the CIRB issued its reasons for imposing the binding arbitration order. TELUS subsequently filed an amendment to its earlier reconsideration application and judicial review application to include the CIRB's April 8 decision as well. On February 2, 2005, the CIRB issued its summary reconsideration decision returning the parties to collective bargaining. TELUS is still awaiting the full reasons for the decision. In the interim, TELUS Communications Inc. (TCI) has requested that the judicial review application before the Federal Court of Appeal be stayed until the CIRB issues its full reasons for the reconsideration decision.
As the CIRB's reconsideration decision reverses the original order to offer binding arbitration, leading to the resumption of collective bargaining, this may give rise to the associated risk of reduced productivity and work disruptions at TELUS' operations. On reaching a settlement, there can be no assurance that the compensation expenses will be as planned or that reduced productivity will not occur as a result of the process. Notwithstanding the expectation that the collective bargaining process will resume, on February 16, 2005, the TWU filed an application in the Federal Court of Appeal seeking to overturn the CIRB's decision that reversed the Board's previous decision that placed the parties in binding arbitration. The operational and financial impacts of the outcome of the appeal process on the Company are not practicably determinable currently.
The TWU has filed several applications with the CIRB to further expand the existing bargaining unit beyond Alberta and B.C. In March 2001, the TWU filed an application to include TELE-MOBILE employees (i.e. non-unionized former Clearnet employees and unionized employees in the former QuébecTel Mobilité operations) in the bargaining unit. On May 21, 2004, the CIRB issued its summary Letter Decision 1088 declaring TELE-MOBILE and TCI a single employer for labour relations purposes. In addition, the CIRB held that those formerly non-unionized Clearnet employees performing work similar to that performed by unionized employees in TELUS Mobility's Alberta and B.C. operations (i.e. former TELUS Mobility West) should be included in the bargaining unit. On June 24, 2004, the CIRB issued its written reasons for its summary Letter Decision 1088. Subsequently, TCI and TELE-MOBILE filed applications for judicial review of the CIRB's TELE-MOBILE decision, which was dismissed in a decision dated December 16, 2004. TELUS Mobility applied to the Supreme Court of Canada for leave to appeal this decision in February 2005.
On February 4, 2005, the CIRB issued a further decision concerning the TELUS Mobility application. As a result of that decision, the CIRB has ordered the former QuébecTel Mobilité employees represented by the SQET to be included in the bargaining unit represented by the TWU. The CIRB has also ordered that the former QuébecTel Mobilité employees represented by the SAMT remain a separate bargaining unit continuing to be represented by the SAMT. In June 2004, TELUS Mobility signed a renewal collective agreement with SAMT, in respect of the former QuébecTel Mobilité employees, which expires on March 31, 2007. TELUS Québec also concluded a settlement with SAMT for approximately 545 Quebec-based professional and supervisory employees in wireline operations, which was ratified on February 4, 2005.
In addition to the TELE-MOBILE application, the TWU has made three further applications seeking to extend its existing TELUS bargaining unit to include non-unionized employees working at TELUS National Systems Inc. (TNS), working east of Alberta (with the exception of unionized employees working at TELUS Québec) and working at TELUS Solutions de Soutien (TSS) – one of TELUS' call centres located in Montreal. The TNS hearing concluded in October 2003 and the CIRB has not yet rendered a decision. The employees east of Alberta application was filed in November 2002, while the TSS application was filed in December 2003. To date, neither of these cases has proceeded to hearing. There can be no assurance that compensation expenses will be as planned, or that reduced productivity will not occur as a result of or following any of the decisions made by the CIRB.
Reliance on key personnel
The success of TELUS is largely dependent on the abilities and experience of its key employees. Competition for highly skilled and entrepreneurial management and other key employees is intense in the communications industry. There can be no assurance that TELUS can retain its current key employees or attract and retain additional executive officers or key employees as needed. The loss of certain key employees, or deterioration in employee morale resulting from organizational changes, unresolved collective agreements or ongoing cost reductions, could have an adverse impact upon TELUS' growth, business and profitability.
Legal and ethical compliance
TELUS relies on its employees, officers, Board of Directors, key suppliers and partners to demonstrate reasonable legal and ethical standards. TELUS has instituted for its employees, officers and Directors an ethics policy and a toll-free EthicsLine for anonymous reporting by anyone who has issues or complaints. However, there can be no assurance that these standards will be adhered to by all parties and that results will not be negatively affected.
Changing technology in data, IP and wireless may adversely affect revenues, costs and the value of assets
The rapid pace and expanding scope of technological advancements in the communications industry are expected to continue. Three of the universal characteristics of technological advancements are lower unit costs, lower operating costs and increasing flexibility. This creates opportunities for new and existing competitors to offer new services, price reductions and service differentiation to gain market share. TELUS' future success depends in part upon its ability to anticipate, invest in and implement new technologies with high levels of service and competitive prices, while maintaining network, application and customer security integrity. TELUS may be required to make more capital expenditures than are currently expected if a technology's performance falls short of expectations and if new technological opportunities occur. TELUS' earnings may also be affected if technological advances shorten the useful life of certain existing assets.
In 2004, TELUS operationalized its next generation network (NGN) infrastructure, utilizing this core strategic asset for both circuit-switched voice and a significant portion of TELUS Mobility backhaul. As well, the TELUS IP-One suite of services continues to be carried on this infrastructure. As a result, the NGN is evolving from a platform used solely for providing improved operational efficiency to one that is providing convergence at a differentiated application level. As new, IP-based managed services are conceived and operationalized, the NGN backbone will continue to provide efficient connectivity for the holistic TELUS applications infrastructure. Although select customers have already begun adopting the first applications, including managed and integrated voice, data and video solutions with secure IP virtual private network (VPN) connectivity for large corporate customers and TELUS IP-One for small and medium-sized businesses, there can be no assurance that sufficient applications will be available or accepted as planned, that competitors will not begin to launch similar services, or that the efficiencies will materialize as expected. In addition, the underlying infrastructure supporting TELUS IP-One and other managed IP applications may be subject to accelerated technology rollover if advances are made in this infrastructure.
Reliance on systems and information technology (IT) may cause operational problems and financial exposures
TELUS, as a complex telecommunications company, is reliant on many legacy and new IT systems and applications such as billing systems, customer relationship management software, order entry and service systems, and network customer service. The value of IT assets could be negatively affected if the cost of IT solutions is uneconomic, legacy systems fail, projects to integrate systems and applications or introducing new systems and software are not effective, and/or third-party suppliers fail to or do not meet their performance or delivery obligations.
The Company is presently undertaking a transformational billing initiative to re-engineer processes in the Communications segment for order entry, pre-qualification, service fulfillment and assurance, customer care, billing, 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.
The digital protocols and technologies utilized by TELUS Mobility may become technologically inferior
The wireless industry continues to expand the deployment of second (2.5G) and third generation (3G) technologies to deliver increased data speeds required for many new wireless, IP and data services. TELUS Mobility's Mike service uses the iDEN technology protocol and has operated 2.5G packet data capability and service offerings for over three years. TELUS Mobility continues to support and market 1X protocol 3G services on its digital CDMA PCS and cellular networks. TELUS Mobility may begin enhancing its network in 2005 with the next evolution of CDMA 3G technology, namely 1XEVDO (or 1X Evolution Data Only). While the Company believes that TELUS Mobility's CDMA protocol has a reasonable and cost-effective migration path to future evolutions of higher speed technologies beyond 1XEVDO, there can be no assurance that it will be successful and timely. Work is ongoing to determine an optimal migration path for iDEN to 3G, but there can be no assurance that the selected path will be successful or that operating expenses and capital expenditures will be economical.
Furthermore, there can be no assurance that the digital wireless technologies utilized by TELUS Mobility today will continue to enjoy competitive market pricing. The pricing for handsets and network infrastructure is subject to change due to world market buying patterns and foreign exchange rates and as a result, there may be an adverse impact on TELUS' future expenditures.
TELUS' Mike digital wireless iDEN network is in part differentiated by its wide-area, high-capacity digital Push To Talk (PTT) 2-way radio dispatch services, which are marketed as Direct Connect, as well as its installed base of customer work groups. One of TELUS' major wireless competitors announced plans to launch PTT services over CDMA in 2005, and PTT capabilities continue to advance for other carriers using different technologies. In the future, there can be no assurance that TELUS' current market advantage of extensive product sales and marketing experience, and large installed base of Mike iDEN users and work groups, will be maintained. TELUS also operates a CDMA network and launched a CDMA PTT service, marketed as Instant Talk, early in 2005, which may be competitive with the iDEN technology utilized by its Mike network. There can be no assurance that successful deployment and marketing of its own or a competitive CDMA or other PTT technologies will not reduce or eliminate the competitive differentiation of TELUS' Mike network.
In 2004, CDMA operator Sprint and iDEN operator Nextel announced plans to merge their operations. It is expected that the Sprint-Nextel merger will promote greater seamless interoperability between the CDMA and iDEN networks. Although TELUS is well positioned to follow the lead of the major infrastructure developments in the U.S., there can be no assurance that interoperability or the infrastructure migration path will be successful or economical for TELUS or its customers.
Wireless technologies and protocols continue to be developed and extended for a variety of applications and circumstances, such as the Institute of Electrical and Electronics Engineers (IEEE) suite of 802 series of standards. A number of wireless technologies are capable of exploiting both licensed and unlicensed spectrum for both fixed and future mobile applications. While TELUS constantly reviews and examines such developments, and may from time to time choose to utilize a number of these technologies, there can be no assurance that these developments may not adversely impact TELUS in the future. In particular, the emergence of Wi-Fi-based handsets may have a significant impact on traditional CDMA PCS services, and this may trigger accelerated incremental investment in next generation voice infrastructures. As well, with the recent spectrum auction activity in Canada for radio spectrum for WiMax (802.16) wireless technology, significant interest was shown by TELUS' competitors in licence areas inside the TELUS ILEC (incumbent local exchange carrier) region and TELUS CLEC (competitive local exchange carrier) operations. This fixed wireless technology may be exploited by TELUS' competitors to provide alternative voice and data services, in both the fixed and mobile business segments.
Regulatory developments could have an adverse impact on TELUS' operating procedures, costs and revenues
TELUS' telecommunications and broadcasting services are regulated under federal legislation by the CRTC, Industry Canada and Canadian Heritage. The CRTC has taken steps to forbear from regulating prices for services offered in competitive markets, such as long distance and some data services, and does not regulate the pricing of wireless services. Major areas of regulatory review currently include the competitive pricing safeguards for ILEC services, such as price floors and bundling rules, and the utilization of the funds in the ILECs' deferral accounts. On February 23, 2005, the Government of Canada announced its intention to appoint a panel of eminent Canadians to review Canada's telecommunications policy and regulatory framework.
The Government indicated that it will ask the panel to make recommendations before the end of 2005 on ways to modernize Canada's telecommunications framework in a manner that benefits Canadian industry and consumers.
The outcome of the regulatory reviews, proceedings and court or Federal Cabinet appeals discussed below and other regulatory developments could have a material impact on TELUS' operating procedures, costs and revenues.
Price cap regulation
The rules for price cap regulation and local competition were announced in major regulatory decisions issued in 1997. The CRTC adopted a facilities-based competition model that encouraged competitors to invest in facilities and did not provide discounts for use of incumbent facilities. In March 2001, the CRTC began its scheduled public review of the regulatory regime for 2002 and beyond. TELUS and other incumbent telecommunications companies sought to modify the price cap regime to achieve greater pricing flexibility for regulated services. Certain CLECs requested changes to the regulatory framework that would require ILECs to provide their facilities to CLECs at large discounts. Some parties also requested that the CRTC impose penalties on the incumbent companies for failure to meet CRTC-established quality of service indicators. On May 30, 2002, the CRTC announced its decision on the regulatory framework for the second price cap period for ILECs, which established the framework for regulation of ILECs, including TELUS. This decision covers a four-year period beginning June 2002. On July 31, 2002, the CRTC released its price cap decision for TELUS Communications (Québec) Inc., which established a four-year price cap period beginning August 2002 and moved TELUS Communications (Québec) Inc. from rate-of-return regulation to price cap regulation.
The CRTC 2002 price cap decisions reaffirmed the CRTC's preferred facilities-based competition framework, which TELUS supports. The decisions did not introduce the large discounts of up to 70% for use of ILEC facilities sought by competitors, and allowed TELUS the opportunity to benefit from annual inflation-adjusted productivity improvements greater than 3.5% on most tariffed services. However, the decisions extended the regulation of local prices and service levels, reduced the ability of the ILECs to raise prices, introduced more complexity and caused a negative impact on TELUS earnings. The 2002 price cap decisions also initiated a number of implementation proceedings, some of which are still underway.
The incremental impact of these decisions was an increase in consolidated EBITDA for TELUS of $15 million for the 12-month period ended December 31, 2004, primarily as a result of a $10.2 million recovery from the deferral account of previously incurred costs for local number portability and local competition capital investments. TELUS anticipates an approximate $5 million incremental negative impact on EBITDA for 2005, primarily as a result of the 2004 recovery for local number portability and local competition costs. TELUS can give no assurance that earnings will not be further adversely affected as regulatory rules continue to be reviewed, adjusted or changed. The price cap decision also established a rate adjustment plan and associated penalties for ILECs that do not meet the quality of service standards approved by the CRTC. TELUS incurred approximately $5 million in penalties in 2004, and would anticipate a slightly lower level of penalties in 2005. TELUS' quality of service continues to improve as new systems and processes are introduced and TELUS anticipates reduced penalties in 2005. Nevertheless, TELUS has no assurance that these penalties will not significantly affect earnings in the future.
On November 16, 2004, the CRTC approved TELUS' $23.5 million total service improvement program for extending and upgrading service where required in Alberta and B.C., to be completed over four years ending in 2006. The cost of the service improvement program specific to non-high-cost bands will be recovered from TELUS' deferral account established in the 2002 price cap decisions. The cost of the service improvement program in high-cost bands will be recovered through the existing high-cost subsidy mechanism for residential service in high-cost bands. The CRTC has not yet determined how the remaining balance of the deferral account liability will be utilized.
In the 2002 price cap decisions, the CRTC established new lower prices for some digital services provided by ILECs and made those new lower prices available only to competitors. The CRTC then initiated a proceeding to consider whether ILECs should be required to provide more digital services to competitors at prices below normal tariffed rates. The proceeding to consider competitor digital network access (CDNA) service was completed in December 2003 and a decision was released on February 3, 2005. Telecom Decision 2005-6 finalized the scope of the CDNA service and the terms and conditions under which it is made available. For existing CDNA elements (link and access), TELUS will be compensated through deferral account draw downs, calculated based on the difference between retail rates on June 1, 2002 and the rates approved in Decision 2005-6. Some new elements were added to the scope of CDNA (e.g. intra-exchange service, interexchange service in metropolitan areas, and a channelization service), which are to be priced above cost plus 15%, with higher margins up to and including existing retail rates. TELUS will be compensated through the deferral account for retail digital network access (DNA) rate reductions to competitors stemming from this decision, based on the difference between retail rates today and the reduced rates provided for in the decision. The reduced rates for the new elements apply on a prospective basis. For TELUS' incumbent operations, negative retail re-pricing is primarily confined to services on legacy copper facilities and the value of TELUS' investments in higher bandwidth intra- and inter-exchange fibre facilities is preserved. Competitors seeking deeper discounted rates must remain on copper facilities. TELUS' non-ILEC wireline business can take advantage of cost savings and the additional service elements included by the decision.
Pricing safeguard review
The CRTC has initiated a proceeding to review pricing safeguards and is proposing modifications to the service bundle pricing rules as well as the introduction of a new pricing safeguard for volume and term contracts for retail tariffed services. The CRTC is also proposing to modify the imputation test that is used when ILECs propose rate decreases. If the CRTC implements the changes it has proposed to the pricing safeguards, the ILECs will have less pricing flexibility and TELUS' ability to respond to competitive pressures will be constrained. TELUS' business operations could be negatively affected by the CRTC's decision in this proceeding, which is expected in early 2005.
Terms of access
In 1999, the CRTC had ordered power companies to grant access to their power poles to cable companies at fixed rates significantly lower than the expectations of the power companies. The Federal Court of Appeal determined the CRTC did not have jurisdiction over power poles of provincially regulated power companies, and on May 16, 2003, the Supreme Court of Canada upheld that decision. TELUS may be negatively affected by this decision to the extent that it relies on power poles to deliver services to its customers, rates may escalate over time, and it has facilities placed on approximately 200,000 poles owned by power companies. As part of the follow-up process to Decision 2003-11, a proposal was made to reassign the ILECs' support structure services so as to make them available at cost-based rates (cost plus an approved mark-up). The CRTC has yet to make a determination on this proposal, which may result in a reduction of the revenues that TELUS receives for the use of its support structure facilities.
On June 30, 2003, the CRTC ruled on a proceeding to establish terms of access to tenants in multi-dwelling units (MDUs), such as office complexes and apartment buildings. Building owners were demanding substantial fees for such access. In its decision, the CRTC announced principles that allow for access by all local telephone companies to equipment and wiring in MDUs. The decision reduced considerably the uncertainty TELUS faced in gaining access to such buildings. From a financial perspective, the decision reduced TELUS' exposure to potential significantly increased costs of building access. However, on November 8, 2003, an association representing building owners was granted leave to appeal this decision by the Federal Court of Appeal. It is possible that future costs to TELUS may materialize as a result of court challenges.
In July 2003, the CRTC directed the incumbent telephone companies to provide their retail high-speed Internet services to residential customers receiving primary local telephone service from competitors upon request. The CRTC also directed the incumbent telephone companies to provide their retail high-speed Internet services to business customers receiving primary local telephone service from competitors. Previously, the provision of high-speed Internet service was directly linked to the local telephone line.
On July 14, 2004, the CRTC released Telecom Decision 2004-46, which revised the interconnection regime between local exchange carriers. The CRTC expanded the use of the bill and keep mechanism that had previously been used for the exchange of traffic between local service carriers to include toll traffic as well. In addition, the CRTC consolidated exchanges to form local interconnection regions. Under the bill and keep mechanism, all local exchange carriers terminate each other's traffic within the local interconnection region, but do not specifically compensate each other for the traffic termination functions they perform. Where the exchange of traffic between local exchange carriers is not balanced, a local carrier is compensated for terminating traffic in accordance with a mutual per-minute traffic termination scheme based on CRTC-approved cost-based tariffs.
TELUS' broadcasting distribution undertakings
On August 20, 2003, the CRTC approved applications by TELUS Communications Inc. (TCI) to operate terrestrial broadcasting distribution undertakings to serve various communities in Alberta and British Columbia. On September 9, 2003, the CRTC approved TELUS' application for a video-on-demand undertaking licence with the same terms and conditions as previously licensed video-on-demand undertakings in Canada. The licence is national in scope and extends for a seven-year term. TCI continues to test and assess this opportunity. There can be no assurance that implementation costs or projected revenues and expenses will be as planned or that a launch will in fact occur.
Voice over Internet protocol
On April 7, 2004, the CRTC initiated a proceeding to determine how voice over Internet protocol (VoIP) service will be regulated in Canada. The CRTC expressed its preliminary view that ILEC in-territory VoIP services should be subject to the same economic regulation as ILEC primary exchange services. TELUS strongly opposed the CRTC's preliminary view during the proceeding because VoIP services can be provided over any high-speed retail Internet access line and VoIP services are already available in Canada from multiple sources. If the CRTC's preliminary view is adopted, TELUS' VoIP services would have to be offered as tariffed services. There can be no assurance that the CRTC will accept TELUS' position and will not regulate VoIP services as tariffed services. The CRTC is expected to render its decision in this proceeding in 2005.
Radiocommunication licences regulated by Industry Canada
All wireless communications depend on the use of radio transmissions and therefore require access to radio spectrum. Under the Radiocommunication Act, Industry Canada regulates, manages and controls the allocation of spectrum in Canada and licenses frequency bands and/or radio channels within various frequency bands to service providers and private users. Voice and data wireless communications via cellular, SMR, ESMR and PCS systems, among others, require such licences. TELUS Mobility's PCS and cellular licences include various terms and conditions, such as: meeting certain performance levels, meeting Canadian ownership requirements, obligations regarding coverage and build-out, spending at least 2% of certain PCS and cellular revenues on research and development, annual reporting, and resale to competitors. While TELUS believes that it is substantially in compliance with its licence conditions, there can be no assurance that it will be found to comply with all licence conditions, or if found not to be compliant that a waiver will be granted, or that the costs to be incurred to achieve compliance will not be significant. Initial licence fees and annual renewal fees are payable for licences which have not been obtained via spectrum auction. There can be no assurance that Industry Canada will not seek to increase these fees in the future.
Wireless number portability
The CRTC indicated in its 2005 work plan that wireless number portability would be an issue it would be looking at in 2005. In its February 2005 budget, the Government of Canada indicated that it intends to ask the CRTC to consider the matter of wireless number portability in Canada. While TELUS anticipates that proceedings will allow for an appropriate balanced approach to the issue, there can be no assurance that TELUS will be able to implement any required changes without incurring significant additional implementation costs and/or ongoing administration costs, or that TELUS will be able to pass these costs on to Canadian consumers. There can also be no assurance that any changes would not lead to increased subscriber churn, or additional customer retention costs for TELUS.
Foreign ownership restrictions
TELUS and its subsidiaries are subject to the foreign ownership restrictions imposed by the Telecommunications Act and the Radiocommunication Act. Although TELUS believes that TELUS Corporation and its subsidiaries are in compliance with the relevant legislation, there can be no assurance that a future CRTC or Industry Canada determination, or events beyond TELUS' control, will not result in TELUS ceasing to comply with the relevant legislation. If such a development were to occur, the ability of TELUS' subsidiaries to operate as Canadian carriers under the Telecommunications Act or to maintain, renew or secure licences under the Radiocommunication Act could be jeopardized and TELUS' business could be materially adversely affected.
10.8 Process risks
TELUS systems and processes could negatively impact financial results and customer service – Billing/revenue assurance
TELUS has merged with and acquired several companies, which have a variety of billing systems and billing processes. The number of different billing systems at TELUS presents the risk that the systems and processes are not sufficiently integrated, causing unrecognized revenue leakage, billing errors in customer accounts, and the sharing of incorrect and inaccurate information. Although TELUS has a finance department that focuses on revenue assurance and increasing the accuracy and completeness of billing, the risk associated with the volume and variety of billing system transactions could result in adverse effects on TELUS' earnings.
Also, as a result of system changes, staff reduction and training requirements associated with TELUS' ongoing efficiency improvement efforts, there is potential for further impact on the operations of TELUS' internal processes involved with billing that could negatively affect TELUS' earnings.
To remain cost competitive and maintain profitability when prices are lowered by regulatory and/or competitive actions, it is important for TELUS to continue reducing costs. Beginning in 2001, and continuing through the end of 2003, TELUS introduced a multi-phased operational efficiency program aimed at improving operating and capital productivity and competitiveness. From program inception to the end of 2003, TELUS reduced its net staff by approximately 7,500 employees.
In 2004, TELUS continued to focus on enhancing its competitive position by looking at ways to further improve its operations and achieve cost synergies. In 2004, a departmental reorganization was initiated, primarily in the Communications segment information technology resources area, consolidating from 15 locations to two primary locations. Also in 2004, a reorganization was initiated in the Communications segment with the merging of two customer-facing business units. The resulting integration and consolidation aimed to improve TELUS' competitiveness as well as its operating and capital capacity. However, there can be no assurance that the financial goals and maintenance and improvement of customer service levels will be achieved. If TELUS is unable to control costs, the Company may not achieve cost competitiveness and the profitability required to be attractive to investors.
With the local price cap formula regime, certain local prices decrease by a 3.5% productivity factor less inflation until 2006. It is expected that ongoing efficiency programs are necessary in order to avoid an adverse impact on earnings.
Cost and availability of services
The availability of various data, video and voice services in CLEC regions where TELUS' wireline network is only partly available represents a significant challenge in terms of delivery deadlines, quality and cost of services. The lease of facilities from other telecommunications companies and rebilling for the use of their networks may prove to be costly and unprofitable.
10.9 Manmade and natural threats
Concerns about natural disasters and intentional threats to TELUS' infrastructure and operations
Recognizing that TELUS as a communications company is a key provider of critical infrastructure to Canada, there exists the ongoing exposure of natural disasters and intentional threats to TELUS' network, IT and physical assets. Although TELUS has robust and ongoing business continuity planning processes there can be no assurance that specific events will not impact TELUS operations.
10.10 Health and safety
Concerns about health and safety, particularly in the wireless business, may affect future prospects
Radio frequency emission concerns
Some studies have asserted that radio frequency emissions from wireless handsets may be linked to certain adverse health effects. However, the overwhelming evidence in the scientific community, as determined and published in numerous studies worldwide, supports the conclusion that there is no demonstrated public health risk associated with the use of wireless phones. Government agencies in Canada responsible for establishing safe limits for signal levels of radio devices also support the conclusion that wireless telephones are not a health risk. TELUS believes that the handsets sold by TELUS Mobility comply with all applicable Canadian and U.S. government safety standards
There can be no assurance that future health studies, government regulations or public concerns about the health effects of radio frequency emissions would not have an adverse effect on the business and prospects for TELUS. For example, public concerns could reduce customer growth and usage or increase costs as a result of modifying handsets and product liability lawsuits.
Some studies, including reports released by the Insurance Corporation of B.C. and the University of Montreal, have shown an increase in distraction levels for drivers using wireless phones while driving.
In July 2004, New Jersey and Washington, D.C. followed a precedent set by New York in 2001 by enacting bans on handheld wireless phone use by drivers. In 2002, Newfoundland & Labrador became the only Canadian jurisdiction to ban drivers' use of handheld wireless phones (as with similar bans on handheld phone use while driving, the province allows the use of hands-free wireless kits).
TELUS promotes responsible driving and recommends that driving safely should be every wireless customer's first responsibility. TELUS believes that current laws adequately address all forms of careless and negligent driving, and laws that are specific to mobile phones are unnecessary and counterproductive.
There can be no assurance that additional laws against using wireless phones while driving will not be passed and that, if passed, such laws will not have a negative effect on subscriber growth rates, usage levels or wireless revenues.
Investigations, claims and lawsuits
Given the size of TELUS, investigations, claims and lawsuits seeking damages and other relief are regularly threatened or pending against the Company and its subsidiaries. TELUS cannot predict with any certainty the outcome of such investigations, claims and lawsuits and as such, there can be no assurance that results will not be negatively impacted. See Note 16(f) of the Consolidated financial statements of TELUS.
Uncertified class action
A class action was brought August 9, 2004, under the Class Actions Act (Saskatchewan), against a number of past and present wireless service providers, including TELUS. The claim alleges that each of the carriers is in breach of contract and has violated competition, trade practices and consumer protection legislation across Canada in connection with the collection of system access fees, and seeks to recover direct and punitive damages in an unspecified amount. Similar proceedings have been filed by or on behalf of plaintiffs' counsel in other provincial jurisdictions, but plaintiffs' counsel has formally undertaken not to advance them until the Saskatchewan action has been decided.
The class action has not been certified and procedural objections to certification have been identified. TELUS further believes the claim is unsound on the merits. Should the ultimate resolution of this action differ from management's assessments and assumptions, a material adjustment to the Company's financial position and the results of its operations could result.
TELUS has been subject to federal privacy legislation, the Personal Information Protection and Electronic Documents Act (PIPEDA), since January 1, 2001. TELUS has a privacy compliance program that is overseen by a designated privacy officer. Notwithstanding this, situations might occur where personal information of a TELUS customer or employee is inadvertently collected, used or disclosed in a manner which is not fully compliant with PIPEDA, thereby exposing TELUS to the possibility of sanctions under that Act. Although management cannot predict outcomes with certainty, management believes it is unlikely that any such sanctions would be material.