management's discussion & analysis
1. overall performance
A summary of 2005 consolidated results and a description of performance against annual targets set for 2005
1.1 Materiality for disclosures
Management determines whether or not information is material based on whether it believes a reasonable investor’s decision to buy, sell or hold securities in the Company would likely be influenced or changed if the information were omitted or misstated.
1.2 Canadian telecommunications market
Canadian real GDP (gross domestic product) growth was recently estimated at 2.8% in 2005 by the Conference Board of Canada. Canadian wireless industry revenues grew by approximately 16% as market penetration for the industry increased by approximately five percentage points. TELUS’ wireless segment, carrying on business as TELUS Mobility, achieved 17% revenue growth in 2005 and its largest ever wireless subscriber net additions of 584,300. Price competition and technological substitution of voice services to wireless and Internet contributed to further softness in Canadian wireline industry revenues, estimated to have been flat in 2005. TELUS’ wireline segment revenues grew by 1.5% in 2005.
Voice over Internet protocol (VoIP) services became an important competitive factor in the wireline consumer market in 2005. TELUS’ major cable-TV competitors began to offer VoIP telephony in the Company’s incumbent territories, while other VoIP competitors expanded their offerings. At the end of 2005, the Company began a limited commercial launch of TELUS TV services following extended employee-based trials. The business market is also increasingly adopting Internet protocol (IP) and managed services as a means of achieving operational efficiencies and improving revenue generation. Wireless resellers entered the prepaid market in 2005. Technology also continues to evolve, both increasing the Company’s opportunities and facilitating increased competition. See Risks and risk management Sections 10.1 Competition and 10.2 Technology for the discussion of competitive and technology risks facing TELUS.
1.3 Consolidated highlights
Despite the labour disruption experienced in Western Canada from late July to late November of 2005, solid growth in consolidated Operating revenues was achieved, with wireless segment revenues increasing by 17% for the full year. Wireline segment revenues increased by 1.5% for the full year, as growth in data revenues more than offset the decline in voice long distance and equipment revenues. The increase in consolidated EBITDA resulted from improved wireless profitability, partly offset by a temporary increase in wireline expenses in order to maintain operations during the labour disruption. The 6.6% growth in consolidated EBITDA was the primary contributor to $224.1 million higher Operating income in 2005, when compared with 2004. The net effect of the labour disruption was estimated at approximately $133 million additional operations expense in 2005.
Net income and earnings per share increased for the full year of 2005, when compared with 2004, due primarily to increased Operating income, partly offset by one-time financing costs arising from the early redemption of $1.578 billion Canadian dollar Notes on December 1, 2005.
Cash provided by operating activities increased by $376.5 million in 2005, when compared with 2004. The increase was primarily from the receipt of $350 million additional proceeds from securitized accounts receivable on November 30. Free cash flow increased because of improved EBITDA, lower payments under restructuring programs and higher interest received, partly offset by lower cash tax recoveries.
Effect of the labour disruption on TELUS operations during 2005
TELUS 2005 results were affected by a labour disruption that commenced on July 21 and concluded following the ratification of a collective agreement on November 18 (see Reaching a collective agreement in Section 3.1 Corporate priorities for 2005). Revenue grew at a slower pace in the second half of the year due in part to the work stoppage and increased competitive activity. However, the recent increase in competition for local residential telephony services by resellers, cable-TV companies, and other competitors offering VoIP services makes it difficult to fully separate the competitive effects from the impacts of the labour disruption on wireline revenues and subscribers. Reduced availability of field resources resulted in the Company giving priority to repair activities, and business and data services, which limited installations of residential access lines.
Significant emergency operations planning costs were incurred in the second quarter. With the labour disruption beginning in July, emergency operations procedures were put in place to maintain customer service at the highest possible level. The labour disruption was most evident in British Columbia, where all unionized employees were not at work for the duration of the labour disruption. A sizeable number of bargaining unit employees were working in Alberta. There was no labour disruption in the Ontario and Quebec operations, but additional costs were incurred for extra workload in areas such as call centres. Incremental expenses that arose from emergency operations procedures included management reassignments, paid overtime, third-party security and contractor costs, travel and accommodation and reduced capitalization of labour. These incremental expenses exceeded cost savings, such as those arising from lower compensation expenses for employees who stayed off work and adjustments to accruals for payroll and other employee-related expenses, as shown in the table that follows.
With ratification of the new collective agreement, and the return to work of TELUS team members by early December, certain capital spending resumed, and in fact increased, in the fourth quarter of 2005, when compared to the same period in 2004. For the full year of 2005, capital expenditures were still lower than originally planned, due to deferral of some construction activities, while the balance of assets under construction rose due to delays in completion of in-progress work.
The new five-year agreement provides increased operating flexibility and productivity, while facilitating better service for customers in an increasingly competitive marketplace. It fosters a performance culture with universal variable incentive pay, when performance metrics are met, and promotions that are based on performance as well as seniority. The agreement also establishes a new paradigm. For example, the Company and union agreed to work together to withdraw various types of lawsuits between the parties. As well, a Common Interest Forum has been established as a mechanism for co-operation and dialogue.
1.4 Performance scorecard for 2005 results
TELUS’ original targets for 2005 did not include the impacts of the four-month work stoppage. Despite this, the majority of the original targets were achieved or exceeded as a result of being ahead of plan early in the year. Guidance was revised for selected items in the interim reports for the first, second and third quarters (released in May, August and November, respectively), as well as the December 16, 2005 announcement of 2006 targets. Generally, guidance revisions were improvements from the original targets or narrowing of guidance ranges. All of the final guidance items were achieved. See Section 9 Looking forward to 2006 for the 2006 targets announced on December 16, 2005.
- The original target for consolidated revenues was exceeded because of strong wireless average revenue per subscriber unit per month (ARPU) and subscriber growth, as well as growth in wireline data revenues.
- The original targets for consolidated and wireline EBITDA were achieved, while the original target for wireless EBITDA was exceeded. Guidance for wireline segment EBITDA was revised upward in the first quarter to $1.875 billion to $1.925 billion based on being ahead of plan at the time, but this higher range was not achieved as a result of the work stoppage. Guidance for wireline EBITDA was lowered in the third quarter to $1.8 billion to $1.875 billion to reflect the net effects of the work stoppage somewhat offset by lower restructuring charges, and updated in December to narrow the expected range to $1.84 billion to $1.865 billion.
- The guidance for consolidated capital expenditures was revised in May to approximately $1.4 billion due to an expected increase in the wireline segment. The expectation was subsequently reduced in November to approximately $1.3 billion as a result of the work stoppage. Guidance for wireline capital expenditures increased to the upper end of the target range of approximately $1.0 billion in May, and was subsequently reduced to approximately $900 million in November. The original consolidated target was achieved.
- The original target for free cash flow was exceeded because of lower capital expenditures and higher wireless EBITDA.
- The target for high-speed Internet subscriber net additions was not achieved, as the work stoppage limited gross additions of subscribers and increased competitor activity, particularly in the third quarter. Guidance was lowered to approximately 65,000, while competitive activity increased in the second half of 2005. In December, the guidance was revised to more than 65,000, which was achieved.
- The original target for wireless subscriber net additions was exceeded due to successful wireless marketing, as well as the fact that the Canadian wireless industry market penetration increased by approximately five percentage points rather than the approximately four percentage points originally anticipated.
