management's discussion & analysis
5. results from operations
A detailed discussion of operating results for 2005
5.1 Selected annual information
The following selected three-year consolidated financial information has been derived from and should be read in conjunction with the Consolidated financial statements of TELUS for the year ended December 31, 2005, and its annual Consolidated financial statements for previous years. Certain comparative information has been restated on a basis consistent with the 2005 presentation.
Some significant changes over the three years included:
- Wireless segment revenues increased to approximately 40% of consolidated revenues in 2005 (approximately 37% in 2004 and 33% in 2003). This reflects wireless revenue growth rates of 15 to 17% in each of the last two years, while wireline revenue growth was 0 to 1.5% in each of the last two years.
- Consolidated operations expenses in 2005 included the effects of a four-month work stoppage including incremental expenses of approximately $133 million net of cost savings. These incremental costs primarily affected the wireline segment.
- Financing costs in 2005 included two significant one-time expenses totalling $51.0 million, as discussed in Section 5.3 Consolidated results from operations.
- Net income included significant favourable impacts for the settlement of prior years’ tax matters and consequential adjustments. The amounts were approximately $65 million (18 cents per share) in 2005, approximately $73 million (21 cents per share) in 2004, and approximately $72 million (20 cents per share) in 2003.
5.2 Quarterly results summary
The trend in consolidated Operating revenues continued to reflect strong wireless growth resulting from an increased subscriber base and increased average revenue per subscriber unit (ARPU). TELUS’ wireline segment revenue growth slowed in the second half of 2005, due in part to the work stoppage and increased competitive activity. The wireline revenue growth continues to be generated from data revenues, partially offset by reduced voice long distance revenues and voice equipment sales. Wireline segment revenues include the impacts of regulatory price cap decisions.
Net income and earnings per share for the second, third and fourth quarters of 2005 were impacted by increased net expenses leading up to and resulting from the labour disruption, as described earlier. In addition, financing costs in the fourth quarter of 2005 included a one-time $33.5 million pre-tax loss on early redemption of debt, while in the second quarter of 2005, a one-time $17.5 million pre-tax provision was recorded for estimated damages stemming from an Ontario Court of Appeal ruling. See Section 10.10 Litigation and legal matters. Aside from the effects of the work stoppage and one-time financing costs, the trend in Net income and earnings per share reflected improved operating profitability and lower interest on long-term and short-term debt.
There is significant fourth quarter seasonality in terms of wireless subscriber gross additions, related acquisition costs and equipment sales, and to a lesser extent, wireline high-speed Internet subscriber gross additions. For a more detailed discussion of fourth quarter results, refer to TELUS’ fourth quarter press release, including Management’s discussion and analysis.
Net income and earnings per share for seven of the quarters included net favourable impacts for the settlement of prior years’ tax matters and consequential adjustments, as shown in the table below:
On February 15, 2006, the Board of Directors of TELUS declared a quarterly dividend of 27.5 cents per share on outstanding Common and Non-Voting Shares payable on April 1, 2006 to shareholders of record on the close of business on March 10, 2006.
5.3 Consolidated results from operation
Consolidated Operating revenues increased by $561.5 million in 2005, when compared with 2004, primarily as a result of strong revenue growth in the wireless segment as well as growth in wireline segment data revenues. Consolidated EBITDA increased by $204.7 million in 2005, when compared with 2004, as a result of improved wireless profitability, partly offset by the effects of the labour disruption.
The increase in employees was primarily from the acquisition of Ambergris in February 2005, which had approximately 3,200 employees at the end of 2005, as well as growth at TELUS Mobility to support a larger subscriber base.
For further detail by segment, see Section 5.4 Wireline segment results and Section 5.5 Wireless segment results.
Depreciation and amortization
Depreciation increased in 2005, when compared with 2004, due primarily to growth in shorter life data and wireless network assets and a reduction in service lives for ADSL (high-speed Internet) customer equipment, partly offset by lower depreciation arising from full amortization of older cell sites. Amortization of intangible assets decreased in 2005, when compared with 2004, as a result of several software assets becoming fully depreciated partly offset by a $5.0 million write-down of an intangible right, related to termination of an indefeasible right-of-use contract for fibre, in the third quarter of 2005.
Other expense includes charitable donations, accounts receivable securitization expense, gains and losses on disposal of property, and income (loss) or impairments in equity or portfolio investments. Charitable donations were approximately $9 million in 2005, an increase of approximately $2 million, when compared with 2004. The accounts receivable securitization expense was $7.3 million in 2005, or approximately $3 million higher than 2004, as a result of the $350 million increase in proceeds from securitized accounts receivable on November 30, 2005 (see Section 7.6 Accounts receivable sale). The balance of other expense in both years included losses and impairments in equity and portfolio investments, net of gains from the sale of real estate. Gains on real estate in 2005 included recognition of a portion of gain deferred under sale and leaseback arrangements for administrative properties sold in 2002, following the return of some space to the respective landlords. The balance of other expense in 2004 also included a write-off of approximately $5 million of accumulated acquisition costs for the expired offer to purchase Microcell.
In 2005, Financing costs included two significant one-time items. The first item was the second quarter accrual for estimated damages stemming from a June Ontario Court of Appeal ruling on litigation affecting TELUS Communications Inc. (TCI). This ruling related to a BC TEL bond redemption matter dating back to 1997. See Section 10.10 Litigation and legal matters. The second one-time item was a loss on redemption of long-term debt recorded when the Company exercised its right to early redeem, on December 1, 2005, the remaining $1.578 billion of 7.50%, Series CA, Notes outstanding. The loss on redemption amount included the loss that arose from the settlement of the financial instrument that was an interest rate hedge associated with the debt redeemed on December 1. The loss on redemption was lower than the interest expense that would have been recorded over the remaining term of the debt.
Aside from these one-time items, interest on long-term debt decreased by $29.0 million, when compared with 2004. This included approximately $10 million lower interest expense in December 2005 as a result of the early redemption. The remaining decrease was primarily due to the repayment of TCI Debentures and Medium-term Notes in 2004 and conversion/redemption of convertible debentures in the second quarter of 2005. TELUS maintains a hedging program using cross currency swaps, and as a result, long-term financing costs were generally unaffected by fluctuations in the value of the Canadian dollar against the U.S. dollar. Debt (the sum of Long-term Debt, Current maturities and the deferred hedging liability) was $5,803.0 million at December 31, 2005, a 21% reduction when compared with $7,374.2 million one year earlier.
Interest income earned in 2005 includes $25.2 million interest for the settlement of various prior years’ tax matters (as compared to $26.2 million in 2004). The balance of interest income earned primarily from cash and temporary investments was $33.5 million in 2005 and $12.9 million in 2004.
The increase in the blended federal and provincial statutory income tax expense was due to 24.8% growth in income before taxes in 2005, when compared with 2004. The blended federal and provincial tax rate decreased due mainly to changes in the B.C. tax rate. The B.C. provincial government enacted a reduction to general corporate income tax rates from 13.5% to 12.0% on income taxed in B.C., effective July 1, 2005. The change in the B.C. tax rate also required a revaluation of the future tax liability and the future tax asset, resulting in a further net recovery of $12.8 million, recorded in the third quarter of 2005. The Quebec provincial government substantially enacted an increase to general corporate income tax rates from 8.9% to 11.9% to be phased in over four years beginning January 1, 2006. The prospective increases in the Quebec tax rate required a revaluation of the future tax liability and the future tax asset, resulting in a net expense of $7.7 million in the fourth quarter of 2005. Reductions in tax also included changes in estimates of available deductible differences in prior years and a tax rate differential and consequential adjustments from the favourable reassessment of prior years’ tax issues.
Based on the assumption of the continuation of the rate of TELUS earnings, the legal entity structure and the first quarter of 2006 reorganization of TELUS, and no substantive changes to tax regulations, the Company expects to be able to fully utilize its non-capital losses before the end of 2007. The Company’s assessment is that the risk of expiry of such non-capital losses is remote. Based on a review of the Company’s tax position, any material current income taxes recorded in 2006 are not expected to be paid until 2008.
Other items
Non-controlling interest represents minority shareholders’ interests in several small subsidiaries, including minority shareholders’ interest in Ambergris, acquired in February 2005.
Preference and preferred dividends ceased with the redemption of all of the publicly held TELUS Communications Inc. Preference and Preferred Shares, completed on August 3, 2004.
5.4 Wireline segment results
Operating revenues – wireline segment
Key operating indicators – wireline segment
Wireline revenues increased by $71.7 million in 2005, when compared with 2004, as growth in data services revenue significantly exceeded long distance revenue erosion and lower voice equipment sales.
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Voice local revenue increased by $28.7 million in 2005, when compared with 2004, as regulatory recoveries and the effect of business rate increases implemented June 1, 2005 were partly offset by the effect of continued line losses and a one-time regulatory recovery in 2004. Regulatory recoveries in 2005 included approximately $50 million drawn from the price cap deferral account to offset mandated additional discounts for competitive digital network services (in basic data services) pursuant to CRTC Decision 2005-6. This adjustment was required because TELUS used the liability method for recording price cap deferrals. See the discussion below for data revenues, which contains the equal and offsetting negative revenue impact for Decision 2005-6. Another regulatory recovery affecting 2005 results was a one-time positive $6.4 million recorded in the first quarter of 2005 for CRTC Decision 2005-4 (pertaining to subsidy requirements for high cost serving areas in TELUS Québec ILEC territory for 2003 to 2005). In 2004, a $10.2 million regulatory recovery was recognized in the second quarter (in respect of CRTC Decision 2004-42 pertaining to deferral account recognition items).
The increase in residential line losses in 2005, when compared with 2004, was due to increased competition from resellers, VoIP competitors (including the introduction of cable telephony in Calgary, Edmonton, Rimouski and Victoria), technological substitution to wireless services, lower numbers of second lines resulting from migration of dial-up Internet subscribers to high-speed Internet, and the labour disruption. The trend of declining residential network access lines may worsen in the future due to increased competition facilitated by cable telephony launches in January 2006 into Vancouver and likely into additional regions in the future. Net business line losses in 2005 improved from 2004 due to growth in non-incumbent regions partly offsetting competitive losses and migration to more efficient ISDN (integrated services digital network) services in ILEC regions.
- Voice long distance revenues decreased by $32.9 million in 2005, when compared with 2004. The decrease is consistent with industry-wide trends of strong price competition and technological substitution. The 3.6% rate of revenue erosion for the full year of 2005 improved from the 4.1% rate of erosion experienced in 2004, because of increased minute volumes (including growth in non-incumbent volumes) as well as an increase in the monthly long distance administration fee in certain long distance plans. This was despite continued decreases in average per-minute prices arising from strong competition as well as reduced call centre winback activity in the second half of the year because of the labour disruption.
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Wireline segment data revenues increased by $117.0 million in 2005, when compared with 2004. This included an aggregate increase of approximately $59 million from two recent acquisitions (Ambergris in February 2005 and ADCOM in late 2004).
Data revenue growth that was not attributable to acquisitions was approximately $58 million in 2005. This growth was primarily due to: (i) increased Internet, enhanced data and hosting service revenues of approximately $79 million as a result of traction from new business contracts, continued growth in high-speed Internet subscribers and a higher average price; (ii) increased managed data revenues from the provision of business process outsourcing services to customers; and (iii) increased data equipment sales. These increases were partly offset by the additional discounts for competitive digital network services of approximately $50 million recorded in basic data services, mandated by CRTC Decision 2005-6, as well as migration to enhanced data services. The increase in data revenues from acquisitions described above was substantially offset by these additional discounts in the same periods.
The rate of growth in high-speed Internet subscribers has slowed, as expected, from that observed in 2004 due to the high existing household penetration rates for high-speed Internet services in Western Canada and lower gross additions caused by increased competitive activity and the labour disruption, mitigated in part by fewer deactivations of existing customers. In addition, the Company had experienced high net additions in the first quarter of 2004 due to a very attractive introductory marketing promotion of limited duration.
- Other revenue decreased by $34.9 million in 2005, when compared with 2004, due mainly to lower voice equipment sales. In addition, an increase in the provision for expected retail and competitive quality of service penalties was made for lower service levels resulting from the work stoppage. The Company expects to apply to the CRTC in 2006 for an exemption from quality of service penalties related to the work stoppage.
- Intersegment revenue represents services provided by the wireline segment to the wireless segment. These revenues are eliminated upon consolidation together with the associated expense in the wireless segment.
Total external operating revenue discussed above included non-ILEC revenues of $631.6 million in 2005, an increase of $70.9 million or 12.6% when compared with 2004. The increase was a result of revenues from the purchase of ADCOM and growth in data service revenues, partly offset by competitive pricing pressures on voice services.
Operations expense – wireline segment
Operations expense increased by $166.5 million in 2005, when compared with 2004. The increase was due primarily to activation of emergency operations procedures to minimize the impact on customer services during the labour disruption. As a result, customer service was maintained at higher than anticipated levels. Increased temporary expenses associated with the labour disruption included: management reassignments, overtime, third-party security and contractor costs, travel and accommodation, and lower capitalization of labour, which exceeded savings in compensation for employees who were not working, and a revision to the labour settlement estimate. Expenses increased by $49 million in aggregate due to acquisitions (ADCOM in late 2004 and Ambergris in February 2005). The addition of a contract in late 2004 to provide payroll services to the B.C. government, as well as two new human resource services contracts in the fourth quarter of 2005, also contributed to increased expenses. The total number of employees, aside from those added with the acquisition of Ambergris and the new payroll and HR services contracts, was not significantly changed in 2005.
- Salaries, benefits and employee-related expenses decreased by $36.6 million in 2005, when compared with 2004. The decrease was due primarily to lower compensation expenses for employees who stayed off work and adjustments to accruals for payroll and other employee-related expenses, partly offset by increased expenses due to acquisitions and new contracts for the provision of payroll and human resources services described above, as well as increased compensation. The expense for defined benefit pension plans decreased by approximately $16 million for the year due to favourable returns on plan assets more than offsetting the negative impact of a lower discount rate for 2005, when compared with 2004.
- Other operations expenses increased by $203.1 million in 2005, when compared with 2004. The increase was due primarily to temporary expenses incurred during the labour disruption, such as increased third-party security and contractors. Increased expenses of approximately $43 million for the year were recorded due to lower capitalization of labour resulting from deferral of capital expenditures and reassignment of staff to operational activities during the labour disruption. Expenses also increased as a result of acquisitions and the new contracts for the provision of payroll and human resources services described above, and increased product and service cost of sales associated with higher data equipment sales. Otherwise, expenses decreased as a result of: (i) nominal payments to Verizon under the renegotiated Software and Related Technology and Service Agreement, compared with approximately $33 million in 2004; (ii) reduced facilities, transit and termination costs of approximately $22 million due to the movement of traffic on-net and price cap discounts from competitor ILECs arising from CRTC Decision 2005-6, partly offset by higher outbound traffic volumes; and (iii) a lower bad debt expense of approximately $10 million due to lower credit risk and continued improvement of collection practices that have reduced credit loss exposure.
Included in the total segment expenses discussed above are non-ILEC operations expenses of $610.4 million in 2005, an increase of $27.5 million or 4.7%, when compared with 2004. The increase in operations expense supported growth in non-ILEC revenues for the same period.
Restructuring and workforce reduction costs – wireline segment
General
In 2005, the Company undertook a number of smaller initiatives within the ILEC portion of the wireline segment, such as operational consolidation, rationalization and integrations. These initiatives are aimed at improving the Company’s operating and capital productivity. As at December 31, 2005, no future expenses remain to be accrued or recorded under the smaller initiatives substantially completed in 2005, but variances from estimates currently recorded may be recorded in subsequent periods. The Company’s estimate of restructuring and workforce reduction costs in 2006, arising from its competitive efficiency program, which includes the office closures and contracting out and integration of wireline and wireless operations, does not currently exceed $100 million. See Forward-looking statements at the beginning of Management’s discussion and analysis.
Office closures and contracting out
In connection with the collective agreement signed in the fourth quarter of 2005, as further discussed, an accompanying letter of agreement set out the planned closure, on February 10, 2006, of a number of offices in British Columbia. This initiative is aimed to improve the Company’s operating and capital productivity and is a component of the Company’s competitive efficiency program. The approximately 250 bargaining unit employees affected by these office closures were offered the option of redeployment or participation in a voluntary departure program (either the Early Retirement Incentive Plan or the Voluntary Departure Incentive Plan).
Similarly, an additional accompanying letter of agreement set out that the Company intends to contract out specific non-core functions over the term of the collective agreement. This initiative is aimed at allowing the Company to focus its resources on those core functions that differentiate the Company for its customers and is a component of the Company’s competitive efficiency program. The approximately 250 bargaining unit employees currently affected by contracting out initiatives were offered the option of redeployment or participation in the voluntary departure program (either the Early Retirement Incentive Plan or the Voluntary Departure Incentive Plan).
As at December 31, 2005, no future expenses remain to be accrued or recorded under the letter of agreement setting out the planned closure of a number of offices in British Columbia, but variances from estimates currently recorded may be recorded in subsequent periods. Other costs, such as other employee departures and those associated with real estate, will be incurred and recorded subsequent to December 31, 2005.
As at December 31, 2005, no future expenses remain to be accrued or recorded under the letter of agreement setting out the contracting out of specific non-core functions, in respect of the approximately 250 bargaining unit employees currently affected, but variances from estimates currently recorded may be recorded in subsequent periods. Future costs will be incurred as the initiative continues.
Integration of wireline and wireless operations
On November 24, 2005, the Company announced the integration of its wireline and wireless operations, an initiative that will continue into future years and that is a component of the Company’s competitive efficiency program. During the year ended December 31, 2005, $3.0 million of restructuring and workforce reduction costs were recorded in respect of this initiative and were included with general programs initiated in 2005.
EBITDA and EBITDA margin – wireline segment
EBITDA decreased by $96.1 million in 2005, when compared with 2004. The primary causes included temporary expenses associated with maintaining operations during the labour disruption, emergency operations planning expenses prior to July 21, increased restructuring charges and flat revenues in the second half of 2005, despite improved non-ILEC profitability. Included in these results were net labour disruption related expenses of approximately $133 million for the full year. Non-ILEC EBITDA was $21.2 million in 2005, compared with $(22.2) million in 2004.
Wireline segment capital expenditures are discussed in Section 7.2 Cash used by investing activities.
5.5 Wireless segment results
Operating revenues – wireless segment
Key operating indicators – wireless segment
Wireless segment Network revenue increased by $464.7 million in 2005, when compared with 2004. Wireless Network revenue for 2005 was a record for TELUS. This growth was a result of the 14.8% expansion of the subscriber base combined with a $2 increased average revenue per subscriber unit per month (ARPU). The ARPU growth can be attributed to increased data usage including text messaging, mobile computing and downloads as well as higher voice revenues related to increased roaming, features and average minutes of use per subscriber per month (MOU).
At December 31, 2005, postpaid subscribers represented 81.1% of the total cumulative subscriber base, remaining relatively stable from one year earlier and contributing to the significant ARPU premium attained over TELUS’ competitors. Despite the commercial launch by new competitors in the prepaid market, the wireless segment achieved significant growth in prepaid net subscriber additions primarily as a result of a successful offering of the Talk Away bundle. Consequently, total subscriber net additions of 584,300 for the full year of 2005 represented an annual record for the wireless segment.
Blended postpaid and prepaid monthly churn rates improved slightly in 2005, when compared with 2004. This is a significant accomplishment in the context of the challenges from labour disruptions, new competition, and other aggressive prepaid and Push To Talk offerings. Deactivations were 694,700 in 2005 as compared with 608,300 in 2004. The monthly churn rate has improved steadily during 2005. These churn and deactivation results reflect a continued focus on customer care including successful loyalty and retention efforts, enhanced product offerings and superior network quality.
- Equipment sales, rental and service revenue for the full year of 2005 increased mainly due to continued subscriber growth. Gross subscriber additions grew to 1,279,000 in 2005 as compared with 1,120,700 in 2004. Handset revenues associated with gross subscriber activations are included in COA per gross subscriber addition.
- Intersegment revenues represent services provided by the wireless segment to the wireline segment and are eliminated upon consolidation along with the associated expense in the wireline segment.
Operations expense – wireless segment
Wireless segment operations expense increased in 2005, when compared with 2004, to support growth in the subscriber base. The wireless segment continued to achieve economies of scale as total 2005 operations expenses increased by only 10.9%, while the corresponding Network revenue growth was 17.9% and year-over-year subscriber growth was 14.8%.
- Expenses related to equipment sales increased in 2005, when compared with 2004, principally due to an increase in gross subscriber activations, higher handset costs from a shift in product mix and increased retention activity. Handset costs associated with gross subscriber activations are included in COA per gross subscriber addition.
- The decrease in Network operating expenses in 2005, when compared with 2004, was a result of efforts to improve roaming rates and reduce leased line costs through microwave build, as well as scale efficiencies, and the competitive digital network services discounts arising from CRTC Decision 2005-6. In addition, the fourth quarter of 2005 included a $5.3 million credit related to years 2003 to 2005, which reflected the December 6, 2005 Federal Court ruling that TELUS not be required to include wireless revenues in the calculation of telecommunications fees payable to the CRTC. These decreases were partly offset by increased transmission and site-related expenses to support the greater number of cell sites, a larger subscriber base, and improved network quality and coverage. The digital population coverage grew to 30.6 million at December 31, 2005, as a result of continued activation of digital roaming regions and network expansion.
- Marketing expenses in 2005 increased primarily due to higher dealer compensation costs, expenses associated with the expanded subscriber base, increased advertising and promotions costs and increased re-contracting activity. COA per gross subscriber addition improved by $3 to $386 for the full year of 2005, when compared with the same period in 2004. With the higher ARPU and lower churn rate, COA per gross subscriber addition expressed as a ratio of the lifetime revenue of the subscriber improved for the full year of 2005 as compared with the same period in 2004.
- General and administration expenses increased by 12.1% in 2005, when compared to 2004, due to the increase in employees to support the significant growth in the subscriber base and continued expansion in the number of Company-owned retail stores. For the full year, the impact of additional labour disruption-related costs was offset by the payroll savings from fewer active employees during the labour disruption.
EBITDA and EBITDA margin – wireless segment
Wireless segment EBITDA increased by $300.8 million in 2005, when compared to 2004. Despite the labour disruption, the improvement in EBITDA and EBITDA margin in 2005 was attributed to the wireless segment’s focus on profitable subscriber growth, increased ARPU, a lower COA per gross subscriber addition, excellent monthly churn rates, and successful cost containment efforts. The EBITDA margin, when calculated as a percentage of Network revenue, improved to 47.1% in 2005, compared with 43.9% in 2004, representing an increase of 3.2 percentage points.
Wireless segment capital expenditures are discussed in Section 7.2 Cash used by investing activities.