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2007 Targets investor conference call - Q & A transcript
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John Wheeler: Just before I turn the call over to Ron to conduct the Q&A session, can I ask your cooperation for one question at a time please. Ron, please proceed.
Operator: (OPERATOR INSTRUCTIONS) Greg MacDonald from National Bank Financial.
Q1. The question is on the wireless guidance change for 2006, a little bit lower than the November time frame. So things have changed a little bit, I guess, with respect to the competitive environment. I wonder, Bob, if you just might talk a little bit about that.
Is this an advertising/promotional activity change that you have seen in the marketplace? Is it a mix issue? What has changed from November to cause you to bring down the guidance a little bit for the 4Q? (Greg MacDonald - National Bank Financial - Analyst )
Q2. My question is on the wireline side. I was wondering if you could give us a little bit more color on the kind of dilutive initiatives? I know DSL growth is stepping up. But when you even normalize for restructuring costs, it still seems like your guidance EBITDA margins are down 100, 200 basis points even in the face of labor disruption costs last year. So I wanted a little bit more color there.
Then also, if you could expand on kind of your thoughts on the competitive environment affecting access line erosion in '07. Thank you. ( Marje Soova - Goldman Sachs - Analyst )
Q3. A question on capex, Bob. Your spending continues to be quite a bit ahead of any other phone company in Canada, close to 25% intensity on the wireline side. I acknowledge you have a better revenue and EBITDA growth profile, and you have a stronger economy in the West. But I think there is a lot of concern amongst investors as to what return you're going to get on these capex dollars. So I am hoping you can break it down in some more granularity as to why the spending is so much more -- maybe into some of the buckets in terms of the billing system, the fiber build, and other projects, to give us some more clarity and comfort that that money is going to good use. ( Vince Valentini - TD Newcrest - Analyst )
Q4. I wonder if you could give us just a little more detail around the option settlement. Should we regard this as sort of a one time item? Do employees -- will they have the option of cashless exercise? Or can they still buy shares in the market? I guess what I am trying to do is see what this might do to years beyond 2007. Thanks. (Glen Campbell - Merrill Lynch - Analyst )
Q5. A question to do with your dividend and balance sheet ratio targets. Your dividends, your own EPS guidance next year normalizes 43% to 46%. I know you're guiding 45 to 55, so you could say you are at the low end. But why so low? Your peer group is a lot higher. Obviously the market seems to applaud big dividend payounts, as shown by the Bell stock price movement on Tuesday. Not necessarily a reason to do, but if you could address.
Q6. I would like you to talk us through this, how you managed to defer taxes for yet again another year. That is good news. Is it solely, as Glen alluded to, as a result of this option expense accounting? Or is there something else going on here?
Q1. The question is on the wireless guidance change for 2006, a little bit lower than the November time frame. So things have changed a little bit, I guess, with respect to the competitive environment. I wonder, Bob, if you just might talk a little bit about that.
Is this an advertising/promotional activity change that you have seen in the marketplace? Is it a mix issue? What has changed from November to cause you to bring down the guidance a little bit for the 4Q?
Bob McFarlane: It is a little hard to tell, Greg. As you know, information is a little imperfect as we sit here in the middle of December. I don't know exactly what the competitors are doing, in terms of their adds or whatever. But I think it is fair to say what has changed is we haven't got quite the ramp up that we were formerly expecting for the Christmas selling season. I think that reflects the discount brands that are out there in the marketplace.
Greg MacDonald: Okay, is it an issue that --? I noted that Bell on its investor day talked about focusing a lot more on its Solo brand, in terms of the way that it is going up against Fido. Had been any thought inside TELUS to coming out with a specific brand focused at that sort of lower-end discount product?
Bob McFarlane: Well, we have resisted doing that to date. As you know, we're kind of going the opposite way for next year in terms of launching a premium brand, the Amp'd Mobile brand. So it is more consistent with our traditional philosophy of trying to maximize value and that sort of thing.
As to what we may do in terms of flanker brands or not remains to be seen. But clearly you have got Bell retaliating against Rogers' price leadership by responding through the Solo brand. So I think that is a dynamic occurring this year that really wasn't there last year.
John Wheeler: Okay, Matthew. Next question, please.
Operator: Marje Soova from Goldman.
Q2. Marje Soova: My question is on the wireline side. I was wondering if you could give us a little bit more color on the kind of dilutive initiatives? I know DSL growth is stepping up. But when you even normalize for restructuring costs, it still seems like your guidance EBITDA margins are down 100, 200 basis points even in the face of labor disruption costs last year. So I wanted a little bit more color there.
Then also, if you could expand on kind of your thoughts on the competitive environment affecting access line erosion in '07. Thank you.
Bob McFarlane: Well, in regards to, I guess, dilutive initiatives really refers to the Future Friendly Home strategy and the commercialization of our TELUS TV offering, which is certainly dilutive to EBITDA in the short term although it would add to revenues. So the very nature of launching a new product offering, where it adds to revenues but it's negative EBITDA at the front end, is going to lower our margins. So that is really the dynamic that we are referring to there.
We have launched it on a limited commercial basis in various neighborhoods and the like. But we are continuing to build out the ADSL2+ technology throughout all the major urban markets in our ILEC footprint; and so hope to have a more substantive commercialization of that product offering in the market in ‘07. I think that is really the effect that we are referring to.
The other thing that is a little -- that affects it somewhat is we have had some major contract wins. The Ontario government, which is one of the largest telecom contracts in all of Canada that we were awarded a few months ago, and so the ramp up phase for that contract is 2007, and so that requires upfront investment. So as is typical of these type of contracts, it is dilutive at the front-end, but attractive over a multiyear period of the term. So those are really the two main influences that come to mind in terms of affecting the wireline margins in a downward sense.
In terms of access lines, which I think was -- if I recall -- the last part of the question, you know, access lines erosion on the residential side has certainly been a factor that we have contemplated in both the '06 plan and the '07 plan. It is a fact of reality.
We certainly have trended better than our telecom peers in North America. It is somewhat a function of how well we do, as well as how aggressive our competitors are. We aren't guiding a specific number in '07, because that would reflect maybe a little too closely what our plans are, or at least our own confidence about resiliency. But suffice to say I think the trailing trends are there, are evident, and I don't think there's any new factors that come into play.
John Wheeler : Okay, Matthew?
Operator : Vince Valentini from TD Bank.
Q3. Vince Valentini : A question on capex, Bob. Your spending continues to be quite a bit ahead of any other phone company in Canada, close to 25% intensity on the wireline side. I acknowledge you have a better revenue and EBITDA growth profile, and you have a stronger economy in the West. But I think there is a lot of concern amongst investors as to what return you're going to get on these capex dollars. So I am hoping you can break it down in some more granularity as to why the spending is so much more -- maybe into some of the buckets in terms of the billing system, the fiber build, and other projects, to give us some more clarity and comfort that that money is going to good use.
Bob McFarlane: Okay. Well, again, I guess on the wireline side, just to be clear for listeners, the expected capex next year is the same as the capex this year. So I think the question, Vince, you're asking, is if this year is high, so why is next year high, as opposed to an increase on the wireline side?
I think the first point is that we are a growth company. As a growth company, we are investing in the growth, and that is part and parcel. So if you want to have growth, you have got to invest in it. Our business model is predicated on that.
Second point goes to the fact that because of our asset mix and relatively low capex intensity on the wireless side, and the strong margins we have as a Company, we have the ability -- and we generate a lot of cash flow. That generation of cash flow means we have the ability to afford to invest in the future much more so than other companies.
We certainly are not sacrificing returns to capital shareholders. We are at all-time record and growing levels in that regard, as I pointed out.
So it really reflects the strategy again that we are a growth company. So when you make reference to other telcos in North America, which is fair, I am not aware of any other telcos in North America with our growth profile. So I think going hand-in-hand with that, if you will, is an investment capex.
As you know, under Darren's leadership, we are fully aligned with executing against our strategy, which is long-term in nature. So in the wireline side, we have significant investments going last year and the next foreseeable future. Investing in increasing the speed, capacity, and resiliency of our broadband network, as well as significant IT investments with billing system conversions that have been underway. All of those things will drive better performance in the future and better service and make us a better Company, but they certainly come at a cost of investing in capex.
So I guess the answer -- the short answer to my longwinded answer is that we are choosing to invest in the future in the wireline area, and that is consistent with our strategy. I think there is really no change in terms of '07 in that regard as compared to '06.
John Wheeler: Okay, Matthew?
Operator: Glen Campbell from Merrill Lynch.
Q4. Glen Campbell: I wonder if you could give us just a little more detail around the option settlement. Should we regard this as sort of a one time item? Do employees -- will they have the option of cashless exercise? Or can they still buy shares in the market? I guess what I am trying to do is see what this might do to years beyond 2007. Thanks.
Bob McFarlane: Yes, thanks, Glen. Well, the first thing is, my recollection is, from a Tax Act perspective, for the expense to be deductible, the option holder has to have the ability to elect either to receive in shares or cash. So the technical answer to your question is they would have the election alternative, I guess.
I think experience shows that virtually all -- not all, but in the 98, 99% territory of options are exercised for cash as opposed to shares. So in the traditional method, that means that the shares are issued upon exercise or sold on the market; so that the employee receives cash at the end of the day.
So the difference here is you're essentially bypassing the issuance of shares by amending our option plans to allow for straight cash settlement of the in-the-money value. So the deduction for cash for tax purposes is recorded in the period in which the respective options are actually exercised and therefore paid out in cash from the Company.
So in this sense, it is -- I look at it akin to an NCIB, if you will, in that where an NCIB goes out and repurchases shares, in this case we are avoiding the issuance of them in the first place. So it is the same type of a factor dynamic.
From an accounting perspective, what triggers the recording of the compensation expense under GAAP is that when you make an amendment to an existing compensation arrangement, then to the extent that the in-the-money value is higher than the original comp expense recorded when they were granted -- which is usually based on the Black-Scholes model -- then that increment has to be recorded as a compensation expense.
So in our case, because our options I think on average are somewhere around $31 in terms of a strike price, so they are significantly appreciated relative to our market price. Therefore that is what triggers the sizable non-cash accounting expense.
So to answer your question whether it is onetime, the accounting is a charge you record when you're amending the option agreement; so that will be a Q1 '07 charge. In respect of the cash tax benefit, that is reaped when the options are exercised. Given we are dealing here with vested options or soon-to-be vested options, the remaining term on them is only probably an average of just under three years, but up to another four years in total. So it's going to be over that period of time.
As to whether we would do it again, I guess we would reassess. Given that we are doing it for vested or soon-to-be vested options, then we would look at this program as options mature to becoming vested in the future. But if you look at the magnitude of what we are doing, it is -- I have not got the exact number in my mind -- but it is somewhere in the neighborhood of 85%, 90% of our outstanding options that we are really amending and intend to handle with the cash settlement program.
Therefore, from that standpoint, I can't say we are not going to take a similar action in the future; but it is substantially being done at this time.
Glen Campbell: Okay, thanks. Just a follow-up. That then pushes out your taxability. Your 2009 becomes your full tax year. Should we expect a large sort of catch-up tax payment over and above the statutory tax in '09? Or would we expect cash tax to be pretty close to statutory tax in '09?
Bob McFarlane : Yes, '09 would be an extra tax pay year; because you would have the catch-up payments from '08 and the new installments from '09. So what was formerly going to be -- I wouldn't say it is a double, but it is certainly more than the statutory amount, which we formerly expected to be the case in 2008, we now expect to be in 2009.
John Wheeler: Good, thank you. Matthew?
Operator: Dvai Ghose from Genuity Capital Markets.
Q5. Dvai Ghose: A question to do with your dividend and balance sheet ratio targets. Your dividends, your own EPS guidance next year normalizes 43% to 46%. I know you're guiding 45 to 55, so you could say you are at the low end. But why so low? Your peer group is a lot higher. Obviously the market seems to applaud big dividend payounts, as shown by the Bell stock price movement on Tuesday. Not necessarily a reason to do, but if you could address.
As far as your balance sheet is concerned, you're talking about $1.5 billion to $1.6 billion of free cash flow. You're returning as per your plan about $500 million in dividends, $800 million in NCIB; that is $1.3 billion, which suggests that your debt will be about 200 to $300 million lower at the end of '07 than the end of '06 by the plan. Which suggests to me, using your math, that your debt to EBITDA will be 1.4 to 1.5 times at the end of next year when you're about to approach taxable event.
So why are you being so conservative both on the balance sheet as well as the dividend payout, especially with a tax event that we expect in 2008?
Bob McFarlane: Well, good morning. I think first point on dividend, as you know, if you run a regression of growth CAGRs versus dividend payouts, you will find that there tends to be a correlation that higher growth companies pay lower dividend. I think that is the case when you compare our yields to some other companies that are higher. In all cases, they're companies with lower growth rates; in some cases, significantly lower growth rates. So that is the first point.
Secondly, we only just increased our dividend hardly a month ago. So I am not going to be defensive about the dividend topic.
Thirdly, on the NCIB, which is another form of return on capital, significant existing NCIB and go-forward NCIB. The dual thrust of our return on capital in the form of both dividends and NCIB provides a significant return on capital and as an element of flexibility on the NCIB front, which is beneficial.
Next point, as you know, our earnings and our cash flow have started, particularly in '06 and going forward, reaping the benefit of not only lower debt but lower refinancing rates. We have a big refinancing coming in a number of months on bond front. So the fact that we have got a prudently conservative leverage policy I think is certainly beneficial to not only debtholders but shareholders alike. So I think that is our basic thinking on the topic.
Dvai Ghose: That makes sense. Can you just remind us what the dates are for the refinancing, please?
Bob McFarlane: We have not set dates for the exact refinancing, although the notes come due by June.
Dvai Ghose: Thank you.
John Wheeler: Matthew?
Operator: Peter Rhamey from BMO Capital Markets.
Q6. Peter Rhamey: I would like you to talk us through this, how you managed to defer taxes for yet again another year. That is good news. Is it solely, as Glen alluded to, as a result of this option expense accounting? Or is there something else going on here?
I would like you to touch on what the potential is, since this is the second time that you have done this, to defer even beyond the '09 time frame into 2010; and your perspective with regards to maintaining this very high share repurchase program beyond, let's say, '07. As Dvai mentioned, you have some room to move up on your debt to EBITDA ratio if you wanted to. Thank you.
Bob McFarlane: You have given me an idea. Maybe I should put as a target for my VP tax that '09 to '10 one. I like that idea, but I certainly have no foundation to convey that. But the reality, I guess, is that the area of tax is an extremely cloudy one, in that at any time we have a significant number of audits, assessments, rulings, and so on and so forth.
So in terms of this time, the '08 to '09 deferred guidance, it is in part due to the cash tax settlement options; but that is just a smaller component of it. It is largely due to the resolution of certain audits, as well as some anticipated tax matters in 2007. The combination thereof we think will shift our tax burden by roughly -- by largely a year.
We are probably -- maybe I should have an audit of R&D tax credits, because that is not the reason to our case. But maybe I should have an audit, because I don't quite understand that one. But maybe there is something we can find out there too.
But so more or less it is really the resolution of some more significant multi-year type of assessments and audits, and the impact of those, and then projecting forward. So that is really what has occurred. Unfortunately, this is not crystal ball stuff. I know it does sound unusual, but it's a very imprecise area. We have recently had some resolution of some items that gave clarity in terms of our tax position over the next couple years, and that is a what I am reflecting in today's guidance.
Peter Rhamey: That is a great answer. With regards to allowing your debt to EBITDA -- this is related to that -- ratio drift up to the upper end of the range, to perhaps fund future share buybacks, does that makes sense provided you get through this year as expected with your guidance? You're looking at '08 with some confidence that you continue to grow?
Bob McFarlane: Yes; I mean, the way I look at it is, we have the 1.5 to 2.0 debt to EBITDA is probably the most important or most looked at leverage metric by agencies or investors. Not the only one, but probably the most important one. So whereas we are -- I hate to even bring up the topic and I think of it -- but if one was a trust and one was not going to pay tax as a trust, then logic would be you would use less leverage than as a share company.
So just as where it probably made more sense to be at the low end of that range as a trust, there's some arguments where being at the mid to higher ranges make sense for a share corporation. So I think that is something that we are open to; but we are going to hold to the range.
Again, it is a long-term target. So the key is, are you acting consistent with that in the long-term? So to do an NCIB or something where we are taking it outside of that range on a sustained basis would be inconsistent. I think your question, to be fair, was taking it to the higher end of the range. So, certainly anywhere within the range is consistent with our policy.
I think that given the definitional change that we made today, just to align ourselves more closely with the way the agencies look at it, effectively being at the -- you would be at a -- 1.9 under the new methodology is the same as 1.8 or whatever in the old methodology. I think we are splitting hairs. So I think the key point for investors is that from a long-term perspective, we are maintaining our leverage policy.
Peter Rhamey: Great, thanks very much, Bob.
Operator: John Henderson from Scotia Capital.
Robert McFarlane, executive vice-president and chief financial officer
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