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2004 Targets Conference Call - Q & A transcript
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Q1: Had a question with respect to margins on the Communications and Mobility sides of the business. On the
Communications side, there's obviously been a significant reduction in the workforce over the last two years
and yet there really hasn't been much of a change in the cash operating costs; a little bit of a reduction,
I guess, if you strip out the stock options and the price cap. So I wonder, Bob, if you could comment on the
productivity improvement there and if you could comment, perhaps, on the level of conservatism, I guess, that
you feel you've baked into the numbers.
And on the Mobility side, the margins are up about 400 basis points year-over-year, but you would have
thought, particularly given the last couple of quarters and the last one which was over 40%, that the full year
margin in '04 might be higher. Just wondered if you could comment on that, please? Thanks.
(Richard Talbot, RBC Capital Markets)
Robert McFarlane: Well, sometimes it's hard to please an audience. TELUS has demonstrated what I believe is one of the more impressive margin expansions at a time when margins have been going the opposite directions generally in the telecom space, so that's my general comment. In terms of our Communications segment specifically, we've had an EBITDA margin expansion occur over the past couple of years and that has been driven by the OEP, so I think your question implied that despite the OEP, margins have gone down. I think -- my understanding is the opposite is the case.
Having said that, in terms of on a go-forward basis, that clearly we have a significant accounting expense flowing through primarily the Communications side from the expensing of options and the like that is predominantly non-cash in nature. The accounting community in Canada has ruled upon that. I don't agree with the expensing up front of a cost that we have about 99.999% probability of not occurring, but in any event, we'll move on with that. So I think the underlying operations in terms of efficiency, we've done a tremendous job. We are expecting to achieve the targets, which most people thought were considerably aggressive when we initiated the OEP. And as we look forward into 2003, I think we need to get by a collective agreement to understand the parameters under which we can address our costs further on a go-forward basis.
In terms of the wireless or Mobility side, I'm quite pleased with the fact that TELUS has the margins it has and that we're expecting to be, I would say, on a network basis over 40% next year on EBITDA and on a total revenue just under. Having said that, some things to keep in mind would be that if we wanted to have an audited statement of Mobility tomorrow I could turn that around in about 20 days, so these numbers are true, actual, accurate numbers and would be the same as if Mobility was a public entity. So there is strong resilience in the accuracy and legitimacy of these numbers and these margins. And in that respect, I'd be interested in knowing operators similarly-sized in North America that have superior margins or superior projected profile, because I'm not aware of it.
Q2: A clarification, Bob, if you could. Stock-based compensations, about $45 million, you gave some colour to the previous question on that. It seems, if you look at it on a percentage of overall net income, it seems a little high, and I was just wondering, are you considering or have you implemented a change in whether you're issuing treasury stock or buying in the market for your -- I think you have an employee stock ownership plan and I'm wondering how significant that would be. I'm trying to get some measure of the profile for stock-based compensation charges next -- well, not next year, '04, but '05/'06. And I note that your average shares outstanding that you're using as your assumption is 354, which suggests you're not issuing shares in the market. Thank you. (Peter Rhamey, BMO Nesbitt Burns)
Robert McFarlane: Okay. Well, the first thing, Peter, on that topic of stock-based compensation is, I guess there's two principal elements that TELUS employs: one being stock options; the other being restricted share units (RSUs). Now, we have used restricted share units in a very limited fashion for senior executives in the past. It's contemplated that we would have an expanded utilization of RSUs going forward, so in that sense, I guess they would probably substitute for a portion of what we would typically issue in stock options. But all of that remains to be seen, because that's not yet reviewed or decided upon by our compensation committee.
One of the reasons why TELUS should have a higher stock option expense than other companies is because we provide stock options to 100% of our employee base. So we have done this for three years and we're going to do it again next year. So in that sense we believe that that is an element in aligning the interests of all employees to our shareholders and getting people at all levels in the organization to have an affinity for the impact, good or bad, to our share price from executing our strategy. So that's probably why it would appear higher to you in that sense. That's 100 options per person, by the way, per annum.
The $45 million number is an approximate number. Obviously, it would depend upon what the Black-Scholes and all of that turn out to be when we actually issue the new options, which won't be for a couple of months. And in terms of treasury policy, that is yet to be determined, but clearly, there's an opportunity down the road, if not sooner rather than later, to consider settling in the market. Of course, in the RSUs, RSUs are typically settled for cash and in that sense, they really don't drive increased shares outstanding, but I acknowledge your point applies to the stock option portion.
Q3: I have a question on capital expenditure. Yesterday we had BC run us through their capex plans which, you know, in total look similar as a percentage of sales to yours and they've got a fairly ambitious network upgrade program. So you're planning to spend around 18% of wireline sales on capex and I'm just wondering if you can run through what your targets are and what that will buy you? (Glen Campbell, Merrill Lynch Canada)
Robert McFarlane: It'll buy us equipment, it'll get us capitalized labour and I'm not going to get into the specifics, Glen. Press releases on ordering equipment are good for suppliers, so my perspective on that type of thing is if we're getting some sort of discount from the supplier to help promote their business, then I'm all for putting out press releases on purchases of equipment. I think that would be -- it would be spurious to suggest that because someone put out a press release in ordering some new equipment and TELUS didn't put out a press release ordering new equipment and we had the same capex intensity, that somehow there's something unusual there. I think that just illustrates a difference in the public relations philosophy.
Q4: I have a question on your plans for your free cash flow of a billion dollars. I notice that your debt to EBITDA ratio, you have just coming down by, you know, .2 points, from 2.7 to 2.5 and I think the free cash flow would bring it down by, I would think, more than that, combined with the growth that you have in EBITDA, so where does it go? Dividend increase? Share buy-back? Have you left some room for possible acquisitions? And then related to that is the $200 million of working capital use. I think working capital and other on Slide 19. I wonder if you can help me with what that is for? (John Henderson, Scotia Capital)
Robert McFarlane: Well, I think the first thing I should just note is, and it's a little complex, but if you recall our lending agreements have a definition of debt in terms of how they adjust it for accounts receivable securitization and given that on accounts receivable securitization, we basically collateralize only a small portion, circa 20% of those outstanding amounts, that that's the portion that is included in the definition of debt for ratio purposes under our bank agreements. So for public disclosure, we have aligned our definition of debt for purposes of debt to EBITDA ratio. For example, with that of the bank agreement so that it's straightforward and when we say hey, our covenant is less than or equal to four times and we say, you know, our ratio is 3.0 or whatever, then people can have an apple to apple comparison. So that being the case then as we're paying down our securitization, which is what we've been doing and we'll continue to do as we go into 2004, each dollar put into reducing securitization is only affecting the debt in that ratio by $0.20. So I think that's the first point.
And second is obviously the surplus on top of this securitization is going to build cash balances in advance of a significant bond maturity that we have in the Spring of 2006. So the simple answer to the use of the free cash flow in the 2004 time period is to reduce our leverage on our balance sheet.
In terms of working capital, the working capital in TELUS in general, if you go to Statement of Changes or whatever, is affected by the accounts receivable securitization flows, because essentially we're reducing that program, which means we're essentially repatriating accounts receivable assets that were formerly off balance sheet back onto our balance sheet. That's a use of cash. Of course, there's an immense number of gives and takes in there, including changes in taxes and a bunch of other liabilities, which I think it's in the shareholders' interests that I don't go into any more detail.
Q5: I'd just like to take over where John left off though, Bob, because I'm a bit confused. Next year you're talking about paying off just half your accounts receivable securitization or about $150 million. As per your Q3 statements, I think you said you had $281 million of debt that matures next year, for a total, let's say, of 431 and you're talking about $800 million of free cash flow. So there seems to be something like a $400 million difference there. What am I missing? (Dvai Ghose, CIBC World Markets)
Robert McFarlane: Well, I don't think in general you're missing anything, Dvai. I think the point is that the surplus amounts, after paying down securitization and debts that have maturities which is minimal, in 2004 is building up cash balances to defuse the repayment of our 2006 bond issue. John has just pointed out to me in my prior comment I think I referenced 2005 as a large maturity. That was an error on my part. It's, of course, the '06 notes mature in Spring 2006.
Q6: On your non-ILEC business you're forecasting revenue growth of roughly $55 million, an EBITDA turnaround of $35 million as you gave. To what extent do those figures reflect on the incremental profitability of new business or do they also reflect on ongoing cost efficiencies within that unit? Thank you. (Rob Goff, Haywood Securities)
Robert McFarlane: Yes, that's a good question, Rob. It's really -- it is a combination of both, that they're -- the efficiencies on the existing business are best described as follows, that we have a portion, although it's certainly declined significantly from where it was, of revenue that was off-net and, of course, as we have built facilities in Central Canada, we've been transitioning existing recurring revenue streams onto our own facilities and therefore picking up incremental margin. So in that sense, that's how you get improved profitability, even if we did not have revenue growth, I guess, to take an extreme example. Of course, the other part is we are having new business and that new business, of course, is also coming on at higher than historic ratios of on-net to off-net business and therefore profitability is increasing there. And I would say lastly, in terms of more one-time type of sales, certainly our thresholds on profitability are much higher than they formerly were, going back a year and a half or so ago. So I think we've been seeing that trend flow into the other line of our product revenue breakdown over the past year and we would continue to expect that to occur. All that means that we're continuing to benefit from a very large incremental margin, and I would therefore say that from a long-term modelling perspective, you would not expect to have non-ILEC margins be anywhere near this high. In fact, you would expect them to be lower than your ILEC margins. Why? Because you don't benefit from some of the legacy costs that have already been amortized, et cetera, and you're always going to have a higher off-net ratio out of market than you do in-market. So I think we're at the tail end, if you will, of this very high incremental EBITDA margin.
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