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Executives

John Wheeler – VP, IR

Bob McFarlane – EVP and CFO

Darren Entwistle – President and CEO

Analysts

Greg MacDonald – National Bank Financial

Phillip Huang – UBS Securities

Jonathan Allen – RBC Capital Markets

Peter Rhamey – BMO Nesbitt Burns

Jeffrey Fan – Scotia Capital

Maher Yaghi – Desjardins Securities

Dvai Ghose – Genuity Capital Markets

David Lambert – Canaccord Capital

Bob Bek – CIBC World Markets

TELUS Corporation (TU) Q4 2009 Earnings Call Transcript February 12, 2010 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the TELUS fourth-quarter 2009 earnings conference call. I would like to introduce John Wheeler. Please go ahead.

John Wheeler

Welcome and thank you for joining us for our fourth quarter call. The call is scheduled for up to one hour. The news release on the fourth quarter financial and operating results and detailed supplemental investor information are posted on our web site, TELUS.com/investors.

In addition for those with the internet access, the quarterly presentation slides are also available at this site. You will be in listen-only mode during the opening comments and let me direct you to the ever-present slide 2.

The forward-looking nature of the presentation, answers to questions and statements about future events are subject to risk and uncertainties and assumptions. Accordingly, actual results could differ materially from statements made today, so do not place undue reliance on them.

We also disclaim any obligation to update forward-looking statements, except as required by law. I ask that you read our legal disclaimers and refer you to the risks and assumptions outlined in our public disclosure and filings with Securities Commissions in Canada and the U.S.

Turning to slide 3 for an outline of today’s agenda, we will start with introductory comments and a review of the quarter by Bob McFarlane, Executive Vice President and CFO. Bob will review both segmented and consolidated results and give updates on the issues outlined. We will then conclude with a question-and-answer session, with Bob and Darren Entwistle, President and CEO.

Let me turn the presentation over to Bob, starting on slide 4. Bob?

Bob McFarlane

Great, thanks, John, and good morning, everyone. Let us begin with a summary of the wireless highlights. Overall wireless revenues were increased slightly with equipment and other revenue growth of $56 million or 85%, which reflects the first full quarter of revenue from Black’s Photography, which contributed $38 million of revenue and increasing smartphone mix. Operational expenses increased by 14%, driven higher by equipment expenses to support retention efforts, and customer migrations to smartphones, notably including the Apple iPhone as well as the inclusion of Black’s.

Marketing expenses increased slightly to support the launch of our 3G+ network and devices, partially offset by lower commissions and lower gross additions. Wireless segment restructuring costs decreased by $3 million and all in, wireless EBITDA declined by 12% and in line with our updated guidance provided in December. The introduction of the iPhone negatively impacted EBITDA by approximately $20 million, given its significant volume, while Black’s was a neutral contributor to EBITDA. CapEx decreased by $44 million or 19% in the quarter, following the launch of our new 3G+ network in early November.

Turning to slide 5, net wireless subscriber additions this quarter were 122,000, with higher quality postpaid net adds for 109,000, representing 89% of the mix compared to 80% a year ago. Year over year net subscriber additions decreased by 18% and primarily reflected a reduction in prepaid net adds as the company shifted focus away from the lower value segment to focus more on adding higher quality customers, particularly with smartphones. Overall, our total subscriber base is up 6.4% year-over-year and now totals $6.5 million.

Slide 6 provides some additional detail on TELUS’ continued success in smartphones, which speaks to the quality of our postpaid loading. Smartphone subscribers now represent approximately 20% of TELUS’ postpaid base, up substantially from 13% a year ago. Although there may be some ambiguity in the definition of what exactly is considered a smartphone when comparing numbers between TELUS and other carriers, for TELUS this represents an apples-to-apples comparison. It is important to highlight that HSPA loading commenced on November 5, when the new network was launched, so we had less than 60 days selling our expanded smartphone lineup. In November and December, subsequent to the new HSPA network launch, more than 40% of TELUS brand postpaid gross loading was on smartphones. 7% of net adds were iPhones, while the retention-to-new ratio was 77:23, as compared to 85:15 that we understand has been experienced by other newly launched second to market iPhone carriers globally.

Meanwhile, there was a tremendous surge of more than 100% in the number of retention subs upgrading to smartphones such as the Android HTC Hero, and more materially, RIM devices, and of course, the Apple iPhone. Overall, smartphone gross loading was up 61% year over year in Q4 and 72% in December, when our sales and marketing efforts started to hit their stride.

Slide 7 shows the breakdown of TELUS’ total ARPU between voice and data for the fourth quarter. Total ARPU continued its year-over-year negative trend, as voice ARPU erosion continued, partially offset by data growth. Contributors to the decline in ARPU were the same as in recent quarters, and included reduced voice usage, with MoUs down 5.6%. Economizing the rate plans by both consumers and business clients, with chargeable MoUs decreasing significantly more than total MoUs, continued declines in Mike ARPU increased penetration of Koodo within the base and reduced roaming, which includes the impact of a domestic roaming rate reduction in the first quarter of 2009.

Encouraging for future prospects is that HSPA net adds were a positive contributor to ARPU year over year. Also on a positive side, data ARPU growth remained strong, increasing $1.43 to $12.60. This now represents 22% of total ARPU, up four points from last year.

As shown in slide 8, data revenue growth for the fourth quarter increased by 20% year over year, reaching $243 million. We remain bullish with respect to the prospects for future wireless data growth, given the increasing penetration of smartphones within our subscriber base. As mentioned earlier, smartphone penetration is increasing, with the addition of new HSPA devices. While it is still early days with respect to our 3G+ network, the ARPU associated with new HSPA devices is encouraging and significantly higher than non-HSPA ARPU.

Slide 9 shows the metrics related to our wireless marketing and retention efforts in the fourth quarter. Gross adds declined by 2%, with the decline caused by prepaid, where we consciously decided not to match the more aggressive fourth-quarter offers in the marketplace. Churn improved slightly by two basis points over last year and postpaid churn, which is not shown on the slide, remained low at 1.18%. COA per gross add increased only slightly by 2.2% to $380, despite higher marketing expenses to support the launch of the HSPA network, and higher per unit subsidy costs associated with smartphones, including the iPhone. As expected, cost to retention increased by 27%, reflecting higher subsidy costs as part of our focus on migrating clients to smartphones, including customer upgrades to new, more expensive HSPA devices.

Turning to slide 10, let us review our wireline results. Revenue decreased by 3.8%, due to ongoing local revenue declines, augmented by accelerated LD and equipment revenue declines at an aggregate were only partially offset by modest data growth. Operational expenses were relatively flat, reflecting effect of cost control as I will illustrate shortly. When excluding defined benefit pension expenses from both periods, operational expenses declined by 3%, which is a more representative reflection of our operational efficiency efforts. As disclosed in December, restructuring costs increased $42 million in the quarter, driven by a number of initiatives under our accelerated operating efficiency program. Operating profitability as measured by EBITDA was down by 20% and impacted primarily by the higher restructuring and pension costs, which I will review in a moment. Wireline capital expenditures decreased by 18%, mainly due to lower investments in network access, large enterprise deals.

Turning to slide 11, we can see clearly the impact of the higher restructuring costs and pension expense on wireline profitability. When adjusting for the $29 million increase in defined benefit pension expenses, as well as the $42 million increase in restructuring costs, normalized EBITDA decreased by 4.4%. The significant investment in restructuring costs in the fourth quarter is expected to lower the wireline cost structure further in 2010, as I will comment more on later.

Let us move to slide 12 and examine Internet results. High-speed net adds declined over the same period last year to 11,000, and reflects a maturing market, a decline in household formation due to the weaker economy, as well as extremely aggressive price competition from Shaw in the fourth quarter.

Slide 13 shows the continued success of TELUS TV in the fourth quarter. Total net adds increased to 120% year over year to 33,000, and represents our best quarter to date, while the total subscriber base more than doubled to 170,000 over the same period. TELUS experienced significant year-over-year growth in IPTV net adds as well as benefited from satellite TV additions, which were not in 2008 results. The overall success is attributable to enhanced broadband coverage and improved installation capability, and supports TELUS’ continued broadband expansion in key urban markets, including Calgary in the greater Vancouver area.

Slide 14 highlights two notable items. First, for the fifth straight quarter, residential line losses continued to show a stabilizing trend and slightly improved in the fourth quarter over the same period a year ago. Second, we are and courage to see TELUS TV and high-speed Internet loading of 44,000 exceed the decline of residential line losses of 41,000. These two items reflect more effective win back capabilities and the results of our continued broadband expansion, which facilitates wireline bundling opportunities, including TELUS TV.

In an exciting development, 10 days ago, TELUS announced the availability of a new TELUS TV service powered by Microsoft Media Room. The new service offers a better television viewing experience for TELUS TV customers, and includes many new innovative features, including PVR Anywhere, which allows customers to record and watch a show on any connected television in any room in the house, TELUS TV connections for up to six TVs in a home, with multiple HD streams, superior picture quality, enhanced channel browsing, and guide with picture-in-picture channel surfing, and instantaneous channel changing. In addition, the new service enables faster dynamic Internet speeds. Importantly, these new features help differentiate TELUS TV against our cable TV competitor and leverages the significant investments we have made in our wireline broadband network.

Speaking of our broadband build, slide 16 provides an update. During the quarter, fiber to the node coverage continued to expand, with TELUS now covering more than three quarters or 1.8 million households in BC and Alberta with a minimum 15 megabits per second broadband service. Meanwhile, the continued build-out led to a significant jump in coverage in the greater Vancouver area to more than 70% of households in the quarter. As we continue our broadband expansion in 2010, we expect to cover up to 90%, or 2.2 million households in the top 48 communities across Western Canada by the end of 2010. Starting during the second half of 2009, TELUS began a program to reach the top 48 communities, with VDSL2 by the end of 2011. This will double current data download speeds to up to 30 megabits per second, and better enable our enhanced IPTV and Internet services. In all, new Greenfield developments in Western Canada have to continue deploying fiber to the home, while at the same time; we have been deploying fiber to the building with Ethernet to the suite technology for years.

Putting it all together, let us look at TELUS on a consolidated basis starting in slide 17. Consolidated revenue in the fourth quarter decreased slightly by 0.4%. Increased operating expenses and higher restructuring and pension costs caused reported EBITDA to decline by 16%. More detail on this in a moment. In line with guidance, reported EPS decreased to $0.49 in the quarter, driven largely by decreased operating profitability, but with a few non-recurring items we will talk about in slide 23. Meanwhile, consolidated CapEx decreased by 19%, given trends toward lower CapEx in both wireless and wireline segments, as already mentioned. All in all, consolidated results were in line with our most recent guidance provided in December.

Slight 18 shows that consolidated profitability was significantly impacted by higher defined benefit pension and restructuring costs. When adjusting for these two costs, underlying EBITDA was lower by 8.3%. Normalized fourth-quarter EBITDA was impacted by lower legacy local and LD voice revenues, as well as increased wireless retention costs.

Slide 19 shows restructuring costs over the last three years, and our target for this year on the right-hand side of the chart. The significant acceleration of operational efficiency initiatives over the last year is clearly evident, and reflects our response to the challenging economic and competitive environment. Particularly given the ramp up in restructuring efforts in 2009, for which the consequent OpEx savings were only partially reaped in year, along with continued emphasis on OpEx reduction in 2010, restructuring investments are expected to provide TELUS with a much better cost structure in 2010 and beyond.

As part of our operating efficiency program, slide 20 shows the changes in full time equivalent staff count for 2009. The domestic staff count for the year, excluding the new staff in the Black’s Photography acquisition, is down 2150 approximately. TELUS International was higher by about 750 positions, which substantially consists of internal positions offshored. These significant employee reductions led to a sizable decrease year over year in employee-related expenses. In addition, as mentioned earlier, the full year flow-through effect of 2009 reductions is expected to lower the 2010 cost structure further.

Slide 21 shows TELUS’ progress over the last four quarters in reducing domestic full-time equivalence for 2009 and our expectation for 2010. Going forward, we expect to continue to focus on operating efficiency, as highlighted earlier and as reflected by the associated target reduction in domestic FTEs of approximately 1000 in 2010. Given the reduction in domestic FTEs throughout 2009, combined with an additional 1000 FTE reductions targeted for 2010, TELUS is expecting an incremental savings of approximately $135 million, largely from reduced employee-related expenses.

On slide 22, we can see the significant year over year annual OpEx savings, largely resulting from wireline FTE reductions, combined with low variable payouts, leading to an 8% reduction and compensation and employee-related expenses. Total wireline OpEx increased 3% despite the efficiency savings, due to significantly increased pension expense and restructuring costs.

Slide 23 shows the detailed breakdown of the components of reported EPS, including the positive income tax-related adjustments incurred this quarter, and the same quarter last year. As previously disclosed, earnings per share included an impact of $0.22, resulting from the loss on early partial redemption of our June 2011 US dollar notes. More on this on the next slide. Normalized EBITDA contributed $0.18 to the decline, primarily from higher wireless retention costs, while higher pension and restructuring costs negatively impacted EPS by $0.09 and $0.06 respectively. Slightly higher depreciation and amortization and other expense contributed $0.01 to the downside.

Turning to slide 24, I would like to take a moment to review TELUS’ refinance in December. As previously announced, TELUS successfully issued $1 billion of senior unsecured 10 year notes at 5.05% at the beginning of December. The net proceeds of the refinancing were used to redeem 20% for US $577 million of the outstanding 8% US dollar notes to June 2011. In addition, TELUS paid $315 million to terminate the associated cross currency interest rate swaps. TELUS recorded a pre-tax charge of $99 million comprised of $63 million for the early partial redemption and $36 million upon terminating the associated interest rate swaps. The total after-tax impact was $69 million or $0.22 per share as previously highlighted. This debt issue provides a significantly lower effective interest rates as compared to the rate for the redeemed notes and extended TELUS’ average long-term debt maturity by an additional year overall to five years.

Before I conclude, we wanted to update our 2009 actual on 2010 pension exemptions, now that we have the final year-end results. We now estimate defined benefit pension expense to estimate an increase of approximately $10 million in 2010, following better asset returns in December, and a 5.85% discount rate. We also expect a decrease in cash pension contributions of approximately $36 million. We have prudently managed our obligations for pensioners over an extended period of time, and combined with good returns in 2009, the assets in our defined benefit pension plans cover 99% of estimated future obligations.

In summary, 2009 was a year where we utilized our strong financial position to strategically invest to enhance our competitive position and future growth. We launched ahead of schedule a national 3G+ network and expanded greatly the ADSL2+ coverage for our wireline network. We significantly improved our organizational cost efficiency to address dilutive impacts of certain growth initiatives, and the recession on our business, such that we reduce our salaries and benefits by $174 million or 7%.

Moving into 2010, we expect numerous benefits from our strategy, including accelerated wireless data growth. Leveraging our broadband investments and the launch of our new IP TV platform, we look for ongoing TV growth. We also expect $135 million of EBITDA savings in 2010 from last year's and this year's continued focus on operating efficiency initiatives.

In conclusion, we expect a significant growth in free cash flow in 2010, primarily due to the $400 million reduction in CapEx, more than offsetting the increase in cash income taxes. This is outlined in the appendix slides.

On that note, let me conclude and let us move to the Q&A session with Darren and myself. Back to you, John.

John Wheeler

Thanks, Bob. And just before we start the Q&A, I just want to make a small correction. Back on slide 6 on the smartphone mix, we incorrectly gave you the percentage. The percentage there for the – since November and December for Apple iPhone net adds is actually 17%, and not 7% as stated. So, just a minor correction on slide 6.

So, on that note, we will turn it over to Daniel, and can you please proceed with the questions from the queue for Darren and Bob, please?

Question-and-Answer Session

Operator

Yes, thank you. Our first question will be from Greg MacDonald of National Bank Financial. Please go ahead.

Greg MacDonald – National Bank Financial

Thanks. Good afternoon, guys, or good morning. Wireless ARPU a little later than expected, from my estimates, both on data and voice. We have seen historically Rogers when it has a reasonably big quarter with the iPhone, it takes one or two quarters before you see the real ARPU lift, particularly on data. Is that the case that we are seeing here, in particular, are we going to see a greater benefit on the year over year growth in data ARPU in the first quarter or the second quarter from what looks like reasonable smartphone loads in the 4Q? Thanks.

Bob McFarland

Thanks, Greg. I think your comment is appropriate in terms of reduced launch the iPhone on November 3, so we had a few days short of two months in the quarter of loading and ramping up. Early indications remain we have an ARPU for HSPA adds well north of $100, now representative that is on a sustained basis remains to be seen, but certainly very strong ARPU across the board, not just the iPhone, but on all the HSPA devices. So, we are certainly encouraged by that development, and we need to have a little more of an empirical trail as you allude to in terms of really getting good handle on that, but it is certainly a positive factor in terms of a go-forward basis, but it had a negligible impact in quarter because of really the partial quarter results.

Greg MacDonald – National Bank Financial

Thank you.

John Wheeler

Can we have the next question please?

Operator

Our next question will be from Phillip Huang of UBS Securities. Please go ahead.

Phillip Huang – UBS Securities

Based on my estimates, the voice ARPU is a relatively stable pace with 12% for the last three quarters. So the acceleration in overall ARPU, you know, for me, it looks like mainly comes from slowing data growth. I just wanted to understand the different drivers behind that, like how significant was the dilutive impact of data-only subs and lower rate, roaming rates. And to what extent did the presumably higher new sub activity in the latter part of the quarter contribute to the dilutive impact? Thanks.

Bob McFarland

Well, in terms of ARPU, firstly, obviously, as reflected by the MoU on the voice side, down 5.6% year over year. That reflects really two things, bit of the economy in terms of people rightsizing or moderating their usage, as well as presumably some messaging or data substitution for voice. We have experienced that trend throughout 2009, really impacted by the economy. In terms of the data side and roaming, in respect of roaming, we had a rate reduction on the domestic roaming, with the Dell organization in the first quarter of 2009. So the results for 2009 are impacted on a revenue side and the expense side, but here we are just looking at revenue and the ARPU in terms of the domestic roaming rate. That was not the case in the denominator, i.e., the prior year, because the rate reduction transpired in Q1. So, from that standpoint, the rate reduction flowed through in combination with reduced international travel, if you will, or volume as it turns up on our network, from international inbound roamers from the United States. We are really talking about CDMA here from materiality perspective and so consequently, the overall roaming bucket was a deflator for our ARPU.

In addition to that, on the data side, we have a significantly greater volume of Internet sticks being added in the base. That is a cause of development for the organization, but one facet of that is the increasing transition of that product being adopted in the consumer as opposed to the business segment at lower price points. Now, we all know that prices are coming down on the sticks, the business model is certainly adjusting favorably, but in terms of penetrating the consumer market at generally lower rates that we are finding in terms of the year over year that was a meaningful contributor.

Of course, in our case, we also have messaging, where we, and this is quite specific to TELUS, where we did a commenced charging for inbound messaging in the fourth quarter of 2008 and so when you are looking on a year-over-year basis, the first quarter that you would have the inclusion of inbound messaging charges both in the current period and the prior year over year period is this fourth quarter. And so, messaging revenue, of course, expanded. It increased in absolute dollars, but because there was a jump in the fourth quarter of 2008, the (inaudible) in terms of euro your comparison this quarter was impacted negatively. So all in all, we are not really concerned, if you will, on the stand of underlying data growth rates or some a little bit of a measurement issue there on a year-over-year basis.

I think more importantly, as we track the categories and we look at the data usage on the smartphones, which is significantly greater, then it is on a general phones at the take-up rate for data packages when we upgrade on a retention basis existing subscribers as well as the new ones coming on board. The increased percentage of smartphones in our base is definitely a positive factor, and so I guess that relates to my prior answer, we are hopeful and encouraged by early HSPA. We need a little more empirical experience to be able to track it better, but it is certainly a positive trend and we would hope to see significant improvement in our ARPU over the course of 2010.

Phillip Huang – UBS Securities

Yes, thanks. That is helpful. I need to just a quick follow-up on the voice side, and you know, based on your view of the competitive activity right now, do you feel comfortable commanding a premium for the more mature networks that you have, or do you think that it is more prudent and important to more promptly react to match a more aggressive pricing out there?

Bob McFarland

We are very comfortable in terms of our pricing. In fact, when we launched our new updated rate plans that started in November, concurrent with the network launch, it is quite an organizational effort that we implemented, doing both. You know, we think those are very resilient and very effective and very consumer friendly, consistent with our future friendly brand promise. So, if you ask the question, you know, in the front half of last year, I think we had an issue with respect to the system access fee. That isn't the case. That has been addressed, I think in a customer-friendly manner and so, from a go-forward perspective, we are quite comfortable with our positioning on PCS.

In respect of our flanker brand, keep in mind that we have been operating for year, up for almost 2 years on the Koodo side. We have had stable loading with that brand on a year over year basis and remember that – you know, in your early periods, you have moderated churns and now that we are down the road in that brand launch, we really have normalized period churn flowing through and therefore, to have your net adds being stable is very encouraging. So we have that position in the market that is exceeding and we see no reason to adjust pricing response to competitive developments in the marketplace.

Phillip Huang – UBS Securities

Great. Thanks very much.

John Wheeler

Daniel, next question, please?

Operator

Thank you. Our next question will come from Jonathan Allen of RBC Capital Markets. Please go ahead.

Jonathan Allen – RBC Capital Markets

Thanks very much. Well, the question about the wireless margins. This quarter, network margins were down just over 400 basis points, which was in line with the revised guidance and I think pretty much in line with where the street was. But COA was surprisingly not really the driver with the COA expense actually being down year over year and COA per gross add up only 2%. So I am kind of confused and perhaps a little worried as we look at 2010, that if margins already have seen pressure down 400 basis points, what happens when the subsidies on COA start to increase on the HSPA network over the next few quarters? Do we see incremental margin pressure there, or am I missing something here? Is maybe COA going to be a lot more manageable, like along the 2% increase that you had this quarter? Or should we assume that the wireless margins start to improve and offset some of that COA growth? Hopefully, I explained that properly.

Bob McFarland

Well, I think I understand the question, but the answer to your first question, I think you did miss something in terms of the COA COR. First of all, the COA reflects the full cost of loading in fact in a quarter where we had a brand-new launch with new HSPA devices. If you look at the cost curve or technology pricing curve of the handsets in HSPA technology, yes, there is going to be new models introduced, but on average, it is going to trend down at a fairly fast pace, until it is going to be significantly below that for CDMA, one of the rationales for our HSPA network launch. So, the trend in terms of going forward on COA is neutral, I would say, at worst and positive in terms of opportunity, (inaudible) lower at best.

In terms of what was affecting the margins in the quarter was really two things, primarily I think in terms of this discussion was the COR side of things, the cost of retention. And the cost of retention was a very predictable thing. In fact, we, in our launch announcing the iPhone talk about $100 million circuit dilution in 2010 with respect to the iPhone and given that a significant element of loading for that new handset is from your existing basis or as it pertains to contract renewals, this has always been something that is not unique to ourselves. The key issue from a profitability perspective was what is the ratio, or what would the ratio be in respect of new subscribers, where the revenues were fully incremental versus retained existing subscribers, where the uplift in terms of greater usage is partially incremental.

And in that respect, with our 77:23 mix, we are very encouraged, because in talking with the Apple organization, I am talking about Canada, I am talking about the internationally, and the experience of various launches, we were advised to expect an 85:15 type of initial ratio. Obviously, as you have seen in other carriers that are more mature in their offering the iPhone, that trend is down significantly over time, but the question was what would it be in our initial period. So we have started off on a much better ratio than expected and that ratio should improve on a go forward basis, obviously. So, at the end of the day, COA is not our concern, COR is not. I think in terms of COR really relates to investment in the iPhone and smartphones, and I think the real issue then becomes the ARPU, and if your ARPU is eroding at a greater rate than your sub base is increasing, that affects your overall margins. So, one of the missions of this organization is to arrest the ARPU decline and we are set on doing that in 2010.

Jonathan Allen – RBC Capital Markets

That is very helpful. Thank you very much, Bob.

John Wheeler

Go ahead, Daniel.

Operator

Our next question will come from Peter Rhamey of BMO Nesbitt Burns. Please go ahead.

Peter Rhamey – BMO Nesbitt Burns

Thanks very much, thanks for taking the question. Couple of questions again on wireless. There was some commentary that you had backed out of the prepaid market during the quarter. Of course, your broader strategy is to focus on postpaid, but I was wondering if this marked an intensification of competition in the prepaid market. Second of all, I think one of your base assumptions for 2010 guidance was market launches by competitors in Q1 2010 and only one market has been launched so far. I am just wondering whether that is an optimistic sign that perhaps competition is going to come off the quarter too later for you, and whether you are feeling a little bit better about your business as a result?

Bob McFarland

Well, thanks, Peter. I guess, going in sequence, firstly, you enquired about prepaid. Look, we like prepaid properly priced in terms of both service revenues and in terms of subsidies. The lessons with respect to prepaid are well-documented in the wireless industry that if you overly subsidize and don't have an investment in the handset and to the absence of contracts and the churns spike up and make a product uneconomical. So, we have a decent prepaid ARPU and we have a decent approach historically and economically to prepaid. But that reflects some discipline and what we saw in the fourth quarter was efforts by certain competitors to go to fully discounted are nearly fully discounted handsets on a prepaid basis and we won’t play in that. And so, if that meant sacrificing some loading, then so be it and that is what transpired and I think that is the right thing to do for our shareholders. And so, when we talk about a higher-quality mix in the fourth quarter, it wasn't because we said we don't want prepaid, it was more we are not going to participate in a prepaid loading characteristic that we don't believe has the proper economics. So that is the Koodo side of things.

In terms of new entrants, well, there really was – well, there wasn't a measurable impact, obviously in the fourth quarter that we saw and various new entrants are struggling to operationalize their efforts, perhaps not too surprising. So, whatever the impacts are going to be, which are primarily Central Canada-focused, so less direct on TELUS, but in any event, are not expected to be a meaningful factor over the first half of 2010.

Peter Rhamey – BMO Nesbitt Burns

With regards to prepaid, those offers are still in the market, I believe. Fair to say?

Bob McFarland

I would have to just check on that, put it this way, they were very prevalent in terms of being promoted in the December Christmas timeframe and there is a lot of gift purchasing on that basis going on.

Peter Rhamey – BMO Nesbitt Burns

Great. Thanks very much, Bob.

John Wheeler

Next question.

Operator

Our next question will come from Jeffrey Fan at Scotia Capital. Please go ahead.

Jeffrey Fan – Scotia Capital

Thanks very much and good morning. Just one quick one on the definition of smartphone. I am just wondering Bob you can just clarify what your definition is. This is to help us compare between companies. And then, switching gears, the bigger question on the fiber front related to wireline, with BC and (inaudible) line I guess moving to fiber to the home in some of the areal footprint, just wondering if you can provide us with some facts on what your areal coverage is in Alberta and BC and your thoughts on whether fiber to the home over areal deployment really make sense? Thanks.

Bob McFarland

Hey, Jeffrey. In terms of the definition, in our case, we define smartphones as including devices such as the iPhone, RIM devices and PDAs. It does not include data sticks, air cards, modems, embedded laptop devices, multimedia and messaging devices. So essentially, you are talking about it is a handset that has a multimedia capability, so Internet broadband connection. And so, so that is the definition and obviously from a materiality perspective, that largely consisted of RIM product and then laterally, iPhones, subsequent to the launch of the new network.

In terms of wireline broadband deployment in Western Canada, we have been deploying our fiber to Greenfield developments for quite some time, over a year by memory now, I think it started approximately 2007 or thereabouts, and any of that, we can add it for a considerable period of time. And as well, we have experimented with some Brownfield development to understand the cost structure of doing that and the business model certainly in respect of some MDU buildings and the like. We are connecting Internet to the suite, and this has been something that we have been doing for some time.

We have also begun the very early stages of the VDSL2 deployment in the past six months, and so we will be rolling that out and in a position to offer it on a commercial perspective in terms of speeds up to 30 megs really in the back half of this year and finishing that upgrade in the 2011 timeframe. So, this is something that we have been doing for some time. Obviously, this is not a Verizon-like model, where we are taking fiber to every premise in our coverage footprint, but we are doing it selectively, where the economics make sense and that largely consists of Greenfield developments or highly-concentrated MDUs.

John Wheeler

Next question, please. Daniel?

Operator

Hello, I thought there might have been a follow-up. Our next question will come from Maher Yaghi at Desjardins Securities. Please go ahead.

Maher Yaghi – Desjardins Securities

Yes, thank you for taking my question. I just want to go back maybe to the ARPU declines we are seeing in the wireless and just look at the minutes of use. If I look at your quarter’s decline here of 5.6%, it is higher than what we were seeing from your competitors. Can you maybe tell us, is there a special carrier focus that your customers are trying to reduce the usage of voice on, and is this particular to TELUS and what is your view going forward as to when you think the decline could start to taper off and hold steady at the level instead of the decline increasing?

Bob McFarland

In respect of the ARPU, the 5.6% minutes of use decline is total minutes of use. Unfortunately, if we measured it on available basis or a de-chargeable minutes of use, the decline was greater than that. So that reflects a challenge of the organization. Essentially, what we are experiencing is – and this is a trend really for the past year that we have witnessed is that our subscribers on average are not only using less minutes in total, but they are right sizing their usage. So for example, if someone subscribed to a package with 400 included minutes, whereas before they would go over the 400 and we would earn chargeable incremental revenue on a per minute basis, that is happening less frequently. So, they are managing, for example, a usage of 399 minutes to make the point. So, that is an example of right sizing. So, to a certain extent, it reflects where we have some bundles of bundling minutes, and you see are getting the monthly recurring fee, so it a little bit of a shift there, but regardless, we are seeing an overall usage decline.

I think, in terms of go forward, it is not something that is self-controlled easily in terms of predicting. I think, from a strategic perspective, we need to, knowing that part of that substitution effect is going to data, we want to make sure that we are getting our fair share of that data growth pie, and this is where smartphones fit in so importantly as they attract a heavier user with more applications, more revenue sources, and we have experienced higher ARPUs with them. So hence the emphasis on the smartphones and we are hopeful that that is going to be a helpful factor in terms of arresting the decline in ARPU on a go-forward basis.

If you look at the underlying challenge on the ARPU front in the economy, is it going to get better, well, you probably have better sources than we do, given you have economists to work for you, but certainly, it is a consensus out there, the Canadian economy getting better and certainly, we are seeing that in Western Canada. So to the extent that plays a factor, that would be nice headroom for us.

Maher Yaghi – Desjardins Securities

Do you think that the offering that you have to your wireless subscribers has in any way, you know, being different than maybe your competitors are offering your customers the potential to lower their voice usage, more than, because I mean, if I look at Dell or Rogers, we are not seeing those kind of declines in minutes of use. Is there anything particular to the package that you are offering that is making this happen?

Bob McFarland

Well, I think the thing that is most unique in respect of our sales, two things come to mind. One is that we have a Mike subscriber base and our subscriber base, unlike other Canadian competitors and as you are probably familiar, we have been migrating the heavy mobile voice users off of that service, as it has become more push-to-talk centric. And the reason for that, amongst others, is that there is no 3G data path for Mike, and so, these heavy users, like everyone else, are wanting to use smartphones and multimedia devices and the like and so we either migrated over to our PCS brand or we risked having them turn away. And so, in doing that, Mike historically was priced on the voice side at a premium to the market because of its unique functionality and combination of push-to-talk capability. As that is not the case anymore and you are converting over your re-pricing at the market and so there has been an ARPU reduction on the Mike that has been flowing through our numbers that would not be something seen at other carriers. In fact, that also pertains to net additions, because obviously, Mike net additions are negative, and so they pulled down our results. So that is one reason.

Another reason would be related to roaming. Yes, we do have some international roaming from largely Verizon and less really from Sprint. On a cross border basis, as mentioned, US decay in traffic has actually declined in the past year with the recession, etc, but from an international perspective beyond that, the CDMA roaming revenues have been negligible because of the lack of roaming partners. The HSPA launch opens up the opportunity for ourselves to participate in that HSPA international roaming revenue that heretofore has been exclusively on a GSM basis to the benefit of one carrier in Canada. So, fourth quarter that was nascent because we are just ramping up but in on a go-forward basis, we would expect that that should be a regular growth element in a positive way in our ARPU and that was one of the business rationales behind the HSPA launch.

Maher Yaghi – Desjardins Securities

Thank you very much.

John Wheeler

Thanks Daniel. Next question please.

Operator

Our next question will come from Dvai Ghose at Genuity Capital Markets. Please go ahead.

Dvai Ghose – Genuity Capital Markets

Yes, thanks very much, couple of things on the wireless side as well. Given the fact that both WiLAN and TELUS launched HSPA with some fanfare in early November, I understand there is only eight, nine weeks until the end of the quarter, but both companies reported fairly modest postpaid additions, about 100,000 each and less if you include the write-offs of both companies, total, theirs obviously being much bigger than yours, so I am wondering, is this a function of weak demand overall because of economic factors or would you think that there are competitive issues and Rogers actually did much better in terms of retention as well as acquisition, we will see obviously their numbers next week.

And my second question really for Darren regarding cash cost to users and AMPU, I think you have been using this phrase AMPU, which I think is quite interesting because it acknowledges that while ARPU slips, it does not necessarily have to destroy value if you can reduce recurring cost. Obviously, your margins in the quarter were negatively impacted by big cost of retention. But can you give us an idea how things like Koodo and Clear Choice plans have helped you in terms of cash cost per user and therefore AMPU as a potential offset in future quarters to ARPU decline?

Bob McFarlane

Okay Dvai, in respect of your first question on HSPA and your riders, partially quarter so it is early days, remember again, I guess to cut the chase, I do not think it was absence of demand, I think it was sort of normal course. Remember that in respect of the HSPA product, which is new to the market, it tends to be higher priced, more fully featured product. Look at the iPhone, look at the Bold, the HTC Hero, etc. So in that respect, we are not down the maturity curve of production of HSPA handsets and so for example on our Koodo product line, it is exclusively CDMA, we do not sell prepaid. So, from a standpoint on whether it be Koodo or HSPA, I do not think HSPA is not an element of a volume driver with more focus on quality. As the technology curve evolves and there is a greater portfolio of handsets at a variety of cost points where in fact the subsidy should hopefully be lower than they have historically been on CDMA, then we should be able to pursue better volume at and efficient COA, I guess we referenced that earlier.

So, at the end of the day, I think it reflects really the quality effect that was going on. It is difficult to say with all the press that was going on in the fourth quarter whether they were purchase deferrals or not. I think at the end of the day, it was really a reflection of the marketing orientation of this organization towards quality products.

Your second question was in respect of AMPU, and for those not familiar with that acronym, average margin per unit, so the point here is that in respect of whether it be increased competition, whether it be the fact that voice revenues are declining and data may or may not be sufficient to offset that, one needs to look at cost structure in order to maintain and improve margins, and so that means managing on an AMPU basis. So, an example of that would be the introduction of the new rate plans in early November by organization and essentially the strategy related there was to deal off the future friendly need to not be charging spectrum system access fees, and at the same time look at the cost structure whether sell that from an AMPU perspective over time, there is no negative impact.

Now, the ARPU impact from that change was negligible in the fourth quarter. As we indicated at the time of launch, it is available for new subscribers, it is also available to the existing to the extent that they want to fully adopt that new rate plan, which means giving up any benefit that may be embedded in a historical price plan that they have. So we really did not have a significant number of shall we say of internal conversions, and I think it positions us well in the marketplace. But as mentioned, given that we did a $5 increase, which was less than the elimination of the system access fee and e911 charge, we do have a focus on the cost side of the organization and we are driven to hold that in 2010.

Darren Entwistle

Maybe just make one comment Bob on the Koodo cost structure in terms of how we engineered that product.

Bob McFarlane

I think with Darren’s suggestion there is in respect to Koodo, when we launched that product, it was understanding as a flanker brand focusing on the affordable voice and messaging segment that one needed for a flanker brand of the future, one needed to have a low and efficient cost structure. So we looked at early opportunity in saying that up including significantly outsourced service model and the like. So from a variety perspective, without giving away our competitive secrets, that brand was constructive from a low-cost perspective and so when we look at our business plan, how it has materialized shall we say, we are heading near to the second year of operation. We crossed the EBITDA many quarters ago, it is ramping up quarter over quarter with significant EBITDA improvement. So, it is a distinctly positive factor in respect of margin improvement. And so, given that it is an important source of loading for our organization, that is an encouraging development.

So, at the end of the day on the PCS brand, the HSPA launched differentiation and talked about the factors and the handsets are the means by which we will improve that side and then that leaves the Mike where, as you see the total subscribers now getting down to 9% and less of our subscriber base, as we finish the migration on that over the course of next year or so, then we will be on a very solid footing in respect of overall AMPU in the organization.

Dvai Ghose – Genuity Capital Markets

Now that makes sense. I guess my only request, when you give us a lot of really good disclosures, if you can help us to trace the AMPU and cash costs for users because it gets a little bit dwarfed with things like retention expenses and acquisition expenses, I think that will be really useful, and at least it will help us understand how you are achieving these targets.

Bob McFarlane

Thanks for the input, Dvai.

Dvai Ghose – Genuity Capital Markets

Thanks.

John Wheeler

Next question Daniel, please.

Operator

Our next question will come from David Lambert at Canaccord Capital. Please go ahead.

David Lambert – Canaccord Capital

Thanks. On the wireline side, you seemed to have a pretty significant jump in the data revenues this quarter. I was wondering if you can talk about, I suspect it is coming from the enterprise side of the business, I was wondering if you could talk about how the new contracts are starting to get layered into your revenue?

Bob McFarlane

Thanks David. Yes, on the data side, on wireline, good news story. There is really a couple of things there, one you thought TELUS TV, additions on the consumer side that are contributing to the data growth, that is a primary element. And the other notable one is in terms of the implementations of some of the large complex enterprise deals where they are data centric that as well as contributing to our growth in the wireline side on the data front. So those would account for 80% to 90% of that growth.

David Lambert – Canaccord Capital

Okay. How would the enterprise contracts would become honored [ph] during 2010, of the new wins that you have had over the last year, what percentage of those are actually generating revenues today versus throughout the year?

Bob McFarlane

Okay. Well, in terms of large enterprise deals, we have de-emphasized them on a go-forward basis as we re-orientate towards the middle market, and that in part reflects the fact that with these large enterprise transactions in terms of the business model, you have got a dilutive timeframe. It depends on the size, the scale and the timeframe, but generally speaking, you are dilutive for the first year to a year and three quarters as you incur expenses in advance of a revenue ramp up. So, given the plethora of growth initiatives, HSPA, iPhone, TELUS TV, so on and so forth and trying to balance that on a free cash flow side, and given the success in having some large implementations like government Quebec and City of Montreal that are already underway, so from an organizational implementation perspective, we want to focus on implementation as opposed to just acquisition.

Then, we felt that that was the appropriate transitional strategy into 2010. So therefore do not expect any major new enterprise transactions that leaves the ones that are, shall we say, in the pipeline I mentioned, Quebec and Montreal. They are underway. We do have some others that are in implementation phase. They are contributing negative EBITDA in 2010 and if you look at the Department of National Defense, which was recently implemented as well. So, there is an improvement expected in terms of the contribution from LCDs in 2010 and that should be an element of margin enhancement and we think that the shift away from going after new ones focusing on implementation is the right direction for the organization, and another byproduct of that obviously is in the absence of new deals that helps lessen the capital expenditure, demand, the success based demand that we have experienced in the past couple of years and that is one of the reasons why we are able to have a lower CapEx profile in wireline this year.

David Lambert – Canaccord Capital

Thank you.

John Wheeler

Okay. We are now through an hour, so we will take one more question and that would be it, Daniel?

Operator

Thank you. Our last question will come from Bob Bek at CIBC World Markets. Please go ahead.

Bob Bek – CIBC World Markets

Thanks. Good afternoon. Just the big picture questions ended off I guess, Bob you are through the CapEx hump with the HSPA out of the way and obviously some strong free cash flow growth expected for 2010, can you refresh us on management and the Board’s views on free cash flow usage and priorities, obviously some competitors and many of your peers looking at dividend increases and buyback, so can you just refresh us where you stand on the use of cash, thanks.

Bob McFarlane

Sure Bob. Yes, we try to be helpful and be, I do not know, predictable if you will by publishing our financial policy guideline targets that whether it be in respect of leverage or whether in respect of dividend payout, to help give some color, the dividend payout ratio can get somewhat complex for an organization just because you have some one-time tax adjustments that seem typically positive or in that quarter as well a debt redemption charge. So, we show calculation in the MD&A [ph] we are back I think by memory, I think we are 67% or something like that in terms of the adjusted payout ratio, which is obviously higher than our 55% high end of our payout ratio guideline.

Really, what we are trying to do is given that the organization has gone from a period where we had tax refunds making tax a source of cash for the organization to a timeframe when we are in tax paying from a cash perspective and making that all look much more complex, given our structure and ability to defer some tax, we are able to move that peak tax period from last spring to this spring. So, the peak tax timeframe actually is going to be Q1 of 2010 because we will have catch-up installments on 2009. We also will commence the regular normal installment for 2010 and so we are going to have probably an all-time high cash tax remittance in Q1 2010, and then it will trend back to a more normalized phase. So, what that would mean is 2011 is going to be significantly lower cash tax than 2010 as was 2009.

So, really then what we are looking at it to date is as we say, we have a leverage guideline, we want to stay within it, there is no signs to going it over by a fraction or what have you but it is more the spirit of what we are looking at and we have a spirit to stay with that and so, given we are at the high end, then we can increase dividends or we can do share repurchases to the extent that we have a positive free cash flow, and given the cash taxes in this quarter, that was an element or a decision in the fall not to raise the dividend. So, as we have come through 2010 and see the guidances for significant turnaround in the organization in terms of profitability, that should buy us some head room and if we deliver upon that, we are going to have head room within that payout ratio to consider a dividend increase would certainly be our desire, and to look at things like share repurchases, but given where we are at present, we think we are taking the right prudent approach.

Bob Bek – CIBC World Markets

It is helpful, thank you.

John Wheeler

Okay, well thank you very much everybody for joining us today, and we appreciate your interest and continued support of TELUS. Have a great day.

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Source: TELUS Corporation Q4 2009 Earnings Call Transcript
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