Q4 2009 TELUS investor conference call - About TELUS

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           Q4 2009 TELUS
           investor conference call

           Darren Entwistle
           President & CEO

           Robert McFarlane
           EVP & Chief Financial Officer


           February 12, 2010




                                            Presentation


Operator
Good morning, ladies and gentlemen. Welcome to the TELUS Q4 2009 Earnings Conference
Call. I would like to introduce John Wheeler. Please go ahead.


John Wheeler – TELUS, Vice President, Investor Relations
Welcome and thank you for joining us today 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 Internet access, the quarterly presentation slides are also available at this
site. You will be in listen-only mode during the opening comments. Let me direct you to the ever-
present slide 2…


The forward-looking nature of this presentation, answers to questions, and statements about
future events are subject to risks 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
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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’ll start with introductory comments and a
review of the quarter by Bob McFarlane – Executive Vice-President & 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 McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Great, thanks John, and good morning everyone. Let’s begin with a summary of the wireless
highlights. Overall wireless revenues 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. 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 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 of 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 5th
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when the new network was launched so we had less than 60 days selling our expanded
smartphone line-up. 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 to 23” as compared to “85 to 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 total MOU’s down 5.6%, economizing
of rate plans by both consumers and business clients, with chargeable MOU’s decreasing
significantly more than total MOU’s, 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 the positive side, data ARPU growth
remains strong, increasing $1.43 to $12.60. This now represents 22% of total ARPU, up 4 points
from last year.


As shown on 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 2 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 of
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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’s review our wireline results. Revenue decreased by 3.8% due to ongoing
local revenue declines, augmented by accelerated LD and equipment revenue declines that in
aggregate were only partially offset by modest data growth. Operational expenses were relatively
flat reflecting effective cost control as I’ll 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 and 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’s 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 weak 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 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 IP TV net adds as well as benefitted 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 and 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 encouraged to see TELUS TV and high-speed Internet
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loading of 44,000 exceed the decline in residential line losses of 41,000. These two items reflect
more effective winback capabilities and the results of our continued broadband expansion, which
facilitates wireline bundling opportunities including TELUS TV.


In an exciting development ten days ago, TELUS announced the availability of a new TELUS TV
service powered by Microsoft Mediaroom. 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, Fibre to the
Node coverage continued to expand with TELUS now covering more than 75% or 1.8 million
households in B.C. 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 IP TV
and Internet services. In all new greenfield developments in Western Canada have continued
deploying fibre to the home, while at the same time we have been deploying fibre to the building
with ethernet to the suite technology for years.


Putting it all together, let’s look at TELUS on a consolidated basis starting on 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 49 cents
in the quarter driven largely by decreased operating profitability, but with a few non-recurring
items we’ll talk about on 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.
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Slide 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 3 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 from the
Black’s Photography acquisition, is down 2,150 approximately. TELUS International is higher by
about 750 positions, which substantially consists of internal positions off-shored. 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
equivalents for 2009 and our expectation for 2010. Going forward, we expect a continued focus
on operating efficiency, as highlighted earlier and as reflected by the associated target reduction
in domestic FTE’s of approximately 1,000 in 2010. Given the reduction in domestic FTE’s
throughout 2009, combined with an additional 1,000 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 pay-outs leading to an 8% reduction in
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 in the same quarter last year. As
previously disclosed, earnings per share included an impact of 22 cents resulting from the loss on
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early partial redemption of our June 2011 US-dollar notes. More on this on the next slide.
Normalized EBITDA contributed 18 cents to the decline, primarily from higher wireless retention
costs, while higher pension and restructuring costs negatively impacted EPS by 9 and 6 cents,
respectively. Slightly higher depreciation and amortization and “other” expense contributed 1 cent
to the downside.


Turning to slide 24, I would like to take a moment to review TELUS’ refinancing 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
30% or US$577 million of the outstanding 8% US-dollar notes due 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 22 cents per share as previously highlighted. This debt issue provides a
significantly lower effective interest rate, as compared to the rate for the redeemed notes and
extended TELUS’ average long-term debt maturity by an additional year overall to 5 years.


Before I conclude, we wanted to update our 2009 actual and 2010 pension assumptions 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 to our 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 the 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 of 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 reduced 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 IPTV 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.
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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’s move to the Q&A session with
Darren and myself. Back to you John.


John Wheeler – TELUS, Vice President, Investor Relations
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'll turn it over to Daniel and can
you please proceed with the questions from the queue for Darren and Bob, please.


Q&A


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


Greg MacDonald – National Bank Financial, Analyst
Thanks. Good afternoon guys or good morning. Wireless ARPU - a little lighter than expected
from my estimates, both on data and voice. We've seen historically Rogers, when it adds the, or
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're 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,
the second quarter from what's looks like reasonable smartphone loads in the 4Q? Thanks.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Thanks, Greg. I think your comment is appropriate in terms of we just launched the iPhone
November 3rd. So, we had few days short of two months in quarter of loading and ramping up.


Early indications, I mean, we have an ARPU for HSAP, its well north of $100. How representative
that is on the sustainable basis remains to be seen, but certainly a very strong ARPU across the
board, not just the iPhone, but on all the HSPA devices. So, we're certainly encouraged by that
development. And we need have a little more of an empirical trail as you allude to in terms of
really getting good handle on that. But it's certainly a positive factor in terms of a go forward
basis. But it had a negligible impact in quarter, because of the really, the partial quarter result.
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Greg MacDonald – National Bank Financial, Analyst
Thank you.


John Wheeler – TELUS, Vice President, Investor Relations
Next question, please.


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


Phil Huang – UBS Securities, Analyst
Based on my estimates, voice ARPU decline is at a relatively stable pace with 12% for last three
quarters. So the acceleration in overall ARPU, for me it looks like mainly comes from slowing data
growth. I just want 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 McFarlane – TELUS, Executive Vice President and Chief Financial Officer
On 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, a bit of the economy in terms of people right sizing or
moderating their usage as well as presumably some messaging or data substitution for voice.
We've 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 Bell 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're just looking at revenue and the ARPU. In
terms of the domestic roaming rate that was not the case in the denominator ie 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 Untied States.


We're really talking about CDMA here from a 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's a positive 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 those sticks.
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The business model is certainly adjusting favourably. But in terms of penetrating the consumer
market at generally lower rates, we're finding in terms of year-over-year CAGR that was a
meaningful contributor.


Of course, in our case, we also have a 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 look, 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 '08, the CAGR, in terms of year-over-year comparison
this quarter, was impacted negatively. So all in all, we're not really concerned, if you will on the
substat of underlying data growth rates or a little bit of a measurement issue there on 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 than it is on a general phones at the take up rate
for data packages when we upgrade on 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're hopeful and encouraged by
early HSPA results. We need a little more empirical experience to be able to track it better but it's
certainly a positive trend and we would hope to see a significant improvement in our ARPU over
the course of 2010.


Phil Huang – UBS Securities, Analyst
Thanks. That's helpful. Maybe just a quick follow-up on the voice side, based on your view of the
competitive activity right now, do you feel comfortable combining a premium for the more mature
networks that you have or do you think that it’s more prudence and important to more promptly
react and match more aggressive pricing out there?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
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, that’s quite an organizational
effort we implemented doing both. We think those are very resilient, very effective and very
consumer friendly, consistent with our future friendly brand promise. So if you ask the question on
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's been addressed, I think, in our customer friendly manner. And so from a go
forward perspective we are quite comfortable with our positioning on PCS.
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In respect of our flanker brand, keep in mind that we've been operating for almost two years on a
Koodo side. We've had stable loading with that brand on a year-over-year basis. And remember
that in your early periods, you have moderated churn and now that we are down the road in that
brand launch, we really have normalized full period churn flowing through. And so to have your
net adds being stable, it's very encouraging. So we have that position in the market that's
succeeding and we see no reason to have to adjust our pricing in response to competitive
developments in the marketplace.


Phil Huang – UBS Securities, Analyst
Great. Thanks very much.


John Wheeler – TELUS, Vice President, Investor Relations
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, Analyst
Thanks very much. Robert, 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
COA expense actually being down year-over-year and COA per gross add up only up 2%.


So I am kind of confused and perhaps a little worried as we look at 2010, that if margins are
already seeing pressure down 400 basis points, what happens when the subsidies and 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 have this quarter, or should we assume that the
underlying wireless margin start to improve and offset some of that COA growth? Hopefully, I
explained that properly?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Well I think I understand the question. But to answer your first question, I think you did miss
something in terms of COA/COR. First of all, the COA reflects in all the full cost of loading, in fact
in the quarter where we had a brand new launch with new HSPA devices, if you look at the cost
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curve or technology pricing curve of handsets and HSPA technology, yes, there is going to be
new models introduced, but on average, its going to trend down at a fairly fast pace, until it’s
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 on the subsidy being lower at best. In terms of what was effecting the
margins in the quarter, was really two things, primarily I think in terms of this discussion with the
COR side of things, the cost retention. And the cost retention was a very predictable thing and in
fact we, in our launch announcing the iPhone, talked about a $100 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 base as it pertains to contract renewals, this is always been something that is not
unique to ourselves. The key issue, from a profitability perspective, was what's the ratio or what
would the ratio be in respect of new subscribers where the revenues are 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're very encouraged because in talking with the Apple
organization, I'm not talking about Canada, I'm talking about internationally, and the experience of
various launches, we were advised to expect an 85/15 type of initial ratio. Obviously, as you've
seen in other carriers that are more mature and they’re offering the iPhone, that trends down
significantly over time. But the big question was what it would be in our initial period. So we've
started off at 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 that 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 margin. So one of the missions in this organization is to arrest
the ARPU decline, and we are set on doing that in 2010.


Jonathan Allen – RBC Capital Markets, Analyst
That's very helpful. Thank you very much, Bob.


John Wheeler – TELUS, Vice President, Investor Relations
Go ahead Daniel.


Operator
Our next question will come from Peter Rhamey of BMO Nesbitt Burns. Please go ahead.
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Peter Rhamey - BMO Capital Markets, Analyst
Great. Thanks very much. Thanks for taking the question. A couple of questions, again, on
wireless. There was some commentary that you'd 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 and second of all I think one of
your base assumption 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's optimistic sign that
perhaps competition is going to come a quarter or two later for you and whether you are feeling a
little bit better about your business as a result?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
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, lessons in
respect for prepaid are well documented in the wireless industry that if you overly subsidize and
don't an investment in the handset and the absence of contracts and churn spikes up and make
the product uneconomical, so we have a decent prepaid ARPU and we have a decent approach
historically and economically to prepaid and - but that reflects some discipline in what we saw in
the fourth quarter was efforts by certain competitors to go to fully discounted or nearly fully
discounted handsets on a prepaid basis but we won't play in that and so if that meant sacrificing
some loading and so be it and that's what transpired and I think that's 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's the Koodo side of things. In terms of new entrants, well, there really was - well, it's
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 little 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 Capital Markets, Analyst
With regards to prepaid, those offers are still in the market I believe, is that fair to say?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
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I would have to just check on that, put it this way, they were very prevailing 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 Capital Markets, Analyst
Great. Thanks very much, Bob.


John Wheeler – TELUS, Vice President, Investor Relations
Next question?


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


Jeffrey Fan – Scotia Capital, Analyst
Thanks very much, and good morning. Just one quick one on the definition of smartphone, I'm
just wondering Bob, if you can just clarify what your definition is to help us compare between
companies?


And then switching gears on the bigger question, on the fiber front really it's wireline, with BCE
Bell I guess moving to fiber to the home and some of the aerial footprint, just wondering if you can
provide us with some facts on, what your aerial coverage is in Alberta and B.C., and your
thoughts on where fiber to the home over aerial deployment really makes sense? Thanks.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Ok, Jeffrey, in terms of the definition, in our case, we define smartphone as including devices
such as the iPhone, RIM devices and PDAs. It does not include data sticks, AirCards, modems,
embedded laptop devices, multimedia and messaging devices. So essentially, you're talking
about, it is a handset that has a multimedia capability, so internet broadband connection and so
that's the definition and obviously, from a materiality perspective that largely consisted of RIM
product and then laterally iPhones, subsequent launch of the new network.


Jeffrey Fan – Scotia Capital, Analyst
Okay.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
In terms of wireline broadband deployment in Western Canada, we've been deploying fiber to
greenfield developments for quite some time, a little over a year, by memory now. I think it started
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perhaps in late 2007 or thereabouts. In any event, we've been at it for considerable period of
time.


And as well, we have experimented with some brownfield development. As you understand the
cost structure of doing that in a business model, certainly in respect of some MDU buildings and
the like we're connecting internet to the suite. And this has been something that we've been doing
for some time.


We've also begun very early stages of the VDSL2 deployment in the past six months. And so
we'll 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 time
frame.


So this is something that we've been doing for some time. Obviously, this is not a Verizon like
model where we are taking fibre to every premise in our coverage footprint. But we are doing
selectively where the economics makes sense and that largely consist of Greenfield
developments or highly concentrated MDUs.


John Wheeler – TELUS, Vice President, Investor Relations
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, Analyst
Yes. Thank you for taking my questions. I just want to go back maybe to the ARPU declines we're
seeing in the wireless and just look at the minutes of use. If I look at your quarters declined here
at 5.6%. It's higher then what we're seeing from your competitors. Can you maybe tell us, is there
special area of focus that your customers are trying to reduce their usage of voice? And is this
particular to TELUS? And what is your view going forward as to when you think the decline could
start to tapper off and hold steady at a certain level instead of the decline increasing.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
In respect of the ARPU, the 5.6% minutes of use decline is total minutes of use. Unfortunately, if
we measured it on a bill basis or the chargeable minutes of use, the decline was greater than
that. So that reflects the challenge for the organization.
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Essentially, what we are experiencing is, and this is a trend really for the past year that we have
witnessed, is that subscribers on average are not only using less minutes in total, but they’re 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's happening less frequently. So they are managing, for
example, usage of 399 minutes to make the point. So, that's an example of right sizing. So to a
certain extent, it reflects where we have some bundles or bundling minutes since you are getting
the monthly recurring fee. So a little bit of a shift there, but regardless, we are seeing an overall
usage decline.


I think in terms of go-forward, it's 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 resources and we have experienced higher ARPUs with them. So
hence the emphasis on the ARPUs, sorry, on the smartphones and we're 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've probably got better sources than we do, given you have economists that work for you, but
certainly it is a consensus out there of the Canadian economy getting better. And certainly, we're
seeing that in Western Canada. So, to the extent that plays a factor, that would be a nice
headwind for us.


Maher Yaghi – Desjardins Securities, Analyst
Do you think that the offering that you have to your wireless subscribers has, in any way been
different than maybe what your competitors are offering your customers, a potential to lower their
voice usage more than - because, I mean, if I look at Bell or Rogers, we're not seeing those kind
of declines in minutes of use. Is there anything particular to the package that you're offering that
is making this happen?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Well, I think, the thing that is most unique in respect of ourselves, two things come to mind. One
is that we have a Mike subscriber base in our subscriber base, unlike other Canadian
competitors. And as you are probably familiar, we've been migrating the heavy users, the heavy
mobile voice users off of that service, as it's become more push-to-talk centric.
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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 migrate it 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 it's unique functionality and combination of push-to-talk capability. That's not the case
anymore and as you're converting over, you are re-pricing at the market and so there has been
an ARPU reduction on the Mike that's been flowing through our numbers that would not be
something seen at other carriers, a fact that also pertains to net additions because obviously Mike
net additions are negative and so they pulled down our results.


That's one reason, another reason would be related to roaming. Yes, we do have some
international roaming from the largely Verizon and lesserly from Sprint. On a cross border basis,
as mentioned U.S. to Canadian traffic has actually declined in the past year with the recession
etcetera. 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 sales 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're just ramping up, but in on a
go-forward basis, we would expect that should be a regular growth element in a positive way, in
our ARPU, and that was one of the business rationales behind the HPSA launch.


Maher Yaghi – Desjardins Securities, Analyst
Okay. Thank you very much.


John Wheeler – TELUS, Vice President, Investor Relations
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, Analyst
Yeah. Thanks very much. Couple of things on the wireless side as well. Given the fact that both
Bell and TELUS launched HSPA with some fanfare in early November and I understand there
were only about 8, 9 weeks before the end of the quarter. But both companies reported fairly
modest post paid additions of about 100,000 each and less if you include the writeoffs that both
companies took, their is obviously much bigger than yours. So I’m wondering, is this a function of
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weak demand overall because of economic factors or do you think there are competitive issues in
Rogers actually doing much better in terms of retention as well as acquisition, we’ll see obviously
their numbers next week.


And my second question really is to Darren regarding cash cost to users and AMPU. I think
you’ve been using this phrase AMPU which I think is quite interesting because it acknowledges
that while APRU slips, it doesn’t necessarily have to destroy value if you can reduce recurring
costs. Obviously your margins in the quarter were negatively impacted by an increased cost of
retention. But can you give us an idea of 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 – TELUS, Executive Vice President and Chief Financial Officer
Okay. Dvai, in respect to the first question on HSPA and you're right it was partial quarter, so it's
early days. Remember, again - I guess cut to the chase, I don't think it was absence of the
demand, I think it was sort of normal course. Remember that in respect to the HSPA product, it
was - which is new to the market, it tends to be higher priced, more fully feature product, look at
the iPhone, look at the Bold, HTC Hero etcetera. So in that respect, we are not down the maturity
curve production of HSPA handsets and so for example, on our Koodo product line, it's
exclusively CDMA.


We don't sell prepaid. So from a standpoint on whether it would be Koodo or HSPA, I don't think
we're really, HSPA is not an element of a volume driver, it was more focused on quality. As that
technology curve evolves and there is a greater portfolio of handsets at of variety of cost points,
where in fact the subsidy hopefully be lower than they have historically been on CDMA. Then we
should be able to perceive better volume at an 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's difficult to say with all the press that was going in the fourth quarter whether they would
purchase deferrals or not, I think at the end of the day, it was really reflection of the marketing
orientation of this organization towards quality product. And your second question was in respect
of AMPU and for those not familiar with the acronym AMPU, Average Margin Per Unit. So the
point here is that, in respect of whether it would be increased competition, whether it would be the
fact that voice revenues are declining and the data may or may not be sufficient to offset that.
One needs to look at cost structure in order to maintain an improved margins and so that means
managing on an AMPU basis. So an example of that would be the introduction of the new rate
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plans in early November by organization. And essentially the strategy related there was to deal
up the Future Friendly need to not be charging spectrum access, system access fees.


And at the same time, look at the cost structure whether; still 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, the time of launch, it’s available to new subscribers, its also
available to 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 historical price plan that they have.


So we really didn't have a significant number or shall we say an internal conversions. And I think
it position 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 the e911 charge, we do have a focus
on the cost side of the organization and we're driven to hold that in 2010.


Darren Entwistle – TELUS, President and Chief Executive Officer
Maybe just make one comment, Bob on the Koodo cost structure in terms of how we engineered
that product.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
I think what Darren's suggestion there is in respect of 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 every opportunity in setting that up, including a significantly outsourced
service model and the likes. So from a variety of perspectives, without giving away our
competitive secrets, that brand was constructed from a low-cost perspective. And so when we
look at our business plan, how it's materialized, shall we say, is we're heading near to the second
year of operations. We crossed the EBITDA many quarters ago. It's ramping up quarter-over-
quarter with significant EBITDA improvement. So it is a distinctly positive factor in respect to
margin improvement.


And so, given that it's an important source of loading for our organization, that's an encouraging
development. So at the end of the day, on the PCS brand, the HSPA launch differentiation and I
talked about the factors in the handsets, are that the means by which we'll improve that side. And
then that leaves the Mike where, as you've seen, 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'll be on a very solid footing in respect of overall AMPU in the organization.
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Dvai Ghose – Genuity Capital Markets, Analyst
So, that makes sense. I guess my only request, and you gave a lot of really good disclosures, if
you can help us to trace the AMPU and cash cost per user, because it gets a little bit dwarfed
with things like retention expenses and acquisition expenses. I think that would be really useful
and helpful, at least will help us understand how you are achieving these targets.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Thanks for your input, Dvai.


Dvai Ghose – Genuity Capital Markets, Analyst
Thanks.


John Wheeler – TELUS, Vice President, Investor Relations
Next question, Daniel, please.


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


David Lambert - Canaccord Capital, Analyst
Thanks. On wireline side, you seem to have a pretty significant jump in the data revenues this
quarter. I was wondering if you can talk about, as expected it's coming from the enterprise side of
the business. I was wondering if you can talk about how these new contracts are starting to
getting layered in to your revenues?


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Thanks, David. Yeah on the data side on wireline, good news story. It's really a couple of things
there, one you've got TELUS TV additions on the consumer side that are contributing to good
data growth, as that's a primary element. And the other notable one is in terms of the
implementations of certain large complex enterprise deals, where they are data centric that as
well is contributing to our growth on the wireline side on the data front. So those would account
for 80 to 90% of that growth.


David Lambert - Canaccord Capital, Analyst
How would the enterprise contracts would be coming on, during 2010, of the new ones that
you’ve had over the last year, what percentage of those are actually generating revenues today
versus throughout the year?
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Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Okay. Well, in terms of large enterprise deals, we have deemphasized them on a go forward
basis, as we re-orientate towards the middle market. And in that impart reflects the fact that with
these large enterprise transactions, in terms of the business model, you've got a dilative
timeframe. It depends on the size, the scale and the timeframe, but generally speaking, you’re
dilutive for first half year to year and three quarters, as you incur expenses in advance of the
revenue ramp-up.


So, given the plethora of growth initiatives - HSPA, iPhone, TELUS TV, so 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 of 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 was the appropriate transitional strategy into 2010. So, therefore, don't expect
any major new enterprise transactions. That leaves the ones that shall we say are 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
Department of National Defence, 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 by product of that, obviously, is an absence of new deals that helps lessen the
capital expenditure demand, the success-based demand that we've experienced in the past
couple of years. And it is one of the reasons why we're able to have a lower capex profile in
wireline this year.


John Wheeler – TELUS, Vice President, Investor Relations
Okay.


David Lambert - Canaccord Capital, Analyst
Thank you.


John Wheeler – TELUS, Vice President, Investor Relations
We're now through an hour. So we'll take one more question, and that will be it. Daniel?
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Operator
Thank you. Our last question will come from Bob Bek at CIBC World Markes. Please go ahead.


Bob Bek – CIBC World Markets, Analyst
Thanks. Good morning, good afternoon. Just to be quick, a big picture question to end it off, I
guess. Bob, 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
use of cash? Thanks.


Bob McFarlane – TELUS, Executive Vice President and Chief Financial Officer
Sure, Bob. Yeah, we try to be helpful and be, I don't predictable, if you will, by publishing a
financial policy guideline targets that, whether it be in respect of leverage or whether in respect of
dividend pay out, to help give some colour. The dividend pay out ratio can get somewhat complex
for our organization just because you have some one time tax adjustments that's typically
positive, or in this quarter as well a debt redemption charge. So we show via calculation in the
MD&A, we back it out - by memory I think we are 67% or something like that in terms of the
adjusted pay out ratio which is obviously a higher than our 55% high end of our pay out ratio
guideline.


Really, what we're trying to do is, given that the organization has gone from a period where we
had tax refunds for making tax a source of cash for the organization, to a timeframe when we're
in tax paying from a cash perspective. And making it all 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 Q1, about 2010, because we will have
catch-up instalments on 2009, we’ll also commence the normal instalment 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 more normalized phase. So, what would that 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 today, it is we say we have a leverage guideline. We
want to stay within it. There is no science to going at over above fraction or what have you, but it
is more of 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
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element of decisioning in the fall, not to raise the dividend and so as we come through 2010 and
see the guidance is for significant turnaround in the organization in terms of profitability, that
should buy us some headroom and if we deliver upon that, we are going to have headroom within
that payout ratio to consider a dividend increase, which certainly would be our desire. And 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, Analyst
That's helpful. Thank you.


John Wheeler – TELUS, Vice President, Investor Relations
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.


END