MTS SECOND QUARTER 2008 CONFERENCE CALL AUGUST 11, 2008, 4:00 P.M. ET
x IAN CHADSEY, Vice-President of Investor Relations, Manitoba Telecom Services Inc.:
Good afternoon everyone and welcome to the call. Earlier today, we issued a news release and our second quarter business results for 2008. The news release, along with our MD&A and our supplemental information are now available on our website at mtsallstream.com. I should mention that today, along with releasing our results, the Board of Directors approved the third quarter dividend, which has been set at $0.65 per share.
Today’s comments may contain forward-looking information relating to the finances, operations, and strategies of the company, including comments on revenue, EBITDA, earnings, cash flow, capital expenditures, sales and marketing activities. These statements are based on assumptions made by the company and run the risk that our actual results or actions may differ from those anticipated. The statements made today reflect the assumptions made by MTS as of August 11, 2008, and accordingly are subject to change after that date. MTS disclaims any intention or obligation to update or revise these statements whether as a result of changing circumstances, changing events, or otherwise. These cautionary statements are made on behalf of each speaker for whose remarks contain forward-looking information.
On today’s call we have Pierre Blouin, Chief Executive Officer, Wayne Demkey, Chief Financial Officer, John MacDonald, President of the Enterprise Solutions division, and Kelvin Shepherd, President of the Consumer Markets division. With that, I’ll turn the call over to Pierre.
- PREPARED REMARKS -
x PIERRE BLOUIN, Chief Executive Officer, MTS Allstream Inc.:
Thank you, Ian, and good afternoon everyone. Thank you for joining us today. Let me begin by saying that we are pleased with our operating and financial performance for the second quarter. We’re on track to meet our guidance for 2008 and to date, have not been impacted by the negative forecast around the economy. Both our Enterprise Solutions and Consumer Markets divisions delivered solid gains and profitable growth in the second quarter. I especially want to highlight our 15.4% increase in growth services revenues in the second quarter. Growth in growth services, being wireless, digital television, high-speed Internet, converged IP products and unified communications, has been the key focus for our management team and the foundation of our operating strategy for over two years. Over that time, we’ve taken these growth services from 35% of our total revenues to more than 44% at the end of the second quarter.
Given this momentum in next generation services, our strong balance sheet, solid customer relationships, and the expertise of our employees; we are well positioned to capitalize on future opportunities in the fast-evolving Canadian telecommunications
landscape. In this regard, we take great pride in the announcement made earlier today that our Consumer Markets division has been awarded the prestigious 2008 Frost and Sullivan Competitive Strategy Leadership Award. Frost and Sullivan is a global consultancy with offices in 21 countries around the world. Their competitive strategy award is presented to a company whose strategy has been innovative or has yielded significant gains in market share during the research period.
This award recognizes what we have been saying for quite some time now that our financial and operating performance, as well as our innovative leadership in products such as MTS TV is unmatched in North America. This award is confirmation of the exceptional work that Kelvin and his team have been doing over the past several years.
Let me quickly touch on the quarter’s highlights. This was our third consecutive quarter of year-over-year revenue growth with positive contributions coming from both operating divisions. We continue to deliver on our cost reduction targets. Year to date we have achieved $20.1 million of savings on an annualized basis already reaching our annual guidance range for 2008, and we will not stop there.
We expect to continue to succeed in aligning our cost structure to our market realities and have launched multiple new initiatives to help us become even more efficient. Looking forward, we have recently engaged in the redesign of many of our operating processes to assess whether they are properly aligned with our existing products and customer experience targets. I will have more to say on this initiative over the coming quarters.
Now, turning to our operating divisions. Our Enterprise Solutions division delivered another solid quarter. Revenues were up over the second quarter of 2007 and the first quarter of 2008, while EBITDA remains stable. Revenues from its growth services most notably unified communications and converged IP services increased almost 21% in the quarter, reflecting the continuing strong demand for our IP-based offerings. During the quarter, the division won new contracts totalling $80.6 million, including major wins with DHL Express, the BMO Financial Group, The City of Winnipeg, Manitoba Hydro, the Alberta Teachers’ Association, and BC Housing, just to name a few. Our Enterprise Solutions division remains well-positioned to continue in its growth trajectory as Allstream continues to win new customers as the demand for its IP-based services remains strong, and adds the opportunity to continue to win new business at limited incremental costs with a cross-selling initiative across its customer base.
Our Consumer Markets division delivered another quarter of strong performance with growth services revenue up by 11.4%. Wireless subscriber growth was up a strong 10.6% over last year’s second quarter. The return to more rational wireless pricing in our markets, coupled with MTS delivering the lowest churn in the country, and wireless penetration in Manitoba being approximately 50%, as compared to the Canadian average of approximately 62% at the end of 2007, means that we, in Manitoba, have the right conditions for years of strong growth in our subscriber base as consumer adoption of wireless expands.
Our high-speed Internet segment also generated solid growth with a 9% increase in our customer base and year-over-year revenues rising more than 21%. At quarter-end, we had more than 172,000 high-speed Internet customers, resulting in an industry leading market share of approximately 60% in Manitoba. In our digital television segment, our customer base increased by over 13% in the quarter and revenues by just over 20% from a year ago.
We also continued to perform well in residential telephony. Residential access line losses remain stable for the quarter with our year-over-year loss being approximately 3%. This continues the trend of low residential access line losses over the last seven quarters. Supporting those results is our ability to offer our customers a unique bundle of broadband, home security, television and wireless services in addition to traditional voice services.
Our bundles are a distinct advantage in the Manitoba market and our customers agree as the numbers of bundles are ahead 10% this quarter. The total ARPU for these customers also grew by 5% in the second quarter. Overall, we believe that these results continue to represent one of the best performances against competition from cable operators by an incumbent telecommunications provider in North America.
Before I turn things over to Wayne, I’d like to briefly comment on our participation in the wireless spectrum auction. From the outset, we entered the auction with a clear and disciplined strategy to enable us to maintain our strong balance sheet and current dividend policy. Prior to the start of the auction, Industry Canada said that it expected to raise $1.5 billion from the sale of spectrum. As you now know, the final tally was approximately $4.3 billion.
Even with the support of private equity partners, we would not have been bidding outside of Manitoba at those prices as they simply did not fit the returns we are looking for in our business case. We were successful, however, in strengthening our position in Manitoba by acquiring another 35 megahertz of wireless spectrum covering 1.2 million people across the province for $40.8 million. This spectrum will be used for rolling out new technologies in the coming years. It also provides options and flexibility for aligning roaming and other wireless business arrangements with the spectrum used by other Canadian carriers.
We said we would be disciplined and we were. Buying the Manitoba spectrum at one of the lowest costs per pop per megahertz in Canada. Two new entrants acquired spectrum in Manitoba and represent potential entrants into our market, if and when they decide to build a network and launch. Based on their public disclosure, we believe that these new entrants will initially focus their efforts on more densely populated areas of the country and it will take a few years before they establish themselves in the Manitoba wireless marketplace.
Let’s remember that Winnipeg is the most competitive wireless market in Canada from a pricing point of view. MTS has been competing and winning against stiff competition for
a long time by offering strong value to its customers unmatched in the province through coverage and the most extensive bundles of services available in Canada. As you all know the large majority of our wireless customers are under contract and many have wireless as part of their home services bundle with MTS.
My point is that we will be ready to face them, when and if they enter our market. We also see new entrants providing business opportunities nationally for MTS Allstream to consider once the quiet period ends early September. One of those opportunities is the supply of backhaul services coast-to-coast to those new entrants. This represents a material opportunity similar to when we provided the backhaul services to Microcell on a national basis.
Once our post-auction review is completed, we will be in a better position to discuss our plans and intentions around share buyback programs. In summary, we’re pleased with our progress and performance so far in 2008 and we are confident that our strong franchise and brand recognition will result in continued growth going forward. We delivered on our guidance for 2007 and we expect to achieve our growth outlook for 2008.
Our growth services are expected to continue delivering double-digit growth rates with our Consumer Markets division remaining one of the best performing incumbent telecommunications providers in North America. In addition, our Enterprise Solutions division achieved a number of milestones and is now revitalized and growing. Thank you for your time and I’ll now turn the call to Wayne.
x WAYNE DEMKEY, Chief Financial Officer, MTS Allstream Inc.:
Thank you, Pierre, and good afternoon everyone. We are pleased to report another quarter of solid financial results building on two and a half years of steady progress. Those who have been on these calls before know that we discuss results from continuing operations because we believe they assist investors in assessing the performance of our company. Our reported results include a number of items, which are not from continuing operations such as the cost of our restructuring over the last two and a half years. These items are outlined in our second quarter results, news release and MD&A.
Also, as a reminder to those who model our financials, we plan to discontinue the segmented reporting we make on a geographic basis by the end of 2008. It simply no longer accurately reflects how we operate our business. We now segment by customer, regardless of geography, assigning consumers and small business to the Consumer Markets division and the larger business customers to Enterprise Solutions division. EBITDA from continuing operations in the second quarter of 2008 was $171.3 million, half a percentage higher than the second quarter of 2007. Earnings per share from continuing operations was $0.81, up by $0.02 from the same period in 2007 and in line with our guidance. Revenue from continuing operations for the second quarter was %486.4 million, up by 2.6%. These results were driven by strong increases in our
growth services revenues, which were up by 15.4% in the second quarter. Revenues were higher on a year-over-year basis for the third consecutive quarter.
We are pleased with the steady improvement of our Enterprise Solutions division with revenues up by 3.2% in the second quarter; the third consecutive quarter of year-over-year growth. A stronger performance demonstrates the growing demand for this division’s products and services. Next generation data Services revenues, which include converged IP and unified communications services achieved a strong 20.7% year-over-year growth in the second quarter, with converged IP services revenues up by 12.2% and unified communication services revenue up by 39%. Our IP-VPN customers are up 33% from the same quarter last year.
Overall, our Enterprise Solutions division generated over $18.8 million of incremental revenues from its growth services products. This strong performance in growth services revenues led to overall growth for the third quarter in a row. With this growth, the Enterprise Solutions division is on track to meet our 1% to 3% target range for revenue and EBITDA growth for the entire year.
In our Consumer Markets division, wireless revenues grew by 6% for the quarter and by 8.4% year to date on the strength of 10.6% growth in new cellular customers since the second quarter of 2007. Churn for the quarter was 1.3% on a blended basis. The overall increase in subscribers helped offset a 2.1% decrease in overall average revenue per user to $56.46 for the first six months of 2008. The decrease in average revenue per customer arose mostly from a reduction in wholesale revenues and by our success with more aggressive rate plans in the fourth quarter of 2007, as we explained in our first quarter 2008 call. These rate plans have been discontinued. You should note that our Manitoba wireless business represents approximately 25% of our total cash flows. Our high-speed Internet revenues also showed significant growth with consumer Internet revenues up by 21.4% year-over-year. This increase in revenues was driven by an increase in new subscribers of 9% since the second quarter of 2007, along with an 11% increase in average monthly revenue per subscriber.
Our digital television services continued their strong growth with revenues up by 20.2% in the second quarter, driven by a healthy 13.2% increase in our customer base and a 7.8% increase in ARPU to $50.80. Net additions were also ahead in the second quarter as compared to last year by 22%, with a total of over 80,000 installed subscribers. Looking ahead, we expect the positive trends experienced in our Consumer Markets division will continue with near double-digit growth in wireless subscribers and solid double-digit subscriber growth in both high-speed Internet and digital television for the full 2008 year.
Revenues from these growth services are expected to account for approximately 47% of our Consumer Markets division’s total revenues in 2008. Legacy declines in the second quarter continued flattening out with only a 3.3% decline in local services lines as compared to last year. This confirms that we’ve made significant progress stabilizing our legacy business in our Consumer Markets division while generating solid margins
and delivering the best performance in Canada. On the strength of our year-over-year increase of 15.4% on growth services revenues, our proportion of total revenues attributable to growth services at 44.2% in the second quarter getting close to our annual objective of 45% for this year. As the percentage of revenues from our growth services continues to grow, the impact from the decrease in legacy services revenues will continue to diminish, which should strengthen our overall performance.
Today, MTS is operating with a positive revenue growth outlook and strong, positive momentum in both divisions. EBITDA is also growing, demonstrating that we are disciplined on our cost structures as well.
Before reviewing our cost savings and capital expenditures, I want to cover off the one-time wireless charges. We incurred $10.3 million in expenses related to our review of the opportunities arising from the AWS spectrum auction and the costs associated with transitioning certain wireless services agreements away from Bell Mobility to other providers or our own platforms. As disclosed in the first quarter of 2008, we took steps to terminate certain wireless alliance agreements with Bell Mobility in accordance with the terms of these agreements. We have negotiated a transition agreement with Bell Mobility that ensures the continuity of service for our wireless customers in Manitoba and are finalizing terms with new suppliers to replace the services covered by those agreements or transitioning these services to our wireless platform.
This transition relates to agreements dealing with the supply of certain handsets and the provision of some wireless applications that we are transitioning to the same or new suppliers and the application to our own or new wireless platform. The work has been underway for many months and has not been customer-affecting. I want to note that this transition does not impact our roaming on the Bell Canada network and the same for Bell Mobility on the MTS Mobility network. We now have a better view of the costs related to this transition and to our participation in the spectrum auction. We have incurred $10.3 million for AWS auction costs and transition costs and anticipate incurring a total of $40 million to $50 million, including this $10.3 million, over the next two years. We are disputing certain costs being charged by Bell Mobility that relate to transitioning away from Bell Mobility and are of the opinion that such costs are recoverable from them. We have commenced formal proceedings in accordance with the dispute resolution mechanisms in our agreement. This transition away from Bell Mobility into our own wireless platform is not expected to impact our operating cost structure or wireless EBITDA, and will give us additional flexibility in providing services to our customers, in particular, as we look at the rapidly changing landscape in Canadian telecommunications.
On the expense front, we are continuing to work diligently on aligning our cost structures to the realities of the market by identifying and executing on potential efficiencies throughout both our divisions. Our target for 2008 in cost savings is $20 million to $30 million. With the second quarter results, we have achieved a total of $20 million of annualized savings year to date and have already reached the lower end of our 2008 target range. I believe this reflects our ability to take out costs on an
ongoing basis while improving our operating performance. We expect to continue to achieve savings by gaining new efficiencies, organizationally, and through our decreasing usage of incumbent networks.
Capital expenditures totalled 70.1% for the quarter and included some timing differences, which places us ahead year to date by $23 million as compared to last year. For 2008, we continue to target a capital intensity of 14% to 15% for the year, in line with our 2007 expenditures. This is below the levels that you are seeing at other telcos as we continue to benefit from the significant investments in state-of-the-art networks that we have made within both divisions in recent years.
Free cash flow from continuing operations for the second quarter was $72.4 million as compared to $88.6 million in the second quarter of 2007. For 2008, we are expecting free cash flow of between $250 million and $280 million. This covers all cash requirements, including non-recurring items, such as restructuring costs, pension solvency payments and wireless transition charges. Our wireless spectrum of 35 megahertz will be funded by a combination of free cash flow and incremental borrowing from our existing borrowing facilities. Additionally, we have unused and available tax deductions that will shelter us from paying cash taxes until 2014, which will have a continuing positive impact on cash flow.
With our continuing strong results and positive outlook, the Board of Directors has declared a third quarter 2008 cash dividend of $0.65 per share, which is payable on October 15, 2008, to shareholders of record on September 15th, 2008. On an annualized basis, our dividend ranks us as one of the highest yielding stocks on the Toronto Stock Exchange.
Thank you for your time and attention today. We will be pleased to answer any questions you may have. Operator, please open up the lines for questions.
- QUESTION-AND-ANSWER SESSION -
GREG MACDONALD, National Bank Financial:
Can you confirm that the $70 million in notes payable on the balance sheet is, in fact, part of that revolving credit facility that you have broken out in detail on page 12 of the MD&A?
x WAYNE DEMKEY, MTS Allstream:
Yes.
GREG MACDONALD, National Bank Financial:
As for more detail, your cost efficiency program appears to be running ahead of expectations. It looks to me that at minimum you’re going to hit the mid-end of that range, probably more like the high end, possibly higher than that. Could indicate – I’m not looking for a new target range – whether it’s possible that you could beat that target range and talk a little bit about where you’re getting the success year to date?
Secondly, I’ll note that despite the target range that you’re hitting, the margin on the enterprise side of the business is down approximately 100 basis points sequentially. I understand there are up-front costs that are associated often with large contract wins and you have spoken about some of those. That would suggest that the margin weakness might be temporary. I wonder if you could comment a little bit about margin expectations on the enterprise side of the business, especially since you tend to be seasonally weaker in the second half relative to the first half.
x WAYNE DEMKEY, MTS Allstream:
With respect to the cost efficiencies, we have targeted $20 million to $30 million in annualized costs and it is our target to get to those as early as you can in the year because then you benefit a little bit in the year that you achieve them as well. So it was by intention that we hit the low end of our target range early, and there still are a few more things that we’re working on, but I wouldn’t expect a huge increase in what we’ve targeted. I would think that the range is what we continue to expect.
When we look at the impact on margins, there are pressures in the telecommunications industry on margins and pricing and so on. We, like all other players in this market, need to continue to work hard and to succeed at our cost reductions. We think that we have done that and keeping our margins basically flat over last year, is I believe a pretty solid achievement.
As you noted, typically lower margins are seen in the latter half of the year. We’re not anticipating that that’s going to occur this year. What you’ve seen is likely more expenses in the fourth quarter. I would probably look more towards the annual margins than the amount you’re seeing each quarter because it can swing by a few points one way or another, as we happen to incur some expenses in one quarter that only happen once during the year, rather than evenly over the four quarters.
GREG MACDONALD, National Bank Financial:
To reiterate, you’re looking for flat enterprise margins year-over-year relative to last year?
x WAYNE DEMKEY, MTS Allstream:
Yes.
JOHN HENDERSON, Scotia Capital:
It looked like wireless ARPU was down 4% or a little more in the quarter. Can you comment whether that has settled out now? Is it really driven by competitive forces in the quarter and has that settled out? Or is it a decrease in roaming revenue that is likely to continue?
x WAYNE DEMKEY, MTS Allstream:
I can provide the historical perspective and Kelvin can provide an outlook as to what he sees going forward. With respect to the in-quarter ARPU decrease, it was approximately 3% and, as we noted, that’s coming from a reduction in our wholesale
revenues and, as well as some additional customers that we took on in the fourth quarter and early part of the first quarter that were in price points specific to our market. There were a few players, including us, who had a $10 plan in the market which has subsequently been taken out.
There’s good and bad to that in that we added some customers who probably weren’t otherwise there. However, there is a negative impact on ARPU and that was the trade-off. When you look at our customer growth year-over-year, which includes this year, the majority at that time was when the $10 plan had already been removed and we still had 10.6% growth. This shows a pretty strong performance on the wireless side.
x KELVIN SHEPHERD, President Consumer Markets division, MTS Allstream Inc.:
More rationality appears to be returning to the local market in terms of pricing and certainly our pricing at this point is back to where it was pre-introduction of the $10 plan. There’s some impact in ARPU as you have that base of customers that were on lower price promotional plans, but we think to some extent that’s mitigated as we go forward, and we see some of the pricing action we’ve taken reflected in ARPU going forward.
JOHN HENDERSON, Scotia Capital:
Can you also comment as to what your wireless data ARPU levels are and how much they increased year-over-year?
x WAYNE DEMKEY, MTS Allstream:
Yes, the increase in wireless data was approximately 60%, I believe, year-over-year or so. We’re seeing really good growth from that aspect. We haven’t itemized the ARPU with respect to that at this point. One other thing I would mention on wireless is that looking at our July results, we were particularly strong in July so we definitely see continuing growth in that market. At 8% year-to-date, it compares fairly well with what others are seeing and the July results gives us comfort that it’s going to continue.
ANDREW CAULDER, RBC Capital Markets:
You mentioned that the transition away from Bell Mobility facilities does not change the operating cost structure but only improves the flexibility. It seems like a high cost for flexibility, in particular, in light of your current success with the current system. Could you expand on that transition? Was this a decision made in anticipation of going national with wireless? Or is this a final decision? Can you get back in a deal with Bell Mobility? Can you describe more about the flexibility benefits and the nature of the one-time costs?
x PIERRE BLOUIN, MTS Allstream:
I’m going to try to give you an answer but, unfortunately, with respect to parts of the question you’re asking, we can’t answer because we’re in the quiet period. We’re not allowed to comment until September. But let me try to give you an answer. First, the costs that you’re seeing, as referenced in our MD&A, the majority of those costs are currently under dispute. We disagree with certain of those costs. We expect that some
of them will be recoverable, so it’s not necessarily the amount. The $40 million to $50 million is not necessarily the amount in the years to come.
Secondly, we had started the disclosure on this in the first quarter. The agreements in question had an end date that had passed, and we were already in discussion a few years ago – in fact, since 2006. Indeed, as part of the spectrum auction rules we had to separate from Bell to bid in the auction. We did what we had to do. We were prudent in how we acted, and we’ll be able to comment more going forward as we exit the quiet period and as this situation unfolds.
ANDREW CAULDER, RBC Capital Markets:
Wayne, you mentioned the wireless business was 25% of cash flows but could you clarify if you’re speaking in terms of consumer or MTS as a whole?
x WAYNE DEMKEY, MTS Allstream:
I was speaking specifically about our wireless business, which does have some customers in both divisions, but the majority of it would be in the Consumer Markets division.
ANDREW CAULDER, RBC Capital Markets:
I thought you had said the wireless business was 25% of total cash flows. That was of the Consumer Markets division?
x WAYNE DEMKEY, MTS Allstream:
No, that would have been of the entire company.
VINCE VALENTINI, TD Newcrest:
Is there any of your commitment to purchase AWS spectrum already factored into the net debt at the end of the second quarter?
x WAYNE DEMKEY, MTS Allstream:
In regards to the spectrum purchase, the first payment was made in August so there wouldn’t be any impact on the spectrum purchase included in the second quarter results.
VINCE VALENTINI, TD Newcrest:
Pierre, to clarify your answer to last question: Are you not saying the $40 million to $50 million is the high end? If I interpret it this way, $40 million or $ 50 million is what Bell would say you owe them for these transitions but your interpretation of it could lead to a lower amount?
x PIERRE BLOUIN, MTS Allstream:
I’m not sure what Bell would say because I am not sure what numbers they would be looking at. But, what I can say is the $40 million to $50 million is our best estimate currently. In that amount, there is indeed an amount that is under dispute so it could be lower.
VINCE VALENTINI, TD Newcrest:
I’m a little fuzzy on who you transitioned to. Is there a main supplier that you would use for handsets or other sorts of technology? If it doesn’t involve roaming, I’m not sure who these other suppliers are.
x PIERRE BLOUIN, MTS Allstream:
Without getting into a lot of detail, thinking about handset suppliers, so you’re moving to having arrangements with various companies selling handsets or a distributor. The same applies to some of the platforms and applications. You could build your own platform and buy it directly from an application provider.
VINCE VALENTINI, TD Newcrest:
In regards to the Allstream segment, I understand that you don’t talk to this specifically anymore but you’re still providing the numbers. If I back out the Rogers and AT&T amounts and also back out the $4 million contributed from acquisitions, I get 4% revenue growth for the national segment in the second quarter. This is an impressive growth rate and I think the best you’ve done in some time. Can you give us any context of how that breaks out between volume and price and what some of the current trends are in the enterprise market?
x WAYNE DEMKEY, MTS Allstream:
I can provide some of the numbers, and John can comment on what he’s seeing in the market. The growth we’re seeing is primarily unified communications and converged IP where I mentioned that we’re seeing 12% growth in our converged IP portfolio and 39% growth in our unified communications portfolio. That’s what is driving it primarily. Because the growth services are becoming a much higher percentage of our overall revenue base, the declines in those services are having a diminishing impact on our overall results, which, as we’ve been saying for a couple of quarters now, leads us to the overall growth number that you’re talking about.
x JOHN MACDONALD, President Enterprise Solutions division, MTS Allstream Inc.:
We see it mostly as being volume-related. We are signing up new customers and existing customers are buying more products in services from us. We believe we have a world class MPLS offer that we continue to enhance with security offers, more classes of service and customers recognize that. They’re buying more of that service.
Also, being able to bundle together, borrowing from what Kelvin is doing. We’re looking at the linkages between professional services, unified communications and converged IP. In the province of Manitoba, with respect to wireless, it’s becoming more of the complete solution. We’re seeing great success and traction in that regard as well.
JEFF FAN, UBS Securities:
To follow up on Vince’s question regarding the transition costs of $40 million to $50 million. Could you provide clarification as to how the Bell Mobility arrangements were originally structured between you and them, how the payment terms were structured and what has changed or how it will change going forward as you bring it
in house? I’m not clear as to why the operating cost going forward isn’t going to go up, and what about the $40 million to $50 million, what exactly are you spending this on? Are you bringing a lot of these applications and developers in-house now? Are you doing a lot of these applications yourself?
x PIERRE BLOUIN, MTS Allstream:
Let me try to answer without getting into too much detail. The $40 million to $50 million of projected costs include our own transition costs and new platforms. This would be the building new platforms or moving to new platforms in the case of applications and tools. It includes charges that are under dispute with Bell and, as well, includes some cost associated with the AWS spectrum auction. In terms of operating costs, Wayne could answer better than I can, but it relates to price of handsets, the cost to operate platforms and similar functions. The pricing in the market of some handsets will be more expensive, some others will be cheaper. This has started already, so we already see what we’re going to face in the market. We don’t see major changes into our operating costs around the wireless nor margin. Again, this relates to the supply of handsets and supply of application and tools. Other costs are under dispute, and those ones will get results once we resolve them through the legal proceedings that we’ve started.
x WAYNE DEMKEY, MTS Allstream:
Jeff, I would make sure you understand that transition costs are non-recurring. They’re one-time and therefore don’t impact our cost structure going forward. The reason why our cost structure going forward is going to be roughly the same as it is now is quite simply that our arrangements with Bell were on commercial terms and had basic market value for those services. So when we go to a transition to other suppliers, it’s not a surprise that those other suppliers are charging about the same amount as we see with respect to Bell. It wasn’t that we were getting a below market cost by virtue of our relationship with Bell. They provided services on commercial terms.
JEFF FAN, UBS Securities:
With respect to building the new platform, does this mean you’re going to be hiring your own R&D staff to do this? It sounds like you’re still going with the third party supplier, which is why we’re a bit surprised that there is this transition cost.
x WAYNE DEMKEY, MTS Allstream:
In some cases there will be other suppliers that we’re getting an application or platform, or in other cases, it may be us doing it ourselves. Either way, we would have been charged our share of the costs when we were with Bell, and now we’ll pay a different supplier or we’ll have the cost in-house. The costs are what they are relatively going to be going forward, so our wireless margins stay about the same. The transition cost is a totally separate issue, and it’s really getting from point A to point B. As Pierre mentioned, we have some costs that are under dispute, and we’re going to follow the process that we’ve started to recover those costs, and we’ll see where that takes us.
x PIERRE BLOUIN, MTS Allstream:
The majority of these costs are under dispute and that’s why the amount may look large. These costs are under dispute so they’re not the cost. All of it is not the cost of building our own platforms.
PETER MCDONALD, BMP Securities:
Can you provide us with the actual breakdown on the $10.3 million, and the $40 million to $50 million between the three categories that you gave us?
x WAYNE DEMKEY, MTS Allstream:
No, we’re not providing that detail at this point in time.
PETER MCDONALD, BMP Securities:
The costs in dispute with Bell, are those break fee costs? Or are those related to something else?
x WAYNE DEMKEY, MTS Allstream:
I would say they’re for services in the transition period. We can’t say too much about it, as it’s a matter that’s under dispute.
PETER MCDONALD, BMP Securities:
When you originally told us about the breaking of the agreement with Bell going into the auction, did you know there would be costs at that point in time?
x WAYNE DEMKEY, MTS Allstream:
We know that there’s going to be costs for transition and there are costs that are under dispute. We have a very different view on what those costs should be versus what Bell does, and that’s why we’re disputing them.
x PIERRE BLOUIN, MTS Allstream:
To be clear, you’re using the term break fee, such as breaking an agreement. We didn’t break any agreement. That’s one of the matters in dispute. In the first quarter, we disclosed that we had taken some action around the Bell agreement. In fact, some of these things were under discussion for over two years. We now have a better view on the situation as well as for our own costs. We’re now disclosing what we have as part of the quarterly disclosure, following the disclosure we made in the first quarter. Now, we’re following up with a better estimate of cost. The matter in dispute will be resolved one way or another. But again, we’re not breaking any agreements.
PETER MCDONALD, BMP Securities:
The answers all seem very vague, and $40 million to $50 million is a pretty material number. Could you provide greater clarity to help us understand? Is there a surprise number that you received this quarter that all the sudden you didn’t realize you had before? I mean you talk about having to build out platforms, you would have known that previously. I’m trying to compartmentalize where the costs of this $40 million to $50 million actually fall into.
x PIERRE BLOUIN, MTS Allstream:
Yes, sorry the answers are vague, because we can’t give you a lot of detail around them other than telling you a few things. The majority of these costs are in dispute. Secondly, the $40 million to $50 million is an estimate over two years and as a one-time charge. It’s an estimate of various costs of transitioning away from Bell or building our own platforms and some costs linked with the AWS spectrum auction. It’s pretty clear in terms of the majority of the costs being in dispute are linked with this transition. They’re not necessarily our own costs that we’re going to incur in a transition to create new supply arrangements.
SANFORD LEE, Genuity Capital:
If you’re assuming that the wireless free cash flow is approximately 25% total - I’ve done some back-of-the-envelope calculations - could you confirm if I’m correct in some of these numbers that I’m going to say. If we take unlevered free cash flow as EBITDA minus capital expenditures, and this excludes the wireless equipment subsidies - I’m doing it on 2007 numbers - it’s $655 EBITDA minus the capital expenditures, and I get an unlevered free cash flow consolidated at $339. If I take 25% of that number, I get $85 million. Then, if I assume that MTS’s wireless services sales is approximately the national average - we’ll say 14% - I’ve got that at $38 million. I derive an EBITDA figure of $47 million. If I do the $47 million of 2007 EBITDA implied over the $269 revenue, that’s only a margin of 17%. Am I doing something totally wrong here? That’s my first question, if you can sort of confirm whether my methodology is correct or incorrect. You also mentioned, Pierre, that you don’t expect wireless AWS new entrants to enter Manitoba for some time. I think you mentioned, that no one can actually say anything at this point. Can you please answer those issues and why you don’t expect wireless new entrants are going to focus on Manitoba? Is it because the margins are so low?
x PIERRE BLOUIN, MTS Allstream:
First, there were some public disclosures in terms of where new entrants would concentrate. If you look at the economics of a wireless business and our own projections, Manitoba is probably the most competitive market in the country with the lowest pricing in the country and with a small density of population. It is not in my view, economical for a new entrant to launch in a market like this. However, if they come here we will be ready. I’m referring to Microcell and Clearnet, in the past that have not looked at Manitoba but also not at smaller provinces. They concentrated in higher density areas where they can operate a network with more potential customers. It’s their choice to follow-up what they disclose. If they come here we will be ready, and they will have to compete with us, TELUS, and Rogers.
SANFORD LEE, Genuity Capital:
This is interesting, you mentioned that Manitoba is one of the most competitive, but you only have two competitors at present. I’m just wondering why you expect then other AWS new entrants not to come in, considering from the number of competitors perspective, it’s not that competitive.
x PIERRE BLOUIN, MTS Allstream:
Again, it’s their choice, but it’s pure economics and density of population.
x WAYNE DEMKEY, MTS Allstream:
On the free cash flow, I’m not sure that I followed the detail. If this answer doesn’t suffice, we’re happy to follow up offline with you. The way I would look at it is perhaps in a simpler manner. You see what our wireless revenues are, and what we’ve said in the past. Our margins on wireless are in the 50% to 60% range. If you look at the deferred wireless cost, the cost of acquisition that is shown on our free cash flow statement, and then you factor in our capital expenditures which we talked about in the context of 14% to 15% of revenues, you would result in a free cash flow number from wireless, which when you compare to the overall free cash flow which was approximately $258 million last year or $250 million to $280 million as our guidance for this year. If you take the percentage, you would get somewhere in the 25% range.
PETER RHAMEY, BMO Capital Markets:
My first question relates to the collective agreement. I’m not sure you’ve addressed this in the past, but certainly could you benchmark, perhaps Wayne or Pierre, how this agreement contrasts to your prior agreement just in terms of flexibility to outsource or reduce costs on a go-forward basis? My second question would be more operational. You had a seasonal up tick in the lines, but it’s a bit larger than last year, and I’m wondering what undercurrent there is in terms of residential line gains during the quarter, whether you were more successful with win-backs during the quarter or not?
x PIERRE BLOUIN, MTS Allstream:
We’re very happy to have renegotiated agreements with our five union partners over the last 18 months. This was quite a task and showed a lot of collaboration between all parties. I don’t have specific numbers on it, other than what you see reflecting in our guidance in terms of total performance of the business. We think that what has been negotiated is a good step into getting the company to remain competitive and have a cost structure that’s aligned to its market. There were a lot of discussions in terms of the company and what it needed to succeed, and I think we’ve made good progress there.
PETER RHAMEY, BMO Capital Markets:
The full impact of all the new agreements was in the quarter, or is that yet to come?
x WAYNE DEMKEY, MTS Allstream:
The costs for the collective agreements would be reflected in our salaries and benefits over the period of the contract. The contract has just ended, so there really wouldn’t have been that much impact in the first couple quarters of this year. It would be more so going forward.
PETER RHAMEY, BMO Capital Markets:
x WAYNE DEMKEY, MTS Allstream:
Yes, I think that’s fair to say, that the cost increases or wage increases aren’t out of line with what we’re seeing in other businesses.
PETER RHAMEY, BMO Capital Markets:
Up from the level that we saw in the previous round of contracts? Is that fair to say?
x WAYNE DEMKEY, MTS Allstream:
It’s a combination. If you’re looking at overall costs, there’s always a wage increase when you look at collective agreements. But then we have some flexibility to manage our costs, and including implementing efficiencies that we have to keep our business competitive. We don’t expect to see cost increases, and I think that when you look at the bigger picture, we are managing our margins to be the same as in prior years and so that we can continue to see the growth in revenues fall to the bottom line.
PETER RHAMEY, BMO Capital Markets:
The second question on line losses?
x WAYNE DEMKEY, MTS Allstream:
Yes, the line losses were a little better than the corresponding quarter last year. The increase in seasonal lines was about the same as the prior year, somewhere around 9,000. The residential line losses are still in line with what we’ve seen in the last seven quarters but a little bit of an improvement over the prior year.
GLEN CAMPBELL, Merrill Lynch:
HSPA conversion has been talked a lot about by your telco peers. If you elect to go that route, is that included in these wireless transition costs that you’re talking about, or would that be on top?
x PIERRE BLOUIN, MTS Allstream:
I’m not sure it would be on top, because we don’t know exactly what they would do, and there hasn’t been an announcement. Depending on the announcement, we’d create additional costs, or it would impact some of these costs. It’s hard for us to make a call at this time. We’ve been looking at this for a while and what it would mean for our business. But clearly, we’re not driving this. You know if Bell and/or TELUS decide to go HSPA or something else, at that point we’re going to have to look at our options and see what type of transition they’re contemplating. It’s difficult to give any ideas of the numbers. It would potentially impact the numbers we gave you, and would probably add to it to some degree, depending on exactly what would be undertaken.
GLEN CAMPBELL, Merrill Lynch:
Could you give us your sense about where the enterprise margins might settle out in the longer term? Have you been making decent gains on the revenues side? Margins have been creeping up lately. Could you talk about where they might go to over the next, two to three years?
x WAYNE DEMKEY, MTS Allstream:
In the short term, holding our margins where they are and in the long term, there is some potential as we focus on efficiencies and selling services that utilize our network; or on-net services. There is potential for that to go up. As you know, there are some pressures that go the other way as well. We need to continue to manage, whether it is pricing or legacy services. As legacy services become a lesser and lesser proportion of our total revenues, there is some opportunity. But the short term, I would say, we’re going to be maintaining pretty stable margins.