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Executives

Kurt Fawkes – Senior Vice President, Investor Relations

Edward A. Mueller – Chief Executive Officer

Thomas E. Richards - Chief Operating Officer

Joseph J. Euteneuer - Chief Financial Officer

Analysts

Michael Rollins - Citigroup

Simon Flannery - Morgan Stanley

David Barden - Banc of America

Jason Armstrong - Goldman Sachs

Mike McCormack - JP Morgan

Chris Larsen - Credit Suisse

Tom Seitz - Lehman Brothers

Anna [Gasgo] – [unspecified firm]

Michael Funk – Merrill Lynch

John Hodulik - UBS

Frank Louthan - Raymond James

Peter Rhamey – BMO Capital Markets

Qwest Communications International Inc. (Q) Q3 2008 Earnings Call October 29, 2008 9:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Qwest third quarter 2008 earnings conference call. (Operator Instructions).

I would now like to introduce your host for today's conference, Mr. Kurt Fawkes.

Kurt Fawkes

Good morning, everyone, and thank you for joining us on our call this morning.

For the format of the call, Ed Mueller, our Chairman and CEO, is going to lead with some high-level observations on our third quarter performance and progress on strategic initiatives. And then following Ed’s remarks our COO, Tom Richards, will discuss individual business unit performance in the quarter, and then Joe Euteneuer, our CFO, will cover the balance sheet, cash allocations, and close out our comments with a discussion of our expectations for the remainder of the year and then we will go to Q&A.

On Slide 3, we have our forward-looking statements. We will be providing some forward-looking statements this morning, which contain risks and uncertainties that could cause our actual results to differ materially from those expressed or implied during the presentation. These risks and uncertainties are on file with the SEC and I strongly encourage you to review them. Additionally, we do not adopt analyst estimates nor do we necessarily commit to updating any forward-looking statements that we will be making this morning.

Also, let me mention that in order to supplement the reporting of our consolidated financial information, we will discuss certain non-GAAP financial measures, including adjusted EBITDA, free cash flow, and net debt, and a full reconciliation of these measures are available on our website.

Moving on to Slide 4, we summarize out net income and EPS results for the quarter, along with adjusted EBITDA and free cash flow. We reported net income of $151.0 million in the quarter. That’s $0.09 per share. That compares with $2.1 billion, or $1.14 per share, a year ago. Net income this quarter reflects full book tax rates while the year-ago period results include a one-time tax benefit of $2.1 billion and a $353.0 million charge for legal matters. Additionally, our lower share count in the quarter affected our earnings per share results.

Adjusted EBITDA for the quarter was $1.08 billion which is down $68.0 million from the same period in 2007. During the quarter two significant items were normalized out of EBITDA results. The current quarter EBITDA includes a charge of $63.0 million for severance and a lease restructuring benefit of $33.0 million, which nets to $30.0 million charge.

Finally, adjusted free cash flow for the quarter was $330.0 million. Adjusted free cash flow in the period excludes a net federal income tax payment of $70.0 million that settles a claim covering the period from 1998 to 2001.

With that, I am going to turn it over to Ed.

Edward A. Mueller

Good morning, I am glad you could join us today and we appreciate your interest in Qwest. In my comments this morning I will review the high-level financial results for the quarter and our progress on strategic initiatives. I also want to update you on some additional changes we have made to our management team since our last call.

Slide 6 summarizes our financial results for the quarter. Overall revenue was in line with our expectations but profit was at the low end. Consolidated revenue was $3.4 billion, which was flat sequentially with [break in audio].

Adjusted EBITDA for the quarter was a little under $1.1 billion with a margin of 32.1%. This was a challenging quarter for us on EBITDA performance and we will go into the reasons behind that in a moment. I will tell you now, though, that we expect to see improved results across each of the business units in the fourth quarter, mainly from an improved product mix and expected cost efficiencies.

Adjusted free cash flow for the quarter was $330.0 million. This brought our year-to-date total to just under $850.0 million and we remain on track to finish the full year in the $1.5 billion range.

Throughout the third quarter there was plenty of evidence to suggest a weakening general economy, including rising unemployment, lower retail sales, and continued softness in the housing market.

The economy had some impact in our mass market performance, where we experienced continued pressure on access lines. However, we were encouraged that despite the more difficult economy we did see a good pop in the take rate for consumer broadband services this quarter.

In the wholesale segment we are also seeing some signs of economic pressure with more aggressive pricing among our competitors.

In the enterprise space, we have not seen any meaningful, tangible evidence of economic effects although we’re probably not out of the woods yet.

The mix of our revenue today is heavily weighted toward fixed, monthly charges with only about 20% of our revenue build on a permitative-use basis. Additionally, many of our principal products, in particular many of our high-growth products, are typically sold through long-term contracts. With these characteristics I think that you will find that as you look at past business cycles telecommunications services is an industry that has historically provided above-average performance during times of economic pressure.

As for the potential ramifications of the current credit markets, I would note we are in good shape with our debt maturity schedule for the next couple of years and our free cash flow production gives us flexibility to weather what may be an extended period of tight credit availability. Joe will share some additional thoughts on our plans in his remarks.

The third quarter marked continued progress on several of our strategic initiatives covered on Slide 8. We began moving non-bundled, wireless customers to Verizon in the quarter. Earlier this month we completed the development of our combined billing platform, which will allow us to really accelerate the migration. At the end of the third quarter we had move a little over 5% of our wireless customers to the Verizon platform.

Another key strategy is our commitment to increase broadband capabilities, which was demonstrated by continued progress on the fiber-to-the-node build out. We have expanded fiber-to-the-node reach to more than 1.5 million potential customers. Sales efforts are also ramping with nearly 40,000 new fiber-to-the-node subscribers added in the quarter. Our fiber-to-the-node efforts support delivering higher speeds to customers. Subscriber take rates of 7 megabit or faster service in our fiber-to-the-node footprint is nearly 70%.

We are also extending our broadband efforts in the business and wholesale markets with the expansion of our nation-wide Ethernet backbone. This investment will position us for the next evolution of data services.

I would like to conclude my remarks by touching on the changes to the senior leadership team we have made over the past couple of months. In addition to naming Joe as our new CFO, Tom has put his team in place running the business units, as you can see on Slide 9.

Tom named Teresa Taylor to succeed him in his former role as the head of the business group. Teresa brings a well-rounded background to her new assignment, including previous stints running our wholesale and product units and most recently was our Chief Administrative Officer.

Dan Yost, whom many of you know was the head of the product and IT organizations, is now running the mass markets group. Dan brings a wealth of expertise and energy to his new role.

Neil Cox, who previously was the head of enterprise sales for the central region, is replacing Dan as the leader of the product and IT organizations. In addition to an extensive telephony background, Neil has broad experience in both running and investing in new product initiatives.

Roland Thornton will continue to run our whole business unit and Bob Tregemba continues as the head of network.

Two other members of the team that continue to report to me are Rich Baer, who is our general counsel and has now picked up the Chief Administrative Officer role, and Stephanie Comfort continues to lead our corporate strategy function.

I am very excited about the level of talent we have assembled and this leadership team is the best that I have worked with.

Now I will turn the call over to Tom to discuss details of the business unit results.

Thomas E. Richards

I am pleased to provide you with an update on our operations this morning and I look forward to meeting many of you in the future. Before diving into the operating details, I would like to take a moment and reinforce Ed’s comments on our management team. I believe that we are aligned on reaching our strategic objectives and improving our execution. With the wealth of telecommunications experience and the track record of these individuals, I am excited about our potential.

Moving on to results in the quarter, at a high level we had a good revenue performance but profitability was soft. In my comments I will highlight several of our initiative, including aggressive workforce actions that will improve the bottom line in the fourth quarter and going forward.

I am going to discuss individual segment performance and I will start with business markets results, detailed on Slide 11. In the quarter our business markets team top line once again outperformed the peer group as we continue to benefit from a strong position on strategic products and a differentiated customer experience.

Business markets revenues were $1.0 billion for the quarter, which is an increase of 3% sequentially and 7% compared to the year-ago period. This marks the fourth consecutive quarter of annual total revenue growth for business markets. This is the sixth consecutive quarter of growth in recurring revenue, which improved by 3% compared to the third quarter of 2007.

At our market segment level we had particularly good results among larger customers and within the federal government space. At a product level revenue growth was driven by strong results in data and Internet services, which grew by 13% year-over-year. Data and Internet revenue now comprise 65% of total business markets revenue.

Voice revenue trends were down sequentially in year-over-year.

Within strategic products we continue our record of strong growth, improving by nearly 40% year-over-year demand for IP and NPOS services. In addition, we had very strong data integration revenues largely due to higher equipment sales. Data integration revenues, which are about 15% of the business segment revenues are expected to be lower in the fourth quarter.

Business markets segment income was $373.0 million in the quarter on a margin of 35.6%. business margins were impacted by the higher equipment sales, accounting adjustments recorded in the prior period for bad debt, and higher selling costs. I expect margins to improve in the fourth quarter due to more profitable product mix and lower operating expenses.

Moving on to Slide 12, I will touch on some of the key initiatives for business markets. We have talked in the past about our investment in an additional 250 sales reps. I am pleased to report that this investment is paying good returns and we expect to exit the year with these reps providing full targeted productivity.

The federal channel is building good momentum around the networks contract opportunity and over the remainder of the year we are anticipating the government will be making a substantial number of additional awards. We recently announced several new customer wins, including the Department of Veteran Affairs, NASA, and the GSA.

Collectively, our networks orders to date could raise our consolidated annual revenues by 50 basis points when fully implemented over the next two years.

Finally, investment in the expansion of our Ethernet backbone will support our momentum in strategic products growth. Today, reaching over 1,100 cities in the United States, we have an extensive Ethernet presence to meet a broad range of customer needs.

Financial results in the mass markets group are summarized on Slide 13. In the quarter we regained momentum on broadband and doubled second quarter subscriber additions. However, we experienced continued pressure on consumer voice services and we are taking cost actions to restore margins. Mass markets revenue of $1.4 billion was impacted by access line erosion and wireless migration. Without wireless, revenues were down 4% year-over-year and 1% sequentially.

Mass markets reported segment income of $673.0 million on margins of 47.2%. In the quarter we had increases in bad debt, marketing, and network expenses which were partially offset by lower wireless operating costs.

Expenses in this quarter also included a one-time $13.0 million asset impairment charge related to our wireless transition.

Consumer RPU was $56 compared to $55 in the second quarter and $53 in the year-ago period. Our efforts to bundle services for customers is driving higher RPU and producing a lower churn rate. You can see on Slide 14 that high-speed Internet is particularly sticky for Qwest, reducing churn at nearly 50% when part of a multi-product bundle.

Looking forward we are focused on ways to enhance our broadband penetration to further capitalize on this dynamic.

Now we will turn to Slide 15 to discuss some of our key customer metrics. Efforts to grow broadband in the quarter, which were supported by promotional activity launched in July, generated over 60,000 new high-speed Internet subscribers. During the quarter we featured an offer that provided 1.5 megabit speeds for $14.99 per month for an introductory period. We also offered attractive pricing on higher speeds and achieved good take rates.

Our broadband promotions also drove growth in sales of associated access line packages.

We also continue to report success on our direct TV partnership, adding 39,000 video subscribers in the quarter, bringing the base of video subscribers to 761,000. Video penetration now stands at 12% of primary access lines, which places Qwest as best in the industry.

In wireless, total subscribers at the end of the quarter were 766,000, a decline of 6% sequentially. The migration to Verizon wireless impacted wireless growth efforts in the quarter as expected. Mass markets access lines were just above 8.0 million at the quarter end, declining 9.7% year-over-year.

In addition to focusing on broadband bundles, we continue to develop a series of additional products to enhance the relevance of the access line. In the fourth quarter mass market segment income should benefit from cost initiatives, lowering headcount, and continued wireless efforts. The company will also continue its promotional activity to stimulate demand, including evolution of our advertising campaign.

Wholesale’s results are show on Slide 16. As forecasted in the second quarter, top line comparisons have improved. A number of margin initiatives are in process and expect to make a significant contribution to fourth quarter results. Revenue was down 5% year-over-year and 1% sequentially. Compared to the second quarter, lower voice revenues were partially offset by growth in data and Internet services.

Wholesale margins were steady in the quarter. Expenses were flat sequentially and down 5% compared to the prior year due to lower facilities costs driven by lower network volumes. We have taken a number of actions that are expected to increase wholesale profitability. Slide 17 details some of these, including expense initiatives, streamlining existing product offers, and launching new services that improve margins.

Finally, I would like to share a few comments on our ongoing efforts to manage employee resources summarized on Slide 18. We have taken additional steps to align workforce to workload. Our continued focus on productivity should reduce costs that benefit all business segments. In total, we expect to reduce our overall workforce by 1,200, or about 3%, during the fourth quarter. These actions give us confidence in our guidance for 2008 results and put us in a good position heading into 2009.

In closing, we are facing challenging competitive environments and a soft economy. In light of these circumstances we have acted quickly and decisively to take steps to address the EBITDA weakness in the quarter. We are optimistic about what we can achieve through the remainder of the year and have a specific plan to accomplish our goals.

Through a combination of improved product margin, workforce cost reduction, and strategic product initiatives, we are confident that EBITDA will show a strong rebound in the fourth quarter.

Now I will turn the call over to Joe.

Joseph J. Euteneuer

I am pleased to be participating on our call today and I look forward to meeting many of you in the weeks and months ahead. During my first 45 days at Qwest I have been impressed with the energy and commitment of the new management team to make a difference in our businesses. In addition, my finance organization is staffed with seasoned professionals, and this is also true across the company. This deep talent pool, combined with strong cash flow and liquidity, and an improving debt profile, provide a strong foundation. While we have challenges in front of us, I believe this team can turn those challenges into opportunities to positively impact the business going forward.

Our sound business fundamentals are illustrated in part on the balance sheet. Slide 20 recaps the key items. At the end of the quarter our total liquidity was approximately $1.4 billion, excluding investments. This consisted of cash of $586.0 million and a revolving credit facility of $850.0 million.

I would also note that while bad debt expense was up in the quarter, this has not impacted cash collections and in the third quarter DSOs declined. We will continue to monitor credit and collections very closely in the current environment.

In the third quarter we retired $171.0 million of maturing debt. Total debt was $14.1 billion at the end of the quarter. Qwest has been prudently managing its debt leverage over the past several years and this has produced a net debt to annualized adjusted EBITDA ratio of 3x. At these levels we are in good shape to handle requirements for the foreseeable future and in light of the current credit markets, we will likely be paying off maturing debt until conditions improve.

I would note, however, that if we are able to subsequently access credit markets at reasonable rates, we would likely return to our practice of refinancing our regulated debt.

Slide 21 looks ahead to the debt maturity schedule for the next few years. We have approximately $390.0 million coming due during the fourth quarter. Beyond the fourth quarter of this year we have just over $800.0 million in maturities in 2009 coming due, between the first and third quarters. In 2010 there are additional maturities of roughly $900.0 million through the third quarter.

In addition, we have $1.3 billion in convertible notes outstanding that provide investors the potential to put the notes back to the company every five years on November 15 beginning in 2010.

As you can see on Slide 22, in this quarter is an illustration of our sound business approach to cash distributions, including disciplined investment in profitable growth opportunities, regular shareholder dividends, debt retirement, and stock purchases.

During the quarter we invested $466.0 million in the business to support new capabilities and enhance capacity. We also distributed $138.0 million to shareholders through our dividend and another $174.0 million through our current share repurchase program.

We have purchased 258 million shares for approximately $1.8 billion since the beginning of the program. While we will continue to strive for this type of balance in our allocations of cash flows, the current state of the economy and capital markets are important considerations in the near term. And as you know, neither of these are currently providing any tail winds.

The Board has recently reiterated its commitment to maintaining a fixed component of our shareholder returns with its declaration of our fourth quarter dividend. This represents a more than $500.0 million annualized cash return for our owners.

Current credit markets are pricing our debt at irrational levels. With refinancing not a viable option, the near-term orientation will be to pay down debt until we see a more healthy credit market.

As a result, the Board extended the authorization of our current $2.0 billion share repurchase program. This authorization has a little under $200.0 million remaining.

We do not expect to have any pension funding requirements in 2009. However, in light of the recent market trends there is a possibility that we could have a funding requirement beginning in 2010. As you know, there are a significant number of variables to calculating these requirements and so the estimates can have a broad range.

Based on recent equity market lows and bond yields, our estimated 2010 funding is in a range of $130.0 million to $300.0 million. While we have every expectation that credit market conditions will improve we are confident we have the resources to manage through today’s challenging conditions.

Finally, I would like to summarize our expectations around full-year results for 2008, which are shown on Slide 23. Our guidance remains unchanged but we are now forecasting results to generally be at the low end of these ranges and in line with analysts’ consensus.

In the fourth quarter we expect business revenues to again be up from a year-ago period but growth will likely be at a much slower pace as equipment revenues return to more normal levels.

In mass markets, growth and data revenues is expected to be offset by the step-up in wireless migrations and loss of access lines. Access lines trends are also expected to continue to pressure the wholesale revenues.

To meet the low end of our full-year EBITDA guidance we will need to produce adjusted EBITDA of around $1.5 billion or about a $70.0 million sequential improvement in the fourth quarter. I want to walk you through on how we intend to get there.

First, I want to point out that the asset impairment charge and some other one-time items in the third quarter cost us about $25.0 million so from an operating perspective we need about $45.0 million to reach our fourth quarter goal. In the fourth quarter we expect that lower headcount and seasonal lower network spending will provide substantial savings and could cover more than half of the required improvement. Business and wholesale revenue and productivity initiatives, that Tom just discussed, will also be major contributors.

Finally, continued growth in data and Internet services will likely mitigate the impacts of ongoing voice pressures. Our forecast for adjusted free cash flow now includes approximately $40.0 million of severance payments that are expected to be made in the fourth quarter. We continue to forecast full-year capital expenditures of $1.8 billion.

This concludes my remarks and I will now turn the call over to the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Rollins – Citigroup.

Michael Rollins - Citigroup

I was wondering if you can outline what we should be thinking about in terms of future settlement payments from any remaining litigation or any of the inquiries into, I think there were some tax issues at a state level that you were still working through.

And then secondly, if I could just ask a little bit more about the business revenue trend in the quarter. If you could break out with a little bit more detail the equipment revenue. And could you describe what you’re seeing on the competitive environment? I know you talked a little bit about it but are you seeing increasing price competition, whether it’s in the government sector or in the larger enterprise sector?

Edward A. Mueller

The litigation we think is pretty much behind us. There may be some small litigation payments but we think that’s pretty much behind us.

I will let Tom handle the question on the business.

Thomas E. Richards

CPE or data integration generally accounts for somewhere between 12% and 15% of BMG’s ongoing revenue and this quarter we came at the high end, and as Joe alluded to, we would expect that to drop back to a more normal rate in the fourth quarter.

And from a pricing perspective, we are not seeing anything abnormal would be the way I would describe it, from aggressive initiatives in the business market segment. As you heard Ed mention, we are seeing some aggressive pricing initiatives in the wholesale segment, but really at this point, on the whole, not so much in the business markets group.

Joseph J. Euteneuer

You referenced tax payments. We don’t have any material tax issues that we are aware of at this point that would change anybody’s model.

Operator

Your next question comes from Simon Flannery - Morgan Stanley.

Simon Flannery - Morgan Stanley

I think last quarter you talked about the capex budget for 2009 being flat with 2008. In light of the recent macro and credit market developments, how are you thinking about possibilities to take the capital spending down, given the growth opportunities?

And on the balance sheet, Joe, you talked about the put option in 2010. We have seen a couple of other companies do convert for equity exchanges. Is that something that you might entertain?

Edward A. Mueller

On the capex, we’re doing our budgets and we will provide further guidance as we get to the end of the year. But we are comfortable with our current capex spend and frankly, the money we’re spending on the growth initiatives are really paying off.

Joseph J. Euteneuer

I think we have a lot of runway room between now and 2010 when that convertible has a one-day put, so right now at these stock prices we would like to preserve our equity where it is.

Operator

Your next question comes from David Barden - Banc of America.

David Barden - Banc of America

Just a follow-up on that convert question, I think that, Joe, you’re making a point that it’s kind of a one-day convert and I think it might be helpful if you elaborated a little bit on some of the flexibility you have to potentially defer the convertible holder’s interest in actually putting it back to you. I think that my interpretation is you have lots of flexibility to, if you wanted to, to alter the terms of that note so that you could defer it’s putability back another five years if you wanted to. If you could clarify that it would be helpful.

I just want to also make sure I understood, so you netted out $63.0 million of a loss and you have a $30.0 million gain, but then what you left in the numbers was $15.0 million of wireless charges and then another $10.0 million of something else. If you could clarify those one-timers because it looks like now, in the numbers you reported, as adjusted, there is still $25.0 million of one-timers in there. And then the free cash flow guidance is also now including a $40.0 million severance payment. So if you could just review that.

And I think you mentioned it like four different times in the release, could you be more specific about what changed about bad debt and how it impacted the financials and why it did not impact the cash flow statement.

Joseph J. Euteneuer

On the last one, what I will tell you is although there has been some work in regards to right-size the reserve, there has really been no change in our bad debt as a percentage of revenue in any of our business units over the past few quarters. So right now what I will tell you is although the economy is changing a lot, we haven’t currently seen an impact to our bad debt, although from an accounting standpoint you see this inordinate increase in bad debt from the second to the third quarter as a result of a second quarter benefit. So, economically, really no impact to the company.

Your second question in regards to the wireless, in regards to the switchover from our one provider to our new provider, there was an elimination of a program that we had in place that we wrote off through operating expenses and that’s a one-time thing that’s through operations, that’s the $15.0 million.

The $40.0 million severance payments is just that. We have announced this workforce reduction and those cash payments are coming due in the fourth quarter.

On the convert, actually I think you answered it for me. I have total flexibility between now and that specific date in November 2010 and to the extent that they don’t put it to us on that date, it doesn’t happen again for another five years. So it’s an every five year thing, on a specific date of November 15.

Operator

Your next question comes from Jason Armstrong - Goldman Sachs.

Jason Armstrong - Goldman Sachs

First, on the dividend, I hear your point as to the Board committing to Q4 and having a fixed component in terms of shareholder returns. But the question is what is the argument for paying this level of dividend at this point? With sort of the dividend and the absolute yield that you’re delivering, it doesn’t seem like you’re getting full credit from investors. And if you think about the cash requirements over the next couple of years, whether it’s debt or it’s potential pension funding, I’m wondering is that something where you might consider a cut to the dividend to get it to a lower level to be able to handle some of the cash requirements.

And second question, on just the fiber-to-the-node initiative, as you sort of look at the initial 20% roll out and determine is this successful, should we roll it out to a broader segment of the base, maybe you can review what are the criteria you are using to determine success and be along those lines. You actually beat us on broadband this quarter. A lot of the success is driven just in that small niche of a footprint where 40,000 signed up for it. So, does that help you in terms of deciding this is successful, there is clearly a demand for higher speeds so this shifts the bias to potentially accelerating the build.

Edward A. Mueller

On the dividend, we won’t adjust the dividend up and down based on the current stock price. We are committed to that $0.08 a share. The Board is committed to that. With the market movements now you see a lot of yields starting to approach ourselves, particularly in our industry. So we are going to stay focused on it and keep paying it and over the long pull we will evaluate it but right now we’re solid on the dividend.

As far as the fiber-to-the-node, we are really happy with that and as you said, the 7 megabit product is terrific. We had mentioned on the prior call, and if not I would like to reinforce it, we are moving our mass markets, the high speed Internet product, to be the anchor of what we’re trying to do here.

That being said, we have reached 1.5 million customers right now and we will be 1.8 million by the end of the year. Our current plan is to continue the build, as we have it. It’s good for us to be able to execute against that. We’re learning as we go. There’s no anticipated acceleration at this point, but we’re getting more and more comfortable.

The criteria that we use for this, as I said before when we launched this, was a five-year payback. And so we have gone backwards to see what the penetration needs to be to equal the five-year payback and have assigned resources to sell and also get it route by route, customer by customer, and in effect, we have routes that are about 300 customers each. That’s a good ballpark.

So with that continued success, and also the nice surprise for us is the higher penetration to 7 mebabit. That’s nice. It lifts RPU probably in the $7 to $10 range a month. We feel really good about that. So I hope that answers your question.

Jason Armstrong - Goldman Sachs

So if penetration is sort of the key criteria here, relative to what you saw this quarter it seems like that would lend to a positive bias here because the numbers were pretty strong on fiber-to-the-node.

Edward A. Mueller

Absolutely. But we would always try and mine out of our own capital spend to put more money into this as the bias continues. We’re not trying to raise the total capex budget.

Operator

Your next question comes from Mike McCormack - JP Morgan.

Mike McCormack - JP Morgan

On the headcount reduction, how quickly does that ramp up? What kind of benefit might we see in Q4?

Secondly, maybe particularly in the enterprise side, what kind of seasonal pressures do you think we might see, particularly in some of that usage-based stuff within enterprise?

Joseph J. Euteneuer

I think the first one, obviously we’re already into the fourth quarter, so the headcount stuff is already, action is being taken and is in place and some of it is already done.

And in your last question, I don’t really think we’re anticipating any pressures.

Thomas E. Richards

I would agree. We started a lot of those initiatives really at the end of the second quarter to get them implemented in the fourth quarter, so we would give ourselves not only an impact in the fourth quarter but give us a good ramp into next year. That was part of the strategy.

And the second thing is, at this point in the enterprise space, we haven’t seen a dramatic impact on usage sensitive, long distance, anything that is involved with minutes of use, at this point.

Mike McCormack - JP Morgan

On the enterprise stuff, I guess you are indicating you are not seeing a lot of pressure from the economy yet. Do you think it’s a revenue mix issue where government contracts probably not impacted or is there something else we should be thinking about?

Thomas E. Richards

Those are kind of two different parts. One, I think the operative word in what you said was yet. We are making sure we keep our eyes wide open. We have seen, in obviously the financial sector, some impact when it comes to the economy. But on the whole and on the average, as we look at all the economic indicators, we really haven’t seen that.

The second point, which is the mix issue, you are right on target. We had several big CP sales in the federal government space and that happened last year in the fourth quarter, this year it happened in the third quarter, which caused some of the comparisons to be a little different. But as Joe alluded to in his comments, we would expect BMG to go back to a more normal balance in the fourth quarter.

And again, to reinforce what our focus is, we continue to focus on monthly recurring revenue. That’s why we’re proud of what has happened sequentially and quarter-by-quarter. And if you look at a lot of the programs Teresa has in place, from an incentive standpoint and from a promotional standpoint and a bundling standpoint, they are centered on monthly recurring revenue.

Operator

Your next question comes from Chris Larsen - Credit Suisse.

Chris Larsen - Credit Suisse

Just to continue on the DSL theme. Can you give us a sense for where the network is in terms of homes that have access to the 3 and 7 megabit, or the 3 and the 6 megabit service?

What was the NOL at the end of the quarter? And at this point do you see any cash needs for the pensions, cash funding that you might have to do for pensions in 2009?

Edward A. Mueller

On the speed question, the way that networks architect it, obviously if you were closer to a central office before we did the fiber-to-the-node you could have higher speeds. Unfortunately that is hard to market to and really not very productive. So we concentrated on the fiber-to-the-node. We have 1.5 million households, like I said before. We will have 1.8 million by the end of the year. And you can expect with our continued roll out that we will make a significant, it even potentially could double by the end of the next year.

So we could eventually get to 5 million pretty quickly here. And as we learn, the 5 million households passed out of our 13.2. And as we get to looking at this, I’m really confident that we will actually, as we start covering the landscape, be able to market into those close to the central offices because we’re starting to get some benefit from that.

So that’s kind of the landscape for the fiber-to-the-node, very optimistic for us.

Chris Larsen - Credit Suisse

Is there a point where you’ve got the 5 million households with the fiber-to-the-node, but then those houses that are close to the node also get the 6 megabit that you couldn’t market, so all of a sudden a large portion of your footprint could actually be marketed with a 5 to 6 to 7+ megabit service in the not too distant future?

Edward A. Mueller

That’s exactly right. I guess I didn’t specify that but that is precisely right and one of the benefits we get here is as our marketing and advertising rolls out with high speed, now we get the pop from people who may be closer. And we’re having programs against that as we cover it. We get the benefit of a prior capex spend, actually.

Joseph J. Euteneuer

And on your questions, I don’t think we’re going to pay cash taxes until 2011 or 2012. Our NOL is about $6.4 billion. You will see it all detailed out in the Q.

And in regards to the pension, the fact is the pension only gets evaluated once a year at December 31. There is a lot of stuff that will happen in the market place. But any cash requirements to fund any shortfall that the pension might have, wouldn’t take place until 2010.

Operator

Your next question comes from Tom Seitz - Lehman Brothers.

Tom Seitz - Lehman Brothers

Ed, last quarter you indicated that DSL results were impacted by lack of promotional activity and advertising. You definitely had a nice quarter, doubling essentially the net adds. And I was wondering if you were promoting and advertising for the full quarter and got a full benefit, or whether there might be some more tail wind as we enter Q4 and you market behind the speed increase roll out.

Edward A. Mueller

Let me have Tom answer that because we’re doing exactly what you might expect.

Thomas E. Richards

We did promote aggressively throughout the entire third quarter and those promotions extend into the fourth quarter and right behind that I can tell you that we have been obviously pleased with the results so we intend to continue along that aggressive path.

And I also alluded to introducing some, what I will describe as more aggressive advertising, to try to get our message across because of the positive results we had in the third quarter.

Operator

Your next question comes from Anna [Gasgo] – [unspecified firm].

Anna [Gasgo] – [unspecified firm]

Just for the benefit of debt holders, I wanted to clarify something. I heard you say that when and if the credit markets improved you would like to refinance your regulated debt. To me that means your operating company, Quest Corp., and one of the concerns in the credit market, I think, with regard to your capital structure policy, is that in the past the prior management team was very, very good about only refinancing Qwest Corp. debt with Qwest Corp. debt. And in no way had ever increased leverage or took holding company debt and refinanced it down to holding company. And the concern has been that the current management team may not continue to have that same policy. So I just wanted to understand what your current policy is towards where and how you refinance debt in the capital structure.

Joseph J. Euteneuer

I actually think I was trying to reiterate the policy that you so stated that has been going on in the past.

Operator

Your next question comes from Michael Funk – Merrill Lynch.

Michael Funk – Merrill Lynch

Could you quantify the difference in line loss trends you are seeing between the FTT end markets and non-FTT end markets and following up on that with a question about opex and can you provide an estimate of opex reduction when you lose a dollar of wire line in region revenue over the short term and over the long term, what you see there.

Thomas E. Richards

I’ll take the question about line loss. What we have observed in the last quarter, thanks to Dan and his team’s digging pretty deeply into the impact HSI had on the business. There is about a 50% change in churn. So that if you have a customer that doesn’t have HSI and you have a customer that has HSI, the churn rate difference in those two market segments is 50%. So it’s pretty dramatic for us, thus the focus on HSI as an anchor, and we think that fits with what’s going on in the market place as far as what will form the relationship we have with our customers going forward.

Joseph J. Euteneuer

In regards to your other question, it is variable on a going forward basis and there is a lot of different variables that will ultimately decide the match up of dollar loss of revenue and expense saving.

Michael Funk – Merrill Lynch

And difference over the short term, though, of course less variable, any guidance or color on that?

Joseph J. Euteneuer

We haven’t really given any specific guidance on that. Because there are just a number of factors as you continue to right-size your operations with the size of your business.

Operator

Your next question comes from John Hodulik – UBS.

John Hodulik - UBS

Just to continue on the business side, your revenue growth trends are different from what we’re seeing at other competitors. Net of the CPE impact, if you look over the last few quarter, could you clarify if you are seeing continued acceleration in growth, say over the last three or four quarters. And then what do you ascribe that to? Are you taking share or are you just doing very well in the network side with the government contract?

And secondly, it seems as if the economy really slowed in September and through October, terrible consumer confidence number this month. Have you seen any real change in the business, even on the consumer side or on the business side, just in the last 30 days?

Thomas E. Richards

In the business market segment we have had MRC growth for six consecutive quarters, and that, as I alluded to in one of the previous questions, has been the focus of Teresa and the business markets team. Where it comes from, I think it’s a function of a number of different initiatives.

One is a kind of a maniacal focus on our base, our customers, and retention. That by definition then takes the pressure off of top line new sales. Two, we embarked on what I will call a total solutions mindset when it came to our customers, and focusing on moving customers to strategic network products. And you have heard us talk about, I think, quarter after quarter, about moving customers to strategic products. Those are all MRC-based products.

So I think it’s been a combination of multiple initiatives over, I might add, a couple of different years.

As far as the impact of the economy, where we see it I would say most, is in the consumer space and specifically in our ability to make new sales and net adds. I think, yes, it impacts your install base but that’s where the head winds, you’ve heard us use that term, that Dan’s facing in attempting to bring on new products and services. That’s why we are so excited about what HSI did this last quarter because it seems like we’ve hit a sweet spot.

John Hodulik - UBS

And on the line side, or even on the business side, you haven’t seen disconnects increase as a result of the economy in the last couple of months?

Thomas E. Richards

No. If we look at our statistics, those that are attributed to economic have been relatively flat. You do see some increase in wireless substitution and there is probably a debate there that says some of that might be economic. But it has been relatively flat for most of the year.

Edward A. Mueller

So the economic part of this is the inwards that we were used to getting, particularly in some of our high-growth states like Arizona.

Operator

Your next question comes from Frank Louthan - Raymond James.

Frank Louthan - Raymond James

Can you give us a little more color on how the costs are coming out because it looks like the revenue is a little better than we were expecting but to get to the EBITDA guidance you need to see some cost improvement. Can you give us some more specifics on that?

And then can you comment on the FCC order on inter-carrier compensation, what impact that would have for you positive or negative, if any?

Thomas E. Richards

On your first question you probably didn’t hear my comments, but basically there is about $25.0 million benefit that you’re going to get as a result of one-time items in the third quarter. So therefore your real goal to make the fourth quarter number is about $45.0 million. And between the workforce impact that we’ve already started, the seasonal lower network spending that typically takes place in the fourth quarter, it’s about half of that. And the fact that business and wholesale revenue, with their productivity initiatives and stuff, will finish it up, offset by the fact that date and Internet services are sort of mitigating any impacts over our voice pressures.

Edward A. Mueller

On the inter-carrier comp, I think we would like to really see what happens November 4. I think there is a big debate. Obviously our team is up there with the FCC and everybody does, there is a lot of pressure, frankly, on the Hill but with the other things that are going on, the election and the economy, there is some pressure to just leave it like it is. Now that’s coming from the Washington side of this, the legislative side. We believe the FCC is committed to try and do something here, particularly Kevin Martin. So, we don’t really have insights. Now we’re in a black-out period so we don’t have insight into what this order will look like. It will pretty well clear itself up coming next week.

Frank Louthan - Raymond James

Are you a net payer or a net receiver of access. And can you give us a comment on your outlook for wholesale as we’ve seen the minute use volume decline. Are you expecting wholesale to be a little weaker for the next 12 months?

Joseph J. Euteneuer

On the access, our switched access cost is significantly above our switched access revenues.

Thomas E. Richards

On the wholesale, I think it would really be premature to forecast that far into the future, especially given what’s going on with on with the economy. I do feel confident that the initiatives that Roland has instituted from a margin perspective are going to pay us dividends in the future.

Edward A. Mueller

Before we take the last question I would like to remind everybody that a replay of our call will be available at our website shortly following the close this morning.

Operator

Your final question comes from Peter Rhamey – BMO Capital Markets.

Peter Rhamey – BMO Capital Markets

On high speed, I’m just wondering how you view it. Are you growing the market or are you taking share from cable? And are you seeing signs that cable is going to or has been reacting to that? So when we project out into the future we can take that into account.

And secondly, I think Tom mentioned on enterprise that there was 50 basis points of improved growth potential out of the networks contracts over the next two years. Could you quantify that, is that 50 basis points compounded on business revenue each year for the next two year?

Edward A. Mueller

Let me take the HSI first. I think we’re holding our own against cable and we are happy because our premise, as we said in the last call, was that we were dark and didn’t have a promotional item. I would say that I am cautiously optimistic going into the future for one big reason. What we have found in the fiber-to-the-node is that touches make a difference and not just waiting for somebody to call you.

And if you did that in today’s economy we know that would hurt us, because we talked about the inwards. So these touches are creating marketing plans and there is more to come. For competitive reasons we are not going to lay them all out on the call, but you can be assured that just being able to compete market by market is a by-product of the fiber-to-the-node and the specificity in the growing up, I think, of how to compete in a market with cable, who is primarily a geographic, street-by-street competitor. And we have got to grow up to that and I think we are learning that.

Thomas E. Richards

The 50 basis points was against current consolidated revenues.

Kurt Fawkes

That concludes our call. Thanks for joining us and feel free to give us a call at Investor Relations this morning if you have follow-ups.

Operator

This concludes today’s conference call.

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Source: Qwest Communications International Inc. Q3 2008 Earnings Call Transcript
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