Qwest Corp Q3 FY2021 Earnings Call

2021 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct the question-and-answer session. As a reminder, this conference is being recorded, Wednesday, November 3, 2021. It is now my pleasure to turn the conference over to Mike McCormack, Senior Vice President, Investor Relations.

Thank you, Florence. Good afternoon, everyone, and thank you for joining us for the Lumen Technologies third quarter 2021 earnings call. Joining me in the call today are Jeffrey Storey, President and Chief Executive Officer, and Indraneel Dev, Executive Vice President and Chief Financial Officer. Before we begin, I need to call your attention to our Safe Harbor statement on Slide 2 of our third quarter of 2021 presentation, which notes that this conference call may include forward-looking statements subject to certain risks and uncertainties. Also, all forward-looking statements should be considered in conjunction with the cautionary statements on Slide 2 and the risk factors in our SEC filings. We will be referring to certain non-GAAP financial measures, reconcile with the most comparable GAAP measures that can be found in our earnings press release. In addition, certain metrics discussed today exclude costs for special items as detailed in earnings material. All of which can be found on the Investor Relations section of the Lumen website. And with that, I'll turn the call over to Jeff.

Good afternoon, everyone. And thank you for joining us. On today's call, I'll provide a few thoughts on our third quarter results, an update on our recently announced transactions, a review of our key capital allocation priorities, and outline our investment plans as we continue to position the Company for long-term, sustainable revenue growth. I'll then ask Neal to discuss the third quarter in more detail. And of course, we will reserve time at the end for your questions. We're pleased with our third quarter sequential revenue progression. In fact, we showed sequential growth in both IGAM and large enterprise, showing the resilience of our business as COVID-related headwinds begin to diminish. We're also pleased with the continuation of the strong sales that we saw in the second quarter and our growing channel, which should provide a strong foundation as we drive towards growth. Overall, it's an exciting time for Lumen as we continue evolving and transforming the Company for long-term growth. Our Lumen Platform continues to resonate with customers and is the cornerstone of our digital transformation for enterprises. In addition, I believe our Quantum Fiber platform is unique in the market, and not only drives an enhanced customer experience, but also drives revenue growth and even lowers the operating cost for our Mass Markets segment, improving the profitability and sustainability of the business. I'm excited to discuss the investments we're making to drive Enterprise and Quantum Fiber growth, but let me start with an update on our previously announced transactions. The sale of our 20 ILEC states and our LATAM business are important steps to positioning our Company for the long term. Those transactions materially changed the mix of our business operations, which will amplify and accelerate the positive outcomes for our focus investments in our retained markets. Both transactions were executed with strong valuations, which we believe validate a much higher value for our retained portfolio of assets. Worth more than $10 billion collectively, we're making excellent progress towards closing both deals. We currently expect the LATAM transaction with Stone Peak to close during the first half of 2022 and believe the Apollo transaction will close in the second half of 2022. After considering the transfer of our EMBARQ debt to Apollo, pension, and OPEB liabilities, tax, and other transaction adjustments, we estimate that we will receive approximately $7 billion in combined net proceeds from the deal. Looking beyond the transactions. If you turn to Slide 4 in our investor presentation, you can see our top 5 priorities for putting to work, the significant free cash flow we generate and the proceeds from these transactions. As this slide illustrates, investing in growth is always our highest priority, and we're very excited about what we see as high return, high confidence opportunities to invest in both enterprise and Quantum Fiber growth. Let me start with Quantum Fiber. First of all, the Quantum acceleration plan has already begun. On our last earnings call, I highlighted the attractiveness of our mass-market assets in the 16 states we will retain after the sale to Apollo. Noted that approximately 70% of our footprint, or about 15 million locations, will be in urban and suburban areas, the majority of which are economically attractive for our Quantum expansion. Our Quantum Fiber initiatives continue to deliver, growing third quarter revenue 25% year-over-year. As we transition from micro-targeting to a broader market approach for deployment, we have high confidence in our ability to drive significant revenue growth for years to come. As I mentioned during the second quarter call, we plan to accelerate Quantum Fiber investments in our retained markets. As of the end of the third quarter, we had approximately 2.5 million enabled locations within the retained 16 states. Historically, we've enabled around 400,000 locations per year, and we expect that pace will continue in the fourth quarter. As we accelerate our investment in Quantum Fiber, in 2022, we expect to ramp that enablement pace over a million new locations, on our way to hitting a run rate of 1.5 million to 2 million enablements per year as we exit 2022. When deploying Quantum Fiber, we typically expect penetration rates of 40% or better with average build costs of less than $1,000 per location enabled. After a thorough review of our footprint and given these economics, we expect our total addressable opportunity to be more than 12 million locations. Our Quantum Fiber plan for 2022 is fully funded and we're very excited about these investments. But it's not just excitement born from hope; it's excitement born from experience and accomplishment. As we build Quantum Fiber, we've done more than simply construct new fiber; we’ve built an excellent Quantum experience and product capability that is now ready to ramp aggressively, providing higher output, lower return, and greater customer lifetime value. Over the past couple of years, we have executed a successful fiber deployment program using a deliberate and micro-targeted approach. This approach has enhanced and improved our capabilities, and we're positioned to execute on our much more aggressive plans. Our custom algorithms predict the cost to build and likely penetration levels for our Fiber enablement opportunities, maximizing the efficiency of our capital spend. Our experienced and actively engaged workforce is already ramping for our accelerated Quantum Fiber build plan. And we are confident in our employees' ability to deliver on our plan. We know supply chain is a major topic currently, so let me address that head-on. We've been in close communication with our diverse and reliable supplier base and have commitments from them on their ability to deliver. However, we take nothing for granted and this is an area where we will continue to closely monitor. Moving to our Enterprise business, rest assured this much larger segment of Lumen is equally exciting for us, and we will continue to invest aggressively in our edge compute and storage platforms, our managed service offerings, and our security products, as well as continuing to automate and improve our customer's digital experience across many of our core networking services. With our extensive long-haul and Vince Metro Infrastructure, our network provides low latency, ultra-high capacity, resilience, and cost advantages over many of our competitors. We have a robust and extensive fiber footprint for enterprises, and that allows us to continue to focus our capital investment on our platform experience, higher penetration in existing buildings, new product offerings, and when driven by customer opportunities, success-based fiber expansion. A few examples of recent wins in our business segment demonstrate the diversity of our customers and the need for our services across virtually all industries. These wins include a cloud TV enabler, an independent renewable energy clean technology provider, and a hyperscale. All of this is in addition to our recently announced network modernization contract for the U.S. Postal Service. There is strong demand for the enterprise services we enable, and we continually evolve our product portfolio to leverage our robust Fiber network and provide services our customers need to drive success in their businesses. We believe our growth investments coupled with our streamlined post-divestiture portfolio will create tremendous value for our shareholders. The transactions will improve our revenue quality from day one and allow for focused investment targeting our most strategic, highest ROI opportunities. We believe there are attractive opportunities through new capital to work, driving revenue growth and with returns well above our cost of capital. You've heard me say this before; we will invest for growth and grow where we invest. Another key priority for Lumen is the importance we place on returning cash to shareholders. Therefore, we have no plans to modify our dividend, which we believe is sustainable at the $1 per share level. Although our payout ratio will likely rise in the near term as we streamline our asset portfolio and invest in the Quantum and Enterprise opportunities, we expect our focused operations to provide the underpinnings for top-line growth in 2 to 3 years, which we expect will drive a more normalized dividend payout ratio over time. Our board believes the return of cash in the form of a dividend is an important part of our value proposition, and we are focused on supporting our dividend, even as we make the investments necessary to reach our growth objectives. As I mentioned on our last earnings call, and as you can see in priority 3, we will manage our balance sheet to remain more or less leverage neutral over the next few years. As we accelerate our Quantum Fiber deployment plan, we do expect the timeline to reach our target net leverage ratio of 2.75 to 3.25 times adjusted EBITDA will be extended with our two announced transactions. I'm not just using CEO speak when I say we are open to smart optimization of our assets; we are open-minded and we will continue to evaluate asset optimization that makes sense for our shareholders, but we've also demonstrated our discipline in driving and working for the right deal, not just a deal to get something done. There's no urgency for us to divest assets. Our thoughtful approach to the ILEC has resulted in additional years of cash flow from operations, a stronger multiple received, and a strong partner in Apollo, as we move our business forward. We will continue the same open-minded, disciplined approach to assess further optimization, both to improve our business mix and to fund growth in our retained businesses. Lastly, let me talk for a minute about share buybacks. As you've seen, we completed the $1 billion share buyback that we announced last quarter, reducing our share count by about 81 million shares, or approximately 7% of our total shares outstanding. I will also note we funded this buyback largely with our third quarter '21 free cash flow. We executed this buyback quickly because we believe our shares are deeply discounted and do not reflect the significant opportunity for Lumen going forward. Our Board continues to believe this and is prepared to authorize further buybacks on short notice if we believe this presents a prudent use of our shareholders' capital. With that, I'll turn the call over to Neel to discuss our third quarter results.

Thank you, Jeff. And good afternoon, everyone. As Jeff said, we're very excited about the transformation of our Company and our plans to drive future growth. Let me begin with our financial summary. For the third quarter of 2021, IGA and Large Enterprise sequential revenue performance returned to growth. We again delivered solid adjusted EBITDA and expanded margins year-over-year. Cash flow remains robust, providing the flexibility to support our capital allocation priorities. With respect to capital expenditures, Enterprise customer demand has been centered around existing on-net buildings and less capital-intensive, higher-level services. We are also seeing benefits from our continued focus on capital efficiency initiatives. As a result, we are reducing our capital expenditure guidance to be in the range of $2.8 billion to $3 billion. Note that as we transition from micro-targeting to a market-based approach for Quantum Fiber and enterprise decision-making, our new network deployment accelerates. We expect capital expenditures to ramp going forward. We remain confident in our EBITDA guidance range of $8.4 to $8.6 billion. And as a result of lower capital spending and lower net cash interest expense, our new outlook for free cash flow is $3.6 to $3.8 billion. Turning to revenue, in the third quarter, total revenue declined 5.4% on a year-over-year basis to $4.887 billion. It is important to remember that year-over-year metrics were meaningfully affected by COVID-related demand last year, making comparisons less relevant. From a sequential perspective, total revenue declined by 0.8%, an improvement from the 2.1% sequential rate of decline in the second quarter. Business revenue in the third quarter declined 0.4% sequentially, versus a decline of 2% last quarter. On a year-over-year basis, revenue declined 5.1% to $3.508 billion. Normalizing for the sale of the correctional facility business in the third quarter of last year, the decline was 4.9%. Within our business segment, IGAM revenue grew 1.5% sequentially and 0.6% on a year-over-year basis. The year-over-year and sequential improvement was primarily driven by increased demand for wavelengths and dark fiber within Fiber Infrastructure Services. IP and Data Services also grew sequentially within IGAM. Large Enterprise grew 0.1% sequentially and declined 5.9% on a year-over-year basis. Sequential improvement was driven by strength in our federal, state, local, and education businesses, while year-over-year trends were impacted by the surge in COVID-related usage last year. Mid-market enterprise declined 2.3% sequentially and 9.6% on a year-over-year basis. While sequential performance improved in the third quarter, trends continue to be pressured by the delayed decision-making environment. Year-over-year trends were also impacted by the previously noted sell of the fractional facility business. Revenue within our enterprise channels now represents about 75% of our total business revenue. Despite the mid-market headwind, enterprise channel revenue was flat on a sequential basis in the third quarter of 2021. Wholesale declined 1.5% sequentially and 7% on a year-over-year basis. Computer and application services for the enterprise channels declined slightly both sequentially and year-over-year. Our price sequential performance was impacted by the mid-markets channel and year-over-year primarily by the large IGAM customer disconnect we referenced in the first quarter. Computer and application services grew both sequentially and year-over-year for large enterprise. IP and data services for enterprise channels declined both sequentially and year-over-year due to declines in new VPN Hybrid Network deployments. We have, however, seen increased demand for IP on a year-over-year basis, as customers transition to SD-WAN and work-from-home technologies. Fiber infrastructure services grew sequentially while declining on a year-over-year basis. The sequential growth was due to dark fiber and wavelength demand, primarily for our large customers. Year-over-year declines were largely due to timing of equipment sales within our federal business. Voice and other services in the wholesale channel declined both sequentially and on a year-over-year basis, in line with our expectations as we manage these areas for cash. Keep in mind that voice comparisons continue to be impacted by higher COVID-related usage in the year-ago quarter. Turning to mass markets. Third quarter of 2021 revenue declined 1.6%, sequentially. Our mass-market fiber broadband revenue grew 25% year-over-year this quarter. During the quarter, we added 28,000 Quantum Fiber customers. Turning to adjusted EBITDA, for the third quarter of 2021. Adjusted EBITDA, excluding special items was $2.078 billion compared to $2.132 billion in the year-ago quarter. In addition to $9 million for transactions and separation costs, special items this quarter include a net benefit of $40 million. SG&A benefited by $70 million from a real estate asset sale, while cost of service was negatively impacted by about $30 million from our real estate rationalization efforts. We continue to drive healthy adjusted EBITDA margins during the quarter, growing by 120 basis points year-over-year to 42.5%. As a reminder, our third quarter is impacted by seasonally higher utility costs. Capital expenditures for the third quarter of 2021 were $690 million. As discussed earlier, we are focused on capital efficiencies penetrating existing on-net buildings while supporting our customers' digital transformation efforts with higher layer of services. In the third quarter of 2021, the Company generated free cash flow of $1.072 billion. We have increased our full-year 2021 guidance for free cash flow, as a result of our reduced outlook for both capital spending and net cash interest expense. During October 2021, we completed our previously announced $1 billion share repurchase program. In total, we repurchased 81 million shares, reducing our annualized dividend obligation by $81 million and reducing our shares outstanding by approximately 7%. We have also reduced our gross pension obligation by approximately $1.4 billion by transferring that obligation to an insurance sponsor without materially impacting our funded status. In conjunction with transferring $2.5 billion of gross pension obligations as part of our ILEC transaction, on a pro forma basis, we have reduced our gross pension obligations by approximately $3.9 billion. At this point, we don't anticipate any required pension contributions over the next few years. Moving onto the business outlook for 2021. In addition to the previously mentioned free cash flow and capital expenditure changes, we are updating our net cash interest expense to now be in the range of $1.475 to $1.525 billion, and our non-cash compensation expense to be approximately $150 million. For depreciation and amortization, we now expect to range of $3.9 to $4.1 billion as we have removed D&A expense related to the assets held for sale. As Jeff mentioned, we will manage our debt profile to ensure that the recently announced transactions are relatively leverage neutral. Our long-term net debt to adjusted EBITDA leverage target of $2.75 to $3.25 remains unchanged. As you think about any coverage ratios, it is important to remember that the announced transactions reduce our exposure to legacy revenues and significantly improve the quality and durability of earnings and cash flows going forward. Moreover, a significant portion of capital investments are expected to go towards long-life fiber infrastructure with predictable returns. In closing, our Company will look very different a year from now. We have made significant progress this quarter in taking steps to optimize our asset portfolio with a clear focus on positioning Lumen to capitalize on the growing and most profitable areas of our business. We are encouraged by our sequential revenue performance this quarter and expect business trends to improve as the economy continues to reopen. With a strong balance sheet, we remain very excited about scaling our Lumen enterprise platform, as well as our significant and unique Quantum Fiber opportunity. With that, friends, we are ready to open it up for your questions.

Thank you. You will hear a three-tone prompt to acknowledge your request. Our first question is from Brett Feldman with Goldman Sachs. Please go ahead.

Thank you for your question and for the detailed insights. Since our last call, we've received numerous inquiries about our plan to maintain our operating business in a manner that appears leverage neutral. Many investors seem to believe that this would require a substantial increase in investment, which might influence our approach to dividends. However, from what you've shared today, it seems the understanding might be clearer or even improved. It appears you're confident in maintaining your current level of leverage to support your entire capital allocation strategy, which includes dividends, potential buybacks, and the capital expenditure program. It doesn't seem that the balance sheet is solely funding any specific area, but rather the overall combination of these initiatives. Is that an accurate interpretation of what you’ve communicated today?

Yes, Brett. Thanks for your question, and I believe you are correct. In our prepared comments, we mentioned that our 2022 plan is fully funded. While it's too early to discuss anything beyond that, we have several options available. We've been enhancing our capital efficiency, which you observed in this year's results. We will continue to evaluate non-strategic assets for potential divestiture if it makes sense. Our capital expenditures are changing, and we are not investing in areas where the major work has already been completed. Many of our transformation initiatives fall into this category. We believe that there are several levers in line with the five key priorities I discussed earlier, which are detailed in the investor presentation, and we are confident that we have the resources to pursue all of them.

If you wouldn't mind if I just ask a bomb question about the fiber deployment. I think you've identified something like 12 million locations that you find attractive for passing the fiber. I think there's going to be 21 million locations in the remaining properties, so there's going to be another $9 million or so that are not part of the immediate plan. Any views on how you intend to operate that portion of the footprint going forward, or would that be on the list of things you may also explore strategic options for?

We are open to various outcomes. Our immediate focus will be to continue operating to deliver an excellent customer experience and retain the business as much as possible, while managing it for cash flow as we have been doing. You are correct that there are approximately 21 million homes in our overall footprint, and we will keep working on ways to optimize those homes for free cash flow over time. Neil, would you like to add anything?

If you take it.

Yeah, the only thing I'll add, Brett, is the $12 million is a view right now based on all the work and analysis we've done. But as the technology evolves, we're always looking at different technologies. That number could grow over time as we continue to build out.

And the $15 million, just one last clarification, was the homes that we thought were in urban and suburban areas. The locations in urban and suburban areas. We'll continue to manage the overall business for free cash flow likely done. We'll continue to manage it to provide a great customer experience so that we keep our customers happy and they stay with us.

Thank you.

Sure.

Our next question is from the line of Eric Luebchow with Wells Fargo. Please go ahead.

Thanks for taking the question. Just following up on the consumer Fiber investment opportunity. Any parameters you can give us on how quickly you think you can get to 12 million homes, 5 years, 7 years? And how much of that will be impacted by the decision to keep the dividend in terms of your ability to lean more heavily into capex in the coming years?

I haven't tracked the exact number of years, but I can share some approximate figures mentioned earlier. Currently, we serve around 400,000 homes using our micro-targeting strategy. We are working to enhance our capabilities and anticipate reaching about a million homes next year in 2022. By the end of the year, we aim to achieve a run rate of approximately one and a half to two million homes per year. We'll navigate this progress, which will primarily depend on the standard requirements for building infrastructure rather than other limitations. We believe we have a strong team with extensive experience and skills, and we are very confident in our ability to achieve these figures and expand the business aggressively.

Great. And just one more for me. I think you mentioned, and correct me if I'm wrong, that you expected that you could return to revenue growth in 2 to 3 years. So, maybe you could provide us some color on your pathway to get there. Is there an expectation, obviously, that Consumer Fiber is growing meaningfully? I assume that's the case, but also that some of your legacy declines improve, or that you improve the revenue trajectory on the enterprise side as well.

Yeah, so first of all, there is the improving mix as a result of these transactions that we've done and we'll look at additional asset rationalization as possible, which we would expect to improve that as well. And we believe in our products and our capabilities. We've been working hard for the last couple of years to build out our capabilities across a broad platform of services. And we're focused as a Company. We are a Fiber platform Company. If you listen to the earnings calls of our competitors, you'll hear about theme parks, television networks, and wireless spectrum auctions. When you listen to Lumen, you hear about two things: fiber, and how we use our platforms to seamlessly integrate our capabilities within our customers' businesses, or within our customers' home. So, it's fibered enterprises, it's fiber-to-consumer, it's fiber to small and medium business, and it's the platform in which we deliver those to create a unique and differentiated experience for our customers.

Great. Thank you.

Thank you.

Our next question is from Phil Cusick with J.P. Morgan. Please go ahead.

Hey, guys. Thanks. I wonder if you can talk about the enterprise funnel early in the year. The hope was that things would ramp up and help revenue in the back half. Where are we, and any one-timers in revenue this quarter? And just to push this a little bit, you are maintaining the dividend. You ran through the buyback really quickly. Accelerating investment over time, the revenue this year didn't come through the way you expected earlier in the year. And it seems like you have a lot more confidence in the improvement and the business and it's justified by the results this year or investors believe in. So just help us think about what you're seeing in the business that's different than what's coming through on the results maybe. Thanks very much.

Sure. Thanks, Phil. Let me start with Enterprise sales. We're pleased with our sales momentum in the third quarter. Nothing's ever linear and it's lumpy sometimes in our business. There's seasonality. There are other factors that go into it. But if you look at IGAM, our International GAM business, and our Large Enterprise, they were particularly strong. And so, we're pleased with the momentum that we've seen. The funnel has been building since about midway through the first quarter. So, we've seen the funnel return to our pre-pandemic levels. We continue to augment our products and capabilities. We believe the Fiber Infrastructure we have is a unique value proposition that brings unique value proposition to our customers. And so, we're pleased with our competitive position and our ability to take share moving forward. Moving forward again, nothing's ever linear, but we have high confidence in our revenue growth and it's part of the reason you did see us go through the buyback so quickly. We absolutely believe that our business is undervalued. And I've got data points that I can point to. We've done the sum-of-the-parts analysis for you before. If you look at the sale of 20 and out of region, small high life estates, we sold those places. We were not investing. So, you would expect to be at a lower multiple than the places where we were investing. We felt those for 5.5 times adjusted EBITDA. And so, we think that was a very good valuation for that business. If you look at LATAM, we sold it for 9 times EBITDA, and we think that's a good valuation for that business. If you look at the RemainCo within Lumen and the context of that, hopefully, you can see why I think we're still undervalued. Then if you couple that with our confidence in our ability to grow, our confidence in the investments that we're making in Quantum Fiber, our confidence in the investments that we've made in edge computing, edge storage, managed services, the platform to deliver all of our core networking services or security capabilities, if you look at those things combined together, you can see why we've decided it was good to be aggressive in the pace of buyback.

On your question, so, one time, nothing specific to call out this quarter. If you look at our fibered and infrastructure services revenue, we had strong growth sequentially. Now some of that is professional services and equipment, but we see that every quarter. So not being out of the ordinary. In fact, those types of non-recurring revenues were actually down on a year-over-year basis. And that tends to be lumpy. So, nothing specific to call out.

Thanks, guys.

Sure.

Our next question is from Batya Levi with UBS, please go ahead.

Great. Thank you. Maybe just to follow-up on Phil's question. Do you expect the sequential improvement that we saw when the revenue declined to continue into Q4 and into the beginning of next year? And as you look at the sales funnel, can you give us a little bit more in terms of the mix of maybe new customers versus existing and any transacts you could pour into in terms of pricing? Thank you.

I'll let Neil provide an overview. We usually don't give revenue guidance, so I won't go into specifics on that. However, our sales funnel has been growing. We're pleased with the sales we achieved in the third quarter. Although progress isn't always straightforward, we are putting in significant effort in the fourth quarter to boost our sales and revenue growth. There was another aspect of your question I intended to touch on.

I can tell you that regarding your question about new and existing customers, we typically conduct some level of business with almost every large company. Much of our revenue growth in IGAM and large enterprises comes from existing customers. We usually start with a wedge product and then grow the relationship further. On the mid-market front, we are focused on acquiring new clients, but that segment has faced some challenges for various reasons. Concerning sequential improvement, I want to emphasize what Jeff said. It's not expected to be linear, yet as Jeff pointed out, we do observe some positive leading indicators, alongside changes from the transactions. The growth observed in the areas where we are investing gives us confidence that we will experience a top-line inflection in the next 2 to 3 years. You also asked about pricing. We don't see any issues with the pricing environment; it's quite healthy, and this is evident in our market expansion.

Got it. Thank you.

Our next question is from David Barden with the Bank of America. Please go ahead.

Thank you for taking my questions. Neel and Jeff, you've mentioned that the portfolio will shift more towards enterprise and away from consumer businesses that are facing challenges. Looking at the current performance of the consumer Mass Market business, how would you assess the performance of the segments you plan to keep versus those you intend to discard? Additionally, with the upcoming end of CAF-2, you mentioned that despite reducing capital expenditures, you expect to increase spending on core initiatives next year. Given that you are currently a company with declining revenues and high leverage, cutting capital expenditures, and recently reaffirming your commitment to dividends while possibly increasing stock buybacks, it raises concerns. This situation seems reminiscent of past scenarios that did not conclude favorably. I'd like to discuss this further, Jeff, and get some clarification.

Sure, I'll address that and then Indraneel jump in. A lot packed in there. Legacy consumer versus the business that we're selling versus the business that we're keeping. We don't really look at it and certainly don't give out information on it separately. But the legacy business is performing like we've seen it perform, and our team has done a really good job of managing that business for cash. And we have invested as we thought it was appropriate to continue to expand our homes past. If you look at the retained 16 states at the end of the year, we'll have something like 2.6 million fiber-enabled homes. You've seen us grow our consumer and mass-market business at the rate of about 45,000 subscribers over a 100 megabits per quarter. Something like 28 to 30,000 of those on turf fiber. And so, we continue to have the parts of the business where we're investing in growth, and we continue to have the parts where we're not investing, and we manage those for cash. Part of the rationale behind the sale to Apollo was that they will invest more in those markets. We think there's a great opportunity in them. We just weren't going to invest in them at the pace that we thought that they deserved. We think that Apollo will do that and gave us a good valuation for it. And so, it's part of our funding philosophy to see how we can fund what we want to do. Part of it is to sell assets, but part of it also is to shift some of that funding obligation to somebody else. They can grow that, and we don't spend the money there. Now, we have gone through it. I can go through it again, but we have lots of sources. We have significant free cash flow that we generate. We have opportunities to continue to rationalize parts of the business that make sense for us, and parts that don't make sense for us. But we think that we're in a very good position to do the things that sound a little dubious about. But we think we're in a good position to do those things and we'll continue to focus on making sure that we maintain our dividend, that we invest in growth first and foremost, that we invest in the growth that we think we can drive, and we can maintain our dividend, and we can stay relatively leverage neutral. And I have not made any commitment to doing additional share buybacks, but I do want you to know that our board is very prepared to authorize one if we thought that was appropriate. And Indraneel, I don't know if you want to add to that?

Yeah, so I'll add data. I think on the mass market, we're scaling up our fiber investment. And so, we see that as a significant opportunity. I think the mechanics are fairly well understood. And so, you're going to see us ramping that business and it's a long-life asset with predictable returns. On your comment on the 5%, you should also look at our sequential performance. We're talking about COVID last year where we had a fair amount of COVID-related demand and voice performance. So, a better number to look at is sequentially. We did decline what we declined 0.8% in IDM and the enterprise grew on a sequential basis. So yeah, like I mentioned before, it's not going to be linear, we are encouraged by the revenue trends we see. The other thing to keep in mind is the capitalization of this business is rapidly changing and it's going to change rapidly going forward. Since the level to be acquisition, we picked on about $7 billion of debt. We just announced $10 billion of transactions in the quarter, we have 7% less outstanding shares. So yeah, we will continue to transform the business and try to support the capital priorities I just laid out.

All good points. Thank you.

Our next question is from Mike Rollins, with Citi. Please go ahead.

Thanks. And good afternoon. First, I was just curious if you can unpack the reason why the gross proceeds at 10.2 billion drops to about 7 billion on a net basis, on slide 5? Second, I was curious if you could just unpack if there are any costs or dilution that you had to incur to transfer the pension liabilities to another entity? And then just finally, while we're on the subject of kind of cash flow, I'm curious, if you could just talk about some of the moving pieces for 2022 that everyone should be mindful of. Whether a kind of cash tax front or the cash two fronts for any other significant moving pieces that could affect just recurring cash flow in a positive or negative way. Thanks.

Let me explain the decrease from 10.2 billion to 7 billion, and then Indraneel can address the cash flow for 2022. As I mentioned in my prepared remarks, there are several factors at play. To start, we are transferring $1.4 billion in EMBARQ debt, which is a liability we are eliminating on the Lumen side. This transfer is one of the benefits of the deal. Additionally, there are pension and OPEB liabilities totaling several hundred million dollars, along with taxes and deal costs. We can provide more details later, but these are the main factors that contribute to the reduction from 10.2 billion to 7 billion.

I think, if I can add, Jeff. I think the big ones are like Jeff said in the purchase agreement that has been filed, so feel free to look through it. So, there's $1.4 billion of EMBARQ debt. We provided debt adjustments, so that's another $100 million. Between pension and OPEB liabilities, that's another $300 million. So that's the bulk of it. So, like Jeff said, just to underline that point, that's a liability shift and the rest of it is basically transaction costs and taxes that we incur on the transaction. I'll keep in mind these assets are very low tax basis. If you think about, we will be using NOLs. But at the same time, we are also using NOLs for our operating income. So, it depends on the timing of the deal. And so, it is an estimate to 7 billion is an estimate the key work there is that's discretionary cash flow that we can decide on how we support our capital priorities, whether to invest in the business, pay down debt, and we will do that as we go along. So, from a cash flow perspective. That's something to keep in mind. Also, keep in mind that we are generating strong free cash flow today. So, if you just look at our fourth quarter guidance based on our updated guidance, we'll generate strong free cash flow there, even after factoring in the dividend. So, we feel pretty good about supporting all the capital priorities that Jeff laid out. Nothing specific to highlight in terms of 2022. I think we've already talked about CAF. You need to make sure you factored in the capital reduction there as well, and then we'll have more to say when we provide next year's guidance. In terms of the pension liability transport, I won't get into the specifics, but like we said on the 8-K, it doesn't materially change our funded status.

And so, just a follow-up and I appreciate all that color. So, the $7 billion cash does not include the $1.4 billion debt reduction. So that kind of enterprise value would be the $7 plus the $1.4 for $8.4. Is that the way to think about it?

Well, the transaction value is the $10.2 though the $1.4 would be on top of the $7. So, the $7 is truly discretionary cash and the $1.4 is a debt reduction. But it's fair transfer rather than just use of discretionary cash, so you are right.

Thanks.

Our next question is from Nick Del Deo with MoffettNathanson. Please go ahead.

Hey, thanks for taking my questions. You know, first, I appreciate the new disclosures on the fiber-to-the-home front. When you point to enablement costs being $7,000 per location, should we think of that as being well below $1,000 in the earlier years and increasing over time? Or should it be relatively consistent over the course of the project? And to confirm, the 12 million opportunities inclusive of the fiber locations you have today or is that incremental to them?

The total is 12 million opportunities. The incremental growth would be in about 10 ZIP codes, meaning we currently have around 2.5 million in the retained states. In terms of cost, we are building at a significantly lower rate today. This is a rough average, but given the current macro conditions, including labor costs, it's difficult to predict exact numbers for the next 2 to 3 years. However, we are confident in the return potential of this business, as we see many opportunities to increase average revenue per user, not just from the basic service but also from our investments in managed Wi-Fi, security, and other capabilities. Therefore, regardless of the actual costs, we believe we have a strong margin for generating excellent returns.

Okay. And then can I ask one EBITDA question too. If I look at your implied EBITDA guidance range for Q4, the EBITDA you generate in Q3 is towards the low end, what you did in Q2 is in lower half. I know you don't give specific quarterly guidance, but is there anything we should be cognizant of that prevent EBITDA from coming in toward the lower end of the range in Q4?

Well, we haven't changed the guidance all year. So, what I would say is we do provide annual guidance and our guidance has been the same from the beginning of the year, and the range is the range.

Okay. All right. Well, thank you, Neil.

Our next question is from Frank Louthan with Raymond James, please go ahead.

Great. Thank you. So, if you're not intending to cut the dividend even after the Apollo deal, is there a certain point where you guys can put a line in the sand and say, at this point, we really think we can have positive sustainable top-line growth. Is that a year out, 2 years, 3 years? How should we think about that?

Well, I mentioned earlier that we are investing in Quantum Fiber through our edge compute and other capabilities on the Lumen platform. We believe that we will finish divesting certain assets. We anticipate returning to topline growth in 2 to 3 years.

Okay. Great. Thank you.

Our next question is from James Ratcliffe with Evercore ISI. Please go ahead.

Thank you. I want to provide some additional insight regarding capital expenditure. It's clear that spending will increase next year as we expedite the Quantum Fiber rollout. However, can you elaborate on the anticipated return on investment at this reduced capital level? Is it expected to be higher or similar? Additionally, without the Quantum Fiber expansion, how should we view the capital intensity of the business segment moving forward? Thank you.

So, on capital, first thing to keep in mind is, we are leveraging a fairly large investment in terms of the infrastructure that we have, and so we're focusing a lot on net buildings. Part of that is the current environment but as the economy continues to reopen and Enterprise start investing in new locations, we will also ramp up, adding new locations. In terms of ROIs, we continue to see very good ROIs on the investment that we make on the Enterprise side and I think the consumer most of the dynamics there. ROI is not an issue for us. It is really managing the legacy revenues for cash that really mutes the returns, if you will, from our perspective. In addition to that, we continue to focus on capital efficiency initiatives. So, we continue to focus on how we get more efficiency in terms of our processes, how we deploy capital, unit costs of capacities. So those things continue to be areas of focus for us.

To add to Neel's answer, from an external perspective, you might overlook our capital efficiency, but from within, we recognize its significance. These are substantial numbers that provide us with real benefits. Our investments in the enterprise sector have been considerable. Firstly, we have ensured that our cost structure allows us to provide a high level of service each year at a lower cost while enhancing service quality. We have also invested in edge computing and edge storage, which we view as excellent opportunities. Earlier this year, we aimed for 95% of the U.S. to be within 5 milliseconds of our edge facilities by year's end. We achieved that around the end of the second quarter, even surpassing our coverage goals and timeframe, delivering faster than expected. We are meticulous with our investments, enhancing our adaptive networking and connected security while developing our unified communications and collaboration capabilities. We’re continuously improving our platform and services, and we are experiencing market success. Additionally, we plan to ramp up Quantum Fiber, as I have mentioned previously. Thank you for the question, James.

France, we have time for just one more question.

Very good. Our last question then will be from the line of Jonathan Chaplin with New Street Research, please go ahead.

Hey everyone. Thank you for the opportunity to ask a question. I wanted to revisit the consumer business. If we consider 2019 as a baseline year, it appears that the growth rate of net additions in both the fiber and non-fiber segments on the consumer side has significantly decreased. This is happening despite the expansion of your addressable footprint in the fiber sector. Could you share your insights on the current broadband market and what factors may be hindering growth? The reason I bring this up is that we've stated that the $10 billion investment in deploying fiber could yield tremendous value, although it’s a long-term process taking around six to seven years. This means you're encouraging investors to anticipate future cash flow from this investment before it materializes significantly. Therefore, building confidence in your ability to penetrate these markets seems essential for achieving a fair valuation for the initiative you’re undertaking. I have a second question, if that's alright. Jeff, you seem to believe that the stock's current value is much lower than its true worth, which we saw reflected in the share buyback in the third quarter. Why don't you allocate all the cash currently spent on dividends and share repurchases if the stock is indeed undervalued? It seems you're not receiving proper recognition for the dividend yields. So why not redirect everything towards share buybacks? Thank you.

Let me address the first question. I will have Neil provide some detailed answers before I share my thoughts on the stock price and our strategy. Your question about consumer investment raises the point of whether the $10 billion investment is justified. We believe these investments are beneficial for shareholders, which is why we haven't focused on stock repurchases. However, you also mentioned the need to demonstrate that these investments are effective, and that is precisely what we've been working on over the past couple of years. While building fiber is manageable, delivering services to customers is challenging. We have been enhancing our capabilities, specifically our Quantum Fiber services, to provide customers with a seamless, low-tech digital experience, allowing us to add more features on top. As we shifted our focus away from previous investments in bonding and vectoring—topics you haven't heard us mention in a while—we aimed to validate whether we could achieve the expected penetration rates. We have successfully done that and provided insights indicating potential penetration rates over 40 percent in areas where we have actively marketed our services. In response to your concerns, we've proven our capabilities and developed a system that allows us to deliver results quickly, instead of waiting years for returns. Regarding stock price conviction, we firmly believe our stock is undervalued, and this plays a significant role in our capital allocation strategy. We are also committed to investing in growth, enhancing our Quantum Fiber business, expanding our fiber services for enterprises, and evolving our platform and services. Additionally, we are focused on maintaining our dividend and managing our leverage. These goals may compete for our capital, but we are confident in our ability to fulfill them all. If the Board determines it is appropriate for us to initiate an additional buyback, we will act promptly, though the pace may differ from our previous buyback efforts, where we were quite aggressive. If deemed suitable, we will proceed with authorization.

I think, yeah, you covered most of it. I think your question on the fundamental thesis, in terms of the market and the opportunity and the symmetrical nature of fiber and how it's resonating with customers. All of that we see, and we're leaning in. Our fiber net adds were a little softer this quarter than we would like, and that is primarily driven by the fact that we are able to improve a major pivot internally in terms of how we go to market. So, like Jeff mentioned, we wanted to prove this out first. So, we had a micro-targeting strategy and we've proven it out. We've seen how it resonates with customers. We've invested in our processes and capabilities, and now we're doing the pivot to go to a more market-based approach. And that takes a little bit of time to get our organization, our size to scale up to a new ecosystem. And so yeah, we feel very confident that opportunity is something we see as creating a fair amount of value. And we're not constraining it, like Jeff said, in terms of the priorities, there's a reason why number 1 is invested revenue, and that's something we will prioritize.

So, thank you, Jonathan, for the question. And as you heard in our answers, Jonathan's questions, and all of your questions today, we have a lot of optimism and excitement here at Lumen as we're growing markets, investing for growth through Quantum Fiber to continue to enhance our already powerful enterprise platform and capabilities. We continue to return cash to shareholders. We're bullish on our future and excited for the ongoing transformational work that lies ahead. So, I want to thank all of you for joining today's call and as always, the interest in Lumen. Thank you all.

We would like to thank everyone for your participation and for using Lumen's conferencing service today. This does conclude the conference call. We ask that you please disconnect your lines. Have a great day, everyone.