Lumen Technologies, Inc. (LUMN) Earnings Call Transcript & Summary

We'll get started now. Thanks, everyone, for joining us. I'm Batya Levi with the communications team at UBS, and our next speaker is Chris Stansbury, EVP and CFO at Lumen. Thank you so much for joining us.

It's great to be here.

So just given the time of the year, we -- I wanted to start off with what you're mainly focused on as we head into '24?

Yes. I mean the fourth quarter is obviously well underway. We're very focused on finishing the year strongly. But really, the pivot is now to next year. We're in the middle of a transformation. If I think about it kind of in terms of renovating a house, over the last year we've done all the ugly stuff that you can't see, right, replumbing it, rewiring it, building new motions for how we retain customers and migrate customers to new things, focusing on innovation, focusing on execution. And so '24 is really where that hard work starts to show up in the results. And so we're very focused on making sure that deep into the organization, all of our objectives are aligned around that and that people have the tools they need to succeed next year. So that's the focus right now.

And a lot of news or attention is going towards the TSA. So maybe if you could just give us an update on where we are, what are the next steps as you complete the process?

Sure. And -- oh, I forgot to say upfront. I might add, that's the forward-looking statement thing. So you can check out all of our language around that on the Lumen IR website. But -- so the TSA, obviously that's something that we came to an agreement with a group on -- about a month ago. We're in the middle of that. We're very focused on bringing that to closure. The portion of that that the focus is on today is really around getting the banking group, the revolving banking group, lined up behind it, and that's where we are right now.

Okay. Maybe just dig into that a little bit. And there was a little bit of confusion around it. If you can help us kind of understand what drove it? Why now? And as we get out of it, maybe sort of some goalposts that we should think about in terms of where -- how much incremental interest expense is this going to need and...

Yes. So there has been a lot of noise around it, not surprising. It's a huge transaction, particularly in a tough credit environment. We were in the motion of refinancing our capital structure, really focused on 2 things: one, making sure we can continue to invest in the turnaround; and two, dealing with a challenging maturity structure where half of our debt of a fairly highly levered company was due in 1 year, in 2027. And so there was overhang on the customer side saying, "Hey, wait a minute, this thing looms even if you guys execute the turnaround. Is there risk?" Because our customers are enterprise customers. They're making multiyear, multimillion dollar decisions, and they want to know that we're going to be around to provide that service. So we were in a motion to address that. Our capital structure, for a lot of legacy reasons, is complex. A group formed as we addressed that, and we viewed that as an opportunity to meet our financial needs, but also deal with those issues in a bigger bite rather than a bunch of smaller bites. And that's really what the TSA got us to. There was -- candidly, there was an alleged technical default. We don't believe there was -- and the real answer is it doesn't matter who's right, because what matters is the noise in the marketplace is not our friend, and that just cast further doubt into customers' minds. And so that's why we embraced the process, and why we are where we are today. It is a more expensive deal. So if you think back, Batya, to our Investor Day, we did say that we would refinance debt at the time of maturity, and we expected to be paying much higher coupon, and that's what those assumptions were. This pulls that forward. So it will obviously move around by year, but it's about a $200 million to $300 million solve that we've got to do. And the way we're going to do that is we're not going to expand our consumer builds. We'll stay at the pace we're at right now, which is a healthy 0.5 million enablements a year. I think the rest of the space is largely adjusted given cost of capital. So I don't think we're out of line with that, but that's how we fund that gap.

Got it. And is it true -- I mean, my understanding is that group that's sort of on the other side, you did not have any control over that group.

None. I mean I think that's a really important point, and thanks for bringing it up. We had no control over who was in the group. We had no control over who was in the steering company, a subset of that group. That -- it's the steering group that we negotiated with. It was a very tough negotiation. We did build in, on our side, basket capacity as well as covenant flexibility to deal with other portions of the capital structure not included in the TSA. We can't talk about that now because of non-solicit rules. So as soon as the TSA closes, we can start to address other portions of the structure.

Okay. Do you expect it to close soon, or could this drag on for the...

The TSA expires December 31. So the focus is on getting it closed before the end of the year.

Okay. And would that give you enough time just to focus on [ the ] operations and you'll have enough funding? And -- or are you -- will you be more opportunistic with other forms of funding? And maybe how do you think about the ABS opportunity...

Yes, I mean -- so certainly, ABS is an opportunity. It's something that we're looking at right now. Obviously, the focus is the TSA, and that's consuming most of our time right now. But we're doing the work that you need to do to enable securitization-type deal to happen down the road. So that work is happening. Look, I think it's an interesting conversation, because I've only been in telecom now for a little over 1.5 years, Kate's been here for a little over a year. And it's a space where, particularly in the enterprise space, there has not been innovation. It's been dumb pipes, and that's it. And there's this accepted view that everything moves down and to the right and therefore the best way to manage the business, I jokingly say, is to die last, right? And so there's that balance sheet management side of returns, which usually ends up in some kind of a restructuring. That's not the opportunity for us. We have significant proprietary technology that has started to enter the market. We've talked about it -- NaaS, ExaSwitch, Edge Fabric -- and the conversation with customers around that is significant. And so the fact that we're focusing on migrating customers from legacy to new and bringing new very disruptive innovation to the market, the fiber is important, but if you stop with the fiber as the story, you're going to lose. It's about the service layer on top of that. And we think that the bigger opportunity is on EBITDA growth than on debt -- simply debt reduction, and [ we've got ] to do both.

Right. I do want to touch on that a little bit more. And you're right. On the enterprise side, the telecom companies are generally known as the connectivity provider and maybe just the dumb pipe, and the value creation goes to others, the tech side, the software side. How do you change that narrative? And what -- how should we -- what should we track to see that you're actually gaining share there?

It's -- that's also a very good question, and I think a big wake-up call for us was the third quarter earnings call. We knew that the bulk of the questions were going to be around the debt deal, fair. What was shocking is that the only business questions were around Fiber to the Home, which is 20% of our business. And so we've got work to do. We owe you and the broader investment community the right set of metrics around, I would say, 3 things, right? If you think about how we manage the Enterprise space, it's secure the base. And think about that as customer migration from legacy old products to new. So don't ignore those customers that are on really profitable cash-rich legacy products, actively engage in a conversation on migrating them to the new thing, because customer lifetime value is a real thing. The second basket of activity is really around driving executional excellence. So the work we're doing in mid-markets on adding new logos. The work we're doing in large enterprise on adding sellers and better metrics around that to add net new. There's a set of metrics around that that we can share. And then the third is the innovation, where I think we can give a better pathway to the disruptive nature of that technology and the share taking that we see in that opportunity. And so as we get into next year we'll give more metrics around that, so hopefully the broader investment community can model more closely to what we're expecting.

And like you said, Kate has been on the CEO role just over a year, you're a little bit longer. But as you look at that transformation phase, what inning are we in? Do you still need to invest or spend time to put the pieces together? Are you -- or is that mostly done, and now it's kind of going after that..?

It's -- I would say we're fourth inning. There's still investment to come. I mean we can't forget there's a lot of EBITDA that's in this business today. And one of the reasons why we're having that conversation is because we're committed to spending all of it on driving the transformation and getting to a better place as fast as we can. So there's still innovation to come. We will continue to innovate around NaaS and ExaSwitch and security, but a lot has also been done. So what you're going to start to see is the impact of the activities over the last year start to reduce the rate of decline and do that in a more meaningful way. If you look at our Enterprise space kind of adjusted for acquisitions and whatnot, I think we're competitively in a very good place today, but there's more improvement to come, and you'll start to see that in the second half of this year. We will also give, I think, in addition to just what's going on inside of Enterprise from a product standpoint, we're going to give you much better visibility around large enterprise, mid-markets, public sector, wholesale, we'll give you all the pieces. So -- because they're behaving in different ways in terms of their point of inflection back to growth, but we'll give you the insights around that as we go forward.

Going back to the Analyst Day, you laid out some operational goals for each segment. You maintained generally your free cash flow targets. But that -- I guess the adjustment is maybe [Indiscernible] matched with lower CapEx. But on the operational side, what are some of the changes that you're seeing right now?

So there's -- again, it's a company that was very focused on paying a dividend. There wasn't a lot of internal investment. 13 order entry systems, 36 GLs, all that's getting cleaned up this year, so the customer experience is improving. Our visibility into our own performance is improving. And when you layer that with a lot of the work that we're doing internally around AI -- we're one of the early launch partners on Copilot -- there's an enormous amount of productivity that's getting unlocked and will continue to get unlocked as we move through the year. So as we get to the end of '24 and into '25, '26, I think we'll be on a pathway to some significant cost reduction and efficiency as we go forward.

Okay. Maybe digging in a little bit with the Enterprise segment and stepping back, can you talk about what you're seeing from a macro environment and sort of competition, maybe some pricing trends?

I would say nothing has changed yet, although early, early signs are that next year will be better than the past couple of years have been as inflation starts to moderate. And we're certainly hearing from customers and just more broadly industry analysts that there's need for investment, right? There hasn't been as much over the last couple of years. So I think that's good, particularly when combined with what we're seeing in terms of things like seller productivity and the things I mentioned earlier around migrating customers and driving better net new performance with new customers. So I think that sets itself up well. But the part that we're most excited about is the disruptive innovation. And if you think about what's happening in enterprise today, customers are working in hybrid environments, right? There's on-prem, there's private cloud, there's public cloud, within those cloud environments there's multi-cloud. And what's happening right now, it's not just something that's projected to happen, is just an explosion in the amount of data. The learning algorithms of GenAI are consuming enormous quantities of data. You talk to the data center providers, third-party data center providers, you talk to the hyperscalers, they're all scrambling to build data centers to meet that need. And the biggest constraint they face is power. So they're getting further and further away from the point of consumption and latency now becomes an issue. So when you look at the innovation we're bringing, we're dealing with that. So we're digitizing the network. What does that mean? That means that you can consume the network the way you want to consume it, when you want to consume it. So NaaS is port-to-port connectivity that you light up through your computer, and you light up that connectivity in minutes, not weeks or, worst case, months, depending on customer experience. That's also a gateway to things like ExaSwitch, where -- okay, what is ExaSwitch? It's a thing and people are confused by it, understandably. It's an optical switch. It reroutes an optical signal from one place to another. And what's happening as you get into these much bigger data load environments that are more fragmented is the need to move massive quantities of data instantaneously. In some cases, between 2 different hybrid or -- sorry, 2 different hyperscale environments. And so ExaSwitch does that. It allows you to move the equivalent of a million-or-so 4K videos in an instant from A to B. And so the ability to do that is something that we have IP around. As we talk to customers, we were in New York talking to the financial services sector a few weeks ago. What we're getting asked is not why. We're getting asked how quickly can I get that, because it's solving a number of immediate problems that can't be solved with just doing more direct connections of laying more fiber. And so the fiber is critical. We've got 6 million miles of 400 gig ways in the ground. There's another 6 million coming. It's important. But if you stop the conversation at fiber, now you're talking about down and to the right, it's commodity, it's not interesting. It's about that service layer. The third leg is really Edge Fabric. So companies today pay a lot of egress fees to get access to their own data. And in a world where we're driven by apps, and apps need data, you're doing all that development work, you can do that in an edge-of-network zero-latency environment that's already built. It's available through Lumen and can be accessed through NaaS and then you wrap security around it. So that's really the future. That's the disruption factor that we think we can bring. It's really a tech focus. And the talent that's coming into Lumen today is astonishing in terms of the people that want in. We'll make an announcement late this year, early next year, about our new Head of Product. It will -- I think it will shock the industry in terms of the kind of talent that's coming into the company.

But there is a perception that as these services are rolled out, they are -- they have deflationary pricing. So how -- will the volumes make up for the difference that you expect that pool of revenue to continue to grow?

I don't -- so I think deflationary pricing is just more and more faster fiber. Again, if that's where the story stops, that's a deflationary story. That's commodity. The service layer, customers are willing to pay for access to ExaSwitch where we have IP protection. Speed is important, so access through NaaS, that's important. So I think what we're going to see, again, just like we saw when third-party data centers came into existence, it's what we saw when data center providers moved to cloud and as-a-service, not just on-prem, we're going to end up with a hybrid environment. You're going to end up with banks needing point-to-point connectivity between San Francisco and New York, but they're also going to need some of these other things that allow them to pulse up, pulse down. And I think in that, not only is there value they're willing to pay for, it's a share-taking opportunity.

Right. And as you go through these opportunities, you're partnering with potential providers as well. Maybe you were the anchor provider. How does the -- sort of the profitability of that partnership look for you?

Still to be solved. So we're -- what I don't want to do is tell you that we've got it all figured out, because we don't. I think the technology is figured out, but how that's priced, how that's priced in a broader ecosystem, all those things are things that we're working on right now.

Okay. So when you look at near-term enterprise trends, they've been pretty stable actually on a sequential basis. Can we expect that to continue, or are there any sort of drivers you would...

I think -- and it's hard to call how much is market versus how much is just us doing a better job of execution. But what we do have a line of sight to, when we get deeper into the data, is we should see, as I said, improvements in our trends in the second half of next year, and I think the rate of deceleration will continue to improve and be more noticeable at that point.

In large enterprise, it's been delayed, but we're starting to pick up more and more wireless companies kind of talking about private 5G opportunities. Are you seeing that as a new competitor coming in?

Haven't seen a lot of it. There's certainly on-campus situations where customers require that. In that case, we partner with others who provide that. We don't have any desire to be in that space, nor do we think it's really where our core competency is. I mean, our core competency is that service layer that sits on top of what is a very fast network today, and that's where our focus is.

Got it. On the -- maybe just one more on the sales funnel for enterprise. Is there any change? Is there a little bit more delays in decision-making?

I'd say it's the same. So it has slowed. What we are seeing in our funnel is the funnel starting to grow as seller productivity rises. So for example, in large enterprise, we've added many, many new salespeople over the course of the last year. Some of those are replacing salespeople who have left, and that's okay because we're pivoting to more of a technology sale than a telecom sale, and it's a different skill set. But we're seeing seller productivity rise every month. We're measuring that very closely. And then in mid-markets, that's a combination of both direct and indirect. Our indirect partner network has grown significantly, and we're -- again, we're measuring great progress there. So I think we'll continue to see improvements as we move into next year.

And maybe moving to the mid-markets. You mentioned that you added more logos. But when you just like simply look at the revenue trend, it's still continuing to decline mid-single digits.

We will -- I mean, I do not want to confuse anyone. We will continue to see revenue declines until '25 because we're trying to turn around an ocean liner that has been really in fairly mid- to high single-digit decline for the last number of years. Our rate of decline when you adjust for divestitures is probably in the 4% to 5% range, which I think is better than the broader competitive set. But that will improve -- that rate of decline will improve as we get into the back half of the year, which should show the market line of sight to our point of inflection in '25.

But specifically for the mid-market group, do you see more competition from cable, or maybe talk...

No. If anything -- if I were to break it apart between large enterprise, mid-markets, public sector, public sector is much longer lead times between sale and revenue, big, big deals. We've won a number of large deals recently, and that will visibly hit revenue in the second half of next year. I'd say the next in line in terms of being closer to that point of inflection is actually mid-markets. That team has done a phenomenal job. There is a huge share-taking opportunity there because we neglected it. We were very focused on a direct selling motion, doesn't work in that space. And so we built a lot more muscle through the partner ecosystem, and that's starting to show results. And then I'd say, just because the magnitude of what we had to do in terms of new sellers and churn in sellers, large enterprise probably lags that. But that's kind of the sequence I think you'll see in terms of as things start to pivot, and that's why I want to give you the visibility.

Right. Okay. So the last 10 minutes, and now we're shifting to quantum fiber. You expect the pace to continue. It seems like it's a dilemma. There is stranded costs kind of building the fiber. But once you build it, you can see some nice penetration and growth of that segment as well. So how do you think about the opportunity?

It's a good business. It's just a different business. And I think the way enterprise, telecommunications and the service layer is valued is very different than the way fiber to the home is valued. And the payback cycles are different and the margins are different. So our view is that the fiber to the home business is important. Our view is that the fiber to the home segment needs further consolidation. And we're very clear in saying we're not going to be the consolidator. If -- our best next investment dollar is in the enterprise space, and quite frankly, I think the build pace we're at in consumer, again, is consistent with what others in the space are doing, and said another way, if additional capital rained down from the sky right now, I don't think I'd put it into Fiber in the Home. I think we use that to pay down debt because of where debt is trading today. So those are the trade-offs. And it's -- I think that consolidation point, when does that happen? Who knows? Obviously, it's a tough environment from a capital standpoint and cost of capital. So we'll have to see how that plays out. But we'll continue to look at it market by market. And you could see us -- I think there's ways for us to do a better job of monetizing that asset. We might sell a market, we might look for a partner in a market. We might look to wholesale some of that. So there's a lot of different levers we can pull to drive additional value today. But longer term and strategically, our belief is these 2 things don't belong together.

Right. And is that view different for your fiber versus non-fiber?

No, I think it's -- I would call it more kind of consumer versus enterprise. I would draw the lines there.

And the SME goes with -- SMB goes with the consumer business?

We'd have to -- there's a line in there. At some level, yes, but the reality is there's obviously access to more of that mid-market customer that is important, where there's last-mile connectivity. But those things are all negotiable as you look at those kinds of transactions.

Right. In the near term, until we sort of get a change in the business model, I think you had assumed that the mass market would start to stabilize from '25 beyond, but with a faster fiber build.

Correct.

And now that the build is slower, should we expect that stability is also pushed out?

Yes, that's going to get pushed out a little further on the revenue side. But again, our focus right now is on return. So I think there's other things perhaps we can do between investment and EBITDA, and those are the things we're looking at right now.

Are you seeing any change in the competitive environment with fixed wireless maybe coming in a little bit faster?

Fixed wireless is certainly a competitor in more of the older copper markets. Fixed wireless I don't think plays as well in the large major metros where we're focused on fiber build, and quite frankly, where a lot of the fixed wireless providers are focused on fiber build. So -- but it is more of an issue in those copper markets. Now for us, we're starting in a pretty poor position, we have 10% market penetration where we have copper. So it's, I think, less of an issue than maybe others are facing.

How quickly should we expect you to think about strategic options for this segment?

We've been thinking about them right now, and we have been. I think the issue is it's not us saying, oh, we want to hang on, we want to wait. It's what's the right point for us to extract value, because that's critical. We're not fire-saling anything. And I think that will be determined by the broader market, cost of capital and other external factors.

Got it. And in the meantime, for example, BEAD opportunity is going to come in, which is -- which could fund some of these investments. Are you interested in tapping that?

It's a possibility, but we're not counting on it in any of our projections. I think those programs are valuable. We're big believers in closing the digital divide. But the way those programs work is there's very often no return in it. And so we're going to be cautious about where we participate and where we don't.

Okay. On the cost-cutting side, I think you laid out $300 million opportunity. When do we get to that run rate? And then how do you think about...

So the $300 million will be a full year impact for next year. Those actions have taken place, and it will benefit us next year. The reason we did that was really twofold. We know that with all the debt noise, there's been a lot of customer overhang. My team, Kate, me, we're spending a lot of time on the phone with customers who are making multiyear multimillion dollar decisions and they want to know we're going to be around. And inevitably, when we have the conversations, business moves forward. We're concerned about the conversations that don't come our way, right, where people make a decision without talking to us. And so we took the cost action to hedge against any EBITDA risk associated with that noise, very hard to quantify. So I don't think we view that as a way to bump up EBITDA next year. I think we look at it as an insurance policy against some of our initial thoughts. And obviously, we haven't given guidance yet. So that's really how we're thinking about it. The second reason we did it is, frankly, there were activities going on inside the business that we were trying to stop. They were more legacy focused. There was really no value in continuing them, and they were continuing. And so the only way to stop them was to eliminate them. And it was a way for us to also drive additional focus on where we're going than where we've been.

All right. One sort of -- still remaining question is that you laid out some financial targets back in June, and there's been some developments. But you also pulled forward the tax NOLs, $900 million, but that doesn't necessarily show up in the numbers. So what is the near term -- where are we going to see the near-term pressure in terms of the financial model?

So the pull forward on the NOLs gives us a benefit. We'll get -- we'll take a bit of it this year. It's going to pay our estimated taxes in Q4, a couple of hundred million, the remaining $700 million will come in early next year. So I think the way you'll see it play out in the model is, from a free cash flow standpoint, we won't see a lot of pressure next year even with the cost of the debt transaction. The adjustment that we made by not increasing the build on consumer is really kind of an average impact over the next 4 years. But I think '24 free cash flow is actually going to be probably a little better because of that.

Right. Okay. And maybe on the CapEx side, the reduction is mostly coming from the fiber side.

All of it is, yes.

And Enterprise -- how should we think about the trend for Enterprise capital intensity? Is it sort of -- is there a lag in terms of trying to drive that revenue growth?

No, I'd say that today, while we're definitely investing in -- we talked at the beginning of this year about the need to invest in things like ServiceNow and the SAP to clean up the IT environment that we have. And that's certainly part of the base this year and next, and we'll be done with those. Today, we're still in an environment where a big, big piece of the Enterprise CapEx is success-based. We do a deal with USPS, there's CapEx that goes with that. As we go forward, I think we'll be in that environment for the next couple of years, but as the digital transformation and disruption takes place, I think we'll see less capital intensity as a percentage of revenue as we move to more of a software-defined kind of model. So yet to be quantified, but I think directionally that's where we move as time goes on.

Is that like 3-plus years out?

I think by the time we get to scale, that's probably about right. Again, we've got to give you better visibility into what we think that scaling ramp looks like around digital innovation. That's part of what we're working on trying to quantify so we can give it to you for next year.

Okay. May be just kind of like putting it all together as we -- you'll give us proper guidance sort of beginning of the year, but as we think about the moving parts and EBITDA decline kind of trending towards '24, what are -- should we expect to see similar trends continue until you start to see the benefits of the cost cutting?

I think you'll continue to see an improvement in the rate of decline, particularly once we get to the second half, you should see a pathway to us getting to the point of inflection on revenue growth. And then as we get into '25 and '26, in addition to the revenue benefits, you'll see some additional productivity coming out of the system. As we cleaned up some of those IT environments, we've improved the customer experience with process improvement and then backed up by ServiceNow. So you'll see both. You'll see the benefit to EBITDA from the revenue, and you should also see it from continued productivity improvements.

And in terms of the leverage, I guess, should we expect you'd like to keep it sort of [indiscernible].

Yes. I don't think leverage gets higher than where it is right now. I mean, maybe a tick. It's not going to be much. And then leverage should come down. But again, our focus on managing the leverage is not taking the easy way out, right? The focus on leverage is about driving EBITDA higher. It's not about driving debt lower. And we think that is the bigger near-term opportunity and that's why we're focused on it. That's why Kate bought stock. It's why I bought stock. We see it out there, and we're excited about it.

Okay. Great. I think that's all we have time for. Thank you so much.

Thanks, Batya.