Lumen Technologies, Inc. (NYSE:LUMN) Q3 2023 Earnings Call Transcript

Lumen Technologies, Inc. (NYSE:LUMN) Q3 2023 Earnings Call Transcript October 31, 2023

Lumen Technologies, Inc. misses on earnings expectations. Reported EPS is $-0.0793 EPS, expectations were $0.06.

Operator: Greetings, and welcome to the Lumen Technologies Third Quarter 2023 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, October 31, 2023. I would now like to turn the conference over to Mike McCormack, Senior Vice President, Investor Relations. Please go ahead.

Mike McCormack: Thanks, Cersei. Good afternoon, everyone, and thank you for joining Lumen Technologies third quarter 2023 earnings call. On the call today are Kate Johnson, President and Chief Executive Officer; Chris Stansbury, Executive Vice President and Chief Financial Officer; and Rahul Modi, our Treasurer. Before we begin, I need to call your attention to our safe harbor statement on Slide 2 of our third quarter 2023 presentation, which notes that this conference call may include forward-looking statements subject to certain risks and uncertainties. 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’ll be referring to certain non-GAAP financial measures reconciled to the most comparable GAAP measures, which can be found in our earnings press release.

A long-distance telecommunications tower looming large against a dawn sky.

In addition, certain metrics discussed today exclude costs or special items as detailed in our earnings materials, which can be found on the Investor Relations section of the Lumen website. With that, I’ll turn it over to Kate.

Kate Johnson: Thanks, Mike. Good afternoon, everybody. I’m excited to share a summary of the material progress we’ve made in our efforts to reposition Lumen for growth. I’ll start with some major structural accomplishments. First, we’ve made significant progress in simplifying Lumen with two divestitures. We expect to close the sale of our EMEA business to Colt tomorrow, November 1, earlier than planned. This transaction will generate approximately $1.5 billion in net after-tax proceeds, which we anticipate will be used for debt reduction. Second, two weeks ago, we announced the sale of the majority of our CDN contracts, a transaction that will enable us to continue to focus our resources on businesses where we can differentiate ourselves in the market at scale.

Next, the balance sheet. We successfully reached a broad agreement with creditors that hold over $7 billion of the outstanding debt of the company and its subsidiaries. The transaction will extend a large portion of our debt maturities and remove questions regarding the company’s compliance with this debt covenants. The creditor group will also provide $1.2 billion of new financing. The closing of the transaction is subject to the satisfaction of certain conditions, including completing work with our banks to extend our revolver in term loan A and getting approval from other creditors as needed. In addition to restructuring the balance sheet, we’ve made the difficult decision to reshape and right-size Lumen for growth. We’re taking immediate actions, which will result in about 4% fewer people inside the company.

This reorg, along with additional optimization initiatives, will generate annualized savings of approximately $300 million. And as you might expect, this is a difficult, but necessary decision given the revenue pressure we felt from the noise in the market regarding our creditor discussions, as well as global macroeconomic pressures. These proactive steps to address our balance sheet and lower our cost base will reduce the noise, it will improve our agility and efficiency, and it will enable us to better compete in the markets we serve. Now, I’d like to talk about some of the operational improvements we’re seeing in our Business segment. As we’ve shared, we have a three-pronged strategy to transform this business: one, secure the base; two, drive commercial excellence; and three, innovate for growth.

And we’re making progress against all three. Securing the base boils down to five things: minimizing disconnects, maximizing installations, driving increased usage, renewing customer contracts, and migrating our customers to newer technologies. If we get these five things right, we reduce churn. So, let me share this quarter’s sequential performance for these five metrics in our North America, large enterprise and mid-market sales channels. We saw a 4% reduction in disconnects, a 9% increase in installs, a 5% increase in usage, a 4% increase in VPN customer renewals, and a 21% increase in voice migration. With heavy use of data and analytics to understand customer behavior and an agile approach, we created a win formula to address churn and deliver improved Business revenue performance this quarter.

Obviously, a lot more work to do here, but we do see a path to success. Let’s look at driving commercial excellence. This is about sales execution that ultimately yields growth. Simply put, there’s just two ways to grow; you either sell to net new customers or you sell more products and services to existing ones. We’re making progress against both of these growth vectors. First, we added more than 2,500 new logo customers so far this year across large enterprise, mid-markets, and public sector segments despite the headwinds I described earlier. Year-over-year, we’ve seen 47% more Grow products sold to existing customers or 16% normalized for a large deal that I’ll talk about in just a moment. Finally, we achieved 14% higher seller productivity year-over-year, a very impressive metric given how many new sellers we have.

A big part of driving commercial excellence is going after net new markets. For example, we see huge potential in the digital inclusion market, which presents an opportunity for Lumen to help states bring reliable broadband connectivity to unserved and underserved markets. We won our first large multi-year deal in this space, representing over $400 million of revenue when the State of California chose Lumen as a key strategic partner. We’re now bringing the same commercial framework for public-private partnerships to other states as they seek to bridge the digital divide. All right. The third prong of our business strategy, innovating for growth. This is all about bringing net new capabilities like Network-as-a-Service, or NaaS, to the market and gaining access to new profit pools.

We’ve made great progress driving adoption of our first NaaS offering called Lumen Internet On-Demand. This new digital capability is now generally available and has lighthouse customers in 13 industries, including healthcare, technology, insurance, retail, manufacturing, and public sector to name a few. In addition to selling NaaS directly to customers, Lumen is also leveraging our partner ecosystem to drive scale. Customers can buy Lumen Internet On-Demand through 136 enabled data centers in 10 different markets across North America through our great partners, Digital Realty and Equinix. Our NaaS product roadmap is industry defining. So, we’ll be adding — soon, we’ll be adding API capability to allow customers to activate NaaS in their own business applications, then we’ll layer in security with DDoS, and then we’ll offer dynamic bandwidth capability for ultimate usage flexibility.

Now together with our Edge Fabric and ExaSwitch, Lumen NaaS is setting the table for a new market category for the modern communication infrastructure platform, one that optimizes application performance across hybrid architectures for on-prem, at the edge, and multi-cloud, and one that makes room for rapidly changing network needs as GenAI becomes mainstream. We are cloudifying telecom, it’s going to be disruptive to the industry, and we are playing to win. All right. Turning to Mass Markets, we have strong growth in Quantum Fiber enablements where our construction factory is operating well. But that said, our subscriber adds this quarter were below our expectations. During the quarter, we took significant steps to improve operations as we combined CenturyLink Fiber with Quantum Fiber, merging all inventory and field tech systems into one and vastly improved order-to-install commitments.

While we believe these operational activities, coupled with lower move activity, dampened subscriber adds this quarter, we do know that we need to do better selling and penetrating existing builds. Therefore, as we face a more constrained capital environment ahead, we’ll prioritize sales and marketing investments over enablement growth. While we will still build at a healthy pace, we should see greater penetration rates and a higher return on capital spent in Mass Markets. All right. To wrap up, I’ve often spoken about rebuilding Lumen starting with our people. We’ve been hard at work doing that for the past 12 months, and I’m proud to share that during the third quarter, Lumen was recognized by U.S. News & World Report as one of the 2024 Best Places to Work in telecom.

It’s our first time being named to the list and I think it demonstrates the power of creating a culture that enables change. Transformation is a messy business. And despite extremely challenging headwinds, we’ve made big and important structural changes to the company, and equally important, we’ve made significant measurable operational improvements. There’s lots more to do, but we’re confident in our strategy to pivot Lumen towards stabilization and growth. And with that, I’ll turn the call over to Chris.

Chris Stansbury: Thank you, Kate, and good afternoon, everyone. Kate spoke about our progress in transforming and disrupting telecom and playing to win. She also spoke of our success in reaching an agreement with a group of creditors to extend our debt maturities. On our Q2 earnings call, we said we viewed the formation of the creditor group as an opportunity to both fund our future as well as address our challenging maturities profile. The agreement we announced today meets both of those objectives and will allow us to continue our transformation journey and the disruption of telecom. Before covering our third quarter results, I would like to take a few minutes to discuss several items which will impact our financial trends going forward.

As Kate mentioned, we closed the CDN sale earlier this month, and we expect to close the sale of our EMEA business tomorrow, November 1. The CDN sale will not have a material impact on our financials. We estimate that these CDN contracts contributed roughly $20 million in revenue and $10 million in adjusted EBITDA to our third quarter 2023 results. Keep in mind that these CDN contracts were part of our Harvest portfolio and have received little capital investment in recent years. The valuation, while not disclosed, reflects the declining nature of the revenue of these contracts. We plan to wind down the remaining CDN contracts in 2024. For the pending divestiture of our EMEA business, our 2023 outlook assumed a full fourth quarter contribution of approximately $140 million in revenue, $50 million in adjusted EBITDA, and $30 million in CapEx. Separately, we’re expecting a tax refund of approximately $900 million previously not included within the financial outlook.

Approximately $200 million of the refund will be applied to pay 2023 estimated taxes and we’re expecting a cash refund of approximately $700 million in the first quarter of next year. While we expect to receive a near-term cash benefit, this is in part due to an accelerated use of our NOLs. Some of the benefits will reverse over the next few years. There are counterbalancing impacts related to the CDN contracts and the pending EMEA transaction that make us comfortable keeping our full year 2023 free cash flow guidance of zero to $200 million. As Kate mentioned, the macro environment and the overhang of our creditor discussions has resulted in revenue headwinds which will pressure our results over the next few quarters. With the creditor agreement reached today and continued execution against our plan, we expect to see sustained improving revenue trends in mid-2024.

In addition, we expect the cost actions that Kate mentioned earlier to help address near-term pressures on adjusted EBITDA. Additionally, we’ve been clear that in the wake of transactions over the last year-and-a-half, our organization needs to be more nimble and continue to work through transaction-related dis-synergies. I’ll now discuss in more detail the financial summary of our third quarter. As I’ve done throughout this year, I’ll reference our financial performance primarily on a sequential basis for better comparability as the year-ago period included the impacts of our divested LATAM and ILEC 20 state businesses. Keep in mind when the impacts of divestitures and commercial agreements are excluded from results, our year-over-year growth rates are substantially better than the reported rates.

Our third quarter total revenue declined 0.5% on a sequential basis to $3.641 billion. Adjusted EBITDA was $1.049 billion in the third quarter with a 28.8% margin. Free cash flow was $43 million in the third quarter. Next, I’ll review detailed revenue results for the quarter. On a year-over-year basis, reported revenue was down 17.1% with the impact of divestitures and commercial agreements representing approximately 73% of the reported decline. Within our two key segments, Business revenue declined 0.1% sequentially to $2.894 billion and Mass Markets revenue declined 2.2% sequentially to $747 million. Within our enterprise channels, which is our Business segment excluding wholesale, revenue grew 1.1% sequentially. Be aware that much of this strength is driven by growth in other products which tend to fluctuate quarter-to-quarter.

However, excluding other products and the impact of divested businesses, our subtotal of Grow, Nurture, and Harvest revenue declined at the slowest rate we’ve seen in years. That said, we continue to expect near-term variability in the revenue trends. Our exposure to declining Harvest revenue is now less than 18% of enterprise channel revenue and was down approximately 70 basis points sequentially. Large enterprise revenue grew 0.3% sequentially in the third quarter. Large enterprise revenue trends improved compared to the second quarter year-over-year when excluding the impact of divested businesses, driven primarily by continued strong trends in the Grow product segment due to demand for IP, dark fiber, and colocation, and moderating declines in Nurture and Harvest.

Now, moving on to public sector, revenue grew 7.2% sequentially. Excluding the impacts of our divested businesses, public sector trends improved year-over-year primarily due to higher other revenue which includes non-recurring equipment and IT solutions, improvement in Grow revenue and moderating declines in Nurture and Harvest products during the third quarter. Mid-market revenue declined 1.8% sequentially. Excluding the impacts of our divested businesses, third quarter revenue trends worsened year-over-year. Strength in Grow products were driven primarily by IP, UC&C, and enterprise broadband, which is more than offset by lower VPN revenue within Nurture. Wholesale revenue declined 3.4% sequentially. We expect our wholesale channel will likely continue to decline over time, as this is an area we manage for cash.

Now, moving on to business product lifecycle reporting. Grow products revenue declined 1.1% sequentially. Excluding the impacts of our divested businesses, this quarter’s results showed moderating year-over-year growth. While results can vary in any given quarter, we expect sustained strength in this area as we execute on our turnaround. Grow continues to represent approximately 39% of our Business segment and carried an approximate 82% direct margin this quarter. Within Nurture and Harvest, we expect — or we continue to expect headwinds in these categories as we take proactive steps to migrate customers to newer technologies. This improves our customers’ experience and provides an uplift in the lifetime value of those customers for Lumen.

As Kate mentioned, we continue to see positive leading indicators that our initiatives are working and it will take some time to be reflected in our results. Nurture product revenue declined 0.5% sequentially due to continued pressure in VPN and Ethernet services. Nurture represents about 30% of our Business segment and carried an approximate 69% direct margin this quarter. Harvest products revenue declined 3.8% sequentially. Recall that Harvest is an important part of our business as it generates cash to fuel our growth initiatives. Harvest represents approximately 24% of our Business segment and carried an approximate 80% direct margin this quarter. Other products revenue grew 23.7% sequentially. Our other product revenue tends to experience fluctuations due to the variable nature of these products.

Now, moving on to Mass Markets, revenue declined 2.2% sequentially. Our Mass Markets fiber broadband revenue grew 3.2% sequentially and represented approximately 32% of Mass Markets broadband revenue. Also note that our exposure to legacy voice and other service revenue continues to improve with a nearly 20 basis point reduction sequentially. During the quarter, total fiber broadband enablements were 141,000, bringing the total fiber enabled locations to approximately 3.5 million as of September 30. During the third quarter, we added 19,000 Quantum Fiber customers. Fiber ARPU was flat sequentially and increased on a year-over-year basis to approximately $61 in the third quarter. At the end of the quarter, our penetration of legacy copper broadband dropped below 11% and our Quantum Fiber penetration stood at approximately 25%.

The agreements with our creditor groups have given us runway to execute against our turnaround plan, but those agreements will result in interest expense increasing sooner than our forecast had anticipated. This leads to a choice of higher enablements or higher returns for the Mass Market business, and we are choosing higher returns. We will continue to build at a pace similar to what we’re doing this year, but we’ll increase our focus on driving penetration and ARPU and growth. As I’ve said many times, our best use of incremental investment is in our Business segment where we see faster and better returns. Turning to adjusted EBITDA, for the third quarter of 2023, adjusted EBITDA was $1.049 billion compared to $1.688 billion in the year-ago quarter.

The third quarter of last year included $332 million related to the divested businesses and the third quarter of this year included a negative impact of $40 million from the divestiture-related commercial agreements. These items represent approximately 58% of the year-over-year decline. Special items impacting adjusted EBITDA this quarter totaled $33 million. Our third quarter 2023 adjusted EBITDA margin excluding special items was 28.8% as we lean into growth and optimization efforts. Capital expenditures for the third quarter of 2023 were $843 million. In the third quarter of 2023, the company generated free cash flow of $43 million. Now, moving on to our outlook. Our financial outlook for 2023, we are reiterating all guidance metrics. We’ll provide our outlook for 2024 when we report our fourth quarter results in early February.

With that, we’re ready for your questions.

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Q&A Session

Operator: Thank you very much. [Operator Instructions] And our first question comes from the line of Simon Flannery with Morgan Stanley. Please proceed with your question.

Simon Flannery: Okay, great. Good evening. Thanks very much. Chris, I know the 8-K just came out, but it would be great if you could just give us a little bit more on the debt agreement. Perhaps quantify the interest expense impact and what happens to your maturity schedule as well.

Chris Stansbury: Yeah. So, there’s obviously a lot of work that needs to continue. What I would say, Simon, is I’d highlight that the agreement does address the maturities and our need for investment. Depending on participation rates, it really does clear a path largely to 2029, which gives us more than ample time to execute the turnaround. And we do see a pathway to being able to execute against that agreement, and we’ve got the flexibility that we need as we move through that. As it relates to interest expense, again, it varies by year. Obviously, more impact nearer in, less further out given the way we modeled higher interest rates at the Investor Day. And the way I’d look at it is we will be cutting back on CapEx in the $200 million to $300 million range over the next few years to compensate for that.

Simon Flannery: Versus the Analyst Day projections?

Chris Stansbury: Correct.

Simon Flannery: And how do you think about BEAD in the context of today’s news? Is that something you kind of deemphasize at this point?

Chris Stansbury: No. I mean, again, I think our feelings on BEAD are very similar to what we have said consistently, which is if there’s an opportunity, we will participate. But again, we’re not resting a lot of hope on that. Those programs tend to get driven down in terms of the returns, and we were very clear today in saying that our focus is return. So, it doesn’t mean we won’t participate, but we’re going to be selective.

Simon Flannery: Great. Thanks a lot.

Operator: Our next question comes from the line of Nick Del Deo with MoffettNathanson. Please proceed with your question.

Nick Del Deo: Hi. Thanks for taking my questions. First, Chris, I was just scanning the 8-K, like Simon, not time to go through everything in detail. But I think one of the bullets noted that you expect the cumulative cash flow that you had previously laid out at the Analyst Day to come in within the range you had targeted but at the low end. And if I’m reading it correctly, it would seem to include a cumulative $600 million improvement in your cash taxes over that timeframe and presumably some of the lower CapEx you just laid out. So, I’m just wondering if you could help us understand the puts and takes there a bit better.

Chris Stansbury: Yeah. I want to make sure I’m answering your question. I mean the only thing that we’ve guided, obviously, is this year. We’re still holding the guidance range. As we said, we expected a couple of hundred million dollars to be used this year. But when you look at just the other expenses and whatnot that we’re incurring on some of the closed transactions and whatnot, that kept us within the guidance range. Going forward — go ahead.

Nick Del Deo: Sorry, go ahead.

Chris Stansbury: No. I was just say going forward, we will have, all other things being equal, a free cash flow shortfall that will be addressed by pulling back on CapEx, as I mentioned in my earlier response.

Nick Del Deo: Okay. So, just to be clear, I was referring to the first bullet in the cleansing information, where you talked about your expectations versus what you had laid out at the Analyst Day.

Chris Stansbury: Oh, I see what you’re saying, yeah. So, as we looked at current performance, which as Kate referenced, was impacted by the overhang from the all the noise in the market around our debt structure and our ability to refinance it, it unquestionably had a near-term impact on sales that we expect will impact revenue. The way we offset that is the cost reduction program that Kate announced today. So, we have line of sight to the — being within that EBITDA guidance range we talked about at the Investor Day. We’ve got work to do, obviously, to reaffirm that for next year. But that’s why we did what we did. There’s great stuff going on inside the business in terms of improving revenue trends, and we’re excited about that. But there’s no question that these near-term conditions have hurt the revenue trend more near term.

Nick Del Deo: Okay. And just on the pace of the fiber enablements, what’s the magnitude of the change you’re thinking? And is the CapEx reduction just a function of lower enablements?

Chris Stansbury: Yeah, I think that’s the way to think about it. It will come in the form of lower enablements. And directionally, I think it means that next year and coming years look relatively flattish to what we’re doing this year in terms of enablements.

Nick Del Deo: Okay. Thanks, Chris.

Operator: Our next question comes from the line of Michael Rollins with Citi. Please proceed with your question.

Michael Rollins: Thanks, and good afternoon. Two questions, if I could. First, just curious if you can unpack a bit more of the EBITDA pressure in the third quarter relative to revenue, of course, excluding the divested assets and the transitory items that you highlighted in the slide? And then just secondly, just in response to the last — or following up on the last couple of questions. Is Lumen considering other ways to try to fund the business and try to get back some of the CapEx and some of the investment opportunities that you thought would be very productive when you laid out the original business plan goals at the Analyst Day? Thanks.

Chris Stansbury: Yeah, sure. So, I’ll address both of those. So, near term, I think we’ve heard our competition talking about a tough economic environment. There’s no question that that’s impacting us. Although I would say on a relative basis, we’re pleased with our performance. And then, as I said in my previous response, I think just the amount of noise in the marketplace over whether our turnaround disruption was going to matter, because we had this huge ’27 tower, that had an impact. And it’s hard to measure that, but it undoubtedly had an impact. And that’s why we’re pleased with where we ended up with a proposed transaction today. So I think that clears the way. I’d say the third thing is, again, great things happening inside the company.

But as we’ve said consistently, it’s going to bounce around as we move through the transition and start to scale the things that are working. In my prepared remarks, I did say that we see line of sight to sustained improvement in revenue kind of starting mid-year next year, and that remains. So, we feel good about that. As it relates to other ways to fund CapEx, so more specifically, the asset-based securitization question, yeah, that remains an option. And we’ll continue to do work around structures like that to see if there’s an opportunity. So, those remain, but my comments today do not assume any additional structures helping us fund CapEx.

Michael Rollins: Thanks.

Operator: The next question comes from the line of Batya Levi with UBS. Please proceed with your question.

Batya Levi: Great. Thank you. A follow-up on the new deals. How should we think about the net proceeds of the new financing that you’re announcing? And how — what should we think about the split in terms of how much of it will be used in terms of driving new growth versus debt paydown? And through this transformation phase, where do you think your maximum leverage would be?