Lumen Technologies, Inc. (NYSE:LUMN) Q2 2023 Earnings Call Transcript

Lumen Technologies, Inc. (NYSE:LUMN) Q2 2023 Earnings Call Transcript August 1, 2023

Lumen Technologies, Inc. beats earnings expectations. Reported EPS is $0.35, expectations were $-0.35.

Operator: Greetings, and welcome to the Lumen Technologies Second 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, August 1, 2023. I would now like to turn the conference over to Mike McCormack, Senior Vice President, Investor Relations. Please go ahead.

Mike McCormack: Good afternoon, everyone, and thanks for joining Lumen Technologies second quarter 2023 earnings call. On the call today are Kate Johnson, President and Chief Executive Officer; and Chris Stansbury, Executive Vice President and Chief Financial Officer. Before we begin, I want to call your attention to our Safe Harbor statement on slide 2 of our second 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 will be referring to certain non-GAAP financial measures reconciled to the most comparable GAAP measures, which can be found in our earnings press release.

In addition, certain metrics discussed today exclude costs for 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 the call over to Kate.

Kate Johnson: Thanks, Mike. Hi, everybody. Thanks for joining us today. In a few minutes, I’m going to turn the call over to Chris as usual. But first, I just want to give you a quick overview of our transformation progress. This quarter, we added two big leaders to the Lumen executive team Kye Prigg, an experienced telecom exec steeped in both driving large-scale network transformations and leading big teams joined us last month as EVP of Enterprise Operations. And Ana White, an experienced CHRO with an impressive track record of culture renovation and tech companies joined us as our Chief People Officer. These additions round out what I believe to be the most talented team in the industry and I couldn’t be more excited to see the positive impact of both of these two new kids bring to Lumen.

All right. Turning to the transformation work itself. I’m going to use the framework we introduced at Investor Day on June 5. To refresh your memory, we’re pursuing a three-part plan to deliver on our North Star. First, secure the base; second, drive commercial excellence; and third, innovate for growth. Each of these three parts of the plan will require hard work and they’re going to take time to deliver results. But I’ll share several positive early indicators, which give us confidence we’re on the right path, and I’m going to start with securing the base. This is about intentionally migrating customers from legacy telecom platforms to modern ones to stem churn and deliver fundamentally better customer experiences. Success here drives higher customer lifetime value to Lumen, while it will be a multi-quarter journey to yield material financial results with this new motion, our recent results are noteworthy.

For example, we’ve been building out a scaffolding for our voice migration program over the past couple of months. We staffed up with great talent, significantly growing the dedicated team. Now we instituted a no seller left behind enablement program, giving our reps a winning sales playbook, AI-enabled sales targeting and digital tools to enable quick creation and delivery of customer-focused sales content. And we give our sales managers tooling to enable deep data-driven inspection of the funnel across the life cycle with analytics to feed learning into the process. This newly dedicated team with their new digital tools and sales content, they’ve only been in place fully since June 1 of this year. And in less than 60 days, we see material increases in pipe and close rates and probably more importantly, a quadrupling of the dollar value of wins from June to July.

I’m happy to share that we also had two record-breaking voice migration deals in terms of dollar value. They both closed in July, and they’re basically confirming our hypothesis that we’re likely to see our migration efforts yield greater customer lifetime value. We’re also seeing material progress in learning from our focus on migrating customers from VPN to SD-WAN and SASE. Great customers like Nissan and WE Bowers are choosing to work with Lumen because of our new customer-centric approach and our long-term orientation around customer lifetime value, it just shows that when we focus, we win. Now, I’ll move on to the second part of our three prime strategy, driving commercial excellence, which is all about consistent execution across all of our core businesses.

And success here looks like growing at or greater than market rates wherever we compete. In our mass market segment, we’ve added approximately 250,000 fiber-enabled locations year-to-date in 2023, and we’re confident that we can meet or exceed our plan of $500,000 for the year. With the fiber enablement factory delivering predictable output now, we’re well positioned to nearly double our current Quantum Fiber footprint to over 7 million locations in the next four years. And as I’ve shared in the past a couple of times, the federal lead program could potentially represent enablement and economic upside, but it’s not currently forecasted in our model. In our business segment, we’re building a program to drive commercial excellence that uses all the same tools, I just described in our voice migration program, and we’ve built a hiring engine to go after tech sales talent.

We’re using AI in our sales platform to drive more automated and informed seller activities. And we use data and analytics to create wind formulas to help our managers coach our salespeople. This programmatic focus is driving better results in a small mid-market pilot where we deployed these tools and saw an 80% reduction in sales cycle time and an 85% shortened customer onboarding time. Additionally, our opportunity win rates in this channel, they’ve increased 160% since the start of the year, and we’ve seen 50% year-over-year increase in new global acquisitions for our grow products. One thing I mentioned at Investor Day was our belief that emerging technology trends, such as AI and data-driven services, will lead to large-scale demand increases for our growth products.

We are seeing early signs of this with second quarter wins in tech, retail, manufacturing and financial services. Again, the consistent themes in these wins at customers like Quick Trip and Provident Bank is that Lumen’s focus on customer experience and their business outcomes was a key differentiator in the selection process. We think this focus is part of the reason why our grow product sales trend returned to year-over-year growth for the first time in four quarters. Now let’s talk about innovating for growth. And there are two key pieces to this part of our strategy to build a digital enterprise and to innovate new capabilities in our network to drive more value for customers. While we’re making material progress in both areas, this quarter is all about two breakthrough innovations that we brought to market.

The first is ExaSwitch, our new on-demand 400-gig capable optical interconnection platform that we announced in mid-June. It’s an amazing piece of technology that’s strategically important as we position our network and infrastructure at the center of connectivity. Created in partnership with Google, Microsoft and another large hyperscaler, this platform leans into the growth tailwinds that we talked about at Investor Day, tailwinds like Gen AI and Edge Cloud by enabling the low latency and flexibility customers are going to need as network demands increase with explosive data growth. Exit Switch is a great example of the new Lumen strategy coming to life. We’re using our intellectual property and innovating side-by-side with customers and partners to create differentiated technology in an on-demand digital fashion to un-tap more value from our crown jewel of the network.

The second big breakthrough innovation this quarter was announced yesterday. Lumen launched its flagship capability on its network as a services platform. It’s called Lumen Internet on demand and it’s offered in limited availability and is already oversubscribed. This is the first and a very important step toward the company’s bold vision to disrupt the telecom industry. By offering customers radical flexibility in how they buy, use and managed networking services, Lumen is cloudifying traditional telecom. We’ve been preparing for this moment for a long time, building a world-class telecom network with state-of-the-art fiber, broad coverage and unsurpassed route diversity and scalability. Lumen’s NAS offering takes that next step to deliver on our customers’ networking dreams, the ability to fire up any port, with any service at any time.

It’s your network, your way with the Lumen platform. So I hope that it’s clear we’re playing to win here. The team and I are super excited by our position and progress, and we’ll be sure to keep you updated on our road map as we advance our network-as-a-service platform and capabilities. And with that, I’ll turn the call over to Chris.

Chris Stansbury: Thank you, Kate, and good afternoon, everyone. As Kate described, our turnaround is underway, and we’re very excited with what lies ahead. Our teams are energized. We’re pleased with our progress on the quantum bill with fiber enablements outpacing our first quarter result and we expect further acceleration in the third quarter. This gives us confidence that we will meet or exceed our plan of 500,000 locations in 2023. Our growth product group’s performance was solid this quarter and when excluding the divested businesses and foreign currency impacts, it grew year-over-year at a similar rate compared to our first quarter’s performance. I’ll now discuss in more detail the financial summary of our second quarter.

As I did on our first quarter earnings call, 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. We’re again providing supplemental information of the discrete impacts in our footnotes were applicable in our earnings presentation and on a separate page in our financial trending schedule. When these impacts of the divestitures and commercial agreements are excluded from results, our year-over-year growth rates are substantially better than the GAAP reported rates. Our second quarter total revenue declined 2.1% on a sequential basis to $3.661 billion. Adjusted EBITDA was $1.229 billion in the second quarter with a 33.6% margin.

Free cash flow was negative $896 million in the second quarter, including $938 million of taxes paid related to our two divestitures last year. We’ve now paid all of the transaction-related taxes for those divestitures. As a reminder, our 2023 free cash flow guidance excludes the impact of these taxes. Next, I’ll review our detailed revenue results for the quarter. On a year-over-year basis, reported revenue was down 20.6% with the impact of the divestitures and commercial agreements, representing approximately 72% of the reported decline. Within our two key segments, business revenue declined 2% sequentially to $2.897 billion and mass markets revenue declined 2.3% sequentially to $764 million. Within our enterprise channel, which is our business segment, excluding wholesale, revenue declined 1.8% sequentially.

Our exposure to legacy voice revenue continues to improve and is now less than 11% of enterprise channel revenue and is down approximately 50 basis points sequentially. Large enterprise revenue declined 1.3% sequentially in the second quarter. Large enterprise revenue trends were similar to the first quarter year-over-year when excluding the impact of divested businesses, driven primarily by declines in harvest due to legacy, voice and partially offset by stronger trends in grow due to demand for cloud, colocation and IP. Public sector revenue declined 3.7% sequentially. Excluding the impact of our divested businesses, public sector trends worsened year-over-year primarily due to lower other revenue, which includes non-recurring equipment and IT solutions.

Declines in nurture and harvest products were also contributed to the declines, with a partial offset by accelerating growth within grow driven by IP, Voice over IP and wavelengths. As a reminder, we had a contract expiration at the end of the year ago quarter, which is impacting the year-over-year comparisons for public sector grow products by approximately $10 million. Mid-market revenue declined 1.6% sequentially. Excluding the impact of our divested businesses, there was a similar level of year-over-year decline compared to last quarter. Strength in growth products was driven primarily by broadband, IP and UC&C and was partially offset by lower legacy voice revenue within Harvest. Wholesale revenue declined 2.4% sequentially. Excluding the impacts of our divested businesses, trends worsened year-over-year.

As with Public Sector, the accelerated decline rate was primarily due to lower other revenue. Recall that in the second quarter of last year, we benefited by approximately $25 million related to a non-recurring IT professional services agreement, that was provided in connection with the now divested 20 state ILEC assets. Separately, we lapped the benefits from certain carrier contract discount expirations, which we previously identified in the year ago quarter. We expect our wholesale channel will likely continue to decline over time, and it is an area we manage for cash. Now moving to our business product life cycle reporting, grow products revenue grew 0.9% sequentially. As I mentioned earlier, excluding the impact of our divested businesses, this quarter results showed a similar level of strong year-over-year growth to the first quarter of this year.

While results can vary in any given quarter, we expect continued strength in these areas as we execute on our overall pivot to growth. Growth now represents approximately 39% of our business segment and carried an approximate 83% direct margin this quarter, accelerating growth by growth is a key focus of our strategy and we continue to be pleased with these early results. Moving on to nurture and harvest. 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 lifetime value of those customers for Lumen. And as Kate mentioned, securing the base is hard work and will take some time to be reflected in our results.

Nurture Products revenue declined 4% sequentially due to continued pressure in VPN and Ethernet services. Nurture represents about 30% of our business segment and carried an approximate 68% direct margin this quarter. Harvest Products revenue declined 3% sequentially. Recall that Harvest is an important part of our business and generates cash to fuel our growth initiatives. Harvest represents approximately 25% of our business segment and carried an approximate 81% direct margin this quarter. The subtotal of our business product revenue, including grow, nurture and harvest, collectively declined 1.7% sequentially and 14.8% on a year-over-year basis. The impact of the divestitures and commercial agreements accounted for approximately 68% of the reported decline.

Other products revenue declined 6% sequentially. Our other product revenue tends to experience fluctuations due to the variable nature of these products. Within other, we have deemphasized low-margin equipment and changed our sales commission structure, which will continue to impact comparisons to prior periods. These changes are focusing our sales efforts on products that provide a better customer experience and stronger returns for Lumen. Moving on to mass markets. Revenue declined 2.3% sequentially. Our mass markets fiber broadband revenue grew 3.3% sequentially and represented approximately 31% of mass markets broadband revenue. Also note that, our exposure to legacy voice and other services revenue continues to improve with a nearly 40 basis point reduction sequentially.

During the quarter, total fiber broadband enablements were approximately 130,000, bringing the total fiber-enabled locations to approximately 3.4 million as of June 30. We are focused on penetrating our deployed fiber assets through our simplified Quantum Fiber broadband product, to maximize subscriber and ARPU growth. In the second quarter, we added 21,000 Quantum Fiber customers. This brings our total Quantum Fiber subscribers to 877,000. We expect to add subscribers at a faster rate in the second half of the year with our significant increase in quantum marketing. Our marketing plans are ramping in conjunction with our conversion of the CenturyLink Fiber brand to Quantum Fiber later in the third quarter of this year, potentially further benefiting subscriber growth as more potential customers can benefit from our world-class quantum digital experience.

Fiber ARPU increased both sequentially and on a year-over-year basis to approximately $61 in the second quarter. New customers are seeing the value and quality of Quantum Fiber with most choosing our flagship symmetrical gig and in some cases, multi-gig service, benefiting our fiber broadband ARPU, which grew both sequentially and year-over-year. As of June 30, our penetration of legacy copper broadband was approximately 11%, highlighting the significantly share taking opportunity as we accelerate the Quantum Fiber build Our Quantum Fiber penetration stood at approximately 26% and as we expand our footprint, we expect penetration to fall as we increase our addressable market at a higher rate than new customers are at. Our Quantum Fiber 18-month penetration rate of the 2021 vintage was at approximately 20%.

The performance of our 2021 vintage continues to track below that of 2020 at these milestones and I expect the same will be true of our 2022 vintage. This performance was the catalyst for us to reevaluate our quantum build enablement targets during the fourth quarter of last year, refocusing our efforts on locations that provide the best opportunity and returns for Lumen. We expect that our 2023 vintage will exhibit stronger performance given our more disciplined approach to our build. That said, our Quantum Fiber NPS score remains greater than positive 60, an indication of the quality, value and superior service that Quantum Fiber delivers. Quantum Fiber is an all-digital prepaid product that features simplified pricing with no contracts, helping reduce call center volumes and supporting our very strong NPS scores.

Now turning to adjusted EBITDA. For the second quarter of 2023, adjusted EBITDA was $1.229 billion compared to $1.811 billion in the year ago quarter. The second quarter of last year included $398 million related to the divested businesses and the second quarter of this year included a negative impact of $51 million from divestiture-related commercial agreements. These items represent approximately 77% of the year-over-year decline. Adjusted EBITDA benefited during the second quarter from a year-to-date adjustment related to a carrier settlement. Given legal agreements, I will not be able to comment further on this settlement. Special items impacting adjusted EBITDA this quarter totaled $102 million. Our second quarter 2023 adjusted EBITDA margin, including special items, was 33.6%.

Capital expenditures for the second quarter were $796 million. In the second quarter, the company generated free cash flow of negative $896 million. As previously noted, this includes $938 million of taxes paid related to our two divestitures that closed last year. Now moving on to our financial outlook. We’re reducing our estimate for stock-based compensation expenses to approximately $65 million for the full year 2023. We are reiterating all of our guidance metrics. Now before we go to Q&A, I’d like to take a moment to address recent media reports regarding lead sheet cables and telecommunication networks. We began phasing out lead sheet cables from our network infrastructure during the 1950s. And based on our initial analysis, we currently estimate that less than 5% of our approximately 700,000-mile copper network contained lead, of which we believe the majority, is buried and conduit based infrastructure.

We thoughtfully manage our network to ensure the health and safety of our employees and the communities we serve. We also regularly assess our safety protocols and meet established regulatory and scientific standards related to potential lead exposure for workers. Moving forward, we’re committed to working with independent experts, regulators and our industry peers to maintain our positive track record of safety and compliance. With that, we’re ready for your questions.

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Q&A Session

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

Simon Flannery: Great. Thank you very much. Good evening. Chris, if I could just stay on the lead issue. Have you had any discussions around remediation? And any sense of what sort of amounts that might take to do some of this for whatever aerial or underwater plant you might have?

Chris Stansbury: Yes. So I guess, first of all, I think it’s very early for that. Again, we spent a lot of time just determining how much lead is in the system. And the good news is, it’s quite small. But beyond that, we don’t really think there’s any meaningful way to estimate what that would be at this point. And so we will continue to, as we said, work with regulators and outside experts as this moves forward. But again, we feel good about our network and the fact that a lot of it is conduit based and subterranean.

Simon Flannery: Okay. Thank you. And then just one more housekeeping. On the EMEA transaction. Could you just update us on the timing? I think you’ve got a decision out of Europe coming up in the next few weeks here. What’s your latest thinking on?

Chris Stansbury: We’re still on track. I mean, I would say at this point, it would be great if we could close this year. I think it’s a little too early to call that. But as we said, it was going to be late this year, early next year, and we’re still on track for that.

Simon Flannery: Great. Thanks a lot.

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

Batya Levi: Great. Thank you. First, maybe on the enterprise trends, can you provide more color on what you’re seeing from the macro environment? And if there is any change in the sales funnel versus bookings? And on the EBITDA side, you’re tracking above your guidance so far. How should we think about some of the puts and takes in expenses and pacing of new investment in the second half? Thank you.

Kate Johnson: But I’ll have the first part. And I’ll let Chris at the second piece. So the macroeconomic environment remains complex and tough. We still see slow decision-making. We’re still working on training our sellers to be focused on business outcome selling, which is a new motion for them, but one that’s deeply appreciated when we can connect, how our network can help deliver fundamentally new business outcomes for our customers. So in all of the places that I talked about driving commercial excellence, we’re seeing better motions and more progress from a selling perspective, while there’s work to be done. But do you EBITDA?

Chris Stansbury: Sure. So Batya, on the EBITDA, to your point, we did come in a little stronger and that relates to what I mentioned in terms of a year-to-date adjustment for that carrier negotiation. And we’ll continue to get some benefits from that as we go forward. But that was contemplated in our guidance for the year. And as we’ve said and we said, at Investor Day, we do have higher OpEx and investments in the back half of the year, as we’re staying very aggressive and committed to our turnaround plan. So we’ve we kept guidance where it is for a reason. And again, we’ll be spending more in the back half to support those plans.

Kate Johnson: Great example is, we just got the voice migration team in place on June 1.

Chris Stansbury: Yes.

Kate Johnson: And so…

Chris Stansbury: So there’s been a lot to tune into that.

Kate Johnson: Yes.

Batya Levi: Great. Just one more quick follow-up on the EMEA shell, can you provide an update on how we should think about the proceeds, would that mainly go towards paying down the term loan? Or would you consider splitting it across other issues?