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.
Great. So just given the time of the year, I wanted to start off with what you're mainly focused on as we head into 2024.
Yeah, I mean, the Q4 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, you know, if I think about it, kind of in terms of renovating a house, you know, 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 2024 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.
A lot of news or attention is going toward the TSA. 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 up front.
Right.
I might 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 the 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?
Yeah.
As we get out of it, maybe sort of some goalposts that we should think about in terms of where—like, how much incremental interest expense is this going to need, and-
Yeah, 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 two 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 one year, in 2027. 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 our 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. You know, there was c andidly, 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 casts 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'll obviously, you know, move around by year, but it's about a $200 million-$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 half a million enablements a year.
I think the rest of the space is largely adjusted, given cost to capital, so I don't think we're out of line with that, but that's how we fund that gap.
Got it. Is it true, I mean, my understanding is that group that 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, in the steering committee, a subset of that group. That it's the steering group that, that we negotiated with. It was a very tough negotiation. We did build in, on our side, a basket capacity, as well as, you know, 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 the other portions of the structure.
Okay. Do you expect it to close soon, or could this drag on for a little?
The TSA, you know, expires December thirty-first, so the focus is on getting it closed before the end of the year.
Okay. And would that give you enough time just to continue to focus on the operations, and you'll have enough funding, and or are you but will you be more opportunistic with other forms of funding? And, maybe, how you think about the ABS opportunity?
Yeah, I mean, so certainly ABS is an opportunity. That'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, you know, enable securitization-type deal to happen down the road. So that, that work is happening. Look, I think it's, it's a, it's an interesting conversation because I've only been in telecom now for a little over a year and a half. 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 into the right, and therefore, the best way to manage the business, I jokingly say, is to die last, right? And so there's, there's that, the balance sheet management side of returns, which usually, you know, 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, and the conversation with customers around that is significant. And so, the, the fact that we're focusing on, you know, 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 gonna lose.
It's about the service layer on top of that, and, and we think that the, the bigger opportunity is on EBITDA growth than, than on debt, you know, simply debt reduction.
Right.
We're gonna do both.
I do wanna touch on that a little bit more. You're right, on the enterprise side, the telecom companies are generally known as the connectivity provider and maybe just the dumb pipe.
Yeah.
The value creation goes to others, the tech side-
Yeah
-the software side. How do you change that narrative? And how—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 Q3 earnings call. We knew that the bulk of the questions were gonna 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, three 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, you know, 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, o r is that mostly done and now it's kind of going after that?
It's I would say we're, you know, 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 debt conversations is because we're committed to spending all of it-
Right
-on driving the transformation, and getting to a better place as fast as we can. So there's still, there's still innovation to come. We will, we will continue to innovate, around NaaS and ExaSwitch and security, but a lot has also been done. So what you're gonna start to see is the impact of the activities over the last year, start to reduce the rate of decline, and, and do that in a more meaningful way. If you look at our enterprise space, kind of adjusted for, for acquisitions and whatnot, I think we're, competitively in a very good place today, but there's, there's more improvement to come, and you'll start to see that, in the H2 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 gonna 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 higher interest matched with lower CapEx. But on the operational side, what are some of the changes that you're seeing right now?
Again, it's a company that was very focused on paying a dividend. There wasn't a lot of internal investment, you know, 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 2024 and into 2025, 2026, 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, what you're seeing from a macro environment in terms of competition, maybe some pricing trends?
I would say nothing has changed yet, although, you know, early, early signs are that next year will be better than-
Mm-hmm
-you know, 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 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, 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, o kay, what is ExaSwitch? It's a, 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 two different, you know, hybrid, or sorry, two different hyperscale environments. And so ExaSwitch does that. It allows you to move the equivalent of, you know, 1 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 waves 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'll. I think it'll 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 have deflationary pricing. So how will the volumes make up for the difference, that you expect that pool of revenue to continue to grow?
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, 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 gonna end up with a hybrid environment. You're gonna end up with banks needing point-to-point connectivity between San Francisco and New York, but they're also gonna need some of these other things that allow them to pulse up, pulse down.
I think in that, not only is there value they're willing to pay for it, but 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, 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-
Again, I think. 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 line of sight to when we get deeper into the data is we should see, as I said, improvements in our trends in the H2 of next year. 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.
Mm-hmm.
Are you seeing that as a new competitor coming in?
I haven't seen a lot of it. There's certainly on-campus situations where customers require that, and 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, our core competency is, is that service layer that sits on top of what is a very fast, you know, network today, and, and that's where our focus is.
Right. 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 measuring great progress there. So, you know, I think we'll continue to see improvements as we move into next year.
Maybe moving to the mid-markets, you mentioned that you added more logos.
Mm-hmm.
But when you just, like, simply look at the revenue trends, still continuing to decline mid-single-digit.
We will, I mean, I do not want to confuse anyone. We will continue to see revenue declines until 2025, because we're trying to turn around an ocean liner that has been really in fairly, you know, 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%-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-
Right
-in 2025.
But specifically for the mid-market group-
Yeah
Do you see more competition from cable or maybe tougher?
No, if anything, if I were to break it apart between large enterprise, mid-markets, public sector. Public sector is, you know, much longer lead times between sale and revenue. Big deals. We've won a number of large deals recently, and that will visibly hit revenue in the H2 of next year. I'd say the next in line, in terms of being closer to that point of inflection, is actually mid-markets. The 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. It doesn't work in that space.
Right.
And so we built a lot more muscle through the partner ecosystem, and that's starting to show results. 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.
Yeah.
You expect the pace to continue?
Yeah.
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?
Yeah. 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 adding 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'd 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, you know, when does that happen? Who knows? Obviously, it's a tough environment from a capital standpoint and cost to 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, you know, 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 two 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.
Right.
I would draw the lines there.
The SME goes with- SMB goes with the consumer business?
We'd have to, t here'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 and b ut those things are all, all negotiable, you know, 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 2025 beyond, but with a faster fiber build.
Correct.
Now that the build is slower, should we expect that stability is also pushed out?
Yeah, 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-
Right
-between investment and EBITDA, and, 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 builds, and quite frankly, where a lot of the fixed wireless providers are focused on-
Right
-on fiber builds. So, but it is, it is more of an issue in those copper markets. Now, for us, we're starting in a, 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, how quickly should we expect you to think about strategic options for this, segment?
We're thinking about them right now, and we have been. I think the issue is, it's not us saying, 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. I think that will be determined by the broader market, cost to capital and other external factors.
Got it. And in the meantime, for example, BEAD opportunity is going to come in, 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.
Yeah.
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'll 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 multi-year, multi-million-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. 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. 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.
Got it. 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,
Yeah
NOL, $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 it. We'll take a bit of it this year. It's gonna pay our estimated taxes in Q4, $200 million, then the remaining $700 million will come in early next year. So I think the way you'll see it play out on 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 four years. But I think 2024 free cash flow is actually gonna 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, yeah.
All of it. Enterprise, how, 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 residential revenue growth?
No, I'd say that today, while we're definitely investing in, y ou know, 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. You know, we do a deal with USPS. There's CapEx that goes with that. As we go forward, yeah, 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-
Mm-hmm.
as we move to more of a, 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+ years out?
I think, 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, 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. Maybe just kind of, like, putting it all together as we and 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 2024, what should we expect to see similar trends continue until you start to see the benefits of the cost cutting or?
I think you'll continue to see an improvement in the rate of decline, particularly once we get to the H2. You should see a pathway to us getting to the point of inflection on revenue growth. And then as we get into 2025 and 2026, in addition to the revenue benefits, you'll see some additional productivity coming out of the system. As we've 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.
In terms of the leverage, I guess, should we expect you'd like to keep it sort of-
Yeah, I don't think leverage gets higher than where it is right now. I mean, maybe a tick. It's not, it's not gonna 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.
Right.
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.