Qwest Corp Q4 FY2020 Earnings Call

Greetings and welcome to Lumen Technologies Fourth Quarter 2020 Earnings Conference Call. As a reminder, this conference is being recorded today, Wednesday, February 10, 2021. It is now my pleasure to turn the conference over to Valerie Finberg, Vice President, Investor Relations. Please go ahead, Valerie.

Thank you, France. Good afternoon, everyone, and thank you for joining us for the Lumen Technologies fourth quarter 2020 earnings call. Joining me on the call today are Jeff Storey, President and Chief Executive Officer; and Neel Dev, Executive Vice President and Chief Financial Officer. Before we begin, I need to call your attention to our safe harbor statement on Slide 2 of our 4Q 2020 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, in the risk factors in our SEC filings. We will be referring to certain non-GAAP financial measures, reconciled to the most comparable GAAP measures that can be found in our earnings press release. In addition, certain metrics discussed today exclude transformation costs and other special items as detailed in our earnings materials, all of which can be found on the Investor Relations section of the Lumen website. Finally, we are announcing changes to our reporting categories beginning with the first quarter 2021 reporting. These changes can be found in our earnings presentation and press release with additional details and pro forma reporting for prior periods in the earnings supplement on our IR website. With that, I’ll turn the call over to Jeff.

Thanks, Valerie, and thank you everyone for joining us today. On today’s call, I’ll provide a summary of 2020 and an overview of our growth priorities for 2021. Neel will then review our fourth quarter financial results, guide you through our new reporting structure and provide our outlook for 2021. After that, we will take your questions. We delivered solid execution in 2020 as our employees quickly pivoted to the new operating environment and empowered our customers to meet their own rapidly changing environment. It was a challenging year for our customers and our employees. The year also highlighted the power, flexibility and scalability of our fiber-based offerings and the agility of our employees. I’m exceptionally proud of the team’s performance during difficult times. I’d like to cover a few highlights from the year and this is on Slide 4 in the presentation. For the last three years, you’ve heard me talk about the integration of Level 3 and the digital transformation of our company. Many of our efforts culminated last fall with the introduction of the Lumen platform. The primary purpose of digital transformation is to improve the customer experience, but when done right, improving customer experience also enables cost savings. Our results reflect the dual benefit of our transformation efforts. In 2019, we announced $800 million to $1 billion in cost improvement associated with our transformation initiatives. Through a combination of digitalization, simplification and other transformation programs, we achieved $830 million in savings as of the fourth quarter of 2020, a year ahead of our original schedule. The benefits of that work are seen in the fact that we grew both adjusted EBITDA and adjusted EBITDA margin in the fourth quarter. These efforts, to enable more efficient digital interactions also drove improvement in our net promoter scores, particularly in those areas where we have invested for growth in fiber-based services for enterprise and consumers. You can also see the benefit of the better customer experience in our improving revenue trajectory, which is up 150 basis points compared to 2019. While I know we have more to do, I’m encouraged by that improvement. We are turning to growth in those parts of the business in which we are investing and are managing our declining businesses with discipline, focused on preserving the free cash flow they generate. Our foundation for future growth comes from our investment in the Lumen edge cloud infrastructure, expanding fiber for enterprises, and deploying new in-building technology for greater security, service resilience and speed of delivery. In 2020 we added 400,000 homes passed to our fiber-to-the-home footprint. We now reached more than 2.4 million homes and are very excited about the digital customer experience we are providing to our Quantum Fiber brand. We also continue to pay down debt and refinance maturities, reducing interest expense and strengthening our balance sheet. Lastly, we’ve expanded our commitment to ESG initiatives and recently issued our first sustainability-linked bond. Additionally, over the last year, we increased our focus on diversity and inclusion, adding a number of new programs, naming a Chief Diversity Officer to spearhead our efforts and extending the leadership teams accountability and engagement in our diversity and inclusion goals. We remain committed to continually improving our approach to ESG and I encourage you to review our annual ESG report. Looking forward, we believe the launch of the Lumen platform sets a strong foundation for growth. More customers in more areas, accessing more services seamlessly and in real-time is the vision for the Lumen platform. Of course, given the pandemic and macroeconomic implications, uncertainties remain in 2021 and we’re keeping an eye on that. Still, we are excited about the coming year. We feel good about our sales funnel and customer engagement, but we do see lengthening sales cycles as companies continue to evaluate their new infrastructure needs. I’ll start now with the physical infrastructure layer. The physical infrastructure is a foundational requirement for everything driving our economy today. I believe Lumen has the best local and long-haul fiber infrastructure in the world. First of all, we connect customers in more than 180,000 on-net buildings directly to our infrastructure with secured and reliable fiber. We have deep and robust interconnections and peering facilities to the world’s eyeball networks and ISPs acquiring and distributing traffic to and from millions of endpoints. We have direct fiber connectivity to cloud service providers, hyperscalers and more than 2,200 global data centers with tremendous scalable capacity. Over our global fiber network, we operate one of the world’s largest Internet backbones and carry a significant portion of the earth’s Internet traffic each day. The role we play in enabling the global Internet uniquely positions our Black Lotus Labs team to quickly gain visibility and insight into emerging cyber threats, which we then use to secure and protect our customers’ networks and applications. The Lumen platform has the scale, security, ubiquity, and resilience necessary to meet the needs of the fourth industrial revolution. Moving up one layer in the slide, Lumen dynamic connections is the result of recognizing that our customers needed software-based agility to consume and interact with our infrastructure. We meet this need by utilizing software-defined networking to allow customers to consume a variety of services, enabling instantaneous consumption of additional network services. Our platform approach improves the velocity with which customers can respond to their application needs and the velocity we experience in capturing and converting opportunity to revenue. Moving beyond the dynamic network, the next layer highlights the capabilities of the Lumen hybrid cloud, allowing access to multiple clouds over an agile, seamless and secure communications fabric. This functionality is critical for our customers with dynamic environments and shifting workloads. The Lumen hybrid cloud capabilities allow customers to control and locate compute resources in their on-premises data centers, Lumen private and public cloud offerings or with major cloud service providers. We believe the Lumen Edge cloud offers a compelling solution for many of our customers’ latency-sensitive applications and are encouraged that it will contribute to our improving revenue trends as it is more fully deployed and adopted. We are excited about the partnership we announced with VMware, which combines their orchestration capabilities with our automated Lumen platform. We expect to work with VMware to bring new services to market. I’ll now take a moment to walk you through our 2021 priorities. The first priority is to drive growth over the Lumen platform. We will continue to expand the digital marketplace we’ve developed and the products and services available to customers. To that end, we anticipate new products like Lumen Edge Bare Metal, Lumen Edge Private Cloud, and others to enhance our offerings. For our auto company partnership and a financial services collaboration, we will support them in improving their services and delivery capabilities. Our second priority is to improve penetration of our robust product portfolio on our existing assets. Over the last few years, we have invested in expanding our fiber-to-the-home footprint and new technology deployments. We are well-positioned to provide work-from-anywhere solutions in a remote environment. Our third priority focuses on our ongoing transformation to make it easier for customers to consume our services. Expanding our digital marketplace and increasing the number of digital interactions remains a key goal. Fourth, we continue with our balanced approach to capital allocation. We remain committed to creating shareholder value through investment in growth, returning value through dividends, and reducing debt. We hope these changes will provide better visibility into our performance, where we are investing for growth, and how we're managing voice and other declining businesses for cash. I'll wrap up by saying that I am encouraged by the progress we’ve made. We leave 2020 with improving revenue trends, better EBITDA margins and a strengthened balance sheet. I believe we can take out costs to meet the pressures of legacy revenue loss. Going forward, we will implement customer-centric operational improvements that drive EBITDA growth. The Lumen platform is the right solution for our customers and will help us drive revenue and efficiencies. We are excited about the opportunities ahead. We intend to host a Virtual Analyst Day in late spring. During that event, we will share additional insights on our strategies and new solutions coming to market. With that, I’ll turn it over to Neel.

Thank you, Jeff, and good afternoon, everyone. We have a lot to cover. So I'll start with a few highlights. Despite the macro environment, we delivered solid results. For the full year, we improved the total earning trajectory by 150 basis points, generated $8.9 billion in adjusted EBITDA, expanded our adjusted EBITDA margins, and generated $3.1 billion of free cash flow. We continue to invest in the business with capital expenditures of $3.7 billion. Over the course of 2020, we reduced net debt by approximately $1.6 billion and refinanced approximately $13 billion in long-term debt, further reducing interest expense, extending maturities, and strengthening our balance sheet. Finally, we achieved approximately $830 million of annualized run-rate adjusted EBITDA cost transformation savings, reaching our targeted savings range more than a year ahead of schedule. Moving on to revenue, for the full year 2020, total revenue declined 3.5% to $20.712 billion. As I mentioned, this is a 150 basis point improvement from the 5% year-over-year decline in total revenue from 2018 to 2019. In summary, for the full year 2020, IGAM and Enterprise, which represent 59% of business revenue, grew slightly on a constant currency basis. In a year of macro uncertainty, this highlights the relevance of our products and services. Our turnaround plans for SMB were impacted by the pandemic, but relatively low churn and improving macro conditions give us confidence in the long-term growth potential of SMB. In terms of capital expenditures, for the fourth quarter 2020, they were $758 million. We exit 2020, having materially improved our maturity profile, further strengthening our balance sheet and enhancing our ability to invest in the business. Moving to our new reporting structure, as mentioned, our two segments will be business and mass markets. Our enterprise channel narrows its focus and becomes large enterprise, and now we have a sales channel focused specifically on mid-sized customers. We have high expectations for IGAM, large enterprise, and mid-market segments. For consumer, our broadband revenue for the fourth quarter of 2020 grew 1.8% year-over-year. Our net debt to adjusted EBITDA leverage ratio is now at 3.6 times. We are focused on improving the revenue trajectory across all channels. In terms of outlook for 2021, we expect adjusted EBITDA to be in the range of $8.4 billion to $8.6 billion. We have robust plans in place to improve revenue performance while continuing cost-saving initiatives. Overall, we are well positioned for 2021.

Thank you, Neel. Our first question will be from Batya Levi with UBS. Please go ahead.

Great, thank you. Maybe starting off with your EBITDA guidance for 2021. It looks like you're expecting it to be flat to down. Can you help us quantify how much you're planning to spend on the transformation side? And with the outlook for potentially improving revenue trends and continued cost-cutting efforts, why would we still see a decline in EBITDA? And maybe finally, you did mention that your one of your focuses will remain to lower leverage. I believe with this guidance you will still be above your leverage targets at year-end. Can you help us think about your capital allocation policy going forward? Thank you.

Hi, Batya. So I'll start with your question on EBITDA. Our guidance includes the cost to continue to transform the business, so we expect a similar amount of cost in 2021 like we did in 2020. The other thing impacting EBITDA in 2021 are the investments we're making in growth and changing the revenue trajectory of the business. While we are committed to paying down debt, our target leverage ratio is still 2.75 to 3.25 times. We will balance between paying down debt and investing for growth. Overall, we remain focused on improving our revenue trajectory and doubling down on investments that contribute to positive growth.

Hey, guys. Thanks so much for taking the questions. I guess two, first is for Neel. Within the CapEx guidance that you've given, could you kind of carve out how much of that is going to be related to the CAF II commitments? And then, I guess following up on Batya's question a little bit, Jeff. On Slide 5, you've got this aspirational trajectory towards growth, but on Slide 11, we're looking at declines in almost every business unit. So what are the biggest moving parts, both headwinds and tailwinds that are going to get us from Slide 11's negatives to looking more like Slide 5, which is this trajectory towards growth in the fourth industrial revolution? Thanks.

Sure. On capital guidance forecast, we've averaged over $300 million of spending against CAF II. This year, we're working on a series of initiatives to bring that down. And when you look at it from our product segment, we are particularly focused on getting growth in areas like compute, applications, and IP services, which will comprise the majority of our business.

To connect David's question, we’ve made significant investments in improving customer experience and digital interactions. We’ll continue to do that and leverage our investments in the Lumen platform. We see growth opportunities with edge computing and hybrid WAN services, which we’re heavily invested in. We’re also investing in our enterprise segment and partnerships that will help drive our product portfolios and services. Our investments will help drive revenue growth across all segments, including consumer markets.

We’ve seen improvement in our growth rate indicating a shifting trajectory, and while 3.5% declines aren't ideal, our cost management and strategic investments position us well for recovery.

Great. Thanks for taking the question. So Neel, I wanted to follow up on that, on the CAF II rollout. I think as you said, it sounds like potentially next year there could be a several hundred million dollar impact to free cash flow. How do you think about your dividend payout ratio beyond this year? And in addition, if you could maybe frame-up the outlook for fiber-to-the-home within your consumer segment, how many homes you think makes sense to build to, and maybe some more color on that would be helpful? Thanks.

So on CAF II, we were averaging more than $300 million of capital. Looking ahead, this won't materially impact our free cash flow or capital allocation perspective. Regarding fiber-to-the-home, as we look to enable more homes, we believe our micro-targeting strategy will drive strong results with continued investments yielding high returns.

Thanks, guys. Can you give us a little bit more color around the Lumen platform? How differentiated do you think you are now versus your peers? It sounds like you're excited about revenue growth improving. Please talk about the flow shares that you're seeing with some of your larger customers out there.

Our Lumen platform is uniquely positioned due to our exceptional fiber infrastructure and its integration with edge computing. We’re able to provide low latency capabilities and are actively investing in partnerships to deliver innovative solutions. The ability to rapidly adapt to customer needs sets us apart from competitors, and we believe this will drive significant future growth.

Great. Thanks very much. Jeff, you've talked a lot about broadband today. What are you hearing from your folks in Washington regarding opportunities presented by initiatives such as RDOF and others? Also, please elaborate on the current lengthening sales cycle. Has anything changed in the past month or two that has impacted your outlook?

We're focusing on returns within our existing footprint. While we're aware of federal initiatives, we remain committed to our strategic direction. Regarding sales cycles, we've noted increased caution from customers evaluating post-pandemic needs. This influences their decisions and impacts our longer sales cycles, but we believe there are significant opportunities to support their evolving needs.

First, you've highlighted the improvement in the growth rate this year versus last year. How about COVID's net revenue effect over 2020? Also, how would you characterize the level of conservatism in the outlook, given the economic situation? What are the biggest takes and puts into your guidance?

Overall, I see the net effect of COVID as negative due to external economic constraints. However, we're comfortable with our guidance, seeing our services as resilient regardless of the challenges faced in 2020. Our path forward includes plans to capture growth opportunities alongside cost management initiatives.

Thanks. On the cash interest side, how much room do you think you still have? Lastly, regarding the fiber-to-the-home, can you clarify whether those added homes were new constructions or expansions?

Our cash interest has significantly improved. Regarding fiber-to-the-home, our strategy spans a range of activities, including new constructions, overbuilding existing areas, and expanding outside traditional footprints. We view each opportunity carefully to optimize revenue growth.

A few housekeeping questions for me. What's the penetration in those CAF areas now and how much revenue has this contributed?

We don't disclose specific numbers, but our penetration levels in enabled areas are significantly higher than average, and revenues from these areas are gradually improving.

As we wrap up, I want to emphasize our growth ambitions. Despite challenges, we made significant progress and will leverage our strong operational foundation and expanding customer platform in 2021 to fuel revenue growth and shareholder value.

Thank you, Mr. Storey. We would like to thank everyone for your participation, and for using Lumen Technologies service today. This does conclude the conference call, we ask that you please disconnect your lines, and have a great day everyone.