Lumen Technologies and Super Micro Computer Report Strong Q2 2024 Earnings

Lumen Technologies (LUMN) Q2 2024 Earnings Call Transcript | The Motley Fool

Greetings, and welcome to Lumen Technologies' second quarter 2024 earnings call. [Operator instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to Jim Breen, senior vice president, investor relations. Jim, please go ahead. Jim Breen -- Senior Vice President, Investor Relations Good afternoon, everyone, and thank you for joining Lumen Technologies' second quarter 2024 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 need to call your attention to our safe harbor statement on Slide 1 of our second quarter 2024 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 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 our investor relations section of our Lumen website. With that, I'll turn the call over to Kate. Thanks, Jim. Good afternoon, everyone. Thanks for joining. I'm cognizant of the timing of this call because over the past two days, the markets have been a bit noisy with lots of uncertainty about the health of the economy in the next six to 12 to 18 months. In contrast, the announcement we made last night about Lumen's pivot to growth is all about building critical infrastructure to support the AI economy for the next several decades. And to net it out, there are three key takeaways from our call today. First, Lumen's enterprise operational turnaround is progressing well. With continued sales momentum across our growth portfolio and further improvement in customer satisfaction. We are also executing extremely well in our quantum fiber business. Second, Lumen has been anointed as the trusted network for AI by some of the most important technology companies on earth with over $5 billion in major partnerships in to date and visibility to nearly $7 billion more in opportunities, we see the market for Lumen's private connectivity fabric as providing a major positive momentum shift for this company. Third, given our success in forging these partnerships, we're seeing a significant improvement in our overall liquidity profile, further securing our ability to transform the company and pivot to growth. Let me give some detail on the operational turnaround part first. As I've described on prior calls, we're focusing on delivering dramatically improved customer experiences from quote to cash, giving customers a reason to choose Lumen for core network services. The best way to measure that progress is to look at three areas: sales, customer SAP and securing the base. I'm delighted to share our progress across the fundamentals. After a blockbuster Q1, we continue to see strong sales performance in the second quarter, with North American large enterprise and mid-market sales up nearly 26% year over year. Additionally, large and mid-market new logo sales increased 10% and net total contract value for all channels was up nearly 40% year over year. Two notable wins are Uber, who is leveraging custom fiber waves from Lumen to ensure unparalleled activity between their data centers and the State of New Mexico who is using Lumen to build its first statewide education network. To complement these sales results, we saw another step function improvement in customer SAP in our service delivery process with year-over-year transaction Net Promoter Scores rising 10 points for large enterprise, 35 points for wholesale, 37 points for mid-market and a whopping 42 points for public sector. Once again, every one of our enterprise customer channels showed significant year-over-year improvement, which should manifest in lower churn, higher growth sales and improved overall revenue growth over time. Finally, we're making progress securing the base with our relentless focus on five key levers: installs, renewals, migration, usage and disconnect. We think the best way to measure our progress here is to compare ourselves to market trends. And once again, we saw less revenue declines this quarter than our industry peers. We continue to fine tune in our motions, developing and launching new product bundles and educating our customers on the best migration path from legacy to modern technologies. And while we're excited by the progress of our operational turnaround in legacy core network services, the real breakthrough to share with you is how we're repositioning the company for the future in the growing market of AI. Two ways that we're repositioning Lumen. First, we're cloudifying telecom by delivering a digital platform to enable enterprise customers to digitally design, price, order and consume secure network services. quickly, securely and effortlessly. We're thrilled with our progress driving adoption of our Lumen digital flagship network as a service offering with companies like Versa, T Marzetti and DXC Technologies, as well as many other companies across the industry. OK. The second way we're repositioning the company for growth is with Lumen's private connectivity fabric. To summarize what's happening. The dramatic rise in AI innovation spring explosive growth in data center build-outs, and data centers simply have to be connected. We're honored that technology powerhouses like Microsoft and several other big technology firms are choosing Lumen to build their AI backbone, and they're choosing us for two reasons. First, our world-class fiber network with its unique route vast coverage and state-of-the-art fiber solutions from our strategic partnership with Corning. And second, the digital platform we're building that makes consumption quick, secure and effortless. With $5 billion in closed deals so far and the active discussions we're having with a long list of additional customers, we believe Lumen is becoming known as the trusted network for AI. The growth in this type of sale will be meaningful and accretive to our cash position in the short term and positions us for long-term predictable revenue growth in the future. Looking ahead, I'm sure you, like everybody else on Planet Earth, is wondering how big are these networking deals gonna be for AI and what's the market look like, so I'm going to share our early hypothesis with you. We think there are likely to be three distinct phases. The first phase as evidenced by our closed deals is with huge technology companies, cloud providers, social platforms, etc., who are AI thought leaders and are building and training AI models responsible for the explosive growth in data center build-outs. They were the first to recognize that today's Internet simply won't serve tomorrow's AI economy, and they're partnering with Lumen to massively expand their connectivity infrastructure. We think the next tranche of demand is likely to come from the AI model inference phase, probably with forward-thinking enterprises who see AI as a way to transform their businesses, think financial services, healthcare and retailers to start. And finally, in the third phase, we suspect breakout growth in demand for connectivity and digital on-demand network services will come when AI starts talking to AI in rings and exchanges. We're in very early discussions with strategic partners who are helping shape our view in this space. Please note that these recent announcements, which were not included in our 2024 guidance, fund the necessary upfront opex and capex to ramp and scale these new AI workloads. Additionally, these deals provide funding for continued innovation and strategic cost takeouts. And that leads me to my next important piece of news. Today, we're announcing that we see a path to creating $1 billion in cost takeout by the end of 2027. This next cost wave of efficiency will come from deeply strategic infrastructure simplification in three major areas: network, product portfolio and IT. These infrastructure projects are rooted in network standardization. We're now integrating the network from four different architectures, engineering them into one simplified standardized and unified network fabric. This move provides a step function change in the level of simplification that we can drive inside the company, providing breakthrough improvements in our customer and employee experiences. Let me provide just a little bit more color on the impact of the plan. Our target is to ensure that the majority of our net new services are on this unified network fabric by the end of 2025. This will enable massive simplification in our product portfolio, enabling us to significantly reduce our product count from thousands of product codes to a target of around 300, of massive simplification enabler across Lumen and our ecosystem. Once we unify the network and simplify the product portfolio in our enterprise business, we'll go after technical cost savings in IT. For example, we'd like to compress our 24 order management systems to a target number of one and reduce our 17 billing systems to, well, you guessed it a target of one, this work is going to take a few years to complete, but it will yield material and enduring bottom-line benefits. To reemphasize, the work wouldn't be possible without the additional liquidity gained from our private connectivity fabric sales, which also allows us to self-fund a spending increase in key areas to drive out these costs for the long term. To summarize our enterprise business transformation efforts, we've got the cash, we've got the assets. And we've got a world-class leadership team needed to execute on the next phase of our transformation, unlocking breakthrough growth opportunities and strategic cost savings moving forward. And finally, I'm really delighted to share that our mass market segment is showing steady results improvement. We continue to opportunistically deploy capital, enabling 136,000 locations in Q2, on track to deliver 500,000 new fiber-enabled locations this year. We also continued our strong fiber sales momentum from first quarter '24 as indicated by our record level of 2Q fiber net adds of 40,000. And we're happy to announce we've reached over 1 million fiber subscribers in July. This is a significant milestone and reinforces the value of the product we're delivering to the consumer. And it also shows our mass markets team who really knows how to execute well. With that, I'll turn the call over to Chris. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Thanks, Kate. Before I discuss the quarter, I want to take a moment to reflect back to Q2 earnings last year. Since that time, we successfully completed a refinancing that addressed over $15 billion of our debt and extended over $10 billion of our maturities, and we secured access to over $2.3 billion in new liquidity. And we launched our PCS solutions, as well as our suite of new digital offerings. And we've generated early growth in our public sector in the growth segment of our large enterprise business. And as of yesterday, we announced the largest sales in the company's history, totaling nearly $5 billion fueled by our AI hyperscaler customers. This is all as we drive in network unification from four discrete enterprise networks to one, resulting in over $1 billion in cost efficiencies. None of this would be possible without a world-class management team who's executing on our vision. We're moving with pace and we're not done. The recent developments in our business reflect major proof points in terms of early and material execution on women's transformation path forward, and we are pleased the market is starting to value this opportunity. We believe we're in the first inning of the AI growth opportunity for our fiber infrastructure and Lumen digital services. Accordingly, the positive impact these private connectivity fabric sales will have on our financials are powerful and clear. First, we believe the progress we've made on driving PCF sales these past few months is just the beginning of a vast new TAM, which brings long-term sticky revenue offsetting higher churn legacy declines. Second, we estimate that the cash received from PCF sales will close any free cash flow deficit between now and when we reach sustainable positive free cash flow growth. Third, we will have ample free cash flow to invest in our transformation and reduce debt. And finally, in our view, PCF sales are significant and incremental to the overall value of Lumen's business. The building blocks of our value creation are clear, starting with our nationwide fiber network. We believe Lumen is one of the few companies with the resources and scale to provide the critical infrastructure for AI. And the partnerships we've announced represent a large and growing opportunity to provide private connectivity fabric solutions. We see a runway to growth as we transform telecom, and we believe this sets up a value-creation path for Lumen all as we continue to execute on our core strategic goals of commercial excellence, securing the base and innovating for growth. As Kate mentioned, our sales growth engines within our large and mid-market enterprise channels in our business segment, along with our mass market segment showed solid performance this quarter with large enterprise and mid-market sales both up over 26% year over year. Additionally, Quantum Fiber broadband net additions of 40,000 again, sets an all-time record, and we passed the 1 million total fiber subscriber mark in July. Outstanding work by the team. While consolidated revenue and adjusted EBITDA still feels the impact of legacy declines, we are encouraged by improvements we're making in the business. Now let's move to the discussion of financial results for the second quarter. On a year-over-year basis, total reported revenue declined 10.7% to $3.268 billion. 36% of the decline was due to the impact of divestitures, commercial agreements and the sale of the CDN business. Business segment revenue declined 11.4% to $2.577 billion, and approximately 42% of that decline was due to the impact of divestitures and commercial agreements. Mass markets segment revenue declined 8.2% to $691 million. Adjusted EBITDA was $1.011 billion, with a 30.9% margin and free cash flow was negative $156 million. Next, I'll review our detailed revenue results for the quarter on a year-over-year basis. Within our North America enterprise channels, which is our business segment, excluding wholesale, international and other, revenue declined 3.6%. We continue to expect public sector to be the first channel to pivot to sustainable growth later this year, followed by mid-market and then large enterprise. Overall, North American business declined 5.5%. Large enterprise revenue declined 6.9% in the second quarter. Our grow revenue was approximately flat year over year with continued pressure in nurture and harvest product revenue. We expect continued variability in trends as we drive toward overall stabilization. Mid-market revenue declined approximately 7% year over year, with improvement in growth offset by near-term harvest. Public sector revenue increased 8% year over year, driven by strength in our grow and other product revenue and partially offset by declines in return harvest. We continue to see traction with large bookings in this space. which take time to ramp to revenue, and these wins give us continued confidence that public sector will be the first sales channel to return to sustainable growth this year. Wholesale revenue declined approximately 10% year over year. The harvest portion of the wholesale portfolio, which is comprised of products like TDM voice and private line, saw revenue contract by 17.9% year over year in the second quarter. This is primarily driven by telco partners that are selling legacy services. Our harvest product revenue will likely continue to decline over time and is an area that we will manage for cash. International and other revenue declined 67.1%, driven primarily by the divestiture of our EMEA business and the sale of select CDN contracts in the fourth quarter of last year. Moving to our business product life cycle reporting our reference results based on our North America enterprise channel. The 3.6% year-over-year decrease was due to declines in our nurture and harvest segments partially offset by growth, particularly enterprise broadband, dark fiber and IT. While results can vary in any quarter, we expect sustained strength in the grow product revenue as we execute on our core turnarounds. Within Nurture and Harvest, we continue to expect headwinds in these markets, declining categories. However, we continue to take proactive steps to migrate customers to newer technologies and these actions improve our customers' experience and will provide an uplift in customer lifetime value for Lumen. Additionally, we will continue to pursue opportunities for cost optimization when we help customers migrate from off-net legacy and TDM-based services onto Lumen's network. Within North American enterprise channels, grow Products revenue increased 1.5% year over year. Grow now represents approximately 43% of our North America enterprise revenue. And for our total business segment carried an approximate 80% direct margin this quarter. Nurture Products revenue decreased 12.1% year over year. Nurture represents 30% of our North American enterprise revenue and for our total business segment carried an approximate 66% direct margin this quarter. Harvest products revenue decreased 10.6% year over year and continues to be negatively impacted by declines in TDM-based voice and private line. Harvest represented approximately 16% of our North America enterprise revenue in the second quarter. For our total business segment, it carried an approximate 77% direct margin this quarter. Other product revenue improved 18.5% year over year. As a reminder, other product revenue tends to experience fluctuations due to the variable nature of these products. Now moving on to mass markets. Our fiber broadband revenue grew 14.6% year over year and represents approximately 38% of mass markets broadband revenue. During the quarter, Fiber broadband-enabled location adds were 136,000, bringing our total to over 3.9 million as of June 30th and pacing toward our targeted annual 500,000 build target this year. We also added 40,000 Quantum Fiber customers, which is our best fiber net add quarter reported to date, and this brings our total to 992,000. Fiber ARPU was $62, up slightly, both sequentially and year over year. Importantly, we reached a significant milestone of 1 million fiber broadband subscribers in July. At the end of the second quarter, our penetration of legacy copper broadband was approximately 9% and our quantum fiber penetration stood at approximately 25%. As we look ahead, we will continue our market-by-market assessment of the mass markets business as we explore a range of strategic options to maximize its value. Those options include potential joint ventures, wholesaling arrangements or future divestitures to generate incremental cash. Now turning to adjusted EBITDA. For the second quarter of 2024, adjusted EBITDA was $1.011 billion, compared to $1.229 billion in the year-ago quarter. Second quarter EBITDA was positively impacted our strong first quarter sales bookings, as well as efficiency improvements from our second quarter cost actions and overall margin management. Special items impacting adjusted EBITDA totaled $136 million. The majority special items in the quarter were related to severance. For the second quarter of 2024, our adjusted EBITDA margin was 30.9%, Capital expenditures were $753 million, and free cash flow, excluding special items, was negative $156 million. As we've previously stated, we're leaning into our network investments to support the rapid growth in demand our customers are facing. Now before I provide an update on our 2024 financial outlook, I'd like to provide some color around the near-term impact of our PCF sales and the additional liquidity and flexibility we have. As Kate mentioned, we're moving full speed ahead in investing in our transformation, which includes additional spending on network and systems unification that will ultimately lead to more efficient operations and a better customer experience. Given our improving liquidity profile, we intend to pull forward some expenses from '26 and '27 into '25, accelerating the time line of our cost takeout goals. With the investments in transformation and costs associated with recent PCF sales and in conjunction with continued legacy revenue declines, directionally, we see 2025 EBITDA below 2024 levels with a significant rebound in 2026 and growing thereafter. We will provide more detailed 2025 guidance on our fourth quarter 2024 call in February. Now moving on to our financial outlook. We now estimate fiscal year '24 EBITDA to be in the range of $3.9 billion to $4 billion. Capex in the range of $3.1 billion to $3.3 billion. Cash interest in the range of $1.15 billion to $1.25 billion and free cash flow in the range of $1 billion to $1.2 billion. This guidance includes some incremental opex, capex, and cash flows associated with our PCF sales growth, the gain on a sale of an investment, as well as incremental spending to ultimately improve our cost structure and margins. This additional opex and capex will be fully funded upfront by the incremental PCF cash flow. And with that, I'll turn it back to Kate for closing remarks. Kate Johnson -- President and Chief Executive Officer Thanks, Chris. Before we open up the call for questions, I wanted to pause to acknowledge where we are. AI represents one of the most significant technology shifts in history. Every person and every organization on earth will be impacted. AI needs data, data needs data centers and data centers need to be connected. What was once an overbuilt fiber network is shifting from commodity to something much more valuable. At Lumen, we aren't streamlining and digitizing our operations to try to find growth in legacy telco markets. Instead, we're building a digital platform to help us become the trusted network for AI so we can capitalize on the markets that will likely see explosive growth for decades. This is Lumen's moment. We are playing to win. This is the business that we are in. Operator, we're ready for questions. Operator Thank you. [Operator instructions] Your first question comes from the line of Michael Rollins with Citi. Please go ahead. Michael Rollins -- Analyst Thanks, and good afternoon. First, with respect to the $5 billion of sales, Curious if you could give some additional color on the competitiveness of that process? Are these customers using single vendors for the solution or multiple vendors. So this is something that's not just helping Lumen but maybe the ecosystem. And then, for women specifically, can you share the mix of assets that are existing fiber, existing conduit, leveraging assets that are already out there from you versus what you're building as new infrastructure. And as you consume some of those fiber inventories such that investment mix or margin mix might look differently over time as you continue to sell within this new PFC segment? Thanks. Kate Johnson -- President and Chief Executive Officer Mike, so I'll take the first the first part, let Chris handle the second part. So first part, what does the competitive landscape look like? Look, obviously, I'm a little bit biased, but here's my observation. Our network is the crown jewel that we always thought it was. It's got great coverage, unique routes, it's diverse and it's got state-of-the-art fiber because we've been taking care of it for a long time. And that's giving us great positioning with our customers. They're looking at -- sometimes building some routes by themselves. Most of the time understanding that we can get them there faster with higher quality and better service and that's the observation across the deals we've won so far. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yeah. And just on the economics, it's a really good question, and then, I'm not gonna be evasive with you. But the reality is it's really complicated. So it's a deal to deal, every deal is different in terms of where they want to go from and to, how much capacity they need. And inevitably, you will end up with a combination of existing fiber, new fiber, existing conduit, new conduit. It really does vary deal to deal. Now on that, we'll never disclose it because -- these are called private connectivity fabric for a reason. And our customers want to keep it private because it's a competitive -- a secret that they have as is it a competitive secret for us. So it will vary deal to deal, but the video that we released, I think, gives a good flavor on average. Operator Your next question comes from the line of Sebastiano Petti. Please go ahead. Sebastiano Petti -- Analyst Hi. Thanks for taking the question. Just had a quick question on the free cash flow guidance. Can you help us think about, is that fully just driven by the customer deposits from the just private custom fiber -- fabric AI? Or is that also reflective of the -- I think, Chris, you said gain on the sale? And in addition to that, can you help us maybe think -- does the free cash flow uplift that you're seeing here? Is that something that we should expect to stay on the balance sheet in 2024 or is this something that will probably get spent as you probably get to fund the increase in capex that you've guided to today? Just trying to help think about the commencement of the build-out in pacing? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer I'll give you credit because you asked one of the great questions on the call early. So the cash flow guidance for this year is driven by both some of the upfront cash received. We haven't received all of it, obviously, for the PCF deals, and it is also related to the asset sale that we did, so both of those things contributed to the free cash flow. As it relates to where we go from here, and again, I want to really be really careful because we are not giving 2025 guidance yet. But we haven't received all the cash yet. That will be received some this year, some next year, some the following year because again, these are massive construction projects. They take time. And we will start to spend the capex as evidenced by our guidance. This year and have more next year. But the point is on these deals, we're not financing the build, so we get paid in advance of the construction. The only thing that is kind of hanging as you go out 12 months is we pay tax on the cash received. So even though the revenue is amortized, the IRS likes to get paid on a cash basis for these deals. So that will be something that we deal with, and we'll get more color on that as we move through. But high level, I would say that next year, free cash flow looks good. Operator Your next question comes from the line of Batya Levi from UBS. Please go ahead. Batya Levi -- Analyst Great. Thank you. Looking at the EBITDA guidance change for the year, is that purely related to the incremental opex for getting ready for these networks? Or -- is there any change in terms of the underlying trend? And can you just go over the $1 billion cost savings you expect over the next three years the pacing of that? I think you mentioned some of the expenses will be pulled forward. And then, is there any incremental cost to achieve that savings through the next three years? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yes. So as it relates to this year, the vast majority of the -- there's, obviously, a lot of things that go on inside of EBITDA. But the main driver here are the TCF deals. And the opex investments we need to make to get that construction factory up and running in a more scaled way. It's a group that exists. It's one of Lumen's core competencies, but the size of that group needs to get substantially larger to support just the quantum of these deals. And so, that's the key driver. As it relates to the $1 billion cost takeout, we haven't -- again, I want to stay away from 2025 guidance as much as I can. We're not expecting those savings to start until next year. There will be some investment next year, and we'll disclose that when we give guidance for next year. But my comments on just trying to dimensionalize where we go from here, are really around the fact that we're taking the opportunity near term balance of this year and '25 to really pull forward investments we were going to have to make in '26 and '27 to get to a place where our IT systems, as Kate mentioned, are more consolidated, simplified to drive a customer experience. And I would say, if there's one key driver in that, it's going from what our four enterprise networks today to one. And that is a legacy that exist today that needs to be cleaned up because it just drives a much more seamless customer experience as we go forward. Operator Your next question comes from the line of David Barden from Bank of America. Please go ahead. David Barden -- Analyst Hey, guys, thanks so much for taking the question. Chris, I guess, it's not so much a question is I want to put forward a hypothesis and I want you to tell -- it would be, I think, super helpful for people to share what you think is right or wrong about it. So we've got this $5 billion deal, but the majority of the cash is coming in, in the next three to four years, and the majority of the cash -- of that cash is also going out the door in the next three to four years. So any kind of cash inflow we're getting is kind of a timing benefit relative to the capex that's required under the contract. And if it's a $5 billion contract and the majority of it is related to the construction piece, let's just call it $3 billion round numbers. That means that the actual IRU sale piece is about $2 billion. And as you shared in your video, that IRU revenue doesn't start until after the build is done, which would be probably Year 4 or 5, over a 20-year period, $2 billion dollar, a $100 million in revenue a year, very high margin, maybe $85 million in EBITDA, tax affected, as you've mentioned in your video, maybe, again, the taxes will be timing related, but let's just call it $65 million of tax-affected cash flow over a 20-year period. So a $5 billion deal announcement turns into $65 million of cash flow five years from now, what's right and what's wrong about that assessment? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer I'd say most of it is wrong. The -- Yes, I think, David, here's where we go, so again, it's multiple deals that added up to the $5 billion. Not just one. And in the video, we talked about a cash contribution margin, which is effectively the EBITDA less the capex, pre-tax that's roughly in the ballpark of our existing EBITDA margin. So you do the math on that that will give you the pre-tax free cash flow associated with these deals. And that cash flow, to your point, does come largely at the front end. Now there's ongoing payments for space and power, for operating and maintenance if they want us to run the networks for them that gives us nice cash flow over the years, but the tax would also be front-end loaded. So the key thing here is that in one set of deals in those $5 billion deals that the net after-tax cash generated from that fully fund the liquidity gap that we've talked about for so long on these calls. It's older, it's behind us. And we're not done. So as we said, there's another $7 billion of discussions underway right now. And this trend will continue. The demand isn't one and done. So that's the key difference, so there's more cash in the deal than you've laid out and there's more to come. Kate Johnson -- President and Chief Executive Officer And additionally, it's not one deal. The $5 billion represents multiple customers, and each contract is very different. I think that's important to stress. David Barden -- Analyst I just want to follow up on that, Chris, if I could. So just to make -- so if the majority of the cash is coming in, as you say in the press release, in the next three to four years, and it's also going out in the next three to four years. So then you've got this minority of the $5 billion that's then realized over the following 20 years. Is that -- what's -- so there's a net kind of zero. And then, there's this tail of income. Is that -- how is that not what you said in the press release. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer I'm not -- I guess, I'm not following and we can do it in the after call. I'm not following the net zero. The net is significant and fully fund the liquidity gap that you and your peers have modeled over the next number of years. That's now fully addressed. So -- and you're right, then yes, the renew leads in over a much longer time frame. But that cash allows us to fund the transformation. It allows us to pay down debt and start to attack the debt structure. And again, that's with this first bundle of deals that total $5 billion and there's more coming. David Barden -- Analyst And so, just my last follow-up. Great. So when you say in the press release that the majority of the cash comes in the next three to four years, and there's a roughly equal amount of disbursements, so that the capex related to the deal is smaller than -- so if I add the deficit and the capex necessary to win these deals, that gets us to the breakeven, the liquidity that you're talking about. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer That's right. So said another way, David, the cash contribution, the $5 billion, less the opex to support it less the capex to support it, leaves us with an amount of cash. We pay tax on that cash. and the after-tax impact of that fully funds the liquidity gap that we have modeled over the next few years, from this first kind of deals. Operator Your next question comes from the line of Jim Schneider with Goldman Sachs. Please ask your question. Jim Schneider -- Analyst Good afternoon. Thanks for taking my question. I was wondering if you could maybe give us some color on -- within the $5 billion of closed deals. The diversity of customers within that is that a few large hyperscale customers? Is it a much longer tail of customers, including corporates? And then, if you could give us any kind of sense about the same kind of color on the additional $7 billion you're pursuing now? Kate Johnson -- President and Chief Executive Officer So the first $5 billion is that first tranche that I talked about. It's hyperscalers, it's social platforms. It's huge technology companies. It's a cloud company. It's everybody building the AI models, right? Where they're building them and they're training them. They're seeing the data flows and they're saying, holy cow, current networks simply don't serve where the state of growth is going. So they're building out their data centers because data needs compute. And that is driving the requirements that they bring to us about, "Hey, can you get me from here to there? And by the way, can you connect me back to the main Internet highways so that I can continue to serve my customers there as well. So that's the first one. The second tranche is, and we're just at the really early phase of that piece, which is enterprises that are using the AI models. And frankly, we are one of them. We're using AI models to transform our business. We've had great partnerships with all of these guys to try and take cost out, drive efficiency, gain insight, more intelligent services. And those enterprises that are leading the way are in healthcare, retail and financial services for the most part. And they're doing it in a different way. It's not necessarily an end-to-end custom private network per se. But it's a little bit of fiber and some advanced services on top of it, dramatically increasing their bandwidth and performance needs. Jim Schneider -- Analyst And then, maybe just relative to the network build-out itself. I believe your analyst day last year, you referenced that you had 6 million inner city fiber route miles in the network, and you were planning on doubling that, which is, I think, the same commentary you made on earlier announcements. So is -- with the pre-funding and the revenue associated with these deals, is that simply accelerating the build-out you already had contemplated and pulling them forward in time? Or is there any change to the profile or complexion of that build plan? Kate Johnson -- President and Chief Executive Officer So I'm struggling to figure out where the baseline is from your question. I'll just give you continually what's happening. We are increasing connectivity both inside the metro areas, as well as in the long-haul networks. And that's with new routes and pulling more fiber on existing routes. And so, it's a combination of all of it. And each deal is a bit different when you overlay them all together what you see is a doubling in metro and a significant increase in long haul. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer I would just add to that that the fiber that we put in the ground already and the fiber that we're adding today supports 400-gig waves. And over the next two years, that will scale to 800 and 1.6 terabytes, so the fiber that's going in the ground has enormous expandability. And I don't think -- at least I'm not aware of anyone else who's investing at that rate to meet the needs of customers. Operator Your next question comes from the line of Jonathan Chaplin with New Street. Please ask your question. Jonathan Chaplin -- Analyst Great. Thanks for taking the question, guys. First, just to follow up on David's question. I wonder if you could help contextualize the recurring revenue piece that comes on the back of these massive transactions that you're doing? How should we think about -- these transactions or driving growth in the grow segment, presumably this is sort of all large enterprise at this point? And then, given how important this sort of transformative event for the business is, unlike embarrassed to be asking about mass markets, but you did really well on net adds in mass markets this quarter. It's been sort of a pretty dramatic acceleration in the business over the course of the last two quarters. I'm wondering if you can give us some context for what's driving that. And also, just speak to sort of the strategy around ARPU a little bit. It looks like ARPU is well below peers. I assume that's sort of a conscious decision to drive penetration. I'm wondering if you -- if there's sort of a plan to close the gap over time? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yeah, there's a lot in there. I'll try to remember. As it relates to the PCF deals, we did say in the video that once you get to scale, and again, as David pointed out, it's anywhere between that three- and five-year window. In some cases, not all. Customers will ask us to run the networks, we'll also provide space and power. So again, if you're powering a signal from San Francisco to New York, long way, you're going to need huts where you can put rats, you can pull the equipment that powers those signals. And we said that on average, think about that as roughly 10% of the total contract value. And that revenue and cash will be earned in the year the services are provided, so that's, I think, a good broad guideline. As it relates to mass markets, yes, I could not be more proud of the team. They're killing it. There's an intense focus on driving marketing execution and really focus on both enablement and penetration. And they kept the enablement machine chugging along, but we're just super pleased that the -- is the growth in penetration. They're executing flawlessly right now. On ARPU, that's part of the strategy, yes. I mean, we're not trying to over or under price. In fact, we have raised prices where we see the opportunity to do so, and we'll continue to do that. But we're pleased with the way everything is working in combination ARPU penetration, etc., so more to come. Operator Your next question comes from the line of Nick Del Deo with MoffettNathanson. Please go ahead. Nick Del Deo -- Analyst Hi. Thanks for taking my questions. First, Chris, the comments you've made around the cash contribution margins associated with these deals seem to apply mostly to the $5 billion in signed deals. As we think about future deals, like the $7 billion you have in negotiation, would you expect those to have more favorable cash economics by leveraging some of the fiber being put in the ground for these earlier deals, or should they be kind of in the same ballpark? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yeah. I would say, on average, I think the guidance we gave is pretty good. Again, it's hard to say. So I mean, I can tell you that -- we've had discrete decisions that we've made along the way of do we make some incremental investments now on routes where we may have slightly less capacity to try to help for the future, and that would, obviously, be a benefit to your point. But then, we don't know yet the full scale of what all of the customers want, and that may require us to do additional things that we don't have today. So it's just -- again, given the quantum of the deals and the complexity it's hard to answer right now. But I would tell you that I think the guidance we gave is good general guidance around how to think about it. Nick Del Deo -- Analyst OK. So not trying to get too far ahead of signed deals in terms of capital commitments and whatnot? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Right. I mean, look, we will continue to invest in our network as we have for years, and I view that more as kind of baseline responsibility. As it relates to big capex expansions, we will be very measured in how we do that. This is not a gamble. We will -- if we see a route where we know there's going to be demand in the future, and we are already pulling fiber, we may pull more. If it's a route where we've got lots of capacity, we won't. So it really is route by route mile by mile that we do those analytics, and it's actually really impressive what the team is doing as they model this out. That's a core capability. And quite frankly, I think it's one of the reasons in addition to the digital services that we can offer these customers that customers come to Lumen. Nick Del Deo -- Analyst OK. OK. And then, Chris, you quickly alluded to it in your prepared remarks, but I was hoping you could expand a bit on how you're thinking about cannibalization risk, whether current revenue or revenue that you otherwise might have generated. So for example, if you're selling someone dark fiber, I'm guessing you're not selling them waves on that route going forward? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer So think about it -- think about it this way, private connectivity fabric is a bundle of everything from dark fiber to waves to IP. It's your network, your way. And these first deals happen to be very large infrastructure, dark fiber-y kind of deals with some of the other things mixed in. As time goes on, I would expect that mix to continue to evolve. And so, it depends on what -- again, what the customer wants, where they want to get as to whether we've got some of that fiber already in the ground or whether we need to pull more. Kate Johnson -- President and Chief Executive Officer I'd also like to add as person coming from the tech world into telecom, there's this proclivity to worry about cannibalization rather than evolution of portfolio. And I think that's how we got to a place of being quite overbuilt. And as I look at the demand for these services and our strategy moving forward, we are going to prioritize penetration of our assets to deliver return to our shareholders. And I think that that's gonna be very accretive long term. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yeah. This is not to be very clear. We haven't even talked about cannibalization. This isn't cannibalization of legacy at all. This is about net new and where we're going. And this is why we see the upside that we see in our ability to drive returns for shareholders. Operator Your next question comes from the line of Greg Williams with TD Cowen. Please go ahead. Greg Williams -- Analyst Thanks for taking my questions. We're all trying to size the total addressable market of AI and you did a good job of articulating those three phases. Maybe we'll start just with that first phase and all these deals are more dark fiber-y as Christa. So really, I think the addressable market would be how many new data centers are they creating? And we are talking about it earlier this week in some reports. And really, the better way of asking you, guys, how many new data centers are you feeding roughly $4 billion to $5 billion of deals? Is it like 10? Is it 30? I'm just trying to get a sense of that, and it helps us with our scope. Kate Johnson -- President and Chief Executive Officer I mean, we're not tracking that really. What we're tracking is across the group of technology companies that we're speaking to, which is at this point in the dozens, what do their needs look like? What are the synergies between the requests that we can drive economies of scale and how can we drive to closure as fast as possible so we can group them in those ways by route, and by how operationally we can deliver upon these. The one thing we do look at when we model it out is where is the power. Data centers need power space cooling and fiber. And I think the energy piece of the equation is where can you build a data center that you can deliver a green footprint because there's also that piece of it as well. And so, it's pretty complex. Operator Your next question comes from the line of Frank Louthan with Raymond James. Please go ahead. Frank Louthan -- Analyst Great. Thank you. Maybe you can give us a little more color within this sort of $5 billion group, can you give us an idea of the largest deal as a percentage of revenue? And then, as it relates to the $5 billion in bookings here, what do you -- what's an average annual bookings? And how much is it up this year, including the PCF deals? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer So yeah, in terms of the biggest one, again, that starts to get close to really starting to disclose stuff around customers because if I gave you that, then it's just a guessing game as to which customer it is. And that's not fair to the customer. And frankly, it's sensitive information for us. So we're not going to give that. As it relates to the bookings, I want to make sure I understand -- are you asking that once we get to scale, how much -- how does that relate to what we are selling today? Is that the question? Frank Louthan -- Analyst Well, it seems -- maybe I'm misusing the terms here, but it seems like you've done $5 billion in sales for here, which sounds like a bookings number. Not necessarily something hitting revenue in the income statement. What is -- I'm just getting an idea of what the incremental upside from that -- from bookings is in '24 versus, say, '23, inclusive of this bump from the PCF deals? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yes. I would say, from a modeling standpoint, I would think about that as largely all incremental. We always sell dark fiber. And I think the dark fiber run rate -- I'd have to go back and check frank because I don't know off the top of my head, but ex these deals, dark fiber is, obviously, in the grow bucket, and we continue to grow that segment. But this -- yes, we had the state of California in the fall that we mentioned, right, so that was a big deal. But again, we've done those in the past, and we'll do other deals like that going forward. This shift that we're seeing right now, which, quite frankly, I don't think comes as a surprise, right? There's been so much research and communication around the amount of investment required to support AI. And everybody forgot about the fact that the data doesn't originate in the data center and stay in the data center, right? It's got to get in, it's got to get out. So what we're really seeing is that now finally being realized and I'd say that's largely incremental. Frank Louthan -- Analyst OK. And one quick thing, did you -- can you clarify the split and the increase in free cash flow between the asset sale and the upfront cash? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Your next question comes from the line of Eric Luebchow with Wells Fargo. Please go ahead. Eric Luebchow -- Analyst I appreciate you taking the question. Thank you. So you talked about getting back to EBITDA growth in 2026 after a step down next year. How should we think about the visibility of getting back to revenue growth, given the trajectory of bookings you've had. And it sounds like these PCF deals since they'll be amortized over a very long contract duration. They'll certainly help revenues, but I don't know if there are enough to really get you back to revenue growth by 2026 as well? If you could kind of talk through the moving parts there. Christopher David Stansbury -- Executive Vice President and Chief Financial Officer Yeah. So again, I don't want to get too close to guidance here. As we've said, revenue will, obviously, lag the EBITDA turnaround because of our ability to drive significant cost takeout as we fix what's broken, right? And we go from four networks to one -- so the timing on the revenue, we -- I guess, what we said most recently is that that's going to lag by at least a year. And I think that still holds in this situation. But again, the comments that I made, I wanna be really clear about this, around kind of directionally '25 and '26. To be very clear, that excludes the $7 billion set of discussions we're having right now. right? We don't count that until it comes in because just like this first batch of deals, they're very hard to predict one, what's required to deliver them; and two, what the timing is. Eric Luebchow -- Analyst Yes. Understood. And then, just one follow-up. These new data center deals, the ones you've announced and then the ones that are in your pipeline, you tied them to the intercity fiber investments that -- where you'll double your fiber capacity over the next handful of years. We've heard a lot about data center deals moving to more further out rural locations given power constraints in a lot of markets. So can you talk at all about like splits between middle mile, long-haul fiber versus metro fiber this in your pipeline to support these types of deals given data center deals are being done in further out locations, it seems based on what we've seen? Christopher David Stansbury -- Executive Vice President and Chief Financial Officer What I'll say is this, our network, one of the reasons why it's so attractive. And by the way, when I say network, it's fiber and in some cases, it's conduit, right? It's this vision that was built 25 years ago. And now, because of the advances in fiber technology, we have the ability to monetize it, so it's both. It's both of those things. And so, I would say, the strength of both the inner city and the metro that customers, broadly speaking, are wanting to access. And as we continue to invest in things like waves, it will be to deliver against both of those. Waves customers want two things. They want to get where they want to get, and they want to get there quickly. And I don't know if anyone else in the space who is investing the kind of money that we are to make sure that happens. Operator Since there are no more questions, I will now turn the conference back over to Kate Johnson, CEO, for closing remarks. Please go ahead. Kate Johnson -- President and Chief Executive Officer Thanks so much. To wrap, it's an exciting time for Lumen as AI charts the course for our pivoted growth, and our future is very, very bright. Thanks for joining today. We look forward to meeting you at the upcoming conferences and updating you on the significant progress we're making in transforming our company.

Lumen Technologies, Inc. (LUMN) Q2 2024 Earnings Call Transcript

Michael Rollins - Citi Sebastiano Petti - J.P. Morgan Batya Levi - UBS David Barden - Bank of America Jim Schneider - Goldman Sachs Jonathan Chaplin - New Street Nick Del Deo - MoffettNathanson Gregory Williams - TD Cowen Frank Louthan - Raymond James Eric Luebchow - Wells Fargo Greetings, and welcome to Lumen Technologies' Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to Jim Breen, Senior Vice President Investor Relations. Jim, please go ahead. Jim Breen Good afternoon, everyone, and thank you for joining Lumen Technologies second quarter 2024 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 need to call your attention to our Safe Harbor Statement on Slide 1 of our second quarter 2024 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 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 in our Investor Relations section of our Lumen website. Thanks, Jim. Good afternoon, everyone. Thanks for joining. I'm cognizant of the timing of this call, because over the past two days the markets have been a bit noisy with lots of uncertainty about the health of the economy in the next six to 12 to 18 months. And in contrast, the announcement we made last night about Lumen's pivot to growth is all about building critical infrastructure to support the AI economy for the next several decades. And to net it out, there are three key takeaways from our call today. First, Lumen's enterprise operational turnaround is progressing well with continued sales momentum across our growth portfolio and further improvement in customer satisfaction. We are also executing extremely well in our Quantum Fiber business. Second, Lumen has been anointed as the trusted network for AI by some of the most important technology companies on earth. With over $5 billion in major partnership inked to date and visibility to nearly $7 billion more in opportunities, we see the market for Lumen's private connectivity fabric as providing a major positive momentum shift for this company. Third, given our success in forging these partnerships, we're seeing a significant improvement in our overall liquidity profile, further securing our ability to transform the company and pivot to growth. Let me give some detail on the operational turnaround part first. As I've described on prior calls, we're focusing on delivering dramatically improved customer experiences from quote to cash, giving customers a reason to choose Lumen for core network services. The best way to measure that progress is to look at three areas, sales, customer sat, and securing the base. I'm delighted to share our progress across the fundamentals. After a blockbuster Q1, we continue to see strong sales performance in the second quarter, with North American large enterprise and mid-market sales up nearly 26% year-over-year. Additionally, large and mid-market new logo sales increased 10%, and net total contract value for all channels was up nearly 40% year-over-year. Two notable wins are Uber, who's leveraging custom fiber waves from Lumen to ensure unparalleled connectivity between their data centers, and the state of New Mexico, who's using Lumen to build its first statewide education network. To complement these sales results, we saw another step-function improvement in customer sat in our service delivery process with year-over-year transaction net promoter scores rising 10 points for large enterprise, 35 points for wholesale, 37 points for mid-market, and a whopping 42 points for public sector. Once again, every one of our enterprise customer channels shows significant year-over-year improvements which should manifest in lower churn, higher gross sales, and improved overall revenue growth over time. Finally, we're making progress securing the base with our relentless focus on five key levers: installs, renewals, migrations, usage, and disconnects. We think the best way to measure our progress here is to compare ourselves to market trends. And once again, we saw less revenue declines this quarter than our industry peers. We continue to fine tune our motions, developing and launching new product bundles and educating our customers on the best migration path from legacy to modern technologies. And while we're excited by the progress for our operational turnaround in legacy core network services, the real breakthrough to share with you is how we're repositioning the company for the future in the growing market of AI. Two ways that we're repositioning Lumen. First, we're cloudifying telecom by delivering a digital platform to enable enterprise customers to digitally design, price, order, and consume secured network services quickly, securely, and effortlessly. We're thrilled with our progress driving adoption of our Lumen Digital flagship network as a service offering with companies like Versa, T-Marzetti, and DXE Technologies, as well as many other companies across industry. Okay. The second way we're repositioning the company for growth is with Lumen's private connectivity fabric. To summarize what's happening, the dramatic rise in AI innovation is bringing explosive growth in data center build-out. And data centers simply have to be connected. We're honored that technology powerhouses like Microsoft and several other big technology firms are choosing Lumen to build their AI backbone. And they're choosing us for two reasons. First, our world-class fiber network with its unique routes, vast coverage, and state-of-the-art fiber solutions from our strategic partnership with Corning. And second, the digital platform we're building that makes consumption quick, secure, and effortless. With $5 billion in closed deals so far and the active discussions we're having with a long list of additional customers, we believe Lumen is becoming known as the trusted network for AI. The growth in this type of sale will be meaningful and accretive to our cash position in the short term and positions us for long-term predictable revenue growth in the future. Looking ahead, I'm sure you, like everybody else on planet Earth, is wondering how big are these networking deals going to be for AI and what's the market look like? So I'm going to share our early hypothesis with you. We think there are likely to be three distinct phases. The first phase, as evidenced by our closed deals, is with huge technology companies, cloud providers, social platforms, et cetera, who are AI thought leaders and are building and training AI models responsible for the explosive growth and data center build-out. They were the first to recognize that today's Internet simply won't serve tomorrow's AI economy, and they're partnering with Lumen to massively expand their connectivity infrastructure. We think the next tranche of demand is likely to come from the AI model inference phase, probably with forward-thinking enterprises who see AI as a way to transform their businesses. Think financial services, health care, and retailers to start. And finally, in the third phase, we suspect breakout growth and demand for connectivity and digital on-demand network services will come when AI starts talking to AI in rings and exchanges. We're in very early discussions with strategic partners who are helping shape our view in this space. Please note that these recent announcements, which were not included in our 2024 guidance, fund the necessary upfront OpEx and CapEx to ramp and scale these new AI workloads. Additionally, these deals provide funding for continued innovation and strategic cost takeout. And that leads me to my next important piece of news. Today we're announcing that we see a pass at creating $1 billion in cost takeout by the end of 2027. This next cost wave of efficiency will come from deeply strategic infrastructure simplification in three major areas: network, product portfolio, and IT. These infrastructure projects are rooted in network standardization. We're now integrating the networks from four different architectures, engineering them into one simplified, standardized, and unified network Fabric. This move provides a step function change in the level of simplification that we can drive inside the company, providing breakthrough improvements in our customer and employee experiences. Let me provide just a little bit more color on the impact of the plan. Our target is to ensure that the majority of our net new services are on this unified network fabric by the end of 2025. This will enable massive simplification in our product portfolio, enabling us to significantly reduce our product count from thousands of product codes to a target of around 300, a massive simplification enabler across Lumen and our ecosystem. Once we unify the network and simplify the product portfolio in our enterprise business, we'll go after technical cost savings in IT. For example, we'd like to compress our 24 order management systems to a target number of one and reduce our 17 billing systems to, well, you guessed it, a target of one. This work is going to take a few years to complete, but it will yield material and enduring bottom line benefits. To reemphasize, the work wouldn't be possible without the additional liquidity gained from our private connectivity fabric sales, which also allows us to self-fund a spending increase in key areas to drive out these costs for the long term. To summarize our enterprise business transformation efforts, we've got the cash, we've got the assets, and we've got a world-class leadership team needed to execute on the next phase of our transformation, unlocking breakthrough growth opportunities and strategic cost savings moving forward. And finally, I'm really delighted to share that our mass market segment is showing steady results improvement. We continue to opportunistically deploy capital, enabling 136,000 locations in Q2, on track to deliver 500,000 new fiber enabled locations this year. We also continued our strong fiber sales momentum from first quarter 2024, as indicated by our record level of 2Q fiber net ads of 40,000. And we're happy to announce we've reached over 1 million fiber subscribers in July. This is a significant milestone and reinforces the value of the product we're delivering to the consumer. And it also shows our mass markets team really knows how to execute well. Thanks, Kate. Before I discuss the quarter, I want to take a moment to reflect back to Q2 earnings last year. Since that time, we've successfully completed a refinancing that addressed over $15 billion of our debt and extended over $10 billion of our maturities. And we secured access to over $2.3 billion in new liquidity. And we launched our PCF solutions as well as our suite of new digital offerings. And we generated early growth in our public sector and the growth segment of our large enterprise business. And as of yesterday, we announced the largest sales in the company's history, totaling nearly $5 billion, fueled by our AI hyperscaler customers. This is all as we drive a network unification from four discrete enterprise networks to one, resulting in over $1 billion in cost efficiencies. None of this would be possible without our world-class management team who's executing on our vision. We're moving with pace and we're not done. The recent developments in our business reflect major proof points in terms of early and material execution on Lumen's transformation path forward and we are pleased the market is starting to value this opportunity. We believe we're in the first inning of the AI growth opportunity for our fiber infrastructure and Lumen Digital Services. Accordingly, the positive impact these private connectivity fabric sales will have on our financials are powerful and clear. First, we believe the progress we've made on driving PCF sales these past few months is just the beginning of a vast new TAM, which brings long-term, sticky revenue offsetting higher churn legacy product declines. Second, we estimate that the cash received from PCF sales will close any free cash flow deficit between now and when we reach sustainable positive free cash flow growth. Third, we will have ample free cash flow to invest in our transformation and reduce debt. And finally, in our view, PCF sales are significant and incremental to the overall value of Lumen's business. The building blocks of our value creation are clear, starting with our nationwide fiber network. We believe Lumen is one of the few companies with the resources and scales to provide the critical infrastructure for AI, and the partnerships we've announced represent a large and growing opportunity to provide private connectivity fabric solutions. We see a runway to growth as we transform telecom, and we believe that sets up a value creation path for Lumen, all as we continue to execute on our core strategic goals of commercial excellence, securing the base, and innovating for growth. As Kate mentioned, our sales growth engines within our large and mid-market enterprise channels in our business segment, along with our mass market segment, showed solid performance this quarter with large enterprise and mid-market sales, both up over 26% year-over-year. Additionally, Quantum Fiber broadband net additions of 40,000 again sets an all-time record and we passed the 1 million total fiber subscriber mark in July, outstanding work by the team. While consolidated revenue and adjusted EBITDA still fuels the impacts of legacy declines, we are encouraged by improvements we're making in the business. Now let's move to the discussion of financial results for the second quarter. On a year-over-year basis, total reported revenue declined 10.7% to $3.268 billion. 36% of the decline was due to the impact of divestitures, commercial agreements, and the sale of the CDN business. Business segment revenue declined 11.4% to $2.577 billion, and approximately 42% of that decline was due to the impact of divestitures and commercial agreements. Mass markets segment revenue declined 8.2% to $691 million. Adjusted EBITDA was $1.011 billion, with a 30.9% margin and free cash flow with negative $156 million. Next, I'll review our detailed revenue results for the quarter on a year-over-year basis. Within our North America enterprise channels, which is our business segment excluding wholesale, international, and other, revenue declined 3.6%. We continue to expect public sector to be the first channel to pivot to sustainable growth later this year, followed by mid-market and then large enterprise. Overall, North American business declined 5.5%. Large enterprise revenue declined 6.9% in the second quarter. Our grow revenue was approximately flat year-over-year with continued pressure in nurture and harvest product revenue. We expect continued variability in trends as we drive towards overall stabilization. Mid-market revenue declined approximately 7% year-over-year with improvement in grow, offset by nurture and harvest. Public sector revenue increased 8% year-over-year driven by strength in our grow and other product revenue and partially offset by declines in nurture and harvest. We continue to see traction with large bookings in this space, which take time to ramp to revenue, and these wins give us continued confidence that public sector will be the first sales channel to return to sustainable growth this year. Wholesale revenue declined approximately 10% year-over-year. The harvest portion of the wholesale portfolio, which is comprised of products like TDM, voice and private line, saw revenue contract by 17.9% year-over-year in the second quarter. This is primarily driven by telco partners that are selling legacy services. Our harvest product revenue will likely continue to decline over time and is an area that we will manage for cash. International and other revenue decline 67.1% driven primarily by the divestiture of our EMEA business and the sale of select CDN contracts in the fourth quarter of last year. Moving to our business product lifecycle reporting, I'll reference the results based on our North America enterprise channel. The 3.6% year-over-year decrease was due to declines in our nurture and harvest segments, partially offset by grow, particularly enterprise broadband, dark fiber, and IT. While results can vary at any quarter, we expect sustained strength in the grow product revenue as we execute on our core turnaround. Within nurture and harvest, we continue to expect headwinds in these markets to decline in categories. However, we continue to take proactive steps to migrate customers to newer technologies, and these actions improve our customer's experience and will provide an uplift in customer lifetime value for Lumen. Additionally, we will continue to pursue opportunities for cost optimization when we help customers migrate from off-net legacy and TDM-based services onto Lumen's network. Within North American enterprise channels, grow products revenue increased 1.5% year-over-year. Grow now represents approximately 43% of our North America enterprise revenue and for our total business segment carried in approximately 80% direct margin this quarter. Nurture products revenue decreased 12.1% year-over-year. Nurture represents 30% of our North American enterprise revenue, and for our total business segment, carried an approximate 66% direct margin this quarter. Harvest products revenue decreased 10.6% year-over-year and continues to be negatively impacted by declines in TDM-based voice and private line. Harvest represented approximately 16% of our North America enterprise revenue in the second quarter. And for our total business segment, they carried an approximate 77% direct margin this quarter. Other product revenue improved 18.5% year-over-year. As a reminder, other product revenue tends to experience fluctuations due to the variable nature of these products. Now moving on to mass markets. Our fiber broadband revenue grew 14.6% year-over-year and represents approximately 38% of mass markets broadband revenue. During the quarter, fiber broadband enabled location ads were 136,000, bringing our total to over 3.9 million as of June 30 and pacing towards our targeted annual 500,000 bill target this year. We also added 40,000 Quantum Fiber customers, which is our best fiber net add quarter reported to date, and this brings our total to 992,000. Fiber ARPU was $62, up slightly, both sequentially and year-over-year. Importantly, we reached a significant milestone of 1 million fiber broadband subscribers in July. At the end of the second quarter, our penetration of legacy copper broadband was approximately 9%, and our Quantum Fiber penetration stood at approximately 25%. As we look ahead, we will continue our market-by-market assessment of the mass market's business as we explore a range of strategic options to maximize its value. Those options include potential joint ventures, wholesaling arrangements, or future divestitures to generate incremental cash. Now turning to adjusted EBITDA. For the second quarter of 2024, adjusted EBITDA was $1.011 billion compared to $1.229 billion in the year-ago quarter. Second quarter EBITDA was positively impacted by our strong first quarter sales bookings, as well as efficiency improvements from our second quarter cost actions and overall margin management. Special items impacting adjusted EBITDA totaled $136 million. The majority of special items in the quarter were related to severance. For the second quarter of 2024, our adjusted EBITDA margin was 30.9%. Capital expenditures were $753 million. And free cash flow, excluding special items, was negative $156 million. As we previously stated, we're leaning into our network investments to support the rapid growth and demand our customers are facing. Now, before I provide an update on our 2024 financial outlook, I'd like to provide some color around the near-term impacts of our PCF sales and the additional liquidity and flexibility we have. As Kate mentioned, we're moving full speed ahead in investing in our transformation, which includes additional spending on network and systems unification that will ultimately lead to more efficient operations and a better customer experience. Given our improving liquidity profile, we intend to pull forward some expenses from 2026 and 2027 into 2025, accelerating the timeline of our cost takeout goals. With the investments in transformation and costs associated with recent PCF sales, and in conjunction with continued legacy revenue declines, directionally, we see 2025 EBITDA below 2024 levels, with a significant rebound in 2026 and growing thereafter. We will provide more detailed 2025 guidance on our fourth quarter 2024 call in February. Now moving on to our financial outlook. We now estimate fiscal year 2024 EBITDA to be in the range of $3.9 billion to $4 billion. CapEx in the range of $3.1 billion to $3.3 billion. Cash interest in the range of $1.15 billion to $1.25 billion and free cash flow in the range of $1 billion to $1.2 billion. This guidance includes some incremental OpEx, CapEx, and cash flows associated with our PCF sales growth, the gain on a sale of an investment, as well as incremental spending to ultimately improve our cost structure and margins. This additional OpEx and CapEx will be fully funded upfront by incremental PCF cash flow. And with that, I'll turn it back to Kate for closing remarks. Kate Johnson Thanks, Chris. Before we open up the call for questions I wanted to pause to acknowledge where we are. AI represents one of the most significant technology shifts in history. Every person and every organization on earth will be impacted. AI needs data, data needs data centers, and data centers need to be connected. What was once an overbuilt fiber network is shifting from commodity to something much more valuable. At Lumen, we aren't streamlining and digitizing our operations to try to find growth in legacy telco markets. Instead, we're building a digital platform to help us become the trusted network for AI so we can capitalize on the markets that will likely see explosive growth for decades. This is Lumen's moment. We are playing to win. This is the business that we are in. Thank you. The floor is now open for questions. [Operator Instructions] Your first question comes from the line of Michael Rollins with Citi. Please go ahead. Michael Rollins Thanks and good afternoon. First, with respect to the $5 billion of sales, curious if you could give some additional color on the competitiveness of that process? Are these customers using single vendors for the solution or multiple vendors? So this is something that's not just helping Lumen, but maybe the ecosystem. And then for Lumen specifically, can you share the mix of assets that are existing fiber, existing conduit, leveraging assets that are already out there from you versus what you're building is new infrastructure. And as you consume some of those fiber inventories such that investment mix or margin mix might look differently over time as you continue to sell within this new [PCF] (ph) segment? Thanks. Kate Johnson Hey, Mike. So I'll take the first the first part, I'll let Chris do the second part. So first part, what does the competitive landscape look like? Look, obviously, I'm a little bit biased, but here's my observation. Our network is the crown jewel that we always thought it was. It's got great coverage, unique routes, it's diverse and it's got state-of-the-art fiber because we've been taking care of it for a long time. And that's giving us great positioning with our customers. They're looking at sometimes building some routes by themselves. Most of the time understanding that we can get them there faster with higher quality and better service and that's the observation across the deals we've won so far. Chris Stansbury Yes. And just on the economics, it's a really good question, and then I'm not going to be evasive with you. But the reality is, it's really complicated. So it's a deal to deal, every deal is different in terms of where they want to go from and to, how much capacity they need. And inevitably, you will end up with a combination of existing fiber, new fiber, existing conduit, new conduit. It really does vary deal to deal. Now, on that, we'll never disclose it, because these are called private connectivity fabric for a reason. And our customers want to keep it private because it's a competitive secret that they have as is it a competitive secret for us. So, it will vary deal to deal, but the video that we released, I think, gives a good flavor on average. Your next question comes from the line of Sebastiano Petti. Please go ahead. Sebastiano Petti Hi. Thanks for taking the questions. Just had a quick question on the free cash flow guidance. Can you help us think about, is that fully just driven by the customer deposits from the just private custom fiber -- fabric AI? Or is that also reflective of the -- I think, Chris, you said gain on the sale? And in addition to that, can you help us maybe think -- does the free cash flow uplift that you're seeing here. Is that something that we should expect to stay on the balance sheet in 2024 or is this something that will probably get spent as you're probably -- to fund the increase in CapEx that you've guided to today? Just trying to help think about the commencement of the build-out in pacing? Thank you. Chris Stansbury I'll give you credit, because you asked one of the great questions on the call early. So the cash flow guidance for this year is driven by both some of the upfront cash received. We haven't received all of it, obviously, for the PCF deals, and it is also related to the asset sale that we did. So both of those things contributed to the free cash flow. As it relates to where we go from here, and again, I want to really be really careful because we're not giving 2025 guidance yet. But we haven't received all the cash yet. That will be received some this year, some next year, some the following year, because again, these are massive construction projects. They take time. And we will start to spend the CapEx as evidenced by our guidance. This year and have more next year. But the point is, on these deals, we're not financing the build. So we get paid in advance of the construction. The only thing that is kind of hanging as you go out 12 months is, we pay tax on the cash received. So even though the revenue is amortized, the IRS likes to get paid on a cash basis for these deals. So that will be something that we deal with, and we'll get more color on that as we move through. But high level, I would say that next year free cash flow looks good. Your next question comes from the line of Batya Levi from UBS. Please go ahead. Batya Levi Great. Thank you. Looking at the EBITDA guidance change for the year, is that purely related to the incremental OpEx for getting ready for these network [indiscernible]? Is there any change in terms of the underlying trend? And can you just go over the $1 billion cost savings you expect over the next three years, the pacing of that? I think you mentioned some of the expenses will be pulled forward. And then, is there any incremental cost to achieve that savings through the next three years? Thank you. Chris Stansbury Yes. So as it relates to this year, the vast majority of the -- there's obviously a lot of things that go on inside of EBITDA. But the main driver here are the TCF deals. And the OpEx investments we need to make to get that construction factory up and running in a more scaled way. It's a group that exists. It's one of Lumen's core competencies, but the size of that group needs to get substantially larger to support just the quantum of the deals. And so, that's the key driver. As it relates to the $1 billion cost takeout, we haven't -- again, I want to stay away from 2025 guidance as much as I can. We're not expecting those savings to start until next year. There will be some investment next year, and we'll disclose that when we give guidance for next year. But my comments on just trying to dimensionalize where we go from here, are really around the fact that we're taking the opportunity near term balance of this year and 2025 to really pull forward investments we were going to have to make in 2026 and 2027 to get to a place where our IT systems, as Kate mentioned, are more consolidated, simplified to drive a customer experience. And I would say, if there's one key driver in that it's going from what our four enterprise networks today to one. And that is a legacy that exist today that needs to be cleaned up because it just drives a much more seamless customer experience as we go forward. Your next question comes from the line of David Barden from Bank of America. Please go ahead. David Barden Hi, guys. Thanks so much for taking the question. Chris, I guess it's not so much a question is, I want to put forward a hypothesis and I want you to tell -- it would be, I think, super helpful for people to share what you think is right or wrong about it. So we've got this $5 billion deal, but the majority of the cash is coming in, in the next three to four years, and the majority of the cash of that cash is also going out the door in the next three to four years. So any kind of cash inflow we're getting is kind of a timing benefit relative to the CapEx that's required under the contract. And if it's a $5 billion contract and the majority of it is related to the construction piece, let's just call it $3 billion round numbers. That means that the actual [indiscernible] sale piece is about $2 billion. And as you shared in your video, that [indiscernible] revenue doesn't start until after the build is done, which would be probably year four or five, over a 20-year period, $2 billion is a $100 million in revenue a year, very high margin, maybe $85 million in EBITDA, tax affected, as you've mentioned in your video, maybe, again, the taxes will be timing related, but let's just call it $65 million of tax-affected cash flow over a 20-year period. So a $5 billion deal announcement turns into $65 million of cash flow five years from now, what's right and what's wrong about that assessment? Chris Stansbury I'd say most of it is wrong. The -- Yes, I think, David, here's where we go. So again, it's multiple deals that added up to the $5 billion. Not just one. And in the video, we talked about a cash contribution margin, which is effectively the EBITDA less the CapEx, pretax that's roughly in the ballpark of our existing EBITDA margin. So you do the math on that, that will give you the pretax free cash flow associated with these deals. And that cash flow, to your point, does come largely at the front end. Now there's ongoing payments for space and power, for operating and maintenance if they want us to run the networks for them that gives us nice cash flow over the years. But the tax would also be front-end loaded. So the key thing here is that, in one set of deals in those $5 billion deals that the net after-tax cash generated from that fully fund the liquidity gap that we've talked about for so long on these calls. It's over, it's behind us. And we're not done. So as we said, there's another $7 billion of discussions underway right now. And this trend will continue. The demand isn't one and done. So that's the key difference. So there's more cash in the deal than you've laid out and there's more to come. Kate Johnson And additionally, it's not one deal. The $5 billion represents multiple customers, and each contract is very different. I think that's important to stress. David Barden Thank you. I just want to follow up on that, Chris, if I could. So just to make -- so if the majority of the cash is coming in, as you say in the press release, in the next three to four years, and it's also going out in the next three to four years. So then you've got this minority of the $5 billion that's been realized over the following 20 years. Is that -- what's -- so there's a net kind of zero. And then there's this tail of income. Is that -- how is that not what you said in the press release. Chris Stansbury I'm not -- I guess I'm not following and we can do it in the after call. I'm not following the net zero. The net is significant and fully funds the liquidity gap that you and your peers have modeled over the next number of years. That's now fully addressed. So -- and you're right, then, yes, the renew leads in over a much longer time frame. But that cash allows us to fund the transformation. It allows us to pay down debt and start to attack the debt structure. And again, that's with this first bundle of deals that total $5 billion and there's more coming. David Barden And so just my last follow-up. So when you say in the press release that the majority of the cash comes in the next three to four years, and there's a roughly equal amount of disbursements, so that the CapEx related to the deal is smaller than -- so if I add the deficit and the CapEx necessary to win these deals, that gets us to the breakeven, the liquidity that you're talking about. Chris Stansbury That's right. So said another way, David, the cash contribution, the $5 billion, let's the OpEx to support it less the CapEx to support it, leaves us with an amount of cash. We pay tax on that cash. And the after-tax impact of that fully funds the liquidity gap that we have modeled over the next few years, from this first kind of deals. Your next question comes from the line of Jim Schneider with Goldman Sachs. Please go ahead. Jim Schneider Good afternoon. Thanks for taking my question. I was wondering if you could maybe give us some color on -- within the $5 billion of closed deals, the diversity of customers within that is that a few large hyperscale type customers? Is it a much longer tail of customers, including corporates? And then if you could give us any kind of sense about the same kind of color on the additional $7 billion you're pursuing now? Kate Johnson So the first $5 billion is that first tranche that I talked about. It's hyperscalers, it's social platforms, it's huge technology companies, it's a cloud company. As everybody building the AI models, right? Where they're building them and they're training them. They're seeing the data flows and they're saying, holy cow, current networks simply don't serve where the state of growth is going. So they're building out their data centers because data needs compute. And that is driving the requirements that they bring to us about, "Hey, can you get me from here to there? And by the way, can you connect me back to the main Internet highways so that I can continue to serve my customers there as well." So that's the first one. The second tranche is -- and we're just at the really early phase of that piece. Which is enterprises that are using the AI models. And frankly, we're one of them. We're using AI models to transform our business. We have great partnerships with all of these guys to try and take cost out, drive efficiency, gain insight, more intelligent services. And those enterprises that are leading the way are in health care, retail and financial services for the most part. And they're doing it in a different way. It's not necessarily an end-to-end custom private network per se. But it's a little bit of fiber and some advanced services on top of it, dramatically increasing the bandwidth and performance needs. Jim Schneider Thanks. And then maybe just relative to the network build-out itself. I believe at your Analyst Day last year, you referenced that you had 6 million inner city fiber route miles in the network, and you were planning on doubling that, which is, I think, the same commentary you made on one of your earlier announcements. So is -- with the pre-funding and the revenue associated with these deals, is that simply accelerating the build-out you already had contemplated and pulling them forward in time? Or is there any change to the profile or complexion of that build plan? Kate Johnson So, I'm -- I struggled to figure out where the baseline is from your question. I'll just give you continually what's happening. We are increasing connectivity both inside the metro areas as well as in the long-haul networks. And that's with new routes and pulling more fiber on existing routes. And so it's a combination of all of it. And each deal is a bit different when you overlay them all together what you see is a doubling in metro and a significant increase in long haul. Chris Stansbury I would just add to that, that the fiber that we put in the ground already and the fiber that we're adding today supports 400 gig waves. And over the next two years, that will scale to 800 and 1.6 terabytes. So the fiber that's going in the ground has enormous expandability. And I don't think -- at least I'm not aware of anyone else who's investing at that rate to meet the needs of customers. Your next question comes from the line of Jonathan Chaplin with New Street. Please ask your questions. Jonathan Chaplin Great. Thanks for taking the question, guys. First, just to follow up on David's question. I wonder if you could help contextualize the recurring revenue piece that comes on the back of these massive transactions that you're doing? How should we think about these transactions driving growth in the grow segment, presumably this is sort of all large enterprise at this point? And then given how important this sort of transformative event for the business is, unlike embarrassed to be asking about mass markets, but you did really well on net adds in mass markets this quarter. It's been sort of a pretty dramatic acceleration in the business over the course of the last two quarters. And I'm wondering if you can give us some context to what's driving that? And also just speak to sort of the strategy around ARPU a little bit. It looks like ARPU is well below peers. I assume that's sort of a conscious decision to drive penetration. I'm wondering if you -- if there's sort of a plan to close the gap over time? Thanks. Chris Stansbury Yes. There's a lot in there. I'll try to remember. As it relates to the PCF deals, we did say in the video that once you get to scale, and again, as David pointed out, it's anywhere between that three and five year window. In some cases, not all, customers will ask us to run the networks, we will also provide space and power. So again, if you're powering a signal from San Francisco to New York, along the way you're going to need huts where you can put rats, you can put the equipment that powers those signals. And we said that on average, think about that as roughly 10% of the total contract value. And that revenue and cash will be earned in the year the services are provided. So that's, I think, a good broad guideline. As it relates to mass markets, yes, I could not be more proud of the team. They're killing it. There's an intense focus on driving marketing execution and really focus on both enablement and penetration. And they kept the enablement machine chugging along, but we're just super pleased that the -- is the growth in penetration. They're executing flawlessly right now. On ARPU, that's part of the strategy, yes. I mean we're not trying to over or under price. In fact, we have raised prices where we see the opportunity to do so, and we'll continue to do that. But we're pleased with the way everything is working in combination ARPU penetration, et cetera. So more to come. Your next question comes from the line of Nick Del Deo with MoffettNathanson. Please go ahead. Nick Del Deo Hi. Thanks for taking my questions. First, Chris, the comments you've made around the cash contribution margins associated with these deals seem to apply mostly to the $5 billion in signed deals. As we think about future deals, like the $7 billion you have in negotiation, would you expect those to have more favorable cash economics by leveraging some of the fiber being put in the ground for these earlier deals, or should they be kind of in the same ballpark? Chris Stansbury Yes. I would say, on average, I think the guidance we gave is pretty good. Again, it's hard to say. So I mean I can tell you that -- we've had discrete decisions that we've made along the way of do we make some incremental investments now on routes where we may have slightly less capacity to try to help for the future, and that would obviously be a benefit to your point. But then we don't know yet the full scale of what all of the customers want, and that may require us to do additional things that we don't have today. So it's just -- again, given the quantum of the deals and the complexity it's hard to answer right now. But I would tell you that I think the guidance we gave is good general guidance around how to think about it. Nick Del Deo Okay. So not trying to get too far ahead of signed deals in terms of capital commitments and whatnot? Chris Stansbury Right. I mean, look, we will continue to invest in our network as we have for years, and I view that more as kind of baseline responsibility. As it relates to big CapEx expansions, we will be very measured in how we do that. This is not a gamble. We will -- if we see a route where we know there's going to be demand in the future, and we're already pulling fiber, we may pull more. If it's a route where we've got lots of capacity, we won't. So it really is route by route mile by mile that we do those analytics, and it's actually really impressive what the team is doing as they model this out. That's it's a core capability. And quite frankly, I think it's one of the reasons in addition to the digital services that we can offer these customers that customers come to Lumen. Nick Del Deo Okay. Okay. And then Chris, you quickly alluded to it in your prepared remarks, but I was hoping you could expand a bit on how you're thinking about cannibalization risk, whether current revenue or revenue that you otherwise might have generated. So for example, if you're selling someone dark fiber, I'm guessing you're not selling them waves on that route going forward? Chris Stansbury So think about it -- think about it this way, private connectivity fabric is a bundle of everything from dark fiber to wave to IP. It's your network, your way. And these first deals happen to be very large infrastructure, dark fiber kind of deals with some of the other things mixed in. As time goes on, I would expect that mix to continue to evolve. And so it depends on what -- again, what the customer wants, where they want to get as to whether we've got some of that fiber already in the ground or whether we need to pull more. Kate Johnson I'd also like to add as person coming from the tech world into telecom, there's this proclivity to worry about cannibalization rather than evolution of portfolio. And I think that's how we got to a place of being quite overbuilt. And as I look at the demand for these services and our strategy moving forward, we are going to prioritize penetration of our assets to deliver return to our shareholders. And I think that, that's going to be very accretive long term. Chris Stansbury Yes. This is not to be very clear. We haven't even talked about cannibalization. This isn't cannibalization of legacy at all. This is about net new and where we're going. And this is why we see the upside that we see in our ability to drive returns for shareholders. Your next question comes from the line of Greg Williams with TD Cowen. Please go ahead. Gregory Williams Great. Thanks for taking my questions. We're all trying to size the total addressable market of AI and you did a good job of articulating those three phases. Maybe we'll start just with that first phase and all these deals are more dark fiber, as Christa. So really, I think the addressable market would be how many new data centers are they creating? And we are talking a stab at it earlier this week in some reports. And really the better way of asking you guys how many new data centers are you feeding roughly $4 billion to $5 billion of deals? Is it like 10? Is it 30 ? I'm just trying to get a sense of that, and it helps us with our scope? Thanks. Kate Johnson I mean we're not tracking that really. What we're tracking is across the group of technology companies that we're speaking to, which is at this point in the dozens, what do their needs look like? What are the synergies between the requests that we can drive economies of scale and how can we drive to closure as fast as possible so we can group them in those ways by route, and by how operationally we can deliver upon these. The one thing we do look at when we model it out is where is the power. Data centers need power space cooling and fiber. And I think the energy piece of the equation is where can you build a data center that you can deliver a green footprint because there's also that piece of it as well. And so it's pretty complex. Your next question comes from the line of Frank Louthan with Raymond James. Frank Louthan Great. Thank you. Maybe you can give us a little more color within this sort of $5 billion group, can you give us an idea of the largest deal as a percentage of revenue? And then as it relates to the $5 billion in bookings here, what do you -- what's an average annual bookings? And how much is it up this year, including the PCF deals? Chris Stansbury So yes, in terms of the biggest one, again, that starts to get close to really starting to disclose stuff around customers because if I give you that, then it's just a guessing game as to which customer it is. And that's not fair to the customer. And frankly, it's sensitive information for us. So we're not going to give that. As it relates to the bookings, I want to make sure I understand -- are you asking that once we get to scale, how much -- how does that relate to what we're selling today? Is that the question? Frank Louthan Well, it seems -- maybe I'm misusing the terms here, but it seems like you've done $5 billion in sales for here, which sounds like a bookings number. Not necessarily something hitting revenue in the income statement. What is -- I'm just getting an idea of what the incremental upside from that -- from bookings is in 2024 versus, say, 2023, inclusive of this bump from the PCF deal? Chris Stansbury Yes. I would say from a modeling standpoint, I would think about that as largely all incremental. We always sell dark fiber. And I think the dark fiber run rate I'd have to go back and check frank because I don't know off the top of my head, but ex these deals, dark fiber is obviously in the grow bucket, and we continue to grow that segment. But this -- yes, we had the state of California in the fall that we mentioned, right, so that was a big deal. But again, we've done those in the past, and we'll do other deals like that going forward. This shift that we're seeing right now, which, quite frankly, I don't think comes as a surprise, right? There's been so much research and communication around the amount of investment required to support AI. And everybody forgot about the fact that the data doesn't originate in the data center and stay in the data center, right? It's got to get in, it's got to get out. So what we're really seeing is that now finally being realized and I'd say that's largely incremental. Frank Louthan Okay. And one quick thing. Did you -- can you clarify the split and the increase in free cash flow between the asset sale and the upfront cash? Your next question comes from the line of Eric Luebchow with Wells Fargo. Please go ahead. Eric Luebchow Appreciate you taking the questions. Thank you. So you talked about getting back to EBITDA growth in 2026 after a step down next year. How should we think about the visibility of getting back to revenue growth, given the trajectory of bookings you've had. And it sounds like these PCF deals since they'll be amortized over a very long contract duration. They'll certainly help revenues, but I don't know if there are enough to really get you back to revenue growth by 2026 as well? If you could kind of talk through the moving parts there? Thanks. Chris Stansbury Yes. So again, I don't want to get too close to guidance here. As we've said, revenue will obviously lag the EBITDA turnaround because of our ability to drive significant cost takeout as we fix broken, right? And we go from four networks to one. So the timing on the revenue, we -- I guess what we said most recently is that that's going to lag by at least a year. And I think that still holds in this situation. But again, the comment that I made, I want to be really clear about this, around kind of directionally 2025 and 2026. To be very clear, that excludes the $7 billion set of discussions we're having right now. right? We don't count that until it comes in because just like this first batch of deals, they're very hard to predict. One, what's required to deliver them; and two, what the timing is. Eric Luebchow Yes. Understood. And then just one follow-up. These new data center deals, the ones you've announced and then the ones that are in your pipeline, you tied them to the intercity fiber investments that -- where you'll double your fiber capacity over the next handful of years. We've heard a lot about data center deals moving to more further out rural locations given power constraints in a lot of markets. So can you talk at all about like splits between middle mile, long-haul fiber versus metro fiber this in your pipeline to support these types of deals given data center deals are being done in further out locations, it seems based on what we've seen? Thanks. Chris Stansbury What I'll say is this, our network, one of the reasons why it's so attractive. And by the way, when I say network, it's fiber and in some cases, it's conduit, right? It's this vision that was built 25 years ago. And now because of the advances in fiber technology, we have the ability to monetize it. So it's both. It's both of those things. And so I would say the strength of both the inner city and the metro that customers, broadly speaking, are wanting to access. And as we continue to invest in things like waves, it will be to deliver against both of those. Wave customers want two things. They want to get where they want to get, and they want to get there quickly. And I don't know if anyone else in the space who is investing the kind of money that we are to make sure that happens. Since there are no more questions, I will now turn the conference back over to Kate Johnson, CEO, for closing remarks. Please go ahead. Kate Johnson Thanks so much. To wrap, it's an exciting time for Lumen as AI charts the course for our pivoted growth, and our future is very, very bright. Thanks for joining today. We look forward to meeting you at the upcoming conferences and updating you on the significant progress we're making in transforming our company. Have a great night. Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.

Super Micro Computer, Inc. (SMCI) Q4 2024 Earnings Call Transcript

Michael Staiger - Vice President, Corporate Development Charles Liang - Founder, President, Chief Executive Officer and Chairman David Weigand - Senior Vice President and Chief Financial Officer Thank you for standing by. My name is Harry and I will be your conference operator today. At this time, I would like to welcome everyone to the Super Micro Computer Incorporated SMCI US Q4 2024 Earnings Call. With us today, Charles Liang, Founder, President and Chief Executive Officer; David Weigand, CFO; and Michael Staiger, Vice President of Corporate Development. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Michael Staiger Good afternoon and thank you for attending Supermicro's call to discuss financial results for the fourth quarter, which ended June 30th, 2024. With me today are Charles Liang, Founder, Chairman and Chief Executive Officer; and David Weigand, Chief Financial Officer. At the end of today's prepared remarks, we will have a Q&A session for sell-side analysts. Our press release was issued after close of market and is posted on our website, where this call is being simultaneously webcast. The slides that accompany this webcast can be downloaded at ir.supermicro.com. These include statements regarding our financial outlook and operations, our strategy, technology and its advantages, our current and new product offerings, and competitive, industry and economic trends. Any forward-looking statements that we make are based on facts and assumptions as of today, and we undertake no obligation to update them. Our actual results may differ materially from the results forecasted, and reported results should not be considered as an indication of future performance. A discussion of some of the risks and uncertainties relating to our business is contained in our filings with the SEC, and we refer you to those public filings, including our most recent Annual Report on Form 10-K. During this call, all financial metrics and associated growth rates are non-GAAP measures other than revenue, and cash and investments. Reconciliations to the most directly comparable GAAP measures are provided in our earnings press release and slides. This call is being broadcast live on the Supermicro Investor Relations website and is being recorded for playback purposes. An archive of the webcast will be available on the IR website and is the property of Supermicro. Our first quarter fiscal 2025 quiet period begins at the close of business, Friday, September 13th, 2024. Thank you, Michael. Today, I am pleased to announce another record quarterly result of $5.31 billion, a 143% year-over-year growth. For fiscal 2024, we have achieved $14.94 billion in revenue, a 110% year-over-year growth rate. To put this in perspective, our Q4 revenue has exceeded the full year revenue of fiscal 2022. Our robust growth is driven by our technology and product leadership in the AI infrastructure market, especially with Generative AI training and inferencing. We have been scaling quickly to secure a large share of AI CSP opportunities, deploying some of the largest AI SuperClusters in the world. Leveraging our system building blocks, we build and optimize rack-scale plug and play solutions with the latest DLC liquid cooling technology, helping our customers achieve the best TTD time-to-deployment and TTO time-to-online and lowest TCO with their AI solutions. Here are some key quarterly highlights. First, Supermicro is pleased to be included in the NASDAQ 100 Index last quarter. Fiscal Q4 net revenue totaled $5.31 billion, up 143% year-on-year with a strong record high backlog. We could ship more if not for DLC liquid cooling component shortage. Fiscal Q4 non-GAAP earnings of $6.25 per share were well above $3.51 last year, which was 78% year-on-year growth. Our Q4 operating margin is 7.8%, which is lower than what we expected due to the higher mix of hyperscale datacenter business and expedited costs of our DLC liquid cooling components in June and September quarters. Some key new components shortage delayed about $800 million of revenue shipments to July, which lowered our EPS for June and will be recognized in our September quarter. The availability of our Malaysia facility later this calendar year and our dominating position in DLC liquid cooling total solutions will be instrumental in increasing our profitability. Supermicro is powering the largest AI factories around the world today. We believe more and more datacenters will be opting for our latest DLC liquid cooling solutions, which dramatically improves TCO relative to traditional air-cooled datacenters and is less environmentally taxing. We have proved that DLC solutions also offer higher performance and better uptime, with advantage to support the upcoming new AI chips. At Computex Taipei, I shared that Green Computing can be free with a big bonus. This means the cost of deploying liquid cooling DLC is on par with traditional air-cooled datacenter and significantly lowers the operational power cost. Since then, we have been delivering over 1,000 highly reliable DLC racks to multiple customers. Our goal is to quickly make DLC liquid cooling to be a mainstream solution for most datacenters and AI factories that focus on increasing efficiency and performance while reducing OpEx. We are targeting 25% to 30% of the new global datacenter deployments to use DLC solutions in the next 12 months, with most deployments coming from Supermicro we believe. We are happy to help any customers transform and adapt their existing air-cooled datacenters to DLC liquid cooling in the coming years for four major reasons. First, it helps customers save energy costs up to 40%. Second, it boosts datacenter computing performance and third, it helps pull in customers' datacenter lead times or to be more precisely reduces their time to on-line because of less electrical power required and fourth, it reduces carbon footprint for our one-and-only mother earth. As an end-to-end IT infrastructure solutions company, our customers' experience is our number one priority. By leveraging our system building block and rack scale plug and play solutions, we help our customers achieve the best time-to-market advantage with new and performance optimized technologies. Now, we are further expanding this solution to the entire datacenter. With rapid deployment of large-scale AI infrastructure, datacenters worldwide are facing power shortages and cooling inefficiency challenges. Building these new AI-ready datacenters traditionally takes a long time, averaging three years for example. Our upcoming Supermicro 4.0 DCBBS, Datacenter Building Block Solutions will reduce customers' new datacenter build time from about three years to two years. For smaller facilities or old datacenter transformation, Datacenter BBS can enable an optimized, cost-effective datacenter in less than one year or even in just six months. This new offering will significantly improve datacenters' TTO time-to-online and cost, with full integration of AI compute, server, storage, networking, rack, cabling, DLC liquid cooling facility water tower, end-to-end management software, onsite deployment services and maintenance. We will start offering it later this calendar year. Playing a significant role in realizing our Datacenter BBS and providing additional economies of scale, our new Malaysia campus will start production this November. With its geographic advantages, we expect it to quickly ramp up shipping volume and improve our cost structure. In the US, we are adding new buildings and production POC provisioning capacity near our Silicon Valley headquarters as well, which will further boost our monthly DLC liquid cooling rack capacity and value this fiscal year. Moreover, we are on track to expand to a few other global manufacturing locations, leveraging our strength in product design, build quality, supply chain and deployment, positioning Supermicro as one of the largest IT infrastructure company. In summary, we are entering fiscal 2025 with record-high backorders, winning products, large volume DLC liquid cooling capacity, Datacenter BBS and more new customers. While our long-term investments impact short-term profitability, they position us well for future success by providing a sustainable competitive advantage and necessary economies of scale. This gives me confidence to forecast the September quarter revenue between $6 billion to $7 billion, and fiscal 2025 revenue between $26 billion to $30 billion. Again, we anticipate that the short-term margin pressure will ease and return to normal ranges before the end of fiscal 2025, especially when our DLC liquid cooling and Datacenter Building Block Solutions start to ship in high volume later this year. Lastly, I would like to announce a 10-for-1 forward stock split of Supermicro's common stock to make ownership of Supermicro stock more accessible. We are targeting trading on a split adjusted basis commencing at market open on October 1st, 2024. Before passing the call to David Weigand, our Chief Financial Officer, I want to say thank you to our partners, customers, Supermicro employees on an incredible year where we were able to bring AI at scale to the world and to our shareholders for your continued support. David? David Weigand Thank you, Charles. We had robust growth in the fiscal year, and I am pleased with the progress we made on our strategic initiatives. For fiscal year '24, we reported revenues of $14.9 billion, representing 110% growth over fiscal year '23 revenues of $7.1 billion. Fiscal year '24 non-GAAP diluted EPS of $22.09 grew 87% over fiscal year '23 non-GAAP diluted EPS of $11.81. Between fiscal year '21 and fiscal year '24, we achieved significant operating leverage with revenues growing at a compound annual growth rate of 61% per year while non-GAAP operating expenses only grew at 19% per year. Between fiscal year '21 and fiscal year '24, gross margins have met or exceeded the target range of 14% to 17%. Non-GAAP operating margins were above the target range of 5% to 8% between fiscal year '21 and fiscal year '24 and more than doubled from 4.4% in fiscal year '21 to 10% in fiscal year '24 due to strong revenue growth and operating leverage. Q4 revenues were $5.31 billion, up 143% year-over-year and up 38% quarter-over-quarter, and above the midpoint of guidance of $5.1 billion to $5.5 billion. Growth was driven by strong demand for next generation air-cooled and direct liquid-cooled rack-scale AI GPU platforms, representing over 70% of revenues across enterprise and cloud service provider markets where demand remains strong. We exited the year with an acceleration in innovative DLC products, a large design win pipeline and a strong backlog, positioning us for continued growth in fiscal year 2025. We expect gross and operating margins to gradually increase in the year driven by product and customer mix, manufacturing efficiencies for new DLC AI GPU clusters and new platform introductions. As Charles discussed, shipments may continue to be constrained in the short-term by supply chain bottlenecks for key new components for our advanced platforms. However, long-term gross margins will benefit from lower manufacturing costs as we scale up production in Malaysia and Taiwan, in addition to expansion in the Americas and Europe. During Q4, we recorded $1.83 billion in the enterprise-channel vertical, representing 34% of revenues versus 49% in the last quarter, up 87% year-over-year and down 3% quarter-over-quarter. The OEM appliance and large datacenter segment revenues were $3.41 billion, representing 64% of Q4 revenues versus 50% in the last quarter, up 192% year-over-year and up 76% quarter-over-quarter. Emerging 5G, Telco, Edge/IoT revenues were $75 million or 2% of Q4 revenues. For fiscal year '24, enterprise-channel revenues grew 79% to represent 41% of total revenues. The OEM appliance and large datacenter segment grew 149% and represented 58% of total revenues. The emerging 5G, Telco, Edge/IOT segment represented 1% of total revenues. One CSP/large datacenter customer represented approximately 20% of revenues for fiscal year '24. Server and Storage Systems comprised 95% of Q4 revenue and Subsystems and Accessories represented 5%. ASPs increased on a year-over-year and quarter-over-quarter basis driven by the value and complexity of rack-scale Total IT Solutions. By geography, US represented 61% of Q4 revenues, Asia 24%, Europe 10%, and Rest of World 5%. On a year-over-year basis, US revenues increased 94%. Asia increased 437%, Europe increased 128%, and Rest of World increased 386%. On a quarter-over-quarter basis, US revenues increased 20%, Asia increased 66%, Europe increased 74% and Rest of World increased 187%. The Q4 non-GAAP gross margin was 11.3% versus 15.6% in Q3 due to product and customer mix, focus on winning strategic new designs with competitive pricing and higher initial costs in ramping production of new DLC AI GPU clusters. For fiscal year '24, the non-GAAP gross margin was 14.2% versus 18.1% for fiscal year '23. We have a path to improve gross margins to the target range of 14% to 17% as we introduce innovative platforms based on multiple new technologies from our strategic partners and improved manufacturing efficiencies on our DLC solutions. Q4 operating expenses on a GAAP basis increased by 15% quarter-over-quarter and 75% year-over-year to $253 million driven by higher compensation expenses and headcount. On a non-GAAP basis, operating expenses increased 11% quarter-over-quarter and 39% year-over-year to $185 million. Q4 non-GAAP operating margin was 7.1% versus 11.3% in Q3, due to the lower gross margins. Other income and expense for Q4 was $11 million, consisting of $3 million in interest expense and $14 million from interest income on higher cash balances offset by a loss from foreign exchange and other investments. Interest expenses decreased sequentially as we paid down short-term bank credit facilities. The tax provision for Q4 was $1 million on a GAAP basis and $21 million on a non-GAAP basis. The GAAP tax rate for Q4 was 0.3% and the non-GAAP tax rate was 5%. The GAAP tax rate was 4.9% for fiscal year '24 versus 14.7% in fiscal year '23 and the non-GAAP tax rate was 10.4% in fiscal year '24 versus 15.9% in fiscal year '23. Q4 GAAP diluted earnings per share of $5.51 was below the guidance of $7.20 to $8.05 and non-GAAP diluted EPS of $6.25 was below the guidance of $7.62 to $8.42 due to lower gross margins and higher operating expenses in the quarter. The GAAP fully diluted share count increased quarter-over-quarter from 61.4 million to 64.2 million and the non-GAAP share count increased sequentially from 62 million to 64.8 million shares reflecting the effects of the two recent stock offerings and the convertible bond offering. Q4 cash flow used in operations was $635 million compared to $1.52 billion in the previous quarter, as inventory and accounts receivable grew due to higher levels of business and the timing of shipments. For fiscal year '24, cash used in operations was $2.5 billion due to strong revenue growth of 110% and working capital needs to support large customer design wins. Q4 closing inventory was $4.4 billion in anticipation of future growth. CapEx for Q4 was $27 million resulting in negative free cash flow of $662 million for the quarter. CapEx for fiscal year '24 was $137 million up from $37 million in fiscal year '23 as we invested in new property, plant, and equipment globally, including our greenfield Malaysia plant. The Q4 closing balance sheet position was $1.7 billion, while bank and convertible note debt was $2.2 billion resulting in a net cash position of negative $504 million versus a net cash position of $252 million last quarter. Turning to the balance sheet and working capital metrics compared to last quarter, the Q4 cash conversion cycle was 94 days versus 96 days in Q3. Days of inventory decreased by 10 days to 82 days compared to the prior quarter of 92 days. Days sales outstanding was unchanged at 37 days while days payables outstanding decreased by 8 days to 25 days. Now turning to the outlook for Q1 fiscal year '25, we expect strong growth as we ramp new air-cooled and DLC AI GPU design wins with new and existing customers. For the first quarter of fiscal 2025, we expect net sales in the range of $6 billion to $7 billion. GAAP diluted net income per share of $5.97 to $7.66 and non-GAAP diluted net income per share of $6.69 to $8.27. We expect gross margins to improve sequentially due to product and customer mix and improving manufacturing efficiency. GAAP operating expenses are expected to be approximately $282 million and include $84 million in stock-based compensation expenses that are not included in non-GAAP operating expenses. The outlook for Q1 of fiscal year 2025 fully diluted GAAP EPS includes approximately $48 million in expected stock-based compensation expenses, net of tax effects of $35 million, which are excluded from non-GAAP diluted net income per common share. We expect other income and expenses, including interest expense to be a net expense of approximately $20 million. The company's projections for Q1 fiscal year '25 GAAP and non-GAAP diluted net income per common share assume a GAAP tax rate of 9.9% and a non-GAAP tax rate of 14.6%, and a fully diluted share count of 65 million for GAAP and 66 million shares for non-GAAP. We expect CapEx for Q1 to be in the range of $45 million to $55 million. For fiscal year 2025, we are introducing guidance for revenues from $26 billion to $30 billion. Thank you. [Operator Instructions] Our first question today is from the line of Michael Ng of Goldman Sachs. Please go ahead. Your line is now open. Michael Ng Hey, good afternoon. Thank you very much for the question. I guess, I have, two. Encouraged to see the revenue guidance for $26 billion to $30 billion for fiscal '25. I was wondering if you could just provide a little bit of color around the assumptions underpinning that revenue guidance and any visibility that you have in terms of backlog and some of the contingencies you might be assuming in terms of supply availability? And then secondly, I was just wondering if you could provide a little bit more color around the growth in operating margin, improvement throughout the year. Should we think about the, the long-term gross margin targets as applicable for the full year as well or exiting the year? Thank you. Charles Liang Okay. Thank you. I mean as to what we share, I mean, we continue to gain design wins and we see lots of new product available, including DLC liquid cooling and Datacenter Building Block Solutions, we see a lot of customer engagement and also more new customer like to engage with us. So with our capacity continue to grow $26 billion to $30 billion. That's our target for the next 12 months. And as to gross margin, as what we just mentioned, our DLC liquid cooling now have been very mature. So we are able to take advantage from that and also Datacenter Building Block Solutions that provides a much better value, improve customers' Datacenter time to online and also EG customers job to build their data center. So all of those will increase our profitability gradually. Our next question today is from the line of Samik Chatterjee of JPMorgan. Please go ahead. Your line is now open. Samik Chatterjee Yes. Hi. Thanks for taking my questions. I have a couple as well. Maybe if I can start with the gross margin performance in the quarter. I know you mentioned you had a hyperscale customer, which impacted product customer mix and margin impact there. How should we think about sustainability or sort of repeat orders from that customer? It sounds like you're saying that's part of the improvement and you probably don't see as much repeat, but just wanted to confirm if that's how we should be thinking about the hyperscale customer you had, which is that it doesn't really repeat through fiscal '25. And I have a follow-up. Charles Liang Yes. We have been very consistent. I mean before we are Silicon Valley based, operations was in Silicon Valley. So we focus on enterprise, high-quality, higher performance customer only, that's before. But when we start to take production operation advantage from Taiwan, we start to grow large-scale datacenter customer. And now we have a huge capacity in Malaysia, it will be ready by later this year. So with the economic large-scale advantage, we are waiting for a large customer. So we will continue to grow with large customers. At the same time, we also continue to enhance our enterprise customer base. So recently, we also see the growth in some demand from our enterprise with our software total solution, I mean Datacenter Building Block Solutions. We start to gain more attraction for the datacenter, I mean, enterprise customers as well. So we believe long-term economic scale, the enterprise customer base and overall Taiwan and Malaysia advantage cost advantage that we have a way to grow gross margin and net profit. Samik Chatterjee Got it. And for my follow-up, Charles, there have been reports more recently about the delay of the GB200 from NVIDIA. Just wondering if you can share your thoughts of how that would impact the conversion of the robust backlog or pipeline that you're looking at to revenue through the year? And is that accounted for when you talk about liquid cooling now being a materially higher portion than what you talked about at COMPUTEX. Are you taking some of those delays into account? Thank you. Charles Liang Yes. I mean, yes, we heard NVIDIA may have some delay, right? And we treat that as a normal possibility. When they introduced new technology, new product, they are always have a chance to -- there will be a push out a little bit. In this case, it pushed out a little bit. But to us, I believe we have no problem to provide the customer with a new solution like H200 liquid cooling. We have a lot of customers like that. So although we hope better deploy in the schedule, that's good for a technology company, but this push out overall impact to us. It should be not too much. Our next question today is from the line of Ruplu Bhattacharya of Bank of America Merrill Lynch. Please go ahead. Your line is open. Ruplu Bhattacharya Hi. Thanks for taking my questions. I have two of them. The first one relates to the gross margin performance in the quarter. David, can you specify of the 430 bps sequential decline, how much was the result of the customer mix, which is the higher hyperscale customer mix versus the impact of ramping liquid cooling solutions? And how much was that impact to gross margins? And in terms of, I think, Charles, you said you lost about $800 million of revenue in the quarter because of nonavailability of components. Is that all liquid cooling related or was that related to other things like GPUs as well? Thank you. Charles Liang Pretty much liquid cooling key components related. But now it's much ready now. I mean when we move to July, August, we have a much liquid cooling key components are available now. David Weigand Ruplu, it wasn't a loss. It was pushed out into the next quarter. Yes. So there was -- we really -- we were surprised by the amount of demand that we had in this market. And so we -- our manufacturing efficiency improves -- has been improving every day. And so we expect that to continue and that's going to help our gross margins going forward as we deploy liquid cooled racks at scale. Ruplu Bhattacharya And is that deployment expected to be linear for these liquid cool racks throughout the year or is it more back-end loaded? Thanks. Thanks for taking my questions. Charles Liang Basically, we support a handful customer for liquid cooling. And most of them, once they try our liquid cooling, they will continue to deploy higher percentage with liquid cooling because the cost -- the hardware acquisition cost is about the same, but they will save a lot of energy costs. So I believe this growth will be consistently growing. Our next question today is from the line of Ananda Baruah of Loop Capital. Please go ahead. Your line is open. Ananda Baruah Yes. Good afternoon, guys. Thanks for taking the question. Charles, you said a lot of good stuff on this call. So I'll try to just ask about one or two things here. I guess to start, could you frame for us how the company is thinking about its liquid cooling capability relative to others who are providing liquid cooling service as well. That's been a big top of the conversation. It sounds like you guys are really high on your capability and it seems to be showing up at least in the guidance. But I think additional context around how you guys are competitively positioned and maybe some of the technical reasons why would be super useful for those. And then I just have a quick follow-up. Charles Liang Yes. Thank you. I mean as you know liquid cooling have been in the market for 30 years and market share compared with overall datacenter size always small, less than 1% or close to 1%, I would have to say. But just June and July two months alone, we shipped more than 1,000 racks to the market. And if you calculate 1,000 racks, AI rack is about more than 15% on a global datacenter new deployment. So we are very happy. We are happy that the industry pushed from air cooled to liquid cooling and to help customer save energy costs and reduce carbon footprint. At the same time, because of the liquid cooling, DLC liquid cooling datacenters require 30% to 40% less power, that's why it's met customers' datacenter availability quicker because the customers don't have to wait for higher power budget from a powering company. So overall we see more customers like our liquid cooling solution. Ananda Baruah And Charles did I hear you accurately that you guys think you did 50% liquid cooling share in the June quarter? Charles Liang I believe for June and July in last next two months we may ship at least 70% to 80% or liquid cooling compared with all the liquid cooling in the world. So for liquid cooling, we have at least 70% to 80% market share. Ananda Baruah That's useful. Thank you. And then just real quick, my follow-up is you've made remarks earlier this year in the recent past about how you envision expanding your rack capacity sort of over the sort of into the future. I was just wondering if you could give us an update on how to think about, how you're thinking about rack capacity expansion for both liquid cooled and air cooled and that's it for me. Thanks. Charles Liang It's a very good question. I mean, last month, we have about 1,000 racks per month liquid cooling capacity. And today, we already grow another 50%. So now we have a 1,500 rack per month capacity. By this year-end, we will grow that to 3,000 rack per month. That's with liquid cooling alone. So we really believe liquid cooling is a much better choice for the market and we provide kind of consultation to customers. And most of the customer when discuss with our engineering team, they love liquid cooling. And again, we are growing customer base for liquid cooling very strongly. And we're really happy for that because minimized power consumption have been common value to the world and especially save operation costs. Ananda Baruah And that's fiscal year fiscal year you say end of the year and the fiscal year? Charles Liang For the next 12 months, I believe, liquid coding will be a big portion of our business. Our next question today is from the line of Aaron C. Rakers of Wells Fargo. Please go ahead. Your line is open. Aaron Rakers Yes. Thanks for taking the question. I've got two as well. I guess I want to go back to the earlier question on Blackwell just because I think it's going to be a key focal point for a lot of investors here especially as we kind of shape the full year guidance. So Charles I want to be clear. So has your guidance contemplated as we think about the December quarter, do you believe that you'll be shipping the Blackwell platform solutions for revenue in the December quarter or should we think about the full year guide is a bit more weighted to the back half of the fiscal year given some of these concerns around the timing of Blackwell availability and NVL36 and NVL72 platforms, et cetera. I'm just curious of how you want us to say for the street to think about the cadence of that full year guidance shaping up on a quarterly basis. Appreciate you're not going to give quarter-by-quarter guidance. Charles Liang Yes. Thank you. I mean, indeed, we are relatively very conservative. I understand Blackwell may postpone how much we don't exactly know because the new technology always what can be pushed out, right? So for Q3, for sure, we do not expect any Blackwell volume. For Q4, I mean December quarter, I guess, it will be very small. Engineering sample small volume. So the real volume, I believe, had to be March quarter next year. And that's why we foresee only $26 billion to $30 billion. Aaron Rakers Yes. That's very helpful. And then as a quick follow-up, I want to go back to kind of the gross margin discussion too. We talked about the impact of the DLC platforms. You talked about product mix. One of the other comments, David, you had made was that winning strategic new customers was a factor in that 430 basis point gross margin degradation. Can you help us appreciate what exactly the impact of that has been? How that might have changed this last quarter? And then I'll flip my final one in. Any disclosure on purchase obligations coming out of this last quarter? Thank you. David Weigand Yes. Thanks. I'll answer those in reverse order. We don't have any announcements in terms of purchase obligations and so we'll point you to the 10-K for that. But with respect to your first question, I would say, we prepared the market for a downturn in margins or a softening of margins in our guidance last quarter. But even we were surprised by the acceleration that we saw in the liquid cooled rack market. And so we had to ramp up our supply chain. We paid a lot of expedite costs and higher supply chain costs. So I think as the supply chain improves, we expect those efficiencies to now come back out, but that impacted us more than we had expected. Is that the majority of the -- was that the majority for the 430 basis point decline? David Weigand Well, no, I think. No, so half was targeting specific accounts like we announced last quarter. And the other half was really the higher supply costs that we encountered. Our next question today is from the line of George Wang of Barclays. Please go ahead. Your line is now open. George Wang Hey, guys. Thanks for taking my question. I have two parts. Firstly, can you give more color just in terms of share gains, especially within the hyperscale arena? Traditionally, Supermicro has been more Tier 2, Tier 3 enterprise. And you guys talked about higher mix on hyperscale. Just curious does that mean you guys are winning new penetration to the hyperscale space? Charles Liang Yes. Again like what I just mentioned with our Taiwan capacity is getting bigger and Malaysia capacity will be ready. So we're fully ready for large scale datacenter customer, but we will be selective. So that's why we foresee only $26 billion to $30 billion. If we try to be more aggressive in a large scale, our growth can be even faster than that. But we try to grow in both ways enterprise and large scale datacenter kind of try to balance so to maintain our healthy profitability. George Wang Okay. Great. Just a second question, if I can squeeze in. Just as we enter the Blackwell era with liquid cooling kind of larger deployments, higher ASP, but also comes with some potential working capital need. Just in terms of the capital raise, is that fair to say you guys are sufficient or there could be some potential to come to the market? Just maybe you can talk about the puts and takes for the next 12 months. Charles Liang Liquid cooling, I mean, for sure, is necessary and it's very helpful for Blackwell solution. Although Blackwell solution pushed out a little bit. But indeed we enable liquid cooling for H100 and H200 as well and a lot of customers are interested in our H100 and H200 liquid cooling now indeed. So liquid cooling to from our position we'd like to support the whole datacenter not just Backwell. George Wang Okay. Can you address on the working capital if you can give any color on that? David Weigand Yes. So we announced a $500 million credit line with a group led by the Bank of America. And so we expect we are really working on our balance sheet and leveraging our balance sheet. And we expect to some announcements to be coming in terms of additional loan possibilities in the future. Our next question today is from the line of Jon Tanwanteng of CJS Securities. Please go ahead. Your line is open. Jonathan Tanwanteng Hey, good afternoon. Thank you for taking my question. I was wondering if you could just talk, given your time to market and volume capabilities and liquid cooling, the energy and compute advantages, can you walk through what your pricing strategy is and why not pass those costs on especially relative to the value that you're providing? Is it a stronger competitive environment close to behind you or are you effectively trying to get ahead of them and get that share first? Charles Liang Yes, I mean, indeed, the liquid cooling from our point of view it is really a good value to the whole market and our whole planet because of less energy consumption, right? So we enable liquid cooling primarily for Blackwell, right, because Blackwell higher power that's for sure. Lots of cases need liquid cooling. But we enable that for H100, H200 and regular CPU as well. Because overall liquid cooling once mature, once economical scale is good enough, it's good for all different kind of computing. And not exactly now, we are deploying, we are promoting. Lot of our customer continue to interest in our liquid cooling even enough for Blackwell. Jonathan Tanwanteng Got it. Thank you. And then you mentioned getting back to the gross margin target range by the fiscal year-end. Can you help us narrow down a little bit more where in that target range you expect to be at the low end? Is it more towards the middle kind of help us understand how you're getting there? Charles Liang Okay. For June, it's really a unique quarter because we deploy lots of liquid cooling and we pay lots of exploration cost. So that makes our June gross margin much worse. But now, indeed, our liquid cooling technology have been getting very mature, and we have a high volume now. So that though our liquid cooling cost are now. And however we try to promote liquid cooling as a mainstream product solution. So we try not to add the value too much to customers. But, instead, we try to gain market share and make liquid cooling everywhere. Jonathan Tanwanteng Okay. Thank you. And any color just on where in the margin range you expect to end up? David Weigand Well, so we, I think if you look at the guidance that we gave for Q1, we expect to be above 12% in the first quarter. And we're doing -- we'll be working very hard to move back into the range as we mentioned as soon as quickly as we can. Charles Liang Especially with our commissioned Datacenter Building Block Solutions with more software, on-site deployment, maintenance and kind of end-to-end management service. So our profit margin should grow from a Building Block Solution for Datacenter very soon. Our next question is from the line of Mehdi Hosseini of SIG. Please go ahead. Your line is open. Mehdi Hosseini Yes. Thanks for taking my question. I just have two housekeeping item. David, what kind of other income did you have in the June quarter. You did say that you had interest income of $12 million that you realized in the June quarter? David Weigand That was a net figure, Mehdi. So we actually had $20 million of interest income, but that was offset by some adjustments too, some investment adjustments which brought down lower. Mehdi Hosseini But the $20 million is that interest income. The $20 million is that interest income? David Weigand $20 million was interest income, yes, from higher cash balances. That was offset by some investments. Mehdi Hosseini Okay. All right. And then a question I have for Charles. Obviously, you've done a good job of doubling revenue in fiscal year '24. But you also had a negative free cash flow of $2.6 billion. And if I were to look at the high end of your revenue guide for fiscal year '25, you're on track to double revenues again. Does that mean that you're going to need to burn another $2.5 billion to $2.6 billion of free cash flow to hit those revenue targets? Charles Liang Not necessarily. I mean if we try to be very aggressively growing market share maybe if example we forecast on $30-something billion, right, so in that case, we may need more. But if we try to focus on below $30 billion then not necessary. David Weigand And Mehdi, one thing I would add to that is we believe that we have an IG profile. And as such, like I mentioned earlier, we're starting to leverage our balance sheet more with targeting toward unsecured debt. And so that will help us on an inter-quarter basis. Mehdi Hosseini Got you. Thank you. What should I assume for fiscal year '25 CapEx? David Weigand No. We don't have -- we're not giving a guide at this time. Mehdi Hosseini Okay. But would it be down on a year-over-year basis since most of the expansion in Malaysia and US are behind us? David Weigand Well we have other projects going on expansion here in the US, but we'll -- nothing to announce today. Our next question today is from the line of Nehal Chokshi of Northland Capital Markets. Please go ahead. Your line is now open. Nehal Chokshi Yes. Thank you. I want to talk about DLC and some of the chatter that's been out there from some competitors and that, it sounds like failure rates for DLC, broadly speaking, not necessarily for Super Micro is high relative to air-cooled. Can you comment on what is Super Micro's DLC failure rates relative to air-cooled and then also relative to other DLC solutions. And I guess maybe we can do it on a per-node basis annualized failure rates or whatever basis you want to utilize? Charles Liang Yes. We spent a lot of effort in last, I would like to say, two years to prepare our optimized DLC solution, including lots of new design, redesign, refining the components of the system. So finally, I mean, about May this year, right, we have our DLC solution for you ready. And we have more than a handful, high-profile customers who really like our DLC solution. That's why we're deploying the solution to them and that's why we paid lot of exploration charge, right? But now the good thing is our whole DLC solution has been very mature and ready for really high-volume production. So now for any customer want DLC, we are able to support them quickly and with a much reasonable cost now. So looking forward, I mean, DLC, I believe, will be a really popular solution for the world because it's more efficient, especially energy saving. So we are very happy that we establish DLC solution much ahead of anyone else. Again like June and July, I believe, we have at least 70% or 80% maybe even higher market share in the world for DLC. And air-cooled, again, we have been -- have a very optimized air-cooled solution. So we continue to promote air-cooled solution for sure. Nehal Chokshi And do you have any thoughts on the actual like failure rates relative to air-cooled and then relative to other suppliers DLC solutions? Charles Liang Yes, liquid cooling, as you know, because a very high efficient in cooling, right? So they allow CPU, GPU other components running at a lower temperature. And then in lot of case, indeed, are able to optimize customers' datacenter performance by percentage, right, a couple of percentage to even high single-digit percentage. So a lot of customers really like DLC at this moment. Nehal Chokshi So are you saying that you actually can achieve lower failure rates with DLC because you can run the GPUs at lower temperatures. Charles Liang CPU, GPU and other components at a lower temperature that which you have the kind of the whole datacenter quality, uptime, availability time. Nehal Chokshi Okay. And then my follow-up question is that, I think, June 21st, you did an 8-K after market close, leasing significant datacenter space from prime datacenter and then you're leasing it back to Lambda Labs. It seems like a rather odd arrangement. Can you guys talk about the purpose of doing this? David Weigand So we consider ourselves experts in datacenter solutions. And so this is really just one more facet of being a total provider. Thank you. And our next question is from the line of Thomas Blakey of Key Corp. Please go ahead. Your line is open. Thomas Blakey Hi, guys. Thanks for taking my questions. I have a few here. David, could you comment on the mix shift -- mix rather of AI rack scale revenue here in the quarter? Was it -- did it increase quarter-on-quarter in the June quarter? David Weigand Absolutely. I mean our revenues went up -- over a $1.5 billion and that was primarily driven by liquid cooled racks. Thomas Blakey Okay. Excellent. And an update maybe on the capacity utilization did that increase as well or decrease? And relatedly to that, you commented last quarter that there would be a number, I think of about 1,000 rack per month going out at a 64 GPU configuration? Could you give an update in terms of did you shipped those to the three customers? One was new in the June quarter? And again an update on the capacity utilization related to that question. Charles Liang Yes. Customers like our high density computing solution especially per rack. That's why you say 64 GPU or more GPU, right? So we are very efficiently provide the customer for whatever configuration they like. And very soon we will allow something even better for sure. Thomas Blakey So that -- so to be clear is that a yes that you shipped 3,000 racks during the quarter at that configuration to those three customers? Charles Liang We are building that capacity for that because how many customers will move to DLC, especially when Blackwell ready. So we are very optimistic for that, especially after Blackwell in high volume production. And we have many Blackwell ready optimized system and rack scale design. David Weigand Yes. But Thomas the 1,000 per month was the capacity. We're not saying that we shipped 1,000 per month. But one thing I can tell you is that the efficiency, yes. Thank you. And we have run out of time for any further questions. So this will conclude the Super Micro Computer Incorporated Q4 2024 Earnings Call. Thank you to everyone who is able to join us today. You may now disconnect your lines.