Lumen Technologies, Inc. (LUMN) Earnings Call Transcript & Summary

Okay. Good afternoon, everybody. I'm Simon Flannery, I want to add my welcome to all of you here today, and my great pleasure to welcome Neel Dev, the CFO at CenturyLink. Welcome, Neel. Thanks so much for your time today.

Thank you.

Before we get started, please note that all important disclosures, including personal holding disclosures and the Morgan Stanley disclosures, appear on the Morgan Stanley public website at www.morganstanley.com\researchdisclosures or at the registration desk.

So Neel, you reported earnings a few days ago. You put out guidance for 2020, which is very consistent with the strategy you've laid out both on the EBITDA, cash flow trajectory, balance sheet, et cetera. But perhaps you just talk about that outlook and the key priorities for the company in 2020 and beyond.

Sure. Good afternoon, everyone, and thanks for your interest in CenturyLink. To your question on our key priorities, the #1 priority for us is improving the revenue trajectory of the business. And so really investing in order to do that. We're investing in fiber, we continue to expand our fiber network, we're investing in products and services that leverage our extensive fiber network. So that's our #1 priority. In terms of our #2 priority, it would be really transforming our operations. And it's more than cost transformation. We're investing in digital customer experience. We're investing in digital employee experience. In addition to delivering a lot of cost savings, that priority, in fact, enables our priority #1 in terms of improving the revenue trajectory of the business. And so if you think about our priority 1 and 2, it is really about investing in products and services that are growing and harvesting the legacy products that are declining. And our objective is to really carefully, and it's a balancing act, carefully manage that transition and that transformation in order to deliver EBITDA growth which is a key priority for us. And finally, we want to continue to delever. We paid down about a couple of billion dollars of debt. Last year, we refinanced about $17 billion of debt. And so we'll continue down that path. We'll pay down another couple of billion in 2020. And we're committed to getting to the 2.75 to 3.25 net leverage target that we laid out.

And you've been able to take out significant reduction in your cost of borrowing as well, right?

Yes, we did. So if you look at the midpoint of our net cash interest guidance, it's down over a couple of hundred million relative to last year and over $350 million relative to 2018. So we are fairly pleased with that outcome.

Great. All right. Well, let's go back to the revenue trajectory then because I think it's one of the questions we get a lot from investors is the shape of the curve. And you started it off with the post merger integration of really taking some actions to get out of unprofitable revenue. So perhaps just talk us through where we are on that transition, and are we now really looking at more apples-to-apples type numbers? And what are the drivers around the Enterprise, IGAM, et cetera, to get the whole organization improving on revenue?

Sure. So you're right. We had a large effort around focusing around profitable revenues. We want to focus on durable revenues, revenues that are core to who we are. So if you think about our revenue decline in 2019, roughly 25% to 30% of that was from actions that we took in terms of profitable revenues, deemphasizing Prism, et cetera. Going forward, most of that is behind us. So if you think about it sequentially, in the fourth quarter of last year, we only had about $25 million or so of Prism revenues left that will continue to accrete away. In terms of your question on the trajectory going forward, we were pleased with the progress we've made with IGAM and Enterprise. So the growth rates improved towards the second half of the year. We feel good about those businesses. Our products and services are resonating with our customer base, typically more complex set of requirements as you go higher up that stack. If you think about it, every business is going through massive transformation, and we're leaning in and enabling our customers with that transformation. So not only are we taking share in that space, we're also enabling a lot of emerging technologies that our customers are deploying. So that area, we feel good about. We've done fairly well on the federal space. We've won a lot of contracts, and we're actually taking share there. In terms of SMB, what I would say is it's still early days for us. We have the capabilities. It is really about fine-tuning the way we go to market. So if you think about that space, it is -- in order for us to grow that business profitably, it is all about scale, so the number of volumes and transactions that you have in that space. So we've done a lot of work in terms of really, the right word, maybe tweaking our product set to make sure that that resonates with that customer base and the way we deliver service in a way that we can scale. So we're seeing preliminary progress, but it will take some time. Plus that business also has a fair amount of legacy voice revenues. And so we need to overcome that voice revenue in order for us to show growth. But over the long term, we believe that's a growth business for us. For the Wholesale segment, that is a business that we manage for cash. Carriers will continue to consolidate -- or is going to be a continuous move from TDM to Ethernet. But we will see demand as wireless carriers roll out 5G networks. We have an extensive fiber network when we expect to capture some of that demand. And on the Consumer side, it's, again, a tale of 2 cities. The voice revenues will continue to accrete away. We'll manage that for cash. But we're very optimistic about the broadband business. We're investing in fiber. We're driving up penetration for our competitive assets. Last year, every quarter, we saw growth on a year-over-year basis. So we'll continue to invest in that business.

Okay. And just since you touched on Consumer, just help us understand where are you on the strategic review. Is that behind us now? Or is that still something where there may be some other things you could do over time?

So with Consumer review, just to be clear, it was always about creating shareholder value. So we did a very comprehensive review, and Jeff spent a fair bit of time talking about it on the earnings call. And so coming out of the review, we have a very good organic plan. And so like I mentioned, I think we are -- we've stopped investing in the legacy networks. We've stopped investing in copper. We are investing in fiber. We're seeing very good traction. We are investing in the digital customer experience. If you think about fiber and the digital customer experience and the customers' propensity to self-serve over time, it's a very high-margin business. So we like the economics. We're investing in it. But a transaction is not off the table. But anytime we look at a transaction, there are some complexity associated with separating the networks, et cetera. But the real yardstick there is what we can do with the business and the cash flow that it generates.

Yes. So it's -- you've got to weigh the choice.

Yes. The one thing I would add is I think the way we're running it, we think we're creating more value every day in terms of improving the margins of that business and getting the infrastructure to be more and more fiber-based.

Right. So if we look at the Enterprise segment, it seems like the booking trends have improved fairly steadily. So what's the latest gem on bookings? And how much of that is things that you've done versus the overall marketplace?

So our fourth quarter sales were very good, especially in IGAM and Enterprise, some part of it driven by the strength in federal. So we haven't seen any change. We would like to think that it really is our execution where we're taking share by leaning in and driving that transformation that our customers are going through.

And how long does it normally take those bookings to turn into cash. The federal stuff has often has quite a long runway, right?

It all depends. It just so happens that we did have a fair amount of large deals in fourth quarter where it does take some time to get those installed. And it's really not just us. It's also the customer being ready to deploy the network and the complexity that comes along with it.

And then on the Wholesale side, with the Sprint-T-Mobile merger, they talked a lot about a lot of network synergies. I think Jeff was here over the last year or 2 talking about similar things, and you know how to do it as well as anybody. But how should we think about your exposure to that as well as your opportunities as you were talking about in terms of being a vendor to them and to DISH as -- helping their 5G deployment?

Just like you said, in any of these consolidations, and over the years, we've gone through a number of them. There is always pluses and minuses. And so they will -- it'll -- hard to tell from a timing standpoint but there will be consolidation. In some areas, we may lose some business, but also all the areas that they will consolidate away from other vendors and we'd want to win some of that business. So we'll lean in. We have a good relationship on both sides. And then there's also the 5G network build and we want to lean into that as well, and also the fourth carrier coming into play. So we like the landscape. There is always going to be pluses and minuses.

And Sprint does have a long-haul business that they've kept there. I mean is that for primarily use themselves? Or do you compete against that business much?

We don't see them as often for the customers that we focus on.

Okay. And then back on the Consumer side of things and relating to your investment here, I think you characterized 20 megabits a second as sort of below that people are cutting the cord or moving to cable or whatever. So -- but it feels like fiber's really what your goal is, and I think you said you've got 2 million connections now. So help us understand that opportunity as a combo urban-plus-rural telco. Can you get economic buildout to a lot more of your footprint than you have today? And how do you do the whole ROI, IRR analysis with your CapEx? And what sort of returns should you be seeing?

So we're actually seeing very good returns with the approach that we're taking. So we have a very micro-targeting approach. When we go into an area, we're doing the analysis at a household level. So as you can imagine, it's a combination of your build cost and how quickly you can penetrate that asset. So the first phase that we're focusing on is really high-density areas, mostly aerial. But I think the economics even make sense beyond that. But right now, there is enough addressable market for us to go after with those economics. So as we think about the Consumer business, what we say internally is really driving up the penetration of what we call the competitive asset. So all our capital is going towards building out fiber because we think that's a durable asset. But we also have a lot of assets today that are competitive. So if you think about CAF, it's in an underserved area we're seeing high penetration, and there is opportunity to continue to drive up penetration there. We also have networks in certain markets where the -- given the competitive landscape, 30, 40 megs is just fine. So we're only focused on really understanding our asset base and then channeling our sales efforts to really drive up the penetration.

So when we saw the CapEx number went up last year and I think, again, this year, so are you getting a lot more homes passed or homes upgraded, say, in '20 versus '19? Or how should we think about that?

So we're going to be very success-based about it. And so the CapEx that you're seeing is a combination of both Consumer and Enterprise. And it's mostly what I would say is fiber and then investing in our digital customer experience. So even on the Enterprise side, some of the federal wins we've had requires a fair amount of builds. Jeff touched on how we've upgraded a lot of our fiber networks with ultra-low-loss fiber. And so we continue to invest in fiber. So that's been one of our primary drivers. The way we think about it is it's a really long-life asset. And there is no real alternative today to that. And if you look at all the emerging technologies, it's all about more network connectivity, it's about more bandwidth, it's about network-based security and it's about applications that need really low latency. And to us, that just means fiber becomes more and more valuable. So we continue to invest in that.

And how does fixed wireless fit into that?

So we've been talking to a lot of our customers, and it's one other technology. It maybe complements it more, fiber more than anything else. We don't see it as a replacement.

Okay. You mentioned the CAF funding. The FCC is moving ahead with the Rural Digital Opportunity Fund auction in June. So I guess we've still got some documents to see here. But what's your latest expectation on how active you'll be in that?

So for us, it's about the economics. And so we like what we see so far. I think the FCCs move towards making it more of a durable asset. We like higher speeds, more facilities-based. Those are things that we like. I think one of the things that get missed on folks is that there is a big opportunity cost to us to participate. What I mean by that, we have to divert resources to build, resources to sell into those assets. So we're going to lean in. If it's a durable asset, that means it's going to be a longer-term good return profile for us. So we see what we -- we like what we see so far.

And where are you on finishing the CAF builds? Is there much more CapEx to go on those?

It will be similar to what we did in the last couple of years. So we're generally on track. I think we were at around 900,000-or-so homes at the end of last year.

Okay. Great. So if we turn to the digital transformation. So are we still in this sort of 3-year program where we're -- by midyear, we'll sort of be halfway through that? Is that the right way to think about it? Perhaps you could just give us a sense of what are the big kind of programs that will bear fruit over the next few quarters.

So about -- call it, about 1/3 of them, maybe more, like 30% of the savings, has been for off-net to on-net or customers that are buying services from us today off-net, but we're bringing those buildings on-net and moving the customers on-net and eliminating that cost. So that will continue, and that will continue even beyond the program. That's an ongoing effort for us. So we're focused on that. Number two, I would say, a major area for us is the digital transformation in terms of the customer touch points. Just to give you a simple example in terms of how we enable self-installs for consumer customers, how they can troubleshoot their WiFi network with an application as opposed to calling into a call center. So there is a series of efforts that we have ongoing to really drive that cost structure change. And then the third bucket would be really rightsizing our cost structure as legacy revenues go away. So think voice switches, rightsizing real estate and other fixed costs. So at a high level, those are kind of the 3 major areas that drive the savings.

And I know you have sort of put this 3-year program in place around your capital structure, I mean but is there a sense that there's always going to be new productivity initiatives that you can continue to lever?

Absolutely. So the 3-year, I would characterize that as programs that we have good line of sight to. But the broader point is we don't see margin expansion kind of coming to an end at 3 years. And that's really driven by the customer behavior that we see, right? So if you think about Consumer customers, everybody wants to really walk into a home and fire up an app and turn their services up and change their services and troubleshoot. And so that's what we're trying to enable. And the same thing is true on the Enterprise side. Enterprise want to consume our network without talking to us, right? And so they want to turn up and turn down services to different cloud providers. And over time, they want their applications to do that. And that has tremendous implications for our cost structure. Now we're not there today. We're making progress in a fragmented way. But that's one of the big initiatives for us to really enable over the last -- over the next handful of years, and that has huge implications in terms of EBITDA margin expansion.

Okay. So there's still -- I mean what sort of -- do you have a stat on calls to care, how that's trended over time? And...

Yes, we have some stats. I think they're all moving in the right direction. I think just Consumer, our call center volume is half of what it was maybe about 1.5 years or so ago. So we continue to make progress. We're continuing to make progress on like online billing, et cetera. So we've got a series of things that we're focused on.

Okay. When you get a market turmoil like this, investors are always focused on why not buy back stock with an 8% yield versus pay down debt with a lower coupon or whatever, particularly in this rate environment. Is there any opportunity to revisit that over the next few -- let's say, you hit the high end of the range before -- of your leverage range before the end of next year. How flexible is that?

Look, we're very disciplined. We're very long term-focused. So if you think about the debt that we paid down last year, now you can say, well, what was the yield on that? The interest savings that I just touched on, so we saved $200 million and $350 million relative to 2018, now that's a combination of paying down debt and refinancings, but I would argue, a lot of that wouldn't have been enabled unless we're on our deleveraging a plan. So that was a very high return on paying down that debt. So we will continue down that path. If you think about the market turmoil, because we're long term-focused, we don't have to tap the markets. In 2021, we have less than $4 billion of maturities, and we intend to pay down about $4 billion, a combination of 2020 and 2021. So we'll be opportunistic. If there's an opportunity to do refinance, we will, but we don't need to. My key point is we manage the business for the long term.

And the dividend remains an important part of that?

It's a very important part of our story. Their coverage is in the 30s if you look at percentage of free cash flow. And so like we said, we're doing 3 things: we're returning a lot of cash to shareholders, we're delevering and we've ramped up investment in the business and really positioning the business for the long term.

Great. Before we open it up for questions, we have to get a coronavirus question in there. Are you seeing any -- or hearing any concerns in the supply chain? It doesn't seem like you're not really buying smartphones during the night. But anything that you're getting that makes you concerned about your CapEx being able to get the equipment or whatever?

We reached out to all our equipment vendors, and we're working very closely with them. So nothing material at this point but still early days. But that is 1 area that would be of concern to us. So we're staying on top of that to make sure that we have enough equipment and where we need it.

Remind us who your major vendors would be.

We won't comment on that.

Okay. All right. Time for a couple of questions. Up front here.

What percent of revenue now is sort of nonstrategic? What percent of revenue would be nonstrategic today or not core?

So if you look at our disclosures, I would say, without giving you percentages, different for business and consumers primarily the voice revenues, and they will -- it will continue to be a long tail. And that is some of the revenues that we'll have to overcome.

So the industry has -- so we're just talking about a lot of consolidation. You've done many deals, both from the Level 3 side and from the CenturyLink side. It's been quiet. I don't know if you've ever gone this long without doing a major deal. I mean you've done a couple of smaller ones. But what's the philosophy there? And what -- is this something that as your balance sheet gets stronger, that we could see more of these RLEC assets out there? There's other maybe more on the software side of things, international assets. What's the focus?

So we've done -- well, we did 1 last year. It's a small, Streamroot, that was really enabling or enhancing our CDN capabilities. So we'll continue to look at small tuck-in acquisitions, if you will. That will be relatively small in the overall scheme of things. In terms of larger deal, we think our equity's undervalued. So that really comes in the way for us doing anything large.

Okay. So most of them will be for cash and -- all right. But are you still looking? Are you still....

We always evaluate.

Yes. Okay. So 1 question we also get a lot is around MPLS and we're talking about legacy assets. So where are we today on SD-WAN, MPLS? And are they displacing each other? Or do you think it's really a joint solution? So how has the experience being through -- over the last few quarters with that migration and the impact on profit and cash flow from that?

So we continue to see demand. We see hybrid networks, like we've always said. And we really don't see any change in that. So as enterprises upgrade their networks or the new sales we're selling into, it isn't like everybody is going 100% SD-WAN. It's been a hybrid network solution in most cases. So yes, it complements the offering that we have.

Okay. And when you look at the -- your segments, the IGAM, the Enterprise, are you seeing much of cable in there? Or is cable mostly competing in the SMB, and you're really competing against Verizon, AT&T?

So we don't see cable much in the higher end of our customer base. Cable tends to be more regional. We see them more when we're in the SMB space. They do a great job in the SMB space. But as you get to larger customers that have more complex requirements, more national requirements, some international requirements, we don't really see cable there much.

So who -- is it mostly AT&T and Verizon that are your main competitors there?

Primarily and then also some pure-play or niche providers for certain parts of the business.

When you talk about the cable companies, they're obviously coming at this with now wireless. I mean it seems like the MVNO opportunities may be greater now, particularly maybe with DISH up there. I think CenturyLink has looked at that in the past. But is that something that could be in the consideration, if you're able to get a decent MVNO, that you might look at wireless again? And you backed out of video with Prism, but is there an opportunity to bundle maybe with one of the other streaming services or something like that?

We've never found that to be something that comes in the way of selling core network services. So as we've approached enterprises and focused on the services that we sell, that's never been an issue for us. So we'll -- that's not something we're focused on.

Okay. Great. We have time for 1 last question. Okay, Neel, thank you so much. We appreciate your time.

Thank you.