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

All right. Thanks for joining us. My name is Phil Cusick. I follow the comm services and infrastructure space as well as media here at JPMorgan. Pleased to be joined today by Chris Stansbury, the CFO of Lumen. Chris recently joined the Lumen team, and before that, was the CFO of Arrow Electronics. Chris, congratulations on your seventh week.

Yes. Thanks. Great to be here.

We'll take it a little easy on you. I mean, listen, you just joined. As you dive into it, what are the main priorities as you just sort of come in? How do you get your hands around the business this big in such a short time?

Yes. it's been a lot of fun. I've had a great support from the team at Lumen, not just my team but more broadly, and that's been a huge help. I mean full disclosure, I started the first day of second quarter, and a month later, I had to report Q1 earnings that I wasn't there for. So that was the first test. And then we had Board meetings last week. But the team has been great. I love the analytical challenge of just trying to figure out something new. And I think there's a lot of opportunity at Lumen, which is really why I came.

I really am curious. So you sit down in the seat, it's April 1. What are the first things you asked for? Like, okay, I need to see these things because I need to understand them to run this business.

The key thing is where do you make money? And by the way, I think that ties right into what the investment community has been looking for from Lumen, which is help me understand this Enterprise thing because, as I look at it from the outside, I don't fully understand what's under the covers. And so what's in decline, what's growing? Where are our opportunities? Because that ultimately not just builds understanding for me, but I think it addresses a really important issue with the investment community, which is how do we do a better job of explaining that externally. So it really helped me on both sides.

So that Enterprise piece is where you sort of start by focusing.

Yes. So I wouldn't say it was just Enterprise, but Enterprise was the more complex piece. I think in the Mass Markets and consumer space, there's clear line of sight to what the key metrics are. And we, in Q1, made the conscious choice to share more of that on the consumer side with investors. And there'll be more of that as time goes on in both segments.

Yes. But you're right. I mean, consumer is a more simple sort of P&Q business. We can all see how many fiber homes...

Yes.

So let's sort of dig down into the Enterprise side, which, as you say, is more complicated. As you dug into that, what are the things that surprised you as you learned about it?

I think the biggest single surprise was just how much progress has been made in the last number of years around key investments to enable growth. And when you start to unbundle the business, and of course, there's legacy product and decliners in there, but there's a significant portfolio of growing products that Lumen had been talking around the edges on but not really shining a light on. And so that's a real opportunity as we go forward, and we'll be doing more of that. But a lot of work has been done to enable that growth, and there's already a sizable base there. So I think we're further ahead than I had anticipated coming in, and that's really encouraging.

So the consumer space is -- the communication space has a long history of declining high-margin businesses being offset by growing, hopefully, someday, high-margin businesses. And so as that sort of shift happens, how do you get comfortable that the overall company continues to be as profitable?

I think the key thing there is that, one, acknowledging it; and two, I think being very conscious about managing those buckets very differently, right? If you think about a growth mindset, when I went into Arrow, it really wasn't growing. It was an industry that hadn't seen growth and we did a lot of things to enable that. But the way you think about growth is very different than the way you think about managing a business that's in decline that you want to harvest as much cash from as you can. So I think not just the visibility piece of it for investors, but I think internally the way we manage the company. The way you incent somebody to run a legacy business that's in decline as efficiently as possible is very different than the way you incent and you resource a growth platform. And so that's the motion that we're in right now. Again, a lot of really good work has been done. But I think some increased focus by managing those buckets differently will not just unlock a faster pathway to growth, but also unlock efficiency in the businesses that aren't growing.

So can you give us a couple of examples of the sizable growth businesses that are underlying?

If you look at what Lumen has done today, I'd say the single biggest one is the Edge product. And today, we're passing 97% of the businesses that matter in that space with 5 milliseconds or less latency. And so that product is growing very nicely. It's in demand, and so that's the biggest. Then you can get into things like SASE and SD-WAN, and those are real growth opportunities as well.

So that Edge product is something we've been hearing about for a while. What's the sort of momentum of current revenue to sales to funnel? Is it sort of telescoping all the way back?

Yes. If you look at the growth -- was just looking at this last week as we were presenting to the Board, if you look at the growth rates, we're kind of rapidly doubling the size of those businesses. Now we're starting from a low base, admittedly. But if you look at the overall portfolio that exists in the business segment, I would say that it's probably in the neighborhood of about 1/3 of our revenue today that you could argue is a growth portfolio. So there's more that we will say around that as we go forward, but we're not starting from nothing.

Okay. It's better than we thought. And then on the declining side, what has been done? And how do you think about doing things differently given your experience at Arrow to sort of mitigate some of that decline going forward?

Yes. The company, in its DNA, does a very good job of driving efficiency. There's no question that, that's there. And I think a lot of work has happened and continues to happen about managing those businesses as efficiently as possible. I think where we go from here, though, is more along the lines of, all right, there's -- if you group products kind of into that grow versus maintain versus harvest. Harvest and maintain are very different, right? Maintain might be in slow decline, but the NPV stream is over many, many years. These are products that are not going away anytime soon. They may require some level of investment to automate to continue to drive efficiency. Whereas a harvest product, it's gravitational pull, right? It's nearing the end. You're not going to be investing in those products. And there, it's about how can you convert those customers to next-gen kind of technologies so that you don't lose those customers. And so very different mindsets, and I think, very different resource requirements. And I think that's where the opportunity lies for us.

Okay. Let's talk about that funnel for the growth businesses. Jeff's been saying for nearly a couple of years that customers have been reluctant to make decisions, sort of waiting on COVID and some certainty there. Where are we now? Are you starting to see some acceleration in that decision-making?

Yes. We are. If you look at large Enterprise and IGAM, we're definitely seeing strong sales. Now sales don't mean immediate revenue, right? And that's, I think, a frustration that we have inside. I'm sure it's a frustration that investors have. But the sales activity is strong. What's happening is customers are moving up the stack. These are more complex solutions that take much longer to install. So if you think about wins like USDA, for example, that's going to take multiple years to get full installation to all the locations. That's the bad news. The good news is they're very sticky relationships over time. So once that pipe starts to get to more of a run rate level, I think we'll see very strong results. But the front end of that, the sales activity is strong. I think in the Mid-Market space, where, admittedly, we've got work to do, again, I think a lot of work has been done. The digital selling motion there is critical and a lot has been done to stand that up. Our Lumen Marketplace just launched a few weeks ago. That's where we can do better. And so in the Mid-Market space, we're also starting to see more pull-through post COVID, but that's a real opportunity for us to get quicker revenue in the system that's easier to execute. So that's a definite area of focus for us.

Has there been any change as we've seen inflation starting to pick up, COVID starting to come back a little bit? Are customers pausing at all?

Right now, we're not seeing the pause. It's more, I would say, people are willing to make decisions. A lot of work -- and this is frankly something that I saw in my previous role at Arrow where, on the Enterprise side, you can only delay those kinds of decisions so long, right? And we're obviously in a world today where security concerns continue to rise. And so I think businesses are now in a position where it's not even that optional anymore, right? There's work that has to be done. It's been put off. And so now they're acting on that.

And what about on the government side? I mean there's been just an issue of people not being at work to make decisions and buy communications. Is that what you see now?

I would say that the government business has been relatively strong. So we've seen good activity there. The key issue isn't really on the sales side, it's now about getting things installed. And with what's going on in the Ukraine, there's a lot of sensitivity around how much of the network gets touched right now. So there's a little bit of that going on. But I would say on the sales side, things have actually picked up a bit.

That's interesting. Just before we leave it, you mentioned something about giving some more transparency on the recent conference call. As you look at the way this company has reported over the last 3, 5 years, how do you think that should change to maybe give investors more confidence in its management?

Yes. I would say that the reporting has been very traditional just in terms of product groupings and channels. So nothing wrong with that, but I don't think that it really highlights what's going on in a more comprehensive way. So rather than necessarily a product focus, really a growth focus. So as I mentioned earlier, I think breaking things into categories of, yes, this is the basket of goods that are in decline. That basket shouldn't surprise anybody, right? We know what those are. And then here's the things that are in less decline or slight growth or more stable that are going to be here for a very long time that are big and important and foundational cash flows for the organization. And then here's the things that are real growth opportunities and they are growing and here's how big they are, and here's where we see them going from here. I think if we did that, we would give a different lens on just how much has been done inside the company and where there is future success in terms of revenue and profit streams for the company. So that's the twist that I'd like to see us put on it, and I think you'll see a lot more from us as we go forward.

I'm curious if you think about those 3 sort of product categories, I imagine most customers have some or all of the 3.

Yes, I think that's right. Absolutely.

So how do you sort of segment like, okay, Bob's lumberyard used to have legacy communications and now he's got all these fancy stuff. Is it really a different revenue stream? Are you sort of allocating within?

At a customer level, it's obviously not. I mean, right, if we want to keep up with the pace of technological change, then we've got to be converting those customers through the technology cycle. But from a product focus, I think when you get into these big legacy businesses, they're so big, right, that if you look at it in traditional categories and channels, you're going to look at a page that has a lot of brackets on it in terms of growth rates and you're going to say, what's the way out of this, right? And I think that's the piece that's missing. So it's not about talking to the customer in a different way at all. So today, we're trying to move the customer through the progress of change. We're making sure they convert from old tech to new tech. It's not about changing any of that. It's really more that there is a new tech solution or solutions that Lumen has and we should be the provider of choice, given our strength in that space. And we do have sizable businesses that are growing. So investor don't just think that this is a legacy company that everything is in decline, which is certainly not the case.

Okay. Okay. Wrapping up on the Enterprise side, and then we started there because it's sort of what I thought was really interesting, you sort of picked that one first. What do you think the opportunities are from here that investors should get more excited about?

I think the real opportunities are really around the things that we do well. I mean, network is our strength. People, I think, are envious of the network capabilities that we have. And when you think about the products that either sit right on that network or on an adjacency or connectivity to that network like Edge, that's really where the opportunity is. Particularly as we move to more automated environments, more distributed environments, all of those nodes have speed issues. They have security issues. They have compute issues. And that is what we do well. So I think there's a very bright future in that for Lumen, and I'm excited to start talking about that more as we go forward.

Remind me what the guidance is for Enterprise and IGAM in terms of growth over time.

I think what we said most recently is that we would see Enterprise growth in total in 2 to 3 years. And I think that's possible. I'm still unpacking a lot of that. Again, had to get through earnings and Board meetings. But as I have more time now to spend on truly understanding where we are, I think that's absolutely achievable.

And is that an acceleration in the third and probably growing sort of growth parts? Or is it just a mix shift as the declining businesses get smaller and less impactful?

It's really both, right? But mix alone isn't going to get you there. You really need to have tangible meaningful growth in that growth bucket, and that's what we're focused on.

Okay. Okay. Let's switch to consumer. Talk about how you have gotten your hands around the consumer business. You've got the legacy copper business, the fiber builds. What are you thinking about right now?

Yes. I mean, obviously, the business gets simplified as we divest of the LATAM and the 20-state ILEC business, and that's -- both of those divestitures are well on their way. But if you look at RemainCo, which has really been my focus as it relates to how we go forward, as you said earlier, it's a [ PxQ ] business. We're looking at 12 million fiber enablements. We're starting -- I'm starting, if you will, at 2.7 million. This year, we're going to add 1 million. Next year, we'll add 1.5 million to 2 million. So really, by the time we exit 2023, we'll be well on our way there. And that's a long-term investment that has a great return associated with it. And as you look at kind of Lumen's investment time horizon, really the next 2 to 3 years when you're looking at both sides of the business, right, consumer and Enterprise, that's the window where we've got to manage things really closely. Once we get beyond that and Mass Markets is growing in total, and we're starting to see the EBITDA generation from the fiber build-out, I think the EBITDA generation of the company is going to be really strong. So we're super excited about Quantum. The feedback from customers has been very positive when you look at Net Promoter Scores and whatnot. The penetration as well on its way to achieving the 40% target that we have. I think the 2020 vintage 1 year in was about 22% penetration. So everything is on schedule. I'd say the biggest challenge is really getting the enablements scale. So there's a lot of time spent, obviously, with market identification then engineering, then permitting. We're actually ordering all the product we need to deploy in parallel with those activities. So that's not a delay once we get permit approval. And so really from the last part of last year to today, it's been about filling that funnel so that we have the -- once we get the permitting approvals, we can get to that 1 million enablements this year, which we will. So that's going to be very back-end loaded just given the nature of the funnel. But really, by the time we exit this year, we're going to be in great shape for 2023 just in terms of the permitting process and having that funnel full. So things look really good.

On the outside, company says, hey, we're going to ramp up CapEx and we just assume that CapEx is going to go from a to b in the first quarter, and you came in below that. Is that just our stupidity because it takes a long time to get these engines up and running? Or has it taken a little longer than maybe you would have thought?

Yes. No, it's definitely not stupidity. I would say that what it really comes down to on that level is just the timing of cash flow. So if you look at accrued CapEx, right, our commitments, we're right on schedule. It's just the timing of when payments get made and the build-out. So again, I think in the second quarter, you're not going to see huge numbers for enablements. It will be sequentially improved over first quarter. But when we get into the second half, and more specifically, third quarter, you start to see things really ramp.

And you've talked about exiting this year, I can't remember, a much faster run rate and then building that into next year.

Correct. Yes. So we'll hit the 1 million this year and then next year, said, we should be at in the 1.5 million to 2 million enablement range. So much bigger next year.

How have you found sourcing material and labor? Because Lumen is the -- probably one of the biggest potential builders, but also one of the last to this party.

Yes. It's -- part of it is we -- on the labor side, we're using a mix of our own teams as well as some contract labor. I don't want to say it's easy, but we've been able to do it. No impacts in terms of delays. And frankly, there's been a huge effort internally to train our teams, obviously, as we make the shift to fiber. So that's been good. On the equipment side, same problems everybody else is having. But again, we're not delaying our ordering of product to wait for a permit. So once we have an engineered design that we know we're going forward with, we started ordering product then so that, once we get the permit, we're ready to go. And so far, that's been manageable and it hasn't impacted our turn things on.

Being new to the communications space, I imagine that working with unions is a fun new lesson.

Yes. Way back, I had some union experience. And look, our -- those teams are an important part of Lumen's success. And the management teams that work with those unions spend a lot of time making sure that those relationships are as good as they can be. So it's certainly the case today. We've got a lot of things that we want to get done. And it's in the best interest of everybody, union or not, to make sure that we succeed.

I would think that teaching people to build fiber and creating that long-term path is really good for the union. Have you gotten some sort of trades that help in terms of maybe work rules and things like that, that would speed this along?

I'm not as close to that. I do know that, again, the management teams in this space are working closely with our union partners on that. But beyond that, I just haven't had the chance to get that deep in it.

If fiber is such a good business, and again, it's easy for me to say from the outside, but why not faster? If not this year, then next year or the year after?

I would say that, really, when you think about the amount of energy that goes into the engineering and permitting side, that's probably the biggest single constraint. Now if we -- and I'm going to take the high end, if we can do 2 million next year, 1 million this year, we're starting at 2.7 million, we're getting pretty close to halfway through that 12 million enablement. So we'll certainly look for opportunities to go faster. I would say that the operations team has just done an outstanding job of reducing the cycle time as much as they can. So we'll certainly look for more opportunities as we go forward, but we want to do this right. We've got a market-based approach that we like. We think we're focusing on the right markets. And we know that getting there as fast as possible is to our advantage. So we're going to stay focused on that.

So you talked about market identification. From the outside, Minneapolis, Denver, Phoenix, Salt Lake, these are massive cities with huge growing populations. Many of us have been surprised that the company was more in a cherry-picking mode over the last 5 years than just go build it. I would think you'd want to just build an entire swath of city almost regardless of what the homes look like. How sort of universal are these builds in the major cities?

I would say that they're fairly universal, right? These are dense urban locations where the demand for broadband and just overall connectivity is going to grow. We're obviously building a network that has scalability in terms of more dense workloads in the future. And so the goal is to blanket those cities so that we are the provider of choice. Obviously, there'll be competition in those markets, but we think we've got a best-in-class product and it will perform very well as we build those cities out.

Are you, for the most part, avoiding areas where there's already been a competitive fiber overbuilder?

I would say that if you go forward, the primary competition is going to be cable and I think that's why we think our product is superior. And if you look at the footprint of where we go with RemainCo, about 50% of that will be Comcast. And so I think from a competitive landscape, what we don't expect is a lot of fiber overbuild competition because there will be 2 -- at least 2 strong competitors in the markets that we're in, us being one of them. And so I think that's good for us as well.

Okay. Yes. No, I wouldn't think anybody would want to build on top of you, but there are already areas. I think about Seattle where Wave has come through and really picked off a lot of that Central Seattle. Do you want to build on top of them and just say, listen, this is mine. You had a good run, but it's over now. Or do you sort of avoid that in this first pass?

I would say that when we say we have a market-based approach, we mean it's the market. It's the whole market. So there will be more competition in certain parts of those markets versus less in other areas. But again, we think we'll stand up well there.

Okay. Sorry. So in the meantime, the copper segment continues to see subscriber declines. How do you think about mitigating the losses in that? Are there areas where you're going to come in and build fiber in a few years or areas where you don't plan to build fiber? How do you treat that?

Yes. I think if you look at, again, our RemainCo business going forward, we -- our copper customers are important. I think in a lot of cases, copper is servicing areas where there's less dense populations. And so people are more reliant on that copper. So yes, there's declines, but I also think there's a population that doesn't want to change or doesn't have a lot of other alternatives there. So we will continue to make sure that we're focused on those customers, and we can service them well going forward. I think if you look at kind of Lumen today versus the RemainCo and the percentage of subscribers that are below 20 meg speeds, it's going to go down quite a bit from where we are today. And so the exposure does get smaller on a percentage basis as we go forward.

How many of those customers -- I don't know if this is too close, but how many of those copper customers are in areas that are uncompetitive or where cable really doesn't have an offer?

I couldn't give you a number outright. I could tell you that in the remaining 16 states, there still is a portion of those customers that are in more remote areas. Again, we've got about -- if you think about 19 million customers and we're going to build fiber to 12 million, you still have a fairly sizeable piece that tend to be in those less dense locations.

Yes. I'm just curious if the penetration of your copper footprint in those remaining 7 million, is that higher than the average?

I don't know the answer to that.

Okay. Okay. And do you sort of price that copper product differently over time? We talked earlier about sort of businesses that are declining slowly, businesses you're harvesting. How do you treat those?

I think -- so we're always looking at, obviously, the price-value equation, and I think that's something that can change over time. I mean, obviously, when we're in a location where we are doing fiber overbuilds, we're going to try to convert as many customers as we can. But we also want to make sure that, that makes logical sense, right? We're not going to go do the added expense of getting somebody to switch if the difference in ARPU just doesn't drive that kind of payback. So we'll look at those market by market, case by case. But where there's opportunities to price, we will; and where there's not opportunities to price, we won't.

Okay. You mentioned Mid-Market earlier briefly. Should we think of the Mid-Market sort of small and medium business looking not like a consumer, but trending like consumer where sort of fiber gets out there, the business starts coming up, copper sort of slowing down?

I think we will see more of that SMB space, more of that Mid-Market business space, making the shift to fiber. Frankly, part of the Lumen platform opportunity is making that selection process easier for our customers but then also being able to wrap additional services around it. So yes, I do think we will see that segment follow, particularly as there's just more demand for symmetrical capacity that continues to grow.

Okay. we've talked about -- you mentioned briefly the Apollo and Latin America transactions. Is sort of strategic change still a big focus right now? Or are you more focused on the assets you have and sort of this is done?

I would say that we will always look for opportunities to divest the businesses that are less strategic or in decline. And as long as it -- there's a good return associated with that divestiture and as long as it fits the strategy, and again, the strategy, I think, is clear, we're going to focus on core assets in key markets where we can drive growth, then we will look at other opportunities.

Is it fair to say that U.S. assets that you wanted to be rid of or were willing to part with would have gone to the Apollo transaction rather than hanging on to them for something else?

I would say largely, but again I would also say never say never, right? For the right price at the right opportunity, there may be more in there. Again, just haven't had a chance to get into that too much. But I would say right now, that's not the focus. Right now, the focus is completing the 2 divestitures that are on the table and I think that's going well, and then -- and really focusing on getting our core assets firing in terms of growth.

Okay. One of the questions we've had for a long time is as revenue collectively has declined and now you've got a new place to put capital, the dividend and then especially returning capital with stock buybacks doesn't make a lot of sense to me. And so help me think about how you coming in look at this on balance sheet. What do creditors say to you about these actions? And just what's your impression overall?

Yes. I mean, the critical thing is our #1 strategic priority is driving profitable growth, right? We're here to drive long-term returns for all stakeholders, investors, employees. That's why we exist. That's why we're here. So the CapEx to support growth and making sure that we're driving accretive returns is job #1. The way I'm looking at it is if we look at kind of unpacking the business and providing more visibility, that's informative to me as well because more clarity around where we're driving those returns will ultimately inform the pace and scale of the investments we want to make, first; and then, second, how we pay for that. So I don't have an answer today, but I would tell you that I think that work, that level of visibility ultimately will inform how we manage our way through, as I said, what is probably a 3-year kind of window until we start to see EBITDA generations from things like Quantum that start to free up more capital.

Okay. That's a good place to leave it. Thanks very much, Chris.

Great. Thanks a lot.

Thanks, everybody.

Good to be here.