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

All right. Great. So thank you very much, everybody, for being here. My name is Frank Louthan and I'm the senior wireline analyst here at Raymond James. Proud to have Chris here with Lumen again with us this year.

So Chris, Lumen's one of my companies that we cover that -- I think the investors, consumers use almost every day and they have no idea how pervasive it is just this [ totals ] probably on your network and people accessing the webcast and over their cable modems that buy Internet access from you. But so tell us a little bit about Lumen where you are, how you fit into the space relative to some of the other telecom names that folks know.

Sure. And good to be here, Frank. Thanks for having me. The business is about 80% enterprise, 20% consumer. So if you think about the enterprise side, it is the largest ultra-low loss fiber network in the world. We've added about 6 million fiber miles over the last number of years. And there's another 6 million to come. We reach 240 third-party data centers with 400 gigabyte service. We have about 150,000 on-net buildings and the ability to expand from there. So connectivity is what we do. It's what we do really well. But we also have strong portfolios in security, in edge compute. So we have an edge compute network that's built that passes 97% of U.S. businesses within 5 milliseconds. And that's something that increasingly companies are looking for. And then there's a real opportunity for us to be expanding into the whole solution space, managed solutions and where partner networks can come in and consume our network assets. On the consumer side, we are largely in the west, so 16 states, also Florida, so good to be in Florida. And we're doing a significant fiber build across those assets that we expect will reach in the neighborhood of 8 million to 10 million homes in the coming years. We're at about 3 million right now. And so that's a much longer-term opportunity for us as well. So -- and that can reach also a small business depending on what their needs are. It's a very scalable product. It's a very easy-to-consume product that is going very well with consumers.

All right. Great. So 2022 as a year of management turnover in my sector, including Lumen, you joined just under a year ago, have a new CEO since -- named whole new executive suite there. Talk to us about the differences and how the new leadership team, management team are going to go about the business that are maybe different from what folks knew about the company before.

Yes, it's really an interesting space to me. I came from outside of telecom. Kate Johnson, our CEO, and a lot of the leadership team came from outside of telecom. And that's with intent, right? I think when you look at broader telecom, one of the more interesting things to me is it's a sector where I think a lot of people in management have this belief that everything is going to continue down and to the right and that there really aren't opportunities for growth, and they manage accordingly. And when you look at Lumen historically, it was a very internally-focused company. It was focused on efficiency. It acquired a lot of assets. They did great work with that. But longer term, that wasn't a winning strategy. If you look at what we do on a daily basis as it relates to connectivity, that's increasingly getting commoditized. So that's not an interesting ending to the story. The way we monetize that or this is by selling the services and bringing value added to market that companies are buying but really rely on that network. And so that's where we think we can compete very effectively. And the management team that we brought in is focused on that. Very heavily tech-based in terms of their backgrounds, companies like HP and Red Hat and Microsoft. And they're very aligned and focused on where we're going. So if you look at our vision as we go forward, it's quite simply to connect people, data and applications quickly, securely and effortlessly. And it's those last 3 words that are really hard to do, and that's where our focus is. From a priority standpoint, we have 5 for this year, and they're really important to share because I think they speak to the shift that's going on inside the company. The first is developed customer obsession. Again, like a lot of companies in our space, Lumen was very internally focused on driving efficiencies. It worked for a number of years, but it's not a pathway to growth. And so building something and expecting customers just to show up and buy it, that's not going to work. You've got to be really focused on what customer problems are and how you're going to solve them, and that's developing customer obsession. The second is innovate and invest for growth. We, this year and probably next are investing about $700 million of our free cash flow in really 3 things. The first is how do you digitize the end-to-end selling process. We've got a really good front end. It's a great customer experience, but provisioning and billing and all the things that come after that front-end experience are broken. So that needs to be digitized. So it's a much more seamless way to buy. And that's particularly important in the mid-market space, but even on some products in large enterprise. The second would be the investments that are required for us to sell more network as a service. So you think about solutions integration and the expansion of a partner ecosystem that consumes network, we want to make that really easy to take place on Lumen's network. And then the third would be to really automate internal processes like a lot of telecoms, a lot of M&A over the years that has created an efficiency, too many IT systems and we're going to clean that up. So that's really innovating and invest for growth. We need to build a far more reliable execution engine. That's the third one. So if you look at our execution in the marketplace today, we've got a great product. We compete well, but we're not performing at the same rates in a lot of our product categories as the market. So a deeper focus on execution, making sure that incentive systems are aligned is a key focal point for us. Radically simplifying the company, I talked a bit about that with the IT investment. And then the last is to develop a growth mindset culture. Again, telecom is a space where winning is defined as losing last, which is not what we want to be. Winning is going to be defined as growing. And so that's what the new management team is focused on.

Okay. So you laid some of those out. And so what are some of the tactics to get to top positive top-line growth? I mean that's kind of the long-term challenge here. It's a slow process to understand. But what are some -- can you be a little more specific on some of the things you're tactically -- you do that can put all those pieces together and solve them?

Sure. So if you look at just the products that we have in hand today, and again, I would say that we're starting from a position of strength vis-a-vis our competitive set with investments that have already been made, things like edge compute, I talked about, SD-WAN, SASE. So it's twofold. It's how do we bring better product, more differentiated product to market? So think of things like we own Black Lotus Labs, which is world-class proactive threat detection on bad actors around the network. The U.S. government relies on it. Governments around the world rely on it. We can monetize that. We haven't and we can. So that can be part of our security solutions going forward. So there's some near-term things that we can do there. But the other piece of it really comes down to making sure that everybody is aligned around execution. So I would say that the accountability model, the incentive model has fundamentally changed in the last 4 months. The way we set quota, the way we focus all of our resources around who gets what financial and human resources depending on which products that they're in. All of those things are now aligned this year. And with all of that, that's why we believe we can get to relatively stable revenue and EBITDA by the end of '24 and growth thereafter.

All right. Great. So one question I get a lot from investors, especially more generalist, Embarq, that's a wireless asset. Talk to us about that. How does that affect your ability to sell and talk about it both from the large enterprise and also the consumer side.

Yes. It really hasn't impacted our ability to sell at all. I mean if you think about data and yes, more and more data is connecting through wireless, I've been doing it here today, but data wants to find its way to fiber as fast as it can, right? It's -- if you think about all the 5G towers around the country, they're connected to fiber. So we have relationships with the wireless provider so that if we have an on-campus environment or a customer who has a wireless need, we can bring that. But we don't feel we need to own those assets, again, back to the kind of the partner ecosystem to compete effectively. There's people that do that far better than we ever will. And we're going to stick to what we're good at, but we can bring in those partners when we need to, to bring the right solution to a customer.

All right. Great. So one of the things that you promised right off the bat was bringing us some more KPIs and how we can look at the business and give us some more information there. You've given us some grow, nurture and harvest buckets. Talk us through what goes into those, how you came up with that and how investors should view those parts of the business going forward?

Yes. When I came to Lumen, like a lot of our investors, there was not good visibility into what was inside of enterprise. When you think about the way we talked about products, it was a very high level as well as channels. And so the reason for the shift to grow, nurture and harvest was really twofold. One of it was disclosure because we think it gave a much better picture of why we saw a pathway to growth. But it was also a way for us internally to bring more of that product life cycle mindset to the way we allocated resources. So when I arrived at Lumen, and started to unpack what was in the Enterprise segment. 70% of our product managers thought that they were in products that needed to grow. So they were asking for CapEx and OpEx and human -- I mean it was just nuts, right? Even products that weren't #1 or 2 in their category or they were in categories that were in steep decline. And so that nomenclature forced us to think about who got what? Where we're going to focus resources and where we weren't. And that has now led right into all the changes that we've made this year. So it's been tremendously helpful. If you think about what's in those buckets, high level, think of harvest is legacy voice, so things that aren't really sold anymore. Nurture, think about things that are being sold, but at declining rates, VP and Ethernet. And in the grow bucket, think about IP, waves, SD-WAN, SASE, edge compute-type solutions.

Okay. And so how should we think about the life cycle of the nurture and the harvest? Those are both -- myself and I think investors, we're a little surprised to how much those were declining. How should we think about how you can -- you talk about bringing the life cycle mindset there, move those out and then replace them with other products?

It's a really interesting opportunity because one of the things that I think existed certainly at Lumen, and I think more broadly across telecom is there is this mindset of, hey, if you've got an EBITDA-rich customer buying an EBITDA-rich product, don't go talk to them, right? Leave them alone because they might wake up and turn something off. And so if you look at the opportunity that exists here, first of all, this is a motion that will continue forever, right? What is currently a grow product, 10, 15 years down the road could be a harvest product. And then there's the next thing. So this needs to be a muscle memory that we build. But the shift is, no, we need to be having proactive conversations with customers where we can shift them from an old technology to a new technology. And it's about customer lifetime value. Again, it's about that outside-in customer-focused rather than inside-out operational EBITDA-dollar focus. And so there's specific programs that we have for this year around voice migration -- legacy voice migration around TDM-based VPN migration. And that's not just about maintaining a longer-term revenue cycle around those customers. It also unlocks our ability to get at some really cost-inefficient technologies where we could go in and start turning off very expensive switches, TDM. And so that's a huge focus for us. It's part of how we've built targets and quotas and everything else for the year. So everything cascades from that.

Okay. Great. And with that, you've made some divestitures. But there was Latin America, the Midwest assets sold in the European business. Talk us through the thought process. You got good multiples for all of those. So besides that, talk us through sort of the thought process of how that simplifies the business? And how does that help you move forward with what you've been describing?

Sure. I think the winner in this space longer term is going to be the company that has the easy button, if you will, for our customers. They can still provide that global connectivity, but now through a much more regionalized footprint that exists around the world, this is a space that needs scale. It's a space that needs constant investment to keep pace with technology change. And so there was no way that Lumen could continue to support all of those assets as well as invest in the spaces that we feel we need to grow. And so that's really what drove the decision to divest. The LATAM transaction was a really great valuation. But it was an asset that on a free cash flow basis was generating very little. So it gives us the opportunity to still have those relationships but to let them focus on success and scale. EMEA looks much the same as that. And then the 20-state ILEC, those are more mature assets in more rural areas, where we just simply weren't going to invest and do what that business needed going forward. So it was a way -- all those things are a way for us to monetize those, reduce debt and focus our efforts where we think we can play best.

Okay. Great. And so another conversation I often have with investors, they look at a large enterprise part of the business, which is now even bigger part of your business. And they believe it's somewhat impaired, they don't see a lot of growth. Even if you look at AT&T and Verizon, who arguably don't care as much about those anymore, but what do you -- what would be your answer to that? And how do you see getting being able to get growth out of that bucket again?

Yes. If Kate were sitting here today, she'd talk about total addressable problems rather than total addressable market. And again, that's that customer mindset, what problems are they trying to solve. They're buying these services, but is not buying them from us. And there is some special sauce we can bring with things like Black Lotus Labs, with our edge of network compute solution that is differentiated and so we really should play well there. Those kinds of investments, nobody else has made in the space. So you're right. If you think -- look at our competitive set, they're more focused on the assets where they play well. So there's a huge obvious focus on wireless. They've got tough competitors, and they're all fighting with each other over that space. We don't have any competitors who have made the investment in the underlying network that we have. So we're starting with something that's incredibly strong. It's how do you monetize it and our focus is on that. And certainly, the management changes and the refocusing of our resources on those growth products is why we think we will do well. I think there's also some real data there when you look at public sector. If you -- the public sector space, things move in a chunky way. So you got to be really careful about looking at year-over-year changes, but huge wins last year for Lumen. These are share-taking gains. DOD, Borderland security, USDA, USPS, every one of those contracts is incredibly complex. So if you think about the new world of hybrid work, which we firmly believe is here to stay, that requires complexity in terms of communication, security, everything else. In complexity, there is margin. And those wins we're also experiencing a large enterprise. We're not able to talk about those logos, but you'd know what they are, but we can do better. And that's why we think we'll continue to take share and grow.

Okay. Great. So on the consumer side of the business, let's talk a little bit about the fiber upgrade, what the goal is there and the opportunity, and then we'll come back and talk a little bit about what the current status is.

Sure. I mean, I think if you think about our existing copper plant footprint, that's a really good example of where Lumen did a fantastic job of not cannibalizing itself, and it's why we've only got 10% penetration right now, right? It was truly one of those things of now don't invest because the customer might leave and then a customer left anyways. They just went to cable, broadly speaking. So the investment in fiber is a big one for us. The product that we have is -- has been received incredibly well by our customer base. So NPS scores above 50. It is a -- there's no contracts, so there's no termination clause, it's a prepaid product. The price point is right. It's a $65 a month, all taxes and fees included, and it's very scalable. So once you have the device in your home, very easy to scale up or scale down. So it plays well. We've done very little marketing because we haven't been at scale and the penetration rates have looked good from that. We're focused on 6 major metros. So Seattle, Portland, Denver, Minneapolis, Salt Lake and Phoenix. Those are tough markets to build in. We're talking about rocky soils. We're talking about a lot of permitting, and we have physical plant in those markets, which we think is critical in terms of the ability to execute. So that's the plan.

So on the prepaid side, that's interesting because I know I have a couple of smaller private companies are doing that. I think it actually makes a lot of sense. I haven't heard of any of your public peers doing that. What's sort of the response from customers? Do they care? And it must be much easier from your standpoint and lower bad debt...

Yes, there's been no pushback on that because, again, we're also not asking to sign a fixed-term contract. They can turn it on, they can turn it off. So the whole point here was to make it very easy to interact with our Quantum Fiber product. And as a result, there's been -- there's really been no resistance to that.

And so you made a decision to sort of pause the build there, generate a lot of inbound calls for me. So I appreciate that but...

Yes, for me as well.

But tell us -- so what is the rationale here for sort of pausing the spend? And is it something that -- is it about the opportunity? Is it just -- how should we think about it?

Look, it's -- there's a few layers to it. When I came to Lumen, the operations team only had 2 metrics, get to 12 million enabled locations at $1,000 per enablement. Well, that's troublesome as a CFO and so you want to make sure that you're building to the right markets and maybe $1,000 isn't the right number. We're now at $1,200. If you can earn a return on the locations in the markets that you're in, that's what matters. And so that's what the focus was. But the real early-tell was that what we were doing in '21, we were seeing lower penetration rates than we were seeing on the 2020 vintage. So the 2020 vintage after 12 months was at 22%. It's now over 30%. The goal is to get to 40%. The '21 vintage was 17%. That's not good enough in terms of the ramp that we expected. So clearly, something wasn't right. We hit pause to make sure that we were doing the right things. Just 1 data point that we'll share as we go forward. There's something that we look at internally called planning yield. And if you think about the top of the funnel being here's all the locations we plan to go to and then people do site walks, and then the engineers start doing a whole lot of work around what the specific build is going to look like, and they come up with a cost estimate and then it goes to my finance team and the finance team says, yes, that makes sense or no, it doesn't. Our planning yield was horrendous. It was sub 20%. So over 80% of our resources were wasted. When Kate came in, she made some immediate changes in the first week. The first thing she did is she took operations and split it. It was a horizontal function that supported both enterprise and consumer. Consumer -- the consumer build now reports to Maxine Moreau, who owns that entire business internally. So dedicated resources. The second thing we did is we took the planning function out of operations and moved it into finance. Within a month, that planning yield went to over 90%. And what we've seen consistently since when we measure it weekly is a 7- to 8-fold increase in the number of units coming through that are passing, if you will. So that flywheel is really starting to get moving in the right direction. I think what's interesting now is even as we've done that, and we're going to build 0.5 million units this year, we've seen a lot of our competitors start to adjust. I think some of that relates to the inflationary pressures that are real. But I think there was also a little bit of a gold-rush mentality as it relates to fiber to the home. And I think that emotional exuberance has been at least tempered somewhat with some more rational thought. And I think people are pulling back on their build plans, more realistic cost estimates and ARPUs coming with that as well.

Have you seen any -- go the other direction that were building in your territory and see your pause as an opportunity to take some share? Are you concerned about the opportunity cost there at all?

Not really. I mean, again, it's -- to succeed in this space, you really do need operations on the ground. And so the markets we're in, we have strong -- a strong operating model. They're tough markets to build in, as I mentioned earlier. I'll give you an example. We're obviously out of the Greater Denver area. We see overbuild activity, if you think about 90 miles outside of the Denver area. So you think about 4 coins to the north, Colorado Springs to the south, Greeley. You see a little bit of activity in those markets. You don't see it in the core of Denver, where there's really high density and it is hard to build. So there's a little bit, but it's really not at the core of what we do. And frankly, I think over time, there'll be a fallout from some of those players as well, and that may provide future opportunities for us down the road. We'll see.

All right. Great. We have to see and take a second and see if anybody has any questions from the audience. All right. So as you -- also with this, how do you think about it where there has been some overbuild activity, right? So if you're looking at a market, there's a cable company there, someone else has already overbuilt. As the lack as you mentioned, you've got network there. You've got a lot of advantage on the make-ready costs and everything else to start in there. Is that enough? Do you think if there's already 2 wires there? Is that something you would just model, would you build?

Yes. No, if you think about it, I mean, really being first or second with fiber, I think is critical. But the reality is this is a share-taking opportunity from cable, period, right? The share that we lost, that 10% copper penetration that we have today, that was lost to cable because cable had a better offer than DSL. Fiber is a much better offer than cable. And so it's -- the tables are turned now. And when you look at the markets that we're focused on, it really is cable that we're competing against. So in most cases, we will be number 1. But even if we're number 2, there's a tremendous opportunity for us to take share there, and that's our focus.

Yes?

The general companies are migrating on the [indiscernible], but also in fiber deeper and they can get sort of something much more comparable to fiber I guess just wondering how do you differentiate from some more advanced?

Yes. I mean DOCSIS is a thing, but it's not symmetrical. It's not. I mean our $65 a month, again, all taxes and fees included product is a gig up and down. It's symmetrical gig. So it's a far more superior product. There is obviously activity where they're obviously trying to bundle wireless wherever they can and everything else. But their price point is higher than that. So the ability to compete going forward, I think, is tough for them because they've got a very high-margin product. They're obviously subsidizing wireless right now to compete. That's a real opportunity for us. I think it's going to be hard to compete with the product offering we have. Again, no contracts, it's not just the price and the performance. But I think that's our opportunity. Yes?

[indiscernible]

Yes. So that comes after this. So really, if you think about it, it's a simple model financially, right? You invest the money upfront, it's PxQ, you've got your return. The hard part is getting that flywheel of the factory moving. And now that we've got the planning nailed, I think you'll see that grow quickly. By the way, that's really critical because that allows us to more effectively negotiate for things like third-party labor. You need to have a volume base to be able to negotiate effectively. And when you're only just doing a few or if you're trying to micro target markets, you're dealing with what you can get. And so there's really a twofold piece to this. One is you get better momentum just internally in terms of the resources, but you get much more leverage externally with the third parties that you need. So we'll come back. We're having the Investor Day in June to provide a lot more detail around how we see ourselves turning to growth in total, but that will also provide some more detail on the consumer build and how we see that ramping from here.

[indiscernible]

Yes. To be honest with you, I don't know where that number came from. So -- but from our standpoint, we're focused on the right markets. And frankly, from our standpoint, the fact that a number of our competitors are now pulling back on their build plans, I think, is a good sign that, that supply-demand equation on third-party labor could be coming closer to equilibrium.

All right. Great. Chris, thank you very much for being here. We'll have a breakout session after the same moment, so continuing the conversation. Thank you very much.

Thanks very much.