Greetings, and welcome to Lumen Technologies Second Quarter 2022 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded Wednesday, August 3, 2022. It is now my pleasure to turn the conference over to Mike McCormack, Senior Vice President, Investor Relations. Please go ahead, sir.

Thank you, France. Good afternoon, everyone, and thanks for joining us to the Lumen Technologies' Second Quarter 2022 Earnings Call. Joining me on the call today are Jeff Storey, 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 2 of our second quarter 2022 presentation, which notes that this conference call may include forward-looking statements subject to certain risks and uncertainties. All forward-looking statements should be considered in conjunction with the cautionary statements on Slide 2 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 that can be found in our earnings press release. In addition, certain metrics discussed today exclude costs for special items as detailed in our earnings material, all of which can be found on the Investor Relations section of the Lumen website. Before turning the call over to Jeff, please be aware that we will not be able to discuss our active cash tender offers for certain of our outstanding debt securities. These tender offers are expected to expire later this week. With that, I'll turn the call over to Jeff.

Thanks, Mike. Good afternoon, everyone, and thank you for joining us. On today's call, I'll provide some thoughts on our second quarter results as well as our plans for the second half of the year. Chris will discuss the second quarter in more detail, and we'll reserve time after Chris' remarks for your questions. I want to begin today's call by thanking our team for the hard work in closing the LATAM divestiture to Stonepeak. We are excited for the team at Cirion, but we'll certainly miss our LATAM friends and colleagues. Our ongoing partnership will allow us to continue working with this extremely talented team. We are also looking forward to the upcoming close of our ILEC transaction with Apollo. We are working hard towards an early fourth quarter close. Combined, these transactions streamline our focus on the most strategic opportunities for Lumen, which we believe will drive significant long-term shareholder value. Chris will provide more detail on our new business product group formation and what that will mean on a go-forward basis, but I can tell you that our teams are energized by a clear focus on managing products by life cycle. Our reinvigorated approach to product life cycle management will help customers transition to go-forward technologies and allow Lumen to maximize the contributions of more mature offerings, all helping to drive our #1 priority, profitable growth. Our Quantum Fiber build is ramping with second quarter enablements more than doubling since the fourth quarter of last year, and we expect further acceleration in the second half of 2022 and into 2023. Permitting processes for our Quantum Fiber builds haven't improved as much as we would like, and we see supply chain challenges across our business. But we have not changed our target of 1 million or so enablements…

Thank you, Jeff, and good afternoon, everyone. It has been about 4 months since I joined the Lumen team, and I am more excited than ever for the opportunities that lie ahead. I've been working with the leadership team here at Lumen to rethink the way we manage our business and products. You'll find a change in the way we plan to report our revenues of the Lumen business segment in today's materials. After closing the ILEC transaction, which is expected early in the fourth quarter, we will provide a pro forma historical revenue view of these product groups. I want to emphasize that these new categories are not simply a recut of our external reporting but a significant internal change that addresses how we manage the products that reside within each category. This will drive enhanced efficiency and discipline as we drive towards our key strategic initiative of attaining profitable top line growth. As Jeff discussed, we face some macro headwinds, and we are actively working to address these challenges through cost reduction and other initiatives. We will keep a watchful eye on these issues that are and will likely continue to impact nearly every industry in the near term. With that, I will begin with a financial summary of our second quarter. We are very pleased to have closed the LATAM divestiture to Stonepeak on August 1 for approximately $2.7 billion, and we are on track for an early fourth quarter close of the ILEC divestiture. Our revenue performance has improved across all enterprise channels with overall business revenue growing sequentially. We continue to see fiber broadband revenue growth, which is helping to improve our Mass Markets revenue trajectory and supporting our expectation for Mass Markets broadband revenue and subscriber growth in the second half of next year.…

[Operator Instructions]. Our first question is from Simon Flannery with Morgan Stanley.

Chris, thank you for the new disclosure on the nurture and grow, et cetera. Are we going to get profitability metrics? Can you give any sense of how the margin is distributed? And then on capital allocation, you had a few months now to look at this. Can you just give us an update on timing when you'll give us more thoughts? And where do you stand today on the thoughts about leverage, particularly given the inflationary pressures, dividends, buybacks as we go into '23 and beyond and the CapEx ramps?

Sure. In terms of the product categories, we'll continue to look at how much we disclose around that. I want to be careful. Obviously, we don't want to disclose competitive information. I can tell you that broadly speaking, if you look at the margin profile of the different buckets, while they differ, it's not drastic. So at a gross margin level, all of those buckets do have strong margins. Obviously, on the OpEx side, we'll invest more in grow because we're really trying to get those products moving along. And we're going to invest a lot less in harvest as we're managing for cash. So we'll think about it. I think for now, this is a good start, but we'll see what we can do around more color going forward. As it relates to capital allocation, I'd just say, look, the discussion on the buckets and obviously getting more aggressive on things like harvest and managing for cash, those are all inputs. Obviously, closing the divestitures are inputs. The macro environment's an input. So we continue to evaluate that. I think it's the right question to ask. I would say, at this point, no change, and we'll continue to monitor that as we go forward. We feel good about the work that we're doing to finalize the divestitures and focus on growth, and we'll keep you updated as we go forward.

Great. And just, I guess, one just follow-up on that macro point. One of the other telcos was mentioning yesterday some notion of delayed decision-making by enterprise, longer quote to contract signing. Are you seeing much of that yet?

We don't see -- it's early to say, okay? So I'll try and answer the question, Simon, but it's early to say. We don't see necessarily a slower decision-making to the technology choice, to picking us. We might see a little bit of slower signing. There may be more people in the process for signing these contracts. But we don't -- we aren't seeing necessarily yet a slower decision-making on picking the technology, picking the winning thing. But it could be a little bit more thoughtful from our customers and how they sign and when they sign.

Our next question is from Brett Feldman with Goldman Sachs.

And actually, I'll follow up on that, Jeff. Could you maybe elaborate on what continues to be a priority for your customers? I mean, it would be very easy to say that they're just going to put things on the back burner. It would sound like from your answer that there are elements of their network transformation that they fully intend to pursue and are maybe just being extra careful with how they select vendors. And so if you can give us some sense as to what those big projects are and why you remain confident that they're going to move ahead with it, that would be helpful. And then just a follow-up question. You made the point earlier in the call that while you're seeing some inflationary cost pressures, you are identifying ways to cut other expenses and you're keeping your outlook for the year. The reason I ask about that is you had implied you were going to do a little less in terms of cost transformation this year because you were more focused on investing in areas that would support the company's growth as you move through these transactions. And I'm just wondering, are there any areas where you had to make a trade-off in terms of managing costs this year relative to what you had hoped in order to make sure you're still coming into your financial commitments?

Sure. So back to what are we seeing from customers, I'll take that one first. The -- we see customers -- unlike COVID, when COVID hit, people just said, "We don't know what's going on. We got to stop." Unlike that, what we see today is people are looking -- customers are looking at their networks and recognizing that they have to continue to transform. And they have to transform in the products and services that we've built the Lumen platform to deliver. So fiber-based services through APIs where they can use edge computing to augment their cloud computing, use edge storage to augment their on-premises storage. They are moving toward those solutions, embedding security into them where they can, as you've heard me say before, be very nimble and adaptive and innovative in the way that they acquire, analyze and act on their data. And so we see that continuing as customers continue to upgrade. And in fact, in some -- historically, we've seen that during economic downturns, customers will accelerate some of that so that they can gain efficiencies within their own business. And so that's kind of what we're seeing today. With respect to expense reductions, and Brett, I'm interpreting the question as, did we give up anything as a result of the acquisition -- or the sale, the divestitures that we have, we did delay some of our ongoing transformation because the same people that were preparing for those divestitures were the people that drove our ongoing transformation. We talked about that early in the year. Those are coming to a close. And so we're continuing to look at transformation. But Chris alluded to the fact that we were actually doing more than that. It's not just the -- going back to the path that we had. We continue to look at everything, and we make sure that we figure out how best to deal with the environment that we've got. I'll give you kind of an ancillary example. We have CWA District 7 that represents about 5,000 of our employees. It's the largest union representative group that we have. And our contract with them expires -- I believe it's April of next year, right around that time. We started months ago working with them and trying to give predictability into our costs, trying to give predictability into our workforce and how we can align jobs and that sort of thing. And last night, the union members voted to ratify the agreement that we've made. So we have much better visibility into our cost structure for the coming 3 years beyond April of next year. And so those are the types of things we do on a very regular basis to make sure that we're looking at our cost structure, that we're looking at how do we invest in growth but, at the same time, fund that growth.

Our next question is from Phil Cusick with JPMorgan.

I wonder if you can talk about any sort of onetimers we should be considering, either in the SG&A or the cost of service side. Costs were a little bit higher than we expected. And then it looks like from this quarter's EBITDA, you're trending at the low end of guidance. You talked about some costs that need to get done to get there. Anything else that really needs to get done to get you to that low end of guidance or alternatively, things that could come through and really take you well above that?

Yes. Phil, it's Chris. The -- if you look at the quarter and just some of the cost pressures that we faced, I'd say that the bulk of it really relates to what other companies are seeing in terms of inflationary pressures on things like energy and labor. And obviously, just as a reminder, our Q3 is seasonally always one of our toughest for energy consumption. So I think near term, those pressures obviously continue. We did have some onetime activity that hurt us a bit as it relates to a little bit on rerates, and then we do have some of our transition costs. I mentioned that, that hit above the line and then we recaptured below the line, and that was in there, too. But I'd say the bulk of it relates to inflation. So we've gone in, and I wouldn't say that there's any kind of major shift in how we're managing the business. This is, I would say, business as usual in terms of how we respond to macro events like this. So we are working as a team to take cost out, look for things that aren't going to have near-term impacts on our ability to grow, and those are the things we're going after. In terms of being able to do better than that, I think that's really where, again, the new product portfolio focus can help us. I think the harvest teams are looking at a lot of different things that probably don't have an immediate benefit but in the relatively near future could have a benefit, but they're just getting started. So I'm optimistic about that but more to come as we go forward. So right now, we feel good with the guidance because of our ability to respond to the external environment with the cost cuts.

Our next question is from Eric Luebchow with Wells Fargo.

I wanted to touch on the supply chain. Jeff, you brought that up earlier in the call. It sounds like there were some pressure points there. Maybe you could provide some more color, whether that's related to equipment or materials or labor availability. And does it change at all kind of the plans to accelerate the rate of Quantum Fibers up to 1.5 million new fiber passings by the end of this year? And then secondly, I just wanted to touch on the -- some of the inflation pressures again. I'm just wondering, to what degree do you think like you have the ability to maybe raise pricing on some of your products that you're selling to maybe offset some of that? Just wondering, in the enterprise outlook, how the pricing equation looks versus the volume equation on growth.

Sure. I'll take the first half of that question and let Chris talk about the second half. On supply chain, Eric, you asked if is it equipment, labor or materials. The answer is yes on all 3 of them. We deal with each of them differently. But the inflationary pressures that you see, that the rest of the market sees are the same ones that we see, and they come in those 3 main areas. We've got great -- not the inflation -- I'm sorry, the supply chain pressures. We've got great relationships with our large vendors. So whether that's material vendors or equipment vendors, we've got great relationships with them. We're working through their challenges with them, and we feel pretty good about that. And we think it's improving slightly. But it's too early to call whether that's a blip or a trend. And we'll continue to stay very focused on that, working closely with our large suppliers and our large vendors. And we will continue to work on labor costs. So for example, I mentioned CWA, but one of the things that we've also done with our employees is we brought -- we plan to bring all of the Quantum Fiber splicing in-house. We want to do that with super qualified technicians, very capable people. That's very important to get done, right? So we'll continue to look at how can we do some of these things ourselves as opposed to going out in the outside market. With respect -- does it slow the Quantum Fiber build? I have not changed my expectations that I've given our team, okay? I still want to get to close to 1 million homes this year. It certainly does affect us. We've talked about permitting. I mentioned it in the comments. Their labor shortages in permitting departments causes problems for us. Labor challenges in electric companies cause problems with us for pole attachments. And so there are other people's labor challenges that do cause us to slow. But I have not changed my targets that I've given our team internally at this point.

And Eric, to the second question on the pricing environment, look, I think the pricing environment is favorable right now. And certainly, we will adjust where we can and be at market rates. We're going to make sure that we're maximizing the value to our shareholders by pricing where the market is. And that's certainly part of our plan as we move through the current environment.

Next question is from David Barden with Bank of America.

First, I guess, Chris, I think last quarter, in preparation for retooling how the reporting for the business segment happened, there was a conversation about KPIs and the idea that one of the missing links between the market and your guys' internal view of the business is that we don't have a buildup to get to these revenue categories. So I know Simon was asking earlier about the profitability. But I'm asking if there's an ability -- an intention and an ability to share something like that with the market. I guess the second question would just be on broadband, kind of 2 subfactors in there. One, the transition from the EBB program to the ACP program, a little less money out there, a little less government stimulus helping the broadband segment; and then fixed wireless access looking like they're going to come in with 100% market share in broadband this quarter. Could you kind of comment on the impact that those 2 things are having on your kind of run rate business and your outlook for fiber?

Before we answer, David, would you repeat the second part of that? I didn't catch it.

Sorry. The second question was the impact on the broadband business from the twin forces of fixed wireless access and the kind of reduced government stimulus in the system.

Okay. The part I missed was fixed -- I just didn't understand it. Thanks. Go ahead, Chris.

Yes. So David, I'll certainly spend more time looking at this. I do want to walk before we run. I think the biggest gap at least that I saw between how Lumen was reporting and the way we were talking about the business was really giving insight into how we're going to grow. So I think this was a first big step, and we'll certainly continue with that as we go forward. I do -- and I base this off of my previous experience, I do want to be careful about telling too much to our competition about where and how we make money. I think that's -- in a lot of ways, that can provide more harm to Lumen's shareholders than benefit. So we'll certainly consider that as we go forward. We'll certainly try to give more color, but I do -- I don't want to overpromise on that at this early date. And you do have my commitment. We'll continue to certainly talk about the revenue pieces and try to give more color on that as we go forward on how we're going to grow.

With respect to stimulus and what is that effect on the broadband -- the transitioning from one stimulus program to another one investment program, subsidy program, we -- it's too early to say. These programs are just being established. We'll see what they look like and how they come out. We do think there are opportunities for Lumen and Quantum Fiber to engage with those government programs, to make sure that we're bringing our capabilities to the largest footprint that we can. But our strategic focus is also a part of that. If you look at our Quantum Fiber build, we're focusing in on areas where we have network advantage, where we have scale advantage and where we can invest in dense ways to make sure that we have the low-cost advantage on building out networks. And so our strategic focus in honing in on the places that make most sense for Quantum Fiber is part of that whole equation. With respect to fixed wireless access, I don't know if you're meaning in Enterprise or if you're meaning in Mass Markets. In Mass Markets, I'd love to compete with fixed wireless access. Is it going to have an application? Of course, it is. The fiber wins, we announced this morning that we're going to build -- that we have the capability. On the platform that we're putting in the ground today, the platform delivers 8-gigabit solutions, 3-gigabit solutions. We can go to where our customers need us to go, and I think fixed wireless access runs out of scale much quicker than that. And you've heard me say this many times. Communication, data wants to get to glass as quickly as it can. And so we strongly believe in our ability to build Quantum Fiber in a way that competes with fixed wireless access. If you look at the Enterprise side, I have some of the same comments, but I see it more as an opportunity for us as we do campus area networking for our customers. We take the traffic in. We'd carry it out to our edge storage. We may use fixed wireless access to help them with their campus area networking. And so that's kind of my comment on that.

Great. If I could ask one quick follow-up on wholesale. AT&T guided down their enterprise segment for the rest of the year based on higher rerates and the cost. You mentioned that even though wholesale was a benefit on the revenue line that the costs were actually higher than the revenue benefit. Who's on the other side of these transactions that's making all the money?

Well, I'll try and answer that. I can only really speak for Lumen, but I'll try and be as complete in my answer as possible. If you look at Lumen, we have -- our vendors, our off-net providers have been raising our rates to market rates as they can contractually. And we've been dealing with it, shielding it from our business by being very aggressive in our off-net to on-net transitions. Why pay anybody anything if you can do it yourself? And so since -- certainly, since the Level 3 transaction but really long before, we have been very focused on making sure that we move off-net to on-net and manage our costs that way. We also get to manage the customer experience. We give a much better customer experience when we control it end-to-end. And so we'll continue to do that, and we've seen that. But we've seen rate hikes over many years as either contracts expire or a specific thing will expire. We see our vendors moving to market rates. Now we intend to do the same thing. We do the same thing in our business, and we'll continue to do that. We raised our customers' rates to market rates if they're below and some particular deal expires. And I'm not addressing any particular one of our vendors or any particular one of our customers. But we do the same behavior. Who's making money at it? I can't answer that part of it. I mean, I know what the impact is on us.

I would just add really quick, just a nuance here that wholesale as well as other in our new classifications were impacted by an IT solutions contract. It was about $25 million. So that's why you see the variances that you're seeing in both of those 2 buckets.

Our next question is from Nick Del Deo with MoffettNathanson.

First, Chris, just on that last $25 million you mentioned. So that's a one-timer? It's not going to persist as the transitions continue?

And that's why we -- as we mentioned in the prepared remarks that IT solutions and equipment, we're pooling into that other bucket because they are spiky. And it's also a lower-margin business. So we pulled those out. And that was in the wholesale bucket.

Okay. Okay. And then earlier in the call, you also talked about how there are certain costs that you're incurring for the transition that you then bill to customers. I see that there's, I guess, a $30 million net income reconciliation that you have in your supplement. Is it fair to say there's roughly $30 million in OpEx that you're bearing and about $30 million that you're taking back, and we should think about that as we contemplate your margins?

Yes. That's right. And what it is, is that where we have non-100% dedicated resources, they're doing their day jobs for Lumen, but they're also, if you will, part-time or part of their time on supporting transaction service agreements. All of the OpEx hits our OpEx line. We'll adjust that out in adjusted EBITDA, but then we recover it in other income.

Okay. Okay. And finally, in the past, you've given some rough numbers for the contribution from the LATAM assets and the Apollo assets. I think you've been hesitant to give those with any specificity. But given you just closed the LATAM deal, given the amount of time you've been working to close the Apollo deal, any chance you can share kind of more detailed figures for revenue, EBITDA, CapEx, whatever it might be, to help us as we model the business after these divestitures close?

Yes. So after we close the ILEC sale, we will give restated numbers. And that, I think, will give you the visibility you need. But we're going to wait until we close both or have closed both.

Okay. So the restatement will have or the recast numbers will have both the impact of LATAM and the ILEC deal?

That's correct, yes.

Our next question is from Batya Levi with UBS.

You've signed a lot of deals within the public sector lately, and some of your peers are talking about pressure in that segment. Can you provide more color if we should think about these deals as incremental to your base and what type of trends you're seeing? And maybe a rough estimate of what percent of your enterprise -- large enterprise comes from the public sector, that will be helpful. And just another question on the competitive environment in broadband. Are you seeing any response from cable right now ahead of your Quantum launch in terms of pricing or marketing, anything that you would call out?

So let me take as many of those as I can, Batya, and then I'll let Chris chime in if I miss any of them. With respect to government, look, we don't give out the percentage of any of those types of things for the reason Chris mentioned a minute ago, because we don't want to educate competitors in that sort of thing. But let me talk again about Lumen and what I see from our public sector. I think we have a great public sector team that does a great job of selling excellent products that fit our customers' needs. And if you look at the deals that I mentioned, USDA, the Border and Protection agency, USPS, just looking at those deals, those are all new to us that we took share from somebody because those are not new deals themselves. So if you look at our business, we are a share taker in the government. And it's because of the quality of the products, the Lumen platform and the excellent team that we have supporting the government and the track record that we have supporting them. So I feel very good about our government business. I think it's represented in our large enterprise customers, too, that I feel the same way for them that, yes, sometimes others look to large enterprises declining, and we certainly have challenges with it as well. But we take share from people more than some brand-new thing that never existed before. And so I feel good about the government business. With respect to cable, they'll always do something to kind of lead and preempt some overbuild and overcapability. And we saw a little bit increase in DSL declines but not anything substantial. Once we get our Quantum Fiber product in front of them, I think that we'll more than hold our own. When you have multi-gigabit symmetrical capacity with layered-on capabilities, I think we'll -- anything they do in the meantime won't really matter.

No. I think you're done with it.

Our next question is from James Ratcliffe with Evercore ISI.

As we look forward to Lumen post the Apollo divestitures and the like, how should we be thinking about what the EBITDA margin profile of this business looks like? I mean, your -- some of the declining areas are pretty high margin revenue, but you're also sort of presumably the -- on the wholesale side, you're ongoing saving money there as you continue to build out the fiber network. Right now, you're running margins sort of, for example, above AT&T's business or consumer broadband segments. But how do we think about RemainCo, where that looks like going forward?

Yes. Again, I don't want to get too far ahead of ourselves here. I think we will give you, as I just mentioned a few minutes ago, a good RemainCo footprint P&L and how those financials play out once we're closed with the divestitures. What I would say is that as we go forward, though, with our growth opportunities in both segments, we feel good about where our margin profile is and our abilities to grow top line as well as EBITDA. So I think I'd leave it there. Jeff, did you want to add anything?

Yes. James, the other thing is we believe that we're transforming our business, and a big part of that are reductions in our cost structure and improvement in our customer experience. And we think that we've opportunities ahead of us. And we'll continue to focus on those things. Our business is evolving, and we are very good at evolving with it and modifying the way that we deliver our services. We've got the Lumen Marketplace. We've got the Lumen platform. We've got all sorts of capabilities that we're putting in place to make sure that we can deliver an outstanding customer experience with the lowest cost.

Operator, we've got time for just one more.

Our last question will be from Bora Lee with RBC Capital Markets.

So fiber infrastructure services revenues posted sequential growth in each of your sales channels. Is there anything to call out there in terms of products or services that drove that growth and if you think that trend is sustainable? And then regarding the change to the business reporting structure, can you talk about how you envision how this change might impact your sales force, be it organizational structure, sales force incentives as well as your go-to-market strategy?

Sure. So let me take the first one slightly. There's nothing special to call out that comes to mind in fiber infrastructure services. But we're a fiber-based company, and that is the core of who we are and what we do. So I don't have any kind of special onetime. It's always lumpy. Those -- a lot of our business is lumpy, but fiber infrastructure tends to be lumpier than most. But it's who we are, and we're really, really good at it. And so I don't have any special thing to call out.

Yes. And on the second question, look, I mean, broadly speaking, this is not true for every product, but broadly speaking, if you look at the harvest category, those are products that really aren't being sold anymore, certainly not in any major quantity. So that really becomes a focus on how do we maximize the long-term value of existing customers, and that can be through cost management as well as pricing. And the cost management, frankly, can cross multiple technologies and frankly beyond that bucket. So it's a complex thing to go after, but we've got the right people to tackle that. As it relates to incentives, I mean, again, I'd say that the whole organization is focused on growth. We'll constantly look at how we incent ourselves and our teams to make sure we maximize that, and that's certainly something that we do every year as we plan for the next year. But I think the real benefit of the buckets is a sharper focus on, for lack of a better term, who gets what. The way we deploy capital, the way we deploy OpEx and our internal resources will be delineated around those buckets, right? And I think that clarity and focus is a benefit to the organization, and I think we'll see that in future results as we go forward.

Thank you. Look, in closing, this has been a very active year for us. In addition to seeing the growth across multiple strategic enterprise product offerings, we closed the LATAM divestiture. We're on the eve of closing our ILEC divestiture. We've ramped Quantum Fiber build while launching new product capabilities. We see significant opportunity ahead for both our Business and Mass Market segments as we focus Lumen on the most strategic and best return opportunities. So I look forward to updating you on our progress as we execute our plan. And thank you for your participation in today's call. With that, we will end the call. Thank you again.

We would like to thank everyone for your participation and for using the Lumen conferencing service today. This does conclude the conference call. We ask that you please disconnect your lines. Have a great day, everyone.