Business News

Qwest Reports Third Quarter 2010 Results

Wednesday 03. November 2010 - Revenue trends continue to improve

Third Quarter Highlights

Revenue trends continue to improve
Strategic revenue growth of 8 percent year over year driven by demand for enterprise IP services and residential fiber-based services
Adjusted EBITDA(a) margin expands 240 basis points year over year to 38.2 percent
Generates strong free cash flow; debt leverage ratio at 2.5 times adjusted EBITDA
Adds 40,000 net broadband customers
Wireless subscriber base exceeds 1 million
Updates financial guidance

Unaudited (in millions, except per share and margin amounts)
3Q 2010 2Q 2010 Change 3Q 2009 Change
Operating Revenue 2,935 2,930 0.2 % 3,054 (3.9 %)
Operating Income 497 509 (2.4 )% 485 2.5 %
Income before Income Taxes 18 266 (93.2 %) 211 (91.5 %)
Net (Loss) Income (90 ) 158 nm 136 nm
Net (Loss) Income per Diluted Share $ (0.05 ) $ 0.09 nm $ 0.08 nm
Adjusted EBITDA 1,120 1,092 2.6 % 1,093 2.5 %
Adjusted EBITDA Margin 38.2 % 37.3 % 90 bps 35.8 % 240 bps
Adjusted Free Cash Flow 554 609 (9.0 )% 428 29.4 %
(a) See Attachment E for Non GAAP Reconciliations
nm—not meaningful

Qwest Communications (NYSE:Q) today reported financial results for the third quarter 2010. For the quarter, the company reported improved sequential and year-over-year revenue comparisons across all segments, expanded adjusted EBITDA margin and strong free cash flow. Qwest also continued to strengthen its balance sheet.

The third quarter reported loss per share was 5 cents compared to earnings per share of 8 cents in the third quarter 2009. Excluding special items, earnings per share were 11 cents compared to 9 cents in the year-ago period, an increase of 22 percent. Special items for the quarter are discussed in the Consolidated Financial Results section below.

The company continues to make steady progress in improving revenue trends. Reported revenues were flat sequentially for the first time in 8 quarters and declined 4 percent on a year-over-year basis. After normalizing for the effects of the company’s transition to a new wireless business model, third quarter consolidated net operating revenue declined 3 percent year over year. This compares to a normalized decline of 4 percent last quarter.

Adjusted EBITDA of $1.12 billion for the quarter increased 3 percent sequentially. Adjusted EBITDA margin increased 240 basis points year over year and 90 basis points sequentially to 38.2 percent.

Qwest delivered on key growth initiatives in the third quarter. The Business Markets segment reported strong growth of 24 percent year over year in IP services revenues. Mass Markets continues to expand its fiber-to-the-node (FTTN) footprint, and services are now available to approximately 4.5 million residential households. In the quarter, 92,000 customers added high-speed Internet services that utilize the fiber network, bringing total users to 621,000. The Wholesale Markets segment is now providing fiber-based backhaul services to more than 1,000 wireless towers.

“I am very pleased we delivered strong operating and financial results in the third quarter,” said Edward A. Mueller, Qwest chairman and CEO. “We are confident we will continue our solid execution, and we are raising our revenue, adjusted EBITDA and cash flow outlook to the top-end of our 2010 guidance. Under difficult market conditions, solid subscriber additions on the FTTN network, stable results in Business Markets, improving revenue trends in Wholesale, and increased margins demonstrate our disciplined focus on strategic growth opportunities. During the quarter, we also made substantial progress on the approval process including overwhelming support from both companies’ shareholders, moving us closer to completing our merger with CenturyLink.”

CONSOLIDATED FINANCIAL RESULTS

Revenue

Qwest reported consolidated net operating revenue of $2.9 billion in the third quarter. Strategic services revenue increased 8 percent year over year compared with a 6 percent increase in the second quarter. The growth in strategic services was offset by an 11 percent annual decline in legacy services revenue. Legacy services declined 12 percent year over year in the second quarter.

Expense

Consolidated operating expenses decreased 5 percent year over year to $2.4 billion. Cost of sales declined 5 percent primarily due to lower network facilities costs. Selling expense declined 8 percent mainly driven by lower headcount and reduced marketing and advertising spend. General, administrative and other operating expenses were down 4 percent in the quarter, primarily as a result of lower legal and pension-related expenses partially offset by a one-time adjustment to USF fees. Total employees at the end of the period were approximately 28,500, a decrease of 2 percent from the second quarter and 9 percent from the third quarter 2009.

Net (Loss) Income

Net loss for the third quarter was $90 million compared to net income of $136 million in the prior year. The current quarter includes pre-tax charges totaling $71 million for severance and realignment, merger-related expenses and a one-time adjustment to USF fees. The current quarter also includes a $229 million pre- and post-tax charge related to the conversion option on convertible notes. This charge is due to strong appreciation of Qwest’s stock price during the third quarter. The prior-year period includes pre-tax charges totaling $27 million for severance and realignment, and litigation reserve.

SEGMENT FINANCIAL RESULTS

Business Markets

Business Markets revenue was flat year over year and improved 2 percent sequentially. The unit benefited from strong enterprise demand for IP services and increased data integration sales. During the quarter, Business Markets continued to experience positive new sales momentum. The segment also maintained strong customer retention performance in the quarter.

In the third quarter, Business Markets strategic revenues exceeded legacy revenues for the first time since the company began reporting this revenue mix. Strategic revenues grew 9 percent year over year driven by growth in IP services. Legacy services declined 7 percent year over year mainly due to lower local voice revenue and migration to newer generation services.

Segment operating expense declined 2 percent year over year and 2 percent sequentially. The expense decrease is primarily due to improved sales productivity and a one-time legal settlement in the second quarter. Business Markets income contribution increased 4 percent year over year and 7 percent from the second quarter. Segment income margin of 40.7 percent increased 140 basis points from the year-ago period and 190 basis points sequentially.

Mass Markets

In the quarter, Mass Markets achieved its fourth consecutive quarter of improved year-over-year revenue trends while delivering a strong margin. This success was driven by increasing customer ARPU and excellent cost management. Consumer ARPU was $65 in the quarter, a 10 percent increase compared to the third quarter 2009. Mass Markets reported a strong rebound in broadband additions in the quarter driven by demand for higher speed service, the launch of its new Heavy Duty Internet marketing campaign, and seasonal benefits. Consumer and small business voice access line loss in the quarter improved on a year-over-year basis and held steady with the second quarter.

Mass Markets segment revenues of $1.2 billion declined 5 percent from the third quarter 2009 and were flat with the second quarter. Revenues in the third quarter declined 3 percent annually compared to a 6 percent decline in the second quarter after adjusting for the wireless business model transition. Strategic revenues grew 10 percent year over year due to growth in broadband services while legacy voice revenues decreased 9 percent. Revenue comparisons in Mass Markets benefited from a stronger contribution from Small Business.

Segment expenses decreased 9 percent from the year-ago period and increased 1 percent sequentially. The year-over-year improvement is mainly due to lower network facilities costs, sales and marketing expenses and reduced staffing. Segment income for the quarter declined 1 percent compared to the year-ago period and 1 percent from the second quarter. Segment income margin of 53.0 percent improved 190 basis points compared to the year-ago quarter but decreased 50 basis points sequentially.

Mass Markets broadband subscribers totaled 2.9 million at the end of the third quarter. Mass Markets added 92,000 FTTN subscribers in the quarter, ending the period with 621,000 subscribers, or 21 percent of the subscriber base. This growth was offset by a decline of 52,000 traditional ATM-based DSL subscribers.

At the end of the third quarter, Verizon Wireless customers sold by and/or billed by Qwest exceeded 1 million, increasing 62,000 from the end of the second quarter. Total DIRECTV video subscribers increased 12,000 in the quarter to 963,000.

Wholesale Markets

Wholesale Markets reported improved revenue trends while delivering a strong margin for the quarter. This unit is benefiting from increased demand for strategic services and an improved product mix.

Segment revenue declined 8 percent year over year compared to a 10 percent annual decline reported in the second quarter. Sequentially, revenue held steady.

Wholesale Markets segment income declined 1 percent from the third quarter 2009 and improved 1 percent from the second quarter. Wholesale segment income margin of 67.8 percent increased 480 basis points year over year and 30 basis points sequentially, mainly due to improved mix and lower headcount.

The company continued to make solid progress in deploying fiber services to wireless cell sites. More than 1,000 sites are currently complete and billing, and this is expected to grow to approximately 2,000 sites by the end of the year.

Cash Flow and Capital Investment

In the third quarter, adjusted free cash flow was $554 million, bringing the total to $1.5 billion year-to-date. For the quarter, capital expenditures requiring cash were $373 million and $1.1 billion year-to-date. Since the beginning of the year, the company has financed $115 million of additional capital investment through leasing, including $60 million in the third quarter. Capital investment in the quarter was focused on key strategic projects including broadband services for enterprises, consumers and small businesses and wholesale fiber initiatives.

Balance Sheet

In the quarter, the company continued to strengthen its balance sheet and improve financial flexibility. Net debt was $11.0 billion at the end of the quarter compared to $12.1 billion at the end of the third quarter 2009. Cash and short-term investments were $2.0 billion. The company’s net debt-to-adjusted EBITDA leverage ratio improved to 2.5 times, down from 2.7 times at the beginning of the year. This is the lowest leverage ratio for the company since 1999.

In February, the company announced plans to reduce debt by $3.5 billion through the first quarter of 2011, and, to date, the company has reduced total debt by $2.1 billion. On Oct. 19, Qwest announced it will redeem all of its 3.50 percent convertible senior notes due 2025. Approximately $1.1 billion in principal amount of the notes is outstanding. In addition, Qwest will settle the convert option with cash during the fourth quarter. The amount of the settlement will depend on the number of holders that exercise their conversion rights and the future stock price during the conversion period. Assuming all holders convert with a stock price of $6.67 (as of Nov. 2, 2010), Qwest would be required to pay approximately $450 million in cash in excess of the principal amount. Under this example, the company would be required to take an additional charge of approximately $100 million in the fourth quarter.

CenturyLink Merger Agreement

On April 22, 2010, Qwest and CenturyLink announced an agreement for CenturyLink to acquire Qwest in a tax-free, stock-for-stock transaction. Under the terms of the agreement, Qwest shareholders will receive 0.1664 CenturyLink shares for each share of Qwest common stock they own at closing. On Aug. 24, 2010, shareholders of both companies overwhelmingly approved all proposals related to the merger between CenturyLink and Qwest.

In addition to approvals by CenturyLink and Qwest shareholders, the companies have received clearance from the U.S. Department of Justice and approval from 12 regulatory utility commissions. Reviews continue in 10 other states and at the Federal Communications Commission. The companies expect to complete the merger in the first half of 2011.

Shareholder Returns

Qwest returned $139 million to shareholders in the third quarter through a dividend of 8 cents per share. Year-to-date, Qwest has paid common stock dividends totaling $416 million. On Oct. 21, the Qwest board of directors declared a fourth quarter dividend of $0.08 per share. The quarterly dividend is payable on Dec. 17, 2010.

The merger agreement requires that CenturyLink and Qwest coordinate with each other to designate the record dates and payment dates for the two companies respective quarterly dividends. Thus, the timing of Qwest’s future dividends may deviate from historical dates due to this requirement.

Guidance

Qwest now expects to report a low-single digit annual rate of revenue decline in the fourth quarter. Previously, the company expected to report a low- to mid-single digit rate of revenue decline by the fourth quarter. Qwest now expects to achieve full year 2010 adjusted EBITDA of approximately $4.4 billion. The company previously expected to achieve full year 2010 adjusted EBITDA in a range of $4.3 to $4.4 billion. Qwest continues to expect capital investment to be approximately $1.7 billion with approximately $150 million of this investment financed by leasing. Full year adjusted free cash flow is now expected to be $1.7 to $1.8 billion with the benefit of capital leasing. Without the benefit of capital leasing, free cash flow is expected be in the range of $1.6 to $1.7 billion.