Qwest Communications (NYSE: Q) today reported financial results for the first quarter 2010. In the quarter, the company reported solid growth in business and consumer data services, improved margins and continued to make solid progress on key initiatives.
In the first quarter, net income was $38 million. Earnings per share were 2 cents compared to 12 cents in the first quarter 2009. The current quarter’s earnings per share results include an 8 cent non-cash charge for the disallowance of certain federal income tax deductions under the Medicare Part D program, a charge related to the early retirement of debt, and severance and realignment. Results in the prior-year period include a 1 cent per share charge for severance and realignment. In addition, the prior year includes a 1 cent per share benefit due to a lower effective tax rate.
First quarter consolidated net operating revenues declined 7 percent compared to the first quarter 2009. After excluding the effects of the company’s transition to a new wireless business model, revenue declined 5 percent year over year. Excluding wireless, revenues declined 7 percent year over year in the fourth quarter 2009. Reported net operating revenues declined 1 percent sequentially from the fourth quarter. Reported revenues declined 2 percent sequentially in the fourth quarter.
Adjusted EBITDA for the quarter was $1.12 billion compared to $1.15 billion in the prior year and $1.09 billion in the fourth quarter. Adjusted EBITDA improved 4 percent sequentially while adjusted EBITDA margin improved 170 basis points to 37.9 percent.
Qwest continued to make strong progress on key growth initiatives in the first quarter. The Business Markets segment reported strong growth of 33 percent year over year in IP services revenues. Qwest continued to expand its fiber to the node (FTTN) footprint in the quarter, and services are now available to more than 3.8 million residential households. In the quarter, 64,000 customers added high speed Internet services that utilize the fiber network. The company continued to make solid progress on retention efforts in the consumer market with the absolute number of access line losses improving 22 percent from the first quarter 2009. In the current quarter, Qwest continued to see strong demand to deliver fiber-based backhaul services for wireless companies, and initial cell sites were activated.
“We are off to a great start in 2010,” said Edward A. Mueller, Qwest chairman and CEO. “Our proposed merger with CenturyLink will combine two well run companies to create a stronger competitor. Together, we will enhance the ability to deliver differentiated services for our customers and expand the opportunity to provide substantial value for our shareholders. In the first quarter, we improved our revenue trends and increased margins. The quarter’s results illustrate our disciplined focus on our key strategies and perfecting the customer experience. We are optimistic about continuing this momentum throughout the year.”
CONSOLIDATED FINANCIAL RESULTS
Revenue
Qwest reported consolidated net operating revenue of $3.0 billion in the first quarter. Total strategic services revenue of $1.1 billion increased 5 percent year over year. Legacy services revenue of $1.6 billion decreased 13 percent year over year. The 1 percent sequential revenue decline was due to a 2 percent increase in strategic revenue that was offset by a 3 percent decline in legacy revenue.
Expense
Consolidated operating expenses were $2.4 billion in the quarter, a decrease of 9 percent year over year. Cost of sales declined 7 percent due to lower volumes, a reduced workforce and the completion of the wireless migration in the fourth quarter 2009. Selling expense declined 19 percent mainly driven by lower bad debt expense, a reduction in workforce, and reduced marketing and advertising expense. General, administrative and other operating expenses were down 5 percent in the quarter, primarily as a result of lower pension and OPEB, realignment and severance costs. Sequentially, operating expenses declined 6 percent largely due to lower volumes, employee-related expense and severance costs. Total employees at the end of the period were approximately 29,500, down 2 percent from the fourth quarter and 10 percent from the first quarter 2009.
Net Income
The current quarter includes a one-time, non-cash tax impact of $113 million related to the disallowance of certain federal tax deductions. In addition, the company recognized a pre-tax charge of $53 million due to the early retirement of debt, and severance and realignment. Net income for the first quarter was $38 million compared to $206 million in the prior year. The year-over-year decline was mainly due to the one-time charges in the current quarter. Net income declined $70 million sequentially primarily due to the $113 million tax charge, which was partially offset by increased adjusted EBITDA and lower depreciation expense.
SEGMENT FINANCIAL RESULTS
Business Markets
Business Markets produced stable top-line performance and delivered a solid profit contribution in the quarter. Qwest’s success in the enterprise space continues to be driven by a strong mix of data and IP services, a diverse customer mix and differentiated user support.
Business Markets reported total revenues of $1.0 billion, a 1 percent decline from the fourth quarter 2009 and flat compared to the year-ago period. Total recurring service revenue was up slightly from the fourth quarter and down 1 percent from a year ago. Strategic revenue growth of 8 percent year over year was driven by growth in IP services. Legacy services declined 9 percent year over year mainly due to lower local voice revenue and the migration from legacy data to IP-based services.
Segment operating expense declined 3 percent both year over year and sequentially. The Business Markets income contribution increased 5 percent year over year and 2 percent from the fourth quarter. Segment income margin of 40 percent improved 180 basis points from a year ago. The margin improvement mainly is due to improved customer acquisition efficiencies and lower facility costs.
Mass Markets
In the quarter, Mass Markets continued to achieve success from its move to a more localized go-to-market approach. This included continued success in selling higher broadband speeds, improving access line retention and additional cost efficiencies. Consumer ARPU was $62 in the quarter, a 7 percent increase compared to the first quarter 2009.
Mass Markets segment revenues of $1.2 billion declined 11 percent from the first quarter 2009. Revenues declined 7 percent after adjusting for the wireless business model transition. Strategic revenues grew 5 percent year over year while legacy revenues decreased 11 percent due to continued line losses. Sequentially, revenue declined 1 percent from the fourth quarter.
Segment expenses decreased 13 percent from the year-ago period and were flat sequentially. The year-over-year improvement mainly was due to lower sales and marketing expenses and lower wireless costs. Segment income for the quarter declined 9 percent compared to the year-ago period and declined 3 percent from the fourth quarter. Segment income margin percentage improved 110 basis points compared to the year-ago quarter.
Total broadband customers reached 3 million in the quarter, including 2.9 million Mass Markets subscribers. Total net mass markets broadband subscribers increased by 40,000 in the quarter. Once again, demand within the FTTN footprint fueled subscriber growth. The FTTN subscriber base reached approximately 480,000, or 17 percent of Qwest’s Mass Markets high-speed Internet customers.
Qwest continues to see success from its key business partnerships. Total Verizon Wireless subscribers at the end of the quarter were 922,000, up 84,000 from the end of the fourth quarter. Qwest added 11,000 net video subscribers in the quarter, bringing the total to 951,000.
Wholesale Markets
Wholesale Markets reported improved revenue comparisons in the quarter. Segment revenue declined 11 percent year over year compared with a 14 percent annual decline reported in the fourth quarter. Sequentially, revenue decreased $10 million, or 1 percent. Wholesale Markets revenue continued to be impacted by lower long-distance volumes and a decline in access revenue.
Wholesale segment income declined $11 million, or 2 percent, from the first quarter 2009 and improved 4 percent from the fourth quarter. Wholesale segment income margin percentage improved 590 basis points year over year, mainly due to continued benefits from profitability initiatives, lower facility costs and improved bad debt expense.
Cash Flow and Capital Investment
In the first quarter, adjusted free cash flow was $335 million. Cash flow from operating activities increased $65 million compared to the first quarter 2009 due to improved working capital partially offset by lower EBITDA. Capital expenditures for the quarter were $387 million.
Balance Sheet
In the quarter, the company continued to strengthen its balance sheet. Net debt was $11.7 billion at the end of the quarter compared to $12.8 billion at the end of the first quarter 2009 and $11.8 billion in the fourth quarter. Overall cash and cash equivalent and short-term investments increased to $1.9 billion from $547 million a year ago. The company’s net debt-to-adjusted EBITDA leverage ratio was 2.7 times, which is equal to the fourth quarter and an improvement from 2.8 times in the year-ago quarter.
In February 2010, Qwest called $525 million in notes early, and in March 2010, the company successfully completed a cash tender for $960 million in notes. As a result of the tender, the company expects to have annual interest expense savings of approximately $50 million. 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 debt by $1.5 billion.
Shareholder Returns
Qwest returned $138 million to shareholders in the first quarter through a dividend of 8 cents per share. On April 15, Qwest’s board of directors announced the payment of a second quarter dividend of 8 cents per share. The dividend will be paid on June 11, 2010, to shareholders of record as of May 21, 2010. This marks Qwest’s 10th consecutive quarterly dividend.
CenturyLink Merger Agreement
On April 22, 2010, Qwest and CenturyLink announced an agreement for CenturyLink to merge with 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.
The transaction is expected to close in the first half of 2011, and is subject to certain governmental consents and approvals as well as approval by both companies’ shareholders.
Guidance
Qwest continues to expect to report improving revenue comparisons over the course of 2010 with the year-over-year reported decline improving to a low- to mid-single digit rate by the fourth quarter. Qwest continues to expect to achieve full year 2010 adjusted EBITDA in a range of $4.3 to $4.4 billion. In 2010, Qwest expects full year non-cash pension and post-retirement benefit expenses to be approximately $130 million, a decline of approximately $70 million from 2009 levels. The outlook for full year 2010 capital investments is $1.7 billion or lower. Similar to 2009, the company may continue to use lease financing in 2010 for some of its capital investments. Full year adjusted free cash flow is expected to be $1.5 to $1.6 billion.
Conference Call Today (05-05-2010)
As previously announced, Qwest will host a conference call for investors and the media today at 9 a.m. EDT. A live webcast, including a simultaneous slide presentation, and replay of the call is available at investor.qwest.com. Additional quarterly historical financial information can be found at http://investor.qwest.com/overview.
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