Qwest Beats

Qwest Communications (Q), the third-largest U.S. local-phone service operator, announced second-quarter 2010 adjusted earnings per share of 10 cents, surpassing the Zacks Consensus Estimate of 9 cents and the year-ago earnings of 8 cents.

Adjusted earnings exclude a one-time charge of 2 cents for severance and merger-related expenses partially offset by a 1 cent one-time gain associated with the accounting of convertible debt.

Net income, on a GAAP basis, plunged 25.5% year over year to $158 million. Operating revenue declined 5.2% year over year to $2.93 billion due to landline disconnections, but was ahead of the Zacks Consensus Estimate of $2.92 billion. Adjusted EBITDA remained flat year over year at $1.09 billion.

Segment Results

Business Markets: Revenues from the business market segment remained flat year over year at $1 billion, as growth in strategic revenue offset the decline in legacy services. Strong IP services led to the 9% growth in strategic revenue, while revenues from legacy services decreased 9% due to declines across legacy voice and data businesses.

Mass Markets: Revenues from this segment fell 8% year over year to $1.2 billion. Strategic revenue (including broadband and video revenue) upped 6% year over year, driven by strong broadband growth, while voice service revenue declined 11% in the second quarter.

Total subscribers in access lines reached to 6.5 million, down 11.7% year over year. On an annualized basis, broadband subscribers increased 4.3% to 2.9 million, while Video subscribers leaped 11% to 951,000. Qwest added 60,000 wireless subscribers in the quarter to reach 982,000 customers, up 33.1% year over year. ARPU (average revenue per unit) rose 7% in the second quarter.

Wholesale Markets: Revenues from Wholesale Markets dropped 10% year over year, due to access line erosion and lower long-distance sales.

Liquidity

Qwest exited the quarter with cash and short-term investments of $1.8 billion. Net debt reduced to $11.3 billion compared with $12.3 billion in the year-ago quarter. Net debt-to-adjusted EBITDA leverage ratio improved to 2.6 times from 2.7 times in the year-ago quarter. The company generated free cash flow of $609 million compared with $657 million in the year-ago quarter. Capital expenditure fell 5.2% year over year to $330 million.

Qwest remains committed to offering attractive returns to shareholders. The company paid a dividend of 8 cents per share for the quarter, amounting to approximately $139 million.

Outlook

For 2010, Qwest expects adjusted EBITDA in the range of $4.3 to $4.4 billion. CapEx for the year is projected at $1.7 billion or lower. Adjusted free cash flow for 2010 is projected between $1.5 billion and $1.6 billion.

The company expects pension and post-retirement benefit expenses of roughly $125 million for 2010, down from $70 million reported in 2009. Qwest envisions improving revenue trends in 2010 and expects the pace of sales decline to slow to the low-to-mid single digit rate by the fourth quarter.

Our Analysis

Qwest continues to offer attractive returns to shareholders in the form of healthy dividend payouts. However, its high debt exposure remains our primary concern, as it impedes the company’s ability to invest in expanding business operations.

We expect the company’s growth prospects to be driven by continued strong demand for its broadband Internet service, expansion of fiber-based network capabilities and the wireless backhaul wholesale service. However, access line losses due to competition will continue to erode operating revenues in the upcoming quarters.

We are currently maintaining our Neutral rating on Qwest supported by Zacks #3 Rank (Hold).

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