Qwest Reports Second Quarter 2010 Results

DENVER, August 4, 2010 – Qwest Communications (NYSE: Q) today reported financial results for the second quarter 2010. In the quarter, the company reported expanded margins, improved year-over-year revenue trends across all segments and strong cash flows.

In the second quarter, net income was $158 million. Earnings per share were 9 cents compared to 12 cents in the second quarter 2009. The current quarter’s earnings per share results include a 2 cent charge for severance, realignment and merger-related expenses, which was offset by a 1 cent gain related to the accounting treatment of the company’s convertible debt. Results in the prior-year period include net one-time benefits from special items of 4 cents per share.

Second quarter consolidated net operating revenues declined 5 percent compared to the second quarter 2009 and declined 1 percent sequentially. After normalizing for the effects of the company’s transition to a new wireless business model, second quarter consolidated net operating revenue declined 4 percent year over year. In the first quarter 2010, reported net operating revenues declined at an annual rate of 7 percent and excluding wireless, revenues declined 5 percent year over year.

Adjusted EBITDA of $1.09 billion for the quarter held steady compared to the prior year, and operating income increased 4 percent. Adjusted EBITDA margin of 37.3 percent increased 200 basis points year over year compared to an annual increase of 180 basis points in the first quarter.

Qwest continued to deliver on key growth initiatives in the second quarter. The Business Markets segment reported strong growth of 25 percent year over year in IP services revenues. Mass Markets continued to expand its fiber-to-the-node (FTTN) footprint in the quarter, and services are now available to more than 4 million residential households. In the quarter, 52,000 customers added high speed Internet services that utilize the fiber network, bringing total users to more than 500,000. This growth was offset by declines in DSL subscribers. In the quarter, the Wholesale Markets segment made solid progress in deploying fiber-based backhaul services for wireless companies.

“We delivered strong financial performance under challenging market conditions during the second quarter,” said Edward A. Mueller, Qwest chairman and CEO. “Our results reflect improving revenue trends, increased margins and added financial strength. We continue to maintain a disciplined focus on execution while perfecting the customer experience. Additionally, we are very pleased with the progress of our planned merger with CenturyLink. The integration planning is well under way, and we are achieving key approval milestones.”

CONSOLIDATED FINANCIAL RESULTS

Revenue
Qwest reported consolidated net operating revenue of $2.9 billion in the second quarter. Total strategic services revenue of $1.1 billion increased 6 percent year over year compared with a 5 percent increase in the first quarter. The growth in strategic services was offset by a 12 percent decline in legacy services revenue. Legacy services were $1.6 billion in the period.

Expense
Consolidated operating expenses were $2.4 billion in the quarter, a decrease of 7 percent year over year. Cost of sales declined 9 percent due to lower volumes, a reduced workforce and the completion of the wireless migration in the fourth quarter 2009. Selling expense declined 13 percent mainly driven by lower headcount, bad debt expense, and marketing and advertising spending. General, administrative and other operating expenses were up 1 percent in the quarter, primarily as a result of merger-related items and increased USF fees, which were partially offset by lower pension-related expenses. Total employees at the end of the period were approximately 29,200, a decrease of 1 percent from the first quarter and 7 percent from the second quarter 2009.

Net Income
Net income for the second quarter was $158 million compared to $212 million in the prior year. The current quarter includes pre-tax charges of $8 million for severance and realignment and $27 million for merger-related expenses. The current quarter also includes a $21 million pre- and post-tax gain on the convertible debt. The prior-year period includes one-time income tax benefits totaling $83 million, which were offset by a $23 million pre-tax charge for severance and realignment expense.

SEGMENT FINANCIAL RESULTS

Business Markets
Business Markets produced stable top-line and bottom-line performance driven by strong growth in IP services and solid cost management.

Business Markets reported total revenues of $1.0 billion, which was flat with the year-ago period and the first quarter. Total recurring service revenue was down slightly from the first quarter and down 1 percent from a year ago. Strategic revenue growth of 9 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 increased 1 percent year over year and 2 percent sequentially. The expense increase is primarily due to a one-time legal settlement and higher data integration costs, partially offset by lower bad debt expense. As a result, Business Markets income contribution declined 2 percent year over year and 3 percent from the first quarter. Segment income margin of 38.8 percent declined 60 basis points from the year-ago period and 120 basis points sequentially. Excluding the impact of the legal settlement, segment income and margin would have been in line with both the first quarter and the year-ago period results.

Mass Markets
In the quarter, Mass Markets achieved its third consecutive quarter of improved year-over-year revenue trends while delivering a strong margin for the quarter. This success was driven by customer adoption of higher broadband speeds, increasing customer ARPU and excellent cost management. Consumer ARPU was $62 in the quarter, a 7 percent increase compared to the second quarter 2009. The rate of consumer access line loss in the quarter held steady with the first quarter. The company is beginning to see encouraging signs in small business, where revenue and access line trends improved on both a year-over-year and sequential basis.

Mass Markets segment revenues of $1.2 billion declined 8 percent from the second quarter 2009 compared to an annual decline of 11 percent in the first quarter. Revenues in the second quarter declined 6 percent after adjusting for the wireless business model transition. Strategic revenues grew 6 percent year over year due to growth in broadband services while legacy voice revenues decreased 11 percent. Sequentially, revenue declined 2 percent from the first quarter.

Segment expenses decreased 13 percent from the year-ago period and declined 3 percent sequentially. The year-over-year improvement mainly was due to lower headcount, bad debt expense, wireless costs, and sales and marketing expenses. Segment income for the quarter declined 4 percent compared to the year-ago period and declined 1 percent from the first quarter. Segment income margin of 53.5 percent improved 250 basis points compared to the year-ago quarter.

Total broadband customers were 3 million at the end of the quarter, including 2.9 million Mass Markets subscribers. Within Mass Markets, net broadband subscriber additions were 7,000 in the quarter. Growth in FTTN subscribers was offset by a decline in the legacy DSL subscriber base due to customer migrations and competitive market conditions. The FTTN base at the end of the period was 529,000, or 19 percent of total Mass Markets subscribers.

At the end of the second quarter, Verizon Wireless customers sold by and/or billed by Qwest totaled 982,000, up 60,000 from the end of the first quarter. Total DIRECTV video subscribers were flat for the quarter.

Wholesale Markets
holesale Markets reported a modest improvement in year-over-year revenue comparisons in the quarter and maintained solid profitability. The business unit also made good progress in deploying fiber services to wireless carriers.

Segment revenue declined 10 percent year over year compared to an 11 percent annual decline reported in the first quarter. Sequentially, revenue decreased 4 percent. Wholesale Markets revenue continued to be impacted by lower long-distance volumes and a decline in access revenue.

Wholesale Markets segment income declined 1 percent from the second quarter 2009 and 3 percent from the first quarter. Wholesale segment income margin of 67.5 percent improved 590 basis points year over year and 50 basis points sequentially, mainly due to an improved revenue mix and lower bad debt expense.

At the end of the quarter, Qwest had completed construction of fiber-based services to more than 600 wireless cell sites, and this number is expected to grow to approximately 2,000 sites by the end of the year.

Cash Flow and Capital Investment
In the second quarter, adjusted free cash flow was $609 million. Capital investment in the quarter was focused on funding key strategic projects including broadband services for enterprise, wholesale, small business and consumer customers. Capital expenditures for the quarter were $330 million, a decline of $18 million from the year-ago period.

Balance Sheet
In the quarter, the company continued to strengthen its balance sheet and improve financial flexibility. Net debt was $11.3 billion at the end of the quarter compared to $12.3 billion at the end of the second quarter 2009 and $11.7 billion in the first quarter. Cash and short-term investments were $1.8 billion. The company’s net debt-to-adjusted EBITDA leverage ratio improved to 2.6 times, down from 2.7 times last quarter. 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 $2.0 billion. In July, the company announced a tender offer to purchase for cash its $1.265 billion outstanding 3.50 percent convertible senior notes due in 2025. The offer is scheduled to expire on Aug. 12, 2010.

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 company announced it will hold a special shareholder meeting on Tuesday, Aug. 24, 2010. Shareholders will vote on a proposal to adopt the merger agreement with CenturyLink. The record date for determining the shareholders entitled to vote at the meeting is July 13, 2010.

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. On July 15, the transaction was cleared by the Department of Justice. In addition, the companies have received approval from six of the 21 required state commissions. The Federal Communications Commission also is required to approve the transaction.

Shareholder Returns
Qwest returned $139 million to shareholders in the second quarter through a dividend of 8 cents per share. Year-to-date, Qwest has paid common stock dividends totaling $277 million.

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 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 $125 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.