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Third-largest US local-phone service operator Qwest Communications (NYSE:Q) announced first-quarter 2010 earnings with adjusted earnings per share (NYSEARCA:EPS) of 10 cents, beating the Zacks Consensus Estimate by a penny while falling from the year-ago quarter adjusted EPS of 13 cents.

Adjusted earnings exclude a one-time non-cash tax related charge associated with the recent federal healthcare reform, severance charges (associated with job cuts) and a charge related to early extinguishment of debt.

Net income plunged 81.6% year-over-year to $38 million or 2 cents a share due to the above-mentioned charges and lower revenues as erosion in legacy landline business continues due to wireless substitution.

Operating revenue declined 6.5% from the prior-year quarter to $2.97 billion, but beat the Zacks Consensus Estimate of $2.94 billion. The annualized revenue decline is primarily attributable to lower voice service revenue as consumers continue to disconnect their landline services. Adjusted EBITDA declined 1.8% to $1.12 billion.

Results by Segment

Business Markets

Revenue from the business market segment declined 0.2% year-over-year to $1 billion due to declines across legacy voice and data businesses. The segment contributed 34% of the group revenue for the quarter.

Driven by growth in IP services, strategic revenue increased 8.3% year-over-year to $417 million and accounted for 42% of total business market revenue. Revenue from legacy services declined 9.1% year-over-year to $447 million on account of lower local voice sales. Data revenue increased 8.9% year-over-year to $135 million. Total access lines declined 6.3% year-over-year to 1.97 million.

Mass Markets

Revenue from this segment declined 10.7% year-over-year to $1.18 billion, representing 40% of total sales. Strategic revenue (including broadband and video revenue) increased 4.6% year-over-year while voice service revenue declined 11.2%, partly due to wireless substitution.

Qwest’s growth business, broadband Internet added 40,000 new customers in the quarter, taking the total mass market subscriber base to 2.85 million. Direct TV video subscriber base grew by 71,000 to 951,000 customers. However, these positives were offset by an 11.7% year-over-year decline in access lines that reached 6.67 million. Qwest added 66,000 wireless subscribers in the quarter to reach 922,000 customers, up 28.4% year-over-year.

Wholesale Markets

Revenue from wholesale markets declined 10.9% year-over-year to $685 million (23% of total sales), due to access line erosion and lower long-distance sales. Strategic service revenue increased 1% year-over-year to $316 million, while legacy voice revenue contracted 19.1% to $369 million. Total access lines decreased 10.4% on an annualized basis to 1.02 million.

Cash Flow, CapEx and Dividend

Adjusted free cash flow for the quarter declined 1.2% year-over-year to $335 million, due to higher capital expenditure (CapEx), which increased 15.9% year-over-year to $387 million. Qwest remains committed to offering attractive returns to shareholders as it paid a dividend of 8 cents per share for the quarter, amounting to approximately $138 million.

Outlook

Qwest has not released its second quarter guidance. For 2010, the carrier 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 forecasted between $1.5 billion and $1.6 billion.

The company expects pension and post-retirement benefit expenses of roughly $130 million, down from $70 million reported in 2009. Qwest envisions improving revenue trends in 2010 and expects the pace of sales decline to slow to “low-to mid-single digit” rate by the fourth quarter.

Qwest continues to invest in building necessary infrastructure to boost network capacity and availability. Historically, the company has allocated a major portion of the overall CapEx for deploying additional fiber-to-the-node (FTTN) capacity to increase the performance of its broadband network. Moving forward, Qwest plans to increase spending on the deployment of fiber optic cable to support wireless services.

Leveraging its FTTN network, Qwest introduced a new fiber-based Ethernet backhaul wholesale service for wireless operators in 2009. This new service enables wireless operators to upgrade their existing copper-based wireless backhaul networks to faster fiber optic connections.

However, Qwest remains more challenged than other regional telephone companies (“Baby Bells”) in the US such as AT&T (NYSE:T) and Verizon (NYSE:VZ) given the lack of its own wireless and satellite TV services. This has prevented Qwest from achieving meaningful penetration in these lucrative markets.

Qwest recently agreed to be acquired by rural telecom carrier CenturyTel (NYSE:CTL) in a deal valued at $22.4 billion. The integrated entity will have complementary assets and geographic coverage and will compete with greater scale and operational efficiency in a mature US home-phone market. However, the merger (likely to close in first-half 2011) is already facing challenges as some Qwest shareholders recently sued the carrier arguing that the price offered by CentryTel is too low.

Moving forward, we expect the company’s business prospects to be driven by continued strong demand for its broadband Internet service, expansion of fiber-based network capabilities and the wireless backhaul opportunity. However, access line losses due to competition will continue to erode operating revenue in the upcoming quarters. We currently have a Neutral rating on Qwest.

Source: Qwest Beats, Net Hit by Charges