Verizon Communications (NYSE:VZ) posted its second-quarter earnings Tuesday morning, beating analysts' expectations on the bottom line, but missing on the top line. The company earned $1.04 per share on $32.2 billion in revenue. Analysts were looking for $1.01 in EPS on revenue of $32.4 billion.
The company came through and added more phone subscribers after it saw a decline in net phone subscribers in the first quarter. Tablet connections continued to pull most of the weight, with 842,000 net additions, compared to just 322,000 net phone additions. Overall, it was a rather mixed quarter for Verizon, which saw its shares down nearly 2% by 2:45 p.m.
Here are the key takeaways for investors.
Tablets dominate net adds
As mentioned, Verizon added significantly more tablets than smartphones. Verizon added 588,000 smartphones, but lost 266,000 basic phones. Naturally, smartphone connections are more valuable than basic phones since they include data plans, but they're also more valuable than tablet additions. Tablets outnumbered smartphone connections by 254,000.
Verizon (and the other major carriers) have started subsidizing tablets to encourage customers to sign up for the associated data plans. Those subsidies cut into margins, which are already somewhat lower on tablets since they're usually added to family plans. Additionally, many customers simply don't need as much data for tablets since they're more often used with a Wi-Fi connection, which leads to lower return on those subsidies.
But tablets play a significant role in reducing churn. Verizon sees a negative correlation between the number of devices on a customer's account and the likelihood that customer will switch carriers. Verizon's churn rate in the second quarter was just 0.90%, its lowest in three years, and likely one of the best we'll see in the industry this quarter.
Equipment install plans gain popularity
During the second quarter, Verizon activated 49% of new smartphones with its Verizon Edge program, which allows customers to pay for their device in installments in return for a lower service bill. That's an increase from 39% the previous quarter, and just 18% in the year-ago period. As a result, service revenue declined 2.2% year over year, and equipment revenue increased 63%. Combined billings increased 2.3%.
Verizon accounts for Edge equipment purchases by posting 95% of the phones' value as revenue at the time of purchase. Verizon justifies putting this high percentage of revenue on its books by requiring customers to pay off at least 75% of the phone's value before they're eligible to trade it in for a new one. Verizon will then turn around and sell that trade-in phone.
More recently, Verizon started securitizing its loans for smartphones and selling them to banks. That allows for Verizon to make up the difference between its stated revenue and cash flow. In the first half of the year, Verizon's cash flow from operations increased to $18.9 billion from $14.8 billion last year.
FiOS improves penetration and carries wireline segment
Verizon added 72,000 FiOS net Internet connections and 26,000 net video connections during the second quarter. Those numbers are down from last quarter as well as the year-ago period. In the first quarter, Verizon added 133,000 and 90,000 Internet and video connections, respectively. Those numbers were 139,000 and 100,000 for Internet and video, respectively, in the year-ago period.
Nonetheless, Verizon continues to improve its penetration of its existing addressable homes, now reaching 41.4% of potential Internet homes and 35.7% of potential video homes. At a time when cable companies are struggling to maintain customer relations, the fact that Verizon is still adding net connections is a sign of a strong business. Overall, FiOS increased revenue 10%, leading to 4% overall revenue growth in the wireline segment.
Verizon's new Custom TV package, which allows customers to pick specific channel bundles based on interest, proved popular. One-third of gross video connections were made using the Custom TV offer. Verizon says, "While Custom TV adoption has an initial negative impact on revenue growth, it is expected to improve profitability," likely due to lower programming costs.
A mixed quarter
Overall, the quarter was mixed with revenue missing estimates, but earnings notching a beat. Tablets continue to dominate net additions, and the Edge program is gaining significant momentum. The impact on cash flow from separate service and equipment billing has seemingly been minimized by the securitization of the loans associated with equipment, and cash flow remains strong at Verizon. Meanwhile, the wireline segment continues to grow on the back of FiOS.
For the third quarter, Verizon expects higher revenue growth than in the second quarter. It expects total consolidated revenue growth in 2015 to come in above 3%. Analysts are currently expecting revenue growth of 3.3% for the year.
Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.