Weak economy hurts Verizon's earnings

Telecom giant's overall profits dip in the second quarter, despite higher revenue and new subscribers for its wireless and TV services.

Updated 8:27 a.m. PDT with information from the conference call.

Verizon Communications' second-quarter profits took a hit as the weakened economy caused some corporate customers to cut spending. Meanwhile, the company continued to see strong growth in its wireless and consumer TV and broadband businesses.

The company's second-quarter results, released Monday, were in line with analyst predictions.

Verizon said it earned $3.16 billion, or 52 cents per share, in the quarter. During the same quarter a year ago, the company earned $3.4 billion, or 66 cents per share.

Excluding special items, the company said it earned about 63 cents per share.

Meanwhile, Verizon increased revenue to $26.86 billion from $24.1 billion last year, an 11 percent increase. This was largely due to the acquisition of regional carrier Alltel. The deal closed in January.

Declines in sales of service to business customers helped drag down the company's profits. Sales to corporate customers fell to $3.7 billion. And the company's wireline business, which includes its traditional phone business, continued to decline with the total number of lines falling 9.9 percent to 34.3 million from 38 million a year ago.

The company's chief financial officer, John Killian, said during a conference call with analysts and investors that the weak economy, which caused layoffs at many companies, was the main reason for the reduced spending. He also said the company would continue to cut costs in an effort to mitigate the negative effects.

Verizon has already eliminated 8,000 jobs in the past year, he said during the call. These employees have mostly been from the company's legacy telephone business. And Killian said that the company plans to cut another 8,000 staff and contract jobs in the second half of the year. While he stopped short of saying where additional cuts would be made, Killian also made it clear that the company was looking to reduce costs in all areas of the business.

"We are looking at all other areas of expense," he said.

At least one analyst noted Verizon's struggle to grow revenue and maintain profitability in a tough economy. But he applauded the company's efforts to cut costs.

"While relatively resilient in the face of recession, Verizon's second quarter results are a reminder that no company is immune to the severity of the current downturn," Craig Moffet, an equities analyst with Sanford Bernstein, wrote in a research note to clients on Monday. "But like so many other companies this quarter, expense control was exceptional."

The company's chief operating officer, Denny Strigl, said during the conference call that the cuts and a focus on growing other parts of the business, such as wireless and Verizon's fiber-based TV and broadband services known as Fios, will help the company maintain strength when the economy recovers.

"These are challenging times," he said. "But we stay focused on our strategy of growing revenue and taking market share, and improving profits. The state of the economy may make it more difficult in the short term, but we are doing what we do best, which is managing our businesses and reducing costs."

While Verizon faced pressure in its traditional phone business and from corporate customers also reducing costs, the company saw growth in its wireless and Fios businesses. Verizon Wireless, a joint venture between Verizon Communications and Vodafone, added 1.1 million new customers in the second quarter to bring its total to 87.7 million subscribers. Still, the company attracted fewer new customers than rival AT&T, which added 1.4 million new subscribers .

Verizon reported an overall churn rate, or the rate at which customers leave its service, of 1.37 percent. Its churn rate for its post-paid customers, or customers who pay their service monthly, was 1.01 percent. Meanwhile AT&T reported an overall churn rate of 1.49 percent and a post-paid churn rate of 1.09 percent for the second quarter.

Wireless data helped boost revenue for Verizon Wireless. And the company reported that the average revenue per user, or ARPU, for data, which includes text messaging and mobile Internet, was up to $14.96 a month from $14.16 in the first quarter.

While Verizon Wireless has one of the best records in the wireless industry for adding and retaining customers, Strigl admitted that the Apple iPhone, sold exclusively in the U.S. by AT&T, has affected sales. Specifically, he said he saw an uptick in customers moving over to AT&T for the new iPhone 3GS in the last part of June. The new phone went on sale in the middle of June, just two weeks before the end of the second quarter. AT&T reported last week it activated more than 2.4 million devices before the end of the second quarter.

"The iPhone has clearly been a successful device," Strigl said. "And it has expanded the overall phone market. We have been competing successfully and will continue to do so. But we did see an uptick in the last couple of weeks in June. (Still,) we think we are extremely well-positioned going forward. The lineup and pipeline of new products we have coming is strong."

Even though AT&T can attribute much of its subscriber growth to the iPhone, the device, which is highly subsidized, has also hurt the company's wireless operating and profit margins.

Strigl pointed to a series of new devices that are coming to Verizon Wireless that he believes will give the iPhone a run for its money, including the new BlackBerry Tour from Research In Motion, which went on sale July 12 . He also said the touch-screen BlackBerry Storm will be upgraded later this year. The current version of the BlackBerry Storm is sold exclusively on Verizon Wireless' network. He also said the company plans to launch a phone using Google's mobile operating system called Android.

Strigl also confirmed that Verizon Wireless will be selling the Palm Pre early in 2010. Sprint Nextel is currently the only company selling the Palm Pre, which went on sale in early June . When the device launched, Sprint's CEO Dan Hesse alluded to a much longer exclusive deal for the Palm Pre .

Test of LTE technology planned
While Strigl said he is confident about the company's upcoming handset lineup, he also pointed to the company's new 4G wireless network as an important differentiator over the next few years.

The company plans to test the network that will use newly acquired 700MHz spectrum and a technology called LTE, or Long Term Evolution, in Seattle and Boston later this year, he said. And Verizon will deploy the service commercially in about 30 markets in 2010. He said the company has plans to cover 100 million potential customers during that time. It will continue to build the network in 2011 and 2012 with plans to cover its entire wireless footprint by the end of 2013.

He said the network upgrade should have only a small financial effect on the company in 2009. Exactly how much the company plans to spend on the deployment in 2010 and beyond hasn't yet been disclosed, but Strigl said it would not increase the overall capital spending budget on wireless much more than what it has been in 2009.

Strigl also noted that the company is experimenting with partnerships at the low-end of the market. Specifically, Verizon has entered into a reseller arrangement with Tracfone Wireless, which sells prepaid phone service. Strigl said the co-branded Tracfone/Verizon Wireless service called Straight Talk would not cannibalize the company's post-paid or contract wireless business. He said the company has the right to pull its brand off the service at any time.

Verizon executives also noted that the company plans to launch a Verizon Wireless App store by the end of the year. And CFO John Killian said the company is on track to convert all of Alltel's former customers to Verizon Wireless by the end of October.

In addition to growth in wireless, Verizon also saw subscriber gains in its consumer Fios business. The company added 300,000 new subscribers to its Fios TV service for a total of 2.5 million subscribers. And it also added 303,000 new high-speed Internet users, raising its total to 3.1 million. Strigl also said the company has been focusing more on retaining its DSL customers in areas where the Fios service is not yet available.

Killian noted that Verizon has been winning customers with the Fios product from its cable rivals, and the company has also been successfully up-selling more services to existing Fios subscribers.

 

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