Verizon Communications Inc. Earnings: Keeping the Customers It Wants

Verizon Communications beat Wall Street's earnings expectations with its Tuesday report despite lower-than-expected revenue and subscriber additions. For the first quarter of 2015, Verizon reported earnings of $1.02 per share on revenue of $32 billion. Analysts had expected earnings per share to come in at just $0.95 on $32.3 billion in revenue.

The company lost 138,000 phone subscribers during the quarter as lower-priced offers from T-Mobile and Sprint helped entice them away. Verizon added plenty of tablet connections to offset the loss in phone subscribers, resulting in total postpaid net adds of 565,000. However, analysts had expected total net adds of 612,000.

Here are the key takeaways from Verizon's earnings report.

Source: Verizon.

A sharp EdgeVerizon's wireless segment reported total revenue of $22.3 billion, an increase of nearly 7% year over year. However, the company's service revenue actually declined 0.4% from the first quarter of 2014.

The decline in service revenue is attributable to a shift to Edge pricing, which separates equipment costs from service costs, and thus accounts for the revenue separately. Verizon increased equipment revenue $1.5 billion year over year, and Edge billing plus service revenue increased 3.1%.

Edge adoption increased to 39% last quarter. Edge does away with the subsidy model, which can negatively impact a carrier's expenses. However, Verizon accounts for 95% of a device's cost as revenue at the time of purchase, even if it is financing the device over two years. That can result in cash flow lagging revenue growth.

The company's operating cash flow during the first quarter (excluding a one-time tower sale) totaled $7.8 billion, a 10% increase year over year.

The shift to 4G devicesWhile Edge has had a big impact on service revenue, the mix of devices has had a slight affect as well. While Verizon lost 138,000 total phone subscribers during the quarter, it added 621,000 4G smartphone subscribers, who upgraded from either 3G or basic phones. Overall, it added 247,000 smartphones.

Naturally, as subscribers move up the chain from basic to 3G to 4G data, their service costs increase. 4G users consume more data due to the higher speeds at which they can download or stream content. The vast majority of differentiation between wireless plans has become data allotments (with most plans offering unlimited talk and text). Moving users to use more data is key to growing service revenue.

Verizon has also done an excellent job of convincing subscribers to add a tablet to their plan. Last quarter, Verizon added 620,000 4G tablet connections. While this pushes average revenue per connection lower, it drives overall revenue and connection growth as the phone market is mostly saturated. Additionally, connecting more devices per customer makes them much stickier, resulting in lower churn. Verizon's postpaid churn fell to 1.03% last quarter.

Still growing the wireline businessVerizon's wireline segment revenue rose 4% in the quarter, with its FiOS business accounting for 78% of the total. The company added 133,000 net FiOS broadband subscribers and 90,000 FiOS video subscribers. Those FiOS Internet subscribers offset the decline of 92,000 subscribers of the company's legacy DSL business.

Converting more DSL customers to FiOS Internet is key to growing the company's pay-TV business. While total broadband connections grew just 2.4% year over year, FiOS TV customers increased 7.9% while other pay-TV providers have seen a decline in subscribers.Verizon said it converted 47,000 customers from copper connections to fiber last quarter, with a full-year goal of 200,000.

While the FiOS TV subscribers add significant revenue to the company's wireline segment, it is lower-margin revenue than its phone and Internet service revenue since a large percentage goes to content costs.

A mixed quarterWhile the competitive pressure from Sprint and T-Mobile is leading many phone subscribers to churn away from Verizon, the company is doing a good job of keeping the customers it really wants, as evidenced by the increase in 4G connections. Verizon's Edge pricing is doing a good job of convincing customers to upgrade to 4G smartphones, but it does impact cash flow and margins in the short term. Meanwhile, Verizon's pay-TV service continues to add meaningful revenue to the company's wireline segment as it converts legacy DSL customers to fiber. All of this resulted in a quarter of strong profits but lower-than-expected revenue.

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