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The second-quarter 2008 financial reports are in –- and the tea leaves aren’t showing a sunny future for phone companies. While their financials today look bearable, economic and demographic trends are acting as gale-force headwinds for the future. Here are some of the major issues they’re facing:

• A slowing economy means people are choosing wireless phones over landlines, resulting in increased access line losses. That, in turn, is reducing the number of people the phone companies can convince to switch to their higher-speed networks and video services.
• Cable’s triple-play bundles, which include higher speeds and voice, are starting to resonate with the residential customers, leading to further landline losses.
• Phone companies’ own higher-speed services are starting to cannibalize their installed base instead of luring customers away from cable companies.

In broadband, cable rules for now

According to Leichtman Research, there were 65.1 million U.S. broadband subscribers at the end of the second quarter of 2008, with cable companies getting a larger share of the total –- 35.3 million subscribers. In comparison, phone companies have 29.7 million subscribers.

The two big cable operators, Comcast and Time Warner Cable, continue to add broadband subscribers at a furious pace, though their growth rate is starting to lose speed. In contrast, phone companies are having trouble adding subscribers, even as they roll out video and faster networks.

Phone companies’ broadband offerings are taking the shine off their DSL services. AT&T, for example, added 46,000 new subscribers (down from 491,000 last quarter) and 170,000 U-verse subscribers. John Hodulik of UBS Research suggests that when taken together, it lost around 124,000 DSL subscribers.

Verizon is experiencing similar issues. It added 187,000 FiOS Internet subscribers, but the total broadband tally came in at just 54,000 net additions for the quarter — a loss of 133,000 DSL lines, using the UBS method.

It shouldn’t come as a surprise. Once you hear about a much higher speed Verizon FiOS connection in your neighborhood, why would you want DSL? Cable companies have used this “more is better” mantra to their advantage, offering up all sorts of geewgaws, like Comcast’s Powerboost.

An AT&T spokesman told the Wall Street Journal that speed is only one component of a broadband service and offered up other arguments such as shared capacity and other technical mumbo jumbo to justify that their DSL connections are better. “We offer the best broadband for the price,” he told the Journal.

I was amused, because when you sell broadband, speed is the most critical component — and all these points made by the phone company guys don’t translate too well in the winner-take-all world of consumer marketing.

The divergence between U.S. cable and telephone companies can be easily explained: Cable companies added phone service and offered triple-play service, stealing voice customers from the phone companies. Phone companies are responding to the triple-play threat by rolling out their own video networks, but it is early days and really slow going. Since voice networks are easy to roll out compared with big video networks, phone companies are finding themselves on the losing end of the equation.

Where did my lines go?

As I’ve said before, the biggest problem for phone companies is that they’re losing voice customers at a rapid clip -– either to cable operators or to wireless. Many believe that uncertainty regarding the economy is making people pick a wireless-only option — a theory supported by robust growth in the wireless additions at Verizon (1.5 million net new subscribers) and AT&T Wireless (1.3 million net new subscribers).

This continuous line loss reduces the pool of potential switchers to video and higher-speed broadband services. You want to know how bad it is? Here’s a quick rundown of second-quarter losses: Qwest saw a 10.2 percent decline in residential lines; AT&T an 8.7 percent drop; Verizon lost 8.5 percent (1.4 percent decline in residential switched access lines), and Embarq lines dropped 7.8 percent. All four percentage losses were higher than in the previous quarter.

What phone companies should do

I think between the bluster and hype, the reality is that phone companies are facing an uncomfortable today and an uncertain tomorrow.

Big phone companies should take a cue from Roseville, Calif.-based Surewest Communications, a smaller player that’s been very aggressive about offering broadband at competitive prices, offering higher speeds and, in general, meeting consumer demands. It reported a 1 percent sequential decline in voice lines for the quarter and a 2 percent jump in broadband subscribers. It’s trying hard to compensate for access line losses with VoIP services. The company said that “over 82 percent of existing data subscribers who signed up for VoIP increased their Internet speeds to enhance the overall experience.”

Maybe it’s time for the big boys to let go of their legacy and fully embrace the future — including offering better broadband, advanced services and new voice at prices that are much lower than cable. At least that way they can start to stem the tide of losses.