Reality Check: Whistling two different (i)Tunes

Editor’s Note: Welcome to our weekly Reality Check column. We’ve gathered a group of visionaries and veterans in the mobile industry to give their insights into the marketplace.
We have yet to learn of the bottom-line successes of the iPhone 4 or Droid X launch to AT&T, Verizon, Motorola or Apple, but we did have some precursor events this week. From Google’s earnings and the iPhone4 “bumper” press conference, we see two fundamentally different ways to handle the media.
For one perspective, let’s see how Google handled its earnings estimates miss this week. It had strong growth (24% annual rate for what looks to be a $27-28 billion company in 2010), yet maintained its operating margin at 35% (a fun problem to have, to be sure). Concerns mounted, however, because the first-quarter margin was 37% (this as we consider whether Verizon’s telecom unit will actually post a pro forma operating profit in 2Q). Google’s second-quarter operating profits were $2.4 billion, generating $1.6 billion in free cash flow. Google now has $30 billion in cash and marketable securities, and, just for grins, opened up $3 billion in commercial paper – a clear sign that stock repurchases are in the offing. (As a reminder, Google has no debt, and no pension obligations. As of Q1, Verizon and AT&T had $130 billion in total debt and nearly $60 billion in pension liabilities).
These earnings disappointed analysts and missed expectations. Granted, you have to set proper expectations, but growing $1.3 billion in revenues and $500 million in operating profits is not enough? The primary concern of the analysts was that Google was hiring too many people (1,200 in the quarter to be exact, which included 300 from the AdMob acquisition) and that this would drive up stock-based compensation expense. Compare this to comments made on the Verizon Q1 earnings call (this is John Killian in the Q&A session – source is Verizon’s investor website):
Now, on the cost side, I hope you get the feel here that we are very focused on improving and continuing to improve the cost structure. I mentioned on previous calls the last couple of years we’ve reduced our wireline workforce by about 13,000 per year and I said we would do the same this year. I actually think we have now the ability to do more than that this year.
You’ll probably read in the press later today that we did reach agreement with our unions and our East Coast unions, the CWA and the IBEW, on an enhanced incentive offer last night. That is going to allow us to take out a significant number of associates. One of our limitations on our ability to downsize the workforce was we were limited in our ability to layoff in our East Coast contracts. We could layoff post-2003 hired employees and we did some of that last year, but beyond that it was voluntary incentives that drove it.
We reached agreement on an enhancement and I think this year we should be able to beat the 13,000 number. I’m not going to put an exact number on that yet because we’re still factoring through that based on the agreement. But I think we’ll be very focused on additional force reductions this year.
Taking out associates. That’s strong language, even for a cost-focused CFO. Compare that to the response from Patrick Pichette, Google’s CFO, to reasons why their hiring expenses are going up (source is from Seeking Alpha):
In terms of hiring I think that it really is the case that we – I am going to take a step back to three quarters ago when we said, ‘Look, for us the recession is over.’ For us we see great products and we have a mindset of the next half decade and the big platforms we are building that are creating these huge ecosystems, and for us search is one and then mobile and Android as we just talked is one. And then display is amazing, right. It’s really growing. And to not put resources to actually fuel this ecosystem, which is the next decade, it’s just such an opportunity. So that’s why we are investing aggressively. We think it’s the right thing to do at the moment in the company. So – and that’s the balance we are striving. Even in Q3, right, if you think of headcount, we have a lot of people – I should call them – the people that we just graduate from university that are going to [be] joining us, right. So there may be even be you can think of the bump of the accepted but not started because they are going to go backpacking for the summer before they come and join us. But I mean ultimately, right, we are looking at a trend of continuing to invest. And it’s the right thing at this time in the history of the company. So that’s on CapEx and on hiring.
So one CFO is talking about taking out associates while the other is talking about their pending hires taking time off to backpack prior to starting their career at Google. That’s where we are in the telecosm right now. Two worlds colliding. (My money’s with the guys with $30 billion in cash and the employees fresh in from the Alps).
Google faces a set of problems that cannot be ignored: Google Voice, Nexus One inventory, China, Apple, net neutrality (if they spent $100 million on the Viacom lawsuit, how much do you think they will spend to defend net neutrality?), and fueling future growth all present a wide range of outcomes. But with $30 billion (+ $3 billion in a line of credit), $10+ billion in operating profits, 25% annual growth, and a best-in-class recruiting machine, who cares?
Bottom line: Google silenced its critics by deftly explaining why expenses were rising faster than expected: They are investing for the future, and they are defending the Internet to keep YouTube relevant. And, with all of their problems, they continue to whistle a happy tune. Despite their expectations miss, their leadership is cemented for another quarter.
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Now we turn to Apple. If you have not seen Friday’s Apple iPhone4 press conference on You Tube, please watch it here after you finish the column. It’s four ten minute segments, and worth the watch. The Scribd version of the presentation can also be found here.
In three weeks, Apple has shipped 3 million iPhone 4 devices. This on top of the iPad success, on top of the App Store success, on top of a long string of successes that have made Apple the most valuable technology company in the world. They are the leader, and have accelerated the advancement of computing and phone design more than any other company in the past decade (maybe ever). And shareholders love Apple. To put in context, Apple has created nearly as much shareholder equity value – $138 billion – in the past 19 months as AT&T has in the past 100+ years (AT&T’s current market is approximately $147 billion). Apple is not a powerhouse, it is the powerhouse.
Then why are they letting a handful of the media get under their skin? Here’s a brief synopsis of what they said on Friday:
1. If you don’t like the phone, don’t buy it. If you bought a phone and don’t like it, take it back. (Here is the video of the iPhone “Antenna Song” they showed prior to the press conference).
2. Every smartphone has this problem. (So AT&T drops calls even on the BlackBerry Bold 9600 and Samsung Omnia II). Mentioning your opponents by name – bad for politicians, and bad for smart phones. Mentioning your network partners by name and featuring AT&T in the BlackBerry Bold example – why?
3. This is a new problem to us and we are working very diligently to solve it. We solved the signal strength problem through a software fix.
4. It’s not a problem because no one has called us about it.
5. It’s not a problem because no one has returned it.
6. It’s not a problem because AT&T’s dropped call rates haven’t risen more
than 50% (< 1 additional dropped call
per 100 is likely more than a 50% increase).
7. We love our users, and try very hard to surprise and delight them every day.
8. We are a great company. Don’t forget, we brought you the iPod, iPhone, iPad, the Apps store, and everything else in between.
9. You want something? Here’s a free bumper. If you still aren’t happy, please return the phone for a free refund (including your AT&T early termination fee).
10. (Q&A) Stop picking on us. You (media) are making stuff up. We make America great, and put America on the map as a technology leader (Google, too).
I have watched this video three times. I can’t help but think about how the media would have responded to a Johnson & Johnson if they had the same tone with the New York Times about the recent Tylenol recall (read more about that here – there was nothing wrong with the product, except for the fact that the packaging smelled musty – apparently, really musty). What if Dell had taken this approach in 2006 with its laptop battery recall? What about Toyota with the Prius brake issue (which everyone knows also impacted the Ford hybrids as well)?
When you ascend to the leadership throne, you have to lead. No one wants to hear excuses – to use a Nascar term, Apple can’t draft if they are the lap leader (and, when your market capitalization exceeds Microsoft, you’re the lap leader). No one wants to be insulted with “You’re holding the phone wrong” comments. And none of the 1% of Apple users who are having problems wants to be dismissed for bothering to speak up about them.
Bottom line: Apple abdicated the technology leadership throne on Friday. The end (free bumpers, full refunds) was right, but they forgot that leaders should be “swift to hear, slow to speak, and slow to wrath.” That’s some advice from a sage man named Paul. Apple needs whistling lessons.
Next week, the start of the 2Q earnings review. More on www.thesundaybrief.com throughout the week.