Apple reported its financial results for the most recent quarter on Tuesday. The most anticipated piece of news was its update on iPhone sales. Apple sold about 5% fewer phones, and generated about 13% less revenue, than it did in the same quarter last year. That’s not good news.
The art of earnings calls
I really like listening to the phone calls that accompany these financial reports. At the end of each quarter, senior executives from publicly-traded companies will discuss their results with investors. It’s an opportunity for investors to ask questions, to try to learn a bit more than what’s in the reports themselves.
The best part for you and me? These calls are open to the public.
There’s another layer to the calls that fascinates me. I like listening to the cadence of the conversation. Did the CEO pause a little more than usual before answering a particular question? Did the CEO rush through the answer? Did the CEO spend a little too much time on an obvious response?
In addition to cadence, I pay attention to how directly executives answer questions. Was it short, sweet, and to the point? Or was it a meandering answer to a question that the analyst didn’t even ask?
Almost all senior executives are well practiced in this regard. They know what topics they want to talk about, and what topics they’d prefer to avoid. They know which information they can divulge, and which must remain proprietary. They know which analysts are likely to lob them softball questions, and which analysts may have slightly adversarial questions.
Tim Cook opines on Apple’s year-over-year weakness
There was a moment in Apple’s call on Tuesday that really stood out to me. Here’s the question, from Shannon Cross at Cross Research LLC:
[C]an you talk a bit more about China, just how you’re thinking about it, where you’re seeing pressure? I know you mentioned that you expect to see a significant rebound during the first quarter, but what are your customers telling you about the demand in China?
The question is about near term demand in China. Now here’s the first part of Tim Cook’s answer, with my added emphasis at the end:
Yeah, it’s a good question, Shannon. So to sort of back up from our results for the quarter, the 90-day clock, and look at the full year of 2016, we were down 17% compared to the fiscal year 2015 which was up 84% from the previous year. So if you look at 2014 to 2016, the revenue grew 52% and the CAGR was 23%, which is really a pretty good result.
Also as you probably know, the fiscal year 2016 performance was hurt by the devaluation of the currency which affected it about 3%, so the underlying business performance was 14% down. And so, why was it down? There’s lots of reasons, but the largest one in our view is that when you look at what happened in 2015 in China, we had a surge of upgraders that came into the market for the iPhone 6 or iPhone 6 Plus, and the upgrade rate increased relatively more in Greater China than elsewhere around the world. And so when that upgrade rate in fiscal year 2016 returned to a more normal upgrade rate, which would be akin to what we saw with the iPhone 5S as a point, it had further to fall. And so that’s the main reason in our view that you see a difference.
Now that spun or created another issue for us, because we didn’t forecast that accurately. So in Q1 of last year, we put in too much channel inventory and had been resetting the channel inventory over the few quarters that came beyond it or came after it. And so those two issues, which really the main one is really the first one and the second one was a symptom of it, are in our views the main issue.
Cook’s answer is interesting on so many different levels. Here are some reasons it stuck out to me:
- The question was about forward-looking demand in China. Cook voluntarily traced it backward to explain historical revenue growth in China.
- Cook made a point, early in his answer, to highlight the two-year trend in China. Yes, things look bad compared to last year. He wants analysts to remember that things look much better compared to two years ago.
- Cook couched Apple’s miss in terms of inaccurate forecasting. In other words, Apple thought its growth in China from 2014 to 2015 was sustainable. It wasn’t. That’s important.
Tim Cook did go on to speak a little about the demand for iPhone 7. But he couldn’t say much. He said demand is strong. Apple is selling everything it’s making in China. Until the story plays out a bit, he can’t put near-term demand in perspective.
The story Tim Cook wants you to hear
Why did Tim Cook speak to the iPhone’s history in China, when the question was about future demand? Because he has a story to tell. He knows the quarterly conference call captures a lot of attention. It’s a great opportunity to speak to the investor community as a whole.
Apple’s stock price is a reflection of future expectations. The more optimistic investors are about Apple’s future performance, the higher its stock price goes. Since stock price is an expectations game, Tim Cook wants to mange those expectations as much as possible.
Tim Cook knows the prevailing narrative around stalling iPhone growth. He knows how that narrative suppresses Apple’s stock price. He also knows that China is the epicenter of that challenge. So, hearing the question about China, he decided to counter the prevailing wisdom and articulate China as an ongoing Apple success story.
I’ll offer one brief aside. Apple reports its revenue by operating segments: Americas, Europe, Greater China, Japan, and Rest of Asia Pacific. Apple separately reports its revenue by product: iPhone, iPad, Mac, Services, and Other Products. Apple deliberately does not report its revenue at the intersection of these two. In other words, while Apple reports its total Greater China revenue and its total iPhone revenue, it does not report its iPhone revenue in Greater China.
Apple, like all publicly-traded companies, has to strike a balance. It has to report enough detail to give investors a sense of how the business is performing. But it also has to hide enough data to not damage itself competitively. While you can estimate Apple’s iPhone sales in China, you’ll never get that number directly from Apple. As a result, Apple’s executives have some room to tell their preferred story, without the data backing them into a corner.
Why do I call this “verbal jiu-jitsu”?
The line that made me think of “verbal jiu-jitsu” was the bit about forecasting. Tim Cook wants people to believe that stalling iPhone sales result from Apple’s own forecasting mistakes. But that’s not true.
The market will buy what the market will buy. The market doesn’t care what Apple is doing with its “channel inventory”. The forecasting mistake actually reflects badly on Apple’s senior leadership. Executives saw the huge jump in iPhone sales in 2015, and assumed that was a new normal. They assumed iPhone sales would continue to grow from there. And they didn’t.
So, yes, it’s true that Apple built a bad forecast. But the forecast isn’t the problem. The problem is that Apple believed unsustainably high upgrade rates were sustainable. In that sense, the executives didn’t completely understand the Chinese market.
That’s why Tim Cook would rather blame the problem on forecasting. It’s one thing to build a crappy forecast. Everyone does it. It’s another thing to misunderstand the one market that’s most responsible for your future growth. That’s more of a black eye. And Tim Cook would rather the investor community not linger there. So he used some verbal jiu-jitsu to try to change the story a bit.
Apple’s incomplete understanding of the Chinese market isn’t the end of the world. Very few people spoke up during 2015, warning of unsustainable growth in China. China’s market is so large that it will take a while to saturate it. With the size of the market in mind, it wasn’t immediately clear 2015’s growth was anomalous. Now the anomaly is becoming more clear.
I urge you to listen to quarterly earnings calls
If you work for a publicly-traded company, listen to your company’s call. You can find the call-in or webcast information on your company’s investor relations page.
If your company isn’t publicly-traded company, find publicly-traded companies in or around your industry. Listen to their calls. Listen to calls for companies you invest in, or buy products from.
In these calls, you’ll pick up the language of Wall Street. You’ll learn how senior executives think, and talk, about their businesses. Almost all of these executives progressed in their careers in part due to their communication skills. Earnings calls will show you how professional communicators talk about businesses that are important to you.
You don’t have to mimic the cadence or language of the conversation. But know the topics. Try to understand why investors ask the questions they ask. Know why the executives respond the way they do. As you listen to more and more calls from the same company, you’ll get a feel for what’s normal. You’ll know when the executives are uncomfortable or confused. This kind of familiarity adds layers to the lessons you can learn from listening.
Inevitably, you’ll start communicating more clearly about your own business. You’ll get better at sifting the important from the unimportant. You’ll more deftly change perspectives, imagining your business from the eyes of different kinds of stakeholders. These skills will help immensely as you progress down your chosen career path.