Palm: Despite Upbeat Results, Challenges Up Ahead

Palm, Inc. (PALM) fourth quarter 2009 results beat Wall Street's expectations as well as ours. The company reported fiscal fourth quarter (May 31) revenue of $86.8 million, down 4.2% from the third quarter of 2009 and a sharp decline of 70.7% from the fourth quarter of 2008.

Although revenue fell sharply in the quarter it exceeded our expectation of $75.0 million as well as consensus estimates of $80.3 million. This was due to strong demand for its recently unveiled Palm Pre. Revenue performance in the quarter was also positively impacted by the strong domestic and international carrier interest in the Web OS platform and ramp up of Treo Pro shipment.

Palm also said that the demand for the Pre was exceeding its expectations and increased Treo Pro volume contributed an increase in margins. GAAP gross margin for the fourth quarter of 2009 improved to 23.1% from 4.6% in the third quarter of 2009 but was slightly below the fourth quarter of 2008 margin of 25.2%.

On a non-GAAP basis, gross margin for the fourth quarter of 2009 was 26.8% versus 5.0% in 3Q09 and 25.3% in 4Q08. Gradually the company expects to reach a gross margin -- on an adjusted basis -- of above 30%.

As a result of a more favorable tax rate and lower-than-expected operating expenses, EPS on a pro forma basis was better than our estimate of a loss of $0.47 and consensus estimate of a loss of $0.65 per share. On a non-GAAP basis, Palm reported a loss of $0.40 per share in 4Q09 versus a loss of $0.86 per share in 3Q09 and a loss of $0.22 per share in 4Q08.

Palm said it could turn to positive cash-flow in the second half of fiscal 2010 and reassured analysts that its capital position was sufficient to revive the company and reap profits. Palm also said that it will no longer manufacture handhelds and will focus all of its resources on smartphone products.

The company shipped 351,000 smartphone units in the quarter, up 6% from the previous quarter but down 62% from the year-ago quarter. In addition, smartphone sell-through during 4Q09 was 460,000 units versus 482,000 units in 3Q09. Although this was down 5% quarter-over-quarter and 52% year-over-year, smartphone sell-through was better than the consensus expectation of 450,000.

"The launch of Palm webOS and Palm Pre was a major milestone in Palm's transformation; we have now officially reentered the race," said Jon Rubinstein, Chairman and CEO. Palm noted that there have been over 1 million apps downloaded for the phone to date.

Palm did not provide specific guidance for fiscal 2010 or the first quarter. As Palm Pre was launched in June, we expect that its impact will be fully reflected in the first quarter of fiscal 2010. We expect $95.0 million in revenues and a loss of $0.28 per share on a pro forma basis for the first quarter of 2010.

Although the 4Q quarter was good, we do not expect PALM to become profitable in the next three to four years. It is also likely that the company will have a tough time delivering a strong top-line growth. Pam Pre has been well received by users, but Palm has struggled to keep up with demand for the new handset.

We believe Palm will continue to struggle as it competes against much larger competitors such as Apple Inc. (AAPL), who launched the iPhone 3G S, Research in Motion (RIMM), who plans to unveil the Tour, the newest Blackberry, and Nokia Corp. (NOK).

These rivals are able to innovate faster and launch more attractive products. Additionally, price cuts from competitors will put pricing pressure on PALM. We reiterate our Sell rating on PALM shares, but raise our six-month price target to $8.00 from $5.00.

Disclosure: No position

Comments

[Yagottabe K...:]

The 4th quarter was not good; it was lousy. In fact, it was horrible. In actual fact, it was a disaster.

Never ever confuse, as pretty much all the Media World has, that very poor "analyst" estimation being "beat" means a company has done a swell job. All it means was some very poor analysis was the bar over which Palm had to jump. NONE of the analysts took into account sell-in of 60,000 Pres; take away the Pre dollars and suddenly the results look as bad as they were. Those dollars, of course, aren't going to be in the NEXT results now, either.

Palm management mentioned 1 million downloads of applications as if it represents something great about the Pre - instead it very clearly shows the Pre sell-THROUGH fell flat - 1 million applications SOUNDS good until you start figuring out how many applications (and updates?) a single Pre owner is going to get (they were all free, remember), then suddenly that 1 million applications downloaded starts translating into 100,000 or so Pres or so and one gasps at the suggested lack of sales.

Jun 28 07:01 AM

[mollytjm:]

Palm knew they were short stocking the stores, trying to make it look like there was a big 'demand'. They issued invitations to existing Palm customers to get them to Sprint stores. If you want to see actual 'big demand', that would have been the weekend of the latest iPhone release. Those lines lasted a week!
And apps. whew. no one has them like the iPhone and playing catch up isn't really going to turn out well for Palm.
Once again, the bottom line in technology companies is FAST, good innovation. Technology is moving at the speed of light...Apple can do it, i'm not too sure about the rest of the bunch.

Jun 28 10:01 AM

[SharonW:]

"Although revenue fell sharply in the quarter it exceeded our expectation of $75.0 million as well as consensus estimates of $80.3 million. This was due to strong demand for its recently unveiled Palm Pre. "

Man, you call yourselves analysts? It had nothing to do with strong demand for the Pre. The Q4 09 quarter ended on May 29th. The Pre didn't launch until June 6th. About the only thing that could be on their books from the Q4 quarter related to the Pre are R&D and COG, but most certainly not revenue. Such faulty assumptions give the appearance that the Pre only added to their revenues in an exceedingly minor way, when they added nothing at all because it hadn't yet sold any Pres.

Going forward they will be using subscription accounting like Apple does. I surely hope your analysis has improved by then.

Nonetheless, if people continue to disbelieve the Pre story and keep on shorting this stock, it's to my advantage being long PALM. These short squeezes are total joy.

Jun 28 03:35 PM

[Yagottabe K...:]

@sharonw - Palm recorded sell-in of 60,000 or so Pres in the quarter, that's one of the main reasons they "beat" those lousy analyst estimates - essentially none of the analysts had accounted for Pre sales in that quarter.

Jun 28 04:59 PM

[SharonW:]

@yagottabe - Ah, I see where my confusion arose. I just re-looked at Palm's report. This is what threw me, from the opening statement:

"These results include the effects of subscription accounting treatment required by GAAP.(1) In accordance with this methodology, revenues and cost of revenues for the Palm® Pre™ smartphone are deferred and recognized over the product’s estimated economic life."

But the Non-GAAP Financial measures near the end clarify the non-GAAP assumptions:

"Palm eliminates the effect of subscription accounting (current sales deferred to future periods) to provide more transparency into Palm’s underlying sales trends. Management uses the non-GAAP measure Adjusted Revenues to evaluate growth rate, revenue mix and performance relative to competitors. Management uses the non-GAAP measures of Adjusted Gross Profit and Adjusted Gross Margin to measure operating performance based on current period sales and to facilitate ongoing operating decisions. These
financial measures are not consistent with GAAP because they do not reflect deferral of revenues and product costs for recognition in later periods."

Have I got it right now? Although the 60,000 Pres delivered by May 29th would be a guess as they did not give any numbers on the Pre deliveries or Pros. And given the fact that their margins improved, I'd suspect that their newer product line has better margins than the old which will be eliminated.

Additionally, Zachs didn't even mention enterprise interest which has been surprisingly strong. I recently read a Gartner report that recommended enterprise IT heads should purchase a Pre to familiarize themselves with it as demand is expected to be strong and Palm is currently in the process of completing a complete enterprise package that will allow IT to do remote wiping and better password requirements, etc. Currently, only the owners can remotely wipe. The completed enterprise package is expected to be complete in two months.

I also understand that both Oracle and SalesForce will be completing software for the Pre for CRM. I think RIMM may have more to worry about from Pre competition than AAPL.

If analysts failed to take into account any Pre deliveries though in making their estimates, wouldn't that be their own fault? Thus not invalidating the surprisely better report.

Jun 28 07:52 PM

[Yagottabe K...:]

Well, if I say Company X is going to do N dollars of revenues and Company X actually does 2xN dollars of revenues because I forgot they had two products instead of one then, sure, it really was my fault that Company X "did so well" compared to my estimate.

Hold on!

That sure looks like what Palm did!

Well, in any case, the already-reported earnings are past-tense and the Market has forgotten them. On to the future!

Jun 28 09:17 PM

[SharonW:]

Thanks. That's what I thought. :D

Jun 28 10:32 PM

[typopolice:]

"Revenue performance in the quarter was also positively impacted by the strong domestic and international carrier interest in the Web OS platform"

Could someone explain to me how revenue performance was positively impacted by domestic and international carrier interest in Web OS? This statement makes ABSOLUTELY NO SENSE. How do derive revenue from potential customer interest? Do you even read what you write? Did it just "sound good" to you? Just when you think you've read it all on Seeking Alpha.

Jun 29 09:56 AM