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Executives

Teri Klein – Vice President of Investor Relations

Jonathan J. Rubinstein – Chairman of the Board, President & Chief Executive Officer

Douglas C. Jefferies – Chief Financial Officer & Senior Vice President

Analysts

Simona Jankowski – Goldman Sachs & Co.

Amir Rozwadowski – Barclay’s Capital

Thomas Michael Walkley – Piper Jaffray

Mike Abramsky – RBC Capital Markets

Matthew Thornton – Avian Securities, LLC

Phil Cusik – Macquarie Research Equities

Jonathan Goldberg – Deutsche Bank North America

Analyst for [Edward Synder – Charter Equity]

Analyst for Maynard Um – UBS

James E. Faucette – Pacific Crest Securities

Tavis McCourt – Morgan, Keegan & Company, Inc.

Analyst for Jeffery Fidacaro – Susquehanna Financial Group

Jim Suva – Citi

Deepak Sitaraman – Credit Suisse North America

Paul Coster – J. P. Morgan

Palm, Inc. (PALM) F2Q10 Earnings Call December 17, 2009 4:30 PM ET

Operator

At this time I would like to welcome everyone to the Q2 2010 Palm, Inc. earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question and answer session. (Operator Instructions) I would now like to turn the call over to Ms. Teri Klein, Vice President of Investor Relations.

Teri Klein

I’d like to welcome you to Palm’s fiscal year 2010 second quarter financial results conference call. On the call today are Jon Rubinstein, Palm’s Chairman and CEO and Doug Jefferies, our Chief Financial Officer. I’d like to remind everyone that today’s comments including the question and answer session will include forward-looking statements including but not limited to guidance on future revenue and other financial and business activity.

These statements are subject to risks and uncertainties that may cause actual events to differ materially. These risks and uncertainties are detailed in Palm’s filings with the Securities & Exchange Commission including its quarterly report on Form 10Q for the first quarter of fiscal year 2010. Palm undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after this call.

Please note that today’s results will be discussed on a non-GAAP basis except where specifically noted in the commentary as GAAP results or estimates. Non-GAAP reporting is provided to help you better understand our business however, non-GAAP financial results are not meant to be considered in isolation or as a substitute for or superior to GAAP results. You should be aware that non-GAAP measures have inherent limitations and should be used only in conjunction with Palm’s consolidated financial statements prepared in accordance with GAAP.

Our earnings press release includes tables detailing non-GAAP measures together with the corresponding GAAP numbers and reconciliation to GAAP. You can also find this information on Palm’s IR website. We encourage listeners to review these items. Now, I’d like to turn the call over to Jon.

Jonathan J. Rubinstein

Palm is continuing to build momentum through innovation and focused execution. We’re meeting our strategic goals as we work to rapidly expand our installed base my launching more Web OS products with more carriers to extend our reach in new and existing markets. Since we last spoke we launched the Palm Pre with Telefonica Europe and began establishing the Palm brand in this important market. We introduced the Pre to Mexico with Telcel and we brought to market the Palm Pixi, the thinnest, lightest, full qwerty touch screen phone on the market and a perfect device for first time Smartphone users.

We now have Web OS products available with four carriers in seven countries in just a little over six months since launch and we expect our momentum to continue. We’ll be launching with new carrier partners in the near future and we’re pleased to have their committed strong support. We at Palm will be working hard on the marketing front to support our partnerships including the introduction of a new broad based campaign to drive better awareness of Palm products and our new carrier relationships.

Equally exciting is the imminent launch of Palm’s full developer program which will showcase its CES in Las Vegas in January. I’ll speak more about our ad catalog and developer program in a moment. These are exciting achievements and I’m proud of the Palm team which has consistently delivered on key milestones we’ve put in place since we began our transformation over two years ago. We’re pursuing our strategic objectives in a crowded market which is no surprise given that intense competition has always defined high growth tech sectors.

Despite the proliferation of products, we’re still at the very beginning of a long race and the competitive offerings we see on the shelf today only reinforce our conviction that our vision and product philosophy are the right ones to drive sustainable success. Two things in particular continue to give us confidence in Palm’s strategic position. First, more than ever we believe that owning and controlling every part of the product experience including the operating system, hardware design and services infrastructure creates advantages that will ultimately distance Palm from those competitors who depend on others for their core software.

These advantages include our ability to drive hardware and software development at a fast pace and one which we determine, adopt and integrate new industry technologies faster than competitors, offer customers and carriers a single cohesive and most importantly differentiated experience associated with our brand and create a single scalable platform for developers with no fragmentation and no diverging interfaces to complicate app development and distribution.

Our ownership of every facet allows us to take leading edge functionality and package it in to what we and many others consider to be the most elegant, easy to use and intuitive user experience available to consumers. End Gadget calls Web OS one of the prettiest platforms on the market and CNET describes Web OS as multitasking capabilities and notification system as unparalleled.

This past month Web OS and Palm Pre were also ranked as one of the best products of 2009 by PC World and one of the 10 most brilliant products of 2009 by Popular Mechanics. As the Smartphone market starts to mature and consumers move up the learning curve we think mass market appreciation for the Palm Web OS experience will only grow.

Second, we believe that Web OS is the platform best positioned to leverage the migration of content and communications to the cloud. In fact, even among our peers with integrated solutions Palm’s forward-looking cloud centric view of the world sets us apart. In particular our over the air software update capability is a powerful way to continually evolve and improve our products even after they’re in customer’s hands.

Since the launch of the Pre we’ve provided eight over the air Web OS updates and each has included a wide variety of new functions, improvements and fixes ranging from things like support for new synergy partners like linked in Yahoo to improvements in email and messaging to enhance security measures for the enterprise. Our 1.3.1 update was made available to Web OS users in mid November and within just one week it was installed by 70% of our user base.

This tells us that consumers are quickly learning to appreciate and look forward to this Palm capability which in keeping with our product philosophy we think is easier and more delightful to use than any update mechanism out there. Anticipation is already building for Web OS version 1.3.5 which will also be highlighted at CES. Among other things this update will let customers download and store more applications, enhance Wi-Fi and application performance, improve battery life and increase Pixi’s speed and responsiveness.

We have an aggressive Web OS software roadmap in place and we’ll continue to deliver enhancements to our user experience on a regular basis. This includes investing heavily to make Web OS a preeminent development platform. At CES in January we’ll be celebrating Palm’s move out of its early access program and showcasing our full production developer program and the many ways Palm is innovating in this area.

For example, we clearly recognize that having a critical mass of apps in important. Today, the Palm app catalog has over 800 apps from our early access partners, almost 10 times the number of apps we had at our last earnings call. After we opened the door to all interested developers, we expect to have thousands in very short order. But, we’re equally focused on providing developers with ground breaking opportunities to create apps which leverage the unique integration capabilities of Web OS.

The sporting news pro baseball application by Zumobi is a great example. This app not only provides information for baseball fans to follow their teams but also lets them add their team schedule to their calendar with one click and uses Web OS alerts and notifications to send score updates in real time. The ability for applications to share data and services like this creates the compelling integrated and differentiated experience we want users to associate with Palm.

Another key priority in redefining application distribution and discovery and at CES we’ll be demonstrating the innovative ways that developers can market and deliver their Web OS apps via the web in addition to the on device app catalog. Applications submitted to Palm for web distribution would get a unique URL and will be added to a publically available Palm database which has information about each Web OS app including a description, stats, ratings and reviews.

Developers can use their URL to market their own apps online. For example, by posting the link to their blog, or Facebook page or Twitter. At the same time members of the web community at large can use the database and URLs to build application directories, ranking mechanisms and other creative online tools to help users discover Palm apps. Palm users simply have to click on a link to get an application sent directly to their phone via Palm’s unique over the air functionality. We think this is an important step forward for developers looking for better ways to promote their work and for consumers who need better ways to discover relevant applications.

Just this morning we launched Project Ares, a groundbreaking new way to make building apps for Web OS faster and even easier. With Ares, Palm is bringing to market the first complete full featured mobile development environment to run entirely in the browser. Getting started with Ares requires no downloaded configuration, developers just log in and start building taking advantage of a complete set of tools such as drag and drop interface builder, finger tip access to the full library of Mojo UI widgets and instant project upload and download for seamless desktop to cloud work flow, to name just a few features.

Ares and the other initiatives I’ve outlined today show that Palm is maintaining its status as a leading innovator but we still have much more work to do to achieve the goals we set our sights on. We’re working to significantly improve financial performance by continuing to deliver innovative differentiated products that consumers associate with Palm establishing Web OS as a world class developer platform and building on our already strong relationships with carriers.

In particular as Doug will discuss in a moment, we are investing heavily in marketing to drive better awareness of our products and improved revenue and sell through. Our success will require consistent and outstanding execution in all aspects of our business. But, the progress we’ve made this past quarter and the plans that we have for the future give us confidence that Palm is well positioned for success.

Now, I’ll turn the call over to Doug to give you more detail on our Q2 results.

Douglas C. Jefferies

Before I review this quarter’s results I’d like to briefly touch on a couple of administrative items. First, my discussion today will be based on non-GAAP information which adjusts our GAAP information to exclude the impact of subscription accounting, stock-based compensation, mark-to-market accounting adjustments related to our Series C preferred shares and other items which are detailed in the release.

Second, in October new accounting standard were issued that will change the way we recognize revenue for Web OS products. I’d like to highlight the announcement we made in our release about Palm’s intention to adopt these new guidelines in Q3. These accounting changes will result in a substantial portion of Palm Web OS product revenues being recognized upon delivery. The remaining Palm Web OS revenues which are related to future services and deliverables will be recorded as deferred revenues on our balance sheet and amortized on a straight line basis over the estimated economic product life which is currently 24 months.

Under the new standards, all related costs of revenues will be recognized upon delivery. This change in accounting will have no impact on cash flows and does not change on how Palm accounts for legacy products like the Centro or Trio. Consistent with our past practice, we will continue to provide non-GAAP adjusted measures which exclude the impact of deferred revenue accounting and other items as appropriate.

Now, turning to our Q2 results, as Jon discussed, we’re continuing to make good progress towards our long term strategic goals. Revenues for the second quarter came in at $302 million compared to $361 million in Q1. As anticipated, revenue in the second quarter was lower than Q1 due to the timing and relatively smaller scale of our Q2 product and carrier launches and due to the continued decline and sales of our legacy products. We delivered a total of 783,000 Smartphone units in Q2 compared to 823,000 units in Q1. Q2 deliveries were primarily Web OS products.

Our combined Smartphone ASP which includes our legacy products was $375 in the second quarter compared to $427 in the first quarter. The lower ASPs in the current quarter result primarily from the launch of the lower priced Palm Pixi. The total Smartphone sales for Q2 was 573,000 units and Web OS products accounted for close to 80% of this number. This compares to total sell through of 810,000 units in Q1. Consistent with our past reporting, sell through represents sales by our carrier partners to their customers which may include indirect sales channels.

Channel inventories increased in Q2 as a result of the delivery of launch inventories late in the quarter with the Palm Pixi launching with Sprint on November 15th and the Palm Pre launching in Mexico with Telcel on November 27th. Also contributing to higher channel inventories were lower than expected sell through volumes at Sprint. We still have work to do in increasing the awareness of the Palm brand and Web OS products in the market and we’re taking aggressive steps to improve our messaging efforts.

We’ve dramatically ramped our TV advertising and online campaign for Pixi throughout the holiday season. Our recent PR activity has been outstanding and as Jon mentioned, we’ll be launching a new broad based Palm marketing campaign later this quarter. We think these combined efforts, among others, will help drive increasing momentum as the year unfolds.

Our gross margin for Q2 came in at 25.6% versus 27.9% in Q1. Gross margin in the second quarter was affected by higher indirect costs related to scaling our manufacturing capabilities and supporting new products. The impact of spreading these costs along a smaller sales volume and carrier volume incentives reflecting our focus on expanding our installed base. Achieving gross margins is an important long term objective for Palm and gaining scale is fundamental for achieving this objective.

While we continue to target long term gross margins of over 30% our immediate and most important objective is working with carriers to grow our installed base. With this in mind, we expect gross margins to be in the mid to upper 20% range for the second half of this fiscal year. We said in the past that we view fiscal year 2010 as an investment year as we lay the foundation for sustained growth. In this regard, we increased our sales and marketing spending in Q2 by $18 million versus last quarter in support of the launch of the Palm Pre in Europe with Telefonica and the launch of Palm Pixi at Sprint.

We also increased our research and development spending in Q2 by approximately $7 million as we invested in building the teams and infrastructure to deliver continued innovation. As we look ahead, we expect our spending in these areas to increase sequentially quarter-over-quarter in the second half of our fiscal year as we continue to fund our business expansion. Overall, our net loss for the November quarter came in at $60 million, a net loss of $0.37 per share. This compares to a net loss in the August quarter of $14 million, a net loss of $0.10 per share.

Turning to the balance sheet now, our accounts receivable balance decreased to $72 million versus $77 million at the end of Q1 due primarily to lower shipments in the quarter offset in part by the impact of deliveries near the end of Q2. Inventory levels at the end of Q2 increased by $11 million versus Q1 due to the addition of Pixi to our product line and the timing of deliveries near quarter end.

Accounts payable at the end of the second quarter totaled $155 million, an increase of $67 million over Q1 due to the expansion of our product line to include Pixi and due to improved payment terms enabled by our strengthened financial position and the support of our key suppliers. We ended Q2 with cash, cash equivalents and short term investments of $590 million, an increase of $378 million over Q1. Our improved liquidity results primarily from the addition of approximately $360 million in net proceeds from the equity offering we completed in September.

While we generated positive cash flow from operation in Q2 of over $16 million through improvements in working capital utilization, we expect to use case in Q3. We expect cash used in operations during the third quarter will exceed $80 million as we invest aggressively to support our expanding business.

Looking to the second half of fiscal year 2010, we expect our performance to strengthen as we launch products with additional carriers and continue driving sales from products launched in the first half of the year. Since each successive new carrier and product launch builds on prior ones, we expect revenue to increase sequentially quarter-over-quarter in the second half of our fiscal year.

Last quarter we discussed revenues for fiscal year 2010 of between $1.6 and $1.8 billion which could allow us to be cash flow positive and profitable on a quarterly basis by the end of the fiscal year. We still expect to achieve revenue within this range and continue to see the opportunity to achieve our profitability and cash flow goals. Delivering these results however will require that we and our carrier partners execute strongly on the upcoming launches and successfully drive sustained sell through in the second half of fiscal 2010.

Since we began Palm’s transformation we’ve sought to maintain our strategic focus while reshaping the company. We believe we’re delivering on our objectives and putting Palm in a strong competitive position while enhancing the company’s ability to deliver long term value to shareholders. With that, let me turn the call over to the operator for Q and A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Simona Jankowski – Goldman Sachs & Co.

Simona Jankowski – Goldman Sachs & Co.

Can you just give us a little bit more color on the SG&A line? In particular, I heard what you said about increasing marketing to support brand awareness but this is the highest dollar amount that you guys have had in about eight years or so. I mean, are we reaching an [inaudible] here or how should we think about the magnitude and the slope of that increase going forward?

Douglas C. Jefferies

In SG&A, the biggest drivers of our spending are sales and marketing spends followed by engineering and G&A. As we talked about in the last few minutes we do expect SG&A, primarily the marketing and sales area to increase sequentially over the next couple of quarters. So, you should expect SG&A to increase sequentially over the next two quarters as well.

Simona Jankowski – Goldman Sachs & Co.

But just on the marketing specifically I mean the increase we had this quarter for the Pixi was higher than what you guys had for the original pre-launch and I would kind of characterize the Pixi as a potentially smaller launch. We certainly didn’t see as much on it so what would have driven kind of an even higher sequential increase this quarter and last quarter? And, is this the kind of jump we should be expecting going forward or something of a smaller magnitude?

Douglas C. Jefferies

Keep in mind when you look at this quarter’s results that we also launched a Pre in Europe as well. So, as we talked about I think last quarter, our brand is not as strong in Europe as we would like and it’s a big investment for us looking ahead and so we started making that investment this quarter with the marketing in support of the launch of Pre with Telefonica. That’s a big factor in looking at the spending in Q2 in addition to the Pixi launch.

Simona Jankowski – Goldman Sachs & Co.

If I could just ask Jon how the Google phone announcements changes the competitive environment Jon in your view?

Jonathan J. Rubinstein

Well, as I’ve always said this is going to be a very competitive business so from our perspective it’s one more competitor in the marketplace. Of course, we haven’t actually seen anything announced yet but based on the rumors, I think we’ve got a really good plan going forward and we’re going to continue to execute along that plan.

Operator

Your next question comes from Amir Rozwadowski – Barclay’s Capital.

Amir Rozwadowski – Barclay’s Capital

Doug, one question on the guidance, it seems as though you’re holding your annual guidance here and with the revenues this quarter, at least on a pro forma basis coming in ahead of your prior guidance level I wanted to sort of understand your visibility going in to that annual guidance. It did seem as though you made some comments that sell through at Sprint was perhaps a little bit lighter than you had expected and then perhaps balancing that you’ve got some upcoming carrier launches so I just wanted to understand sort of the visibility going in to the guidance as we stand today versus three months ago?

Douglas C. Jefferies

I mean the foundation for the guidance as we talked about last quarter are the commitments we have in place to launch products in the second half and then beyond that we have commitments for launched quantities to be delivered and we have our forecast along with our carrier partner forecasts that come together to help us build the range of outcomes we’ve talked about in the $1.6 to $1.8 billion total revenues for the year.

Amir Rozwadowski – Barclay’s Capital

In terms of the ASP trajectory I mean certainly the inclusion of a lower priced device, the Pixi this quarter impacted ASPs. We also saw a pricing cut for the Pre, how should we think about sort of your ASP strategy at this point? Is there a goal to drive increased penetration by relying on pricing or have we seen that already?

Douglas C. Jefferies

Amir, as we talked about in the script earlier, our focus is to grow our install base, that is our priority at this point, to increase awareness of Palm and its products and to expand our distribution. That is a focus for us. It’s hard for us to project ASP. We just launched Pixi in the marketplace so having a new family of products with a new member and how those products work together in the marketplace we’ll see over the next couple of months in terms of how that mix lays out. That mix will have a big impact on the average ASP for us so I don’t have a project for you there.

Jonathan J. Rubinstein

But, the objective here is not to fight the battle just on price but to really bring differentiation to the market and to really delight our customers so that they see value in our products.

Amir Rozwadowski – Barclay’s Capital

Lastly if I may, Jon on that point we’ve seen now two devices on the Web OS platform. Certainly you folks have been vocal about this is obviously a portfolio device that you folks are looking to build on the Web OS platform. How should we think about sort of the pace of innovation at these levels? We’ve seen one device every call it six months, should we expect the pace to quicken or is carrier expansion with your current devices really the near term goal?

Jonathan J. Rubinstein

Well, we’re not going to talk about specific products in the future but let me say in general we don’t believe in building large portfolios of products. Our focus is around having a small family of really great products. Right now we have two great products in Pre and Pixi and our objective right now is to expand with more carriers and more regions.

Operator

Your next question comes from Thomas Michael Walkley – Piper Jaffray.

Thomas Michael Walkley – Piper Jaffray

Doug, just a quick clarification question, with the change in the accounting can you give us any kind of estimate of how much of Web OS products are recognized versus deferred? I mean, is it 90% plus now that we recognize in the current quarter?

Douglas C. Jefferies

We’re right in the middle of doing the analysis around how we’ll implement the new standards and so the analytics are in progress and I don’t have a number for you at this point.

Thomas Michael Walkley – Piper Jaffray

Then with your quarter ending on the 27th I believe, can you suggest maybe how that impacted sell through and are there any updates on sell through here in to the holiday season?

Douglas C. Jefferies

We ended on Black Friday, effectively. So in terms of sell through and the channel inventory you see, the holiday and the timing of our quarter end certainly a factor there in having us exit the quarter with more channel inventories because it didn’t have a lot of sell through coming from the holidays. Most of that occurs post Black Friday.

Thomas Michael Walkley – Piper Jaffray

Any comment post Black Friday?

Douglas C. Jefferies

Really, nothing to add.

Thomas Michael Walkley – Piper Jaffray

One last question and I’ll pass it on, Jon just given some growing momentum for the Android ecosystem, in your discussions with your carrier partners has there been any change in kind of their roadmap in rolling out Web OS products given maybe increasing commitment to Google or an Android?

Jonathan J. Rubinstein

Well, we don’t actually see our carrier partner’s roadmaps but as I said earlier, we have very strong support coming from our carrier partners, those present ones and those in the future and we’re very, very excited about our future opportunities with a variety of carriers.

Operator

Your next question comes from Mike Abramsky – RBC Capital Markets.

Mike Abramsky – RBC Capital Markets

Just wondering what approach you took to your guidance with regard to the Q2 beat because you did say that you had lower than expected sell through at Sprint? So as a result of your conservative guidance stance are you maintaining the same kind of stance going forward? Can you just give us a little clarity there?

Douglas C. Jefferies

In terms of the Q2 guidance, as you are aware there’s a range of things in terms of forecasting an outcome. It depends on product timing, launch timing, demand obviously and so there’s not a single factor that I can point to that had us come in better than we expected it’s just in certain areas we ended up having better results than we expected and the overall outcome was better than guidance. But, nothing specific in terms of the fact that we did better than we thought.

Mike Abramsky – RBC Capital Markets

When you mentioned the reiteration of your full year outlook you saying that you expect the revenue to be in range, I just wanted to evaluate or understand you qualified that to some extent with execution which I think it’s pretty obvious but I guess the question is when you last delivered the guidance, have the execution risks say risen or changed in any way?

Douglas C. Jefferies

No, we’ve been saying that pretty consistently since we launched Pre that we felt like there was a big opportunity in front of us as a company, that we had the right products at a great window in the marketplace and that ultimately our success would be around execution and we feel the same way.

Mike Abramsky – RBC Capital Markets

Then lastly, Jon you talked about strong differentiation now I think you’re probably getting this question in a couple of different ways but clearly from the outside people see it as an increasingly clouded market so how do you view the sustainability of differentiation of Web OS versus competitors and when you look forward in your roadmap are you comfortable with the things that you’re planning on doing in hardware and software basis to sustain that? And also, I understand marketing is one aspect as is PR of trying to increase your awareness to get these great products in the hands of folks. How are you thinking about trying to rise above what’s obviously a higher level of competitor intensity.

Jonathan J. Rubinstein

That’s a lot of questions, let me take a whack at the first one. Again, I think the fact that we own the entire user experience on the product the hardware, the software, the services, I think that really gives us a unique opportunity to differentiate and I think we already have. I think our user experience is really terrific and is a much more consumer experience than some of the other new products that have come out recently. I think that we’ve done a great job at designing the specific products for the marketplace.

I don’t know how man you have held a Pixi in your hand but I strongly encourage you to actually go hold one in your hand and experience the full Web OS experience on it. It’s a great little product. Again, one that is really well suited for first time Smartphone users, ones that are coming from feature phones. That was a very successfully strategy for us when we did Centro which we sold over three million.

So yes, I absolutely think we can continue to innovate and continue to differentiate. We’re doing some really cool work right now and I think the second half of your question is about marketing and how do we get the word out. I think we’re again doing some very innovative marketing right now. I don’t know how many of you have seen the new Pixi TV commercials, those are great where we’ve got posters on busses and bus stops and various other places. There’s a broad set of marketing efforts going on going in to this holiday season really driving both Pixi and Pre in to the marketplace. But, you’re absolutely right, we need to work very hard to get the word out and get people to understand why our products are better than the competitions.

Operator

Your next question comes from Matthew Thornton – Avian Securities, LLC.

Matthew Thornton – Avian Securities, LLC

First question Doug, the 210 million units of channel fill, the delta there between sell through and sell in I think you alluded to again the Pixi channel fill at Sprint and some pre-channel fill going in to Telcel late in the quarter. Can you give us kind of the breakdown of how that breaks out? Was one much stronger than the other or how is that allocated?

Douglas C. Jefferies

I don’t have a breakdown for you but the bigger drivers in terms of the growth in channel inventory did come from those launches.

Matthew Thornton – Avian Securities, LLC

You talked a little bit about – and this may be a question for Jon, but you talked about sell through at Sprint perhaps being a little weaker than expected. Is that both across Pixi and Pre? Maybe you can kind of contrast the two and maybe talk a little bit about linearity during the quarter just in that Android product started to launch in October and then a second one launched in November so maybe you can kind of just talk a little bit about linearity and whether you saw again some competitive impact there?

Jonathan J. Rubinstein

First of all you have to remember, we just started shipping Pixi on November 15th in what is a very traditional couple of weeks that are slow prior to Black Friday. I would have a hard time putting my finger on exactly the cause and effect that you’re trying to get there. I don’t know Doug, do you want to add anything to that?

Douglas C. Jefferies

I guess what we saw was we really didn’t see any kind of linearity from other things in the marketplace.

Matthew Thornton – Avian Securities, LLC

I guess last question, you didn’t talk much about some of the European properties, I guess what’s your thoughts there on sell through relative to what you would have expected?

Douglas C. Jefferies

We’re pleased with the partnership with Telefonica is working out for us, they’ve been great. As we said, early on we talked about launching in Europe. We’ve got a lot of work to do there, we’ve got a lot of effort that will need to go behind building success in Europe but we’re really pleased with how the partnership with Telefonica is panning out.

Matthew Thornton – Avian Securities, LLC

So it’s probably fair to say that while Sprint was perhaps a little bit slower than you expected that the European ramp is on plan? Is that fair?

Douglas C. Jefferies

I’d say that we’re meeting expectations. We’re always looking to do better than expectations and over perform so we’re probably never quite satisfied but look, we’re making good progress and that’s what we’re shooting for.

Operator

Your next question comes from Phil Cusik – Macquarie Research Equities.

Phil Cusik – Macquarie Research Equities

I wonder if you can just walk through the financial guidance with me? We stuck with the full year guidance and we talked about revenue being up sequentially quarter-over-quarter going forward. We also talked about mid to high, I think the language was, 20% range for the second half. Should we assume that gross margins sort of go up with revenue over the next couple of quarters so up sequentially from here as well?

Douglas C. Jefferies

We talked generally about gross margins benefitting from higher revenue volume. There’s a fixed component to our gross margin around indirect cost so there is a benefit from higher volumes for us.

Phil Cusik – Macquarie Research Equities

You talked about I think it was fixed costs sort of scaling up this quarter, is that pretty much done as you’ve built out your manufacturing plant or should we expect those fixed costs to rise as well?

Douglas C. Jefferies

I think we’ve made a lot of progress particularly in this quarter as we built the team to ramp Pixi on the manufacturing side and then on the product support side building the team there to handle broader distribution both in the quarter and then looking ahead to the second half. I’d expect probably you’d see sort of the balance of the year continue to make investments there as we continue to scale the business.

Phil Cusik – Macquarie Research Equities

Then on the sales and marketing side and someone alluded to this a little bit earlier but a fairly big jump this quarter but you’ve been spending a lot of money out there, you alluded to how you’re going to spend more this quarter but can you give us an idea of the magnitude of that jump? $18 million sequentially should we be looking for in the single digits, double digits, anything you can help us with there on the sales and marketing side?

Douglas C. Jefferies

Again, I think I’d just have you think about the fact that it was an $18 million increase in Q2 but it was addressing relatively smaller launches for us, important ones and we put a lot of wood behind those but as you can tell from our guidance around revenue outlook for the second half, we see big opportunities in the second half and we’ll invest accordingly.

Phil Cusik – Macquarie Research Equities

Then on the R&D side you talked about staffing up there again, we had sort of a $6 million sequential increase, should that increase start to slow here or do we have a couple of quarters of really ramping up that R&D before it starts to stable off?

Douglas C. Jefferies

Yes, I think we still see opportunity to build the team to support the product road map both hardware and software. You’ll see us continue to invest there. The rate of investment will likely slow but I think it’s an area where we will continue to make good investments.

Phil Cusik – Macquarie Research Equities

Is there a time at which you’ll start to give sort of a geographic mix US versus Europe or US versus Latin America type thing or do you think that’s not in the cards?

Douglas C. Jefferies

I think we may down the road. Again, most of the business for us today is in North America but as what we’re doing outside the US becomes more significant than you might expect us to break something out.

Phil Cusik – Macquarie Research Equities

One last question, as you think about the accounting side we’re going to recognize most of the revenue upfront going forward but there will be some level of deferred. Can you give us an idea is that deferred amount going to be 5%, 10%, 20%, how are we going to even think to deal with this?

Douglas C. Jefferies

As I mentioned earlier, we’re still working through how the new standard gets applied and how the valuation will work that will drive how much gets deferred. So, I don’t have a specific answer for you. We’ll know a lot more by the end of next quarter when we have this conversation. But, we will continue to provide the non-GAAP reporting that we have historically so you’ll have pretty good visibility in terms of the impact of the standard on our results.

Operator

Your next question comes from Jonathan Goldberg – Deutsche Bank North America.

Jonathan Goldberg – Deutsche Bank North America

Two questions, the first I guess a question for Doug, how should we think about gross margins growing? I’m not going to pin you down on timing but as unit volumes increase is there potential for gross margins to scale sort of extra linearity faster than people may – is there step function increase out there?

Douglas C. Jefferies

We’ve talked about having the opportunity for stronger gross margins as we achieve scale and that happens on a number of areas but I think for us, and we tried to be clear on the call earlier, our priority is to grow our market share and so that’s the biggest priority for us. We want to have strong margins, that continues to be a focus but our priority is to gain share. That’s why we wanted to be a little more specific about outlook for the margin in the second half that we’re looking at kind of the mid to upper 20s for margins in the second half reflecting the fact that we’re not optimizing for margins today. We’re investing in growing the business and as a result we’re not seeing the margins we talk about being our outlook for the long term.

Jonathan Goldberg – Deutsche Bank North America

A question for Jon on the developer eco system, you mentioned 800 apps can you just give us some more color on how that community is developing, how large you think it is, what gives you confidence that once we’re out of beta it will scale?

Jonathan J. Rubinstein

First of all let me remind everybody that the 800, actually it’s over 800 today is from our early access program so we haven’t opened up the program to all the developers yet and we’ve had tens of thousands of downloads of the SDK over the last couple of months so we have pretty good visibility of the pipeline going in to the app catalog and we have a great developer relations team. They’re doing tremendous work with the community out there and so we have a lot of confidence in the work that they’re doing and we’ve gotten great feedback from the developers. I think once we open up the doors we’re going to see a lot more submissions and we’re going to see real good growth on the app catalog.

Jonathan Goldberg – Deutsche Bank North America

Is there any need to go to C++ SDK or is web tools resonating in a way with developers the way you originally expected?

Jonathan J. Rubinstein

We think we’ve got a great development environment. It’s really fast and easy to develop apps, it’s a lot of fun. I encourage you to take a look at Project Ares. It’s a very unique way to develop applications, something the open source community has been driving a lot around. I think we’re right on the right path going forward.

Operator

Your next question comes from Analyst for [Edward Synder – Charter Equity].

Analyst for [Edward Synder – Charter Equity]

When we look at the marketing expense in launching with the carriers, is this going to involve co-marketing, are the carriers going to match you particularly in North America one-for-one as they have with some of your competitors? Can you give me any color on that?

Douglas C. Jefferies

I can’t get specific in terms of the carrier arrangements that we have in place but in general we do work with our carrier partners to leverage our marketing spend. Being a relatively small player it’s important to align with partners who will work with us to help us deliver our message to the marketplace.

Analyst for [Edward Synder – Charter Equity]

Then I wondered, you mentioned in the past that uptake with Pre with the enterprise was stronger than you had expected. I assume Pixi is primarily consumer, can you give any updates on the enterprise progress with the Pre?

Jonathan J. Rubinstein

I think it’s too early to determine that Pixi will not be necessarily attractive to the enterprise because it’s a great form factor for the enterprise. But, I don’t think we can say anything at this point in time. We’ve been working steadily on improving the attractiveness of Web OS to the enterprise and we’ve put lots of capabilities in the variety of releases we’ve done. We’ve got Gartner’s appliance level certification and we’ve been working with a variety of Fortune 500 class organizations.

We’ve already been certified in over 50 of them and we’re working hard to get certified in a lot more. So, I think that while we don’t have a specific breakout today of what’s happening in enterprise, I think we’re seeing a lot of interest there.

Analyst for [Edward Synder – Charter Equity]

Then my final questions, one of the criticisms of Pixi was that it was a little bit under powered for Web OS so is the update you alluded to earlier, is that a software fix to hardware issue or how does that interplay between the hardware and software on Pixi?

Jonathan J. Rubinstein

Well, there is no hardware issue. I think people were jumping to conclusions around the product. I think that actually the hardware has great capability and we’re just always working to improve the capabilities of the device by adding more features, more capabilities, tuning the performance and tuning the battery life. So, I think that people will be very pleased with our next set of updates that come out and the enhancements and improvements they make to the products.

Operator

Your next question comes from Analyst for Maynard Um – UBS.

Analyst for Maynard Um – UBS

Can you also help us understand how many operators you’re assuming within your annual revenue guidance?

Douglas C. Jefferies

No, we really haven’t broken out the number of operators that underlay that.

Analyst for Maynard Um – UBS

Then just following the secondary offering can you give us an update about how you think about managing your cash and the linearity of your cash flow in the second half?

Douglas C. Jefferies

With the offering we’ve got a really nice reserve in terms of our liquidity so I feel good about where we are from a capital perspective. Then I think in the call we wanted to be clear that with the improvement we had with working capital in Q2 we did generate positive cash flow from operations but that in Q3 we would see a cash burn in that quarter in excess of $80 million. Then, we talked about the opportunity and the overall guidance to reach cash flow positive. So, I think that should give you a pretty good context for the linearity.

Analyst for Maynard Um – UBS

But you’re focusing on investing and operations?

Douglas C. Jefferies

Investing and building the business. It’s really across the company, marketing, sales, engineering.

Operator

Your next question comes from James E. Faucette – Pacific Crest Securities.

James E. Faucette – Pacific Crest Securities

I’m wondering if you could touch on the reasons that you saw specifically lower than expected sell through at Sprint? Then, I guess based on your comments related to Pixi and the timing of its launch if you could deduce that the disappoint was really associated with the Pre? That’s the first question and the second question is just can you talk a little bit about pricing for your products and the associated margins and how that’s measuring up to your expectations say from 90 or 180 days ago? And, where you think we’ll start to see pressure on pricing on margins may be?

Douglas C. Jefferies

I guess I’ll maybe just talk about pricing first and then talk about sell through at Sprint. On pricing I think we’re tracking along the line that we thought we would be in terms of looking at the product portfolio and the launch calendar and how we view the competitive set coming out. I mean, it’s a competitive environment and we’re making sure that we stay competitive by working with our carriers on pricing and making sure the value is there. So, I would say no big surprises in that regard and we continue to operate pretty close to where we had our outlook.

Jonathan J. Rubinstein

On the sell through we really haven’t broken down Pre versus Pixi. I think one of the things we need to work very hard on is making sure we get the word out about how great our products are and how great Web OS is so we’re investing very heavily right now to do that.

James E. Faucette – Pacific Crest Securities

Then just one housekeeping question, I apologize I know I can look it up but, can you just quickly give me the shares outstanding at the close of the quarter?

Douglas C. Jefferies

The fully diluted shares?

James E. Faucette – Pacific Crest Securities

Yes.

Douglas C. Jefferies

Around 240 million is a good number to use. Just to point out, that includes the full benefit of the shares that were issued mid quarter. So, if you look at the weighted average for the second quarter you only have the effect of the offer that was completed. So getting full effect of those shares being outstanding for a full period, 240 is a good number to use.

James E. Faucette – Pacific Crest Securities

Then what about on the basic side?

Douglas C. Jefferies

I think the basic around 143.5.

Operator

Your next question comes from Tavis McCourt – Morgan, Keegan & Company, Inc.

Tavis McCourt – Morgan, Keegan & Company, Inc.

Doug, another housekeeping, the $80 million cash burn that is cash flow from operations not an EBITDA number, correct?

Douglas C. Jefferies

That is cash flow from operations, exactly.

Tavis McCourt – Morgan, Keegan & Company, Inc.

Then in terms of as your ramp the other carriers your DSOs have been around 20 days which is typically very low for this industry. Where should we think about that kind of over the longer term as you ramp beyond Sprint and some smaller carriers?

Douglas C. Jefferies

I think the DSO is driven a lot by carrier mix. As we do more outside the US you’d expect to see DSOs stretch out a little bit so I’d think of it that way. As we continue to expand outside the US down the road DSOs would continue to go up a little bit.

Tavis McCourt – Morgan, Keegan & Company, Inc.

Then Jon for you, in terms of the new marketing campaign which obviously is crucially important because I think everyone would agree these are phenomenal products. Can you give us a little bit of a taste of what you’re going for in terms of what you’re trying to drive in terms of the brand promise or brand image for Palm as you launch this new campaign?

Jonathan J. Rubinstein

Well, I think you can get a good taste of what you’re seeing already. I mean the new Pixi campaign has gotten great response and people really like it so I think you can see that as the first step. What we’re really trying to do is drive the Palm experience to make sure people understand what a pleasure it is to use the device and in fact by using the device you never miss a thing. So we’re going to push hard on the experiential part of Web OS and you’re seeing the beginnings of that with the present Pixi campaign. I assume you’ve seen the present Pixi campaign?

Operator

Your next question comes from Analyst for Jeffery Fidacaro – Susquehanna Financial Group.

Analyst for Jeffery Fidacaro – Susquehanna Financial Group

I just wanted to ask a question about the product roadmap, could you give us a sense of the types of products that you’ll be announcing? We’ve seen some indications that maybe the Pixi would be heading to initial carriers, is there a Pre like product or another high end device in the mix that could potentially benefit your ASPs? And, what kind of mix can we think about as far as the guidance for the second half of the year?

Jonathan J. Rubinstein

We don’t discuss specifics of our roadmap but you can see that we’ve built a family of products and of course we will continue to evolve those products over time. Yes, we want to take Pixi to multiple carriers in multiple regions and in the future and no definition of future. Of course we’ll have products that evolve off of our present product lines. We have a roadmap that goes out both on the hardware and software side that go out basically a couple of years and we’ve got some very exciting products on that roadmap. We’ve gotten great feedback from our carrier partners on that roadmap. So, I think we’re doing the right things and we just need to go execute the plans that we have.

Analyst for Jeffery Fidacaro – Susquehanna Financial Group

Just a follow up on the ASP element of that, should we expect mix of Pre versus Pixi to be relatively similar along these lines of maybe other devices going forward meaning that the ASP trajectory is going to continue to decline sharply or do you expect maybe a less sharp continuous decline in ASPs baked in to that revenue guidance?

Douglas C. Jefferies

I think as I said earlier, Pixi just got to the marketplace and so we have a point of view on what the mix will be but the market will determine that so it’s really hard to give you specifics on the outlook for ASPs at this point. We’ve looked at the guidance and that’s part of the reason y0ou see a range in our guidance is that there’s variability on product mix as well as some timing things that causes us to provide a range. So, we’re going to learn a lot about Pixi in the marketplace alongside Pre over the next couple of quarters.

Operator

Your next question comes from Jim Suva – Citi.

Jim Suva – Citi

A quick question, you beat this quarter from your midpoint by 21% which is very impressive but you’re keeping the full year guidance unchanged, can you help me connect that?

Douglas C. Jefferies

I think Jim we talked about one quarter and there’s variability within those estimates and we happen to come out better on some areas than we thought for the second quarter. The full year outlook is dependent upon a completely different set of circumstances. We’ve got different carriers and different timing. So the context of the beat is fairly small and the context of the overall numbers for the year and so it didn’t make sense to necessarily try to adjust anything based on that because again, the execution piece of it, the opportunity we see in the second half is large and really subject to a lot of really good execution on our part.

Operator

Your next question comes from Deepak Sitaraman – Credit Suisse North America.

Deepak Sitaraman – Credit Suisse North America

John, can you perhaps talk a little bit about how the European launch has gone relative to expectations and whether that has been anything that surprised you in terms of how the Pre has done so far in Europe?

Jonathan J. Rubinstein

I think the launches went great. I think Telefonica did a phenomenal drive particularly in Germany, the Pre is their primary Smartphone and so we’re very pleased with our partnership with Telefonica and things are proceeding as expected and we look forward to more success with Telefonica moving forward.

Deepak Sitaraman – Credit Suisse North America

I guess as you build the Palm brand outside North America and the US how should we be thinking about the cost associated with that branding effort?

Douglas C. Jefferies

I think in general for us our brand is strongest in the US and I think when we go outside of the US and Europe, Telefonica is an example. We are incurring higher marketing costs because we’ve got to go in and take advantage of the innovation we have and leverage that through marketing spend to build our brand in these markets. So, relative to the revenue opportunities in these markets you’d expect marketing spend to be higher than you’d see in the US.

Operator

Your last question comes from Paul Coster – J. P. Morgan.

Paul Coster – J. P. Morgan

Just a couple of questions, first of all Doug you’re not breaking out the international versus the domestic because the international is not material yet, is that correct?

Douglas C. Jefferies

Yes, in terms of the overall trends in the business it’s a good long term opportunity for us but we’re not talking about it separately from the other parts of the business at this point.

Paul Coster – J. P. Morgan

Is it less than 10% of revenues at the moment?

Douglas C. Jefferies

I think it’s slightly above.

Paul Coster – J. P. Morgan

The other question I’ve got is I think we all have difficultly servicing this very rapid price action when new products come out and I assume it’s usually offered by the carriers and not by you so it’s presumably a good thing for you. But, long term what does it do from the perspective of giving you flexibility on bringing new products to market at prices that you choose rather than prices that have really been set by these precedents of moving to zero fairly quickly?

Jonathan J. Rubinstein

I’m assuming you’re talking about Pixi and what you’re seeing on the online distribution and the price war that’s going on between Amazon and Wal-Mart, is that what you’re referring to?

Paul Coster – J. P. Morgan

Yes.

Jonathan J. Rubinstein

You’re right, we really have nothing to do with that. This is a game they’ve been playing for a while. What they do is they pick hot products or really cool products to use to drive traffic to their websites. There was actually a really good article in the New York Times about this. From our perspective, it benefits customers. The thing you need to keep in perspective though is a very small percentage of sales goes through those online channel number one and number two, in the brick and mortar stores we’re still at the regular pricing.

I think it generates some really good PR and it generates good customer awareness when the run lots of ads and things like that. Again, like I said it benefits customers. Right now our objective is to get to scale and to really drive velocity on this and I think it’s helpful in that way.

Teri Klein

That concludes our Q and A session for today. Thanks everyone for joining us for our second quarter fiscal year 2010 earnings conference call. We look forward to speaking with you again next quarter.

Operator

This concludes today’s conference. You may now disconnect.

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Source: Palm, Inc. F2Q10 (Qtr End 11/27/09) Earnings Call Transcript
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