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Executives

Teri Klein – VP, IR

Jon Rubinstein – Chairman & CEO

Doug Jeffries – SVP & CFO

Analysts

Amir Rozwadowski – Barclays Capital

Jonathan Goldberg – Deutsche Bank North America

Jim Suva – Citi

Ehud Gelblum – Morgan Stanley

Matt Thornton – Avian Securities

Shaw Wu – Kaufman Bros.

James Faucette – Pacific Crest Securities

Mike Abramsky – RBC Capital Markets

Mike Walkley – Piper Jaffray & Co.

Vivek Arya – BofA Merrill/Lynch

Kevin Hunt – Hapoalim Securities

Simona Jankowski – Goldman Sachs & Co.

Phil Cusik – Macquarie Research Equities

Sanjiv Wadhwani – Stifel Nicolaus

Edward Snyder – Charter Equity Research

Rod Hall – JPMorgan Securities Inc.

Palm, Inc. (PALM) F3Q10 (Qtr End 02/26/10) Earnings Call Transcript March 18, 2010 4:30 PM ET

Operator

Good afternoon. My name is Angelia and I will be your conference operator today. At this time I would like to welcome everyone to the Q3 2010 earnings results 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) Thank you.

I would now like to turn the call over to Ms. Klein, Vice President of Investor Relations.

Teri Klein

Thank you. I’d like to welcome everyone to Palm’s fiscal year 2010 Third Quarter Financial Results Conference Call. On the call today are Jon Rubinstein, Palm’s Chairman and CEO and Doug Jeffries, our Chief Financial Officer.

Today’s call is being recorded and will be available for replay on Palm’s IR Web site.

I’d like to remind everyone that today’s comments, including the Q&A 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 results and events to differ materially. These risks and uncertainties are detailed in Palm’s filings with the Securities and Exchange Commission, including its quarterly report on Form 10-Q for the second 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 Web site. We encourage listeners to review these items.

And now I would like to turn the call over to Jon.

Jon Rubinstein

Thanks, Teri, and thanks, everyone for joining us today. Since we began Palm’s transformation, our vision for Palm webOS has been to create the platform best designed to meet the web-based cloud-centric future of mobile.

We’ve received critical acclaim for our accomplishments in this regard, but we have also experienced unforeseen challenges from intense competitive marketing efforts to our own execution in these steps, which have so far prevented us from achieving our carrier launch and sell-through goals.

Our recent underperformance has been extremely disappointing to me personally and to the entire Palm team. But we are more committed than ever to delivering truly innovative mobile experiences to propel our company forward and build value for our stakeholders.

Today, I want to tell you what we’re doing to correct our course. At the same time, I want to put recent developments into perspective and discuss why we remain very optimistic about Palm’s future.

The Palm team has worked to understand the cause of our weaker than expected sales and to put real initiatives in place to address some important areas which need improvement, including Palm’s product training and point-of-sale, the clarity of our marketing message and value proposition, especially in light of significant competition and our product performance.

First, as part of every new webOS product launch, Palm provides in-store sales personnel with significant training, recognizing that our platform represents a new and unique user experience. It’s become clear, however, that more intense training efforts are necessary at point-of-sale to ensure that field sales reps can confidently recommend webOS products.

Since the point-of-sale experience is arguably the most influential part of the smartphone purchase cycle and critical to driving sales, we launched an intensive Palm Brand Ambassador program designed to improve in-store knowledge and endorsement of Palm products across the U.S.

Palm representatives have been visiting and revisiting hundreds of stores a day and providing sales reps with tools and techniques to help them better sell our products. We’ll continue this work until we’re satisfied that customers who walk into a store can easily understand the value proposition of a Palm product.

Our carriers have been supportive partners. They are encouraged by the speed and effectiveness of our efforts to impact sales. And the assistance they provide along the way underscores their commitment to our long-standing relationships.

In addition to intensifying Palm’s point-of-sale training support, we are working to increase the effectiveness of our marketing to better communicate the benefit of Palm products.

A large number of competitive offerings and related marketing efforts has made our work here more challenging and at the same time more important. Here too, we have seen significant support from our carrier partners and we are making measurable progress.

Both Sprint and Verizon are prominently featuring Palm products in their national TV campaigns. Verizon, in particular, is aggressively promoting our products with a broad-based Palm-specific campaign comprised of TV, print, out-of-home and online advertising, all highlighting the unique functionality of webOS.

Palm is complementing carrier efforts with our own outdoor advertising in the 11 biggest metropolitan markets across the U.S., featuring our “Don’t Miss a Thing” campaign. This marks our biggest effort to-date to put the Palm brand and products front and center in customers' lives and explicitly communicate the benefits of using our products.

Simply put, we believe Palm delivers the most innovative and at the same time simplest to use technology on the market today. This allows customers to stay easily and more completely connected to everything that’s important to them. So they don’t miss a thing.

This week we launched a new 30-second ad based on this concept, showcasing the unique multitasking interface found in webOS. The ad is debuting during the first two weeks of March Madness on CBS to build momentum. Then we will be showcasing a spot across social media sites and the web, leveraging scale and reach of the online community as a cost-effective alternative to TV advertising while we continue our store training.

We are putting a great deal of effort behind these and other sales and marketing initiatives. And while efforts will take time, we’re encouraged by the early results. We’ve seen improved product knowledge at the stores we’ve worked with and with continued focus and support, we think we can continue to positively impact the sales channel and motivate people to buy our products.

But we know that sales and marketing can only take us so far. To successfully compete against larger players, our device quality and performance has to be of the highest caliber, and the functionality we bring to market has to be groundbreaking.

With this in mind, we are moving forward at full speed to continually improve product quality and bring new innovation to market. While some competitors are still working to bring mobile platforms to market for the first time this year, webOS continues to mature.

We are leveraging our unique over-the-air update capability to continue to optimize performance, improve battery life and add pioneering new features at a rapid pace even after our products are in customers’ hands.

At the end of February, we made webOS 1.4 available. Palm’s 10th over-the-air update since we first launched nine months ago. 1.4 delivered full video functionality to users as well as enhancements to all of our core applications.

We also greatly improved battery life and made a big push forward on the performance front, improving the speed with which apps load and respond to gestures. Customers’ response to 1.4 has been great. And the message we hear across feedback channels is that people are thrilled that webOS is just getting better and better.

Our app catalog and the developer tools powering this growth are also increasing in both scale and quality. We have over 2000 apps in our catalog today, more than twice the amount we had in January. This number is growing rapidly, but we are more pleased to see our catalog increasingly recognized for its quality. Our completely redesigned Facebook app has generated a wave of positive reaction as have much other awaited offerings, like Koala [ph] and (inaudible).

And thanks to our plug-in development kit. Palm now has both the developer tools and hardware necessary for high-end gaming capabilities. The Palm PDK lets developers use C and C++ alongside the web technologies that power our SDK. This gives developers who book games for other platforms an easy way to bring their titles to webOS.

We feature over 35 3-D game titles in our app catalog, and they have been a big hit with users. As a result of their success, we have committed game developers who continue to invest in webOS. In fact, as a testament to the platforms potential, Palm and Epic Games announced last week that the Unreal Gaming Engine will be coming to webOS soon.

As you can see, we’re gaining more and more ground on the technical front, even as we do the tactical work necessary to amplify sell-through. We have a dedicated team that’s driven to succeed. And we think the plans we have in place to enhance the performance and quality of our products, improve our marketing and point-of-sale execution and evolve and differentiate the Palm experience in breakthrough ways will result in improved performance.

And now I would like to turn the call over to Doug to review our financial results.

Doug Jeffries

Thanks, Jon. Before I review this quarter’s results I’d like to briefly touch on a couple of financial reporting items. First, as we indicated in our last call, we’ve adopted new accounting standard this quarter which change the way we recognize revenue for webOS products under GAAP. These changes result in the recognition of the majority of Palm webOS product revenues upon delivery.

The remaining Palm webOS revenues, which are related to future services and unspecified deliverables are recorded as deferred revenues on our balance sheet, and will be amortized into future revenues on a straight line basis over the estimated product life, which is currently 24 months.

All costs of revenues are recognized upon product delivery. This change in accounting has no impact on cash flows and does not change how Palm reports legacy product sales like the Centro or Treo.

We have provided non-GAAP adjusted measures for this quarter, which exclude the impact of a new revenue recognition rules and other items which are detailed in the release.

Note, that both GAAP and non-GAAP results for prior periods have been recast to reflect changes related to the application of the new accounting standards.

As a reminder, my discussion today will be based on non-GAAP information unless otherwise noted.

Now, turning to our Q3 results, revenues for the third quarter came in at $366 million compared to $302 million in Q2. Our Q3 top-line results were better than we guided in our February 25th announcement, as we were able to deliver several in-transit shipments during the last days of the quarter, which was earlier than expected.

It’s worth noting that in the context of full year results the difference between our final Q3 revenue and our previous guidance should not be taken as out-performance, rather this represents only a change in the timing of revenue between the fourth quarter and the third quarter.

In the third quarter, we shipped a total of 960,000 smartphone units compared to 783,000 units in Q2. Third quarter deliveries were virtually all webOS products. Our combined smartphone ASP was $367 in the third quarter compared to $375 in the second quarter. This slightly lower ASP resulted primarily from increased shipments of the lower-priced Pixi.

Total smartphone sell-through for Q3 was 408,000 units compared to 573,000 units in Q2. WebOS products accounted for most of the third quarter volume. We believe that sequential decline was due to declining sales of our legacy products and post-holiday sales deceleration, offset in part by sales at Verizon.

Consistent with our past practice, sell-through is based on information supplied by third parties on carrier and distributor sales, which may include sales to indirect channels.

As Jon discussed, sell-through of our products is proceeding at a much slower pace than we and our carrier partners anticipated. While we are continuing to work closely with carriers to improve our performance, to-date we have seen much lower than expected retail sales of both our Pre and Pixi product lines.

As a result, we have seen significant declines in near-term demand for our products as carriers have deferred existing orders or reduced the size of upcoming orders.

Our gross margin for Q3 came in at 17% and was impacted by $45 million charge taken in the quarter for inventory purchase commitments, which exceeded forecast demand. Excluding the impact of this charge, our gross margin for the quarter would have been 30%.

Total operating expense for Q3 came in at $162 million versus $133 million in Q2. This sequential increase was driven primarily by sales and marketing initiatives during the quarter, including our December TV campaign for Pixi and our print, radio and outdoor advertising for the Verizon launch.

Adjusted EBITDA loss for the quarter totaled $90 million. And our net loss totaled $103 million, which translates to a loss of $0.61 per share.

Turning to the balance sheet now, our accounts receivable balance increased to $104 million at the end of the third quarter versus $68 million at the end of Q2, due to higher third quarter sales volumes.

Our inventory levels at the end of Q3 of $31 million, were lower than the $39 million reported at the end of Q2, due primarily to the timing of deliveries near quarter-end.

Accounts payable at the end of the third quarter totaled $189 million versus $165 million at the end of Q2, due to higher marketing costs related to the Verizon launch.

Accrued liabilities at the end of the third quarter increased $90 million to $290 million at the end of Q3, due to higher reserves for inventory purchase commitments and accruals for product promotions.

Due to the favorable timing of payments to vendors and promotional payments to carriers, we ended Q3 with cash and short-term investments of $592 million, roughly equal to our ending Q2 levels.

Looking ahead, we ended the fourth quarter with higher than expected levels of channel inventory. And as I indicated earlier, carriers have deferred deliveries or reduced planned order quantities.

Several swing factors, including sell-through trends and the size of planned carrier launches are still in play, which could impact our revenue, so near-term visibility is limited. Given the level of sell-through volumes reported today and the shipments delivered late in Q3, we currently expect fourth quarter revenue to be less than $150 million.

Our focus in Q4 is on accelerating sell-through of our webOS products and helping our carrier partners work down the substantial inventory that they are currently carrying.

Sell-through, rather than revenue, will be the real measure of our success. And I want to emphasize that we do not view Q4 as establishing a new revenue run rate or otherwise being representative of our future revenue expectations.

We expect gross margins in the fourth quarter to be relatively low, likely in the mid-teens, due to the effect of manufacturing overhead costs and lower sales volumes and due to planned promotional incentives.

We expect the actions Jon outlined to strengthen sales over time. But in response to our current lower revenue outlook, we’re also taking steps to revise our spending and investment plans to mitigate our cash requirements, including focusing sales and marketing spend on the opportunities that improve sell-through, like our field training efforts, adjusting our cost structure where appropriate by reducing or deferring spending and ensuring that our product growth map is focused on the highest potential opportunities in this fast changing market.

As a result of these steps, we expect our fourth quarter operating expenses to be lower than Q3 and more consistent with the level of spending in our second quarter.

Given our Q4 revenue outlook along with the expected reductions in accrued liabilities and accounts payable during the quarter, we expect cash consumption to be higher in Q4 than our operating results might otherwise indicate. Once again, we view Q4 as an exceptional situation and not representative of our future cash flow expectations.

We’re proceeding through a very challenging period. So while we focus on initiatives to improve demand for our products, we will follow a disciplined approach to managing our resources.

We are under no illusions about the hard work in front of us, but we believe we continue to have the opportunity to establish our place in this rapidly expanding market by continuing to deliver an unparalleled customer experience.

With that, let me turn the call back over to Jon to wrap up our discussion before we take Q&A.

Jon Rubinstein

Thanks, Doug. As Doug has outlined, we are very realistic about our near-term challenges but the issues we are facing are far from insurmountable. Despite some setbacks, our core strategy and product philosophy remains sound, leveraging the web as the future of mobile, owning and integrating hardware, software and services and delighting consumers, carriers and developers with the newest, most innovative yet simplest to use mobile technology available today.

The long-term potential for our company also remains strong. We’re making great progress on future new products and our software road map. Carriers continue to have an active interest in Palm products and we are looking forward to upcoming launches with new partners.

Most importantly, we have built a unique and highly differentiated platform in webOS, which provides us with a considerable and growing advantage in the marketplace. The full weight of that advantage has yet to emerge, as the market is still young, and we have not yet been able to transfer it into commercial success. But the successful turnarounds I’ve been involved with, give me confidence that with focus, execution and continued industry-leading innovation we can achieve our goals.

And with that I’ll turn the call over to the operator and we will take your questions.

Teri Klein

Operator, we are ready for the first question please.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is from the line of Amir Rozwadowski.

Amir Rozwadowski – Barclays Capital

Thank you very much and good afternoon, Jon, Doug and Teri.

Doug Jeffries

Hi.

Teri Klein

Hi, Amir.

Amir Rozwadowski – Barclays Capital

Jon, you had mentioned that you are looking forward to additional launches with other carrier partners. Given the sort of challenges that you have mentioned that you are currently facing with adoption of your products, can you give us a sense as to the tenor of those conversations and maybe perhaps, some color as to whether or not those conversations have changed in light of recent events or how we should think about things from that perspective?

Jon Rubinstein

We have no changes to our planned carrier launches at this point in time. Obviously, we’ve learned some things from the Verizon launch, which we are carrying forward to use with our future partners and we’re excited about the new launches that are coming.

Amir Rozwadowski – Barclays Capital

Is it fair to say that the expectations for the next quarter’s outlook does not include new carrier launches?

Doug Jeffries

As he said, there’s been no change to our planned carrier launches.

Amir Rozwadowski – Barclays Capital

Okay, thank you very much for additional color.

Teri Klein

Great, thanks. Operator, we are ready for the next question please.

Operator

Our next question is from the line of Jonathan Goldberg.

Jonathan Goldberg – Deutsche Bank North America

Hi, guys. Can you just talk first, how did you get into this situation? And talk about in light of what you’re going to do to change things. It sounds like you had real trouble engaging the carrier retail outlets. And what are you going to do? Do you need to take on more high level sales people who have experience in this? It really seems like there’s been a big trouble with the carrier relationship overall.

Jon Rubinstein

I would say, actually that we have a very good relationships with the carriers. And we do significant training in advance of the launch. We do train the trainer and that supposed to flow through in-store. It became clear to us shortly after the Verizon launch that our training efforts had been insufficient. And so we put our brand ambassador program into place and are aggressively out there now directly in the stores, which Verizon has partnered with us to allow us to do. And we are training at the point of sales and moving from store-to-store. We’re hitting hundreds a day and working directly with the sales reps right there in the channel. And we’re going back to ensure that the retention is there as well.

I think that in entering the market with Verizon, I think that for many years, Verizon had been shipping other products and then had recently gotten their newest products, which they had spent extensive time invested in training for. And I just don’t think our training was sufficient enough when we got off and so we are aggressively moving to fix that right now.

Jonathan Goldberg – Deutsche Bank North America

Okay. And then my other question is have you been approached since your pre-announcement by any potential strategic buyers? Are there any M&A conversations that are any stage at this point?

Jon Rubinstein

There’s all kinds of speculation out there about. That we are going to get bought, that we are not going to get bought, we’re not going to comment on any of those. Obviously, we’re a public company. And if there’s a reasonable proposal, of course, the Board has to consider it. But that being said, our focus since the day I arrived here, and that’s almost three years ago now, is to build a great company with a great mobile platform and great products. And that’s been our focus.

Jonathan Goldberg – Deutsche Bank North America

Thank you.

Jon Rubinstein

Thank you.

Teri Klein

Great, thanks. Operator, ready for the next question please.

Operator

Our next question is from the line of Jim Suva.

Jim Suva – Citi

Great, thank you very much. You talked about going to stores and more aggressively training the stores and their representatives and giving them more knowledge and information, but yet your sales outlook is meaningfully disappointing. It seems like that so far these sales efforts and increased training you are not seeing traction for that. Maybe if you can help me understand, A) am I wrong on that because the outlook for Q4 just look so disappointing. It looks like you’re not seeing much of a benefit and maybe the tail is longer from the training?

And then B) can you help us understand are the people purchasing these products significantly mostly Palm users or attracting new users? Because maybe the problem is not attracting new users to the Palm platform as opposed to helping current Centro and Treo users switch over to webOS. Thank you.

Doug Jeffries

Hey, Jim, it’s Doug. Let me take the first question and Jon will take the second. I think in terms of the Q4 outlook for revenues, it’s just really reflects that we together with our carrier partners more optimistic about the sell-through than its actually taking place. So we got channel inventories that, as we said in the earlier comments, we need to work through and we are and will. But that inventory overhang obviously, does affect near-term revenues. And that’s what you’re seeing in Q4.

As Jon said in his comments earlier, we are seeing progress working with the field sales organizations with the carriers and we do think we will be able to improve significantly over where we are. But near-term, we do have a channel inventory problem that is affecting our revenue outlook.

Jon Rubinstein

And on the second question, I think we’re seeing a really good mix of both traditional Palm users upgrading to webOS and brand-new users who’ve never been on our platform before.

Jim Suva – Citi

Can you quantify at all percent of new users versus upgrades? And on the sell-through, Doug, can you help us understand is that sell-through starting to gain traction? And do you think it will quantifiably have you seen like a 10% increase in the last month of doing your sales efforts?

Doug Jeffries

Jim, on the first question, we don’t have data around the source of the buyers of the Palm products. Don’t have anything to offer there. I think, in terms of the other question, again, just don’t have any specific data we could share.

Jim Suva – Citi

Okay, thank you very much, ladies and gentlemen.

Jon Rubinstein

Thank you.

Teri Klein

Welcome. Great. Operator, we are ready for the next question please.

Operator

Our next question is from the line of Ehud Gelblum.

Ehud Gelblum – Morgan Stanley

Hey, guys, thanks, appreciate it. Couple question. First, let me touch on cash burn. You were talking about greater cash burn than the model would possibly show next quarter. Is that last quarter you said it was $80 million. Can you give us a sense, are we talking $100 million of cash burn or more? And this quarter you originally guided to $80 million worth of cash burn and basically had none. What items besides the top line, which is gross margin positive, shouldn’t have generated a cash burn. What items didn’t happen that allowed you to save that money? And then I have a follow-up on pricing and the market.

Doug Jeffries

I guess in terms of the cash burn for Q4, we gave a lot of background in terms of, as best we can tell how Q4 will shape up. And so it’s clear I think from that outlook we will use cash in Q4. We wanted to clarify for everyone to make sure that you factored in the fact that, as you point out, we did not have cash burn in Q3. That’s really a function of the timing of payments to vendors and carriers. That timing will reverse in Q4. And so, if you look at Q4, you should look beyond the operating results for Q4 in terms of cash burn and include in there. Some portion of the Q3 liabilities that will be paid in Q4.

Ehud Gelblum – Morgan Stanley

Okay. So the working capital didn’t reverse itself the way we thought it was going to. So we are going to get that $80 million of hit from working capital, whatever it was plus the normal cash burn that would have come out with $150 million quarter. So we could be looking at something north of $200 million. Is that cash burn?

Doug Jeffries

Again, we’re not giving specific guidance. I think again, the way to think about it is that some portion of the liabilities that we set up in Q3 will be paid in Q4. And so if you think about the liabilities in Q4, we talked about promotional incentives that we accrued and we talked about an inventory, where we had inventory commitments in excess of current forecasted demand, where we took accrued liability to bear for those commitments. Those are examples of the source of liabilities that will be paid over time. Some portion of them will be paid in Q4, some portion in future periods.

Ehud Gelblum – Morgan Stanley

Okay, helpful. On the channel inventory and pricing, the channel inventory I calculate as a little over $1.1 million. What do you think is a normal channel inventory? i.e., when do you start selling back into those same carriers that you can’t sell into right now? Is it when it drops to 600,000, is that the right number? Or does it drop to 300,000 before the channel is, “cleared” and they just have support levels? And then if you can just touch on pricing that impacted the ASP?

Doug Jeffries

On the channel inventory level, each carrier has a different point of view on what sort of stock they want to carry and what the replenishment points are. So I don’t have something I can give you that’s a broad brush guidance on that.

Ehud Gelblum – Morgan Stanley

But you expect, by the following quarter, by Q1, that will be down to inventory levels that you can build from as opposed to still depleting?

Doug Jeffries

Yes. Again, we are working hard to improve sell-through. As Jon said, we are making progress, but we’ve got a ways to go, and it will take some time to work through this. I don’t have specifics for you in terms of when we get through it, but we are working hard and we think we’re making progress.

Ehud Gelblum – Morgan Stanley

And can you just comment on ASP at all and pricing?

Doug Jeffries

And the specific question is?

Ehud Gelblum – Morgan Stanley

ASP was down a little bit. You said it was more mix. And then, Jon, you commented a little bit about competitive pressures and I wasn’t sure if they were related.

Doug Jeffries

No; actually, the ASP was just down slightly sequentially. And it was really just the fact that we launched Pixi late in Q2. In Q3 we had a full quarter of volume, and so it’s really driven by mix.

Jon Rubinstein

Of course, there are competitive pressures. Obviously, we strongly feel that long-term, the fact that we have webOS and that we have the ability to differentiate our products will stand us in good stead.

Ehud Gelblum – Morgan Stanley

Appreciate that.

Teri Klein

Thanks. Operator, can we have the next question please?

Operator

Our next question is from the line of Matt Thornton.

Matt Thornton – Avian Securities

Hey, good afternoon, guys. Thanks for taking my question. I think this question was asked a little bit, I’m going to try it in a different way. I guess, Jon, could you kind of contrast performance between a couple of your different carrier partners maybe contrast performance of what you are seeing at Sprint relative to what you would have liked to have seen, Verizon relative to what you would have liked to have seen? And then perhaps international bucket relative to what you would have liked to have seen? And then perhaps just touch a little bit on the trajectory of the traction you were seeing as you exited February and what you have seen in March so far?

Jon Rubinstein

We’re not going to break it down by carrier. Obviously, we’re disappointed in our sell-through and we’re working very aggressively right now to resolve that.

Matt Thornton – Avian Securities

And, Doug, just a housekeeping item. I know the stock-based comp I didn’t see it broken out by line item. Do you happen to have that handy?

Doug Jeffries

I don’t think I have it handy actually. Is it in the footnotes? We can get it out to you after the call.

Matt Thornton – Avian Securities

Okay, that’s perfect. I’ll just ask one and all that. Jon, you talked about marketing and advertising and the corrections that need to be made there. And you also talked about in-store training and some of the efforts and some of the corrections that needed to be made there. Any sense as to your hardware design specifications that you are thinking about for next gen products that again could perhaps close the gap and start to bolster some of the sell-through here?

Jon Rubinstein

We are not going to talk about our future road map. Of course, we’re working on new products and we’re excited about the stuff that’s coming in the future. But at this point in time we’re not commenting on future road map.

Matt Thornton – Avian Securities

Great, thanks guys.

Teri Klein

Operator, next question please.

Operator

Our next question is from the line of Shaw Wu.

Shaw Wu – Kaufman Bros.

Thanks. Doug, just on the Series C derivative gain. Looks pretty sizable, it’s basically $96.6 million. Could you share us a little more color on that? Thanks.

Doug Jeffries

Shaw, happy to. For GAAP accounting, there’s accounting rules that took effect at the first of our fiscal year that had aspects or features of our convertible Series C preferred treated as derivatives. And the practical effect of that is that there is a liability set up at the beginning of the year based on the value of our stock. And as the value of the stock increases, we incur a loss as that liability grows. And then in the recent quarter, where we saw the stock decline, that reverses and liability reverses and that comes through as a gain. It’s a non-cash item, and it’s something that really comes out of the GAAP accounting related to derivatives.

Shaw Wu – Kaufman Bros.

Okay, thanks.

Teri Klein

Great. Operator, next question please.

Operator

Our next question is from the line of James Faucette.

James Faucette – Pacific Crest Securities

Thank you very much. Couple of questions. One related to product. You obviously have put out a lot of releases and made some progress on improving performance. I’m just wondering how we should think about you feeling like you can really match some of the other competitive products and things like battery life and application load times and overall responsiveness really across the platform?

Jon Rubinstein

We’ve just got a great team here and we have a very aggressive road map on the cell phone front that we’re working on. I think that what we’ve created in the last three years is phenomenal and really delivers the best user experience in the marketplace. I think the work we’ve done around the app catalog and the third-party software that comes in that keeps getting better and better. So I think we’ve shown that we can make tremendous progress. You look at the 10 over-the-year updates we’ve delivered in the last nine months; we’ve delivered lots of new capabilities and features.

And again, if you look at our platform today, we have everything that you would expect from a world-class device, right? We’ve got the music and the web and the apps, video, etc., sort of the ante to play in a world-class device. But we’ve also gotten lots of innovation, right? And people love the fact that you put your phone down and you get a software update, and all of a sudden, you’ve got lots of new capabilities. They love the fact that you log into a variety of cloud-based services, and all of a sudden all that data shows up on your device through synergy, either that you can be playing a 3D game and if you want to go check your calendar or check e-mail or whatever, you just card the game with the multitasking and great user interface.

Same type of thing with notifications, where you get unobtrusive notifications or you just start typing and you get universal search. People really love these capabilities, and I think these are things that we’ve really innovated on. And we are continuing to innovate. I think we’ve been very innovative on our developer environments, right? With project Aries and with our SDK and with the PDK and so I guess the short answer is yes, I think we can be really competitive based on what we’ve already shown we can do.

James Faucette – Pacific Crest Securities

And then as far as improving your sell-through, obviously, you guys are taking a hard look and trying to be pretty realistic about what you need to do to improve your sell-through. What do you think the role that your carrier partners could play both present and future in improving the sell-through or I guess, maybe a better question is what would be reasonable for them to do that you feel like could have a big impact on your sell-through rates, etc.,?

Jon Rubinstein

Well, we’re working closely with all of our carrier partners and our future partners. Obviously, we want to make sure that the point of sale is well trained. So step one is to make sure that we can get in with the point of sale. Remember, webOS is a brand new operating system. And it takes a while for the people in the stores to get accustomed to something new.

And frankly, same thing with the customers, right? If I look at new technologies and new products that have been brought to market, right? It’s very rare that you see something just sort of take off. It takes a while to build momentum to get to that tipping point. And so we’re working really, really hard. We’re addressing our issues head on. We’re continuing to invest in innovation and differentiation. At the same time we are trying to be really prudent about managing our costs and investments to make sure we can realize the opportunity. But we’re charging forward and driving towards the day we hit that tipping point.

And the best person to market a product is a customer, right? Every happy customer you get sells your product to three to six other people. And so people who use our devices really love them. They love the capability you get and they love the differentiation you get.

James Faucette – Pacific Crest Securities

That’s great, thank you.

Teri Klein

Great. Next question please.

Operator

Our next question is from the line of Mike Abramsky.

Mike Abramsky – RBC Capital Markets

Jon, is there anything in your sort of past experience that gives you confidence that (inaudible) will improve based on the quality of (inaudible) and the activities that you are now focusing on in terms of where you have seen similar products and you face the same kind of transitional challenge shall we say??

Jon Rubinstein

Yes. I’ve had other examples in the past of where you brought a new product to market and it took a while for people to really understand it and get used to it. And then all of a sudden it takes off and then everyone sort of rewrites history that, oh, yes, that was really successful from day one. So I think there’s some patience that needs to happen around this. And while clearly, we’re disappointed and frustrated that we are not moving faster, I still think we’re doing a lot of right things and we need to just keep doing them and stay on mission.

Mike Abramsky – RBC Capital Markets

And maybe Jon or Doug, on the issue of payoff from the investments you’re making in channel execution and marketing, for want of better word, is this hope that by putting one foot in front of the other and doing the right thing that this momentum will improve? Or are you actually seeing any evidence that some of the efforts to-date have started to pay-off?

Doug Jeffries

Yes, Mike, it’s Doug. We are actually, it’s been a big effort internally, and we are seeing evidence. It’s anecdotal in a lot of cases, but gives us confidence in terms of the direction. So it’s not something I can apply broadly to the overall trends. But we’re starting to see dots line up that give us again, confidence that we’re on the right track.

Mike Abramsky – RBC Capital Markets

Thanks.

Teri Klein

Great. Operator, next question please.

Operator

Our next question is from the line of Mike Walkley.

Mike Walkley – Piper Jaffray & Co.

Great, thank you. Jon, just wondering if you could share with us, obviously, some other carriers have watched you’re slower than anticipated sell-through for your products. Has there been any change in conversations in future carriers in terms of demand for webOS products or whether they might launch future products?

Jon Rubinstein

Well, like we said, we’ve had no changes to our planned carrier launches. That being said, I think we see a lot of interest from a variety of carriers around the world, and we are working to try to bring to more carriers over time.

Mike Walkley – Piper Jaffray & Co

Okay, thanks. And then just in terms of the sales channel, could you maybe speak about the execution at the indirect channel and the another channel that you are trying to educate like the Radio Shacks and the Best Buy’s of the world or is it more at your carrier direct channel?

Doug Jeffries

I think to-date, most of our effort has been on the carrier direct channel. We are though, starting to work with some of the indirect channels and developing stronger relationships there. But that said, that’s kind of a fairly early stage.

Mike Walkley – Piper Jaffray & Co

Thank you very much.

Teri Klein

Thanks Mike. Next question please.

.

Operator

Our next question is from the line of Vivek Arya.

Vivek Arya – BofA Merrill/Lynch

Thank you. It’s Vivek Arya from BofA. A clarification and a question. First, clarification for Doug. Doug, could you repeat the cash burn expectations for the fourth quarter? And specifically, what is the minimum level of cash you need to run the business? And do you think you may need to come back to the market to raise cash? And then the question is for Jon. Could you help us qualify the sell-through before and after some of the new initiatives that you have put in place? Thank you.

Doug Jeffries

It’s Doug; let me take your first question. I think a couple things. One is we really haven’t ever given a minimum cash standard for the Company. On the Q4 burn, again, we indicated we don’t have great visibility at this point on the revenue outlook, which is one of the big drivers around ultimate cash burn. And the second part of it is, there are third quarter liabilities that a portion of which will be paid in Q4. And so the timing of that will affect cash burn in the fourth quarter. So we didn’t give specific guidance on Q4, but we did want to emphasize that not only would we have cash consumption from operations, but we would actually have additional cash consumption in Q4, as we start to retire some of the liabilities were established in Q3.

At this point, in terms of do we need to raise additional funding, our operating plans are in place. We’re assuming it’s going to take a while to work through some of the channel inventory we have. But that said, we believe we have adequate capital to get us through to the other side until the business becomes profitable.

Jon Rubinstein

And, on your second question, we have anecdotal evidence that our efforts are paying off out there, but we have nothing that we can give you numbers on right now.

Vivek Arya – BofA Merrill/Lynch

Jon, quickly, the launch with Sprint or Verizon, has gotten off to a somewhat slow start. The question is what gives you the confidence that the launches with other new carriers could be better? Because in a lot of those cases, you have had less of a legacy footprint relative to say, a Sprint or a Verizon.

Jon Rubinstein

Again, we are taking our learnings from what’s happened so far and applying them to new carrier launches, number one. Number two is in the last nine months we’ve significantly improved the product. And so we’re adding more and more capabilities and continuing to drive forward and taking care of any issues that we’ve seen pop up so far. And again, I think it’s one of those things where you hit the tipping point and then it starts accelerating.

Vivek Arya – BofA Merrill/Lynch

Just a last quick one for Doug. Doug, the inventory purchase commitment of $45.3 million charge does that become like cash short that has to be paid out in the next quarter? I’m just trying to see what the cash flow and income statement implications of that will be over the next few quarters. Thank you.

Doug Jeffries

Yes; that’s an estimate of our liability for future inventory component commitments that today are in excess of our current demand. So that’s a situation where we’ll work through it over the next period of time. It’s not like an accounts payable that turns in 30 days. It’s something that will be resolved over a longer period of time. So some portion of it will be resolved in Q4, some portion will go out beyond that.

Vivek Arya – BofA Merrill/Lynch

Thanks and good luck.

Jon Rubinstein

Thank you.

Teri Klein

Next question please.

Operator

Our next question is from the line of Kevin Hunt.

Kevin Hunt – Hapoalim Securities

Hi, thank you. I might have missed it, but did you give an actual ASP number for the quarter or did you just say it was kind of down slightly? And then can you maybe discuss – I thought I heard you say you’re going to be maybe more aggressive on that front going forward. And can you give us any maybe kind of range of quantification of that?

Doug Jeffries

So on ASPs we had $367 a unit for Q3 versus $375 a unit in the second quarter. I’m sorry; I missed the second question.

Kevin Hunt – Hapoalim Securities

So, basically, what that might hear in the coming quarter, even a ballpark range. Is that going to be a tool you use perhaps kind of improve sell-through?

Doug Jeffries

Yes. We haven’t provided a point of view in terms of the outlook for ASP’s. As Jon mentioned, one of the real strengths in the company is that the innovation that’s inherent in the product allows us to, we think, over time maintain stronger ASP’s. I think you see some of that in Q2 versus Q3, where the ASP is really lower as a result of product mix, where we’ve got the lower-priced Pixi representing a larger portion of the sell-in that quarter.

Kevin Hunt – Hapoalim Securities

One other clarification if I could. On the gross margin, you had indicated the inventory payment, I guess if you will. When would you expect the gross margin you said in the release 29% plus, it would have been with all that? How soon before you could get to some number like that?

Doug Jeffries

So we’re trying to clarify that there was this one-time item in terms of the inventory adjustment or at least a large adjustment to our effective gross margins. And so the 29% or 30% excludes that inventory adjustment, which is an accrued liability based on commitments in excess of current forecasted demand. In terms of the outlook, we are not today providing a long-term outlook on the business. I think we’re focused on getting the sell-through to where it should be. And I think when we get that in hand and going in the right direction, then we’ll be in a better position to talk about futures.

Kevin Hunt – Hapoalim Securities

I think as we get the business to scale, there’s clearly opportunities because of our differentiation and innovation, there’s opportunities that will allow us to have reasonable margin. Would there be more inventory adjustments like that? It sound like there would be in the coming quarter.

Doug Jeffries

It’s really a function of matching your purchase commitments to demand. And as we’ve called out in the call so far, demand was way below what we thought. As a result, we’ve got this inventory adjustment coming through. So in the industry, in this company’s history, they’re not unusual. They do have it from time to time, but if we do our job well it shouldn’t be something that’s frequent.

Teri Klein

Great. Operator, we’re ready for the next question please.

Operator

Our next question is from the line of Simona Jankowski.

Simona Jankowski –Goldman Sachs & Co.

Hi, thank you so much. Jon, just would like to get your view on given what’s just happened then there’s obviously the potential explanation that this may be even a structural issue over a longer-term period given the scale. What would be the pros and cons in your mind of a licensing model instead of a hardware model?

Jon Rubinstein

As I’ve said in the past on that one that’s not something that we are religious about one way or the other. If the right business opportunity or strategic relationship came along, it’s something that we would certainly consider, but only if it made business sense for the company.

Simona Jankowski –Goldman Sachs & Co.

Okay, that’s very helpful. And then in terms of the portfolio of products, I think you guys had talked about maybe four products or five products in the family over time. When you are looking now at some of the cost reductions you need to put into effect, should we think about that family getting a little smaller or do you still think that that is a viable number?

Jon Rubinstein

We’ve always said is that we want to have a handful of products. And we don’t want to be a company that’s got 20, 50, 100 different products, and we don’t want to just have one product. And so, we’re not going to talk about our specific product road map, but that’s in our core beliefs, and we are going to continue forward executing on that.

Doug Jeffries

While we will closely manage our spending, we do believe that the engineering, the innovation that comes from our strong engineering team is kind of a core competitive advantage and we’ll continue to invest there.

Simona Jankowski –Goldman Sachs & Co.

And, then, Doug, one is for you as well. When we look at the reserves here on the inventory side, it sounds like it’s at the component level. Shouldn’t we be thinking of these as components now that you have that, you’re carrying at zero cost? So, if you eventually do include them in handsets that you ship, effectively that will boost your margins in those quarters when you do end up using this inventory?

Doug Jeffries

That’s accurate in terms of how the accounting works. If we are able to find demand for those components beyond what we can see today, then there is a margin enhancement that comes from that. But at this point in time, we look at the liability and we look at our current demand, and it’s clear at this point that demand doesn’t cover the liability and so we need to record the exposure.

Simona Jankowski –Goldman Sachs & Co.

Okay, thank you so much.

Teri Klein

Great. Next question please.

.

Operator

Our next question is from the line of Phil Cusik

Phil Cusik – Macquarie Research Equities

Hi, guys, thanks for taking my call. Maybe follow-up, first of all, on Simona’s question. On the inventory, is there a timeframe on that liability? And so, if we go a couple quarters down the road, does that expire and so we can’t sort of draw that back in? And then was that estimate of the excess that you’ve ordered versus the demand, was that given the $400,000 run rate last quarter or is that off of some increase since the quarter ended and these initiatives have kicked in?

Doug Jeffries

Yes. On the timeframe, it’s a situation where we’ve got a component inventory committed to and the timing through which we resolve that, whether it’s through additional sales or otherwise, has been historically for the company a longer time frame. As I mentioned earlier, it’s not the same nature of the liability you have with trade payable, where it rolls over in a fairly short period of time. This is an excess inventory issue that gets resolved over usually a longer period.

And the second question I guess using sell-through for third quarter, we don’t think is representative of the longer-term way to look at the business. If you think about what’s there, you got Verizon, for example, launching relatively late in the quarter. You got sell-through that’s not performing at all, at the level we think it could. So, in terms of the forward view for the business, we wouldn’t believe that the Q3 sell-through is the right metric to use for analysis.

Phil Cusik – Macquarie Research Equities

Okay, that makes sense. And then on the training side – and we’ve talked pretty extensively about this, but how far through the process at Verizon do you think you are? Have you had people go out to every store now and sort of ramping back through? Are you sort of a portion of the way through? And then is there any sign of Verizon allowing you to pay the reps a bonus on the sale of a Palm product? Thank you.

Jon Rubinstein

We have worked our way through not all the stores but a large number of stores and we are going to continue to do that in the future. Again, our goal is to get it where when you walk into a store, that the sales force there is familiar with webOS products and give their customers a choice of picking a webOS product and being able to explain why there’s advantages to buying a Palm product versus our competitors. The second part of your question was – sorry.

Phil Cusik – Macquarie Research Equities

Are they allowing you to pay a dealer spiff to the rep when they sell your product?

Doug Jeffries

We just don’t comment on specifics around carrier agreements.

Phil Cusik – Macquarie Research Equities

Great, thank you.

Teri Klein

Great. Operator, we’re ready for the next question.

Operator

Our next question is from the line of Sanjiv Wadhwani.

Sanjiv Wadhwani – Stifel Nicolaus

Thanks. Two questions on the Pre versus Pixi. Can you talk about Verizon mix versus Sprint mix in terms of sell-through for the quarter? And then just on ASPs, any push by carriers to cut ASP’s to just help with the sell-through in the near-term? Thanks.

Doug Jeffries

On the first question, we don’t provide detail at the product level in terms of the sell-in or sell-through. The second question there’s always pressure from the carriers for stronger ASP’s. Specific to this quarter, you can tell from some liabilities we’ve established that we are interested in having sell-through improve. We are putting promotional incentives in place to facilitate that.

Sanjiv Wadhwani – Stifel Nicolaus

Okay, thanks so much.

Teri Klein

Great. Operator, next question please.

.

Operator

Our next question is from the line of Edward Snyder.

Edward Snyder – Charter Equity Research

Thanks a lot. Jon, you’ve done over some detail what the technical proficiency of your product because I don’t think there’s any doubt in the market, the feedback, the Pre did set some new records and it’s got a lot of features that people are chasing. But it seems to be the case that perhaps the size, Palm’s size has prevented it from hitting enough carriers quickly enough to prevent some of your competitors like Droid, of course, from getting into one of their potential big carriers, Verizon, before you did.

How much of the weaker sales at Verizon do you think may be attributed to the fact that Droid sold phenomenally well from November and December, may have satiated a lot of the folks and even more than a lot of folks as gifts that you would have gotten, had you gotten there sooner? Is Palm size a restriction to maybe making a bigger splash earlier?

And then, Doug, obviously, you are spending more money on promotion now. You’re not going to back off your hardware plans; I wouldn’t imagine given that the pace of competitors coming to the market. So your cash burn is certainly going up. Have you looked at the history of former OEMs in this business who kind of run into this similar problem where you’ve got to kind of double down on your promotion and your R&D investment, if you will?

At the same time you are not bringing in the revenue and therefore, the cash flow that you’ve done before. A lot of folks have kind of tripped up on that and kind of started rolling down this really couldn’t get back from, where do you see yourselves on that? Do you have one quarter, five quarters? How long do you have to correct this problem before you think you run into a real big cash problem? Thanks.

Jon Rubinstein

Let me grab the first one. So, our timing of the launch of Verizon had nothing to do with our size. All carriers would like a time-to-market advantage, especially, if they’re significantly investing in marketing for your product. And that’s not exclusive to any particular carrier; they all prefer that. So we had an arrangement with Sprint when we launched with Sprint that they would invest in marketing and carrying the product. And for that, they would get an exclusive for a period of time. And that really determined when we could do our launch of Verizon. I agree with your premise that if we could have launched at Verizon earlier, prior to Droid then I think we would have gotten the attention that Droid got. And since I believe we have a better product, I think we’d have even done better.

Doug Jeffries

On the second question, on the marketing spend, at this point where we are is that we are finding that the investment that we are making in marketing that affects sell-through is having a lot higher return for us than some of the other market initiatives that are actually more expensive, specifically, brand advertising. And so expect us over time to focus our marketing efforts strategically around educating, training and promotion related to sell-through, related to having the channel be effective in positioning our products. And as a result, we think we can actually be effective in driving demand, at the same time (inaudible) efficient with our marketing spend.

Edward Snyder – Charter Equity Research

And then Jon, real quick, your point on Sprint is well taken. I know there’s an exclusivity arrangement there. Do you have an exclusivity arrangement with Verizon that prevents you from going to say, AT&T earlier?

Jon Rubinstein

We do have a time-to-market arrangement with Verizon. But I can’t really talk about anything more about future carriers or potential carriers.

Edward Snyder – Charter Equity Research

Thanks, guys.

Teri Klein

Great. Operator, we have time for just one more question, so we will take the last question now.

Operator

Our final question is from the line of Rod Hall.

Rod Hall – JPMorgan Securities Inc.

Hi, guys, thanks for taking my question. I have just two quick ones. One is with regards to the sell-through number, you guys have talked a lot about that being a focus for Q4 and it seems like 960,000 units probably isn’t the right number or maybe it is and 408,000 units probably isn’t the right number. So I wonder, can you give us any idea on what you think a successful sell-through number would look like in Q4? Any kind of trajectory idea or if quantification is always better? I got a follow-up question after that.

Doug Jeffries

Yes, Rod, we don’t have a specific number for you. We are pushing hard, so that the bigger number we can deliver in terms of sell-through in Q4 the better. But we don’t have anything for you specifically.

Rod Hall – JPMorgan Securities Inc.

Okay. And then my follow-up is regarding the down in the channel again, obviously, you don’t want to comment on what kind of spiff might be paid to people and you are training people. But to John’s comment earlier, every satisfied customer will sell six other people on the product. And I guess, if it’s a satisfied customer down in the channel, it will be a lot higher number than that. So is there any way that you can get these people using your product on a regular basis as opposed to just training them? Is there any way to get the product out in their hands?

Jon Rubinstein

That is a significant part of our program. So we do give seed units to the carriers so that they can give it to the sales reps so that sales reps can put them on their hip. I agree with you 100%; I think that’s really, really important because if they use the product and they get accustomed to it, then they can speak eloquently about the capabilities of the product.

Rod Hall – JPMorgan Securities Inc.

And Jon, is that a more recent program or has that been going on for a while?

Jon Rubinstein

That’s been going on for a while but we’ve significantly expanded and accelerated it recently.

Rod Hall – JPMorgan Securities Inc

Okay, great, all right. Thanks a lot, guys.

Jon Rubinstein

Thank you.

Operator

There are no further questions at this time. I would now like to turn the call back over to Ms. Klein.

Teri Klein

Thank you. Well, thanks, Jon and Doug. And that concludes our Q&A session for today. Thank you, everyone, for joining us for our Q3 fiscal year 2010 earnings call and we look forward to speaking with you again next quarter.

Operator

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

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Source: Palm, Inc. F3Q10 (Qtr End 02/26/10) Earnings Call Transcript
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