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Executives

John Shandler - IR

Ed Colligan - President and CEO

Andrew J. Brown - Chief Financial Officer

Analysts

Vivek Arya - Merrill Lynch

Michael Ounjian - Credit Suisse

Tavis McCourt - Morgan Keegan & Co. Inc.

Hasan Imam - Thomas Weisel Partners

Mike Walkley - Piper Jaffray

Jim Suva - Citigroup

Jonathan Goldberg - Deutsche Bank

Michael Abramsky - RBC Capital Markets

Lawrence Harris - Oppenheimer

Maynard Um - UBS

Jeff Kvaal - Lehman Brothers

James Faucette - Pacific Crest

Palm, Inc. (PALM) Q2 FY08 Earnings Call December 18, 2007 4:30 PM ET

Operator

Good day ladies and gentlemen and welcome to the second quarter fiscal year 2008 Palm, Incorporated earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I will now turn the presentation over to your host for today’s call, Mr. John Shandler. Please proceed.

John Shandler

Thank you. Good afternoon, everyone. I would like to welcome you to Palm’s fiscal year 2008 second quarter financial results conference call. On the call today are Ed Colligan, CEO and President, and Andy Brown, Chief Financial Officer. Today’s call is being recorded and will be available for replay on our Investor Relations website at www.palm.com. 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 a forecast of future revenue and earnings 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 fiscal quarter ended August 31st , 2007 and its definitive proxy filed on August 10th, 2007.

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 reported 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 press release includes a table detailing the non-GAAP measures together with the corresponding GAAP numbers and a reconciliation to GAAP. You can also find this information posted on our Investor Relations website. The slides that accompany this call include both GAAP and non-GAAP measures and are also available on our Investor Relations website. We encourage listeners to review these items.

Now I’d like to turn the call over to Ed Colligan.

Ed Colligan

Thank you, John. Good afternoon, everyone, and thank you for joining us. Today I will address the Q2 results, talk about some accomplishments for the quarter, and give you an update on our progress in the transformation of Palm.

Q2 did not meet our expectations. We did not execute as well as we need to. Andy will provide details on the quarter during his remarks, but I will address the biggest issue, which was the delivery of the Treo 755P. The Treo 755P which is now shipping to Verizon was gated by certification issues. The time required to run every quality issue to ground before release pushed delivery of the product out of the quarter and was the primary reason we did not meet our revenue expectations. As you know, we have experienced quality issues on Legacy products that have affected customer satisfaction and driven up warranty costs. While we can’t change the past, we are determined now and in the future to deliver only products that top industry standards for quality. We have the mandate from our shareholders to transform this company and world-class quality is the first stop on our drive to operational excellence.

As we transform Palm, we are thinking about OpEx differently than in the past. We are working on next generation products that will eventually require us to invest in all aspects of the business, but during the development period, we have an opportunity to right size many of our activities. We have cut costs through greater efficiencies and some through focus on fewer projects and reduced staffing. We will continue to drive hard on costs until we lower our break even point.

These are the kinds of things we need to do to operate the business more effectively day to day, but when we agreed to the Elevation Partners investment, we also agreed to a more fundamental transformation focused on building long-term value in our company. To realize that transformation, my first priority was to strengthen the team, specifically the Product Development team into a world-class force. To do this, I knew I had to attract a great new technology and development partner. I have found that partner in Jon Rubenstein. Jon has made a profound impact on Palm in very short order and I expect him to continue to strengthen our team and drive them to deliver breakthrough products and underlying technology platforms.

My second objective was to identify an investment partner who believes in our vision and understands the scale of the market opportunity. I also looked for a partner who had a passion for our market space and relevant operating expertise to bring to the table and I have found that partner in Elevation Partners, which today is our largest shareholder and totally focused on the long-term opportunity at Palm

Over the last six months we have revamped our road map, strengthened our team, boosted the standard of execution on our products, reviewed and solidified our strategy, and continued to execute against core platform technologies that will be the cornerstone of some of our future products. We are not done, but we have made substantial progress. Some of that progress is in business processes you cannot see, but some of it is in products you can buy today. The Palm Centro is a hit. It has delivered record sell through rates beyond any Smartphone Palm has delivered to date and as we expand distribution with a wider range of partners this quarter, we expect those sell through rates to expand significantly. The Centro is also a high-quality product that has been recognized by many as beautiful in design and breakthrough from a value and functionality standpoint. We will invest in our marketing efforts to maximize the success of the Centro and we believe the imminent launch of a number of additional global markets will continue its momentum.

In addition, we have recently upgraded the Treo 750 to Windows Mobile 6.0 and we will work with Microsoft to drive more adoption of exchange active synch in the enterprise. Our customers are expanding their deployments of Windows Mobile-enabled Treos. They are making the decision to switch two Palm solutions on a Microsoft-based platform and away from Blackberrys because of the superior industry standard solution and lower total cost of ownership. We intend to continue to develop a compelling array of Windows Mobile solutions through next year and as we see our combined solution gaining momentum in the enterprise.

We still have a lot of work to do to deliver our road map. Two things are clear, however. First, there are huge opportunities for us on both our core platforms, Windows Mobile and Palm System Software. Second, the Smartphone market has never been more open to new design centers, which will enable us to innovate without having to imitate any other vendor. We intend to lead on design, ease of use, and functionality and serve a broad range of customers with products focused on their needs.

Our two-pronged approach is to 1) leverage Windows Mobile and our ODM partners backed by Palm designed expertise to serve our business customers, and 2) build our Palm System Software products for end-to-end seamless consumer solutions. We are leveraging the market advantage of Microsoft’s brand and market support, the cost advantages and design manufacturing expertise of our ODM partners, as well as our own deep design and engineering bench to address the market for Smartphones. We recognize we need to build a larger array of offerings and re-take the mantel of design and innovation leadership and that work is underway. The result of our two-pronged strategy should be a very vibrant diversified business capable of serving a broad range of customers.

We are in the beginnings of one of the largest growth markets in the history of technology. Billions of cell phones will be replaced by billions of devices that integrate computing functionality with voice and data communications. We are working on building key platform technologies and breakthrough product designs. There is a huge market opportunity and it will continue to expand in segment leaving a lot of room for innovation.

In summary, we are working today to build our business and drive for operational excellence. The market we are poised to exploit is huge and growing rapidly. We have key shareholders and partners who believe in us, our plan, and our vision. We continue to make substantial progress towards our breakthrough product and platform goals and yet we know this is a major transformation and it is going to take time. Fortunately we have a team and an investment group that is committed to making it happen.

One more thing I’d like to mention before I turn the call over to Andy to give you more details on the just-finished quarter and some guidance for next quarter. Since this transition is focused on the long-term, we are going to suspend specific financial guidance after this quarter. We will of course continue to provide general business guidance and comment on trends in our business and the industry. We believe this is the right thing to do for the company at this time and I appreciate your understanding.

I’ll now turn the call over to Andy for his comments.

Andrew J. Brown

Thanks, Ed, and good afternoon, everyone. Before I start, I would like to reiterate that all the commentary today is based on non-GAAP financial measures except where specifically identified as GAAP. I encourage you to refer to the reconciliation of GAAP to non-GAAP financial results that is posted to thePalm website and included with the press release.

Reiterating Ed’s comments, we are clearly disappointed with our performance for fiscal Q2 as revenue came inat $349.6 million, declining both sequentially and year over year. The lower-than-expected revenue performance was mainly attributable to our inability to ship the Treo 755P to Verizon before quarter’s end. During the quarter we saw Smartphone revenue essentially flat with the prior year and continued declines of 39% year over year inthe handheld business.

Gross margin for the quarter decreased to 29.9% compared with 35.6% inthe year ago period and 36.3% sequentially and was driven by two factors. We experienced inefficiencies in our repair logistics operation that increased our warranty costs for our older products. In addition, the success of the Centro at Sprint and the previously announced delay inthe launch of the Treo 755P resulted in a product mixed margin profile that was lower than anticipated atthe beginning of the quarter.

Operating expenses for the quarter were $121.6 million inthe range we had expected at the beginning of the quarter. This resulted inan operating loss of 4.9% of revenue and a loss per common share of $0.07. In addition, for Q2 the adjusted EBITDA was negative $8.7 million. Smartphone revenue for the second quarter was $282.4 million on shipments of 777,00o units. ASPs for Smartphones declined more than expected during the quarter to $359 per unit or a 17% decline sequentially. This was the result of the higher than anticipated demand for Centros and the delayed certification of the Treo 755P at Verizon. Smartphone sell through increased 11% year over year to 686,000 units.

Handheld revenue for the quarter was $67.2 million reflecting sales of 372,000 units. Handheld sell through for the quarter was 323,000 units, a 35% decline year over year. Inventory held by our channel partners was nine weeks at the end of the quarter which is typical in advance of the holiday selling season.

In Q2 fiscal 2008, we generated 73% of our revenues from theUS and 27% internationally. The lower proportion of US revenue in the second quarter was attributable to the delayed shipment of the Treo 755P and the launch of the Treo 500 inEurope. In addition, in connection with our recapitalization transaction completed within the quarter on a GAAP basis the loss per common share calculation includes a beneficial conversion feature associated with the sale of the preferred stock to Elevation and the related issuance costs. The beneficial conversion feature is the result of the stock price being higher at the close of the transaction and the effective conversion price underlying the transaction. The difference between these prices are $1.68 multiplied by 38.2 million shares. Elevation will receive upon conversion results ina beneficial conversion feature of approximately 65 million. The total of the issuance costs in a beneficial conversion feature are amortized over the term of the agreement or of seven years, resulting ina projected non-cash charge to our quarterly per common share calculation of approximately $2.4 million or approximately $0.02 per share. Q2 fiscal 2008 included one month of amortization.

Looking atthe balance sheet, our cash and short-term investment balance decreased approximately $334 million from the prior quarter to approximately $293 million. The decrease came mainly from the impact of the recapitalization transaction in which we received approximately $696 million in total net proceeds from the sale of preferred stock and debt borrowings and paid a one-time distribution to shareholders of approximately $949 million. Cash flow used for operating activities was $13.5 million, much of this being attributable to the increase in inventory during the quarter resulting from a build up of Treo 755P inventory for the Verizon launch which occurred after the quarter end.

We also reclassified approximately 75 million of our investments to non-current. These are AAA and AA rated auction rate securities that currently have a limited market and are not needed to meet all liquidity needs for at least the next twelve months. As a result, they have been reclassified to non-current.

Accounts receivable decreased sequentially by $6.8 million to $172.2 million and DSOs were 44 days in our expected range. Inventories increased sequentially by $15.6 million to $49.8 million and terms decreased to 23 times, this the result of the Treo 755P inventory build up mentioned earlier. We expect inventory to return to normal levels as we exit Q3.

As Ed mentioned earlier, we are providing guidance for Q3 but will be suspending specific financial guidance after this quarter. Looking to Q3 fiscal 2008, we currently expect revenues to be between $310 and $320 million. While we expect Smartphone shipment volumes to increase as a result of continued Centro demand, we are anticipating tight component supply, which we expect will constrain our shipments during the quarter. As a result, we expect overall Smartphone revenue will be flat or slightly down on a quarter to quarter basis. In addition, we expect handheld revenue to experience a normal season decline. We anticipate gross margin for Q3 will bein the range of 30l5 to 31% which is below our target model. This is being driven by high Centro demand. In addition, we expect the tighter component supply environment anticipated in Q3 to result in higher product costs than we planned just a few months ago.

To align our expenses with our current operating model, we have taken actions to reduce our operating expenses. This includes consolidating our operations in EMEA and APAC to better align with the near term revenue opportunities and reducing complexity of our US operations, allowing us to put more resources behind fewer activities. We believe this will result in operating expenses that by Q4 will be 10% less than the level in Q2. Inthe interim, as we implement these changes, we anticipate Q3 operating expenses will bein the range of $112 to $115 million. We also expect a restructuring charge on a GAAP basis in the range of $16 to $18 million associated with employee terminations, facilities closures, and other project eliminations.

Adjusted EBITDA in Q3 is expected to be between negative $7 and negative $10 million and the loss per common share of $0.14 to $0.16. Our goal over the next several quarters is to drive improved profitability by returning gross margins to the 32-34% range and reduce operating expenses to below $110 million. I will now turn the call over to the Operator for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Vivek Arya representing Merrill Lynch. Please proceed.

Vivek Arya - Merrill Lynch

Hello. A couple of questions. Ed, first of all, I’m just curious to know when is the earliest we will start to seethe impact of Jon Rubinstein joining the company? I know that he was involved with Centro but what is the next product that we can look forward to? How soon should we start to seean impact? What I’m really trying to geta sense for is what do you do different in 2008 than what you have done in 2007?

Andrew J. Brown

I think you’ll see Jon’s impact throughout the year and for years to come. I think what we’ll do different in 2008 than we did in 2007 as we mentioned was really strengthening the team in a whole host of areas. We’re hiring new talent. Also setting a different bar of expectations in execution. I’d say that the impact on Centro was really towards the very end of that development. That development was well underway and was going to happen but I would say that Jon’s positive influence atthe end was really related mostly to just setting higher standards and holding the team accountable. So some of it is just fundamental management ata different level. Someone who is really experienced in that area and will settle for nothing less than the best and that’s the kind of impact that it will have in the long-term.

Vivek Arya - Merrill Lynch

And also when you look atthe stock prices, actually they’re below where Elevation first got involved in it, are you continuing to look at the current capital structure and are you considering other potential investors at this point?

Andrew J. Brown

We don’t eliminate anything, as you know. It’s a public company, but it’s not something we’re looking at day in and day out. With Elevation, obviously they seethe stock price too but the only thing that has been communicated to me from their perspective is a continued very strong commitment to the long-term outcome of Palm, that they believe the market opportunity is huge, that we execute better on a number of fronts and continue to deliver the products that we have inthe pipeline and the platforms that we have inthe pipeline that they will get a significant return on their investment and that’s what we’ll all shooting for.

Vivek Arya - Merrill Lynch

And one last question. Andy, the gross margin, is 30-31% of the new level, what I’m trying to see is perhaps look forward and say that once your component costs are better under control, once you are done with these excess warranty charges, are you saying, do you expect a return to this 33-36% range that you had second quarter and how soon can we start to see that kind of gross margin range?

Andrew J. Brown

Yeah, I think over the next several quarters that 32-34% is realistic. I think there’s a couple of factors impacting that. One is the mix of products with clearly seeing a fairly significant mix recently towards the... Given the success of the Centro, that is driving some, as far as product costs go, we think we can do better. It may take more than a couple of quarters. I think that’s one area, and the other area is we continue to want to drive down our overall warranty costs so I think a realistic target certainly in the relatively short-term, the 33-36% was a long-term but in the short-term it’s probably in that 32-34% range given the mix of products that we believe is going to occur over the next several quarters.

Vivek Arya - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Michael Ounjian representing Credit Suisse. Please proceed.

Michael Ounjian - Credit Suisse

Thanks. Andy, if first you could give a little more color regarding the component constraints as to just where you’re seeing the shortages and just how you think we should think about it, the timeframe for addressing that? Is that something that’s likely to continue into May? How should we expect to see that proceed over the next few quarters?

Andrew J. Brown

It’s a pretty fluid situation right now. This is something that we’re clearly working daily. It’s not something that we’re saying we’re giving up but as we read the tea leaves right now, we think we’ll be constrained at least through this quarter. IT could continue into May but we’re hopeful that as we move into the May quarter, some of it will lighten up. Abig part of what’s driving this is just the high demand for Centros. We got a hit product on our hands and we’re all hands on deck trying to make sure that we can getthe supply that we need. Like I said, it ‘s a day to day situation.

Michael Ounjian - Credit Suisse

And in terms of the source of the shortage, is this something custom, is this specific to the Centro, or is it this a matter of just strong industry demands out there and it’s harder than you expected it to be after the product and it’s just a more standard product you’re seeing issues with?

Andrew J. Brown

I think the first thing is it’s really strong demand for our product and the second thing, I think that in general the stronger demand of the industry, and these are not custom products, they’re commercially available products to any manufacturer.

Michael Ounjian - Credit Suisse

Now looking into the next few quarters, obviously Centro is strong this quarter, abig part of the mix, but you only had half a quarter obviously with one carrier. As we look forward obviously a full quarter going forward and I would assume there’s more carriers to come. It seems reasonable to think Centro may actually become a bigger piece of the mix over the next few quarters. I guess why... How do you offset the potential margin pressure there inthe short-term and why wouldn’t we see even a little more pressure before things start to move back towards your 32-34% target?

Andrew J. Brown

You know there’s a couple of things there. The first thing is we do believe we can get better costs, be ina better cost position as we look out two or three quarters. We’re still working on driving costs out of some of our other operations like our repair logistics operation. We think in general if we look at itthe mix will somewhat stabilize once we get beyond Q3. That’s kind of what we’re seeing at this point, but it’s a pretty dynamic market at this point.

Michael Ounjian - Credit Suisse

Okay, thanks and then lastly, Ed, you’re obviously making a lot of changes, as you said transforming the business for the position the company better for the long term. That takes some time and there’s likely to be some volatility in results near term. How should we be tracking the business? What metrics do you think we should really be focused on to be measuring sort of the progress of the transformation?

Andrew J. Brown

I think one of the things is continuing to see, and some of this is less visible, assuming we can strengthen the team, we just added some additional talent atthe senior level that we’re excited about. You’re going to see us continue to deliver products throughout the year and those products will meet the highest quality standards we can possibly deliver. You’ll continue to see that. You’ll continue to see milestones around our next generation platforms. As we start rolling that out, it’s likely that we make certain developer announcements or other partnership announcements along the way, so there will be milestones but I think atthe end of the day we intend to continue to execute as best we can short term. We think, as we said, we have a hit product in Centro, we will have some other products coming out this year that we’re excited about, so I expect the business to continue to grow. You’re right, it is a transformational time, so things could be a little lumpy, but we’re going to do our best to manage through that and you’ll see I think some long term milestones being hit that will show that we’re continuing to execute. Inthe end, ultimately we have to deliver. As I said, re-take the mantle of leadership for both the design and innovation and that’ll be really on next generation products and those will bethe place that I think Jon and the retool team will have the biggest impact on.

Michael Ounjian - Credit Suisse

All right, thanks for taking the questions.

Andrew J. Brown

Thank you.

Operator

Your next question comes from the line of Tavis McCourt representing Morgan Keegan. Please proceed.

Tavis McCourt - Morgan Keegan & Co. Inc.

Hey guys. A couple of detailed ones and a bigger picture question. In terms of the inefficiencies and logistics and repair, is that part of the gross margins deterioration and fix or is that still in the mix for the February quarter?

Andrew J. Brown

So that is mostly being fixed at this point. Basically you know what that was our inability to turn around products and our carrier customers unfortunately have to use new product to satisfy their warranty returns. For the most part that is being fixed. There’s a very minimal amount of that inthe Q3 timeframe.

Tavis McCourt - Morgan Keegan & Co. Inc.

And I think I got this from the answer to your other question but I just wanted to confirm. The component tightness you’re seeing is purely on the Centro line at this point?

Andrew J. Brown

It is mostly on the Centro line. There is one component that does impact all CDMA products but it’s mostly on the Centro line.

Tavis McCourt - Morgan Keegan & Co. Inc.

Gotcha and Andy, I think you said for the guidance Smartphones shipment should be up sequentially. Is that correct or did you mean sell through?

Andrew J. Brown

No, I meant unit shipments will be up sequentially, that is correct.

Tavis McCourt - Morgan Keegan & Co. Inc.

Okay, and should there bea significant shift in terms of channel inventory, I know shipment has exceeded sell through by quite a bit this quarter?

Andrew J. Brown

Part of what happened this quarter clearly is the build up of Centro so that was pretty normal and ordinary and we continue to be very comfortable with our channel inventory. That will depend upon what products are out there and which products we’re potentially introducing. That’s as much as I can say about that.

Tavis McCourt - Morgan Keegan & Co. Inc.

And I know one of the frustrating things about giving guidance from your guys’ point of view is kind of the timing of getting the new product out the door, but as evidenced by the 755 this quarter, but in your guidance for February, can you give us some hint of is that betting on a certain product, new product launch this quarter or is that basically with the products that are inthe market assuming the 755 is shipped?

Andrew J. Brown

There is an expectation that we will deliver one more carrier on the Centro line but we... So far, so good, and we’re confident that’ll happen.

Tavis McCourt - Morgan Keegan & Co. Inc.

Okay and from your commentary before on gross margin going back up hopefully later inthe year and I think you mentioned something about the mix of Centros stabilizing a bit, can we take a minute? Should we expect some kind of updated higher end Treo lines this year?

Andrew J. Brown

Yes. You will see additional products inthe Treo line this year that we’re excited about.

Tavis McCourt - Morgan Keegan & Co. Inc.

But not based inthe February guidance.

Andrew J. Brown

Not inthe February guidance, no.

Tavis McCourt - Morgan Keegan & Co. Inc.

Thank you very much.

Operator

Your next question comes from the line of Hasan Imam representing Thomas Weisel Partners. Please proceed.

Hasan Imam - Thomas Weisel Partners

Thank you. I just had a couple of questions. First of all, in terms of the sequential decline in revenues according to your guidance, should we take that to mean that all of the weakness is in handheld?

Andrew J. Brown

What I said was that the flat to slight sequential decline in SmartPhone revenues and then we’d seethe normal seasonal declines in the handheld, so yes, you’ll see the seasonal declines are usually fairly significant inthe February quarter for handhelds, yes.

Hasan Imam - Thomas Weisel Partners

Got it and then in terms of the component constraint, if you can’t ship enough, do you think there will be orders spill over into Q4 or is this lost business?

Andrew J. Brown

I think that there’s definitely lost business when you don’t ship during the holiday season. There’s no question about that. The impact of 755 not getting out this quarter was definitely hurt ongoing sell through. I think as far as the Centro is concerned, it’s growing very quickly. There is somewhat minimal lost revenue during those out quarters and we should be able to make it up. We have a higher probability of getting more component supply obviously the further out you go but we’re trying to move that in as much as we possibly can to deliver as many as we can as early as possible because obviously the product’s quite exciting right now.

Hasan Imam - Thomas Weisel Partners

And then one question on the macro environment. There’s a lot of concern particularly on the enterprise front and also maybe retail that there will be weakening demand for discretionary products like SmartPhones. Are you seeing any of that from some of your enterprise customers or your talk with operators et cetera?

Andrew J. Brown

Not really. I mean, I would argue that there is a huge shift going on. What I hear more from our carrier partners is for instance high end clamshells are not selling and people are looking for products with QWERTY keyboards and more functionality so I think you’re likely to seea bigger dropoff on other kind of more fashion-oriented standard handsets than things that really deliver the kind of functionality that we have. Then the second thing is on the enterprise side, you can practically issue one of our devices to an end user rather than a $2500 laptop to get their email, so if we’re cutting costs, we may actually bein a reasonably good position relative to that and our integration with Windows Mobile and the cost of deployment of that which is essentially no cost for the server side of that could help us in the enterprise as far as deployment, soso far not seeing any or had any communication about that, I think in general we’ve seen the category growing quite a bit and we expect that to continue.

Hasan Imam - Thomas Weisel Partners

One last question. In terms of going forward and not providing specific guidance, I’m just wondering what the real philosophy behind that is because you would think that during times of stress or change more rather than less color would be useful or do you feel that there’s something fundamentally impaired in terms of your ability to forecast the business on a quarterly basis?

Andrew J. Brown

I think the bigger thing is staying focused on thelong term. That’s what we’re really trying to do, is keep the organization and ourselves focused on thelong term. That doesn’t mean we don’t want to execute day to day and it doesn’t mean we won’t give color. We will, we will absolutely talk about the business. It’s really we’re talking about specific financial guidance. There’s clearly a transformational time we’re making longer term decisions and we’re trying not to be too driven by how that’s going to necessarily impact that next quarter and so we’ve decided it probably makes the most sense from both our organizational standpoint and our own focus to stick with focus on the long term.

Hasan Imam - Thomas Weisel Partners

Thank you.

Andrew J. Brown

You’re welcome.

Operator

Your next question comes from the line of Mike Walkley representing Piper Jaffray Please proceed.

Mike Walkley - Piper Jaffray

Thank you. I was wondering if you could share with us now that Centro has launched and been a very strong launch for you guys, did it cannibalize more of the Treo sales than you thought? Is there any color you could give us on how your Treo sales have done now that Centro is out there?

Andrew J. Brown

I’d saya little more than we thought but not much. We’d anticipated a reasonably significant cannibalization and it’s probably done better, frankly, than we thought, the Centro when we were first coming out. So that kind of has a natural cannibalization at some level just because it’s just broader demand overall. It’s hard to tell a little bit because of the lack of the 755P being out at Verizon. We don’t get that data point relative to other carriers but at Sprint where the only place it is shipping, we still have some cannibalization but we expected that. It was expected.

Mike Walkley - Piper Jaffray

I know you expected it, I was just trying to getthe incremental, since it was out.

Andrew J. Brown

Not really much more. I think it’s really pretty much inthe planning horizon.

Mike Walkley - Piper Jaffray

Andy, I might have missed this, but can you give us on kind of the offsets coming down your longer term targets? I know you gave it for the next quarter but maybe what’s the break even level or what level do you think you’re going to take it down to in the interim here?

Andrew J. Brown

So what we expect is that we get our offsets down about 10% from the Q2 level in Q4. We’ll see some transitional this quarter. We’ve taken some actions and like I said, our goal is to get 10% out which will get you to about $110 million in offsets for Q4. I should reiterate that most of those actions have been taken and at this point it would really be focused on additional efficiencies within how we operate the company and the major actions they just will play out over the next two quarters as we’re closing certain facilities or whatever, some of those things just take time to have them settle out.

Mike Walkley - Piper Jaffray

Okay great. Just one last question on your guidance since it’s the last time we’ll get specific guidance in the short term. As you look into the year-end here, can you maybe just talk about inventory levels and what your thoughts are for seasonalities? Just the slightest SmartPhone guidance. Is it more than just component constraints or are you assuming kind of a normal seasonal slow down inthe January - February months? Thanks.

Andrew J. Brown

I think we’d loved to be more bullish here on guidance. We just are being prudent relative to the component situation we’re seeing. Centro is definitely something that’s moving in great volume. We know we could do more and we’re just trying to make sure that we put a number out there that it seems reasonable at this point and it’s really not a seasonal issue at all, certainly on the SmartPhone side.

Mike Walkley - Piper Jaffray

Great, thank you and good luck with your transition.

Andrew J. Brown

Thank you.

Operator

Your next question comes from the line of Jim Suva representing Citigroup. Please proceed.

Jim Suva - Citigroup

Great. Thank you very much. This is Jim Suva from Citigroup. You alluded to during your prepared comments making progress towards a break even point. Can you give us in your mind there internally what Palm views that break even point to be?

Andrew J. Brown

Yeah Jim, this is Andy. We think it’s pretty important in this transition phase to get that break even point down as low as possible. We’d like to getthe break even point, the EBITDA break even point below $300 million in revenue. We’re certainly not expecting revenue of $300 million but that’s what we’re driving the organization to which kind of correlates to what I had mentioned when we talk about driving the gross margin into the 32-34% range and getting our operating expenses below $110 million.

Jim Suva - Citigroup

Okay great and as a follow up I also cover the entire EMS and supply chain. I haven’t heard of component shortages especially for a commodity off the product type of products and with the Centro being launched in October and you were saying about efficiencies or shortages being worked through kind of through February, can you help me understand what exactly kind of arethe problems? Is it like supply chain, ordering type of items? Is it inefficiencies? I guess I just don’t understand why it takes so long to get that product result.

Andrew J. Brown

We had one particular component that is affecting us more than others and it was an issue that has developed at that particular supplier and it is affecting other CDMA based products. I’m not going to get into specifically what it is but it is not related to our demand planning or anything like that. It is a hiccup out ata supplier and so that’s where that is. There are other components I think inthe area of displays in particular where there’s just a lot of demand and much of the supply has been swallowed up and we’re obviously a reasonably small vendor inthe grand scheme of handset manufacturers, small factory displays. So that’s not custom necessarily but it’s an overall kind of capacity issue around that and it really depends on which suppliers you’re using and so forth so anyway those are two big areas. I think the one component in particular is the one that is the biggest constraining factor on this quarter. That supplier feels like they will be out of that issue in the February time frame and we’re just tying to get as much allocation as we can inthe meantime.

Jim Suva - Citigroup

Great, thank you very much.

Operator

Your next question comes from the line of Jonathan Goldberg representing Deutsche Bank. Please proceed.

Jonathan Goldberg - Deutsche Bank

Hi guys. Thanks for taking my call. I just have a question about handsets. The handset market in general is always very volatile and you guys have had, I think this is the second quarter this year in which product delays ata single carrier or delays with a single product have hipped you into loss-making territory. So I just want to know, now that you have a pretty significant debt load, how comfortable are your banks with this, what kind of covenants are on the debt that you now have? If you miss a product shipment again a year from now, are you going to start having your banks calling you worried about bankruptcy? Things like that.

Andrew J. Brown

So just so you know on the debt itself, there are no financial maintenance covenants on the debt. So that’s one thing that you need to be aware of. As far as the business, I think this is a relatively short-term transition where we’re clearly taking some actions to drive more profitability. The recent actions we’ve taken that we think will bring our overall burn rate down and we think that will allow us to drive sufficient cash flow to maintain the debt over the next several quarters.

Jonathan Goldberg - Deutsche Bank

Okay, and then with the cuts in operating expense, are you still going to be able to hit your deadline and getthe new operating system finished by the end of this year? End of calendar really.

Andrew J. Brown

With regard to the operating system work we’re doing, we are not cutting anything in relation to strategic investments. In fact, we’re actually maintaining or increasing, for instance advertising on Centro and investments in our R&D areas, specifically at those strategic product development areas. So what we’re really doing right now is allocating our resources as effectively as possible for the maximum long-term outcome and that’s how we’re looking atthe expense management. We want to bring down overall expenses but doso ina way that we don’t affect the strategic investments.

Jonathan Goldberg - Deutsche Bank

So you’re still on target for the end of ’08 in the operating system?

Andrew J. Brown

As far as the operating system is concerned, I don’t like to get into specific dates, but I think the answer is as far as the operating system is concerned, yes.

Jonathan Goldberg - Deutsche Bank

Okay, thank you.

Operator

Your next question comes from the line of Michael Abramsky representing RBC Capital Markets. Please proceed.

Michael Abramsky - RBC Capital Markets

Thanks very much. The manufacturing and product qualification issues that you talked about, they seem a little surprising in view of the fact that you have already been inthe game serving carriers, making SmartPhones, for some time, particularly since the product qualifications related to 755P and not the Centro which is more of a newer, seems to be a bit of a newer design. So shouldn’t these be resolved by now? How significant arethe problems behind those issues and what is your effort underway to resolve them?

Ed Colligan

Well Mike, I think they should be resolved by now. I’m as disappointed as you are in not being able to deliver this product. There’s nothing in my mind that’s an acceptable excuse for it. We should have done it. The reality is one of the things we’re dealing with that I think is reasonably unique relative to at least the SmartPhone suppliers is we have an older operating system here that is sometimes in certain multi-tasking situations is challenged relative to standard network performance issues. It is not challenged from the standpoint of end-user functionality and what end-users seein the product. In fact the Centro that runs the Palm OS is an incredibly stable, well-received, well-liked product. But when you get into the network certification area, and you’re testing against standard devices that the carriers use as kind of reference devices or benchmark devices, some of those do have real time operating systems and multi-tasking situations that allow them to perform certain network operations more efficiently. We’ve gotten caught up on that. We should be over the top of dealing with those issues. We do everything we can to work with the certification houses atthe carriers to make sure that it doesn’t happen, that we don’t miss deadlines. In this particular instance we weren’t able to get over the top on that. Now there are real issues that exist that are still in bug databases and things that are going on that we have to come through and make sure they’re not real issues before we’re going to ship the product and that’s really what happened here. There were things that were reported towards the end. It turned out that they were not issues and the product and the quality product is shipping and it is something that could have in hindsight shipped earlier, but that’s not what we were able to do without chasing and bringing all those things to ground. I think one of the issues is we have a reasonably narrow product line today and so one miss with one carrier hasa big impact on us. We have to build a broader array of products. We have to get more consistent about it. We have to get to the next generation operating system so that we don’t have some of those underlying issues from a network performance perspective and that’s what we’re doing.

Michael Abramsky - RBC Capital Markets

Thanks. How dramatic do you think the changes are now needed in your product lineup to reverse the fortunes that you’re in. I imagine there’s some rumors you have some WiFi and GPS based designs coming and what you’ve been issuing so far perhaps other than Centro is adjustments to the current form factor. Do you see a major need for new revolutionary designs, slimmer form factors, and perhaps a permanent move down market to $199 level pricing in order to get where you want to go?

Ed Colligan

Absolutely. We’re done with adjustments. That’s not happening anymore. The products we’re working on areall breakthrough form factors and designs. There are certain areas where you are extending a product line or there’s existing product line and we’re taking it to the next step. You don’t want to throw out thebaby with the bathwater and we’re going “We’ll extend that design center.” But we’re working on absolutely breakthrough designs, breakthrough user experience, breakthrough UI and other functionality on next generation systems, so we’re as I said we’re not stopping at anything short of revolutionary and fantastic design on at least our next generation platform products and in addition to that we will continue to deliver products on the Windows Mobile platform again that we’re driving towards world-class design on and nothing short of that so that’s what we’re working on and you’ll have to see those things and make that judgment when they come out. We also feel like we’ve set a very compelling price point with Centro. It has been really well-received inthe marketplace. That’s innovation ina different way, taking a lot of functionality and packaging itin a compelling package at a great price point. We will continue to do that as well.

Michael Abramsky - RBC Capital Markets

Okay, thanks very much Ed.

Ed Colligan

All right Mike.

Operator

Your next question comes from the line of Larry Harris representing Oppenheimer. Please proceed.

Larry Harris - Oppenheimer

Thank you. A question about the Treo 500 that’s available with Vodafone in international markets. I just want to understand. Right now that’s a triband phone and am I correct in assuming that there are no plans to make it a quad band that could make it available here in theUS.

Ed Colligan

It is a triband phone and there are no plans at this stage to make it a quad band available inthe US. We are taking it to other markets internationally but it will not be available inthe US.

Larry Harris - Oppenheimer

I understand but you are working in terms of new hardware products for calendar 2008 in advance of the introduction of the new version of the Palm OS by year end?

Ed Colligan

Absolutely. We’re working on a number of new designs.

Larry Harris - Oppenheimer

Okay, thank you.

Ed Colligan

Thank you.

Operator

Your next question comes from the line of Maynard Um representing UBS. Please proceed.

Maynard Um - UBS

Hi, thank you. So we can see the impact from one operator slipping in any given quarter. Is there any change in your strategy to go after more operators given your reliance and the impact from a slip from this one carrier?

Andrew J. Brown

I don’t think that would bethe answer. That’s just adding more complexity and more possible areas where you have failure points. I think our strategy is to narrow the total focus on fewer operators and execute more effectively against them. There’s no way we can not dothe best we can and be as effective as possible with a partner like Verizon. We just have to doit and so my answer to that is more focus on those guys, make sure those things happen. We have relationships with 100 different operators around the world. It’s not for lack of total numbers. It’s really missing at any point on one of thebig ones is where we getthe biggest impact, so my answer to that is let’s focus more and make sure we nail those.

Maynard Um - UBS

Okay, and then in terms of the restructuring and the head count reduction, where have most of those cuts been? Is that RD, sales and marketing, retail stores? Can you just give us a little more granular detail?

Ed Colligan

It’s really throughout the organization. We really looked at every specific area, tried to take zero based budgeting approach to it and say based on a revenue target that we think, “Okay, what’s our worst case scenario break even point? Let’s try to get expenses in line with that” and do the best we can to preserve strategic investments that are absolutely critical for the long term transformation and cut back on anything that is just non-essential and that’s what we’ve done. It certainly hurts when you end up having to cu t back on the organization as well but we made some decisions on that in particular areas of the company that we thought, “Okay, we’re just not going to focus as much right now there as much as we were in the past or that we had plans to, let’s cut back on that today. We can rebuild it in the future as we have new products or more products for those regions in particular or maybe those segments of the market, so that’s how we looked at it, but it ends up being I think pretty broadly spread across the board.

Maynard Um - UBS

Great, and then last question, how do you think about pricing for these new products that are coming out? Are they on a lower cost structure product which you’ve talked about you’ve been working on and particularly given in light of the fact that the Centro is so attractively priced as well as the 500B, how do you think about the pricing for these new products that the price differential doesn’t cause any type of cannibalization?

Andrew J. Brown

Well I think the Centro is a product that the $99 price point is a fantastic value. We’d like to continue to hold that price point going forward and we also believe we can bring new and more sophisticated functionality out in the future that would allow us to charge more premium prices from there so I think in the end we’d really like to have a broader product line. Today we have products in the $99, $199, $299 price points. I think you’ll see us continue to kind of be in that range from a standpoint of end user pricing and a mix of technical capabilities and functionalities that will allow those different price points to coexist.

Maynard Um - UBS

But given the similarities in the operating system itself across your devices, what new functionality would you be able to layer in on top of these new devices that would be different from the capabilities of a Centro?

Andrew J. Brown

Well Centro doesn’t have WiFi. It doesn’t have GPS. The Centro doesn’t have certain other software applications that may demand premium pricing or functionality. There’s a whole host of things that we can do. Memory, storage capacity, display technology, a whole range of things that could appeal to end users and demand different price points so we’ll keep working on that but the key thing that we’re focusing on is having a range of products at those price points and I think we can do that. We certainly see our way to doing that.

Maynard Um - UBS

Perfect. Thank you.

Andrew J. Brown

Okay.

Operator

Your next question comes from the line of Jeff Kvaal representing Lehman Brothers. Please proceed.

Jeff Kvaal - Lehman Brothers

Thanks very much. Ed, I was wondering, it sounds as though you are planning to get back into Europe a little bit. Certainly that would seem acost call. Could you give us a little sense of visibility and the confidence that you have in your re-entry to Europe? Thank you.

Ed Colligan

The re-entry to Europe isn’t really a re-entry. Let’s just say our continued performance inEurope. I think we’ve struggled. There’s no question that we don’t have the brand presence there that we have here. We don’t have the scale there that we have here. We’ve had a bit of starts and stops in some of those product launches and we could do better there. We’re going to continue to try. I’m not satisfied with what has happened there. I think one of the things we see there that is quite different than here is pretty broadly different demand for the types of products that sell there. If you look for a broad-based QWERTY product, forward-facing QWERTY products like ours, we actually do quite well. Unfortunately the total volume is about 5% of what it is in theUS. The QWERTY products do incredibly well here and just less so there. That business is more driven by tablet kind of design products or 12-T products, things we don’t have in our line, and so we have to continue to figure out what’s the right design center and form factor to be successful in Europe, so I think some of its been product related, some of ithas been execution, some of it’s our scale, but I think the first thing we have to do is get the right product for that market and that’s something we’re working on.

Jeff Kvaal - Lehman Brothers

You had said earlier I think that you expect your sell through to expand as distribution improves globally so I think your statement there that suggests that Europe is not top of line for you in terms of where that global distribution expands or --

Ed Colligan

We have very strong position inLatin America and inCanada and Europe is part of it. There’s certainly distribution and carrier partners inAsia as well so there’s a number of opportunities out there and we expect Europe to continue to grow for us but has it been as big as I’d like it to be? The answer is no.

Jeff Kvaal - Lehman Brothers

Okay and then I may have missed this flash by when you guys launched recently but it seems as though that the wholesale prices of the 755 at Verizon suggested a limited subsidy? Is that a fair assessment?

Andrew J. Brown

I wouldn’t make that assessment at all.

Jeff Kvaal - Lehman Brothers

The standard is supposed to be there?

Andrew J. Brown

Yes, standard subsidy.

Jeff Kvaal - Lehman Brothers

Okay. Thank you both very much.

Ed Colligan

The Operator will take one more question.

Operator

Thank you, gentlemen. Your final question comes from the line of James Faucette representing Pacific Crest. Please proceed.

James Faucette - Pacific Crest

Thank you. Most of my questions have been answered. I did have just a couple of follow up questions though, first as it relates to the 755 being late at Verizon. Can you help us understand what you think were the lost volume opportunities that were maybe permanently lost by the delay in that product versus how much was just pushed from one quarter to the next?

Ed Colligan

I think because of the time of the year, we definitely lost some sell though volume, there’s no question about that. Now this is more of a business product and it’s focused on that small or medium business to enterprise customer. That’s where Verizon is positioning itso my sense is at least from a sell through standpoint from here going forward we’re going to capture as much as we possibly can. We missed some number of months, and during that time frame people bought other products. I’m sure there’s some demand that will evaporate.

James Faucette - Pacific Crest

Okay and then finally in terms of your guidance for the February quarter, what portion of that is dependent on a product that has yet to be qualified at carriers where you intend to ship it?

Andrew J. Brown

James, this is Andy. The answer is that although it’s inthe guidance, it’s a relatively small component of the guidance for the Q3 time frame.

James Faucette - Pacific Crest

And then I guess the question then would beso if the product fails to be qualified, that would obviously represent a potential risk. On the other hand, are there opportunities to get additional products qualified ina route that would represent upside opportunities for the February quarter or would the upside to your guidance come primarily through better than expected demand at places where you already have product?

Ed Colligan

I don’t think so much the better demand. We’ve got some great demand on the Centro. I’d saythe bigger upside for Q3 is really getting the supply that we need for the Centros. I’d say that is the bigger upside opportunity for us in Q3.

James Faucette - Pacific Crest

Great. Thank you very much.

Andrew J. Brown

Thank you and thanks to all of you for joining us for the call today. We appreciate you continuing to stay focused on our long term transformation atPalm and we will continue to perform the best we can and we wish you happy holidays to all of you. Goodbye.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation.

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Source: PALM Q2 FY08 (Qtr End 11/30/07) Earnings Call Transcript
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