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Palm, Inc. (PALM)

Q3 2006 Earnings Conference Call

March 23, 2006, 5:00 p.m. EST

Executives:

Ed Colligan, President and CEO

Andrew J. Brown, Chief Financial Officer

Sandy O’Halloran, Senior Director of Investor Relations

Analysts:

Paul Coster, JP Morgan

Susan Kalla, Carris & Co., Inc.

Charles Wolf, Needham & Co.

Jeff Kvaal, Lehman Brothers

Darrell Armstrong, Citigroup

Travis McCourt, Morgan Keegan

Pablo Perez, Sagio Investments

Scott Coleman, Credence Capital

Operator

Ladies and gentlemen thank you for your patience, and welcome to the third quarter 2006 Palm, Inc. Earnings Conference Call. My name is Bill and I’ll be your conference coordinator today. At this time, all participants are in a listen-only mode; however, we will be facilitating a question and answer session toward the end of today’s conference. If at any time during the conference you require assistance, please key “*” followed by “0” and an audio coordinator will be happy to assist you. As a reminder, today’s conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today’s presentation, Ms. Sandy O’Halloran, Senior Director of Investor Relations. Please proceed mam.

Sandy O’Halloran, Senior Director of Investor Relations

Thank you and good afternoon everyone. I’d like to welcome you to Palm’s third quarter of Fiscal Year 2006 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 the investor relations web page 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 activities. 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 December 2, 2005, and an Annual Report on Form 10-K for the fiscal year ended June 3, 2005. Palm undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after this call.

Today’s results reflect a two-for-one stock split effective in the form of a stock dividend for stockholders of record after close of business on February 28, 2006. The stock dividend was distributed to stockholders of record on March 14, 2006. Also, please note that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, Palm routinely reports certain non-GAAP financial results to help you better understand our business. Non-GAAP financial results are not meant to be considered an 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 non-GAAP operating information excludes amortization of intangible assets and deferred stock compensation. In addition, our non-GAAP earnings for diluted share assumed a 40% effective tax rate. The non-GAAP measures together with the corresponding GAAP numbers and our reconciliation to GAAP are contained in our earnings press release and are posted on our website. We encourage listeners to review these items. I’d like to now turn the call over to Ed Colligan.

Ed Colligan, President and CEO

Thank you Sandy, good afternoon everyone. We executed very well this quarter on the large and growing smartphone opportunity. We continue to scale our company’s capabilities to meet the growing demand for our Treo Smartphone with the continuing goal of bringing delightful products to our customers, expanding our business worldwide, and delivering shareholder value. Also today with the corporate objectives, I’ve asked our company to focus on, so you can track our direction and progress. We are satisfied with these objectives to provide the discipline necessary for our increasing success. Our objectives are to: 1) deliver consistent profitable growth, 2) invest in and strengthen our product engine, 3) sharpen our attention on the customer experience, 4) expand geographically, and 5) collaborate with partners to reach new margins. I’ll start with our just reported results and our first objective -- to deliver consistent profitable growth.

In our third quarter of fiscal year 2006 we reported our ninth consecutive quarter of double digit year-over-year revenue growth. Revenue totaled $388.5 million for the quarter, up more than 36% from the year-ago period, reflecting strong and balanced sell-in and sell-through of our Treo Smartphone. In fact sell-through Treo Smartphones to end-user customers reached a record 559,000 units this quarter, up 102% year over year. Both the Treo 650 which operates on the PalmOS and the Treo 700w which operates on Windows Mobile OS are highly differentiated from other smartphones in the market reflecting Palm’s hallmark of excellent design, software customization, and ease of use. Customer interests in both smartphone products remain high.

We continue to deliver healthy profit. Income before income taxes for the quarter was $32.2 million, up more than 400% when compared with the $6.3 million a year ago, with handheld computers and smartphones both contributing to profitability. The mix shift in favor of smartphones reaching 74% of revenue was a key driver in boosting growth margins to 33.6% of revenue. Other factors included lower manufacturing cost and higher average selling prices on newly introduced products. I’m proud of the discipline we’ve demonstrated in shifting our product net, all while delivering revenue growth and profitability. Consider for example that in the year ago quarter smartphones were 46% of our revenue, and in the third quarter two years ago smartphones were only 28% of revenue.

Turning to cash, we generated $99 million in cash and short-term investments during the quarter, which will allow us to further build our business. We believe we are well positioned for continued growth and profitability. In calendar year 2005, the US-converged smartphone PDA market grew 56% in units. We grew 111%. We concluded the year with 30% marketshare of this category domestically versus 22% last year according to Canalys. Our dedicated focus and unmatched expertise in mobile computing positions us to earn a larger slice of the growing global market for smartphones. We’re still in the early phase of this market and we’re still working to grow awareness of the roles smartphones can play in improving personal and professional lives.

Today, for example, less than 2% of business e-mail boxes are accessed on the go with devices like Treo, so the opportunity is clear. Ongoing market growth will come from customers who replace feature phones, those that handle simple text messages with more robust and capable devices such as the Treo. It’s a natural evolution of the market as carriers deploy higher bandwidth network capable of significantly enhanced data transfer rates and as customers look for more productivity and flexibility in their devices. We believe this market will be won by companies that not only provide an excellent phone and e-mail experience but that add significant value at an excellent customer experience beyond those applications. Treo Smartphones do just that. One major networking company, for example, deployed more than 2000 Treos with GoodLink from Good Technology. In a study of 1000 of those users, this customer found substantial advantages. Respondents roughly saved about three hours of work each week on average, and those who worked away from the office at least half of the time reported saving more than four and a half hours per week. The ROI results were so pronounced the company placed an additional order for 5000 Treos. Look to us to continue to deliver profitable growth as we launch additional smartphones this year on two platforms, Windows Mobile and Palm OS and introduce products designed to accelerate our smartphone expansion in international markets.

Moving to our second objective -- strengthening our product engine, we continue to invest significant in R&D during the quarter. Our engineering and operations organizations are creating and delivering differentiated Treo smartphones at an accelerated pace, and we’re applying profits from our dominant position in handheld computing lines to help fund our smartphone development where the real growth opportunity lies. We made a lot of progress during the quarter. Among our accomplishments, we hired Ron Rhodes as our Senior Vice President of Global Operations. Ron has 30 years experience in supply chain operations with significant expertise in telephone handset manufacturing, ODM management, and scaling for fast growing marketplaces. We built our talent in our new Dublin, Ireland engineering organization, which is working with European carriers to develop custom software applications for Treo Smartphones. We invested in time-to-market advantages and IT ownership in audio, radio frequency, and network testing, and we further diversified our ODM partners to help us deliver more smartphones faster.

In our conference call last quarter, I shared with you that Palm would introduce four new smartphones in calendar year 2006. When I say new smartphones, I am referring to a combination of operating systems, new hardware design, new radio technology or other significant advancements. It’s worth noting that with a new radio technology such as the EVDO we’re able to leverage the investment with multiple new and existing carriers to expand Treo’s presence worldwide. The first of our four new smartphones, the Treo 700w on the Verizon Wireless EVDO network, went on sale on time in early January. Reviewers praised the advent of the Palm experience on top of Windows. You’ll see additional differentiation on Windows mobile products yet to be announced. We look forward to further collaboration with Microsoft to bring more Windows mobiles based Treos to market here and abroad and continue to refine the Palm experience on this platform favored by business. In delivering our three additional smartphones this calendar year, you’ll see us continue to deliver on our open platform strategy offering customers a choice of operating system, Palm OS and Windows Mobile as well as choices among radio technologies and industry-leading e-mail applications. This strategy expands our addressable market to embrace more users at a wider range of price points.

On the third objective, which is sharpened attention to the customer experience from pre-sales through customer support, we plan to attract new customers by delivering on our brand promise, “simple mobile computing.” We invested significantly to improve the quality of the pre-sales and the sales experience at carrier and traditional retail locations during the quarter. We trained more than 5700 carrier reps and 2200 retail reps. We also increased our sales engineering support for enterprise accounts received-to-sale cycle and assist in deployment strategies. Once our customers take our products home, they appreciate our improved getting started guide and on-device tutorials. Treo 700w customers, for example, love having T-applications such as Google web search on the today’s screen, and they report a smooth corporate e-mail setup with Microsoft Exchange 2003. Those factors among others help explain why customers favor our Treos over other devices. In one study of more than 530 US IT managers, Treos were preferred by 43% of the respondents, well more than any competitor. The preference for Treo is so strong that 29% of our registered Treo 650 customers surveyed said they switched carriers just to get it. Our early Treo 700w buyer also had a strong preference for phone. More than 90% of the early buyers knew exactly which phone they wanted before making the purchase and 50% were first-time smartphone buyers, which means we’re drawing new customers into the category. Our products are known for the best ease of use in the industry, but we’re not satisfied. We have much, much yet to do to make our products more inviting for new customers and we are committed to doing just that.

Now, I’ll try turn to our fourth objective, which is expanding our geographic reach. We have had great success where we focused first, the Americas, and we’re working to replicate that success in other regions. Europe is the next major target region. Last month at the 3GSM World Congress in Barcelona we shared our plans with carriers, and we were gratified to see that our roadmap aligns well with their interest. On the operational front, we consolidated and strengthened our European distribution activity by signing up two strong partners during the quarter. Vanguard will serve as master distributor for the Nordic and Eastern European markets and as a complementary distributor in Italy. Vanguard also will deliver services, marketing support, and customer support. A second new distribution partner is Dextra Solutions Limited, which will sell accessories across the region. We look forward to announcing new carrier relationships later this year triggered by product offerings tuned to global demand and supported by our newly established European engineering center and realigned sales team.

The fifth and last objective is to collaborate more extensively with key partners, with the goal of reaching and expanding into new markets. Our highest profile partnership is within Microsoft, the result of enterprise demand for a palm experience on the Windows platform. We are early in the enterprise sale cycle and it’s clear that a lot of new doors are open to us. I am confident we will increase our enterprise business significantly as a result of this new product line. We’re especially eager to deliver a Microsoft Messaging Software update and a Security Feature Pack, which will enable direct Push technology on the Treo 700w. Also, among the capabilities in this software release, are global address lookups for a company’s entire employee population and a “kill pill” that an IT department could dispense for lost devices. We expect enterprise deployment to accelerate when this update is available soon. Among businesses large and small we saw continued success with our partner Good Technology contributing to growing penetration of Treos in the enterprise. Good counted a total of approximately 10,000 company domains that have deployed the combination of GoodLink, Push e-mail solution, and our Treo 650s. In the second quarter of fiscal year 2006, we estimated about 8000 companies who have deployed the combination. In partnership with Research in Motion we completed the core client software for BlackBerry Connect on the Treo 650. Interested carriers are now in the process of certification tests.

Companies see the wisdom and flexibility in our open-platform approach, which gives them choices on e-mail solutions including Microsoft Exchange Accessing, Good technology’s GoodLink, and pending carrier certification BlackBerry Connect on our Treo 650s. Companies also are seeing reduced hardware costs because for many the Treo completely and largely replaces their need for laptops, 12-key cellphones, and handheld computers. Beyond e-mail, the power of open platforms and a robust developer community enable us to reach a wide range of other business customers with specific application needs. As more and more powerful solutions are developed by both Palm OS and Windows Mobile, we see these applications driving an increasing range of new business deployments. Looking ahead, you can measure our progress against our fifth objective by the results of our world class partnerships and our collaboration with carriers and other go-to-market associates. We are tightly aligned to accelerate our sales into the business market serving independent agents, small and medium-sized companies, and global enterprises.

Our progress on meeting the five objectives makes us an even stronger, more competitive company that helps us take advantage of the incredible opportunity for Treo Smartphone. I look forward to reporting our continued progress in future quarters. As I do each quarter, I’d like to thank our employees who are committed to seeing Palm accomplish its objectives and who work so hard to deliver on our vision that the future of personal computing is mobile computing. I will now turn the call over to Andy.

Andrew J. Brown, Chief Financial Officer

Thanks Ed and good afternoon everyone. We are very pleased with the results of our third quarter of fiscal year 2006. Revenues were $388.5 million, an increase of 36% from the year-ago period. Smartphone demand remains strong with the introduction of the Treo 700w on the Verizon Wireless network during the third quarter and strengthening of sell-through for the Treo 650. Gross margin of 33.6% was above our expectations and a healthy increase from 31% in the year-ago quarter. This is a result of greater revenue contribution from Smartphones coupled with manufacturing cost reductions and a new product introduction. Operating expenses on a GAAP basis were $101.9 million and on a non-GAAP basis $101.1 million. As expected R&D spending increased from the last quarter as we continue to invest in our product roadmap. The decline in G&A expenses during the quarter was mainly from a $2 million reduction in our bad deck reserve, the result of lower overall accounts receivable balances. On a GAAP basis, operating income was 7.4% of revenues and earnings per diluted share were $0.28. On a non-GAAP basis, our operating income was 7.6% of revenues and earnings per diluted share were $0.19.

Revenue mix for the quarter was 74% smartphones and 26% handhelds. This compares with 46% smartphones and 54% handhelds for the year-ago period and 61% smartphones and 39% handhelds in the second quarter of fiscal year 2006. We have achieved this dramatic shift in revenue mix and a related change in resource deployment while growing revenues and profitability over the last two fiscal years. As results, we devote relatively few resources to the handheld portion of our business, which continues to produce positive bottomline results. Smartphone revenue of $288.5 million in the third quarter of fiscal year 2006 increased 120% year over year.

We shipped 564,000 smartphones during the third quarter. Smartphone ASPs increased during the quarter and we began shipping the Treo 700w. The newest member of the Treo smartphone family commands a higher price due to its EVDO, broadband radio, and its increased functionality. The impact of the higher Treo 700w ASPs was slightly offset by price reductions on the Treo 650 as carriers continued to achieve higher volume, lower pricing tiers. Treo sell-through, as reported by our carrier partners, was 569,000 units, up a significant 102% year over year. We saw strong demand for the Treo 700w at introduction in early January. In addition, sell-through for the Treo 650 was extremely robust resulting in lower than ideal inventories of the Treo 650 at several carriers as we exited the quarter. Carry inventories at the end of the third quarter of fiscal year 2006 were close to the same overall level exiting the second quarter. They were lower, however, relative to the increased velocity of sell-through we experienced during the third quarter. Handheld revenues for the quarter were $100 million, down 35% from the year ago period. We shipped 510,000 handheld units with sell-through at 765,000 units. We experienced a higher percentage of lower ASP handheld unit shipments during the quarter and we reduced channel inventory to 7.2 weeks, down from 8.4 weeks in the prior quarter. We continue to focus on the sweet spot of the handheld market, which we believe is in the $99-299 range.

Geographic revenue mix for the third quarter of fiscal year 2006 continued to see strong US demand. The revenue mix was 80% US and 20% for rest of the world. International expansion continues to be a key priority for our company, and we expect growth to accelerate in Europe in the second half of this calendar year.

Looking at the balance sheet, cash, cash-equivalents, and short-term investments grew to $536 million by the end of the third quarter. Cash flow from operations in the quarter was an impressive $91.2 million. The cash increase was driven by strong collections of accounts receivable due to the improved linearity of shipments during the quarter. This resulted in net accounts receivable of $119.1 million. DSOs at 28 days were lower than the 40-45 days we would expect longer term. Inventories increased during the quarter to $51.1 million with inventory turns at 25. This level of inventory is more representative of levels we would like to see versus the 36 turns we experienced in second quarter of fiscal year 2006.

Looking at the fourth quarter of our fiscal year 2006, we expect revenues to be in the range of $400-405 million. We believe smartphone revenues will be greater than 75% of our overall revenue mix as demand continues to grow for our Treo Smartphones. Gross margins should be at or slightly higher than those achieved in the third quarter, as the revenue mix of our product continues to be more heavily weighted towards smartphones. We anticipate operating expenses should remain in the range of $100 and $103 million on a GAAP basis and between $100 million and $102 million on a non-GAAP basis. We anticipate minimal declines in R&D and marketing and sales spending from third quarter, which will be offset by increases in G&A as we do not anticipate further reductions in the accounts receivable reserves in the magnitude of the $2 million we benefitted from in third quarter. We expect our tax rate in fourth quarter to be positively impacted as it was in third quarter from the reversal of the remainder of evaluation allowance against our deferred tax assets. We believe our go-forward tax rate will be approximately 40%. Our guidance for non-GAAP earnings per diluted share is based on this 40% tax rate.

Based on this guidance, we expect our fourth quarter fiscal year 2006 earnings per diluted share to be between $0.33 and $0.34 on a GAAP basis and between $0.22 and $0.23 on a non-GAAP basis. At this time, I would like to turn the call over to the operator for your questions.

Question-and-Answer Session

Operator:

Thank you very much sir. Ladies and gentlemen, if you do have a question please press “* and 1” at this time, and if your question has been answered or you wish to withdraw your question at any time, please key “* and 2.” Questions will be taken in the order they received. Please key “* and 1” now to begin, and our first question comes from the line of Paul Coster of JP Morgan, please proceed sir.

Paul Coster, JP Morgan

Yes, thank you very much. Andy, if I can just dwell upon the guidance for a second, can you give us any clues as to the volume of Treos on the go-forward basis and perhaps comment on the ASPs. The ASPs were just excellent this quarter and can we expect them to continue to increase or hold back at that $510 level?

Andrew J. Brown, Chief Financial Officer

Paul, a couple of things, we don’t specifically give volume guidance but you can expect that shipments of Treos will continue to increase as we move into fourth quarter as I mentioned earlier. We’re seeing fairly robust demand for both products. With respect to the ASP that really is more function of mix between the products and depending on the mix of the higher band radio products versus the, for example, the Treo 650, that may have a function, but I do believe ASPs will certainly not go to the level that we saw prior to introducing the higher band radio devices.

Paul Coster, JP Morgan

Is it appropriate to assume that 700 increases as the share of the Treo mix in excess of 50%?

Andrew J. Brown, Chief Financial Officer

You know, the Treo 700w is only at one carrier at this point in time and we’ve got the Treo 650 at many carriers, close to 70 carriers I believe, so I don’t think 50% is likely at least in the short term, and we certainly don’t give those splits.

Paul Coster, JP Morgan

Okay and last question, are there any product introductions this quarter?

Ed Colligan, President and CEO

Paul this is Ed. We don’t comment on product introductions as you know. Well, we’re going to do our best to continue to drive our product engine and roll out new products, but we’re not thinking of any specific dates.

Paul Coster, JP Morgan

Great, thanks very much.

Operator:

Thank you very much sir. Ladies and gentlemen you next question comes from the line of Susan Kalla of Caris & Co., Inc., please proceed.

Susan Kalla, Caris & Co., Inc.

Yes, hello. I wondered if you could give us some of your views on the competitive outlook, especially with Research in Motion and the recent settlement of the litigation with FDP and with Apple, and their plans as a smartphone?

Andrew J. Brown, Chief Financial Officer

Well, when I look at the Research in Motion settlement I think it’s good for the industry and we expected that to happen. We’ve been driving our business focus on competing in the marketplace. We think our solutions stand up well for competitive offering and much of the growth you see in our business is really related to our solutions and our team executing well against the opportunity and less related to whatever is happening at RIM.

I can't speculate about an Apple product. Those are rumors in the press and we don’t speculate on that, but I feel like this category has an enormous growth opportunity. We’re focused on our execution here and our ability to deliver against the opportunity in front of us, and we can’t speculate too much on the competition.

Susan Kalla, Caris & Co., Inc.

Okay and one last question, I wonder if you could give us a timeline perhaps for this Sprint 700w.

Andrew J. Brown, Chief Financial Officer

We just don’t comment on future product releases. We obviously want to roll out Windows mobile products out to as many partners as we can as fast as possible, but we can’t give you a date at this point.

Susan Kalla, Caris & Co., Inc.

Thank you. Excellent quarter.

Operator:

Thank you very much mam. Ladies and gentlemen your next question comes from the line of Charlie Wolf of Needham & Co.

Charles Wolf, Needham & Co.

Yes, I just wanted to follow up on that question, Ed. Presumably, Motorola will be introducing the queue at some point in the future and Nokia has their E series. I was just wondering how you did the competitive landscape with regard those entries. The second question is, what was the sell-through of Treos in the second quarter, I forgot that number. And thirdly, Andy, the drop in accounts receivable is astonishing and I thought you might be able to address that.

Ed Colligan, President and CEO

Firstly, sell-through of Treos in the second quarter was 435.000 units. The competitive landscape, we obviously see the Motorola queue and the Nokia product coming, our focus is total and complete in this category. We’re really becoming a completely smartphone company, that’s what we’re really focussed on, is executing against those opportunities. So, we think we cannot complete effectively because of the complexities of these devices, the software applications involved, and the work that we do really well around this particular category. That being said, I believe this category is really poised for quite a bit of growth and large companies like Motorola and Nokia coming into the category and legitimizing products with small form factor keyboards and trying to push people into this category I believe will benefit us because I think when people go to try those products and use them against ours, they’re going to walk out of the store with the Treo. So, we can’t worry too much about the competition. We’re certainly respectful of it, but we’re focussed on executing against our opportunity that’s front of us. And Charley on the DSOs that I mentioned earlier, I’d like to say that we do a great job of collecting, which I think we do, but a big part of that is really the linearity that we’re seeing in the business and part of that is being in the smartphone business. It becomes more linear during the quarters and now that we’re approaching three quarters of our business being smartphones, you’re really seeing that kind of impact — it’s just primarily linearity.

Charles Wolf, Needham & Company

Okay, thanks a lot guys.

Operator:

Thank you very much sir. Ladies and gentlemen, your next question comes from the line of Jeff Kvaal of Lehman Brothers, please proceed.

Jeff Kvaal, Lehman Brothers

Thanks very much for taking the question. Andy, I have a couple of questions that maybe headed your direction. The first is I’m wondering if you could clarify on the Treo ASPs. It sounded as though you were suggesting that the primary determinant of your ASPs in the next quarter or two will be the mix between the two lines and I’m wondering to what extent there might be volume step-downs particularly in the 700 or are we through that?

Andrew J. Brown, Chief Financial Officer

So Jeff, I mean the volume stepdown that you’re talking about that we’re seeing with all of the parts that we’ve introduced, as carriers take more products they get different pricing, that will continue to occur with the 700 just like it did with the 600 and the 650. So, that will continue. However, what we are seeing from an ASP standpoint is that when you’re delivering the broadband radios with most features and functionality like the Treo 700w, they command a higher price and to the extent we deliver more of those versus, for example, the Treo 650, that will have an impact on the ASPs. So, you are correct in the sense that we will start to see that tearing, but in general the broadband capability Treos will be at a higher price.

Jeff Kvaal, Lehman Brothers

Okay, makes a lot of sense.

Andrew J. Brown, Chief Financial Officer

And certainly we’re taking that into account in relation to our guidance.

Jeff Kvaal, Lehman Brothers

Okay, great. And then Andy, it sounds as though the 650 sales were actually up sequentially quarter over quarter, is this by a significant amount or a sort of flat out or could you give some sense of that?

Andrew J. Brown, Chief Financial Officer

Yeah, we’re not going to get into breaking out the different Treos at this point, but I think it’s fair to say that we saw strong demands for the Treo 650. Like I said earlier, we actually exited the quarter with several carriers that were leaner than ideal inventory positions, so the strength of the Treo 650 continues.

Jeff Kvaal, Lehman Brothers

Okay, great. And now just shifting gears to the PDA side for a second. Traditionally, May tends to be up modestly over the February quarter, is that a pattern that we should expect to continue or any reason for that to be different?

Andrew J. Brown, Chief Financial Officer

At this point in time, I wouldn’t expect it to be up like you’ve seen in the past. I would call it basically flattish to what we saw over the past quarter.

Jeff Kvaal, Lehman Brothers

Okay, wonderful. Very impressive sell-through. Thanks for taking the question.

Operator: Thank you very much. Ladies and gentlemen, your next question comes from the line of Darrell Armstrong of Citigroup, please proceed.

Darrell Armstrong, Citigroup

Thank you very much. I have a couple of questions. The first one, in terms of the gross margin guidance, given the fact that smartphones are becoming a larger part and clearly the volume of the 700w will also ramp on the quarter-to-quarter basis, why wouldn’t your growth margins be a little bit higher? Is that just conservatism or is there another factor implied?

Andrew J. Brown, Chief Financial Officer

No, there’s nothing there. I think I’d mentioned earlier that in fact we anticipate that the gross margins will be at or slightly higher than where they were last quarter, and we talk about smartphones being greater than 75%, they were 74% last quarter. So, there’s no other news on the gross margin front.

Darrell Armstrong, Citigroup

Okay. And then in terms of the mix in your business, you talked about the vast deployment at one enterprise customer during the quarter and some of the momentum that you’ve with your technology, could you give me a sense in terms of what the mix was between enterprise relationship and what is the post membership this quarter and how does that change from last quarter?

Andrew J. Brown, Chief Financial Officer

I think we’ve seen the mix shift some. I think the biggest thing we’re seeing right now, Darrel, is huge number of trials going on both of Microsoft Exchange ActiveSync solution and of Good deployment, but the Microsoft Exchange solution came out last quarter, so we saw a lot of new trials, a lot of enterprise interests there, and I think we’ll see some additional shifting in our business. I’d say quarter-over-quarter it probably shifted from being let’s say 30% of the business to closer to 35.

Darrell Armstrong, Citigroup

And then finally, there was some speculation today that Tim Worth left the company. I’m not sure if that’s true or not. If so, could you tell me if you have a candidate to replace him?

Andrew J. Brown, Chief Financial Officer

Tim did leave the company and so that is true, and we do intend to replace him. One of the things we’re focussing on is bringing in a new product marketing leader that’s focussed on product marketing. Our business has become quite a bit more complex in the range of platforms were supporting and in the range of products were supporting and in the range of carriers were supporting, and so we’re going to focus around two areas, one is product marketing directly and the other is marketing communications and marketing programs which will be headed up by a gentleman named Page Murray who is here today. He’s doing an excellent job on that and we’re pleased to have him join my staff at this point. So, we will be recruiting for a new leader in the product marketing group. In the meantime, I certainly have an enormous amount of experience in that area and I will be leading the charge there.

Darrell Armstrong, Citigroup

Thank you very much for answering the question.

Operator: Thank you very much Sir. Ladies and gentlemen your next question comes from the line of Travis McCourt, Morgan Keegan, please proceed.

Travis McCourt, Morgan Keegan

Hi guys, a couple of questions. First on the operating spins guidance, it looked basically flat. It looks like sales and marketing are down for, I guess, the second straight quarter. Are you just experiencing more operating leverage in the business or was there a big ramp up earlier this year that kind of gives you guys the freedom not to have to grow as much in the back half of the year, just trying to get a sense of…we’re at a stage now where we may seem more operating margin expansion than we’ve seen in the past or is this something more near term in nature?

Andrew J. Brown, Chief Financial Officer

I think the flat guidance on the operating expenses is really more around the engineering portion of the income statement. As you may recall from last quarter, we actually bumped up engineering fairly significantly with prototype materials and things like that for the new products that we plan on introducing this year. That got bumped up last year and you’re more likely to see more of a reduction in the R&D side of things than you are actually in sales and marketing. We do have some specific programs that we drove in sales and marketing last quarter that may not likely to occur this quarter but the majority of the decrease is going to be around R&D and obviously offset by what I mentioned earlier when we took a very large credit for the accounts receivable in G&A. But overall, we do expect over time that we will get more leverage, we’ve been seeing that over the last fiscal year. We drove 7% operating profit last year, we’re in the neighborhood of 8% this year, and we’ll continue to drive it.

Travis McCourt, Morgan Keegan

Great, and then in terms of use of the cash and I guess a little over $5 share on the balance sheet, how should shareholders think about the strategic use of the cash and what you guys are looking at this point?

Ed Colligan, President and CEO

When we look at our past position, we’re pleased with it, and we really believe that the $500 million is a good operating capital for a company of our scale. It does allow us a lot of flexibility to look at some strategic opportunities and we will look at those types of investments to try to build our product portfolio, our software portfolio, our IT position, and those are the kind of things we’ll be focussed on trying to invest in.

Travis McCourt, Morgan Keegan

Great, and I don’t want to be the dead horse on the 650 sell-through, obviously it was up sequentially, do you guys get any visibility on whether that was through enterprise channel solely or whether there was strength there in the consumer channels as well above and beyond November?

Ed Colligan, President and CEO

Oh, I think there was a significant strength across the board. We had strong consumer sell-through in retail. We had strong enterprise pickup as I said, combination of GoodLink and Good Technology. So, it’s a product that’s got a lot of legs, it’s a great product, people love it, and we’re continuing to sell it.

Travis McCourt, Morgan Keegan

Great, thanks a lot.

Operator:

Thank you very much sir. Ladies and gentlemen your next question comes from the line of Pablo Perez, Sagio Investments, please proceed.

Pablo Perez, Sagio Investments

Hello guys, very excellent quarter. The first question has to do with the Treo 650 sell-through and what that implies for new products coming down the line. We did our check and it says that, as you indicated and you confirmed it, the 650 sell-through was excellent. There doesn’t seem to be much pressure there. Is this going to affect your decision when exactly to release subsequent Palm OS products or are you thinking about the possibility of selling a new Palm OS product in conjunction with the 650 at the same time?

Andrew J. Brown, Chief Financial Officer

We would never delay new products introduction when the marketplace is selling well. We want to continue to bring out new products. We will drive those to market. That being said, there are various carriers who maybe excited to continue to sell 650, because you’ve seen some of the pricing has come down to as low as $99 with some of our carrier partners. That’s an outstanding value. I’m sure that’s making an impact on sell-through. So, we can expand the line even more with new introduction, but I’ll tell you I feel like it’s a winning product and against the competition that’s out there and coming, I’d be proud to introduce the 650 today. So, we’ll continue to sell it as long as there’s customer demand.

Pablo Perez, Sagio Investments

Excellent, another question has to do with…I guess I have this one and one more…the channel inventory. I mean your sell-through was fantastic. We did our computations and I know you guys took about a week, but we have a significant decline in channel inventory weeks from last quarter to this quarter which matches your comment about some carriers not having ideal inventory levels. This should be higher. Even when we look at our model and put in additional shipment next quarter and low sell-through growth, it looks like channel will be laying out at next quarter. Are carriers actually asking you to potentially increase orders right now beyond what you’re guiding us, because the channel doesn’t look like it’s going to be very high at the end of next quarter either?

Andrew J. Brown, Chief Financial Officer

I don’t have your computations Pablo, obviously, but what we did is we did lean inventories with several carriers on the 650, as I said. Inventories were basically flat. Therefore, your calculation is correct and that is yes; I mean from an overall velocity standpoint, the velocity of the business is a relative side if the inventory is down. We’ve taken that into account in our guides and that’s what we’re guiding to at this date.

Pablo Perez, Sagio Investments

Okay, final question. The customer operations look fantastic, you also are going to at some point going to receive the $70 million in cash from the land that you just sold, when will you receive the $70 million, next quarter August?

Ed Colligan, President and CEO

Now, that’s actually somewhat difficult to project at this point, but we are under contract for the land as you’re aware. If everything goes as scheduled —and they don’t always go as scheduled, so I need to put that caveat in there — and if the contract goes through, it should be sometime, I would estimate, between August and October is when that…if the sale goes through could land on our balance sheet.

Pablo Perez, Sagio Investments

Okay, thank you very much.

Operator:

Thank you very much sir. Again, ladies and gentlemen, if you have a question please key “* and 1” at this time.” And your next question comes from the line of Scott Coleman of Credence Capital, please proceed.

Scott Coleman, Credence Capital

Hi guys, great quarter. Thank you for taking my question. It seemed as though these past few months had a nice opportunity for you guys to really make some breakthroughs in the enterprise market. You guys own the prosumer and consumer and it seems as though the enterprise market would be a very nice market for you guys to start to take share. So, I’m wondering if you guys could just go over what you’re doing as far as sales and what your sales force is doing to try and breakthrough the enterprise market and also what you’re doing in combination with GoodLink as a package sale.

Andrew J. Brown, Chief Financial Officer

Thank you. We got a lot of effort there. We significantly increased our direct selling effort by increasing our team to focus on that. They work closely in conjunction with GoodLink. We’re also working closely in conjunction with Microsoft and Verizon on selling solutions into the enterprise. They’re very excited about that opportunity with the Treo 700w. Our real emphasis is on trying to extend the business market, not to necessarily replace RIM and take share, because we believe a very small percentage of the overall knowledge workers are actually hitting e-mail on devices like Treo. So, we think there’s a big opportunity for market expansion. We think Microsoft in partnership with Verizon and us can help do that, we think Good can do that, we think we can make an impact in the enterprise where Blackberry is already in by delivering our Blackberry Connect solutions. So, we’ve really tried to take a very open-platform approach to bring in many solutions as possible to the market, and we were doubling down on the sales effort and also really leveraging as much as possible the carrier enterprise sales teams. So, we’ve been doing a lot of training out in the field working with them. All those things we think will result in continuing to expand our footprint in the enterprise and we’re confident that business will forth.

Scott Coleman, Credence Capital

So, we could see a sales call with your sales and somebody from Verizon and somebody from GoodLink all walking into the CTO’s office?

Andrew J. Brown, Chief Financial Officer

It can happen. Usually one of those in first and then if they need some expertise in one of the other areas, they would call on us. If it’s a significant enough opportunity, we would deliver someone to that account and make sure that we put our best foot forward. That’s what I talk about leverage with the carriers. They have many, many more direct sales people going into the account. Microsoft has many, many more direct sales people going into the account than we do. So, we try to leverage those relationships to get our products in the door.

Scott Coleman, Credence Capital

Okay, great, thanks.

Operator:

Thank you very much sir. And ladies and gentlemen, your next question comes as a followup from Darrell Armstrong from Citigroup, please proceed.

Darrell Armstrong, Citigroup

Thank you very much. I just wanted to clarify one of the things you talked about Blackberry Connect solution and of your inroads on the enterprise side. If you think about the entire solution, would you expect that on average the price point that you have in December to the price point that we currently see on Blackberry devices, would it be at a premium or at a discount? And then I have one last followup.

Andrew J. Brown, Chief Financial Officer

With Blackberry Connect as part of the solution…the Treo pricing wouldn’t really be any different and we don’t really control pricing to the end-user account. The carrier is usually delivering those products and they are setting the price with the IT Department, the functional department in that business. We will not charge any incremental amount for the Blackberry solution.

Darrell Armstrong, Citigroup

So, for the most part, I should think of that not really impacting your ASPs one way of the other?

Andrew J. Brown, Chief Financial Officer

No.

Darrell Armstrong, Citigroup

And then second of all, in terms of new product introductions, one thing that you’ve talked about is reducing the return ratios for new product s. You put a lot of processes in place to accomplish that, could you talk about what the return that you would like for the 700w compared to may be some of return ratios from some previous new product launches.

Andrew J. Brown, Chief Financial Officer

Darrell, while we expect the return rates on the Treo 700 to be improved over prior products, it’s relatively too early to tell at this point. The product’s only been in the marketplace 9 or 10 weeks. So, we don’t have a lot of data on that at this point, but we are very confident of the quality of the 700w.

Darrell Armstrong, Citigroup

Right, okay; well, thank you again.

Operator:

Thank you very much sir. And ladies and gentlemen that concludes our Q&A session for today. I’d like to turn the call back over to Mr. Ed Colligan for closing remarks.

Ed Colligan, President and CEO

Thank you everyone. We appreciate your participation in our conference call today and hope you share our confidence in Palms’ future. We are committed to delivering profitable growth through outstanding products and service and by delighting customers around the world. Thank you very much for your time today.

Operator:

Thank you very much ladies and gentlemen for your participation in today’s conference call. This concludes your presentation and you may now disconnect. Have a good day.

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Source: Palm, Inc. F3Q 2006 (Qtr Ending March 3, 2006) Earnings Conference Call Transcript (PALM)
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