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Expectations gap closing but not closed

|Includes: Palm, Inc. (PALM)

This piece was published through TownHall earlier today...

Palm reported quarterly results that showed a significant 29% sequential decline in smartphone units sold through.  We believe results are beginning to reflect the lower than expected Palm Pre sell through at US and international carriers.  This is a step towards closing the gap between guidance and buyer behavior.  However, we believe that revenue guidance continues to reflect volume and pricing targets that will be increasingly difficult for the company to meet.  We continue to believe revenue guidance is at risk.  At this time, we continue to believe that PALM shares are a source of funds and reiterate our Unfavorable Opinion.  We look to become more positive on the company's fundamentals when we see traction of sell through with either the Pre or a future handset at a major carrier.

We believe that the bullish case for owning shares of PALM is driven by a focus on new carriers and new products.  The weak sales at Sprint can be blamed on Sprint's ability to sell the phone and when released with Verizon and AT&T, results could be better.  This may be the case, but investors need to ask themselves why a carrier such as Verizon would commit meaningfully to sell or market the Palm Pre when it could get the same revenue stream by offering a less expensive Smartphone such as the HTC Eris or RIM devices.  It is clear that the Pre is not bringing new customers to Sprint, as the carrier had hoped so why would a carrier such as AT&T aggressively back a phone that is just "good”?

We believe that wholesale prices are coming under pressure in a phased process.  First, co-marketing dollars will be cut for handsets that are not substantially differentiated, shifting the sales, and marketing burden to the handset manufacturer.  Second, store placement of the handsets will begin to shift to indicate which handsets are getting the greatest sell through.  Lastly, handset manufacturers will be forced to capitulate on wholesale prices to enable carriers to offer handsets at low or no upfront cost to consumers while offering a higher margin for the carriers.

PALM stated that it would be increasing spending in the coming quarter to "support its expanding business" but it is backing away from its profitability goals.  The company is now saying that being cash flow positive and profitable on a quarterly basis requires "carrier partners to execute strongly on the upcoming launches and successfully drive sustained sell through.”  However, the carriers are in the catbird seat, as increasing competition among the handset manufacturers will allow carriers to be more selective. 

The company does not appear to be dramatically increasing reserves for doubtful accounts or returns yet.  Doubtful accounts rose a bit, by ~$500,000 less than a $1 per handset shipped.  This increase is more likely due to PALM's new relationship with Telcel, a carrier that has the bulk of its subscribers on prepaid contracts.






Accounts receivable net of allowance for doubtful accounts




    Allowances for Doubtful accounts




ADA as a % of Gross Receivables




Other Accrued Liabilities, which contains rebate obligations, declined in the quarter indicating that returns are not an issue.  We estimate that there are nearly 500,000 Palm Pre units in Sprint's channel and we will be watching this metric as the inventory ages.


Disclosure: No positions in PALM