We do not see a turnaround at Palm Inc. (PALM) in the near future. The shares fell 14.5% after the market closed yesterday, following the company’s third-quarter of fiscal 2010 earnings announcement. The shares have fallen by more than 50% this year.

Although its loss narrowed in the quarter, driven by higher year-over-year sales, Palm provided disappointing revenue guidance for the fourth quarter. Management said that the revenue in the fourth quarter would come in below expectations, as a result of lower sales and reduced demand for both the Pre and Pixi smartphones at its exclusive carriers, Sprint (S) and Verizon (VZ).

Palm expects to generate just $150 million in revenue in the fourth-quarter versus $113.2 million generated in the year-ago period. While this is up year over year, it is well below the consensus estimate of $306 million. The company also expects gross margin in the mid-teens percentage range.

To grow its shrinking smartphone market share, Palm recently signed a carrier deal with Verizon. Despite this, Palm has failed to generate higher sales and profitability. While Palm expects to add other carriers to boost its customer base, we believe achieving this and seeing customer preference for its smartphone over its competitors will be extremely challenging for the company.

The inability by Palm to sell its phones have also increased inventory. Moreover, the impact of high inventory levels of its Palm Pre and Palm Pixi smartphones will continue to affect top-line growth and increase losses.

Clearly, we believe that Palm has failed to attract customers. Palm will continue to struggle as it competes against much larger competitors in the smartphone market such as Apple Inc. (AAPL), Research In Motion (RIMM), Nokia Corp. (NOK), HTC, Motorola (MOT) and Samsung Electronic. With weak fundamentals and waning market share, our confidence in the company’s long term prospects is low.


Revenue on a GAAP basis for the quarter came in at $349.9 million, a sharp increase of 286.1% from the year-ago quarter. On a non-GAAP basis, adjusted revenue (excluding subscription accounting) for the quarter was $366.1 million. Revenue was better than management’s guidance of $300 – $320 million and also above Wall Street’s estimate of $316.2 million. The company said that the better-than-expected revenue was due to a change in the timing of booking sales.

Operating Performance

The company posted a loss (for the 11th consecutive quarter) of 61 cents per share excluding one-time items, beating the Zacks Consensus earnings estimate of a loss of 41 cents per share. Net loss came in at 86 cents per share in the year-ago period.

Operating expenses increased considerably in the quarter to $162 million (up 80.4% from the year-ago period) on an adjusted basis. This led to a rise in operating loss which grew 32.8% from last year. Adjusted EBITDA for the quarter was -$90.2 million versus -$78.6 million in the year-ago period.

Gross margin for the quarter on an adjusted basis was 17.3% in the quarter, impacted by a $45.3 million charge for reserves for inventory purchase commitments, which exceeded management’s forecasted demand. Excluding the impact of the inventory purchase commitment reserves, non-GAAP Adjusted Gross Margin in the third quarter would have been 29.7%.

Palm exited the quarter with $591.9 million in cash and investments versus $590.0 million in the previous quarter. The company used $0.5 million cash from operations in the quarter versus a cash generation of $16.7 million in the previous quarter.

Smartphone Sell-Through Declined

Smartphone sell-through (actual sales) during the quarter was 408,000 units, down 29% quarter over quarter and down 15% year over year, as a result of slowdown in sales of both the Pre and Pixi smartphone.

However, smartphone shipments of 960,000 units in the quarter were up more than 300% year over year, and 23% from the previous quarter. The average selling price for the smartphone was $367 in the quarter, down from $375 in the previous quarter. Even after a cut in price by 20% for the Palm Pixi Plus by Verizon and 50% by Sprint, Palm has been unable to pull up its sales.

Palm has a Zacks #4 Rank, implying a short-term Underperform recommendation.
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