Palm Posts Upbeat 4Q Results

Palm, Inc. (PALM) fourth quarter 2009 results beat Wall Street's expectations as well as ours. The company reported fiscal fourth quarter (May 31) revenue of $86.8 million, down 4.2% from the third quarter of 2009 and a sharp decline of 70.7% from the fourth quarter of 2008.

Although revenue fell sharply in the quarter it exceeded our expectation of $75.0 million as well as consensus estimates of $80.3 million. This was due to strong demand for its recently unveiled Palm Pre. Revenue performance in the quarter was also positively impacted by the strong domestic and international carrier interest in the Web OS platform and ramp up of Treo Pro shipment.

Palm also said that the demand for the Pre was exceeding its expectations and increased Treo Pro volume contributed an increase in margins. GAAP gross margin for the fourth quarter of 2009 improved to 23.1% from 4.6% in the third quarter of 2009 but was slightly below the fourth quarter of 2008 margin of 25.2%.

On a non-GAAP basis, gross margin for the fourth quarter of 2009 was 26.8% versus 5.0% in 3Q09 and 25.3% in 4Q08. Gradually the company expects to reach a gross margin -- on an adjusted basis -- of above 30%.

As a result of a more favorable tax rate and lower-than-expected operating expenses, EPS on a pro forma basis was better than our estimate of a loss of $0.47 and consensus estimate of a loss of $0.65 per share. On a non-GAAP basis, Palm reported a loss of $0.40 per share in 4Q09 versus a loss of $0.86 per share in 3Q09 and a loss of $0.22 per share in 4Q08.

Palm said it could turn to positive cash-flow in the second half of fiscal 2010 and reassured analysts that its capital position was sufficient to revive the company and reap profits. Palm also said that it will no longer manufacture handhelds and will focus all of its resources on smartphone products.

The company shipped 351,000 smartphone units in the quarter, up 6% from the previous quarter but down 62% from the year-ago quarter. In addition, smartphone sell-through during 4Q09 was 460,000 units versus 482,000 units in 3Q09. Although this was down 5% quarter-over-quarter and 52% year-over-year, smartphone sell-through was better than the consensus expectation of 450,000.

"The launch of Palm webOS and Palm Pre was a major milestone in Palm's transformation; we have now officially reentered the race," said Jon Rubinstein, Chairman and CEO. Palm noted that there have been over 1 million apps downloaded for the phone to date.

Palm did not provide specific guidance for fiscal 2010 or the first quarter. As Palm Pre was launched in June, we expect that its impact will be fully reflected in the first quarter of fiscal 2010. We expect $95.0 million in revenues and a loss of $0.28 per share on a pro forma basis for the first quarter of 2010.

Although the 4Q quarter was good, we do not expect PALM to become profitable in the next three to four years. It is also likely that the company will have a tough time delivering a strong top-line growth. Pam Pre has been well received by users, but Palm has struggled to keep up with demand for the new handset.

We believe Palm will continue to struggle as it competes against much larger competitors such as Apple Inc. (AAPL - Analyst Report), who launched the iPhone 3G S, Research in Motion (RIMM - Analyst Report), who plans to unveil the Tour, the newest Blackberry, and Nokia Corp. (NOK - Analyst Report).

These rivals are able to innovate faster and launch more attractive products. Additionally, price cuts from competitors will put pricing pressure on PALM. We reiterate our Sell rating on PALM shares, but raise our six-month price target to $8.00 from $5.00.

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