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When Palm (Nasdaq: PALM ) announced the Pre in January to considerable buzz, this former Treo user was glad that the company had halted its slow fade into irrelevance. But as Palm's latest earnings release shows, there can be a big difference between staying relevant and returning to your former glory.
The numbers for Palm's just-announced first quarter weren't bad. Revenues and earnings both came ahead of estimates, and though Palm didn't break out its Pre unit shipments, overall smartphone shipments of 823,000 suggest that they were decent. But alas, the second quarter looks like a completely different story. The revenue guidance range ($240 million to $270 million) given was a far cry from the $344 million estimated by analysts, and implies a healthy drop in Pre shipments during what's historically been a seasonally strong period.
In fairness to Palm, part of the sequential drop is probably due to inventory issues at Sprint (NYSE: S ) , the Pre's exclusive U.S. distributor. Sprint likely ordered too many Pre units in the first quarter, leading to the revenue beat, and now they're dialing back. But even if you combine the Q1 and Q2 numbers, you're looking at total revenues that are bound to disappoint many optimists. Not what you'd expect from a device that's supposed to be taking the market by storm.
The Pre is definitely a great product. Its innovative features, such as the previewing of applications with "activity cards" and the presence of a "gesture area", show that it's not a me-too device. Unfortunately, the smartphone market has now matured to the point where having an innovative product isn't enough to guarantee huge success. The enormous base of applications claimed by Apple's (Nasdaq: AAPL ) iPhones, and to a lesser extent by Research In Motion's (Nasdaq: RIMM ) Blackberrys, act as a strong competitive barrier. So does the brand power and customer loyalty possessed by Apple and Research In Motion. It also doesn't hurt that, unlike the Pre's webOS operating system, the operating systems behind their products have been widely accepted by corporate IT departments.
It's tough for any new smartphone product, no matter how innovative, to compete with all of that. Throw in ongoing competition from phones running Google's (Nasdaq: GOOG ) Android platform and Microsoft's (Nasdaq: MSFT ) Windows Mobile, and it gets even tougher. No wonder Palm and Sprint agreed to slash the subsidized price of the Pre from $199 to $149 recently. Being merely as cheap as the cheapest iPhone 3GS apparently wasn't enough.
And Palm's competitive struggles come at a time when the company needs every last Pre shipment for its financial health: Palm burned through $43 million in cash during in Q1, ending the quarter with only $212 million in cash and equivalents to offset its $393 million in debt. Competing head-on with Apple and Research In Motion off of a much smaller revenue base clearly takes its toll. From that perspective, the 11% dilution that will be caused by Palm's upcoming share sale seems necessary.
Looking beyond Q2, there are still some reasons for Palm bulls to be optimistic. Palm's exclusivity agreement with Sprint for the Pre is expected to end in early 2010, after which Verizon (NYSE: VZ ) , Sprint's bigger and competitively stronger rival, will start carrying the device. Telefonica SA will start offering the Pre this fall in several European markets, and the Pixi, a cheaper webOS device, will begin to be sold by Sprint. The second half of Palm's fiscal year is easily shaping up to be stronger than its first.
All things considered, Palm looks like it has a good future ahead of it as a niche smartphone vendor offering devices with an innovative software platform. That's a lot more than you could say about it a year ago. But with the company's cost structure being what it is, mere niche status might not be especially profitable. Or, at least, not profitable enough to fulfill the hopes that are now built into Palm's stock price.