Palm: Pondering the future and the vicious cycle ahead

Palm's third quarter was a disaster, the fourth quarter outlook was worse, and the company is stuck with an inventory glut as Verizon Wireless customers went with the BlackBerry Tour and Motorola Droid over the Pre Plus and Pixi Plus. The big question: Where does Palm go from here?

• Sales in the third quarter were weak. So weak that Palm's sell through in the third quarter was 408,000 units vs. a sell-in of 960,000 units. That means Palm seriously overestimated demand for its devices.
• Fourth quarter revenue will be about $150 million, or half of the Wall Street's official estimate. Piper Jaffray was expecting revenue of $203 million in the fourth quarter though.
• Now Palm will have to discount, take charges for inventory and suffer a gross margin hit to lower the inventory of Pre and Pixi devices.

That's a lot of "underperformance."

Piper Jaffray analyst Michael Walkley said in a research note following Palm's earnings:

We estimate webOS channel inventory of roughly 800,000 units, as sell-through remains below company expectations. In fact, Palm accrued a $45 million charge for inventory purchase commitments which exceeds forecasted demand for Palm products.

In the big picture, it appears that Palm miscalculated with the staying power of the Pre and Pixi. The Pre, a savior device in 2009 for Palm, has lost its appeal. Palm has a fine operating system with the webOS, but needs to ramp up the device flow. However, Palm doesn't seem able to keep up with the likes of HTC and Motorola, two companies that throw devices at you almost monthly.

Wall Street crushed Palm shares pushing them down more than 20 percent. Palm has given up all of its gains from 2009.

So now what?

• Palm is unlikely to land AT&T as a big distributor given the weak sales at Sprint and Verizon.
• Palm will have to spend more money on marketing.
• Profits and Palm's cash position take a hit.
• Developers lose faith in the webOS.
• Palm becomes a zombie company as it doesn't want to sell itself to a rival at a discount yet loses more share to Android, Windows Phone 7, BlackBerry, Symbian and Apple devices. Palm CEO Jon Rubinstein doused acquisition speculation.

Also: Review: Verizon Palm Pre Plus can't win back this Palm fan yet · Palm Pre Plus shines in productivity, mobile WiFi · Palm's next steps: Distribution outweighs product buzz (for now) · CES 2010: Palm Pre Plus, Pixi Plus arrive on Verizon with Wi-Fi hotspot ability, 3D gaming in tow

He said on a conference call:

There's all kinds of speculation out there that we are going to get bought, that we are not going to get bought. We're not going to comment on any of those. Obviously, we are a public company. And if there's a reasonable proposal, of course the Board has to consider it.

But, that being said, our focus since the day I arrived here, and that's almost three years ago now, is to build a great company with a great mobile platform and great products. And that has been our focus.

As Deutsche Bank analyst Jonathan Goldberg said in a research note:

A poor showing at Sprint and Verizon, has doused interest from other carriers including AT&T and Vodafone. The risk for Palm is that bad news begets more bad news and that potential customers lose interest.

Bottom line for Palm is that it has to improve sell-through at Verizon and Sprint. Rubinstein said the company is focusing on dealer training and incentives to move sales. Rubinstein said:

Since the point-of-sale experience is arguably the most influential part of the smartphone purchase cycle and critical to driving sales, we launched an intensive Palm Brand Ambassador program designed to improve in-store knowledge and endorsement of Palm products across the US. Palm representatives have been visiting and revisiting hundreds of stores a day and providing sales reps with tools and techniques to help them better sell our products. We'll continue this work until we are satisfied that customers who walk into a store can easily understand the value proposition of a Palm product.

However, Macquarie Research analyst Phil Cusick noted that there is no evidence that those efforts will help matters.

Is it all gloom and doom?

To successfully compete against larger players, our device quality and performance has to be of the highest caliber, and the functionality we bring to market has to be groundbreaking. With this in mind, we are moving forward at full speed to continually improve product quality and bring new innovation to market. While some competitors are still working to bring mobile platforms to market for the first time this year, webOS continues to mature. We are leveraging our unique over-the-air update capability to continue to optimize performance, improve battery life and ad pioneering new features at a rapid pace even after our products are in customers' hands.

We are gaining more and more ground on the technical front, even as we do the tactical work necessary to amplify sell-through. We have a dedicated team that is driven to succeed, and we think the plans we have in place to enhance the performance and quality of our products, improve our marketing and point-of-sale execution and evolve and differentiate the Palm experience in breakthrough ways will result in improved performance.

Is that enough? Probably not. Palm could turn it around with new products. Goldberg said:

We think the company has new products coming. The developer ecosystem is mixed, but stable, with the app catalog still growing. If the company can meaningfully reduce its cash burn, they may be able to eke along in survival mode long enough to improve their trajectory. However, this will be a hard path to follow, with a low likelihood of success.

Rubinstein declined to comment on Palm's roadmap.

The problem: We've seen this movie before. In 2008, Palm was a mess. It spent a year in survival mode, created the Pre and looked like a player again. In other words, Palm hit a home run in the bottom of the ninth with two outs. Now it has a similar situation---albeit with a better operating system. Can lightning realistically strike twice?

Also: Smartphone Evolution 2.0: Who's the biggest loser?