By Jon Fortt
October 2, 2007

Palm (PALM) reported disappointing quarterly results on Monday, and it came as no surprise – the smartphone maker is getting squeezed every which way.

On the low end, smartphones from Samsung and Motorola (MOT) are nibbling away market share. On the high end, Apple’s (AAPL) iPhone has popular buzz and Research in Motion (RIMM) is winning over mobile workers. ABI Research says RIM captured 44 percent of the North American smartphone market this spring, up from 33 percent a year ago. The gains came at the expense of Palm, which slid from 33 percent to 24 percent.

That’s the context for the 1 cent per share, $841,000 loss Palm reported, its first in four years. Unfortunately for Palm investors, it probably won’t be the last. Executives told Wall Street to expect another loss this quarter between 1 and 3 cents per share, on revenues between $370 million and $380 million.

So how can the company turn things around?

The main thing Palm needs to do is finish overhauling its phone software. Though Palm sells phones that run Microsoft’s (MSFT) Windows Mobile software, Palm’s future depends on its ability to ship a new operating system that can smoothly run several programs at once, including software for playing music and video. Executives have said they’re building an OS based on the open-source Linux kernel.

The trouble is, it’s taking an awfully long time. Palm announced a year ago that it would be rolling out a new operating system, and the company has yet to release even a test version to developers. In fact, the company last month canceled its ill-conceived Foleo laptop project to focus its efforts on phone software, a sign that Palm programmers still have plenty of heavy lifting to do.

Software is so important because it’s the main thing that differentiates one phone from another. RIM’s BlackBerry is known for its easy-to-use e-mail delivery software, and Apple’s iPhone is known for its touch-controlled version of Mac OS X. As other software companies make useful new programs that work on top of the basic BlackBerry and iPhone software, they enhance the value of the devices, and increase the chance that consumers and businesses will pay a premium for them.

That’s why Palm’s introduction last week of the $99 Centro smartphone is a mixed blessing. On one hand, there’s a chance that the slightly smaller, cheaper phone will stanch the company’s market share bleeding. On the other, Palm is conditioning buyers to expect $100 phones, so this might make it more difficult for the company to sell more profitable high-end phones in the future – unless, that is, it offers a great new operating system.

In other words, it’s crunch time for Palm. And its future is really riding on software.

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