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Palm May Be Done With One Set of Problems, but Another Looms

Tish Williams

Handheld maker Palm (PALM - Cramer's Take - Stockpickr) has the potential to close a gloomy chapter in its recent history Thursday when it reports fiscal first-quarter earnings after the market closes. If Palm can put the demons of a six-month-long inventory correction, ensuing price war and bungled product launch of the m500 family of handhelds behind it, it will be rewarded with a new set of hideous monsters. Microsoft's (MSFT - Cramer's Take - Stockpickr) Pocket PC-based devices are gaining popularity, according to worldwide figures, consumer spending is questionable in the near term, and handhelds didn't sell very well when spending was steady. Hooray!

Palm started 2001 off with a stumble, going on a component binge that meant the company headed into an economically dismal climate with hundreds of millions in parts to clear from the shelves. In its fourth quarter, its revenue fell 65% sequentially from $471 million to $165 million, and the company took a staggering $436.5 million in charges to cover inventory, real estate and layoffs. CFO Judy Bruner promised to reduce channel inventory levels from 10 weeks to four to eight weeks and work to reduce the $107.8 million in inventory still on Palm's books. The company projected $200 million to $220 million in revenue for its fiscal first quarter, for a $60 million to $80 million operating loss. The Street anticipates an 8 cent-a-share loss, as reported by Multex.com.

The spring quarter was tough all around, as worldwide PDA shipments declined 21% sequentially to 2.8 million in the calendar second quarter, according to Gartner Dataquest. Palm slipped from having a 50.41% market share in the first quarter to a 32.1% slice in the second, while Compaq (CPQ - Cramer's Take - Stockpickr) (7.8% to 16.1%) and Hewlett-Packard (HWP - Cramer's Take - Stockpickr) (3.7% to 6.9%) headed in a positive direction, boosting Microsoft's Pocket PC presence.

In the U.S., of course, Palm is a crushing leader because of its strong sway over consumer buyers, but on its home turf, electronics lovers were increasingly reluctant to buy, as the total U.S. market went from 1.9 million units shipped in the first quarter to 1.27 million units in the second.

"Palm's stock price is certainly being discounted as if it's going to zero. There's a lot of disbelief in the platform, considering the success Microsoft and Pocket PC are having," says CIBC World Markets' Tom Sepenzis. He acknowledges that "from a personal perspective, when it's not a matter of using an enterprise application and the consumer is buying a product, Palm is favored over Pocket PC a zillion to one." But he sees Compaq and H-P dominating the enterprise market and making life more and more difficult for devices built to run the Palm operating system.

Palm and hardware competitor Handspring (HAND - Cramer's Take - Stockpickr) continued a debilitating price war throughout the quarter, reducing items to bargain-basement prices in the hopes of stimulating some purchasing. Last week Palm took the next step, reducing one of its newest handhelds, the Palm m500 from a $399 price tag to $329.

Margins should be hell for the quarter, but the Street will be less focused on the revenue Palm was able to eke out in what is understood to have been a rough summer than on its outlook for the fall quarter. Palm will seriously please the Street if it can straighten up its balance sheet, get its inventory and channel situations under control without using too much cash, and keep its revenue estimates at the $420 million to $440 million it predicted back in June during its fiscal fourth-quarter earnings report. Any hints on a timeline for the release of its upcoming BlackBerry pager competitor will also get investors enthused. Lehman Brothers analyst Joe To posits that Palm will have the device out to create a bigger splash at its PalmSource developers conference at the end of October.

The Street will not be surprised if Palm has to lower its sights for the fall quarter. But Palm needs to crawl out of the hole it dug in the first half of the year and defend itself against the new threats.