Q2 Earnings Call: Palm Inc Retuns to Profitability

Posted By: Ryan Wednesday, December 18, 2002 5:25:35 PM

Palm, Inc. which consists of two operating units – Palm Solutions Group and PalmSource -- today reported revenues of $265 million for the second quarter of fiscal year 2003, ended Nov. 29, 2002, down 9 percent from the $291 million reported during the comparable quarter a year ago, and up 54 percent from the first quarter of fiscal 2003.

Pro forma net income in the second quarter -- which excludes the effects of amortization of intangible assets, separation costs, and restructuring charges -- totaled $5.7 million, or $0.19 per share. This compares to a pro forma net loss in the second quarter of fiscal 2002 of $36.6 million, or $1.29 per share, which excluded the effects of the reduction in special excess Inventory costs, amortization of intangible assets, and restructuring charges. Pro forma net loss in the first quarter of fiscal year 2003 was $36.4 million, or $1.26 per share, which excluded the effects of the change in the valuation allowance for deferred tax assets, amortization of intangible assets, separation costs, and restructuring charges. All earnings-per-share figures have been adjusted for the 1-for-20 reverse stock split effective Oct. 15, 2002.

Net income, as measured by generally accepted accounting principles (GAAP), for the second quarter of fiscal year 2003 was $3.5 million, or $0.12 per share, compared with a net loss of $25.2 million, or $0.89 per share, for the second quarter of fiscal year 2002 and a net loss of $258.7 million, or $8.93 per share for the first quarter of fiscal year 2003.

"Palm has continued to raise its level of execution in the quarter. Our return to profitability fulfills a commitment we made to our shareholders a year ago," said Eric Benhamou, Palm's chairman and chief executive officer, "and we view it as a major milestone."

He noted the following year-over-year improvements in the Palm Inc Earnings Call:

Pro forma gross margins of 32.8 percent vs. 20.5 percent;
Pro forma operating expenses of $84.3 million vs. $113.7 million;
Pro forma net income of $5.7 million vs. a net loss of $36.6 million
Inventory of $38.5 million vs. $78.6 million; and
Cash-to-cash cycle of 3 days vs. 14 days.

"A key driver behind our performance this quarter was the successful introduction and favorable market acceptance of two major products under our new subbrands Zire and Tungsten," Benhamou said. "Together with our new Palm OS 5 operating system, we're demonstrating how Palm's tradition of innovation continues and how our new product engine is executing with renewed vigor."

Solutions Group Update
During the quarter, the group responsible for the world-leading Palm branded handhelds, accessories and add-on hardware and software saw good progress and momentum on a number of fronts. The group announced:

Two new subbrands -- Zire(TM) for Palm's new family of consumer products and Tungsten(TM) for mobile professional and business solutions;
Three new products -- The Palm Zire handheld at $99 (suggested U.S. retail) is aimed at the untapped entry-level consumer market. The Palm Tungsten T handheld at $499 (suggested U.S. retail) is a premium product made for mobile professionals and businesses. Both have earned high marks in product reviews. In the first calendar quarter of 2003, a third product, Tungsten W -- aimed at data-centric wireless communication with voice capability -- will be available with service from leading carriers around the world; and
Commercial availability of Palm's Tungsten Mobile Information Management solution, Palm's behind-the-firewall, push email server software for businesses.

During the quarter, Palm Solutions shipped approximately 1.4 million Palm branded handhelds, bringing cumulative shipments to more than 20 million (see separate news release). Palm Solutions market share in U.S. retail, according to NPD, was approximately 60 percent for the week beginning Nov. 24, 2002, the last week of the fiscal quarter and the Thanksgiving holiday week that initiates the holiday buying season.

Earlier this month, Palm Solutions Group also announced that it will begin selling handheld computers in China during the first half of calendar 2003.

PalmSource Update
During the quarter, PalmSource, the Palm, Inc. subsidiary with responsibility for developing and licensing the Palm OS (R), the world's most popular software for handheld computers and smartphones, achieved the following:

Shipment of the first PalmSource ARM-native, proxyless Web browser to Palm OS licensees, providing unprecedented security, speed and graphics capability;
A $20 million equity investment from Sony Corp., resulting in about 6 percent ownership of PalmSource and Sony becoming the first outside investor in the subsidiary that is expected to be spun off from Palm Inc. in the first half of 2003; and
Announced Fossil, Inc., as a new licensee, which will make a Palm Powered device, the WRIST PDA, and also announced an extension to Samsung Electronics' license of Palm OS for its leading smartphones.

In addition, this month PalmSource announced major initiatives to enter the China market. They include the opening of its subsidiary in Hong Kong and plans for a representative office in Beijing; two new licensees who will develop Palm Powered products for the Asian and Chinese market, Legend Group Limited and Group Sense Limited; and a partnership with Portable Innovation Technology, the first Palm OS System Development Partner.

The quarter ended with more than 250,000 registered Palm OS developers. Those developers created about 16,000 commercially available software applications (http://www.palmgear.com) and thousands of proprietary applications, many used in enterprises. According to IDC's study in the United States, Palm Powered(TM) handhelds accounted for 79 percent of all personal digital assistants shipped as of the third quarter calendar 2002. Palm Powered smart phones lead the U.S. converged handheld space with a projected market share of 75 percent in 2002, IDC said. As of Nov. 30, 2002, the cumulative number of Palm Powered devices that have been shipped was more than 25 million.

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Hmmm.. good profit making strategy.

ska @ 12/18/2002 5:53:38 PM #

-Net income, as measured by generally accepted accounting principles (GAAP), for the second quarter of fiscal year 2003 was $3.5 million,

-A $20 million equity investment from Sony Corp.

------------------
wasn't there also that mysterious $50M investement a while back too?

RE: Hmmm.. good profit making strategy.

IanJD @ 12/18/2002 6:35:02 PM #

The $3.5M profit is for the hardware group, the $20M went to PalmSource, so the hardware group are actually making a real profit; looks like they did it by shifting a lot of inventory.

Sony aren't great philanthropists, either; they like having a stick to hit MS over the head with; $20M will be chump change to them.

I wonder if they split the $50M between the companies. :)

RE: Hmmm.. good profit making strategy.

ska @ 12/18/2002 7:52:54 PM #

I thought the report is for Palm Inc. the holding company of Palmsource and Palm solution groups?

RE: Hmmm.. good profit making strategy.

IanJD @ 12/18/2002 8:00:35 PM #

Oops, mea culpa. Would have thought they'd be releasing separate accounts by now.

$50 million

ginsberg @ 12/18/2002 8:27:46 PM #

Palm never publicly stated the source of the $50 million investment that was made about a year ago.

You can be fairly certain it was from Texas Instruments - sort of a gesture of appreciation for Palm choosing to use TI OMAP processors in Palm's OS 5 devices, instead of Intel or Motorola ARM-based processors.

RE: Hmmm.. good profit making strategy.

rojo @ 12/18/2002 8:50:49 PM #

I hope you are not suggesting the $20 and $50 million investments made the income seem higher than it should.
Although, my accounting class in college was 10 years ago, but an income statement shows the change in Owner's Equity due to operating the business over a period of time and just lists the companies revenues less the expenses. Therefore the investments of sony and other would not affect it.

RE: Hmmm.. good profit making strategy.

EdH @ 12/19/2002 9:21:04 AM #

Note that the in the $3.5M profit is over $4M of interest income. Take about $1M of tax expense out and they made $389K from operations, the rest was interest on their cash balance.

What is impressive to me is that on declining sales and volumes from the same quarter last year, they increased margins quite a bit. They have made significant cost reductions, and given the release of the Zire, Tungsten T, forthcoming Tungsten W and OS5, they seem to be spending what is necessary in R&D.

Man, Yankowski really hosed this companies balance sheet.

RE: Hmmm.. good profit making strategy.

Gekko @ 12/19/2002 10:50:16 AM #

>"they made $389K from operations"

Sheesh. I bet MSFT spent more than that on toilet paper for their employees this morning.

RE: Gekko / Toilet Paper

LgLator @ 12/19/2002 11:15:07 AM #

" I bet MSFT spent more than that on toilet paper for their employees this morning."

Gekko, my dear fellow, I couldn't agree more. These Redmond chappies must surely require vast quantities of toilet paper. Fortunately for them, the Windows revenue stream allows them to buy only the softest tissue.

http://www.theregister.co.uk/content/archive/28128.html

RE: Hmmm.. good profit making strategy.

razzle @ 12/22/2002 5:44:46 AM #

Yeah, well its real easy to make a profit when you cheat owners of M130. Like me and many thousands who live in Australia. You see everybody else in the world got compensated except us down under. We got jack, zip, nada from Palm Inc, ooh except a M130 that doesnt display 65000 colors. Who says crime does'nt pay??

Zire and Tungsten T implications

hotpaw4 @ 12/18/2002 11:32:57 PM #

according to the Reuters story:
> Palm's fiscal second quarter, which ended Nov. 29
...
> Palm shipped some 1.4 million units
...
> Together, the models [Zire & Tungsten] represented some 44 percent of the products sold to retailers in the quarter, Palm said.

But the Zire was only introduced at the beginning of October and the Tungsten T's at the very end. So this 44% combined share of PalmSG shipments implies that they sold over 600 thousand Zires and Tungsten T's in only 1 to 2 months, and *before* the start of the holiday shopping season.

Even if quarterly sales decline around 10% as per their forcasts, this implies that Palm could ship well over a million of units the new models before the end of January.

RE: Zire and Tungsten T implications

Admin @ 12/19/2002 11:23:15 AM #

Another interesting fact I took from the call was that Zire models are in limited supply in some retailers (strong demand) and that based on initial Zire registrations, 90% of Zire buyers are new to PDA's.

-Ryan
webmaster@palminfocenter.com

RE: Zire and Tungsten T implications

EdH @ 12/19/2002 2:55:52 PM #

90%? I want to meet that other 10% that "upgraded" to a Zire. ;-)

RE: Zire and Tungsten T implications

rojo @ 12/19/2002 3:46:48 PM #

Well, I guess if there are still Pilot 1000 & 5000 users out there it would be an upgrade :)

RE: Zire and Tungsten T implications

ginsberg @ 12/20/2002 10:20:56 PM #

Palm's success this quarter was based largely on the confluence of three factors, none of which are likely to be repeated anytime soon.
1) New Zire and Tungsten product lines introduced just before Holiday season allowed huge sell-in.
2) R&D spending has been cut by 27% ($10 million) from the same quarter of a year ago.
3) The factory of a component supplier burned down a few years ago and Palm received $5 million in insurance for lost business.

As such, it seems likely that Palm will be in the RED again in the next few quarters. By cutting R&D, you see the results in the unipressive Tungsten W, which at $550, is going nowhere. Tungsten T needs a price cut to $399 soon because it just is not worth $499 and Palm's share of the enterprise market is slipping.

Palm is now the same size it was in 1999.