Palm (PALM)

Based in Milpitas, California, Palm, Inc. (PALM) designs, develops, and markets smartphones, handheld devices, and accessories. Approximately 80% of Palm's revenue comes from its smartphone line, branded the Treo. In September 2003, Palm shipped the Treo 600, a design it stuck with into 2008, including models Treo 650 in 2004, the Treo 700 in 2006. For international markets, Palm also offers the Treo 750, which is a world GSM phone, compatible with international GSM networks. Also internationally, Palm partnered with Vodaphone to launch the Treo 500v, which runs on the Windows Mobile platform.

In February 2008, Palm launched a low-end version of its smartphone, the Centro, priced at $99.99 at Sprint, and was later launched by AT&T for $79.99. The Centro is sold in more than 25 countries in North America, South America, Europe, and Asia Pacific. The company has already sold two million of Palm Centro since its launch. Palm also introduced an unlocked GSM version of the Centro. On the strength of its Centro, Palm sold more than one million units for the first time in the company's history during the first quarter of 2009.

In July 2008, Palm launched the Treo 800w, its first redesigned high-end smartphone since the Treo 600 launch in 2004. The Treo 800w features a look similar to the Centro and is much smaller and lighter than the 700 series Treo's. The 800w features the latest version of Windows Mobile 6.1, high-speed EvDO Rev A, Wi-Fi, GPS functionality and a 320 x 320 pixel display. Most recently, Palm introduced Treo Pro, a smartphone for its international business to deliver increased security, easier device management and access to information on the corporate network. Treo Pro will be available in September through Vodafone and O2 in Europe and through Telstra in Australia. It will also be available in an unlocked version in the United States, Europe and Asia Pacific for a suggested retail price of $549.

The market for handhelds or PDAs has declined over the past several years due largely to the cannibalization by the smartphone market and accounted for approximately 15% of revenue in fiscal 2008. During the first quarter of 2009, handheld units fell to 166,000 units, a 49% decline year-over-year, a trend which is likely to continue. Palm currently offers three major handhelds, including the T/X for the high-end business user, the Tungsten E2 for the mid-range user, and the Z22 aimed at the low-end of the market.

The mobile computing device market is intensely competitive and is characterized by rapid changes and complex technology. Although Palm was a pioneer in the smartphone market, its core product, the Treo, went for years without a major redesign since the launch of the Treo 600 in 2003. The Treo 650 was launched one year later with a number of upgrades, including Bluetooth, a high resolution screen, removable battery, more memory, and other improvements. However, improvements in later models were in much smaller increments. After going several years without a competitive high-end offering, we believe Palm has done significant damage to its brand, which it will take years to recover from if it ever does. In our opinion, RIM has built an insurmountable lead over Palm in the enterprise market and for the high-end consumer. We don't think Palm is likely to win over BlackBerry users with the 800w and corporate IT departments are unlikely to choose to support Palm based on one or two new products. We do believe that a new Treo will help Palm keep some existing users seeking to upgrade, but do not expect any share gains following the launch. Although the company is likely to see improved results with its latest offering, we would like to see a sustained stream of competitive product launches in order to become more optimistic about Palm.

Over the past year, Palm has focused on the low-end of the market with its Centro smartphone. Although successfully growing unit volume, the low selling price has dragged down revenues and margins. Given that Apple priced its new 3G iPhone at $199, Palm will likely have a hard time competing with its $99 Centro. The only bright point is Apple's exclusive contract with AT&T will let it avoid head-to-head competition at Sprint and Verizon for a few more years.

In an effort to remain competitive, Palm has been growing its investment in R&D and sales & marketing. R&D grew to 15.4% in fiscal 2008, up from 12.3% in 2007 and 8.6% in 2006. Meanwhile, sales & marketing expenses grew to 17.4% of revenue in 2008, up from 15.9% in 2007 and 13.0% in 2006. We believe this highlights the difficulty Palm is having as it competes against larger companies that can pour more resources into product development. Compared to Palm's $202.8 million investment in R&D, RIM spent $359.8 million in fiscal 2008 and Apple spent $811.0 million company-wide during the first nine months of fiscal 2008. Users are generally driven to make their purchase decisions based on product features, where Palm has fallen behind. The company burned $17.5 million of cash in operating activities in fiscal 2008 versus $168.2 million of cash generation from operations in fiscal 2007. In addition, Palm took a $32.2 million charge for auction-rate securities in fiscal 2008. As a result of continued losses, Palm's cash balance fell to $248.3 million as of August 31, 2008 from $627.1 million in the comparable year ago period.

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