; 3 STARS, or hold; recent price: $29) reported fourth-quarter (ended May 31) earnings per share of 32 cents, vs. a 28-cent loss a year ago (both on a non-GAAP basis), and substantially beat S&P and Wall Street estimates. The upside came partly from higher revenue than the company had projected ($267 million, vs. management's guidance of $255 million). PalmOne said its new handhelds helped it gain share in a declining market, and its Treo smart phone continued to witness strong demand.
PalmOne says based on industry data, it holds about 60% of the U.S. market and 40% of the worldwide market in handhelds. A better-than-expected gross margin of 30.5% (more than 100 basis points above our forecast) and lower expenses provided the bulk of the upside in earnings, in our estimation.
One of the more important aspects of PalmOne's earnings conference call, in our opinion, was the revised guidance. Management expects fiscal-year 2005 revenues to be in the range of $1.21 billion to $1.29 billion, up $158 million from its prior guidance. We think the most compelling pieces of this are the growth seen for the Treo smart phone and the company's improved ability to meet demand (PalmOne had been constrained by lack of supply).
SOLID SEASON. Indeed, PalmOne expects Treo shipments to reach 250,000 units in its fiscal first quarter (ending Aug. 31), up from 151,000 in the quarter ended May 31, and it sees sequential growth in units in every quarter of fiscal year 2005.
PalmOne had many other positives, in our view, including accelerating cash flow in the fourth quarter and guidance for net margins to reach 6.5% to 7.5% (non-GAAP) for fiscal 2005, vs. previous guidance of 2% to 5%.
Based on the new guidance, we raised our fiscal 2005 EPS estimate to $1.31, from 59 cents. However, we kept our hold opinion on the shares. We believe the stock price advanced sharply after the quarterly report, not only because of the upside surprise and positive guidance but because the May quarter, which includes the "Dads & Grads" season, had typically been a tough one in terms of management execution in the past. We think the fact that PalmOne beat estimates for the quarter and lifted guidance led to a relief rally in the shares, as investors felt the outfit turned the corner in profitability and came to believe a history of inconsistent execution was behind the company.
PRESSURE POINTS. However, we believe competition looms large in the handheld and smart-phone markets, and that considerable risk exists in our investment opinion, earnings projections, and the valuation of the shares, as significant challenges remain. As we noted above, the handheld market -- which accounted for 72% of PalmOne's revenues in the fourth quarter and is expected to reach about 50% of total sales by the end of fiscal 2005, according to the company -- is declining.
PalmOne is betting that growth will come as it continues to innovate in its handheld product line and attract new users. This puts significant pressure on PalmOne to produce the right device at the right time and execute well in product transitions (see BW Online, 6/22/04, "For the Palms, a Firmer Grip?").
Furthermore, we think the Treo faces stiff competition from products such the phone-enabled BlackBerry from Research in Motion (RIMM
; 3 STARS; $60).
At a price-to-sales ratio of 1.6 times, PalmOne shares trade at the high end of the range of its peers. As mentioned above, looming competition presents considerable risks, in our opinion, and we advise investors to hold, but not add to, positions at these levels. Analyst Graham-Hackett follows computer hardware stocks for Standard & Poor's Equity Research Services