Matthew F. Soccoli Short Fund Manager McIntire Investment Institute October 7, 2003

Transcription

1 Palm Incorporated Matthew F. Soccoli Short Fund Manager McIntire Investment Institute October 7, 2003

2 Company Mission Focus is on creating devices handheld devices that manage and access information rather than creating and editing documents Simple, Wearable, Expandable, Mobile

3 Brief History 1996 Palm Pilots introduced under U.S. Robotics December 1997 Palm Licenses O.S. May 1997 Purchased by 3Com March 2000 IPO / spin-off from 3Com January million units sold June 2003 Handspring Merger Announced

4 Current Corporate Structure Palm Inc. The Solutions Group Design Manufacturing Marketing PalmSource O.S Development Software Licenses

5 Revenues in Millions Q1 - FY Palm Solutions Group Palm Source 168.6

6 Proposed Corporate Structure

7 Product Line Tungsten Series Zire Series Palm Series

8 New Products Tungsten T3 Possible compatibility issues with SD Tungsten E Zire 21 (Post Merger) Handspring Treo

9 Investment Thesis Palm is not going out of business, But Palm is losing market share in a shrinking market Financial Difficulty in Producing a Profit Pending litigation can potentially cause serious financial problems Stock price has been inflated recently by news rather than fundamental data

10 Palm is Losing Market Share Pocket PC s that run Microsoft CE have emerged as a serious competitor 71% to 57.7% Market Share in US 40 % of Global Market New users are trying Microsoft Pocket PC s Old Palm users are switching to Pocket PC s Few are switching to Palms Operating Systems Used By Handhelds Other 20% Palm 50% Microsoft 30%

11 Pocket Pc s Total of smaller sales 43% HPQ 17% Palm 40% Recent price cuts entice switchover The wave of the future Most new users get Pocket PC s Traditional Windows feel - includes Word, Excel, Outlook Toshiba, HP, Compaq, Gateway, Dell, are a few Pocket PC manufacturers Gateway and Dell just got into the market and chose Pocket PC platform

12 Handheld Market is not growing Palm Software has been on over 30 million handhelds sold Many people purchase them and stop using them You can get most handhelds 1/3 of the price at Pawn Shops Many consider them as gadgets Palm executives avoided questions on handheld growth on Sep 18 th conference call, one did not comment, the other said it would be hard to determine if growth could be either single or possibly double digits

13 But suprisingly News came out last week that Palm expected to see growth in Corporate business This only makes up 10% of revenues. Just off this report, in two days the stock went up over 10%

14 Disruptive Technologies Can further weaken handheld market in the long term PDA/Cellphones Tablet PC s Blackberry reading devices

15 Financial Troubles Earlier in the year Palm introduced Tungsten and Zire series Palms Zire has been the best selling handheld of all time yet in FY03 Q4 and in FY04 Q1 both showed operating losses. How can they make a profit when they don t even after the best selling handheld was introduced The only recent profitable quarters have been during the holiday season, yet still they produced no operating cash flows

16 Not Seeking to Improve Margins Hardware 28.1%, Software 89.9% - CFO stated they are in the target range Handsprings margins have been shrinking and they are also losing money why are they buying companies that are losing money? Only positive cash flow is coming from issuing new stock and diluting their shareholder s shares

17 Pending Litigation Xerox v. Palm Over graffiti technology used in Palms. Xerox claims patent infringement on its Unistrokes technology. Has been going on since All but a few of the most recent models use this older graffiti technology(t3, C, E, Zire ) Numerous class action lawsuits Claiming deceiving marketing practices

18 Xerox v. Palm Timeline April 97 Started against 3com Jan 99 US Patent office granted request for examination of Unistrokes validity. They then confirmed the validity of all 16 claims. June 00 A judge narrowly interpreted the claims and found no infringement

19 Xerox v Palm (cont d) Oct 5, 2000 Court of Appeals reversed the finding and sent the case back to the lower court Dec 20, 2001 District Court granted our motions on infringement and for finding validity thus establishing liability Palm appealed, Xerox tried to move for a trial on damages and an injunction 50 Million dollar bond required to Xerox until trial Jan 2003 Palm decided to stop including graffiti in new operating systems

20 Xerox v Palm (cont d again) Feb 2003 Court of Appeals affirmed infringment on the patent and stated Xerox could get an injuction if the validity of the patent is favorably determined Remand procedure limited discovery continued through September Hearing argument scheduled for December 10 th, 2003

21 Why Palm will lose They have stopped using graffiti and created new graffiti software to use in their newest brands that they plan on keeping Palm separated Palm source from Solutions Group in January of 2002, after the ruling They have plans on how they will handle the financial burden, palm solutions group will take a one time charge and Palm Source will have to pay royalties. If they werent losing they wouldn t talk about this

22 Future Implications Injunction could be called on all Palms that carry Graffiti software by the time this happens there might not be any currently for sale that have it. Substantial Punitive Damages on the 20 million devices with palm software that have graffiti, and future royalties

23 Worst Case Scenario In Palms 10k for 2003, they stated Results of operations and financial condition would be significantly harmed and we may be rendered INSOLVENT Insolvent a firm that is unable to pay debts on the way to bankruptcy

24 Recent Run up in Stock Price

25 The Past 3 months

26 Investment Risks Handspring Merger can be successful synergies can be created but handspring is also losing money and has shrinking margins Palm could win Xerox case not very likely given actions they have taken to soften the financial blow. Even if they won it wouldn t necessarily affect the price up Success in the new line of products during the holiday season going into the season, august showed disappointing results Large cash position 8.40 per share

27 Valuation There should be a margin of safety in the value determined through research and the current market value Target Share Price (in process) WACC 18.8% - Financed primarily through Equity

28 Key Financials Share Price (as of this morning) Market Cap 689 M Shares outstanding 31.1 M Short Interest 9.40 % Cash 267 M Cash Per Share 8.40 FY 03 Ebitda -177 M FY 04 Predicted Loss 28.7 M Q1-04 Actual Loss 21.7 M

29 Research Overview Current News, Earnings Conference Calls Interviewing Palm customers, Pocket Pc Customers Interviewing sales associates at Circuit City, Staples, Office Depot Calling Xerox IR Department Reading Palm s 10k s and 10q s Also Xerox s

30 Timeline October 28, 2003 Shareholders vote on Handspring Acquisition and PalmSource Spin-off December 15-20, 2003 Palm Q2 FY04 earnings report on holiday sales quarter December 20, 2003 Hearing on Xerox v. Palm revisited by District Court

31 Recommendation Complete valuation to determine value Follow closely any news on Xerox litigation and Handspring merger Short Palm at a point where a margin of safety exists between the determined value and market price. Cover around a share price of 10 based on current information. Depending on the lawsuit w/ Xerox this could change very rapidly Palm will not go out of business anytime soon

32 Questions?