Analyst: Palm may burn half its cash this quarter

Morgan Stanley analyst Gillian Munson said in a research note that the $200 million in inventory expected to accumulate this quarter and a projected $80 million to $85 million operating loss threaten to halve the company's $595 million in unrestricted cash.

Munson projects Palm could burn through even more money this year--with Palm's readily available cash bottoming out at about $200 million--before its fortunes improve.

"Charges and bigger losses could take that number dangerously lower," Munson warned. "While Palm has a lead in the market?any more issues like this could take away its ability to live up to the opportunity" of the growing handheld market.

The Santa Clara, Calif.-based company also has $238 million in restricted cash serving as collateral for the company's planned new headquarters, although Palm executives say the company is looking for ways to gain access to some of that money.

Palm warned in its quarterly earnings conference call last month that it overestimated demand for its devices. As a result, Palm said, it expects to post a loss in the current quarter and could see its inventory swell by $200 million.

In an interview Monday, Palm Chief Financial Officer Judy Bruner said that Munson's calculations of Palm's burn rate for cash are based on information the company announced during the call last month. But Bruner noted that other factors also affect cash flow and said Palm is doing what it can to lessen the blow of its current problems.

"We're working hard to minimize the cash impact," Bruner said.

Palm's warning last month sent the once high-flying stock rapidly back to earth. Palm's shares have fallen by more than half since then, trading as low as $5.75. However, investors were apparently unfazed by Munson's report; Palm's shares closed up 39 cents, or 6 percent, to $6.48.

The company also said last month it will cut 10 to 15 percent of its staff and will delay its planned move to a new headquarters in San Jose, Calif. Bruner added that the company is looking at ways to gain access to the restricted cash that has secured the financing for the campus.

"That cash is there. And if we sell part or all of that land, then we can access that cash collateral," Bruner said. Among the options are selling part of the land and building on the remaining land, selling the entire property or setting up a more complicated lease under which the property would be sold to another party and then leased back by Palm.

Munson's report comes as Palm prepares to meet with financial analysts Wednesday in Santa Clara.

Although Palm is working hard to cut through its inventory, the backlog comes just as Palm is introducing two new high-end models. The m500 and m505 have gotten high marks, but analysts have criticized the fact that Palm leaked details of the units months in advance of their release. Some analysts say the early announcement is a factor in the slow demand for existing Palm models.

Munson noted that two-thirds of Palm's inventory is in already-manufactured handhelds and that many of the components in inventory are customized for a particular product.

"This is a very serious situation, the kind that can get technology companies way off course," Munson said.

However, CIBC World Markets analyst Thomas Sepenzis said in an interview Monday that he doesn't see Palm's cash position as the company's biggest issue.

"I'm not overly concerned with longevity of this company with the cash they have," Sepenzis said. "Certainly they'll lose some cash over the next couple quarters with the inventory" and the operating losses.

Sepenzis said he is more concerned that Palm has characterized its current woes as an economic issue rather than an issue of a poorly managed product transition. Sepenzis will keep an eye on Palm's plans to make sure the company does not repeat its product transition problem later this year when it introduces a new wireless handheld. That unit, expected later this year, will be similar in form to the m500 and m505 but will add always-on e-mail access with notification--features that have been popular with the BlackBerry pager from rival Research in Motion.

Munson's report traces Palm's current problems back to decisions that Palm executives made in November. At the time, Palm was scrambling to get enough components to build its products. That prompted the company to sign a number of long-term contracts that guaranteed supply, but also left Palm obligated to purchase a large number of components customized for its handhelds.

The deal made sense at the time when Palm was struggling to meet demand and the market was seen as rapidly growing. Strong holiday sales seemed to reaffirm the company's decision, Munson said.

Although sales began to dip in January, that was seen as normal for the post-holiday season. February brought mixed results, Munson said. The first three weeks were quite strong, but a dramatic decline hit in the last week of the month and continued into March.

"The demand falloff happened just as the inventory Palm had committed to started to roll through its subcontractors' factories," Munson said in her report.

Palm is faced with a tough test as it tries to deal with its current woes, while maintaining its dominance in the handheld market, where its operating system is still the overwhelming leader with roughly 90 percent of the market.

Although corporate spending on technology has slowed markedly, winning that market is seen as key to the overall handheld business. To that end, Palm announced a deal last month to acquire mobile data provider Extended Systems. Although the value of the acquisition to Extended shareholders has dropped dramatically along with Palm's stock, analysts say the deal will likely go through, given that insiders who back the deal control a large chunk of the company's stock.

Although the current problems are serious, Sepenzis said, Palm has the opportunity to be in good shape when corporate spending rebounds--if the handheld maker can complete the Extended Systems deal and can release the new wireless handheld on schedule.