Back in February, activist investor Mark Nelson advisedPalm's (Nasdaq: PALM ) management to sell while premium prices were still available. The problem, Nelson wrote, is that Palm competes in a highly competitive market with few, if any, meaningful competitive advantages.
At the time, I thought Nelson was simply an overly concerned investor doing Foolish duty. Today, I wonder if he isn't prescient. Shares of Palm are trading off more than 11%, thanks to concerns over poor first-quarter guidance. If only that were the sole problem.
Of course, all looks well at first blush. Fiscal 2006 sales of Palm's popular Treo smartphone ballooned to $1.1 billion, up 85%. And full-year consolidated sales grew 24%, to $1.58 billion. Non-GAAP per-share earnings over the same period rose by 10%, to $0.85 per stub.
The quarter also looked good. Gross margin improved by nearly 7% and per-share earnings were up 52%, after accounting for a prior-year tax benefit of $278 million. Revenue also improved by double-digits, up 20%.
So, what's the problem? Palm did miserably in terms of real cash earnings in Q4. Huge increases in accounts receivable and inventory turned cash flow negative for the first time since 2003. That troubles me because Palm doesn't typically build up working capital in Q4. I checked earnings statements for both last year and fiscal 2004, and in neither case did it look anything like what transpired at the end of fiscal '06. Indeed, while inventory saw a triple-digit increase last year, accounts receivable growth trailed sales growth by 9%. And during 2004, inventory declined year over year, while A/R kept pace with sales growth. Now, contrast that with Q4 2006, in which A/R was up nearly 46% while inventory ballooned by 63%.
Certainly, I could be reading too much into the financials. It's just that I prefer to buy only when I understand the impetus for unusual fluctuations. So far, Palm hasn't offered a thorough explanation, and I'll be fooled (small-f) if I can think of a reasonable one. To be fair, management mentioned briefly in the conference call that A/R rose because of new Treo shipments. The inventory situation, however, was left murky, with improvement expected to come in 2007.
For me, that means it's time to consider a darker possibility -- that incursions from Motorola (NYSE: MOT ) , Nokia (NYSE: NOK ) , and a resurgent Research In Motion (Nasdaq: RIMM ) are having more impact than many of us, including yours truly, had thought possible. Except, that is, for Nelson. Hmmmmmm. Maybe it is time to sell, after all.
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Fool contributorTim Beyerssays he'll use his Treo 600 till it breaks. Tim owns shares of Nokia. You can find out which other stocks he owns by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.