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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
------------------------
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 2, 2000 COMMISSION FILE NO. 0-29597
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________.
PALM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3150688
(State or other jurisdiction (I.R.S. Employer
of Identification No.)
incorporation or organization)
5470 GREAT AMERICA PARKWAY
SANTA CLARA, CALIFORNIA 95052
(Address of principal (Zip Code)
executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (408) 326-9000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001
PAR VALUE.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
The aggregate market value of the Registrant's Common Stock held by
non-affiliates, based upon the closing price of the Common Stock on July 31,
2000, as reported by the NASDAQ National Market, was approximately
$22,000,000,000. Shares of Common Stock held by each executive officer and
director and by each person who owns 5% or more of the outstanding Common Stock,
based on Schedule 13G filings, have been excluded since such persons may be
deemed affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of July 31, 2000, 564,992,928 shares of the Registrant's Common Stock
were outstanding.
The Registrant's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on November 2, 2000 is incorporated by reference in
Part III of this Form 10-K to the extent stated herein.
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PALM, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 2, 2000
TABLE OF CONTENTS
PAGE
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PART I
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Item 1. Business.................................................... 3
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 17
Executive Officers.......................................... 17
PART II
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Item 5. Market for Common Stock and Related Stockholder Matters..... 19
Item 6. Selected Financial Data..................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 20
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 40
Item 8. Financial Statements and Supplementary Data................. 42
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 68
PART III
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Item 10. Directors and Executive Officers............................ 68
Item 11. Executive Compensation...................................... 68
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 68
Item 13. Certain Relationships and Related Transactions.............. 68
PART IV
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Item 14. Exhibits, Financial Statement Schedule, and Reports on Form
8-K....................................................... 69
Exhibit Index............................................... 69
Signatures.................................................. 71
Schedule II--Valuation and Qualifying Accounts.............. 72
As used in this report on Form 10-K, unless the context otherwise requires,
the terms "we," "us," or "the Company" and "Palm" refer to Palm, Inc., a
Delaware corporation.
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This Annual Report on Form 10-K contains forward-looking statements within
the meaning of the federal securities laws. These statements include those
concerning the following: the intention to continue pursuing licensing
opportunities for the Palm platform, the intention to support web-enabling
technologies such as Wireless Applications Protocol, the plan to expand the
geographic coverage of the Palm.Net wireless access service, the availability of
the Palm Mobile Internet Kit before the end of calendar year 2000, the plan to
pursue licensing opportunities for the Palm platform, the intention to continue
to expand the company's international business, the intention to make strategic
investments to enhance the content and applications available to all of our
handheld devices, the intention to introduce new products and designs, the
intention to continue to make significant investments in research and
development, the plan to integrate Secure Digital card expansion technology into
our products beginning in the first half of calendar year 2001, our expectation
that an increasing portion of our revenues will come from Palm platform
licensing and Internet services and solutions, our expectation that
international revenues will continue to increase as a percentage of total
revenues, our belief that we will continue to experience strong growth in unit
shipments of our Palm handheld devices, our expectation of future gross margins,
our expectation that we will make significant strategic investments throughout
fiscal year 2001, our anticipation for future operating margins and interest
income, and our belief that our cash and cash equivalents will be sufficient to
satisfy our anticipated cash requirements for at least the next twelve months.
These statements are subject to risks and uncertainties that could cause actual
results and events to differ materially.
For a detailed discussion of these risks and uncertainties, see the
"Company--Specific Trends and Risks" section of this Form 10-K. Palm, Inc.
undertakes no obligation to update forward-looking statements to reflect events
or circumstances occurring after the date of this Form 10-K.
HotSync and Palm OS are registered trademarks and Palm, Palm.Net and Palm
Powered are trademarks of Palm, Inc.
PART I
ITEM 1. BUSINESS
GENERAL
On September 13, 1999, 3Com Corporation announced its plan to create an
independent publicly traded company, Palm, Inc., comprised of 3Com's handheld
computing business. Following the completion of Palm's initial public offering
and private placements in March 2000, 3Com owned approximately 94% of Palm's
outstanding common stock. 3Com distributed all of the shares of Palm common
stock it owned to 3Com stockholders on July 27, 2000. 3Com and Palm have entered
into various agreements related to certain ongoing relationships between the two
companies. More information about the separation and our ongoing relationships
with 3Com is contained in Items 7 and 8 of this report on Form 10-K.
We are the leading global provider of handheld computing devices. We
develop, design and market our Palm-branded handheld devices, which currently
include our Palm-TM- III, Palm V and Internet-enabled Palm VII product families,
as well as our recently announced m100 entry level product. According to
International Data Corporation, in 1999 we had a 66% share of the worldwide
personal companion handheld device market, which International Data Corporation
defines as small, pocket-sized devices that feature pen-based input and allow
users to automatically copy and conform, or synchronize, information between the
device and a personal computer. We believe our emphasis on simplicity, elegance
and ease of use and our focus on consumer needs have contributed to our success
to date. Our devices have also won numerous awards, including Business Week's
"Design of the Decade--Gold Award" and PC Computing's Most Valuable Product
award for "Best Pocket PC" in 1999. We intend to build on our global leadership
in handheld computing devices through continued innovation and focus on
addressing customer needs.
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The Palm OS-Registered Trademark- operating system and related software,
which we refer to as our Palm platform, have been the cornerstone of our success
in the handheld device market. The Palm platform combines the distinctive look,
feel and ease of use of our Palm OS operating system with
HotSync-Registered Trademark- technology that enables users to synchronize
information between a Palm device and a personal computer, and includes
pen-based input technology as well as personal information management
applications such as a datebook and an address book. Our Palm VII product also
includes web-clipping software that allows Internet content providers and users
to wirelessly send and receive information via the Internet in a format
optimized for handheld devices. In addition to including the Palm platform in
our Palm-branded devices, we license the Palm platform to manufacturers of
information appliances, which we define as handheld devices that enable users to
access and manage information. Companies including Handspring, Nokia, QUALCOMM,
Symbol, Sony and TRG have licensed the Palm platform. We intend to continue to
selectively pursue licensing opportunities for our Palm platform in the rapidly
converging markets of handheld computing devices, information appliances, mobile
phones and handheld entertainment devices. According to International Data
Corporation, in 1999 devices powered by the Palm OS operating system had over
75% share of the worldwide personal companion device market.
We have also established a wireless Internet access service, Palm.Net-TM-,
which supports the Palm VII handheld and generates revenue from monthly
subscription fees. Palm.Net subscribers can obtain wireless access to
information such as real-time stock quotes, news headlines, airline flight
schedules and on-line shopping. In addition, our Palm.Net service enables mobile
users to access an increasing array of enterprise data and applications. We
recently announced the Palm Mobile Internet Kit, which will enable Palm handheld
users to access Palm.Net and other Internet content using their mobile phones.
We have also developed our Palm.com website, which is emerging as an important
destination site for our customers, users and developer community. As part of
our Internet strategy, we are expanding our Internet wireless and wireline
destination sites to provide new web-clipping applications, provide web-based
personal information management applications and facilitate e-commerce. In
addition, we intend to support other web-enabling technologies, such as Wireless
Applications Protocol ("WAP"), in order to meet emerging customer requirements.
We believe that the continued adoption of handheld devices as well as our
strategic focus on Palm platform licensing and Internet services present us with
significant growth opportunities. We will continue our efforts to identify and
respond to customer needs as handheld computing devices become more
sophisticated, reach a broader customer base and become an increasingly
important means of Internet access on a global basis.
As of June 2, 2000 we had sold over 7 million Palm devices worldwide, and
more than 77,000 third party developers had registered to create applications
based on the Palm platform. Our revenues have increased from approximately
$1 million in fiscal 1995 to approximately $1.06 billion in fiscal 2000. We
outsource the manufacturing of all of our devices to Manufacturers' Services
Limited and Flextronics.
INDUSTRY OVERVIEW
As professionals have become increasingly mobile, often spending long
periods of time away from traditional work settings, they have sought out tools
to access and manage critical personal and professional information.
Traditionally, these professionals used paper-based organizers and, later,
stand-alone electronic pocket organizers or portable computers to accomplish
these tasks. These early tools met with mixed success and often were slow,
large, expensive and difficult to use and offered limited functionality.
The introduction of Palm's first device ushered in a new generation of
handheld devices that offered users a combination of simplicity and
functionality. Innovations in design, synchronization technology, user
interface, programmability, functionality and battery power management
transformed
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these devices into convenient productivity tools. These enhancements
significantly accelerated user demand. While we intend to continue to
participate in the market for handheld devices, we also plan to enter the
markets for smartphones and other information appliances, either through our own
devices, or licensing agreements with other manufacturers. We believe that
continued innovation, increased wireless data connectivity and the emergence of
new usage patterns driven by Internet content and enterprise data will drive
further market growth.
We believe that continued technological innovations that address end-user
needs are an important driver of industry growth. Technological advances have
led to significant reductions in size and weight, as well as improvements in
battery life, reliability and storage capacity, of handheld devices. In the
future, we believe that handheld devices will continue to evolve to include
integrated voice, video and multimedia capabilities. Third party developers, who
create software applications and complementary hardware peripherals and
accessories, supplement manufacturers' innovations and allow users to customize
and enhance their devices. These feature enhancements and performance
improvements, driven by both manufacturers and third party developers, continue
to attract new users and encourage device upgrades. The emergence of
technologies enabling wireless access to the Internet and enterprise data is
again transforming the handheld device industry. The Internet has become an
important way for consumers and professionals to access personal and business
information, download new applications and access new services. We believe that
wireless access to Internet content and enterprise data will make handheld
computing devices increasingly valuable to users. This value proposition is
driving a variety of handheld information appliance makers to add Internet
connectivity features to products such as mobile phones.
As handheld devices are adopted in greater numbers and handheld device
applications become increasingly integrated into other handheld information
appliances, an opportunity exists for operating system developers to extend
their platforms for use on other handheld devices. We believe that the extension
of an operating system to a diverse set of handheld information appliances,
including mobile phones, increases the utility of all devices that use the
operating system and expands the scope and potential market for both operating
system developers and device manufacturers.
BUSINESS SUMMARY
In 1996, we introduced our first handheld device product, based on our
innovative Palm platform, and quickly established global leadership in the
handheld device industry. Our revenues have grown from approximately $1 million
in fiscal 1995 to $1.06 billion in fiscal 2000. Our international business
accounted for 35% of revenues in fiscal 2000. We believe that our users
associate the Palm brand with high-quality products that offer a combination of
portability, connectivity, simplicity and style. By capitalizing on the
popularity of our handheld devices in domestic and international markets and on
our Palm platform, we believe we can become a leader in the emerging market for
Internet services and applications.
HANDHELD DEVICES. We currently have three families of handheld devices, the
Palm III, Palm V and Palm VII product families, each of which is based on the
Palm platform. In addition, we recently introduced our new m100 product, an
entry level device which is targeted to appeal to a broad cross section of
consumers. We develop our handheld devices by focusing on customer needs. While
all Palm devices are designed to offer a combination of utility, simplicity,
wearability and mobility, we have further differentiated individual products to
appeal to specific market segments. For example, to appeal to users who place
the most value on wearability, we introduced the Palm V product, which combines
the traditional functionality of our products with a sleek, compact and
lightweight form factor. Similarly, to appeal to mobile professionals and
enterprise customers that want to provide their employees with convenient remote
access to enterprise data, we introduced the Palm VII product, which combines
connectivity and mobility. Customers buying our devices receive a Palm handheld
device, a cradle to connect the device to a personal computer and personal
information management
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and synchronization software which runs on a personal computer and serves as a
conduit between the device and other personal computer applications. We also
market and resell peripherals and accessories such as portable keyboards,
modems, leather cases, flip covers and other fashion accessories for our
products.
PALM PLATFORM. The Palm platform combines the distinctive look, feel and
ease of use of our Palm OS operating system with our HotSync synchronization
technology, pen-based input technology, personal information management
applications such as address book and datebook, and, in our Palm VII product,
web-clipping software that allows content providers and users to send and
receive Internet data in a handheld device format. We also make development
tools available for our developer community, and we share select parts of the
Palm OS operating system source code in order to enable developers to optimize
the interface of their applications with the Palm platform. As a result, the
Palm OS operating system has emerged as a highly flexible, efficient operating
system. As of June 2, 2000, more than 77,000 developers had registered to create
applications for the Palm platform. We believe that our strong developer support
is due in part to the relative simplicity of developing applications for the
Palm platform, which we believe represents a significant competitive advantage
compared to alternative operating systems.
In addition to including the Palm platform in our Palm-branded devices, we
have expanded our strategy of licensing the platform to device and information
appliance manufacturers. In October 1999, we announced a non-exclusive agreement
with Nokia, the world's leading provider of mobile phones, to integrate the Palm
platform into a future product offering from Nokia. This follows the release of
the pdQ smartphone, the first mobile phone powered by the Palm OS operating
system, by QUALCOMM in late 1998. In November 1999, we entered into an agreement
with Sony to license and develop the Palm platform for use in future Sony
products. In June 2000, Sony announced that the first Palm Powered-TM- device
developed by Sony is scheduled to be released before the end of calendar year
2000. We believe that the potential of these and other new markets represents a
significant growth opportunity for our developer community and us.
INTERNET SERVICES AND APPLICATIONS. The Internet and wireless technologies
enable us to maintain an ongoing connected relationship with our users by
providing mobile personal information management services. We offer users of our
Palm VII device the ability to navigate the Internet through our web-clipping
software, which allows users to download specific information from the Internet
in a format that is optimized for handheld devices. To support the wireless
connectivity of our Palm VII device, we offer the Palm.Net Internet access
service for a monthly subscription fee. We recently announced the Palm Mobile
Internet Kit, which will enable users of Palm III, Palm V and m100 devices to
access Palm.Net and other Internet content using their mobile phones. In
addition, we have developed websites that allow content providers and third
party developers to post web-clipping applications for users to download. Our
websites also serve as resources for our customers, users and developer
community. These Internet services and applications increase the functionality
of our products, provide us with expanded opportunities for product sales,
advertising and transaction revenue and keep us at the forefront of technology
and innovation in our rapidly changing markets.
We intend to leverage our expertise in personal information management to
build an Internet access portal around our existing websites. In addition to
providing access to the increasing number of web-clipping applications, the
plans for our Internet access portal include additional services such as
Internet calendaring, customizable information services and enterprise email
capabilities. In line with this strategy, in May 2000 we announced the
acquisition of AnyDay.com, a leading provider of Internet based calendar
solutions, and Actual Software, a provider of email software for the Palm OS
operating system.
6
THE PALM ECONOMY
Our broad user base has attracted a large community of third party
developers that create software applications and peripherals that increase the
performance and functionality of Palm devices. As of June 2, 2000 more than
77,000 developers had registered to use Palm developer tools to create software
applications for the Palm platform. We provide developer tools to assist our
developer community in developing applications for the Palm platform. While no
license revenue is derived directly from these developers, we believe the
existence of software applications developed by third party developers helps to
increase the market for our handheld device products and services. In addition,
there are several hundred peripherals and accessories developed by us and third
parties ranging from wireless modems to portable keyboards to leather cases.
This expanding Palm economy has, in turn, encouraged licensees to integrate the
Palm platform with new handheld information appliances providing new
opportunities to grow the Palm economy. The Internet is further expanding the
Palm economy by attracting new users and by encouraging developers to create
Internet-specific applications. We believe that the Palm economy creates
opportunities for all participants by continually extending the functionality
and market appeal of both existing and next-generation Palm-branded products and
products based on the Palm platform.
STRATEGY
Our strategy is to develop a leadership position in the broader mobile
devices and services market by providing wireless Internet solutions to all of
our handheld devices, and to establish our Palm platform as the leading
operating system for the next generation of handheld computing devices, mobile
information appliances, mobile phones and handheld devices for entertainment
such as games and music. The key elements of our strategy are as follows:
CONTINUE TO DEVELOP PRODUCTS AND SERVICES THAT LEVERAGE WIRELESS
CONNECTIVITY AND THE INTERNET. The introduction of the Palm VII product
represents the first step in our rollout of wireless Internet-enabled devices.
Our Internet services strategy has four complementary components. First, through
strategic relationships we plan to expand the geographic coverage of our
Palm.Net wireless access service on a global basis. Second, we are developing
hardware and software solutions to enable Palm products in addition to the Palm
VII to access Palm.Net. In support of this strategy, we recently announced that
the Palm Mobile Internet Kit, which will enable Palm III, Palm V and m100
handheld users to access the Palm.Net service, will be made available before the
end of calendar year 2000. Third, we are enhancing the functionality of our
Palm.Net service to increase its utility for enterprise and consumer
applications. Finally, we believe that the proliferation of wireless devices
that link to the Internet will enable us to increase the popularity of our
Internet services. In this regard, we believe that Palm is particularly well
positioned to build an Internet access portal that builds upon our expertise in
personal information management, by providing compelling, personalized wireless
and wireline content and applications. In addition to providing access to the
increasing number of web-clipping applications, the plans for our Internet
access portal include additional services such as Internet calendaring,
customizable information services and enterprise email capabilities. In line
with this strategy, in May 2000 we announced the acquisition of AnyDay.com, a
leading provider of Internet based calendar solutions, and Actual Software, a
provider of email software for the Palm OS operating system.
LICENSE THE PALM PLATFORM TO ESTABLISH A WIDELY ADOPTED OPEN OPERATING
SYSTEM FOR INFORMATION APPLIANCES. We intend to further expand the use of the
Palm platform in a wide variety of handheld devices and information appliances.
This strategy involves selectively licensing the Palm platform to other handheld
device manufacturers such as Sony and Symbol and to manufacturers of other
information appliances that are looking to incorporate an operating system that
is widely adopted by consumers and has broad third party developer support. We
also plan to continue to pursue licensing agreements with wireless companies
such as Nokia and QUALCOMM.
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EXTEND MARKET LEADERSHIP THROUGH CONTINUED DEDICATION TO THE PALM DESIGN
PHILOSOPHY. Our design philosophy carefully balances elegant form with simple
and useful functions. We intend to continue to increase the size of the handheld
device market by extending this philosophy to products targeted at new market
segments. We have recently accelerated our market segmentation activities by
identifying specific user needs across consumer, mobile professional, enterprise
and education markets and by introducing new versions of our handheld devices,
services and marketing programs that combine features tailored to address these
specific needs. Recent examples include the introduction of the m100 product at
an entry level price point to appeal to a broad cross section of consumers and
the launch of our "Simply Smarter" back to school promotion. Underlying our
design philosophy is a fundamental commitment to innovation. We have been first
to market with a number of innovative technologies that we have incorporated
into our products ranging from our first Palm device to our Palm VII wireless
product. We believe that continuing product and technology innovation will be
important to our overall success.
ACCELERATE ADOPTION OF PALM PRODUCTS AND SERVICES IN THE ENTERPRISE
MARKET. We believe the enterprise market represents a significant opportunity
for Palm. Most Palm devices are used in professional environments but have
historically been purchased by users on an individual basis rather than by
corporations or institutions for enterprise-wide deployment. With the
introduction of wireless-enabled devices, enterprise customer support programs
and our enterprise sales force, we are focusing on increasing the adoption of
Palm devices by enterprise customers. As of the end of fiscal year 2000, Palm
devices are on the approved standards list of over 300 companies, including 89
Fortune 500 companies. To accelerate the adoption of our devices by enterprises,
we have established relationships with companies such as Aether, Oracle,
PeopleSoft, Remedy, SAP, Siebel, Sybase and Tivoli to develop applications that
provide access to enterprise databases using devices based on the Palm platform.
Additionally, we are developing synchronization features and network security
capabilities tailored to enterprise networks and computer servers and working
with third party developers to design enterprise-specific software applications.
We have recently begun shipping the Palm HotSync Server, a Windows NT server
based solution which allows enterprise users to synchronize their Palm handhelds
with their corporate database and email systems. We also recently began shipping
an Ethernet cradle which, when combined with our HotSync Server, will enable
enterprise users to synchronize their Palm handhelds with their corporate
database and e-mail systems anywhere a cradle is located.
EXPAND INTERNATIONAL BUSINESS. We intend to continue to expand our
international business. For fiscal 2000, revenues outside the United States
accounted for 35% of our total revenues compared to 29% for fiscal 1999. With
the help of the Palm developer community, we have introduced localized versions
of Palm devices in five languages. We plan to continue our focus on
international markets by expanding our international product offerings,
introducing additional local-language versions of the Palm platform and
broadening our distribution channels overseas. During the fourth quarter of
fiscal 2000, we began selling Palm branded products in Japan through our
subsidiary, Palm Computing K.K.
SUPPORT THE PALM ECONOMY. As the community of users, licensees and hardware
and software developers for Palm products has grown, we have expanded our
efforts to support the Palm economy. Support of the developer community takes a
variety of forms, ranging from offering software tools and technical support
services for third party developers to hosting PalmSource conferences that allow
us to give direction regarding product and strategy trends. In addition, we
expect to make strategic investments in new companies or make acquisitions that
we believe will support or expand the Palm economy. We may also selectively
develop applications designed to increase the functionality of Palm-based
devices and support expansion of the Palm economy. We expect to continue these
efforts to support the Palm economy to stimulate overall demand for products
based on the Palm platform.
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PRODUCTS AND SERVICES
HANDHELD DEVICES. Each of our handheld devices is designed with the Palm
philosophy of providing the user with a simple, elegant and useful productivity
tool. People use our handheld devices for many different purposes, including
managing both personal information and enterprise data, and accessing e-mail and
content from the Internet. Users can also customize their devices by adding a
wide range of applications, peripherals and accessories. We have developed each
of our three current product families to address specific customer needs.
The Palm III product family combines the small form factor, seamless desktop
synchronization, ease of use and fast data access that have been the hallmark of
our handheld devices. The Palm IIIxe product is designed for users such as
professionals or enterprise customers who work with many applications or large
data needs and who desire to add hardware capabilities and software
applications. The Palm IIIc device is our first product with a color display,
and it is designed for users who place a high value on readability and the
ability to use color to categorize information, create images or play
graphics-intensive games.
The m100 is our newest affordable, entry-level product, designed to appeal
to a broad cross section of consumers.
The Palm V product family emphasizes wearability, combining all of the
functions of the Palm III product family with a sleek and stylish form-factor
featuring an anodized aluminum case. It also features advanced display
technology and a rechargeable battery. The Palm Vx device, introduced in the
fall of 1999, has additional pre-bundled software and more memory than the Palm
V device.
The Palm VII device builds on features of our other product families by
adding wireless access to Internet content, enterprise data, e-mail, messaging
and e-commerce services such as online shopping, auctions and stock trading. The
Palm VII device incorporates our web-clipping technology, which presents
Internet content and enterprise data in a format optimized for handheld devices.
We believe the wireless connectivity of the Palm VII device makes it
particularly well suited for the enterprise market as it allows mobile employees
to access enterprise data remotely. Users of the Palm VII device are able to
access Internet content by subscribing to our Palm.Net access service.
As part of our enterprise market strategy, we have entered into an agreement
with Oracle to bundle OracleLite with our developer kit. This bundled product
allows mobile customers in the enterprise market to use a Palm device to gain
access to enterprise databases while working remotely. Similarly, we support
efforts by companies such as Aether, PeopleSoft, Remedy, SAP, Siebel, Sybase and
Tivoli to enable enterprise users to access their database information with Palm
devices. Recently, we began shipping the Palm HotSync Server, a Windows NT
server based solution which allows enterprise users to synchronize their Palm
handhelds with their corporate database and e-mail systems. We also recently
began shipping the Palm Ethernet Cradle for enterprise customers. This product
allows Palm device users to connect directly to an enterprise's local area
network from various locations throughout the enterprise.
We also market and resell peripherals and accessories such as portable
keyboards, modems, leather cases, flip covers and other fashion accessories for
our products.
PALM PLATFORM. Our Palm platform, which integrates a number of components
around the Palm OS operating system, is the foundation for Palm devices as well
as for devices manufactured by our licensees. Our objective is to establish the
Palm platform as the industry standard of excellence for handheld computing
devices and other information appliances.
The Palm platform consists of several components:
- the Palm OS operating system;
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- the Palm user interface, which enables users to interact with the Palm
device, and application programming interfaces, which allow developers to
write applications that run on devices based on the Palm platform;
- standard personal information management applications, including datebook,
address book, to-do list, memo pad, calculator and expense management
functions;
- development tools, including developer kits that enable third party
developers to develop applications and licensee kits with hardware
reference designs that enable licensees to design devices around the Palm
OS operating system;
- HotSync data synchronization technology, which enables a handheld device
to synchronize information with personal computers, enterprise databases
or email;
- Graffiti script recognition technology, which enables users to input
script data directly through our pen-based user interface; and
- Web-clipping software, which allows content providers to present and users
to receive Internet or enterprise data in a format optimized for handheld
computing devices.
The Palm platform has been optimized for handheld devices where instant
access to information, low power consumption and wireless capabilities are
important. These attributes have important benefits for Palm, our developers and
our licensees.
The Palm platform offers a variety of benefits to developers of handheld
devices. The Palm platform software code is designed to allow applications to
run quickly and reliably. It minimizes power, processing and memory requirements
without sacrificing performance, which in turn reduces component costs for
manufacturers. These attributes helped us to design the Palm V with its slim
form factor and will allow our licensees to design products that allocate more
processing resources to new applications rather than to running a complex
operating system. In addition, the architecture of the Palm platform enables the
addition of peripheral devices and software libraries, which broadens the
functionality of the device. We believe that the relative simplicity of
developing applications for the Palm platform represents a significant
competitive advantage compared to alternative operating systems.
The Palm platform provides application developers with significant design
flexibility. The combination of simpler application programming interfaces and
modular code architecture enables developers to quickly and easily learn to
program for the Palm platform. In addition, we share select parts of our source
code to enable developers to optimize the interface of their applications with
the Palm Platform while retaining proprietary control over key aspects of source
code. This helps us maintain a competitive advantage and preserves future
licensing opportunities for us.
The modular architecture of our Palm platform also provides benefits for our
licensees. We design separations between our software layers and the underlying
basic code, or kernel, and the hardware reference design specific to our Palm
devices. This separation breaks the Palm platform into easily configurable
components, promoting innovation and broadening its appeal to manufacturers of
different information appliances. This separation allows components of the Palm
platform to be modified and replaced to allow the Palm OS operating system to
run on a variety of handheld hardware devices.
Significant market acceptance of Palm platform-based devices has attracted a
number of licensees. In October 1998, Symbol Technologies introduced the first
device based on the Palm platform incorporating bar code scanning capabilities.
Symbol has since introduced other products incorporating wireless local area
network access and rugged packaging. These products are targeted as vertical
solutions for retail, transportation, parcel and postal delivery, manufacturing
and healthcare. Other licensees of the Palm platform include QUALCOMM, a maker
of digital mobile phones, which has introduced its pdQ digital smart phone
combining the functionality of the Palm handheld device with a
10
mobile phone, and Handspring, a maker of handheld devices branded as Visor which
are targeted at consumers. In June 2000, Sony announced that the first Palm
Powered device developed by Sony is scheduled to be released before the end of
calendar year 2000.
INTERNET SERVICES AND APPLICATIONS. We have developed two groups of
products and services to address the opportunities created by the emergence of
the Internet: Palm.Net and Palm.com. We intend to build on our expertise in
personal information management to build an Internet access portal around these
existing websites. In addition to providing access to the increasing number of
web-clipping applications, the plans for our Internet access portal include
additional services such as Internet calendaring, customizable information
services and enterprise email capabilities. In line with this strategy, in
May 2000 we announced the acquisition of AnyDay.com, a leading provider of
Internet based calendar solutions, and Actual Software, a provider of email
software for the Palm OS operating system.
In 1999, we introduced Palm.Net, a subscription-based wireless access
service that enables Palm VII handheld users to access web-clipped content on
the Internet. We currently offer pre-paid access packages for $9.99 or $24.99
per month and charge additional amounts for network usage in excess of the
pre-paid package. In addition, we offer an unlimited usage plan for $44.99 per
month. The Palm VII handheld currently comes with nine pre-installed
web-clipping applications. In addition, users receive a CD-ROM that contains
additional web-clipping applications that can be installed on the device. The
Palm.net website also offers links to more than 400 web-clipping applications
that users can download to their devices as well as customer support, technical
support, coverage maps and account information. For example, Palm VII handheld
users can wirelessly access Fidelity.com or E*Trade to get real-time stock
quotes, UPS.com to monitor package delivery, ESPN.com to check sports scores,
WSJ.com to get news or business headlines and Travelocity to check airline
flight times and delays. We believe that we provide a compelling wireless
Internet user experience by providing personalized content in a format that is
optimized for handheld devices.
Palm.net also serves as a resource for both content publishers and third
party developers, who develop downloadable web clipping applications that are
posted to the Palm.net website. As wireless and Internet technologies advance,
we intend to expand the geographical coverage of the Palm.Net network, which
currently covers over 260 metropolitan areas in the United States, into
international markets and to expand the content and application offerings
available through the Palm.Net service.
Palm.com was established as a means to increase our contact with our end
users, customers and third party developers. Visitors to Palm.com can purchase
Palm devices, accessories and peripherals as well as download Palm software
upgrades and link to third party software. They can also find product and
customer supports information and explores links to other Palm-related website.
Palm.com also offers important support resources for developers, enabling them
to register with Palm, obtain access to software development tools and obtain
technical support.
We intend to make strategic investments to enhance the content and
applications available to all of our handheld devices. In line with this
strategy, in May 2000 we announced the acquisition of AnyDay.com, a leading
provider of Internet based calendar solutions, and Actual Software, a provider
of email software for the Palm OS operating system.
DEVELOPER COMMUNITY
The combination of our large user base and the open architecture of the Palm
platform has attracted a large and growing community of third-party developers
who create software applications, peripherals and accessories for Palm devices
and Palm platform-based products. The diverse offerings from this third party
developer community in turn broaden the user appeal of our devices and other
products based on the Palm platform. As of June 2, 2000, more than 77,000
developers had registered to create applications for the Palm platform. In
addition, more than 5,000 applications are currently
11
available in a broad range of categories, including contact and schedule
management, e-mail and Internet communications, sales force and field
automation, personal productivity, groupware, financial management and games.
Developer of several major applications, such as IBM's Lotus Organizer,
Symantec's ACT! and QUALCOMM's Eudora Internet e-mail software, have enabled
these applications to be synchronized with our devices. We have hosted three
developer conferences with attendance growing from approximately 380 in 1997 to
2,000 in 1999 and have begun hosting these conferences internationally in Tokyo,
London and Munich.
SALES AND MARKETING
We sell to our end users primarily through distributors, retailers and
resellers. We also use our dedicated enterprise sales force to market Palm
products directly to enterprises, which then purchase devices through one of our
other sales channels. We also sell directly to customers through our Palm.com
website.
In the United States, distributors represent our largest sales channel.
These distributors generally sell to retailers on a national basis and include
large distributors targeting Internet retailers such as Amazon.com. The retail
channel is our second largest United States distribution channel and encompasses
office supply and consumer electronics retailers, and catalog and mail order
companies. Retailers primarily sell Palm devices to individuals, small
businesses, small offices and home offices. In Europe and the Pacific Rim, we
currently sell our product primarily through distributors. We have over 100
international distributors, located throughout Europe, Asia, the Middle East and
South Africa. These distributors sell primarily to resellers.
We also sell our device products through third parties such as IBM and
Franklin Covey that sell customized versions of our products under their own
brand through their channels of distribution. We believe by developing
specialized and customized products that are re-branded and re-sold by these
third parties, we can quickly and cost effectively enter new geographic and
specialized vertical markets, or expand our penetration into existing markets
such as the enterprise. We have selected established companies that have
significant market presence or access to new markets that can be more
efficiently developed and managed by these third parties than by us. For
example, IBM sells Palm-based products in the enterprise market branded as the
IBM WorkPad PC Companion in the United States, Europe, Japan, Latin America and
Asia.
We build awareness of our products and the Palm brand through mass-media
advertising, targeted advertising, public relations efforts, in-store promotions
and merchandising and through our Palm-branded Internet properties. We also
receive extensive feedback from our end users, the third party developer
community and our channel customers through market research. We use this
feedback to continually refine our product development as well as the position
and assortment of our products in our sales channels.
CUSTOMER SERVICE AND SUPPORT
We believe that customer service and technical support are essential parts
of the sales process in our industry. In order to provide high levels of
customer service, senior management and assigned account managers work closely
with our distributor, retailer, reseller and enterprise customers. We believe
these relationships enable us to improve customer satisfaction and develop
products to meet specific customer needs. For our enterprise customers we
provide a variety of support offerings including a training program for the
enterprise help-desk, website, e-mail and telephone troubleshooting, as well as
a program to provide refurbished units to enterprises needing replacement
devices. Individual consumers also have access to website, e-mail and telephone
support. We outsource our customer service, technical support and product
repairs to regionally based third parties.
12
PRODUCT DEVELOPMENT AND TECHNOLOGY
Our product development efforts are focused on both improving the
functionality of our existing products and developing new products. We believe
the design of our products has played an important role in our success. We
intend to continue to identify and respond to the needs of our customers by
introducing new product designs with an emphasis on innovations in the utility,
simplicity, wearability, mobility, style and ease of use of our products and
services.
To identify and develop technologies for the next generations of Palm
devices, we use parallel development teams to avoid schedule dependency from one
product to the next. At the same time, these parallel development teams share
results to avoid duplication of effort. As a result, we have a rapid product
development cycle that targets releasing new versions of products approximately
every six months to coincide with the summer and winter selling seasons and
introducing new generation products approximately every 12-18 months, depending
on the complexity of the next generation product release. In addition, our Palm
platform software engineering group works both on refining the Palm platform for
our Palm-branded devices and on coordinating development efforts with our
licensees.
We have multiple design centers, including those located in Santa Clara,
California, Bellevue, Washington, Rolling Meadows, Illinois, and Montpellier,
France. Through the acquisitions of Actual Software and AnyDay.com, both of
which are located in the Boston, Massachusetts area, we have added additional
design expertise in the areas of e-mail notification, instant messaging,
personal information management and web portal development.
We believe that our success will depend, in part, on our ability to develop
and introduce new products and enhancements to our existing products. In the
past we have made, and intend to continue to make, significant investments in
research and development. Our research and development expenditures totaled
approximately $75.8 million in fiscal 2000, $46.0 million in fiscal 1999 and
$21.9 million in fiscal 1998. As of June 2, 2000, we had 364 people engaged in
research and development activities.
MANUFACTURING AND SUPPLY CHAIN
We currently outsource all of our manufacturing operations to Manufacturers'
Services Limited and Flextronics. This outsourcing extends from prototyping to
volume manufacturing and includes activities such as material procurement, final
assembly, test, quality control and shipment to our distribution centers. These
distribution centers are outsourced functions operated by Manufacturers'
Services Limited in Salt Lake City, Utah and IEC in Dublin, Ireland.
Manufacturers' Services Limited currently assembles Palm devices for us at its
Utah facility which it purchased from 3Com in November 1999. Flextronics
currently assembles Palm devices at its facilities in Mexico, California and
Malaysia. Our outsourced manufacturing strategy allows us to:
- minimize our capital expenditures;
- conserve the working capital that would be required to fund inventory;
- adjust manufacturing volumes quickly to meet changes in demand; and
- operate without dedicating any space to manufacturing operations.
We believe that additional assembly line efficiencies are realized due to
our product architecture and our commitment to process design. The components
that make up our devices are supplied by a number of vendors such as AMD, Atmel,
Fujitsu and Toshiba, who each supply flash memory chips, and Motorola, the
supplier of our microprocessor. Although we generally use standard components
for our products and try to maintain alternative sources of supply, some key
components, such as the Motorola microprocessors we use, are purchased from sole
or single source suppliers for which
13
alternative sources are not currently available in the quantities and at the
prices we require. Key components of our handheld device products that we obtain
from sole and single source suppliers include displays, power supply integrated
circuits, digital signal processors, Motorola microprocessors, crystals and
several radio frequency and discrete components. We obtain displays from
Phillips and Sharp, integrated circuits from Anadigics, Analog Devices, Burr
Brown, Fairchild, Linear Tech, Linfinity, Lucent, Maxim, Micro Linear, Motorola,
Seiko Epson, Sharp, Siemens, Toko and others, digital signal processors from
Lucent, discrete components from Murata, Coilcraft, Sumida Electronics and Toko
and crystals from KDS and Murata.
COMPETITION
We compete in the handheld device, operating system and Internet services
markets. The markets for these products and services are highly competitive.
Some of our competitors or potential competitors have significantly greater
financial, technical and marketing resources than we do. These competitors may
be able to respond more rapidly than we may to new or emerging technologies or
changes in customer requirements. They may also devote greater resources to the
development, promotion and sale of their products than we do.
Our devices compete with a variety of handheld devices, including pen-and
keyboard-based devices, mobile phones and sub-notebook personal computers. Our
principal competitors include Casio, Compaq, Hewlett-Packard, Psion, Research in
Motion Limited and Sharp as well as licensees of our Palm platform such as
Handspring, Sony, Symbol and TRG. We believe the principal competitive factors
impacting the market for our handheld devices are functionality, features,
operating system performance, styling, availability, brand, price and customer
and developer support. We believe that we compete more favorably than many of
our current competitors with respect to some or all of these factors due to our
operating history, greater number of customers, greater number of third party
software applications and greater brand recognition. Features that we believe
will become increasingly important include wireless connectivity, email and
instant messaging capabilities, expandability and voice integration. For
example, in the area of expandability, Handspring's Visor products include a
Springboard expansion slot. Sony has announced that they will introduce products
which feature Sony's memory stick expansion technology. We have announced that
we plan to integrate Secure Digital card expansion technology into our products
beginning in the first half of calendar year 2001.
Our Palm platform competes primarily with operating systems such as
Microsoft's Windows CE operating system for handheld personal computers and
Symbian's EPOC operating system for wireless communication devices. We believe
that the principal competitive factors affecting the market for operating
systems are the overall number of end users, technological features and
capabilities of the operating system, number and quality of third party
applications available for use on the operating system, architecture of the
operating system and relative ease of developing compatible applications. We
believe that we compete more favorably than many of our current competitors with
respect to some or all of these factors due to our operating history, greater
number of customers, greater number of third party software developers and
applications and greater brand recognition. In our licensing activities, our
Palm platform also competes with the proprietary operating systems of our
potential licensees. The recent emergence of alternative operating systems such
as Linux for handheld devices may result in increased future competition in the
operating system market.
The Palm VII handheld and our wireless Internet access service compete with
a variety of alternative technologies and services. Mobile phone manufacturers
and service providers including Nokia, Motorola and Sprint offer mobile phones
which provide Internet connectivity. Research in Motion Limited also offers a
handheld device which provides mobile email, instant messaging and Internet
connectivity. We expect that the trend toward integrating Internet connectivity
into a diverse set of devices will continue to accelerate as industry standards
emerge. Our subscription-model access business also competes indirectly with
other providers of Internet access, ranging from dedicated
14
Internet service providers such as America Online and Earthlink to phone
companies. In addition, although we currently supply Internet access to Palm VII
subscribers through our Palm.Net service, competing Internet access solutions
have been developed to enable Internet connectivity to Palm devices. For
example, Omnisky sells a wireless modem, that when connected to a Palm V or Palm
Vx device, enables access to Omnisky's subscription-based wireless Internet
access service. We anticipate that other competitors may decide to develop
similar solutions that would compete with our Palm.Net service.
INTELLECTUAL PROPERTY
Our software, hardware and operations rely on and benefit from an extensive
portfolio of intellectual property. We currently have 16 United States patents
issued for our technology and we have 135 United States patent applications
pending. We also have 3 foreign patents issued and 27 foreign patent
applications pending.
We own a number of trademarks, including Palm, Palm III, Palm V, Palm VII,
Palm OS, Palm Computing, the Palm logo, Palm Powered, PalmSource, HotSync,
Graffiti, Simply Palm and Palm.Net. We are working to increase and enforce our
rights to these trademarks, the protection of which is important to our
reputation and branding. We also own copyrights to the Palm platform and our
software development applications.
We license a number of technologies from third parties for integration into
our products. We believe that the licensing of complementary technologies from
parties with specific expertise is an effective means of expanding the features
and functionality of our products.
In addition to our Palm platform, we also license development applications
to third party developers of compatible products, services and applications to
increase the functionality of devices based on the Palm platform. In addition,
we have licensed software that enables numerous website hosts, including ABC
News, Bank of America, Dow Jones, ESPN, E*Trade, Fidelity.com, Fodor's,
MasterCard, Merriam-Webster, MovieFone, Starbucks, TheStreet.com, UPS, USA
Today, VISA, The Weather Channel and Yahoo!, to make their websites accessible
by devices based on the Palm platform using our web-clipping technology.
We rely on a combination of patent, trademark, copyright and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
BACKLOG
We order finished products from our third party manufacturers based upon our
forecast of worldwide customer demand and in advance of receiving orders from
our customers. Our customers generally place orders on an as needed basis and
products are shipped as soon as possible after receipt of an order, usually
within one to four weeks. With very few exceptions, orders may be canceled or
rescheduled by the customer without penalty.
EMPLOYEES
As of June 2, 2000, we had a total of 951 employees, of which 91 were in
supply chain and service and support, 364 were in engineering, 342 were in sales
and marketing and 154 were in general and administrative activities. Our future
performance depends, in significant part, upon our ability to attract new
personnel and retain existing personnel in key areas including engineering,
technical support and sales. Competition for personnel is intense, especially in
the San Francisco Bay Area where we are headquartered, and we cannot be sure
that we will be successful in attracting or retaining personnel in the future.
None of our employees is subject to a collective bargaining agreement. We
consider our relationship with our employees to be good.
15
ITEM 2. PROPERTIES
We occupy approximately 200,000 square feet of leased space in Santa Clara,
California. The lease of this facility is terminable with six-month notice
beginning in July 2001 and expires in February 2003. In addition to our
principal office space in Santa Clara, California, we also lease research and
development facilities in Bellevue, Washington, Rolling Meadows, Illinois,
Montpellier, France, and the Boston, Massachusetts area and sales and support
offices internationally in Winnersh, United Kingdom and La Defense, France. We
believe that existing facilities are adequate for our needs through calendar
year 2000 and are currently in the process of locating additional space and
negotiating the lease terms to meet our expected requirements thereafter. If we
require additional space, we believe that we will be able to secure such space
on commercially reasonable terms without undue operational disruption.
ITEM 3. LEGAL PROCEEDINGS
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District Court
for the Western District of New York. The case is now captioned: XEROX
CORPORATION v. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP., PALM
COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T. The
complaint alleged willful infringement of U.S. patent 5,596,656 entitled
"Unistrokes for Computerized Interpretation of Handwriting." The complaint
sought unspecified damages and to permanently enjoin the defendants from
infringing the patent in the future. In an Order entered by the District Court
on June 6, 2000, the District Court granted the defendants' motion for summary
judgment of non-infringement and dismissed the case in its entirety. On July 5,
2000, Xerox filed a Notice of Appeal of the dismissal with the U.S. Court of
Appeals for the Federal Circuit.
On July 22, 1999, we filed a copyright infringement action against Olivetti
and CompanionLink in the United States District Court for the Northern District
of California and obtained a preliminary injunction against further
distribution, sale, import or export of Olivetti Office USA's "Royal daVinci"
handheld device and the daVinci OS Software Development Kit (distributed by
CompanionLink Software, Inc.), which contained source code copied from the
Palm OS operating system. The injunction is to remain in effect pending the
outcome of the lawsuit. We also initiated a copyright infringement action in
Hong Kong on July 21, 1999, against EchoLink Design Ltd., the company
responsible for developing the operating system software contained in the
daVinci products. The High Court of the Hong Kong Special Administrative Region
issued an order the same day restraining EchoLink from further copying,
distribution, sale, import or export of Palm OS operating system source code or
EchoLink's "NEXUS OS" source code, which we maintain infringes our copyrights.
On October 7, 1999, 3Com notified certain third-party retailers about the
preliminary injunction order cited above. Olivetti has advised that it intends
to assert counterclaims against Palm and 3Com for unfair competition,
intentional interference with potential economic advantage, libel and trade
libel, based upon certain statements that were allegedly made, or that 3Com
allegedly omitted to make, in the October 7, 1999 letter. To date, the
counterclaim has not been filed or allowed.
On December 13, 1999, WaveWare Communications, Inc. filed suit against 3Com,
Palm and others in the Superior Court of California, San Mateo County. The case
is captioned WAVEWARE COMMUNICATIONS, INC. v. 3COM CORPORATION, PALM
COMPUTING, INC., AND MARK BERCOW, No. 411331. The complaint alleges breach of
contract, constructive fraud, fraud and deceit, negligent misrepresentation,
misappropriation of assets and trade secrets, unfair competition, unjust
enrichment and intentional interference with economic advantage in connection
with our and 3Com's discussions with WaveWare concerning WaveWare's potential
acquisition by 3Com. The complaint seeks unspecified monetary damages and
injunctive relief. Discovery is ongoing and the case is set for trial in January
2001.
On December 27, 1999, Telxon Corporation and Penright! Corporation filed a
complaint in the U.S. District Court for the Northern District of Ohio, Eastern
Division (Case No. 1:99CV3157) against
16
3Com and Palm alleging copyright infringement, unfair competition and theft of
trade secrets. The plaintiffs allege that the Palm OS operating system contains
graphical user interface software copied from the plaintiffs' software. The
complaint seeks unspecified compensatory and treble damages and to enjoin, among
other things, distribution and sales of the Palm OS operating system. No trial
date has been set. The case is still in the early stages of discovery.
On February 28, 2000, E-Pass Technologies, Inc. filed suit against
"3Com, Inc." in the United States District Court for the Southern District of
New York and later filed on March 6, 2000 an Amended Complaint against Palm and
3Com. The case is now captioned E-PASS TECHNOLOGIES, INC. V. 3COM CORPORATION,
A/K/A 3COM, INC. AND PALM, INC. (Civil Action No. 00 CIV 1523). The Amended
Complaint alleges willful infringement of U.S. patent 5,276,311 entitled "Method
and Device for Simplifying the Use of Credit Cards, or the Like." The complaint
seeks unspecified compensatory and treble damages and to permanently enjoin the
defendants from infringing the patent in the future. Palm is in the preliminary
stages of investigating the allegations contained in the suit. In an Order dated
June 9, 2000, the Federal Judge assigned to the action transferred the case to
the U.S. District Court for the Northern District of California. No trial date
has been set. No discovery has been exchanged.
On May 2, 2000, Rotis Technologies Corporation filed suit against Palm and
two other defendants in the U.S. District Court for the Northern District of
Texas. The case is captioned ROTIS TECHNOLOGIES CORPORATION V. TRACK DATA
CORPORATION, PALM, INC. AND SPRINT FON GROUP (Case No. 300CV-931-L). The
complaint alleges infringement of U.S. patent 4,473,824 entitled "Price
Quotation System." The complaint seeks unspecified compensatory and treble
damages and to permanently enjoin the defendants from infringing the patent in
the future. Palm is in the preliminary stages of investigating the allegations
contained in the suit. No trial date has been set. No discovery has been
exchanged.
In connection with our separation from 3Com, pursuant to the terms of the
Indemnification and Insurance Matters Agreement between 3Com and us, we will
indemnify and hold 3Com harmless for any damages or losses which may arise out
of the Xerox, WaveWare, Telxon and Penright!, E-Pass and Rotis litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS
Set forth below is information concerning our executive officers who report
under Section 16 of the Securities Exchange Act of 1934, as amended, and their
ages as of June 2, 2000.
NAME AGE POSITION
---- -------- --------
Carl J. Yankowski 51 Chief Executive Officer
Alan J. Kessler 42 Chief Operating Officer, Platform and
Products
Barry Cottle 39 Chief Operating Officer, Content and Access
Judy Bruner 41 Senior Vice President and Chief Financial
Officer
Stephen Yu 34 Vice President, General Counsel and Secretary
Stewart Gill 49 Vice President, Human Resources
Carl J. Yankowski has served as our Chief Executive Officer and one of our
directors since December 1999. From September 1998 to December 1999,
Mr. Yankowski was Executive Vice President of Reebok International Ltd. and
President and Chief Executive Officer of the Reebok Division. From
November 1993 to January 1998, Mr. Yankowski was President and Chief Operating
Officer of Sony Electronics Inc., a subsidiary of the Sony Corporation.
Mr. Yankowski holds a Bachelor of Science degree in electrical engineering from
the Massachusetts Institute of Technology as well as a Bachelor of Science
degree in management, which he earned concurrently from MIT's Sloan School of
17
Management. Mr. Yankowski also serves as a director of Vitts Networks, Safeguard
Scientifics and Avidyne, Inc., and he is a member of the board of advisors of
Boston College Business School.
Alan J. Kessler has served as Chief Operating Officer, Platform and Products
since June 1999. From April 1998 to June 1999, Mr. Kessler was Senior Vice
President of Global Customer Service for 3Com. From July 1997 to April 1998,
Mr. Kessler was Senior Vice President of Worldwide Enterprise Sales and Service
for 3Com. From October 1985 to July 1997, Mr. Kessler held a variety of sales
and marketing management positions at 3Com, including Vice President of 3Com's
North America System Sales, Vice President and General Manager of 3Com's
Internetworking Product Group and a Director of Marketing with responsibility
for key network communication product lines. Mr. Kessler holds a Master of
Business Administration degree from the University of California, Berkeley and a
Bachelor of Science degree in business, with honors, from San Jose State
University.
Barry Cottle has served as Chief Operating Officer, Content and Access since
February 2000. Prior to joining Palm, Mr. Cottle served in a variety of
management positions at The Walt Disney Company since 1991, most recently as
Senior Vice President of Marketing of Disney TeleVentures. He also served as
Vice President at Disney, managing regional business development, marketing and
sales teams. Mr. Cottle also held marketing and consulting positions with Apple
Computer and Andersen Consulting. Mr. Cottle earned an Masters of Business
Administration degree from the Kellogg Graduate School of Management.
Judy Bruner has served as Senior Vice President and Chief Financial Officer
since September 1999. From April 1998 to September 1999, Ms. Bruner was Vice
President and Corporate Controller at 3Com. From October 1996 to April 1998,
Ms. Bruner was the Vice President, Finance for 3Com's Enterprise Systems
Business Unit. From June 1995 to October 1996, she served as 3Com's Vice
President and Corporate Treasurer. From April 1988 to June 1995 Ms. Bruner
served in a variety of 3Com financial management positions including Corporate
Treasurer. Prior to joining 3Com, Ms. Bruner most recently served as the Vice
President and Chief Financial Officer for Ridge Computers Inc., a privately held
company that designed and manufactured computer systems. She was with Ridge
Computers Inc. from December 1984 until April 1988. From July 1980 to
December 1984, Ms. Bruner held a variety of accounting and finance positions at
Hewlett-Packard Company. Ms. Bruner holds a Bachelor of Arts degree in economics
from the University of California, Los Angeles and a Master of Business
Administration degree from Santa Clara University.
Stephen Yu has served as Vice President, General Counsel and Secretary since
September 1999. From November 1994 to September 1999, Mr. Yu held various
positions within the 3Com legal department, most recently serving as 3Com's
Legal Director, Business Development and West Coast Product Operations. From
September 1990 to November 1994, Mr. Yu was an associate attorney with Gray Cary
Ware & Freidenrich, a law firm located in Palo Alto, California. Mr. Yu received
a Juris Doctor degree cum laude from Georgetown University Law Center and a
Bachelor of Science degree in electrical engineering from Purdue University.
Stewart Gill has served as Vice President, Human Resources since
January 2000. Prior to joining Palm, from April 1995 to January 2000, Mr. Gill
was Vice President, Corporate Human Resources for Quantum Corporation. From
March 1993 to April 1995, he served as the Director of Compensation, Benefits,
and HR Systems for Quantum Corporation. During 1992, he was Director, Corporate
Human Resources at Compaq Computer. From December 1987 to December 1992, he was
Director, Compensation Benefits, and HR Systems at Compaq Computer. From
June 1973 to December 1987, Mr. Gill held a variety of positions in Human
Resources with hardware and software technology companies, beginning with
Motorola. Mr. Gill holds a Bachelor of Science degree in education with a
concentration in psychology from Kent State University, where he graduated with
honors.
18
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
FISCAL 2000 HIGH LOW
- ----------- -------- --------
Fourth quarter.............................................. $95.06 $20.81
Our common stock has traded on the Nasdaq stock market under the symbol PALM
since our initial public offering on March 2, 2000. The preceding table sets
forth the high and low closing sales prices as reported on the Nasdaq stock
market during the last quarter. As of July 31, 2000, we had approximately 6,535
stockholders of record. Other than the $150 million cash dividend paid to 3Com
out of the proceeds from our initial public offering, Palm has not paid and does
not anticipate paying cash dividends in the future.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data for each of the three
years ended June 2, 2000 has been derived from the audited consolidated
financial statements contained in Item 8 of Part II of this Form 10-K. The
selected consolidated statement of operations data for the year ended May 25,
1997 has been derived from the audited financial statements contained in our
registration statement on Form S-1 filed on December 13, 1999, as amended. The
selected consolidated balance sheet data as of May 25, 1997 and May 26, 1996 and
the selected consolidated statement of operations data for the period ended
May 26, 1996 have been derived from our unaudited consolidated financial data.
Fiscal year 1996 includes only eleven months of operating results, as our
year-end was June 30 prior to our acquisition by U.S. Robotics.
The information set forth below is not necessarily indicative of results of
future operations and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the consolidated financial statements and notes to those statements included in
Items 7 and 8 of Part II of this Form 10-K.
YEARS ENDED
------------------------------------------------------
JUNE 2, MAY 28, MAY 31, MAY 25, MAY 26,
2000 1999 1998 1997 1996
---------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Consolidated Statements of Operations
Data:
Revenues.................................. $1,057,597 $563,525 $272,137 $114,157 $ 7,054
Gross profit.............................. 444,514 247,909 114,388 36,472 2,575
Operating income (loss)................... 61,449 48,339 6,461 (13,513) (6,777)
Net income (loss)......................... 45,910 29,628 4,171 (7,862) (3,062)
Net income (loss) per share:
Basic................................... $ 0.09 $ 0.06 $ 0.01 $ (0.01) $ (0.01)
Diluted................................. 0.09 0.06 0.01 (0.01) (0.01)
Shares used in computing per share
amounts:
Basic................................... 539,739 532,000 532,000 532,000 532,000
Diluted................................. 539,851 532,000 532,000 532,000 532,000
Consolidated Balance Sheet Data:
Cash and cash equivalents................. $1,062,128 $ 478 $ -- $ -- $ --
Working capital........................... 1,012,476 12,682 53,354 26,963 3,899
Total assets.............................. 1,282,676 152,247 115,359 45,984 9,618
Payable to 3Com Corporation............... 18,374 40,509 15,617 4,412 752
Stockholders' equity...................... 1,029,188 34,018 65,675 31,245 6,466
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read together with our consolidated financial statements
and notes to those statements included in Item 8 of Part II of this Form 10-K.
Prior to June 1, 1998, our 52-53 week fiscal year ended on the Sunday nearest to
May 31. Effective June 1, 1998, we changed our fiscal year to a 52-53 week
fiscal year ending on the Friday nearest to May 31. Fiscal year 2000 contained
53 weeks compared to 52 weeks for fiscal years 1999 and 1998. Unless otherwise
stated, all years and dates refer to our fiscal year and fiscal periods.
OVERVIEW
We were founded in 1992 and introduced our first handheld device in 1996.
Immediately prior to our initial public offering on March 2, 2000, we were a
wholly-owned subsidiary of 3Com. Until 1999, our business was focused primarily
on developing and selling our Palm-branded handheld devices, and as of June 2,
2000, we had sold over 7 million Palm devices worldwide. In 1999, we expanded
our strategy of licensing our Palm platform and developed our wireless Internet
access service to support Internet-enabled handheld devices. Our revenues have
increased from approximately $1 million in fiscal 1995 to approximately
$1.06 billion in fiscal 2000. Through our initial public offering and concurrent
private placements to America Online, Motorola, and Nokia, we raised net
proceeds of $1.17 billion, out of which a dividend of $150 million to 3Com was
paid. On July 27, 2000, 3Com completed the distribution of the remaining shares
of Palm it owned to the stockholders of 3Com. Immediately prior to the
distribution, 3Com owned approximately 94% of the Palm shares outstanding.
Substantially all of our revenues to date have been generated from sales of
our handheld devices and related peripherals and accessories. A small percentage
of our revenues has been derived from licensing our Palm platform or from
subscriptions to our wireless Internet access service. With our expanded focus
on Palm platform licensing and Internet services and solutions, we expect that
an increasing portion of our revenues in future periods will come from these
sources, although they will still represent a relatively small portion of our
total revenues in fiscal 2001. International revenues represented 35% of total
revenues in fiscal 2000, compared to 29% in fiscal 1999, and we expect that
international revenues will continue to increase as a percentage of total
revenues. We believe that we will continue to experience strong growth in unit
shipments of our Palm handheld devices, although the year over year growth rates
may decline on a percentage basis compared to recent levels.
While gross margins have historically remained relatively constant, they
declined in the fourth quarter of fiscal 2000, and we anticipate that gross
margins will remain in a lower range in fiscal 2001. Factors which we believe
may impact gross margins include increased competition, introduction of new
handheld devices, supply constraints for certain components, and an increased
percentage of our revenue being derived from licensing and wireless Internet
services and solutions.
In line with our strategy to expand our business, we expect to continue to
make significant strategic investments throughout fiscal year 2001. These
investments will focus on development and introduction of new products and
Internet solutions, continued expansion into new customer segments and
geographic regions, as well as other marketing investments. We also expect to
incur some duplication of costs during fiscal 2001 as we continue to build the
infrastructure necessary for a stand-alone public company, while also paying
3Com to perform certain of these services under transition service agreements.
In addition, we expect to incur costs related to our separation from 3Com
throughout fiscal 2001. Due to the impact of these factors, our operating
margins declined significantly in the fourth quarter of fiscal 2000 as compared
to the previous quarter. We anticipate that our operating margins will continue
to be lower than recent historical levels throughout fiscal 2001, and there may
be quarters in which we report operating losses as we invest to expand our
business, take advantage of market opportunities and execute our strategic plan
as an independent stand-alone
20
company. Furthermore, we intend to make strategic acquisitions, which would
likely result in amortization costs that would adversely effect our operating
results.
BASIS OF PRESENTATION
Through February 25, 2000, our consolidated financial statements have been
carved out from the consolidated financial statements of 3Com, using the
historical results of operations and historical bases of the assets and
liabilities of the 3Com business that Palm comprised. The consolidated financial
statements also include allocations to us of 3Com corporate expenses, including
centralized legal, accounting, treasury, real estate, information technology,
distribution, customer services, sales, marketing, engineering and other 3Com
corporate services and infrastructure costs. The expense allocations were
determined on bases that 3Com and we considered to be reasonable reflections of
the utilization of the services provided to us or the benefit received by us.
Expenses were allocated based on relative revenues, headcount or square footage.
Palm's legal separation from 3Com occurred on February 26, 2000, at which
time we began to operate independently from 3Com. Beginning in the fourth
quarter of fiscal year 2000, Palm's consolidated financial statements no longer
include an allocated portion of 3Com's corporate services and infrastructure
costs. However, we have continued to incur amounts payable to 3Com under
transitional service agreements, under which 3Com provides services such as
information systems, real estate and transaction processing in accounting and
human resources.
RESULTS OF OPERATIONS
The following table sets forth consolidated statements of operations data
expressed as a percentage of revenues for the fiscal years indicated:
YEARS ENDED
------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Revenues............................................ 100.0% 100.0% 100.0%
Cost of revenues.................................... 58.0 56.0 58.0
----- ----- -----
Gross profit........................................ 42.0 44.0 42.0
----- ----- -----
Operating expenses:
Sales and marketing............................... 22.4 22.6 26.0
Research and development.......................... 7.2 8.2 8.0
General and administrative........................ 4.8 4.2 5.6
Purchased in-process technology................... -- 0.4 --
Separation costs.................................. 1.8 -- --
----- ----- -----
Total operating expenses........................ 36.2 35.4 39.6
----- ----- -----
Operating income.................................... 5.8 8.6 2.4
Interest and other income (expense), net............ 1.6 -- (0.1)
----- ----- -----
Income before income taxes.......................... 7.4 8.6 2.3
Income tax provision................................ 3.1 3.3 0.8
----- ----- -----
Net income.......................................... 4.3% 5.3% 1.5%
===== ===== =====
Excluding purchased in-process technology
and separation costs:
Total operating expenses.......................... 34.4% 35.0% 39.6%
===== ===== =====
Operating income.................................. 7.6% 9.0% 2.4%
===== ===== =====
21
COMPARISON OF FISCAL YEARS ENDED JUNE 2, 2000 AND MAY 28, 1999
REVENUES
Fiscal 2000 revenues totaled $1,057.6 million, an increase of
$494.1 million, or 88%, compared to fiscal 1999 revenues of $563.5 million. The
increase was due primarily to higher unit shipments of our Palm handheld devices
while the average selling price of these devices declined slightly. Revenues
increased in all geographic areas, with revenues in Asia-Pacific and Europe
growing at a faster rate than in the United States. International revenues for
fiscal 2000 were 35% of revenues compared with 29% of revenues in fiscal 1999.
GROSS PROFIT
Gross profit was $444.5 million in fiscal 2000 compared to $247.9 million in
fiscal 1999, an increase of $196.6 million or 79%. Gross profit as a percentage
of revenues decreased to 42.0% in fiscal 2000 compared to 44.0% in fiscal 1999.
The decrease was primarily due to start-up costs associated with establishing
our wireless Internet access services and due to a change in product mix towards
devices with lower gross margins.
SALES AND MARKETING
Sales and marketing expenses were $236.8 million in fiscal 2000 compared to
$127.7 million in fiscal 1999, an increase of $109.1 million or 85%. Sales and
marketing expenses as a percentage of revenues were 22.4% in fiscal 2000
compared to 22.6% in fiscal 1999. The increase in absolute dollars in fiscal
2000 compared to fiscal 1999 was primarily due to increased spending on
activities to generate additional demand for our Palm devices, increased
headcount and related expenses, our worldwide campaign to heighten recognition
of our brand name, and increased international sales and marketing activities,
including the launch of our Palm Computing K.K. subsidiary in Japan.
RESEARCH AND DEVELOPMENT
Research and development expenses were $75.8 million in fiscal 2000 compared
to $46.0 million in fiscal 1999, an increase of $29.8 million or 65%. Research
and development expenses decreased as a percentage of revenues from 8.2% in
fiscal 1999 to 7.2% in fiscal 2000 as certain fixed costs were spread over a
higher revenue base. The increase in absolute dollars from fiscal 1999 to fiscal
2000 was primarily due to increased spending on additional headcount and related
expenses, and due to development costs in new product areas, including Bluetooth
and other wireless communications technology.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $50.9 million in fiscal 2000
compared to $23.7 million in fiscal 1999, an increase of $27.2 million or 115%.
General and administrative expenses as a percentage of revenue increased to 4.8%
in fiscal 2000 compared to 4.2% in fiscal 1999. The increases both in absolute
dollars and as a percentage of revenues compared to fiscal 1999 were due
primarily to increased spending for additional headcount and related expenses to
support the growth in revenues, expenses related to building the infrastructure
for a stand-alone public company and higher allocated costs from 3Com during the
first nine months of fiscal 2000, due to Palm's revenue growth as a percentage
of 3Com's total revenue.
PURCHASED IN-PROCESS TECHNOLOGY
Purchased in-process technology in fiscal 1999 was due to our acquisition of
Smartcode Technologie SARL in February 1999. Approximately $2.1 million of the
purchase price represented
22
purchased in-process technology that had not yet reached technological
feasibility, had no alternative future use and was charged to operations. The
primary project related to the purchased in-process technology was completed in
the first quarter of fiscal 2000 and we began to derive revenue from the
developed technology beginning in the second quarter of fiscal 2000.
SEPARATION COSTS
Separation costs of $19.6 million in fiscal 2000 consist of costs associated
with the process of becoming a stand-alone, public company, including consulting
and professional fees. We expect to continue to incur separation costs
throughout fiscal 2001, with such costs likely to decline each quarter over the
course of the year.
INTEREST AND OTHER INCOME (EXPENSE)
Interest and other income (expense), on a net basis, was $16.4 million in
fiscal 2000, compared to a nominal expense in fiscal 1999. Substantially all of
this increase was attributable to interest income earned from the net proceeds
from the initial public offering and private placements. While we anticipate
that interest income for fiscal 2001 will increase over the amount earned in
fiscal 2000, the interest income earned on a quarterly basis is likely to
decline from the amount earned in the fourth quarter of fiscal 2000 as we make
strategic investments to expand our business, and execute our strategic plan as
a stand-alone public company.
INCOME TAX PROVISION
The effective tax rate for fiscal 2000 was 41.0%, up from 38.4% for fiscal
1999. The increase in the effective tax rate was primarily due to certain
non-deductible separation costs and the establishment of our international legal
subsidiary structure, which in the initial year is expected to create losses in
certain foreign jurisdictions for which no current tax benefit is obtained.
Excluding the impact of the amortization of non-deductible goodwill and
purchased intangibles that result from acquisitions which have occurred or may
occur in the future, we anticipate that our effective tax rate will decline
slightly in fiscal 2001, and may decline further in subsequent years.
COMPARISON OF FISCAL YEARS ENDED MAY 28, 1999 AND MAY 31, 1998
REVENUES
Revenues were $563.5 million in fiscal 1999 compared to $272.1 million in
fiscal 1998, an increase of $291.4 million or 107%. The growth in revenues was
primarily due to increased unit shipments of Palm handheld devices, while the
average selling price of these devices increased moderately. Declining prices of
existing products over this period were offset by the introduction of new
products with additional features such as increased memory, backlit screens,
higher resolution screens, sleeker styling, thinner and lighter form factor and
wireless Internet capability. New product introductions during fiscal 1999
included the Palm IIIe, Palm IIIx, Palm V and Palm VII series of handheld
devices. International revenues for fiscal 1999 were 29% of revenues compared
with 27% of revenues in fiscal 1998.
GROSS PROFIT
Gross profit was $247.9 million in fiscal 1999 compared to $114.4 million in
fiscal 1998, an increase of $133.5 million or 117%. Gross profit as a percentage
of revenues increased to 44.0% in fiscal 1999 compared to 42.0% in fiscal 1998.
The improvement in gross profit in fiscal 1999 reflects increased sales of
higher margin Palm IIIx and Palm V products, as well as reduced manufacturing
costs due to better pricing that we were able to obtain from our component
suppliers and contract manufacturers.
23
SALES AND MARKETING
Sales and marketing expenses were $127.7 million in fiscal 1999 compared to
$70.8 million in fiscal 1998, an increase of $56.9 million or 80%. Sales and
marketing expenses as a percentage of revenues decreased to 22.6% in fiscal 1999
compared to 26.0% in fiscal 1998, as fixed costs were spread over a higher
revenue base. The absolute dollar increase in fiscal 1999 resulted primarily
from an increase in advertising of $29.6 million, which included expenditures on
our "Simply Palm" national advertising campaign, and increased product
introduction activities associated with the launches of our Palm IIIe, Palm
IIIx, Palm V and Palm VII handheld devices. These launch activities included
increased personnel-related expenses associated with increasing the size of our
marketing organization, increased trade show activities and related travel
expenses, point of sale displays, sales collateral and marketing development. In
addition, marketing expenses increased by $15.7 million due to our expansion
into the European market.
RESEARCH AND DEVELOPMENT
Research and development expenses were $46.0 million in fiscal 1999 compared
to $21.9 million in fiscal 1998, an increase of $24.1 million or 110%. Research
and development expenses as a percentage of revenues were 8.2% in fiscal 1999,
compared to 8.0% in fiscal 1998. The absolute dollar increase in research and
development expenses in fiscal 1999 resulted primarily from an increase of
$8.2 million in personnel-related expenses associated with expanding the size of
our engineering organization and an increase of $4.0 million in expenses related
to contractors, consultants and project materials. During fiscal 1999, we also
incurred an additional $6.9 million in engineering costs to develop our wireless
Internet access service that supports our wireless Palm VII device.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $23.7 million in fiscal 1999
compared to $15.3 million in fiscal 1998, an increase of $8.4 million or 55%.
General and administrative expenses as a percentage of revenues decreased to
4.2% in fiscal 1999 compared to 5.6% in fiscal 1998, as fixed costs were spread
over a higher revenue base. The absolute dollar increase in general and
administrative expenses in fiscal 1999 was primarily due to an increase in
allocated costs from 3Com of $4.3 million to support the growth of our business.
PURCHASED IN-PROCESS TECHNOLOGY
Purchased in-process technology in fiscal 1999 was due to our acquisition of
Smartcode Technologie SARL in February 1999 for $17.4 million in cash.
Approximately $2.1 million of the purchase price represented purchased
in-process technology that had not yet reached technological feasibility, had no
alternative future use and was charged to operations in the third quarter of
fiscal 1999. Approximately $5.4 million of the purchase price was allocated to
existing technology, with this amount being amortized over four years.
The purchased in-process technology acquired related primarily to
Globalpulse, a software GSM terminal adapter which acts as a software modem for
products utilizing the Palm OS operating system. The estimated value for the
in-process technology was determined using the income approach which discounted
to present value the cash flows expected to be derived from products that were
still in the process of development at the date of acquisition. The projections
were based on future expectations of the revenue and expenses to be generated in
connection with the products that were still under development. Revenues and
operating profit attributable to the in-process technology were estimated to
total $50.0 million and $9.4 million, respectively, over a five-year projection
period. The resulting projected net cash flows were discounted to their present
value of $2.1 million using a discount rate of 40%, which was calculated based
on the weighted average cost of capital, adjusted for the technology
24
risk associated with the purchased in-process technology, which was considered
to be significant due to the nature of the technology under development. For
projected cash flows attributable to existing technology, a discount rate of 35%
was used, which reflects the weighted average cost of capital, adjusted for the
technology risk associated with these technologies.
The nature of the efforts required to develop the purchased in-process
technology into commercially viable products principally relates to the
completion of all planning, designing, prototyping, verification and testing
activities that are necessary to establish whether the products will be able to
meet its design specifications, including functions, features and technical
performance requirements. The estimated cost to develop the in-process
technology was approximately $0.3 million, all of which was expected to be
incurred before the end of fiscal 2000. The actual cost to develop the
in-process technology has been consistent with the forecasted amount. The
primary project was completed in July 1999 and Palm began to derive revenue
beginning in the second quarter of fiscal 2000.
INCOME TAX PROVISION
Our effective tax rate was 38.4% in fiscal 1999 compared to 34.9% in fiscal
1998. The primary reason for the increase in the effective tax rate was less
research and development credit being available in fiscal 1999 than in fiscal
1998.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at June 2, 2000 were $1,062.1 million, compared to
$0.5 million at May 28, 1999. The increase of $1,061.6 million was attributable
to cash provided by operating activities of $128.8 million and cash provided by
financing activities of $944.8 million, offset by cash used in investing
activities of $12.0 million. On March 2, 2000 we completed our initial public
offering and concurrent private placements to America Online, Nokia and
Motorola, raising net proceeds of $1.17 billion from the sale of 32.4 million
shares of common stock, which represents approximately 5.7% of the outstanding
shares of our common stock. Prior to our initial public offering, we did not
maintain significant levels of cash, as our operations were financed by 3Com
through their centralized corporate cash management program.
For fiscal 2000, cash provided by operating activities consisted of net
income adjusted for non-cash charges and changes in working capital. The most
significant changes in working capital were due to increases in accounts payable
and other accrued liabilities, offset partially by a decrease in the payable to
3Com, and by increases in accounts receivable and inventory. Cash provided by
financing activities consisted primarily of net proceeds from the initial public
offering and private placements totaling $1.17 billion offset by net transfers
to 3Com and the payment of a $150.0 million cash dividend to 3Com. Cash used in
investing activities of $12.0 million consisted primarily of capital
expenditures.
Based on current plans and business conditions, we believe that our existing
cash and cash equivalents will be sufficient to satisfy our anticipated cash
requirements for at least the next twelve months. During fiscal 2001, we believe
that our cash and cash equivalents are likely to decline from the level at the
end of fiscal 2000, as we make strategic investments to expand our business, and
execute our strategic plan as a stand-alone public company.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 and June 1999, the Financial Accounting Standards Board
("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities and SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133. These
statements require companies to record derivatives on the balance sheet as
assets or liabilities, measured at fair value. Gains or losses resulting from
changes in the values of those
25
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. SFAS 133 will be effective for Palm's
fiscal year ending May 31, 2002. Management believes that the adoption of these
statements will not have a significant impact on Palm's financial position or
results of operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 will be effective for Palm's fiscal year ending June 1,
2001. Palm has not yet determined the impact, if any, that SAB 101 may have on
its financial position or results of operations.
In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), Accounting
for Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. FIN 44 clarifies the application of APB 25 for certain issues,
including the definition of an employee, the treatment of the acceleration of
stock options and the accounting treatment for options assumed in business
combinations. FIN 44 became effective on July 1, 2000, but is applicable for
certain transactions dating back to December 1998. The adoption of FIN 44 is not
expected to have a significant impact on Palm's financial position or results of
operations.
COMPANY-SPECIFIC TRENDS AND RISKS
RISKS RELATED TO OUR BUSINESS
IF WE FAIL TO DEVELOP AND INTRODUCE NEW PRODUCTS AND SERVICES RAPIDLY AND
SUCCESSFULLY, WE WILL NOT BE ABLE TO COMPETE EFFECTIVELY AND OUR ABILITY TO
GENERATE REVENUES WILL SUFFER.
We operate in a highly competitive, quickly changing environment, and our
future success depends on our ability to develop and introduce new products and
services that our customers and end users choose to buy. If we are unsuccessful
at developing and introducing new products and services that are appealing to
end users, our business and operating results would be negatively impacted
because we would not be able to compete effectively and our ability to generate
revenues would suffer.
The development of new products and services can be very difficult and
requires high levels of innovation. The development process is also lengthy and
costly. If we fail to anticipate our end users' needs and technological trends
accurately or are otherwise unable to complete the development of products and
services quickly, we will be unable to introduce new products and services into
the market on a timely basis, if at all. For example, we are currently
developing Internet services and content such as web-based calendaring and have
also announced new handheld device products which will contain expansion
capabilities. We cannot assure you that we will be able to introduce these
services and products on a timely basis, or that customer demand for these
services and products will meet our expectations.
Because the sales and marketing life cycle of our handheld solutions is
generally 12 to 18 months or less, we must:
- continue to develop updates to our Palm platform, new handheld devices and
new Internet services, or our existing products and services will quickly
become obsolete;
- manage the timing of new product introductions so that we minimize the
impact of customers delaying purchases of existing products in
anticipation of new product releases;
- manage the timing of new product introductions to meet seasonal market
demands, including the holiday shopping season;
- manage the levels of existing and older product and component inventories
to minimize inventory write-offs; and
26
- adjust the prices of our existing products and services in order to
increase or maintain customer demand for these products and services.
IF WE DO NOT CORRECTLY ANTICIPATE DEMAND FOR OUR PRODUCTS, WE MAY NOT BE ABLE TO
SECURE SUFFICIENT QUANTITIES OR COST-EFFECTIVE PRODUCTION OF OUR HANDHELD
DEVICES OR WE COULD HAVE COSTLY EXCESS PRODUCTION OR INVENTORIES.
Historically, we have seen steady increases in demand for our products and
have generally been able to increase production to meet that demand. However,
the demand for our products depends on many factors and is difficult to
forecast, in part due to the market for our products being relatively new and
currently experiencing high growth rates. For example, in the fourth quarter of
fiscal 2000, demand for our products exceeded our forecast and we were unable to
fully meet the demand. As we introduce and support multiple handheld device
products and as competition in the market for our products intensifies, we
expect that it will become more difficult to forecast demand. Significant
unanticipated fluctuations in demand could adversely impact our financial
results and cause the following problems in our operations:
- If demand increases beyond what we forecast, we would have to rapidly
increase production at our third party manufacturers. We depend on our
suppliers to provide additional volumes of components and those suppliers
might not be able to increase production rapidly enough to meet unexpected
demand. There is the risk that even if we are able to procure enough
components, our third party manufacturers might not be able to produce
enough of our devices to meet the market demand for our products. The
inability of either our manufacturers or our suppliers to increase
production rapidly enough could cause us to fail to meet customer demand.
- Rapid increases in production levels to meet unanticipated demand could
result in higher costs for manufacturing and supply of components and
other expenses. These higher costs could lower our profits. Furthermore,
if production is increased rapidly, manufacturing yields could decline,
which may also lower our profits.
- If forecasted demand does not develop, we could have excess production
resulting in higher inventories of finished products and components, which
would use cash and could lead to write-offs of some or all of the excess
inventories. Lower than forecasted demand could also result in excess
manufacturing capacity at our third party manufacturers and failure to
meet some minimum purchase commitments, each of which could result in
lower margins.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND SEASONALITY, AND
IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR
SHARE PRICE MAY DECREASE SIGNIFICANTLY.
Our operating results are difficult to predict. Our future quarterly
operating results may fluctuate significantly and may not meet the expectations
of securities analysts or investors. If this occurs, the price of our stock
would likely decline. Factors that may cause fluctuations in our operating
results include the following:
- Seasonality. Historically, our revenues have usually been weaker in the
first and third quarters of each fiscal year and have, from time to time,
been lower than the preceding quarter. This seasonality is due to the fact
that our devices are highly consumer-oriented, and consumer buying is
traditionally lower in these quarters. In addition, we attempt to time our
new product releases to coincide with relatively higher consumer spending
in the second and fourth fiscal quarters, which contributes to these
seasonal variations.
- Increases in Operating Expenses. As we expand our operations, we expect
that our operating expenses, particularly our sales, marketing and
research and development costs, will continue to increase. We also expect
to make significant expenditures to expand our Internet solutions and
27
services. If revenues decrease and we are unable to reduce our costs
rapidly enough, our operating results would be negatively affected. In
addition, we are adding costs to continue building an independent business
and administration infrastructure following our separation from 3Com.
- Revenue Mix. Our profit margins differ among the handheld device, Palm
platform licensing and Internet services parts of our business. In
addition, the product mix of our device sales affects profit margins in
any particular quarter. As our business evolves and the mix of revenues
from devices, licenses and services varies from quarter to quarter, our
operating results will likely fluctuate. For example, increased demand for
our licensees' products could negatively impact sales of our handheld
devices, which could adversely impact our operating results.
- New Product Introductions. As we introduce new products and services, the
timing of these introductions will affect our quarterly operating results.
We may have difficulty predicting the timing of new product and service
introductions and the user acceptance of these new products and services.
If products and services are introduced earlier or later than anticipated,
or if user acceptance is unexpectedly high or low, our quarterly operating
results may fluctuate unexpectedly. In addition, we typically increase
sales and marketing expenses to support new product introductions.
- Use of Purchase Orders with Customers. We rely on one-time purchase orders
rather than long-term contracts with our customers. Because we cannot
predict with certainty incoming purchase orders, decreases in orders or
failure to fulfill orders may cause our operating results to fluctuate.
WE RELY ON THIRD PARTY MANUFACTURERS TO PRODUCE OUR HANDHELD DEVICES, AND OUR
REPUTATION AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED BY OUR
INABILITY TO CONTROL THEIR OPERATIONS.
We outsource all of our manufacturing to Manufacturers' Services Limited and
Flextronics. We depend on these third party manufacturers to produce sufficient
volume of our products in a timely fashion and at satisfactory quality levels.
If our third party manufacturers fail to produce quality products on time and in
sufficient quantities, our reputation and results of operations would suffer. We
depend on Flextronics to manufacture some of our device products at its
facilities in Mexico, California and Malaysia, and the rest of our device
products are manufactured by Manufacturers' Services Limited at its Utah
facility. The cost, quality and availability of third party manufacturing
operations are essential to the successful production and sale of our handheld
devices. Our reliance on third parties exposes us to the following risks outside
our control:
- unexpected increases in manufacturing costs;
- interruptions in shipments if one of our manufacturers is unable to
complete production;
- inability to control quality of finished device products;
- inability to control delivery schedules;
- unpredictability of manufacturing yield;
- potential lack of adequate capacity; and
- potential inability to secure adequate volumes of components.
We began working with Manufacturers' Services Limited when it purchased
3Com's Utah facility in November 1999. As a result, we have not had significant
working experience with Manufacturers' Service Limited. If we are unable to
manage our relationship with Manufacturers' Services Limited successfully, our
ability to manufacture our products would be harmed and our results of
operations would suffer.
28
We do not have a manufacturing agreement with Flextronics, upon whom we rely
to manufacture a significant number of our device products. We presently order
our products on a purchase order basis from Flextronics. The absence of a
manufacturing agreement means that, with little or no notice, Flextronics could
refuse to continue to manufacture all or some of the units of our devices that
we require or change the terms under which it manufactures our device products.
If Flextronics were to stop manufacturing our devices, we may be unable to
replace the lost manufacturing capacity on a timely basis and our results of
operations could be harmed. In addition, if Flextronics were to change the terms
under which they manufacture for us, our manufacturing costs could increase and
our profitability could suffer.
WE DEPEND ON OUR SUPPLIERS, MANY OF WHICH ARE THE SOLE SOURCE FOR OUR
COMPONENTS, AND OUR PRODUCTION WOULD BE SERIOUSLY HARMED IF THESE SUPPLIERS ARE
NOT ABLE TO MEET OUR DEMAND AND ALTERNATIVE SOURCES ARE NOT AVAILABLE.
Our products contain components, including liquid crystal displays, touch
panels, memory chips and microprocessors, that are procured from a variety of
suppliers. The cost, quality and availability of components are essential to the
successful production and sale of our device products. Recently, including
during the fourth quarter of fiscal 2000, we have experienced shortages of
certain key components, including liquid crystal displays and related components
and flash memory chips. A number of our suppliers are capacity constrained, due
to high industry demand for their components and relatively long lead times
required to expand factory capacity. In addition, recently our ability to obtain
certain radio frequency integrated circuits was adversely impacted by a fire
which occurred at one of the manufacturing facilities used by one of our
suppliers.
Some components, such as displays, power supply integrated circuits, digital
signal processors, microprocessors, crystals and several radio frequency and
discrete components, come from sole or single source suppliers. Alternative
sources are not currently available for these sole and single source components.
If suppliers are unable to meet our demand for sole source components and if we
are unable to obtain an alternative source or if the price for an alternative
source is prohibitive, our ability to maintain timely and cost-effective
production of our handheld computing device products would be seriously harmed.
In addition, because we rely on one-time purchase orders with our suppliers,
including our sole and single source suppliers, we cannot predict with certainty
our ability to procure components if the demand for our products exceeds our
forecast. If the shortages of liquid crystal displays and related components and
flash memory chips or any other key component persists or worsens, we will
likely not be able to deliver sufficient quantities of our products to satisfy
demand. This could result in quarterly fluctuations in operating results and
could result in market share loss to competitors who are able to supply
sufficient quantities of their products to meet demand. In addition our costs to
purchase these components would increase, which would lower our profits.
WE DO NOT KNOW IF THE PALM PLATFORM LICENSING AND INTERNET SERVICES PARTS OF OUR
BUSINESS WILL BE ABLE TO GENERATE SIGNIFICANT REVENUE IN THE FUTURE, AND WE WILL
CONTINUE TO RELY ON OUR HANDHELD DEVICE PRODUCTS AS THE PRIMARY SOURCE OF OUR
REVENUE FOR THE FORESEEABLE FUTURE.
Our future growth and a significant portion of our future revenue depend on
the commercial success of our Palm handheld devices, which comprise the primary
product line that we currently offer. We expanded our Palm platform licensing
and Internet services parts of our business only recently, and these parts of
our business have generated a small percentage of our revenues. If revenues from
our device business do not grow, our other business activities may not be able
to compensate for this shortfall.
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A SIGNIFICANT PORTION OF OUR REVENUES CURRENTLY COMES FROM A SMALL NUMBER OF
DISTRIBUTORS, AND ANY DECREASE IN REVENUES FROM THESE DISTRIBUTORS COULD HARM
OUR RESULTS OF OPERATIONS.
A significant portion of our revenues comes from only a small number of
distributors. Ingram Micro and Tech Data represented approximately 25% and 8%,
respectively, of our revenues in the year ended June 2, 2000. We expect that the
majority of our revenues will continue to depend on sales of our handheld
devices to a small number of distributors. Any downturn in the business of these
customers could seriously harm our revenues and results of operations.
WE RELY ON DISTRIBUTORS, RETAILERS AND RESELLERS TO SELL OUR PRODUCTS, AND
DISRUPTIONS TO THESE CHANNELS WOULD ADVERSELY AFFECT OUR ABILITY TO GENERATE
REVENUES FROM THE SALE OF OUR HANDHELD DEVICES.
Because we sell a significant portion of our products to distributors,
retailers and traditional and Internet based resellers, we are subject to many
risks, including risks related to their inventory levels and support for our
products. Historically, our distributors, retailers and resellers have
maintained significant levels of our products in their inventories. However, in
the fourth quarter of fiscal 2000, we were generally unable to fully meet the
demand for our products from our distributors, retailers and resellers. If we
are unable to supply our distributors, retailers and resellers with sufficient
levels of inventory to meet customer demand, our sales could be negatively
impacted.
Our distributors, retailers and resellers also sell products offered by our
competitors. In the fourth quarter of fiscal 2000, we were generally unable to
fully meet the demand for our products based on orders placed by our
distributors, retailers and resellers. If our competitors offer our
distributors, retailers and resellers more favorable terms or have more products
available to meet their needs, those distributors, retailers and resellers may
de-emphasize or decline to carry our products or carry our competitors' products
instead. In the future, we may not be able to retain or attract a sufficient
number of qualified distributors, retailers and resellers. Further,
distributors, retailers and resellers may not recommend, or continue to
recommend, our products. If we are unable to maintain successful relationships
with distributors, retailers and resellers or to expand our distribution
channels, our business will suffer.
If we reduce the prices of our products to our distributors, retailers and
resellers, we may have to compensate them for the difference between the higher
price they paid to buy their inventory and the new lower prices. In addition,
like other manufacturers, we are exposed to the risk of product returns from
distributors, either through their exercise of contractual return rights or as a
result of our strategic interest in assisting distributors in balancing
inventories.
We believe our distributors, retailers and traditional resellers are
experiencing heightened competition from Internet-based suppliers that
distribute directly to end-user customers, and that competition among
Internet-based suppliers is increasing. We also sell our products directly to
end-user customers from our Palm.com website. These actions could cause conflict
among our channels of distribution, which could seriously harm our revenues and
results of operations.
IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR
RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS, FEWER
CUSTOMER ORDERS, REDUCED MARGINS AND LOSS OF MARKET SHARE.
We compete in the handheld device, operating system software and Internet
services markets. The markets for these products and services are highly
competitive and we expect competition to increase in the future. Some of our
competitors or potential competitors have significantly greater financial,
technical and marketing resources than we do. These competitors may be able to
respond more rapidly than Palm to new or emerging technologies or changes in
customer requirements. They may also devote greater resources to the
development, promotion and sale of their products than we do.
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- Our handheld computing device products compete with a variety of smart
handheld devices, including keyboard-based devices, sub-notebook
computers, smart phones and two-way pagers. Our principal competitors
include Casio, Compaq, Hewlett-Packard, Psion, Research in Motion Limited,
Sharp and Palm platform licensees such as Handspring, Sony and TRG.
- Our Palm platform competes primarily with operating systems such as
Microsoft's Windows CE for palm-sized personal computers (Pocket PC) and
Symbian's EPOC for wireless devices. Licensees of our Palm platform are
under no obligation to introduce new products based on our operating
system, and may elect to use an alternative operating system, in which
case we may not be able to increase our revenue from licensing the Palm
platform, or expand the proliferation of the Palm economy.
- Our Internet services compete with a variety of alternative technologies
and services, such as those based on different industry standards for
wireless Internet access, information appliances that provide Internet
connectivity and other traditional and developing methods. Competitors to
our wireless Internet services include Research in Motion Limited and
Omnisky. Our subscription-model access business also competes indirectly
with other providers of Internet access, ranging from dedicated Internet
service providers such as America Online and Earthlink to local phone
companies.
We expect our competitors to continue to improve the performance of their
current products and services and to introduce new products, services and
technologies. For example, Microsoft recently introduced a new version of its
Windows CE operating system. We believe that Microsoft is investing aggressively
to assist its licensees in marketing the Pocket PC line of handheld computers
based on this new version of the Windows CE operating system. Successful new
product introductions or enhancements by our competitors, or increased market
acceptance of competing products, such as the Pocket PC line, could reduce the
sales and market acceptance of our products and services, cause intense price
competition or make our products obsolete. To be competitive, we must continue
to invest significant resources in research and development, sales and marketing
and customer support. We cannot be sure that we will have sufficient resources
to make these investments or that we will be able to make the technological
advances necessary to be competitive. Increased competition could result in
price reductions, fewer customer orders, reduced margins and loss of market
share. Our failure to compete successfully against current or future competitors
could seriously harm our business, financial condition and results of
operations.
IF WE FAIL TO EFFECTIVELY RESPOND TO COMPETITION FROM PRODUCTS INTRODUCED BY
LICENSEES OF OUR PALM PLATFORM OR IF OUR LICENSEES FAIL TO SELL PRODUCTS BASED
ON THE PALM PLATFORM, OUR RESULTS OF OPERATIONS MAY SUFFER AS THE REVENUES WE
RECEIVE FROM LICENSE FEES MAY NOT COMPENSATE FOR THE LOSS OF REVENUES FROM OUR
DEVICE PRODUCTS.
The success of our business depends on both the sale of handheld device
products and the licensing of our Palm platform. However, licensees of our Palm
platform offer products that compete directly or indirectly with our handheld
computing devices. For example, licensees such as Handspring and Sony use our
Palm platform in products that can compete with our handheld devices. In
addition, our Palm platform has been licensed by other manufactures such as
Nokia and QUALCOMM for use in devices such as mobile phones or other similar
products that can compete indirectly with our handheld devices. If revenues from
our handheld devices suffer because of competition from licensees of our Palm
platform, our results of operations would suffer and our ability to implement
our business model would be seriously challenged. In addition, our licensees may
not be successful in selling products based on the Palm platform, which could
harm our business and results of operations.
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DEMAND FOR OUR PRODUCTS IS PARTIALLY DEPENDENT UPON SUPPORT FROM THIRD PARTY
SOFTWARE AND HARDWARE DEVELOPERS.
Decisions by customers to purchase our handheld device products, as opposed
to competitive product offerings, are sometimes based on the availability of
third party software, hardware and other expansion capabilties. In the future,
we believe that the level of support from third party developers in developing
products which provide expansion capabilities to handheld devices will become
increasingly important. For example, Handspring's line of Visor products feature
a hardware expansion slot. While we believe that our products compete favorably
with respect to expansion capabilities, our operating results could be adversely
impacted if third party developers focus their efforts on developing products
that provide expansion capabilities to competitive product offerings.
OUR PALM PLATFORM AND HANDHELD DEVICES MAY CONTAIN ERRORS OR DEFECTS, WHICH
COULD RESULT IN THE REJECTION OF OUR PRODUCTS AND DAMAGE TO OUR REPUTATION, AS
WELL AS LOST REVENUES, DIVERTED DEVELOPMENT RESOURCES AND INCREASED SERVICE
COSTS AND WARRANTY CLAIMS.
Our Palm platform and our devices are complex and must meet stringent user
requirements. We must develop our software and hardware products quickly to keep
pace with the rapidly changing handheld device market. Products and services as
sophisticated as ours are likely to contain undetected errors or defects,
especially when first introduced or when new models or versions are released. We
have in the past experienced delays in releasing some models and versions of our
products until problems were corrected. Our products may not be free from errors
or defects after commercial shipments have begun, which could result in the
rejection of our products, damage to our reputation, lost revenues, diverted
development resources and increased customer service and support costs and
warranty claims. Any of these results could harm our business. For instance, we
recently experienced increased support costs related to a faulty memory
component used in a limited number of our handheld devices, which required us to
develop a software patch to address the problem.
IF WE FAIL TO MANAGE OUR GROWTH EFFECTIVELY, WE MAY NOT BE ABLE TO SUCCESSFULLY
MANAGE OUR BUSINESS, WHICH COULD CAUSE US TO FAIL TO MEET OUR CUSTOMER DEMAND OR
TO ATTRACT NEW CUSTOMERS.
Our ability to successfully offer our products and implement our business
plan in a rapidly evolving market requires an effective planning and management
process. We continue to increase the scope of our operations domestically and
internationally and have grown our shipments and headcount substantially. At
December 31, 1999, we had a total of approximately 652 employees. At June 2,
2000 we had a total of approximately 951 employees. In addition, we plan to
continue to hire a significant number of employees this year. This growth has
placed, and our anticipated growth in future operations will continue to place,
a significant strain on our management systems and resources and increase our
expenses.
We expect that we will need to continue to improve our financial and
managerial controls, reporting systems and procedures. While we have implemented
stand-alone versions of most of the transaction processing systems historically
used by 3Com, we intend to implement new systems over the next 12-18 months that
more closely match our business needs and to incur significant additional
expenses in connection with those systems. In addition, we will need to continue
to expand, train and manage our work force worldwide.
Furthermore, we expect that we will be required to manage multiple
relationships with various customers and other third parties. In particular, we
are implementing a new administrative and managerial infrastructure due to our
separation from 3Com. Our future success depends on the effective implementation
of this infrastructure.
We have recently announced two acquisitions, and may make additional
strategic acquisitions in the future. Acquisitions will make it more difficult
to effectively manage our growth, due to a number
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of factors including the addition of new employees, the expansion of our
operations into new geographic areas and the increased geographic dispersion of
our personnel, and the expansion of our product and service offerings. If we are
not able to successfully integrate acquired companies into our business, our
results of operations could be adversely impacted.
THE MARKET FOR THE DELIVERY OF INTERNET SERVICES THROUGH HANDHELD DEVICES IS NEW
AND RAPIDLY EVOLVING, AND OUR BUSINESS AND OUR ABILITY TO GENERATE REVENUES FROM
OUR HANDHELD DEVICES, PALM PLATFORM OR INTERNET SERVICES COULD SUFFER IF THIS
MARKET DOES NOT DEVELOP OR WE FAIL TO ADDRESS THIS MARKET EFFECTIVELY.
The market for the delivery of Internet services through handheld devices is
new and rapidly evolving. In addition, our Internet services strategy has been
developed only recently, and we must continue to adapt it to compete in the
rapidly evolving Internet services market. We currently offer our Palm.Net
service, a subscription-based wireless access service that enables Palm VII
handheld users to access web-clipped content on the Internet. We are currently
developing additional functionality for our Internet services and solutions.
Other competitors have introduced or developed, or are in the process of
introducing or developing competing Internet services accessible through a
variety of handheld devices and other information appliances. We cannot assure
you that there will be demand for the Internet services provided by us or that
individuals, will widely adopt our handheld devices as a means of accessing
Internet services. Accordingly, it is extremely difficult to predict which
products and services will be successful in this market or the future size and
growth of this market. In addition, given the limited history and rapidly
evolving nature of this market, we cannot predict the price that wireless
subscribers will be willing to pay for these products and services. If
acceptance of our Internet services and solutions is less than anticipated, our
ability to expand our business could be impacted.
WE MAY NOT BE ABLE TO DELIVER INTERNET ACCESS IF OUR TELECOMMUNICATIONS CARRIER
RAISES ITS RATES, DISCONTINUES DOING BUSINESS WITH US OR DOES NOT DELIVER
ACCEPTABLE SERVICE.
The future success of our Internet services business substantially depends
on the capacity, affordability, reliability and security of our
telecommunications networks. Only a small number of telecommunications providers
offer the network services we require. We currently rely on BellSouth Wireless
Data to provide all of our Palm VII wireless network services pursuant to an
agreement. Our agreement with BellSouth permits each party to terminate the
agreement on an annual basis. If BellSouth failed to provide us with service at
rates acceptable to us or at all, we may not be able to provide Internet access
to our users. In addition, our Palm VII products are configured around the
frequency standard used by BellSouth. If we needed to switch to another
telecommunications carrier, we would have to redesign significant portions of
our software and hardware to permit transmission on a different frequency and
service to users of existing Palm VII products would be disrupted. If we were
required to redesign these elements, the Internet services part of our business
could be adversely affected. If BellSouth delivers unacceptable service, the
quality of our Internet services would suffer and we would likely lose users who
are dissatisfied with our service. In addition, BellSouth provides service only
in the continental United States.
WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR WIRELESS INTERNET SERVICES INTO
INTERNATIONAL MARKETS.
We intend to expand our network services to support Internet services
internationally, but doing so will require us to enter into new relationships
with telecommunications providers abroad. We may not be able to enter into
relationships with international telecommunications providers, which are on
favorable terms to us. In addition, because many international
telecommunications providers use different standards and transmit data on
different frequencies than BellSouth, we are likely to incur incremental
expenses related to the redesign of significant portions of our software and
hardware.
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OUR REPUTATION AND ABILITY TO GENERATE REVENUES WILL BE HARMED IF DEMAND FOR OUR
INTERNET SERVICES EXCEEDS OUR TELECOMMUNICATIONS AND NETWORK CAPACITY.
We may from time to time experience increases in our Internet services usage
which exceed our available telecommunications capacity and the capacity of our
third party network servers. As a result, users may be unable to register or log
on to our service, may experience a general slow-down in their Internet access
or may be disconnected from their sessions. Excessive user demand could also
result in system failures of our third party network servers' networks.
Inaccessibility, interruptions or other limitations on the ability to access
our service due to excessive user demand, or any failure of our third party
network servers to handle user traffic, would have a material adverse effect on
our reputation and our revenues.
WE PLAN TO EXPAND OUR DIRECT E-COMMERCE OPERATION, AND OUR ABILITY TO GENERATE
REVENUES FROM OUR INTERNET SERVICES COULD BE HARMED IF THIS OPERATION IS NOT
SUCCESSFUL.
We may not be able to achieve any or all of the necessary components of a
successful e-commerce operation. We intend to expand our Palm.com and Palm.net
websites. This expansion will require additional expenditures. We have little
experience in implementing or operating a direct e-commerce business, and if we
are not successful in operating it or in successfully managing our current sales
channels alongside our direct e-commerce channel, our business and financial
condition could be materially harmed.
OUR INTERNET SERVICES BUSINESS PROSPECTS COULD SUFFER IF THE INTERNET DOES NOT
CONTINUE TO GROW AS A MEDIUM FOR INTERACTIVE CONTENT AND SERVICES.
Our future success depends in part on the continued growth and reliance by
consumers and businesses on the Internet, particularly in the market for
Internet services and networking of handheld computing devices. Use and growth
of the Internet will depend in significant part on continued rapid growth in the
number of households and commercial, educational and government institutions
with access to the Internet. The use and growth of the Internet will also depend
on the number and quality of products and services designed for use on the
Internet. Because use of the Internet as a source of information, products and
services is a relatively recent phenomenon, it is difficult to predict whether
the number of users drawn to the Internet will continue to increase and whether
the market for commercial use of the Internet will continue to develop and
expand. Internet use patterns may decline as the novelty of the medium recedes.
The rapid rise in the number of Internet users and the growth of electronic
commerce and applications for the Internet has placed increasing strains on the
Internet's communications and transmission infrastructure. This could lead to
significant deterioration in transmission speeds and the reliability of the
Internet as a commercial medium and could reduce the use of the Internet by
businesses and individuals. The Internet may not be able to support the demands
placed upon it by this continued growth. Any failure of the Internet to support
growth due to inadequate infrastructure or for any other reason would seriously
limit its development as a viable source of commercial and interactive content
and services. This could impair the development and acceptance of our Internet
services, which could in turn harm our business prospects.
IF THE SECURITY OF OUR WEBSITES IS COMPROMISED, OUR REPUTATION COULD SUFFER AND
CUSTOMERS MAY NOT BE WILLING TO USE OUR INTERNET SERVICES, WHICH COULD CAUSE OUR
REVENUES TO DECLINE.
A significant barrier to widespread use of electronic commerce sites, such
as our Palm.com site, and network services sites, such as our Palm.net site, is
concern for the security of confidential information transmitted over public
networks. Despite our efforts to protect the integrity of our Palm.com and
Palm.net sites, a party may be able to circumvent our security measures and
could
34
misappropriate proprietary information or cause interruptions in our operations
and damage our reputation. Any such action could negatively affect our
customers' willingness to engage in online commerce with us. We may be required
to expend significant capital and other resources to protect against these
security breaches or to alleviate problems caused by these breaches.
WE MAY NOT BE ABLE TO MAINTAIN AND EXPAND OUR BUSINESS IF WE ARE NOT ABLE TO
RETAIN, HIRE AND INTEGRATE SUFFICIENT QUALIFIED PERSONNEL.
Our future success depends to a significant extent on the continued
contribution of our key executive, technical, sales, marketing, supply chain and
administrative personnel. It also depends on our ability to expand, integrate
and retain our management team. The loss of services of key employees could
adversely affect our business, operating results or financial condition. Many
members of our senior management have been with the business only a short time.
In addition, recruiting and retaining skilled personnel, including software and
hardware engineers, is highly competitive, particularly in the San Francisco Bay
Area where we are headquartered. If we fail to retain, hire and integrate
qualified employees and contractors, we will not be able to maintain and expand
our business. In addition, we must carefully balance the growth of our employees
commensurate with our anticipated revenue growth. If our revenue growth or
attrition levels vary significantly, our results of operations or financial
condition could be adversely affected. Further, our common stock price has been,
and may continue to be extremely volatile. When our common stock price is less
than the exercise price of stock options granted to employees, turnover is
likely to increase, which could adversely affect our results of operations or
financial condition.
THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE WE ARE INFRINGING THEIR
INTELLECTUAL PROPERTY, AND WE COULD SUFFER SIGNIFICANT LITIGATION OR LICENSING
EXPENSES OR BE PREVENTED FROM SELLING PRODUCTS IF THESE CLAIMS ARE SUCCESSFUL.
In the course of our business, we frequently receive claims of infringement
or otherwise become aware of potentially relevant patents or other intellectual
property rights held by other parties. We evaluate the validity and
applicability of these intellectual property rights, and determine in each case
whether we must negotiate licenses or cross-licenses to incorporate or use the
proprietary technologies in our products. Third parties may claim that we or our
customers or Palm platform licensees are infringing their intellectual property
rights, and we may be found to infringe those intellectual property rights and
require a license to use those rights. We may be unaware of intellectual
property rights of others that may cover some of our technology, products and
services.
For a description of pending lawsuits involving claims that we are
infringing a third party's intellectual property, refer to Part I--Item 3--Legal
Proceedings of this Report on Form 10-K.
Any litigation regarding patents or other intellectual property could be
costly and time-consuming, and divert our management and key personnel from our
business operations. The complexity of the technology involved and the
uncertainty of intellectual property litigation increase these risks. Claims of
intellectual property infringement might also require us to enter into costly
royalty or license agreements or indemnify our Palm platform licensees. However,
we may not be able to obtain royalty or license agreements on terms acceptable
to us, or at all. We also may be subject to significant damages or injunctions
against development and sale of our products.
We often rely on licenses of intellectual property for use in our business.
We cannot assure you that these licenses will be available in the future on
favorable terms or at all.
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IF THIRD PARTIES INFRINGE OUR INTELLECTUAL PROPERTY, WE MAY EXPEND SIGNIFICANT
RESOURCES ENFORCING OUR RIGHTS OR SUFFER COMPETITIVE INJURY.
Our success depends in large part on our proprietary technology. We rely on
a combination of patents, copyrights, trademarks and trade secrets,
confidentiality provisions and licensing arrangements to establish and protect
our proprietary rights. If we fail to protect or to enforce our intellectual
property rights successfully, our competitive position could suffer, which could
harm our operating results.
Our pending patent and trademark registration applications may not be
allowed or competitors may challenge the validity or scope of these patent
applications or trademark registrations. In addition, our patents may not
provide us a significant competitive advantage.
We may be required to spend significant resources to monitor and police our
intellectual property rights. We may not be able to detect infringement and may
lose competitive position in the market before we do so. In addition,
competitors may design around our technology or develop competing technologies.
Intellectual property rights may also be unavailable or limited in some foreign
countries, which could make it easier for competitors to capture market share.
In the past, there have been thefts of computer equipment from us and our
employees. This computer equipment has contained proprietary information. We
have formulated a security plan to reduce the risk of any future thefts and have
cooperated with state and federal law enforcement officials in an investigation
of past incidents. We may not be successful in preventing future thefts, or in
preventing those responsible for past thefts from using our technology to
produce competing products. The unauthorized use of Palm technology by
competitors could have a material adverse effect on our ability to sell our
products in some markets.
OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS.
Since we sell our products worldwide, our business is subject to risks
associated with doing business internationally. We anticipate that revenue from
international operations will represent an increasing portion of our total
revenue. In addition, two of the facilities where our devices are manufactured
are located outside the United States. Accordingly, our future results could be
harmed by a variety of factors, including:
- changes in foreign currency exchange rates;
- changes in a specific country's or region's political or economic
conditions, particularly in emerging markets;
- trade protection measures and import or export licensing requirements;
- potentially negative consequences from changes in tax laws;
- difficulty in managing widespread sales and manufacturing operations; and
- less effective protection of intellectual property.
WE INTEND TO PURSUE STRATEGIC ACQUISITIONS AND WE MAY NOT BE ABLE TO
SUCCESSFULLY MANAGE OUR OPERATIONS IF WE FAIL TO SUCCESSFULLY INTEGRATE ACQUIRED
BUSINESSES.
Recently, we announced the acquisitions of Actual Software and Anyday.com.
In addition, we often evaluate other acquisition opportunities that could
provide us with additional product or services offerings or additional industry
expertise. Any previously announced or future acquisitions could result in
difficulties assimilating acquired operations and products, and result in the
diversion of capital and management's attention away from other business issues
and opportunities. Integration of acquired
36
companies may result in problems related to integration of technology and
inexperienced management teams. Our management has had limited experience in
assimilating acquired organizations and products into our operations. We may not
successfully integrate any operations, personnel or products that we have
acquired or may acquire in the future. If we fail to successfully integrate
acquisitions, our business could be materially harmed.
OUR ABILITY TO PURSUE MERGERS AND ACQUISITIONS MAY BE LIMITED.
3Com has obtained a ruling from the Internal Revenue Service that the
distribution of 3Com's shares of Palm common stock to 3Com's stockholders will
be not be taxable. Such ruling requires 3Com and Palm, through July 27, 2002,
not to engage in certain transactions that would constitute a change of more
than 50% of the equity interest in either company. Consequently, our ability to
engage in mergers and acquisitions will be limited by this requirement. If
either 3Com or Palm fail to conform to requirements set forth in the ruling,
there would be material adverse consequences, potentially including making the
distribution taxable, and causing the company which was responsible for such
non-conformance to indemnify the other company for any resulting damages.
WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC AND FASB.
Recent actions and comments from the SEC have focused on the integrity of
financial reporting. In addition, the FASB and other regulatory accounting
agencies have recently introduced several new or proposed accounting standards,
some of which represent a significant change from current industry practices.
For example, In December 1999, the SEC issued Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements." SAB 101 provides
guidance on the recognition, presentation, and disclosure of revenue in
financial statements of all public registrants. In response to numerous requests
for interpretive guidance of SAB 101, the effective date of the standard has
been delayed twice. We currently expect SAB 101 to become effective during
fiscal 2001. Depending on the final interpretation of the standard, the adoption
of SAB 101 may have a material effect on our reported revenues and results of
operations for any particular quarter. However, we believe that the impact of
SAB 101 will not have a material effect on the underlying strength or weakness
of our business operations as measured by the dollar value of our product
shipments and cash flows.
RISKS RELATED TO OUR SEPARATION FROM 3COM
WE CURRENTLY USE 3COM'S OPERATIONAL AND ADMINISTRATIVE INFRASTRUCTURE, AND OUR
ABILITY TO SATISFY OUR CUSTOMERS AND OPERATE OUR BUSINESS WILL SUFFER IF WE DO
NOT DEVELOP OUR OWN INFRASTRUCTURE QUICKLY AND COST-EFFECTIVELY.
We currently use duplicated versions of 3Com's systems to support our
operations, including systems to manage inventory, order processing, human
resources, shipping, accounting, payroll and internal computing operations. Many
of these systems were not optimized for Palm's business processes and are very
complex. Over the next 12-18 months, we will be implementing new systems to
replace the duplicated versions of 3Com's systems. We may not be successful in
implementing these systems and transitioning data from the duplicated versions
of 3Com's systems to our new systems. We continue to rely upon the network
infrastructure provided and maintained by 3Com. We are in the process of
migrating to our own network infrastructure which we intend to outsource to a
third party. We may experience network interruptions related to either the
current 3Com network infrastructure or the migration to our new network
infrastructure maintained by a third party.
Any failure or significant downtime in 3Com's or our own network or
information systems could prevent us from taking customer orders, shipping
products or billing customers and could harm our business. In addition, our
network and information systems require the services of employees with extensive
knowledge of these information systems and the business environment in which we
operate.
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In order to successfully implement and operate our systems, we must be able to
attract and retain a significant number of highly skilled employees. If we fail
to attract and retain the highly skilled personnel required to implement,
maintain, and operate our information systems, our business could suffer.
In addition, we currently lease office space from 3Com in Santa Clara and
other locations. We have entered into arrangements with 3Com to lease our Santa
Clara facilities under a lease that is terminable with six months notice
beginning in July 2001 and expires in February 2003. After this transition
period, we will need to find alternative facilities. We are currently in the
process of locating additional space and negotiating the lease terms to meet our
expected facilities requirements for the foreseeable future. If we fail to
successfully conclude this negotiation process, or fail to find other
replacement facilities in a timely fashion, our business will be harmed.
OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR RESULTS AS
A SEPARATE COMPANY.
Through February 25, 2000, our consolidated financial statements were carved
out from the consolidated financial statements of 3Com using the historical
results of operations and historical bases of the assets and liabilities of the
3Com handheld computing business that we comprised. Accordingly, the historical
financial information does not necessarily reflect what our financial position,
results of operations and cash flows would have been had we been a separate,
stand-alone entity during the periods presented. 3Com did not account for us,
and we were not operated, as a separate, stand-alone entity for the periods
presented.
Our costs and expenses include allocations from 3Com for centralized
corporate services and infrastructure costs, including:
- legal;
- accounting;
- treasury;
- real estate;
- information technology;
- distribution;
- customer service;
- sales;
- marketing; and
- engineering.
These allocations were determined on bases that 3Com and Palm considered to
be reasonable reflections of the utilization of services provided to or the
benefit received by Palm. The historical financial information is not
necessarily indicative of what our results of operations, financial position and
cash flows will be in the future. We have not made adjustments to our historical
financial information to reflect the many significant changes that have occurred
and will occur in our cost structure, funding and operations as a result of our
separation from 3Com, including increased costs associated with reduced
economies of scale, increased marketing expenses related to building a company
brand identity separate from 3Com and increased costs associated with being a
publicly traded, stand-alone company.
38
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH 3COM WITH RESPECT TO
OUR PAST AND ONGOING RELATIONSHIPS AND MAY NOT RESOLVE THESE CONFLICTS ON THE
MOST FAVORABLE TERMS TO US.
Conflicts of interest may arise between 3Com and us in a number of areas
relating to our past and ongoing relationships, including:
- labor, tax, employee benefit, indemnification and other matters arising
from our separation from 3Com;
- intellectual property matters;
- employee retention and recruiting;
- sales or distributions by 3Com of all or any portion of its ownership
interest in us;
- the nature, quality and pricing of transitional services 3Com has agreed
to provide us; and
- business opportunities that may be attractive to both 3Com and us.
Nothing restricts 3Com from competing with us.
We may not be able to resolve any potential conflicts, and even if we do,
the resolution may be less favorable than if we were dealing with an
unaffiliated party. The agreements we have entered into with 3Com may be amended
upon agreement between the parties.
OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST BECAUSE OF
THEIR OWNERSHIP OF 3COM COMMON STOCK.
Some of our directors and executive officers have a substantial amount of
their personal financial portfolios in 3Com common stock and options to purchase
3Com common stock. Ownership of 3Com common stock by our directors and officers
could create potential or perceived conflicts of interest when directors and
officers are faced with decisions that could have different implications for
3Com and us.
IF THE TRANSITIONAL SERVICES BEING PROVIDED TO US BY 3COM ARE NOT SUFFICIENT TO
MEET OUR NEEDS, OR IF WE ARE NOT ABLE TO REPLACE THESE SERVICES AFTER OUR
AGREEMENTS WITH 3COM EXPIRE, WE WILL BE UNABLE TO MANAGE CRITICAL OPERATIONAL
FUNCTIONS OF OUR BUSINESS.
We are still procuring certain services from 3Com in areas such as
information systems, human resources administration, customer service, building
and facilities, risk management, and some areas of finance. Although 3Com is
contractually obligated to provide us with these services, these services may
not be provided at the same level as when we were part of 3Com, and we may not
be able to obtain the same benefits. We also lease and sublease office space
from 3Com. These transitional service and leasing arrangements generally have a
term of less than two years following the separation. After the expiration of
these various arrangements, we may not be able to replace the transitional
services or enter into appropriate leases in a timely manner or on terms and
conditions, including cost, as favorable as those we have received from 3Com.
These agreements were made in the context of a parent-subsidiary
relationship and were negotiated in the overall context of our separation from
3Com. The prices charged to us under these agreements may be lower than the
prices that we may be required to pay third parties for similar services or the
costs of similar services if we undertake them ourselves.
39
RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
OUR SECURITIES HAVE NOT BEEN PUBLICLY TRADED VERY LONG AND OUR STOCK PRICE MAY
BE SUBJECT TO SIGNIFICANT FLUCTUATIONS AND VOLATILITY.
Our common stock has been publicly traded only since March 2, 2000. The
market price of our common stock has been subject to significant fluctuations
since the date of our initial public offering. These fluctuations could
continue. Among the factors that could affect our stock price are:
- quarterly variations in our operating results;
- changes in revenue or earnings estimates or publication of research
reports by analysts;
- speculation in the press or investment community;
- strategic actions by us or our competitors, such as new product
announcements, acquisitions or restructuring;
- actions by institutional stockholders;
- general market conditions; and
- domestic and international economic factors unrelated to our performance.
The stock markets in general, and the markets for high technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. These broad market
fluctuations may adversely affect the trading price of our common stock.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT
ACQUISITION OF US, WHICH COULD DECREASE THE VALUE OF YOUR SHARES.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could make it harder for a third party to acquire us without the
consent of our board of directors. These provisions include a classified board
of directors and limitations on actions by our stockholders by written consent.
In addition, our board of directors has the right to issue preferred stock
without stockholder approval, which could be used to dilute the stock ownership
of a potential hostile acquirer. Delaware law also imposes some restrictions on
mergers and other business combinations between us and any holder of 15% or more
of our outstanding common stock. Although we believe these provisions provide
for an opportunity to receive a higher bid by requiring potential acquirers to
negotiate with our board of directors, these provisions apply even if the offer
may be considered beneficial by some stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY.
Palm's exposure to market risk for changes in interest rates relates
primarily to our investment portfolio, which consists entirely of cash
equivalents as of June 2, 2000. The primary objective of our investment
activities is to maintain the safety of principal and preserve liquidity while
maximizing yields without significantly increasing risk. This is accomplished by
investing in marketable investment grade securities, and by limiting exposure to
any one issue or issuer. We do not use derivative financial instruments in our
investment portfolio and due to the nature of our investments, we do not expect
our operating results or cash flows to be affected to any significant degree by
the effect of a sudden change in market interest rates on our investment
portfolio. As of June 2, 2000, all investments mature within 90 days and are
carried at cost, which approximates fair market value.
40
FOREIGN CURRENCY EXCHANGE RISK
Prior to our separation from 3Com, our exposure to foreign currency exchange
rate risk was managed on an enterprise-wide basis as part of 3Com's risk
management strategy. This strategy has utilized foreign exchange forward and
option contracts to hedge certain balance sheet exposures and intercompany
balances against future movements in foreign exchange rates. Having now
separated from 3Com, we will manage our exchange rate risk on an independent
basis. Currently, substantially all of our sales are denominated in US dollars.
We do not currently and do not intend in the future to utilize derivative
financial instruments for trading purposes.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE
--------
Consolidated Financial Statements:
Independent Auditors' Report.............................. 43
Consolidated Statements of Operations for the years ended
June 2, 2000, May 28, 1999 and May 31, 1998............. 44
Consolidated Balance Sheets at June 2, 2000 and May 28,
1999.................................................... 45
Consolidated Statements of Stockholders' Equity for the
years ended June 2, 2000, May 28, 1999 and May 31,
1998.................................................... 46
Consolidated Statements of Cash Flows for the years ended
June 2, 2000, May 28, 1999 and May 31, 1998............. 47
Notes to Consolidated Financial Statements................ 48
Quarterly Results of Operations (Unaudited)............... 67
Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts............ 72
All other schedules are omitted, because they are not required, are not
applicable, or the information is included in the consolidated financial
statements and notes thereto.
42
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Palm, Inc.:
We have audited the consolidated balance sheets of Palm, Inc. and its
subsidiaries ("Palm" or "the Company") as of June 2, 2000 and May 28, 1999, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended June 2, 2000. Our
audits also included the financial statement schedule listed in the Index at
Item 14. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Palm, Inc.
and its subsidiaries at June 2, 2000 and May 28, 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
June 2, 2000 in conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion, such financial statement
schedule referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
June 21, 2000
(July 27, 2000 as to Note 12)
43
PALM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED
--------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
---------- -------- --------
Revenues.................................................... $1,057,597 $563,525 $272,137
Cost of revenues............................................ 613,083 315,616 157,749
---------- -------- --------
Gross profit................................................ 444,514 247,909 114,388
Operating expenses:
Sales and marketing....................................... 236,811 127,726 70,765
Research and development.................................. 75,768 46,027 21,863
General and administrative................................ 50,916 23,692 15,299
Purchased in-process technology........................... -- 2,125 --
Separation costs.......................................... 19,570 -- --
---------- -------- --------
Total operating expenses................................ 383,065 199,570 107,927
---------- -------- --------
Operating income............................................ 61,449 48,339 6,461
Interest and other income (expense), net.................... 16,364 (223) (56)
---------- -------- --------
Income before income taxes.................................. 77,813 48,116 6,405
Income tax provision........................................ 31,903 18,488 2,234
---------- -------- --------
Net income.................................................. $ 45,910 $ 29,628 $ 4,171
========== ======== ========
Net income per share:
Basic..................................................... $ 0.09 $ 0.06 $ 0.01
========== ======== ========
Diluted................................................... $ 0.09 $ 0.06 $ 0.01
========== ======== ========
Shares used in computing per share amounts:
Basic..................................................... 539,739 532,000 532,000
Diluted................................................... 539,851 532,000 532,000
See notes to consolidated financial statements.
44
PALM, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
JUNE 2, MAY 28,
2000 1999
---------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $1,062,128 $ 478
Accounts receivable, net of allowance for doubtful
accounts of $6,810 and $3,817, respectively............. 122,276 95,839
Inventories............................................... 24,057 12,186
Deferred income taxes..................................... 34,907 20,688
Prepaids and other........................................ 9,590 1,038
---------- --------
Total current assets.................................... 1,252,958 130,229
Property and equipment, net................................. 13,013 8,136
Goodwill, intangibles and other assets...................... 14,330 13,829
Deferred income taxes....................................... 2,375 53
---------- --------
Total assets............................................ $1,282,676 $152,247
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 104,732 $ 35,577
Payable to 3Com Corporation............................... 18,374 40,509
Other accrued liabilities................................. 117,376 41,461
---------- --------
Total current liabilities............................... 240,482 117,547
Non-current liabilities
Deferred revenue and other................................ 13,006 682
Stockholders' equity:
Preferred stock, $.001 par value, 125,000 shares
authorized; none outstanding............................ -- --
Common stock, $.001 par value, 2,000,000 shares
authorized; outstanding: June 2, 2000, 564,963 shares;
May 28, 1999, 532,000 shares............................ 565 --
Additional paid-in capital................................ 1,032,449 --
Unamortized restricted stock grants....................... (16,053) --
3Com Corporation equity................................... -- 34,151
Retained earnings......................................... 12,437 --
Accumulated other comprehensive income (loss)............. (210) (133)
---------- --------
Total stockholders' equity.............................. 1,029,188 34,018
---------- --------
Total liabilities and stockholders' equity.............. $1,282,676 $152,247
========== ========
See notes to consolidated financial statements.
45
PALM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
ADDITIONAL UNAMORTIZED OTHER
COMMON PAID-IN RESTRICTED 3COM CORP. RETAINED COMPREHENSIVE
STOCK CAPITAL STOCK GRANTS EQUITY EARNINGS INCOME (LOSS) TOTAL
-------- ---------- ------------ ---------- -------- ------------- ----------
Balances, May 25, 1997....... $ -- $ -- $ -- $ 31,245 $ -- $ -- $ 31,245
Net income................... -- -- -- 4,171 -- -- 4,171
Net transfers from 3Com
Corporation................ -- -- -- 30,259 -- -- 30,259
---- ---------- -------- -------- ------- ----- ----------
Balances, May 31, 1998....... -- -- -- 65,675 -- -- 65,675
Components of comprehensive
income:
Net income................. -- -- -- 29,628 -- -- 29,628
Accumulated translation
adjustments.............. -- -- -- -- -- (133) (133)
----------
Total comprehensive income... 29,495
----------
Net transfers to 3Com
Corporation................ -- -- -- (61,152) -- -- (61,152)
---- ---------- -------- -------- ------- ----- ----------
Balances, May 28, 1999....... -- -- -- 34,151 -- (133) 34,018
Components of comprehensive
income:
Net income................. -- -- -- 33,473 12,437 -- 45,910
Accumulated translation
adjustments.............. -- -- -- -- -- (77) (77)
----------
Total comprehensive income... 45,833
----------
Dividend paid to 3Com
Corporation................ -- -- -- (150,000) -- -- (150,000)
Net transfers to 3Com
Corporation................ (77,144) (77,144)
Reclassification of 3Com
equity to additional
paid-in capital............ -- (159,520) -- 159,520 -- -- --
Initial public offering and
private placements, net of
offering expenses.......... 564 1,171,961 -- -- -- -- 1,172,525
Common stock issued under
stock plans................ 1 17,044 (16,483) -- -- -- 562
Restricted stock
amortization............... -- -- 430 -- -- -- 430
Tax benefit from employee
stock options.............. -- 2,964 -- -- -- -- 2,964
---- ---------- -------- -------- ------- ----- ----------
Balances, June 2, 2000....... $565 $1,032,449 $(16,053) $ -- $12,437 $(210) $1,029,188
==== ========== ======== ======== ======= ===== ==========
See notes to consolidated financial statements.
46
PALM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED
--------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
---------- -------- --------
Cash flows from operating activities:
Net income................................................ $ 45,910 $ 29,628 $ 4,171
Adjustments to reconcile net income to net cash provided
by (used in) operating acitivities:
Depreciation and amortization........................... 7,951 4,565 2,029
Loss on disposal of property and equipment.............. 962 2,567 145
Deferred income taxes................................... (16,541) (8,880) (5,361)
Purchased in-process technology......................... -- 2,125 --
Changes in assets and liabilities:
Accounts receivable................................... (26,437) (13,307) (56,783)
Inventories........................................... (11,871) 1,650 (397)
Prepaids and other.................................... (9,004) (805) (176)
Accounts payable...................................... 69,155 19,437 10,874
Payable to 3Com Corporation........................... (22,135) 24,892 11,205
Other accrued liabilities............................. 90,869 22,133 12,867
---------- -------- --------
Net cash provided by (used in) operating
activities........................................ 128,859 84,005 (21,426)
---------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment....................... (10,393) (5,347) (8,833)
Acquisition of businesses, net of cash acquired........... (1,648) (16,831) --
Other, net................................................ -- 97 --
---------- -------- --------
Net cash used in investing activities............... (12,041) (22,081) (8,833)
---------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 1,172,525 -- --
Net transfers (to) from 3Com Corporation.................. (77,144) (61,152) 30,259
Dividend paid to 3Com..................................... (150,000) -- --
Repayment of debt......................................... (902) -- --
Other, net................................................ 353 (294) --
---------- -------- --------
Net cash provided by (used in) financing
activities........................................ 944,832 (61,446) 30,259
---------- -------- --------
Change in cash and cash equivalents......................... 1,061,650 478 --
Cash and cash equivalents, beginning of period.............. 478 -- --
---------- -------- --------
Cash and cash equivalents, end of period.................... $1,062,128 $ 478 $ --
========== ======== ========
Other cash flow information:
Interest paid......................................... $ 11 $ 10 $ --
========== ======== ========
Tax benefit from employee stock options............... $ 2,964 $ -- $ --
========== ======== ========
See notes to consolidated financial statements.
47
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BACKGROUND AND BASIS OF PRESENTATION
Palm, Inc. ("Palm") develops, markets and sells a family of handheld
computing device products, licenses the Palm OS operating system to other device
and information appliance manufacturers and offers a wireless Internet access
service. Palm was originally incorporated in California in 1992 and was acquired
by U.S. Robotics Corporation ("USR") in September 1995. Subsequent to 3Com
Corporation's acquisition of USR in June 1997, Palm became a wholly-owned
subsidiary of 3Com Corporation ("3Com").
On September 13, 1999, 3Com announced its plan to create an independent
publicly traded company, Palm, Inc., comprised of 3Com's handheld computing
business. Following the completion of Palm's initial public offering and
concurrent private placements in March 2000, 3Com owned approximately 94% of
Palm's outstanding common stock, which will be distributed ("the distribution
date") to the stockholders of 3Com.
3Com and Palm have entered into a Master Separation and Distribution
Agreement. In accordance with the separation agreement, 3Com transferred to Palm
the 3Com-owned assets and liabilities which related to Palm prior to the date of
separation from 3Com, except for most of Palm's accounts receivable and accounts
payable, which were retained by 3Com for administrative convenience. Palm began
incurring separation costs in the second quarter of fiscal year 2000, which are
costs associated with the process of becoming a stand-alone, public company,
including consulting and professional fees.
Palm's legal separation from 3Com occurred on February 26, 2000 ("the
separation date"), at which time Palm began to operate independently from 3Com.
For periods prior to the separation date, the consolidated financial statements
reflect the historical results of operations and cash flows of the handheld
computing business of 3Com during each respective period, and include
allocations of certain 3Com expenses, as discussed in Note 11 to the
consolidated financial statements. Beginning in the fourth quarter of fiscal
year 2000, Palm's consolidated financial statements no longer include an
allocated portion of 3Com's corporate services and infrastructure costs.
However, Palm is incurring amounts payable to 3Com under transitional service
agreements, under which 3Com provides services such as information systems, real
estate and transaction processing in accounting and human resources (see
Note 11 to the consolidated financial statements).
Palm completed its initial public offering in March 2000, receiving net
proceeds of $947.5 million, after deducting underwriting commissions and
offering expenses, from the sale of 26,450,000 shares of common stock. Palm also
received net proceeds of $225.0 million from the sale of a total of 5,921,052
shares of common stock to America Online, Motorola and Nokia in private
placements. Using a portion of the proceeds from the offering, Palm paid a
dividend of $150.0 million to 3Com in March 2000.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
Prior to June 1, 1998, Palm's 52-53 week fiscal year ended on the Sunday
nearest to May 31.
Effective June 1, 1998, Palm changed its fiscal year to a 52-53 week fiscal
year ending on the Friday nearest to May 31. These changes did not have a
significant effect on the consolidated financial statements. Fiscal 1999 and
1998 contained 52 weeks, whereas fiscal 2000 contained 53 weeks.
48
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES IN THE PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires Palm to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Palm and its
subsidiaries. All significant intercompany balances and transactions are
eliminated in consolidation.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
CASH AND CASH EQUIVALENTS
Cash equivalents are highly liquid debt investments acquired with a
remaining maturity of three months or less. Prior to Palm's initial public
offering, 3Com managed cash and cash equivalents on a centralized basis; cash
receipts associated with Palm's business were transferred to 3Com on a periodic
basis and 3Com funded Palm's disbursements.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject Palm to concentrations of
credit risk consist principally of accounts receivable. Palm sells the majority
of its products through distributors, retailers and resellers. Generally, credit
risk with respect to accounts receivable is diversified due to the number of
entities comprising Palm's customer base and their dispersion across different
geographic locations throughout the world. However, certain distributors do
represent a significant portion of accounts receivable as shown below. Palm
generally sells on open account and performs periodic credit evaluations of its
customers' financial condition.
The following individual customers accounted for 10% or more of total
revenue for the fiscal years ended:
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Company A........................................... 25% 24% 22%
Company B........................................... -- 14% --
The following individual customers accounted for 10% or more of total
accounts receivable:
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Company A........................................... 21% 24% 28%
Company B........................................... 10% 17% --
49
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories are stated at the lower of standard cost (which approximates
first-in, first-out cost) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are
computed over the shorter of the estimated useful lives, lease or license terms
on a straight-line basis--generally three to five years.
LONG-LIVED ASSETS
Palm evaluates the carrying value of long-lived assets, including goodwill
and other intangible assets, whenever events or changes in circumstances
indicate that the carrying value of the asset may be impaired. An impairment
loss is recognized when estimated future cash flows expected to result from the
use of the asset, including disposition, is less than the carrying value of the
asset. Long-lived assets include intangible assets acquired in business
combinations (see Note 3 to the consolidated financial statements).
SOFTWARE DEVELOPMENT COSTS
Costs for the development of new software and substantial enhancements to
existing software are expensed as incurred until technological feasibility has
been established, at which time any additional development costs would be
capitalized. Palm believes its current process for developing software is
essentially completed concurrently with the establishment of technological
feasibility; accordingly, no costs have been capitalized to date.
INTERNAL-USE SOFTWARE
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 98-1, Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use. SOP No. 98-1
requires that entities capitalize certain costs related to internal-use software
once certain criteria have been met. Palm adopted SOP 98-1 in the first quarter
of fiscal 2000. The adoption of this SOP did not have a significant impact on
Palm's financial position or results of operations.
3COM CORPORATION EQUITY
3Com Corporation equity represents 3Com's net investment in Palm as of
May 28, 1999. Payable to 3Com represents the net amount due to 3Com as the
result of transactions between 3Com and Palm that had not been settled as of
each balance sheet date. No intercompany interest income or expense has been
allocated to, or included in, the accompanying consolidated financial
statements. As of the separation date, the remaining balance of 3Com Corporation
equity was transferred to paid in capital, and Palm began to generate retained
earnings as a stand-alone company.
50
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Revenue is recognized when earned in accordance with applicable accounting
standards, including AICPA SOP No. 97-2, Software Revenue Recognition, as
amended. Revenue from sales of handheld device products is recognized when a
purchase order has been received, the product has been shipped, the sales price
is fixed and determinable and collection of the resulting receivable is
probable. Provisions are made at the time the related revenue is recognized for
estimated product returns, price protection, warranty, royalties and post-sale
telephone support. Handheld device product sales have accounted for
substantially all of the revenue for all periods presented.
Revenue from software license agreements with manufacturers of other
handheld devices is recognized on a per-unit royalty basis and any prepaid
royalties received under the license agreements are deferred and recognized as
earned on a per-unit basis. Deferred revenue is recorded for post contract
support and any other future deliverables, and is recognized over the support
period or as the elements of the agreement are delivered. Vendor specific
objective evidence of the fair value of the elements contained in these software
license agreements is based on the price determined by management having the
relevant authority when the element is not yet sold separately. Revenue from
wireless Internet access service subscriptions is recognized over the service
period.
ADVERTISING
Advertising costs are expensed as incurred, and were $103.1 million,
$52.5 million and $27.2 million for fiscal 2000, 1999 and 1998, respectively.
Cooperative advertising and marketing development obligations for channel
customers are expensed in the period the related revenue is recognized.
SEPARATION COSTS
Separation costs consist of one-time costs, such as consulting and
professional fees, associated with the process of becoming a stand-alone, public
company.
INCOME TAXES
Palm's operating results historically have been included in 3Com's
consolidated U.S. and state income tax returns and in tax returns of certain
3Com foreign subsidiaries. The provision for income taxes in Palm's consolidated
financial statements has been determined on a separate-return basis. Deferred
tax assets and liabilities are recognized for the expected tax consequences of
temporary differences between the tax bases of assets and liabilities and their
reported amounts.
FOREIGN CURRENCY TRANSLATION
The majority of Palm's revenue is denominated in U.S. dollars. For foreign
operations with the local currency as the functional currency, assets and
liabilities are translated at year-end exchange rates, and statements of
operations are translated at the average exchange rates during the year. Gains
or losses resulting from foreign currency translation are included as a
component of other comprehensive income (loss).
51
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
For Palm entities with the U.S. dollar as the functional currency, foreign
currency denominated assets and liabilities are translated at the year-end
exchange rates except for inventories, prepaid expenses, and property and
equipment, which are translated at historical exchange rates. Gains or losses
resulting from foreign currency translation are included in interest and other
income (expense), net in the consolidated statements of operations and were not
significant for any period presented.
STOCK-BASED COMPENSATION
Palm accounts for employee stock plans under the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("SFAS 123").
NET INCOME PER SHARE
Basic net income per share is calculated based on the weighted average
shares of common stock outstanding during the period. Diluted net income per
share is calculated based on the weighted average shares of common stock
outstanding, plus the dilutive effect of stock options, calculated using the
treasury stock method. The dilutive effect of stock options was approximately
112,000 shares for fiscal 2000. For fiscal 1999 and 1998, there was no dilutive
effect from stock options, as there were no Palm stock options outstanding.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of net income plus accumulated foreign
translation adjustments.
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998 and June 1999, the Financial Accounting Standards Board
("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities and SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133. These
statements require companies to record derivatives on the balance sheet as
assets or liabilities, measured at fair value. Gains or losses resulting from
changes in the values of those derivatives would be accounted for depending on
the use of the derivative and whether it qualifies for hedge accounting.
SFAS 133 will be effective for Palm's fiscal year ending May 31, 2002.
Management believes that the adoption of these statements will not have a
significant impact on Palm's financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 will be effective for Palm's fiscal year ending June 1,
2001. Palm has not yet determined the impact, if any, that SAB 101 may have on
its financial position or results of operations.
In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), Accounting
for Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. FIN 44 clarifies the application of APB 25 for certain issues,
including the definition of an employee, the treatment of
52
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the acceleration of stock options and the accounting treatment for options
assumed in business combinations. FIN 44 became effective on July 1, 2000, but
is applicable for certain transactions dating back to December 1998. The
adoption of FIN 44 is not expected to have a significant impact on Palm's
financial position or results of operations.
NOTE 3. BUSINESS COMBINATIONS
The acquisition of Actual Software Corporation ("Actual Software") in
May 2000 for cash and equity and the acquisition of Smartcode Technology SARL
("Smartcode") in February 1999 for cash and the assumption of liabilities have
been accounted for as purchases. Accordingly, Palm's consolidated income
statements include the operating results of the acquired companies from their
acquisition dates. Acquired assets and liabilities were recorded at their
estimated fair values at the dates of acquisition, and the aggregate purchase
price plus costs directly attributable to the completion of the acquisitions
have been allocated to the assets and liabilities acquired. No significant
adjustments were required to conform the accounting policies of the acquired
companies. Unaudited pro forma results of operations, assuming the acquisitions
had taken place at the beginning of the year in which they were consummated,
have not been presented because the effect on Palm's financial position and
results of operations was not significant.
The purchase price of the business combinations were allocated as follows
(in thousands):
ACTUAL SOFTWARE SMARTCODE
--------------- ---------
Purchase price...................................... $3,446 $17,445
Allocation of purchase price:
Net tangible assets............................... -- 965
Purchased in-process technology................... -- 2,125
Developed technology.............................. 1,429 5,400
Assembled workforce............................... 411 1,000
Licenses and customer list........................ -- 1,100
Goodwill.......................................... $1,606 $ 6,855
Amortization period (years):
Developed technology.............................. 3 4
Assembled workforce............................... 2 3
Licenses and customer list........................ -- 2
Goodwill.......................................... 3 6
Actual Software was a developer of e-mail software for the Palm OS operating
system. Smartcode was a provider of wireless data communications and Internet
access software technology. The purchase price for the Actual Software
acquisition included $0.6 million for stock options granted to the principals of
Actual Software. The purchase price for the Smartcode acquisition included
$1.5 million of liabilities assumed in the transaction.
Approximately $2.1 million of the purchase price for the Smartcode
acquisition represented purchased in-process technology that had not yet reached
technological feasibility, had no alternative future use and was charged to
operations in the third quarter of fiscal 1999. The in-process technology
related primarily to Globalpulse, a software GSM terminal adapter (which acts as
a "software modem")
53
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. BUSINESS COMBINATIONS (CONTINUED)
for products utilizing the Palm OS operating system. The value of the in-process
technology was determined using the income approach which discounted to present
value the cash flows expected to be derived from products that were still in the
process of development at the date of acquisition. The projections were based on
future expectations of the revenue and expenses to be generated in connection
with the products under development. The discount rate of 40% used reflected the
risk associated with the development of the in-process technology. The primary
project was completed in July 1999 and Palm began to derive revenue in the
second quarter of fiscal 2000.
NOTE 4. BALANCE SHEET DETAILS (IN THOUSANDS):
Inventories consist of:
JUNE 2, MAY 28,
2000 1999
-------- --------
Finished goods............................................ $22,557 $ 5,900
Work in process........................................... 1,500 4,011
Purchased components...................................... -- 2,275
------- -------
$24,057 $12,186
======= =======
Property and equipment, net, consist of:
JUNE 2, MAY 28,
2000 1999
-------- --------
Equipment................................................. $17,403 $11,971
Leasehold improvements.................................... 2,299 1,398
Furniture and fixtures.................................... 1,085 685
------- -------
Total..................................................... 20,787 14,054
Accumulated depreciation and amortization................. (7,774) (5,918)
------- -------
$13,013 $ 8,136
======= =======
Goodwill, intangibles and other assets consist of:
JUNE 2, MAY 28,
2000 1999
-------- --------
Goodwill.................................................. $ 8,499 $ 6,863
Other purchased intangibles............................... 9,340 7,500
Accumulated amortization.................................. (4,241) (844)
------- -------
Goodwill and intangibles, net............................. 13,598 13,519
Other assets.............................................. 732 310
------- -------
$14,330 $13,829
======= =======
54
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. BALANCE SHEET DETAILS (IN THOUSANDS): (CONTINUED)
Other accrued liabilities consist of:
JUNE 2, MAY 28,
2000 1999
-------- --------
Payroll and related expenses............................. $ 18,053 $ 4,871
Product warranty......................................... 30,984 11,329
Cooperative advertising and marketing development
expenses............................................... 5,197 7,195
Price protection......................................... 737 6,994
Deferred revenue......................................... 18,143 948
Other.................................................... 44,262 9,456
-------- -------
$117,376 $40,793
======== =======
NOTE 5. COMMITMENTS
Certain Palm facilities are leased from third parties under operating
leases. Leases expire at various dates through May 2005, and certain facility
leases have renewal options with rentals based upon changes in the Consumer
Price Index or the fair market rental value of the property. At the separation
date, Palm began to lease certain other facilities from 3Com through
February 2003 with annual rent increases of approximately 3%. See Note 11 to the
consolidated financial statements for further discussion of the Real Estate
Matters Agreement between Palm and 3Com.
Future operating lease commitments are as follows (in thousands):
FISCAL THIRD
YEAR PARTIES 3COM
- ---- -------- --------
2001....................................................... $2,525 $ 9,659
2002....................................................... 1,003 10,576
2003....................................................... 964 8,093
2004....................................................... 983 --
2005....................................................... 586 --
------ -------
Total...................................................... $6,061 $28,328
====== =======
Rent expense was $6.1 million, $3.0 million, and $2.3 million for fiscal
2000, 1999 and 1998, respectively.
On November 27, 1999, 3Com sold to a third party the manufacturing plant
that was used to produce 3Com products as well as the majority of Palm's
products. Concurrently, Palm entered into a two-year supply agreement with the
buyer of the manufacturing plant, which commits Palm to purchase a minimum
number of units of Palm products per quarter. Any deficit or overage in purchase
of products of no more than 20% that occurs during any quarter may be applied
towards the subsequent quarterly period commitment. Palm is subject to a 90-day
notice and cure period if the minimum purchase commitment is not met.
Palm purchases product components from a vendor with which 3Com has agreed
to certain minimum purchase goals over a five-year period. 3Com's agreement with
the vendor provides for an incremental payment to be made to the vendor by 3Com
for any calendar year in which the minimum
55
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS (CONTINUED)
purchase goal is not met. In connection with their separation, 3Com and Palm
have agreed that Palm will assume responsibility for 25% of the minimum purchase
goal and 3Com will retain responsibility for the remainder. In the event that
Palm does not purchase its share of the minimum annual purchase goal from the
vendor in any of the five calendar years, Palm will make an incremental payment
to 3Com for the applicable calendar year. In the event that Palm purchases none
of its share of the minimum annual purchase goal in each year, it would be
required to make payments up to a maximum of the following: $1.9 million for
2000, $2.8 million for 2001, $3.7 million for 2002 and $4.9 million for 2003.
The aggregate of such incremental payments in no event will exceed
$13.3 million.
NOTE 6. STOCKHOLDERS' EQUITY
PREFERRED STOCK
Palm's Board of Directors has the authority to issue up to 125,000,000
shares of preferred stock in one or more series and to fix the rights,
preferences, privileges and restrictions of ownership. No shares of preferred
stock were outstanding at June 2, 2000 and May 28, 1999.
EMPLOYEE STOCK PURCHASE PLAN
Palm has an employee stock purchase plan under which eligible employees can
contribute up to 10% of their compensation, as defined, towards the purchase of
shares of Palm common stock at a price of 85% of the lower of the fair market
value at the beginning of the offering period or the end of each six-month
purchase period. The employee stock purchase plan became effective upon Palm's
initial public offering and no shares had been issued under the plan as of
June 2, 2000. A total of 5,000,000 shares of Palm common stock were originally
reserved for future issuance under the employee stock purchase plan. The
employee stock purchase plan provides for annual increases in the number of
shares available for issuance on the first day of each fiscal year beginning in
fiscal 2001, equal to the lesser of 2% of the outstanding shares of common stock
on the first day of the fiscal year, 10,000,000 shares, or a lesser amount as
may be determined by the Board of Directors.
EMPLOYEE STOCK OPTION PLAN
Palm has a stock option plan under which employees may be granted options to
purchase Palm common stock. Options are generally granted at not less than the
fair market value at grant date, typically vest over a four-year period and
expire ten years after the grant date. Palm's employee stock option plan also
allows for the issuance of restricted stock awards, under which shares of common
stock are issued at par value to key employees, subject to vesting restrictions.
Compensation expense equal to the fair market value on the date of the grant is
recognized as the granted shares vest over a one- to four-year period. During
the year ended June 2, 2000, Palm recognized $430,000 of compensation expense
relating to Palm restricted stock grants. Certain Palm employees also currently
participate in the 3Com restricted stock plan. At the distribution date, Palm
employees who have 3Com restricted stock grants will forfeit the unvested
portion of their 3Com restricted stock grants, and the unvested shares will be
replaced by Palm restricted stock grants. A total of 20,000,000 shares of Palm
common stock were originally reserved for future issuance under the employee
stock option plan. As of June 2, 2000, approximately 6,500,000 shares of common
stock were available for grant under the employee stock option plan. The
employee stock option plan provides for annual increases in the number of shares
available for issuance on the first day of each fiscal year beginning in fiscal
2001,
56
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED)
equal to the lesser of 5% of the outstanding shares of common stock on the first
day of the fiscal year, 25,000,000 shares, or a lesser amount as may be
determined by the Board of Directors.
DIRECTOR STOCK OPTION PLAN
Palm has a director stock option plan, under which shares of common stock
are issued to members of its Board of Directors at an exercise price equal to
the fair market value on the date of grant and typically vest over a 36-month
period. A total of 500,000 shares of Palm common stock were originally reserved
for future issuance under the director stock option plan. As of June 2, 2000,
approximately 300,000 shares of common stock were available for grant under the
director stock option plan. The director stock option plan provides for annual
increases in the number of shares available for issuance on the first day of
each fiscal year beginning in fiscal 2001, equal to 500,000 shares or a lesser
amount as may be determined by the Board of Directors.
The following table summarizes the activity under all of Palm's stock option
plans from the time of their establishment at the initial public offering date
through June 2, 2000:
WEIGHTED
NUMBER AVERAGE
OF SHARES EXERCISE PRICE
-------------- --------------
(IN THOUSANDS)
Granted............................................ 13,178 $34.48
Exercised.......................................... -- --
Cancelled.......................................... (104) 38.00
------ ------
Outstanding, June 2, 2000.......................... 13,074 $34.45
====== ======
Information relating to stock options outstanding as of June 2, 2000 is as
follows:
OUTSTANDING OPTIONS AS OF JUNE 2, 2000
--------------------------------------------------
WEIGHTED WEIGHTED
NUMBER AVERAGE AVERAGE
RANGE OF EXERCISE PRICE OF SHARES EXERCISE PRICE CONTRACTUAL LIFE
- ----------------------- -------------- -------------- ----------------
(IN THOUSANDS) (IN YEARS)
$21.38 to $32.25...................... 3,711 $25.40 9.9
$38.00 to $38.00...................... 9,316 38.00 9.7
$38.50 to $69.38...................... 47 45.36 9.8
------ ------ ---
13,074 $34.45 9.8
====== ====== ===
No options to purchase Palm common stock were exercisable as of June 2,
2000.
Prior to the separation date, certain Palm employees had been granted
options to purchase 3Com common stock under 3Com's employee stock option plans.
As of June 2, 2000, certain Palm employees held options to purchase 3.8 million
shares of 3Com common stock at a weighted average exercise price of $29.37, of
which 1.2 million shares were vested and immediately exercisable. 3Com options
held by Palm employees will be converted into options to purchase Palm common
stock at the distribution date. The number of shares and the exercise price of
the 3Com options that convert into Palm options will be adjusted using a
conversion formula. The conversion of 3Com options into Palm
57
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. STOCKHOLDERS' EQUITY (CONTINUED)
options will be done in such a manner that (1) the aggregate intrinsic value of
the options immediately before and after the exchange are the same, (2) the
ratio of the exercise price per option to the market value per share is not
reduced, and (3) the vesting provisions and option period of the replacement
Palm options are the same as the original vesting terms and option period of the
3Com options. The exact number of 3Com options that will be converted into Palm
options will not be determined until the distribution date.
ACCOUNTING FOR STOCK-BASED COMPENSATION
As permitted under SFAS 123, Palm has elected to follow APB 25 and related
interpretations in accounting for stock-based awards to employees. Under APB 25,
Palm generally recognizes no compensation expense with respect to its option
awards. If Palm had elected to recognize compensation expense based on the fair
value of the options granted at the date of grant as prescribed by SFAS 123, pro
forma net income (loss) and pro forma net income (loss) per share would have
been as follows:
YEARS ENDED
------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Pro forma net income (loss)..................... $18,110 $15,664 $(10,235)
Pro forma net income (loss) per share--basic and
diluted....................................... $ 0.03 $ 0.03 $ (0.02)
The weighted average estimated fair value of stock options granted during
fiscal 2000, 1999 and 1998 was $16.43, $15.53 and $13.30 per share,
respectively. For fiscal 1999 and 1998, the estimated fair value was based on
3Com options held by Palm employees, as there were no Palm stock options
outstanding. The fair value of each option grant was estimated at the date of
grant using the Black-Scholes options valuation model with the following
weighted average assumptions:
YEARS ENDED
------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Risk-free interest rate............................. 6.2% 5.3% 5.5%
Volatility.......................................... 60.0% 62.0% 56.0%
Option term (years)................................. 3.5 4.5 3.5
Dividend yield...................................... 0.0% 0.0% 0.0%
For the purposes of the pro forma information, the estimated fair value of
the options granted is amortized to expense over the option term, using the
multiple option approach. The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because options held by Palm employees and directors have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in the opinion of management, the existing models do not
necessarily provide a reliable single measure of the fair value of these
options.
58
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. INCOME TAXES
The income tax provision (credit) consists of (in thousands):
YEARS ENDED
------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Current:
Federal................................................... $35,747 $22,938 $6,421
State..................................................... 8,436 5,174 1,173
Foreign................................................... 4,261 -- --
------- ------- ------
Total current........................................... 48,444 28,112 7,594
------- ------- ------
Deferred:
Federal................................................... (12,826) (7,825) (4,526)
State..................................................... (3,695) (1,799) (834)
Foreign................................................... (20) -- --
------- ------- ------
Total deferred.......................................... (16,541) (9,624) (5,360)
------- ------- ------
Total....................................................... $31,903 $18,488 $2,234
======= ======= ======
The components of deferred income taxes consist of (in thousands):
JUNE 2, MAY 28,
2000 1999
-------- --------
Reserves not recognized for tax purposes.................... $21,898 $18,352
Tax credit carryforwards.................................... -- 2,024
Deferred revenue............................................ 11,677 --
Other....................................................... 3,707 365
------- -------
$37,282 $20,741
======= =======
The income tax provision differs from the amount computed by applying the
federal statutory income tax rate to income before income taxes as follows:
YEARS ENDED
------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Tax computed at federal statutory rate...................... 35.0% 35.0% 35.0%
State income taxes, net of federal effect................... 4.6 4.5 3.4
Research tax credits........................................ (0.8) (1.2) (4.7)
Separation costs............................................ 1.1 -- --
Other....................................................... 1.1 0.1 1.2
----- ----- -----
41.0% 38.4% 34.9%
===== ===== =====
See Note 11 to the consolidated financial statements for discussion of the
Tax Sharing Agreement between Palm and 3Com.
59
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. BUSINESS SEGMENT INFORMATION
Palm operates in one reportable segment, handheld computing.
GEOGRAPHIC INFORMATION
Palm's headquarters and most of its operations are located in the United
States. Palm conducts its sales, marketing and customer service activities
throughout the world and also has a research and development facility in France.
Geographic revenue information is based on the location of the end customer. For
fiscal 2000, 1999, 1998 no single country outside the United States accounted
for 10% or more of total revenues. Geographic long-lived assets information is
based on the physical location of the assets at the end of each period. Revenues
from unaffiliated customers and long-lived assets by geographic region are as
follows (in thousands):
YEARS ENDED
--------------------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
---------- -------- --------
Revenues:
United States............................................. $ 690,540 $399,944 $198,630
Other..................................................... 367,057 163,581 73,507
---------- -------- --------
Total................................................... $1,057,597 $563,525 $272,137
========== ======== ========
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Property and equipment, net:
United States............................................. $11,576 $7,247 $8,231
France.................................................... 924 811 827
Other..................................................... 513 78 63
------- ------ ------
Total................................................... $13,013 $8,136 $9,121
======= ====== ======
NOTE 9. EMPLOYEE BENEFIT PLAN
Eligible Palm employees currently participate in 3Com's 401(k) Plan ("the
Plan"). As allowed under Section 401(k) of the Internal Revenue Code, the Plan
provides tax-deferred salary deductions for eligible employees. Participants may
elect to contribute from 1% to 22% of their annual compensation to the Plan each
calendar year, limited to a maximum annual amount as set periodically by the
Internal Revenue Service. In addition, the Plan provides for company matching
contributions as determined by the Board of Directors. 3Com matches 50% for each
dollar on the first 6% of target income contributed by the employee. Employees
become vested in 3Com matching contributions according to a three-year vesting
schedule based on initial date of hire. Palm's expense related to matching
contributions to the 401(k) was $1,055,000 in fiscal 2000, $508,000 in fiscal
1999 and $178,000 in fiscal 1998.
On or about the distribution date, Palm intends to establish a separate
401(k) plan for its employees.
60
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. LITIGATION
Palm is a party to lawsuits in the normal course of its business. Litigation
in general, and intellectual property litigation in particular, can be expensive
and disruptive to normal business operations. Moreover, the results of complex
legal proceedings are difficult to predict. Palm believes that it has defenses
to the cases set forth below and is vigorously contesting these matters. Palm is
not currently able to estimate the possible loss, or range of loss, if any, from
the cases listed below and an unfavorable resolution of these lawsuits could
adversely affect Palm's business, results of operations or financial condition.
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District Court
for the Western District of New York. The case is now captioned: XEROX
CORPORATION v. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP., PALM
COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T. The
complaint alleged willful infringement of U.S. patent 5,596,656 entitled
"Unistrokes for Computerized Interpretation of Handwriting." The complaint
sought unspecified damages and to permanently enjoin the defendants from
infringing the patent in the future. In an Order entered by the District Court
on June 6, 2000, the District Court granted the defendants' motion for summary
judgment of non-infringement and dismissed the case in its entirety. On July 5,
2000, Xerox filed a Notice of Appeal of the dismissal with the U.S. Court of
Appeals for the Federal Circuit.
On July 22, 1999, Palm filed a copyright infringement action against
Olivetti and CompanionLink in the United States District Court for the Northern
District of California and obtained a preliminary injunction against further
distribution, sale, import or export of Olivetti Office USA's "Royal daVinci"
handheld device and the daVinci OS Software Development Kit (distributed by
CompanionLink Software, Inc.), which contained source code copied from the
Palm OS operating system. The injunction is to remain in effect pending the
outcome of the lawsuit. Palm also initiated a copyright infringement action in
Hong Kong on July 21, 1999, against EchoLink Design Ltd., the company
responsible for developing the operating system software contained in the
daVinci products. The High Court of the Hong Kong Special Administrative Region
issued an order the same day restraining EchoLink from further copying,
distribution, sale, import or export of Palm OS operating system source code or
EchoLink's "NEXUS OS" source code, which Palm maintains infringes its
copyrights. On October 7, 1999, 3Com notified certain third-party retailers
about the preliminary injunction order cited above. Olivetti has advised that it
intends to assert counterclaims against Palm and 3Com for unfair competition,
intentional interference with potential economic advantage, libel and trade
libel, based upon certain statements that were allegedly made, or that 3Com
allegedly omitted to make, in the October 7, 1999 letter. To date, the
counterclaim has not been filed or allowed.
On December 13, 1999, WaveWare Communications, Inc. filed suit against 3Com,
Palm and others in the Superior Court of California, San Mateo County. The case
is captioned WAVEWARE COMMUNICATIONS, INC. v. 3COM CORPORATION, PALM
COMPUTING, INC., AND MARK BERCOW, No. 411331. The complaint alleges breach of
contract, constructive fraud, fraud and deceit, negligent misrepresentation,
misappropriation of assets and trade secrets, unfair competition, unjust
enrichment and intentional interference with economic advantage in connection
with our and 3Com's discussions with WaveWare concerning WaveWare's potential
acquisition by 3Com. The complaint seeks unspecified monetary damages and
injunctive relief. Discovery is ongoing and the case is set for trial in January
2001.
On December 27, 1999, Telxon Corporation and Penright! Corporation filed a
complaint in the U.S. District Court for the Northern District of Ohio, Eastern
Division (Case No. 1:99CV3157) against
61
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. LITIGATION (CONTINUED)
3Com and Palm alleging copyright infringement, unfair competition and theft of
trade secrets. The plaintiffs allege that the Palm OS operating system contains
graphical user interface software copied from the plaintiffs' software. The
complaint seeks unspecified compensatory and treble damages and to enjoin, among
other things, distribution and sales of the Palm OS operating system. No trial
date has been set. The case is still in the early stages of discovery.
On February 28, 2000, E-Pass Technologies, Inc. filed suit against
"3Com, Inc." in the United States District Court for the Southern District of
New York and later filed on March 6, 2000 an Amended Complaint against Palm and
3Com. The case is now captioned E-PASS TECHNOLOGIES, INC. v. 3COM CORPORATION,
A/K/A 3COM, INC. AND PALM, INC. (Civil Action No. 00 CIV 1523). The Amended
Complaint alleges willful infringement of U.S. patent 5,276,311 entitled "Method
and Device for Simplifying the Use of Credit Cards, or the Like." The complaint
seeks unspecified compensatory and treble damages and to permanently enjoin the
defendants from infringing the patent in the future. Palm is in the preliminary
stages of investigating the allegations contained in the suit. In an Order dated
June 9, 2000, the Federal Judge assigned to the action transferred the case to
the U.S. District Court for the Northern District of California. No trial date
has been set. No discovery has been exchanged.
On May 2, 2000, Rotis Technologies Corporation filed suit against Palm and
two other defendants in the U.S. District Court for the Northern District of
Texas. The case is captioned ROTIS TECHNOLOGIES CORPORATION v. TRACK DATA
CORPORATION, PALM, INC. AND SPRINT FON GROUP (Case No. 300CV-931-L). The
complaint alleges infringement of U.S. patent 4,473,824 entitled "Price
Quotation System." The complaint seeks unspecified compensatory and treble
damages and to permanently enjoin the defendants from infringing the patent in
the future. Palm is in the preliminary stages of investigating the allegations
contained in the suit. No trial date has been set. No discovery has been
exchanged.
NOTE 11. TRANSACTIONS WITH 3COM CORPORATION
Through February 25, 2000, the date of legal separation from 3Com, Palm's
costs and expenses included allocations from 3Com for centralized legal,
accounting, treasury, real estate, information technology, distribution,
customer service, sales, marketing, engineering, and other 3Com corporate
services and infrastructure costs. These allocations were determined on bases
that 3Com and Palm considered to be reasonable reflections of the utilization of
services provided or the benefit received by Palm. The allocation methods
include relative revenues, headcount or square footage. Allocated costs included
in the accompanying consolidated statements of operations were as follows (in
thousands):
YEARS ENDED
-------------------
JUNE 2, MAY 28, MAY 31,
2000 1999 1998
-------- -------- --------
Cost of revenues............................................ $10,443 $ 9,238 $3,694
Sales and marketing......................................... 20,541 16,625 7,023
Research and development.................................... 6,125 3,437 845
General and administrative.................................. 14,550 14,085 5,212
Other (income) expense, net................................. (632) 218 25
62
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. TRANSACTIONS WITH 3COM CORPORATION (CONTINUED)
Amounts paid to 3Com under transitional service agreements during the fourth
quarter of fiscal 2000 (post-separation) were recorded in the consolidated
financial statements as follows (in thousands):
Cost of revenues............................................ $ 2,435
Sales and marketing......................................... 3,093
Research and development.................................... 2,708
General and administrative.................................. 3,276
Historically, Palm has outsourced all of its product manufacturing to 3Com
and other third parties. Products manufactured by 3Com for Palm have been
recorded in the consolidated financial statements at 3Com's actual manufacturing
cost. Effective November 27, 1999, upon the sale of its manufacturing facility
to a third party as discussed in Note 6 to the consolidated financial
statements, 3Com no longer manufactured products for Palm.
For purposes of governing certain of the ongoing relationships between Palm
and 3Com at and after the separation date and to provide for an orderly
transition, Palm and 3Com have entered into various agreements. A brief
description of each of the agreements follows.
MASTER SEPARATION AND DISTRIBUTION AGREEMENT
The Master Separation and Distribution Agreement contains the key provisions
relating to the separation, initial public offering and the distribution. The
agreement lists the documents and items that the parties were required to
deliver in order to have accomplished the transfer of assets and liabilities
from 3Com to Palm, effective on the separation date. The agreement also contains
conditions that were required to have occurred prior to the initial public
offering and must occur prior to the distribution. The parties also entered into
both short-term and long-term covenants, including covenants to enter into
transitional services agreements, exchange information, engage in certain
auditing practices and resolve disputes in particular ways.
GENERAL ASSIGNMENT AND ASSUMPTION AGREEMENT
The General Assignment and Assumption Agreement identifies the assets that
3Com transferred to Palm and the liabilities that Palm assumed from 3Com in the
separation. In general, the assets that were transferred and the liabilities
that were assumed were included on the consolidated balance sheet as of May 28,
1999, after adjustments for certain assets and liabilities that were retained by
3Com, such as most of Palm's accounts receivable and accounts payable at the
separation date, and for activity that occurred up to the separation date.
INTELLECTUAL PROPERTY AGREEMENTS
The Master Technology Ownership and License Agreement, the Master Patent
Ownership and License Agreement, the Master Trademark Ownership and License
Agreement and the Master Confidential Disclosure Agreement together are referred
to as the Intellectual Property Agreements. Under the Intellectual Property
Agreements, 3Com will confirm that Palm owns or will transfer to Palm its rights
in specified patents, patent applications, invention disclosures, specified
trademarks and other intellectual property related to Palm's current business
and research and development efforts. Neither 3Com nor Palm will sue the other
for claims of infringement related to existing patents. 3Com
63
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. TRANSACTIONS WITH 3COM CORPORATION (CONTINUED)
will grant a license to Palm under certain patents owned by 3Com, which were
jointly developed with Palm. Palm has committed to license its operating system
to 3Com pursuant to a separate agreement that the two parties have negotiated
with pricing and other terms more favorable than it would agree to in customary
transactions with third parties. Both 3Com and Palm have agreed not to disclose
confidential information of the other party except in specific circumstances.
EMPLOYEE MATTERS AGREEMENT
The Employee Matters Agreement outlines how 3Com and Palm plan to allocate
assets, liabilities and responsibilities relating to current and former
employees of Palm and their participation in the benefits plans, including stock
plans, that 3Com currently sponsors and maintains. The agreement also contains
provisions describing some of Palm's employee benefit and employee stock plans.
All eligible Palm employees will continue to participate in the 3Com
benefits plans on comparable terms and conditions to those for 3Com employees
until the distribution date or until Palm establishes benefit plans for its
employees, or elects not to establish comparable plans if it is not legally or
financially practical. Palm intends to establish its own benefit program no
later than the time of the distribution.
Once Palm establishes its own benefits plans, it may modify or terminate
each plan in accordance with the terms of that plan and its policies. No Palm
benefit plan will provide benefits that overlap benefits under the corresponding
3Com benefit plan at the time of the distribution. Each Palm benefit plan will
provide that all service, compensation and other benefit determinations that, as
of the distribution, were recognized under the corresponding 3Com benefits plan
will be taken into account under that Palm benefit plan.
Following the date of 3Com's distribution of its Palm common stock to its
stockholders, Palm will be under no obligation to maintain these plans in the
form in which they were established or at all. The transfer to Palm of employees
at certain of 3Com's international operations, and of certain employee benefit
plans, may not take place until Palm receives consents or approvals or has
satisfied other applicable requirements.
TAX SHARING AGREEMENT
The Tax Sharing Agreement allocates 3Com's and Palm's responsibilities for
certain tax matters. The agreement requires Palm to pay 3Com for the incremental
tax costs of Palm's inclusion in consolidated, combined or unitary tax returns
with affiliated corporations. In determining these incremental costs, the
agreement takes into account not only the group's incremental tax payments to
the Internal Revenue Service or other taxing authorities, but also the
incremental use of tax losses of affiliates to offset Palm's taxable income and
the incremental use of tax credits of affiliates to offset the tax on Palm's
income. The agreement also provides for compensation or reimbursement as
appropriate to reflect redeterminations of Palm's tax liability for periods
during which Palm joined in filing consolidated, combined or unitary tax
returns.
The Tax Sharing Agreement also requires Palm to indemnify 3Com for certain
taxes and similar obligations, including (a) sales taxes on the sale of products
purchased by 3Com from Palm before the distribution, (b) customs duties or
harbor maintenance fees on products exported or imported by 3Com on behalf of
Palm, (c) the additional taxes that would result if an acquisition of a
controlling interest in
64
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. TRANSACTIONS WITH 3COM CORPORATION (CONTINUED)
Palm's stock after the distribution causes the distribution not to qualify for
tax-free treatment to 3Com, and (d) any taxes resulting from transactions
undertaken in preparation for the distribution.
Palm's indemnity obligations include any interest and penalties on taxes,
duties or fees for which Palm must indemnify 3Com.
Each member of a consolidated group for U.S. federal income tax purposes is
jointly and severally liable for the group's federal income tax liability.
Accordingly, Palm could be required to pay a deficiency in the group's federal
income tax liability for a period during which Palm was a member of the group
even if the Tax Sharing Agreement allocates that liability to 3Com or another
member.
The agreement also assigns responsibilities for certain administrative
matters such as the filing of returns, payment of taxes due, retention of
records, and the conduct of audits, examinations or similar proceedings. 3Com is
responsible for filing all tax returns for all periods before the distribution
and paying any taxes shown as due on those returns. Palm must provide 3Com with
sufficient information about its activities to enable 3Com to file these
returns. Palm also must pay its share of the tax liability to 3Com within
30 days after 3Com files the return. Palm and 3Com must retain tax returns and
related materials for periods beginning before the distribution and make these
materials available to each other upon request. In general, 3Com will be
entitled to control the contest of any claim by a taxing authority arising from
the audit of a return for any period before the distribution, unless the return
covers only Palm's activities.
MASTER TRANSITIONAL SERVICES AGREEMENT
The Master Transitional Services Agreement governs the provision of
information technology services by 3Com and Palm to each other, on an interim
basis, for one year from the date of separation, unless extended for specific
services or otherwise indicated in the agreement. The services include data
processing and telecommunications services, such as voice telecommunications and
data transmission, and information technology support services, for functions
including accounting, financial management, tax, payroll, stockholder and public
relations, legal, procurement and other administrative functions. Specified
charges for such services are generally intended to allow the providing company
to recover the direct and indirect costs of providing the services, plus 5% for
one year, and plus 10% for an extension of the agreements beyond one year. The
Master Transitional Services Agreement also will cover the provision of certain
additional transitional services identified from time to time after the
separation date that were inadvertently or unintentionally omitted from the
specified services, or that are essential to effectuate an orderly transition
under the separation agreement, so long as the provision of such services would
not significantly disrupt 3Com's operations or significantly increase the scope
of its responsibility under the agreement.
In addition, the Master Transitional Services Agreement will provide for the
replication of some computer systems, including hardware, software, data storage
or maintenance and support components. Generally, the party needing the
replicated system will bear the costs and expenses of replication. Generally,
the party purchasing new hardware or licensing new software will bear the costs
and expenses of purchasing the new hardware or obtaining the new software
licenses.
65
PALM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11. TRANSACTIONS WITH 3COM CORPORATION (CONTINUED)
REAL ESTATE MATTERS AGREEMENT
The Real Estate Matters Agreement addresses real estate matters relating to
the 3Com leased and owned properties that 3Com will transfer to or share with
Palm. The agreement describes the manner in which 3Com will transfer to or share
with Palm various leased and owned properties. The Real Estate Matters Agreement
provides that Palm will be required to accept the transfer of all sites
allocated to Palm, even if a casualty has damaged a site before the separation
date. The Real Estate Matters Agreement also provides that all reasonable costs
required to effect the transfers, including landlord consent fees and landlord
attorneys' fees will be paid by 3Com. No casualty, as contemplated in the Real
Estate Matters Agreement, took place at any site allocated to Palm prior to or
as of the separation date.
INDEMNIFICATION AND INSURANCE MATTERS AGREEMENT
Effective as of the separation date, subject to specified expectations, Palm
and 3Com each released the other from any liabilities arising from events
occurring on or before the separation date, including events occurring in
connection with the activities to implement the separation, the initial public
offering and the distribution. The agreement also contains provisions governing
indemnification. In general, Palm and 3Com have indemnified the other from all
liabilities arising from their respective businesses or contracts, as well as
liabilities arising from a breach of the separation agreement or any ancillary
agreement. In addition, 3Com and Palm have indemnified the other against
liability for specified environmental conditions. Palm will reimburse 3Com for
the cost of any insurance coverage from the separation date to the distribution
date.
NOTE 12. SUBSEQUENT EVENTS
On May 24, 2000, Palm announced that it had entered into a definitive
agreement to acquire AnyDay.com, a developer of an Internet based calendar
solution, for approximately $80 million in cash and stock options. The
transaction closed in June 2000, and will be accounted for as a purchase.
On July 27, 2000, 3Com distributed its shares of Palm common stock to the
stockholders of 3Com. Each stockholder of 3Com received 1.4832 shares of Palm
common stock for each share of 3Com common stock that they owned. Palm employees
who held options to purchase 3.5 million shares of 3Com common stock at the
distribution date received options to purchase 6.6 million shares of Palm common
stock based on the conversion ratio of 1.906 Palm options for each 3Com option.
66
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following tables present Palm's operating results for each of the eight
fiscal quarters in the period ended June 2, 2000. The information for each of
these quarters is unaudited and has been prepared on the same basis as the
audited consolidated financial statements included in this Form 10-K. In the
opinion of management, all necessary adjustments, which consist only of normal
and recurring accruals, have been included to fairly present the unaudited
quarterly results. This data should be read together with Palm's consolidated
financial statements and the notes to those statements included in this
Form 10-K.
For periods prior to the separation date, the historical financial
information may not be indicative of Palm's future performance and does not
necessarily reflect what Palm's financial position and results of operations
would have been if Palm had been a separate, stand-alone entity during the
periods presented.
JUN. 2, FEB. 25, NOV. 26, AUG. 27, MAY 28, FEB. 26, NOV. 27, AUG. 28,
2000 2000 1999 1999 1999 1999 1998 1998
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED
STATEMENTS OF
OPERATION DATA:
Revenues.............. $350,245 $272,292 $258,555 $176,505 $174,334 $125,889 $147,233 $116,069
Cost of revenues...... 213,262 153,479 148,018 98,324 100,746 67,583 84,289 62,998
-------- -------- -------- -------- -------- -------- -------- --------
Gross profit.......... 136,983 118,813 110,537 78,181 73,588 58,306 62,944 53,071
-------- -------- -------- -------- -------- -------- -------- --------
Operating expenses:
Sales and
marketing......... 76,534 57,591 60,038 42,648 41,139 28,725 33,893 23,969
Research and
development....... 25,767 21,450 16,044 12,507 14,578 10,989 10,722 9,738
General and
administrative.... 21,758 12,202 9,796 7,160 6,649 5,739 5,071 6,233
Purchased in-process
technology........ -- -- -- -- -- 2,125 -- --
Separation costs.... 7,587 8,203 3,780 -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.......... 131,646 99,446 89,658 62,315 62,366 47,578 49,686 39,940
-------- -------- -------- -------- -------- -------- -------- --------
Operating income...... 5,337 19,367 20,879 15,866 11,222 10,728 13,258 13,131
Interest and other
income (expense),
net................. 15,732 418 277 (63) (108) (15) (75) (25)
-------- -------- -------- -------- -------- -------- -------- --------
Income before income
taxes............... 21,069 19,785 21,156 15,803 11,114 10,713 13,183 13,106
Income tax
provision........... 8,632 8,832 8,294 6,145 4,270 4,116 5,066 5,036
-------- -------- -------- -------- -------- -------- -------- --------
Net income............ $ 12,437 $ 10,953 $ 12,862 $ 9,658 $ 6,844 $ 6,597 $ 8,117 $ 8,070
======== ======== ======== ======== ======== ======== ======== ========
Net income per share -
Basic and diluted... $ 0.02 $ 0.02 $ 0.02 $ 0.02 $ 0.01 $ 0.01 $ 0.02 $ 0.02
======== ======== ======== ======== ======== ======== ======== ========
67
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by Item 10 of Form 10-K with respect to
identification of directors is incorporated by reference from the information
contained in the section captioned "Election of Directors" in Palm's definitive
Proxy Statement for the Annual Meeting of Stockholders to be held November 2,
2000 (the "Proxy Statement"), a copy of which will be filed with the Securities
and Exchange Commission before the meeting date. For information with respect to
the executive officers of Palm, see "Executive Officers" at the end of Part I of
this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K is incorporated by
reference from the information contained in the section captioned "Executive
Compensation and Other Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of Form 10-K is incorporated by
reference from the information contained in the section captioned "General
Information" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K is incorporated by
reference from the information contained in the section captioned "Compensation
Committee Interlocks and Insider Participation" in the Proxy Statement.
68
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements--See Index to Consolidated Financial Statements and
Financial Statements Schedule at Item 8 on page 37 of this Report on
Form 10-K.
2. Financial Statement Schedules--See Index to Consolidated Financial
Statements and Financial Statements Schedule at Item 8 on page 37 of this
Report on Form 10-K.
3. Exhibits--The following exhibits are filed as part of, or incorporated
by reference into, this Report on Form 10-K:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1(1) Master Separation and Distribution Agreement between 3Com
and the registrant effective as of December 13, 1999, as
amended.
2.2(2) General Assignment and Assumption Agreement between 3Com and
the registrant, as amended.
2.3(2) Master Technology Ownership and License Agreement between
3Com and the registrant.
2.4(2) Master Patent Ownership and License Agreement between 3Com
and the registrant.
2.5(2) Master Trademark Ownership and License Agreement between
3Com and the registrant.
2.6(2) Employee Matters Agreement between 3Com and the registrant.
2.7(2) Tax Sharing Agreement between 3Com and the registrant.
2.8(2) Master Transitional Services Agreement between 3Com and the
registrant.
2.9(2) Real Estate Matters Agreement between 3Com and the
registrant.
2.10(2) Master Confidential Disclosure Agreement between 3Com and
the registrant.
2.11(2) Indemnification and Insurance Matters Agreement between 3Com
and the registrant.
2.12(1) Form of Non-U.S. Plan.
3.1(1) Amended and Restated Certificate of Incorporation.
3.2(1) Bylaws.
4.1(1) Reference is made to Exhibits 3.1 and 3.2 hereof.
4.2(1) Specimen Stock Certificate.
10.1(1)* 1999 Stock Plan.
10.2(1)* Form of 1999 Stock Plan Agreements.
10.3(1)* 1999 Employee Stock Purchase Plan.
10.4(1)* Form of 1999 Employee Stock Purchase Plan Agreements.
10.5(1)* 1999 Director Option Plan.
10.6(1)* Form of 1999 Director Option Plan Agreements.
10.7(1)* Management Retention Agreement dated as of December 1, 1999
by and between Carl J. Yankowski and the registrant.
10.8(1)* Form of Indemnification Agreement entered into by the
registrant with each of its directors and executive
officers.
10.9(1)** RAM Mobile Data USA Limited Partnership Value Added Reseller
Agreement between RAM Mobile Data USA Limited Partnership
(now BellSouth Wireless Data, L.P.) and the registrant.
10.10(1)** Supply Agreement between Manufacturers' Services Salt Lake
City Operations, Inc. and the registrant.
10.11(1) Common Stock Purchase Agreement between America Online and
the registrant.
10.12(1) Common Stock Purchase Agreement between Motorola and the
registrant.
10.13(1) Common Stock Purchase Agreement between Nokia and the
registrant.
10.14(1) Form of Management Retention Agreement.
69
EXHIBIT
NUMBER DESCRIPTION
------- -----------
21.1 Subsidiaries of the Registrant
23.1 Consent of Independent Auditors
24.1 Power of attorney (see signature page)
27.1 Financial Data Schedule.
- ------------------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (No. 333-92657) filed with the Commission on December 13, 1999, as
amended.
(2) Incorporated by reference from the Registrant's Report on Form 10-Q filed
with the Commission on April 10, 2000.
* Denotes an executive or director compensation plan or arrangement.
** Confidential treatment granted on portions of this exhibit.
(b) Reports on Form 8-K
The Company filed the following Current Reports on Form 8-K during the
fourth quarter of fiscal 2000:
1. On May 8, 2000, the Company reported under Item 5. "Other Events" and
Item 7. "Financial Statements and Exhibits" that on March 8, 2000, 3Com
Corporation and Palm, Inc. announced that 3Com's Board of Directors had
declared a stock dividend of all 3Com's shares in Palm and that the shares
would be distributed to 3Com shareholders of record as of 5:00 PM Eastern
Daylight Time on July 27, 2000.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
August 11, 2000 PALM, INC.
By: /s/ CARL J. YANKOWSKI
-----------------------------------------
Carl J. Yankowski
CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
Know all persons by these presents, that each person whose signature appears
below constitutes and appoints Carl J. Yankowski and Judy Bruner, jointly and
severally, his or her attorneys-in-fact, each with the power of substitution,
for him or her in any and all capacities, to sign any amendments to this Report
on Form 10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his or her
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
PRINCIPAL EXECUTIVE OFFICER:
/s/ CARL J. YANKOWSKI
- ------------------------------------------- Chief Executive Officer, August 11, 2000
Carl J. Yankowski Director
PRINCIPAL FINANCIAL OFFICER AND
PRINCIPAL ACCOUNTING OFFICER:
/s/ JUDY BRUNER
- ------------------------------------------- Senior Vice President August 11, 2000
Judy Bruner Chief Financial Officer
/s/ ERIC A. BENHAMOU
- ------------------------------------------- Director August 11, 2000
Eric A. Benhamou
/s/ JAMES L. BARKSDALE
- ------------------------------------------- Director August 11, 2000
James L. Barksdale
/s/ GORDON A. CAMPBELL
- ------------------------------------------- Director August 11, 2000
Gordon A. Campbell
/s/ MICHAEL HOMER
- ------------------------------------------- Director August 11, 2000
Michael Homer
/s/ DAVID C. NAGEL
- ------------------------------------------- Director August 11, 2000
David C. Nagel
/s/ SUSAN G. SWENSON
- ------------------------------------------- Director August 11, 2000
Susan G. Swenson
71
PALM, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED JUNE 2, 2000, MAY 28, 1999 AND MAY 31, 1998
(IN THOUSANDS)
YEAR ENDED JUNE 2, 2000:
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
For the year ended: ---------- ---------- ---------- ----------
Allowance for doubtful accounts..................... $ 3,817 $ 4,960 $ (1,967) $ 6,810
Product return reserve.............................. 17,543 47,051 (45,552) 19,042
Accrued product warranty............................ 11,329 37,761 (18,106) 30,984
YEAR ENDED MAY 28, 1999:
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
For the year ended: ---------- ---------- ---------- ----------
Allowance for doubtful accounts..................... $4,451 $ 4,271 $ (4,905) $ 3,817
Product return reserve.............................. 5,652 24,145 (12,254) 17,543
Accrued product warranty............................ 4,112 25,949 (18,732) 11,329
YEAR ENDED MAY 31, 1998:
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
For the year ended: ---------- ---------- ---------- ----------
Allowance for doubtful accounts..................... $ 601 $ 3,893 $ (43) $4,451
Product return reserve.............................. 7,246 8,982 (10,576) 5,652
Accrued product warranty............................ 1,653 17,527 (15,068) 4,112
72