PALM INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended February 28, 2003

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File No. 000-29597

Palm, Inc.

(Exact name of registrant as specified in its charter)

Delaware

94-3150688

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

400 N. McCarthy Blvd.

Milpitas, California

95035

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (408) 503-7000

Former name, former address and former fiscal year, if changed since last report: N/A

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 whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes x No ¨

As of March 28, 2003, 29,088,183 shares of the Registrant’s Common Stock were outstanding.

This report contains a total of 60 pages of which this page is number 1.

Palm, Inc.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Statements of Operations Three and Nine months ended February 28, 2003 and March 1, 2002	3

	Condensed Consolidated Balance Sheets February 28, 2003 and May 31, 2002	4

	Condensed Consolidated Statements of Cash Flows Nine months ended February 28, 2003 and March 1, 2002	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	50

Item 4.	Controls and Procedures	51

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	51

Item 6.	Exhibits and Reports on Form 8-K	56

Signatures		60

Certifications		61

The page numbers in this Table of Contents reflect actual page numbers, not EDGAR page tag numbers.

References to “Palm,” “Company,” “we”, “us,” and “our” in this Form 10-Q refer to Palm, Inc. and its subsidiaries unless the context requires otherwise.

Graffiti, HotSync and Palm OS are registered trademarks and Palm and Palm Powered are trademarks of Palm, Inc. or its subsidiaries.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Palm, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended						Nine Months Ended
	February 28, 2003			March 1, 2002			February 28, 2003			March 1, 2002
Revenues	$	209,016		$	292,651		$	646,188		$	797,548
Costs and operating expenses:
Cost of revenues (excluding the applicable portion of amortization of intangible assets)		143,674			207,121			439,349			593,942
Cost of revenues-benefit for special excess inventory and related costs		—			(28,265	)		—			(86,415	)
Sales and marketing		46,827			56,528			136,947			183,626
Research and development		26,200			33,767			83,217			111,280
General and administrative		13,506			14,873			37,260			42,508
Amortization of intangible assets (*)		1,419			3,347			5,648			9,184
Separation costs		1,725			—			5,508			376
Impairment charges		102,540			—			102,540			—
Restructuring charges		40,182			—			37,520			25,988

Total costs and operating expenses		376,073			287,371			847,989			880,489
Operating income (loss)		(167,057	)		5,280			(201,801	)		(82,941	)
Interest and other income (expense), net		(3,219	)		(945	)		(2,350	)		2,513

Income (loss) before income taxes		(170,276	)		4,335			(204,151	)		(80,428	)
Income tax provision (benefit)		2,060			1,387			223,410			(25,737	)

Net income (loss)	$	(172,336	)	$	2,948		$	(427,561	)	$	(54,691	)

Net income (loss) per share:
Basic	$	(5.93	)	$	0.10		$	(14.73	)	$	(1.92	)
Diluted	$	(5.93	)	$	0.10		$	(14.73	)	$	(1.92	)
Shares used in computing net income (loss) per share amounts:
Basic		29,082			28,838			29,032			28,541
Diluted		29,082			28,869			29,032			28,541
(*) Amortization of intangible assets:
Cost of revenues	$	1,315		$	1,763		$	4,841		$	4,543
Sales and marketing		—			—			—			11
Research and development		71			1,551			708			4,586
General and administrative		33			33			99			44

Total amortization of intangible assets	$	1,419		$	3,347		$	5,648		$	9,184

See notes to condensed consolidated financial statements.

Palm, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except par value amounts)

	February 28, 2003			May 31, 2002
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	259,407		$	278,547
Short-term investments		5,063			17,970
Accounts receivable, net of allowance for doubtful accounts of $6,008 and $8,485, respectively		91,205			63,551
Inventories		23,293			55,004
Deferred income taxes		—			48,985
Prepaids and other		9,749			14,122

Total current assets		388,717			478,179
Restricted investments		2,619			2,326
Land, property and equipment, net		100,945			211,556
Goodwill		68,785			68,785
Intangible assets, net		1,397			9,585
Deferred income taxes		34,800			205,440
Other assets		7,394			13,225

Total assets	$	604,657		$	989,096

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	81,701		$	88,909
Accrued restructuring		50,329			35,512
Other accrued liabilities		120,358			108,577

Total current liabilities		252,388			232,998
Non-current liabilities:
Long-term convertible debt		50,000			50,000
Deferred revenue and other		15,513			15,250

Minority interest in consolidated subsidiary		20,000			—

Stockholders’ equity:
Preferred stock, $.001 par value, 125,000 shares authorized; none outstanding		—			—
Common stock, $.001 par value, 2,000,000 shares authorized; outstanding: February 28, 2003, 29,088; May 31, 2002, 28,960 shares		29			29
Additional paid-in capital		1,122,909			1,122,674
Unamortized deferred stock-based compensation		(1,626	)		(5,743	)
Accumulated deficit		(853,768	)		(426,207	)
Accumulated other comprehensive income (loss)		(788	)		95

Total stockholders’ equity		266,756			690,848

Total liabilities and stockholders’ equity	$	604,657		$	989,096

See notes to condensed consolidated financial statements.

Palm, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Nine Months Ended
	February 28, 2003			March 1, 2002
Cash flows from operating activities:
Net loss	$	(427,561	)	$	(54,691	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		19,209			21,849
Amortization		9,654			14,770
Deferred income taxes		219,594			(26,158	)
Impairment charges		105,746			120
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable		(27,654	)		17,082
Inventories		31,711			56,936
Prepaids and other		6,089			(3,724	)
Accounts payable		(7,208	)		(128,098	)
Tax benefit from employee stock options		—			95
Accrued restructuring		15,417			(2,223	)
Other accrued liabilities		12,044			(159,629	)

Net cash used in operating activities		(42,959	)		(263,671	)

Cash flows from investing activities:
Purchases of property and equipment		(9,602	)		(15,788	)
Purchases of short-term investments		(4,618	)		—
Maturities and sales of short term investments		17,525			—
Purchases of equity investments		(1,000	)		—
Purchases of restricted investments		(293	)		(275	)
Acquisition of business, net of cash acquired		—			43

Net cash provided by (used in) investing activities		2,012			(16,020	)

Cash flows from financing activities
Proceeds from issuance of common stock, net		1,306			1,504
Issuance of subsidiary preferred stock		20,000			—
Issuance of convertible debt		—			50,000
Other, net		501			63

Net cash provided by financing activities		21,807			51,567

Change in cash and cash equivalents		(19,140	)		(228,124	)
Cash and cash equivalents, beginning of period		278,547			513,769

Cash and cash equivalents, end of period	$	259,407		$	285,645

Other cash flow information:
Cash refund (paid) for income taxes	$	(1,720	)	$	15,697

Cash paid for interest	$	(2,659	)	$	(89	)

Non-cash investing and financing activities are as follows:
Fair value of stock options assumed in business combination	$	—		$	255

Common stock issued for acquisition of businesses	$	—		$	29,607

Purchase of property and equipment through capital lease	$	—		$	2,436

See notes to condensed consolidated financial statements.

Palm, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Basis of Presentation

The condensed consolidated financial statements have been prepared by Palm, Inc. (“Palm,” the “Company,” “us,” “we,” or “our”), without audit, pursuant to the rules of the Securities and Exchange Commission (“SEC”). In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments necessary for a fair presentation of Palm’s financial position as of February 28, 2003, results of operations for the three and nine months ended February 28, 2003 and March 1, 2002 and cash flows for the nine months ended February 28, 2003 and March 1, 2002. On October 15, 2002, Palm effected a one-for-twenty reverse stock split. All share and per share information herein reflect this reverse stock split. Certain prior year balances have been reclassified to conform to the current year presentation. These reclassifications had no impact on net earnings or total shares outstanding.

Palm was legally separated from 3Com Corporation (“3Com”) on February 26, 2000 (“the Separation Date”) and completed its initial public offering on March 2, 2000. Final distribution of Palm common stock from 3Com to its stockholders was completed on July 27, 2000.

Palm’s 52-53 week fiscal year ends on the Friday nearest to May 31. Both fiscal year 2003 and 2002 contain 52 weeks. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in Palm’s Annual Report on Form 10-K for the fiscal year ended May 31, 2002.

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supersedes Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and requires that a liability be recognized when it is incurred and should initially be measured and recorded at fair value. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. Palm adopted this standard, which did not have an impact on the Company’s historical financial position or results of operations.

In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002.

Palm adopted this interpretation, which did not have an impact on the Company’s historical financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, an amendment of SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. In addition, it amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement is effective for fiscal years ending after December 15, 2002. The new interim disclosure provisions are effective for the first interim period beginning after December 15, 2002, which, for Palm, will be the quarter ended August 29, 2003. The adoption of this statement will not have an impact on the Company’s historical financial position or results of operations.

Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows (in thousands):

	Three Months Ended						Nine Months Ended
	February 28,			March 1,			February 28,			March 1,
	2003			2002			2003			2002
Net income (loss)	$	(172,336	)	$	2,948		$	(427,561	)	$	(54,691	)
Other comprehensive income:
Unrealized loss on investments		(798	)		(525	)		(1,384	)		(539	)
Reclass of loss to income statement		—			—			—			119
Change in accumulated translation adjustments		346			16			501			63

Total comprehensive income (loss)	$	(172,788	)	$	2,439		$	(428,444	)	$	(55,048	)

Net Income (Loss) Per Share

Basic net income (loss) 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 and warrants outstanding, calculated using the treasury stock method. Diluted net loss per share is calculated based on the weighted average shares of common stock outstanding because the effect of stock options and warrants outstanding, calculated using the treasury stock method, would have been anti-dilutive. The dilutive effect of stock options outstanding for the three months ended March 1, 2002 was approximately 31,000 shares. For the three and nine months ended February 28, 2003 and the nine months ended March 1, 2002, approximately 170,000, 71,000, and 13,000 common equivalent shares, respectively, were excluded from the computations of diluted net loss per share.

Cash and Available for Sale and Restricted Investments

The Company’s cash and available for sale and restricted investments are as follows (in thousands):

	February 28, 2003							May 31, 2002
	Carrying		Unrealized			Estimated		Carrying		Unrealized			Estimated
	Value		Gain (Loss)			Fair Value		Value		Loss			Fair Value
Cash	$	42,506	$	—		$	42,506	$	8,263	$	—		$	8,263
Cash equivalents:
Money market funds		37,810		—			37,810		73,936		—			73,936
State and local government obligations		104,051		—			104,051		94,448		—			94,448
Corporate notes/bonds		55,028		—			55,028		98,900		—			98,900
Foreign corporate notes/bonds		20,012		—			20,012		3,000		—			3,000

		216,901		—			216,901		270,284		—			270,284

Total cash and cash equivalents		259,407		—			259,407		278,547		—			278,547

Short-term investments:
Corporate notes/bonds		5,053		10			5,063		17,987		(17	)		17,970
Equity investments in publicly traded companies		2,006		(1,437	)		569		35		(26	)		9
Restricted investments:
U.S. government agency obligations		1,722		—			1,722		1,551		—			1,551
Certificates of deposit		897		—			897		775		—			775

		2,619		—			2,619		2,326		—			2,326

Total cash and available for sale and restricted investments	$	269,085	$	(1,427	)	$	267,658	$	298,895	$	(43	)	$	298,852

Inventories

Inventories consist of (in thousands):

	February 28,		May 31,
	2003		2002
Finished goods	$	12,781	$	35,995
Work-in-process and raw materials		10,512		19,009

	$	23,293	$	55,004

Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill for the year ended May 31, 2002 and the nine months ended February 28, 2003, are as follows (in thousands):

	Solutions
	Group			PalmSource		Total
Balance as of June 1, 2001	$	3,680		$	39,489	$	43,169
SFAS No. 142 adjustment, net of deferred income taxes		636			595		1,231

Balance as of June 2, 2001		4,316			40,084		44,400
Goodwill acquired during the period		13,815			10,570		24,385
Goodwill transferred between reporting units		(3,039	)		3,039		—

Balance as of May 31, 2002		15,092			53,693		68,785
Goodwill transferred between reporting units		(1,276	)		1,276		—

Balance as of February 28, 2003	$	13,816		$	54,969	$	68,785

Intangible assets consist of the following (in thousands):

		February 28, 2003										May 31, 2002
		Gross										Gross
	Amortization	Carrying		Impairment			Accumulated					Carrying		Accumulated
	Period	Amount		Charges			Amortization			Net		Amount		Amortization			Net
Core technology	24-48 months	$	18,659	$	(2,540	)	$	(15,229	)	$	890	$	18,659	$	(10,565	)	$	8,094
Non-compete covenants	6-24 months		12,759		—			(12,499	)		260		12,759		(11,692	)		1,067
Other	36 months		710		—			(463	)		247		710		(286	)		424

		$	32,128	$	(2,540	)	$	(28,191	)	$	1,397	$	32,128	$	(22,543	)	$	9,585

Amortization expense of other intangible assets was $1.4 million and $5.6 million for the three and nine months ended February 28, 2003. Estimated future amortization expense for the remaining three months of fiscal year 2003, fiscal year 2004 and fiscal year 2005 are $0.4 million, $0.9 million and $0.1 million, respectively. Under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company recorded an impairment charge of $2.5 million in the quarter ended February 28, 2003 related to the core technology acquired from ThinAirApps.

Deferred Income Taxes

As of February 28, 2003, Palm’s deferred tax assets were comprised of net operating loss carryforwards, deferred expenses and tax credit carryforwards of $360 million offset by a valuation allowance of $325 million. During the first quarter of fiscal year 2003, there were changes in both the valuation of and the nature of the Company’s tax planning strategies that necessitated an increase in the valuation allowance of $220 million, resulting in the net deferred tax asset balance of approximately $35 million. The valuation allowance does not impact Palm’s ability to utilize the underlying net operating loss carryforwards, which expire from 2011 to 2024. For the three months and the nine months ended March 1, 2002, the effective tax rate was 32%.

Commitments and Guarantees

Palm facilities are leased under operating leases that expire at various dates through September 2011.

In December 2001, Palm issued a subordinated convertible note in the principal amount of $50 million. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into common stock at an effective conversion price of $92.64 per share. Palm may force a conversion at any time beyond one year of the closing, provided its common stock has traded above $142.65 per share for a defined period of time. In the event Palm distributes significant assets, the Company may be required to repay a portion of the note. The note agreement defines certain events of default pursuant to which the full amount of the note plus interest could become due and payable.

In June 2001, Palm obtained a two-year asset-backed borrowing-base credit facility from a group of financial institutions for up to a maximum of $150 million with the actual amount available determined by eligible accounts receivable and inventory as well as a real estate line of credit less the amount of any outstanding cash advances and letters of credit. The credit facility is secured by accounts receivable, inventory, and certain fixed assets including real estate and property and equipment. The interest rate may vary based on fluctuations in market rates and margin borrowing levels. Palm is subject to certain financial covenant requirements and restrictions under the agreement including restrictions that require the Company to obtain prior consent from the lenders before it engages in certain specified actions such as incurring certain indebtedness, making certain investments or distributions, making certain acquisitions, making certain capital expenditures or causing a change in control of Palm. As of February 28, 2003, Palm had used its credit facility to support the issuance of letters of credit of $53.0 million. The collateral for the $50 million letter of credit relative to a litigation matter expires on April 30, 2003. If the letter of credit is still required subsequent to April 30, 2003, it will have to be collateralized with either cash or with some other form of credit. The remaining $3.0 million of letters of credit expire in June 2003, upon the termination of the credit facility.

During the third quarter of fiscal year 2001, Palm issued to a vendor a fully vested warrant to purchase up to 12,500 shares of common stock at an exercise price of $584.40 per share. On each anniversary date beginning January 2002, 25% of the shares subject to the warrant become exercisable. The warrant expires in January 2006. The fair value of the warrant of $3.8 million was capitalized and is being amortized to cost of revenues over the term of the agreement. The fair value of the warrant was estimated at the date of grant using Black-Scholes valuation model with the following assumptions: risk-free interest rate, 4.9%; volatility, 67%; option term, 5 years; dividend yield, 0.0%.

Palm has a minimum purchase commitment with a third party under which it could be liable for payments of up to a maximum of $4.9 million during calendar year 2003.

The Company has patent cross license agreements under which the Company is committed to pay $0.8 million for the remaining 3 months in fiscal year 2003, $3.9 million in fiscal year 2004, $4.7 million in fiscal year 2005, $2.1 million in fiscal year 2006, $0.4 million in fiscal year 2007 and $0.2 million in fiscal year 2008.

The Company uses supply partners and contract manufacturers to source components and to manufacture its products. During the normal course of business to ensure timely product supply, the Company enters into short-term agreements with certain contract manufacturers and supply partners to procure inventory to meet forecasted demand for the Company’s products.

As part of the separation agreements with 3Com, Palm agreed to assume liabilities arising out of the Xerox, E-Pass Technologies, and Connelly litigation and to indemnify 3Com for any damages it may incur related to these cases.

Under the indemnification of the Company’s standard reseller agreements and software license agreements, the Company agrees to defend the reseller/licensee against third party claims asserting infringement by Company’s products of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay any judgments entered on such claims against the reseller/licensee.

The Company’s product warranty accrual reflects management’s best estimate of probable liability under its product warranties. Management determines the warranty liability based on historical rates of usage as a percentage of shipment levels and the expected repair cost per unit, service policies and specific known issues.

Changes in the product warranty accrual for the nine months ended February 28, 2003 are as follows (in thousands):

Balance as of May 31, 2002	$	30,008
Payments made		(31,073	)
Change in liability for product sold during the period		30,342
Change in liability for pre-existing warranties		(11,870	)

Balance as of February 28, 2003	$	17,407

10.

Minority Interest in Consolidated Subsidiary

Minority interest in consolidated subsidiary reflects a $20 million investment by Sony Corporation (“Sony”) in Series A Preferred Stock of PalmSource, Inc. (“PalmSource”), a Palm subsidiary, giving Sony an ownership position of 6.25% of PalmSource. Sony has been and continues to be a licensee of the Palm OS owned by PalmSource. Under the terms of the software license agreement between PalmSource and Sony, PalmSource recognized license and support fees of $1.7 million and $3.6 million during the three and nine months ended February 28, 2002 compared to $3.8 million and $8.8 million during the three and nine months ended February 28, 2003.

11.

Restructuring and Impairment Charges

Restructuring charges of $40.2 million recorded during the third quarter of fiscal year 2003 consist of $18.9 million related to the restructuring actions taken during the third quarter of fiscal year 2003 plus $21.3 million of adjustments related to restructuring actions taken in prior quarters.

The third quarter fiscal year 2003 restructuring actions consisted of workforce reductions, primarily in the U.S., of approximately 140 regular employees from the Solutions Group and approximately 60 regular employees from PalmSource, facilities and property and equipment disposed of or removed from service, and canceled projects. Restructuring charges relate to the implementation of a series of actions to better align the Company’s expense structure with it’s revenues. As of February 28, 2003, approximately 120 regular employees from Solutions Group and 60 regular employees from PalmSource had been terminated as a result of this restructuring.

Restructuring charges taken in prior periods included:

The fourth quarter fiscal year 2002 restructuring charges related to workforce reductions across all geographic regions of approximately 90 regular employees, facilities and property and equipment that will be disposed of or removed from service in fiscal year 2003 and canceled projects. As of February 28, 2003, headcount reductions were substantially complete. During the third quarter of fiscal year 2003, Palm recorded a $0.1 million reduction to restructuring accruals due to changes in the estimated costs of certain actions.

The second quarter fiscal year 2002 restructuring charges related to workforce reductions across all geographic regions of approximately 220 regular employees, excess facilities and related costs for lease commitments for space no longer intended for use. As of February 28, 2003, the headcount reductions were complete.

The fourth quarter fiscal year 2001 restructuring charges related to carrying and development costs related to the land on which Palm had previously planned to build its corporate headquarters, facilities costs related to lease commitments for space no longer intended for use, workforce reduction costs across all geographic regions and discontinued project costs. These workforce reductions affected approximately 250 regular employees. As of February 28, 2003 the headcount reductions were complete. During the third quarter of fiscal year 2003, Palm recorded a $21.4 million adjustment to excess facilities costs previously recorded during the fourth quarter of fiscal year 2001 primarily due to changes in estimates of sublease income.

Cost reduction actions initiated in the second and fourth quarters of fiscal year 2002 and in the fourth quarter of fiscal year 2001 are substantially complete except for remaining rent payments related to excess facilities. Cost reduction actions initiated in the third quarter of fiscal year 2003 are expected to be substantially complete by the end of the second quarter of fiscal year 2004.

Accrued liabilities related to the third quarter of fiscal year 2003 restructuring actions consist of the following (in thousands):

	Excess facilities and equipment costs			Workforce reduction costs			Discontinued project costs		Total
Solutions Group
Restructuring expense	$	807		$	5,336		$	10,577	$	16,720
Cash payments		—			(402	)		—		(402	)

Solutions Group balances, February 28, 2003		807			4,934			10,577		16,318

PalmSource
Restructuring expense		172			2,048			—		2,220
Cash payments		(172	)		(1,006	)		—		(1,178	)

PalmSource balances, February 28, 2003		—			1,042			—		1,042

Total Palm
Restructuring expense		979			7,384			10,577		18,940
Cash payments		(172	)		(1,408	)		—		(1,580	)

Balances, February 28, 2003	$	807		$	5,976		$	10,577	$	17,360

Accrued liabilities related to the fourth quarter of fiscal year 2002 restructuring actions consist of the following (in thousands):

	Excess facilities costs			Workforce reduction costs			Discontinued project costs			Total
Balances, May 31, 2002	$	7,652		$	5,385		$	1,273		$	14,310
Restructuring adjustments		345			(458	)		(857	)		(970	)
Cash payments		(7,030	)		(4,485	)		(416	)		(11,931	)

Balances, February 28, 2003	$	967		$	442		$	—		$	1,409

Accrued liabilities related to the second quarter of fiscal year 2002 restructuring actions consist of the following (in thousands):

	Excess facilities costs			Workforce reduction costs			Total
Balances, May 31, 2002	$	2,588		$	1,737		$	4,325
Restructuring adjustments		(515	)		(1,009	)		(1,524	)
Cash payments		(2,079	)		(728	)		(2,807	)
Fixed asset recovery		6			—			6

Balances, February 28, 2003	$	—		$	—		$	—

Accrued liabilities related to the fourth quarter of fiscal year 2001 restructuring actions consist of the following (in thousands):

	Excess facilities costs			Workforce reduction costs			Total
Balances, May 31, 2002	$	16,552		$	325		$	16,877
Restructuring adjustments		21,358			(284	)		21,074
Cash payments		(6,350	)		(41	)		(6,391	)

Balances, February 28, 2003	$	31,560		$	—		$	31,560

During the third quarter of fiscal year 2003, Palm incurred an impairment charge of $102.5 million. This charge includes $100 million related to approximately 39 acres of land owned by the Company in San Jose, California. Market conditions for commercial real estate in the Silicon Valley have deteriorated since the land was acquired in May 2001; and, during the third quarter of fiscal year 2003, the Company determined that it no longer expects to hold the land as long as would be required to realize the $160 million carrying value. As a result, Palm has adjusted the carrying value to the current fair market value of $60 million. In addition, a $2.5 million impairment charge was recorded in accordance with SFAS No. 144, related to the core technology acquired from ThinAirApps. The core technology is no longer considered useful, and its carrying value is not considered to be recoverable. The fair value of the core technology was determined using the discounted cash flow method.

12.

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, with reasonable certainty, the possible loss, or

range of loss, if any, from the cases listed below, but an unfavorable resolution of these lawsuits could materially adversely affect Palm’s business, results of operations or financial condition.

On April 28, 1997, Xerox Corporation filed suit in the United States District Court for the Western District of New York. The case came to be captioned Xerox Corporation v. 3Com Corporation, U.S. Robotics Corporation, U.S. Robotics Access Corp., and Palm Computing, Inc., Civil Action No. 97-CV-6182T. The complaint alleged willful infringement of U.S. Patent No. 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 2000, the District Court dismissed the case, ruling that the patent is not infringed by the Graffiti handwriting recognition system used in handheld computers using Palm’s operating systems. Xerox appealed the dismissal to the United States Court of Appeals for the Federal Circuit (“CAFC”). On October 5, 2001, the CAFC affirmed-in-part, reversed-in-part and remanded the case to the District Court for further proceedings. On December 20, 2001, the District Court granted Xerox’s motion for summary judgment that the patent is valid, enforceable, and infringed. The defendants filed a Notice of Appeal on December 21, 2001. On February 22, 2002, the court denied a request for an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The court also rejected a request by Xerox to set a trial date to determine damages Xerox claims it is owed. In connection with the denial of Xerox’s request to set a trial date on damages, the court required Palm to post a $50 million bond, which was satisfied with a letter of credit from a financial institution. A Notice of Appeal from the District Court’s order of February 22, 2002 was filed by Palm on March 15, 2002. A cross-appeal from the District Court’s order of February 22, 2002 was filed by Xerox on March 4, 2002. A hearing on the appeal and cross-appeal was held on January 6, 2003 before the CAFC. The CAFC has remanded the case to the District Court for a determination on the issue of invalidity of the ‘656 patent. Xerox petitioned the CAFC for reconsideration of its determination on the appeal and cross-appeal, but the CAFC has denied this petition. If Palm is not successful regarding the remand to the District Court, the CAFC has noted that an injunction will apply. If an injunction is sought by Xerox and issued, it could result in business interruption for Palm that would have a significant adverse impact on Palm’s operations and financial condition if Palm has not transitioned to a handwriting recognition system outside the scope of Xerox’s asserted claims. In addition, if Palm is not successful with regard to this remand to the District Court, Xerox has stated in its court pleadings that it will seek at a trial, a significant compensatory and punitive damage award or license fees from Palm. Furthermore, if Palm is not successful with regard to this remand to the District Court, Palm might be liable to Palm’s licensees and other third parties under contractual obligations or otherwise sustain adverse financial impact if Xerox seeks to enforce its patents claims against Palm’s licensees and other third parties. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation.

infringing the patent in the future. The case was transferred to the U.S. District Court for the Northern District of California. In an Order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. The issues on appeal before the CAFC have been fully briefed by the parties, and the oral argument is scheduled for May 6, 2003. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses, which may arise out of the E-Pass litigation.

On January 11, 2001, a purported shareholder derivative and class action lawsuit, entitled Shaev v. Benhamou, et al., No. CV795128 (Super. Ct. Santa Clara Cty.) was filed against Palm and its directors. The complaint alleged that Palm’s directors breached fiduciary duties by not having Palm’s public stockholders approve Palm’s 1999 director stock option plan. Plaintiff filed an amended complaint in November 2001 adding new defendants and new allegations, including that defendants breached fiduciary duties by approving Palm’s 2001 director stock option plan and by making misrepresentations in Palm’s September 2001 proxy statement concerning the 2001 director stock option plan and the 1999 employee stock option plan. In June 2002, plaintiff filed a second amended complaint. Plaintiff added a fifth claim based on allegations that the Company did not have proper board approvals for some of the actions taken in connection with the Company’s separation from 3Com, including the merger between Palm Computing, Inc. and Palm, the issuance of its stock, and the adoption of equity and stock option plans. The plaintiff also alleged that the Company does not have, and has never had, a valid board. Plaintiff sought various equitable remedies, including rescission of the Company’s director and employee stock option plans, an accounting and to enjoin the Company from any distribution of PalmSource stock. Plaintiff also sought an award of legal fees and costs. The Palm Board of Directors has reviewed and considered plaintiff’s allegations concerning actions taken in connection with the Company’s separation from 3Com. While the Palm Board believes that all actions were properly taken and approved, the Board determined that it was in the best interests of Palm to clarify the Company’s records with respect to certain issues identified in the complaint. Therefore, Palm’s Board of Directors has confirmed, ratified and approved certain Palm corporate actions taken in connection with the separation from 3Com. On March 31, 2003, the parties signed a settlement agreement that was subject to court approval. As part of the settlement, plaintiff agreed that the Palm Board had remedied any and all alleged defects in board actions and ratified actions taken by Palm since its incorporation. The settlement agreement includes releases of the defendants, including for all claims that were asserted or could have been asserted in the action. Palm has agreed as part of the settlement to pay $2.150 million in legal fees and costs to plaintiff’s counsel. On April 8, 2003, the court heard the parties’ motion for an order approving the settlement and an order of dismissal. The court approved the settlement agreement, finding in part that the Palm Board had remedied any and all alleged defects in board actions and ratified actions taken by Palm since its incorporation. The court dismissed plaintiff’s claims with prejudice.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, entitled, respectively, “Portable Personal Terminal for Use in a System for Handling Transactions” and “System for Handling Transactions Including a Portable Personal Terminal.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. The case was referred to Magistrate Judge Mary P. Thynge. In a Memorandum Opinion dated July 11, 2002, the Magistrate Judge indicated that she would recommend that the District Court grant the defendants’ motion for summary judgment that there was no infringement. NCR filed objections to the recommendations of the Magistrate Judge, and Palm has filed a response to NCR’s objections. The parties are now awaiting a decision from District Court Judge Kent Jordan.

damages and to permanently enjoin the defendant from infringing the patent in the future. Palm believes that the claims are without merit and intends to defend against them vigorously. Palm is scheduled to respond to the complaint by April 18, 2003.

In June 2001, the first of several putative stockholder class action lawsuits was filed in United States District Court, Southern District of New York against certain of the underwriters for Palm’s initial public offering, Palm and several of its officers. The complaints, which have been consolidated under the caption In re Palm, Inc. Initial Public Offering Securities Litigation, No. 01 CV 5613, assert that the prospectus from Palm’s March 2, 2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The complaints allege claims against Palm and the officers under Sections 11 and 15 of the Securities Act of 1933, as amended. Certain of the complaints also allege claims under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended. Other actions have been filed making similar allegations regarding the initial public offerings of more than 300 other companies. All of these various consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with plaintiffs. Palm joined the motion to dismiss filed on behalf of all issuers, which the court denied with respect to Palm. Palm believes that it has meritorious defenses to the claims against it and intends to defend the action vigorously.

On August 7, 2001, a purported consumer class action lawsuit was filed against Palm and 3Com Corporation in California Superior Court, San Francisco County. The case is captioned Connelly et al v. Palm, Inc., 3 Com Corp et al, Case No. 323587. An amended complaint alleging breach of warranty and violation of California’s Unfair Competition Law was filed and served on Palm on August 15, 2001. The amended complaint, filed on behalf of purchasers of Palm III, IIIc, V and Vx handhelds, alleges that certain Palm handhelds may cause damage to PC motherboards by permitting an electrical charge, or “floating voltage,” from either the handheld or the cradle to be introduced into the PC via the serial and/or USB port on the PC. The plaintiffs allege that this damage is the result of a design defect in one or more of the following: HotSync software, handheld, cradle and/or the connection cable. The complaint seeks restitution, rescission, damages, an injunction mandating corrective measures to protect against future damage as well as notifying users of potential harm. Discovery is closed. The parties engaged in mediation and have reached an agreement in principle to settle the action, subject to acceptable documentation and court approval. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Connelly litigation.

On January 23, 2002, a purported consumer class action lawsuit was filed against Palm in California Superior Court, San Francisco County. The case is captioned Eley et al v. Palm, Inc., Case No. 403768. The unverified complaint, filed on behalf of purchasers of Palm m500 and m505 handhelds, alleges (1) that the HotSync function in certain Palm handhelds does not perform as advertised and the products are therefore defective and (2) that upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty. The complaint alleges Palm’s actions are a violation of California’s Unfair Competition Law and a breach of express warranty. The complaint seeks alternative relief including an injunction to have Palm desist from selling and advertising the handhelds, to recall the defective handhelds, to restore the units to their advertised functionality, to pay restitution or

disgorgement of the purchase price of the units and/or damages and attorneys’ fees. Palm filed its answer denying the allegations and the parties engaged in document and deposition discovery. Plaintiff and Palm engaged in mediation and are considering resolution alternatives. No trial date has been set.

On March 11, 2002, a purported consumer class action lawsuit was filed against Palm in the Wayne County Circuit Court, Detroit, Michigan. The case is captioned Hayman, et al. v Palm, Inc (Case No. 02-208249-CP). Plaintiffs allege that certain of Palm, Inc.’s advertisements for its Palm III, V and m100 handheld devices were false or misleading regarding the ability of the device to wirelessly and remotely access e-mails or the Internet without the need for additional hardware or software sold separately. Plaintiffs allege violations of the Michigan Consumer Protection Act, breach of express and implied warranties and Michigan common law, and seek to recover the purchase price of the device from Palm for themselves and a class of all similarly situated consumers. Palm has filed a motion to dismiss the lawsuit in its entirety. The Court has heard arguments on that motion, and it has advised that it would rule on Palm’s motion to dismiss before considering the suitability of this lawsuit for class treatment.

In October 2002, a purported consumer class action lawsuit was filed against Palm in Illinois Circuit Court, Cook County. The case is captioned Goldstein v. Palm, Inc., No. 02CH19678. The case alleges consumer fraud regarding Palm’s representations that its m100, III, V, and VII handheld personal digital assistant, as sold, would provide wireless access to the Internet and e-mail accounts, and would perform common business functions including data base management, custom form creation, and viewing Microsoft Word and Excel documents, among other tasks. The case seeks unspecified actual damages and indemnification of certain costs. Palm responded to the Complaint and the case is in its early stages. No trial date has been set.

In August and September 2002, four purported consumer class action lawsuits were filed against Palm in California Superior Court, Santa Clara County; California Superior Court, San Diego County; Illinois Circuit Court, Cook County; and Illinois Circuit Court, St. Clair County. The respective cases are captioned Lipner and Ouyang v. Palm, Inc., No. CV-810533; Veltman v. Palm, Inc., No. 02CH16143; Wireless Consumer’s Alliance, Inc. v. Palm, Inc., No. GIC-794940; and Cokenour v. Palm, Inc., No. 02L0592. All four cases allege consumer fraud regarding Palm’s representations that its m130 handheld personal digital assistant supported more than 65,000 colors. Certain of the cases also allege breach of express warranty and unfair competition. In general, the cases seek unspecified damages and/or to enjoin Palm from continuing its allegedly misleading advertising. Other similar actions may be filed. Palm has filed answers denying the allegations in the two former actions. The parties are in the early stages of discovery, and no trial date has been set. Palm has not responded to the two latter actions.

On February 27, 2003, a purported consumer class action lawsuit was filed against Palm in California Superior Court, Santa Clara County. The case is captioned Hemmingsen et al v. Palm, Inc., Case No. CV815074. The unverified complaint, filed on behalf of purchasers of Palm m515 handhelds, alleges that such handhelds fail at unacceptably high rates, and in particular that instant updating and synchronization of data with PCs often will not occur. The complaint further alleges that, upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty, among other things. The complaint alleges that Palm’s actions violate California’s Unfair Competition Law and constitute a breach of warranty. The complaint seeks restitution, disgorgement, damages, an injunction

mandating corrective measures including a full replacement program for all allegedly defective m515s or, alternatively mandating a refund to all purported class members of the full purchase price for their m515s, and attorneys’ fees. Palm’s response to the complaint is due on April 15, 2003.

13.

Related Party Transactions

Subsequent to the Separation Date, Palm paid 3Com for certain transitional services through the third quarter of fiscal year 2002. In addition, Palm leased certain facilities from 3Com after the Separation Date, under which Palm has paid $4.6 million in the nine months ended February 28, 2003.

A 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. The agreement also provides for compensation or reimbursement as appropriate to reflect redeterminations of Palm’s tax liability for periods during which Palm was included in consolidated, combined or unitary tax returns with affiliated corporations.

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 3Com 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.

Effective as of the Separation Date, subject to specified exceptions, Palm and 3Com have indemnified each other for 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.

Under the terms of a software license agreement between PalmSource and 3Com, PalmSource recorded $0.3 million and $0.4 million of support revenues during the three and nine months ended February 28, 2003, respectively, as compared to $0.1 million and $0.1 million of support revenues for the three and nine months ended March 1, 2002, respectively.

Palm has entered into a business consulting agreement with a former executive under which it has paid $0 and $0.3 million during the three and nine months ended February 28, 2003, respectively.

Palm has made a $1.0 million equity investment and entered into a product procurement agreement with a company founded by a second former executive of the Company. During the three and nine months ended February 28, 2003, Palm paid $2.7 million for products purchased under the product procurement agreement. These products are purchased by Palm for resale.

During the nine months ended February 28, 2003, Palm has purchased $0.3 million of software licenses and services from a company whose Chairman and CEO is a member of Palm’s board of directors.

14.

Business Segment Information

The Company is organized into two business units—the Solutions Group and PalmSource. The Solutions Group designs, develops and markets handheld devices and accessories to provide users with simple, elegant and useful productivity tools. PalmSource develops and licenses the Palm OS^® operating system and related software, which is referred to as the Palm platform. The Palm platform is the foundation for Palm devices as well as for devices manufactured by third party licensees.

The accounting policies of the operating segments are the same as for the Company as a whole, except that for segment reporting purposes, PalmSource recognizes intersegment revenues from the Solutions Group on a “contractually reported” basis.

The Solutions Group licenses the Palm platform from PalmSource and pays an intersegment royalty. Intersegment revenues and expenses between Solutions Group and PalmSource are eliminated in consolidation. Certain prior period amounts have been reclassified for current quarter presentation and certain historical segment information has been restated to conform to the current segment presentation, including the application of the terms of the license agreement between the Solutions Group and PalmSource, effective in the third quarter of fiscal year 2002, to the prior periods.

	Three Months Ended February 28, 2003 (in thousands)
	Solutions Group			PalmSource			Eliminations			Total Palm
Revenues	$	197,864		$	26,273		$	(15,121	)	$	209,016
Cost of revenues*		150,792			1,405			(8,523	)		143,674
Research & development, selling, marketing, general & administrative expenses		68,341			18,229			(37	)		86,533
Amortization of intangible assets		—			1,419			—			1,419
Separation costs		765			960			—			1,725
Impairment charges		102,540			—			—			102,540
Restructuring charges		37,952			2,230			—			40,182

Operating income (loss)		(162,526	)		2,030			(6,561	)		(167,057	)
Interest and other income (expenses), net		(2,574	)		(645	)		—			(3,219	)

Segment income (loss) before income taxes	$	(165,100	)	$	1,385		$	(6,561	)	$	(170,276	)

	Three months ended March 1, 2002 (in thousands)
	Solutions Group			PalmSource			Eliminations			Total Palm
Revenues	$	284,278		$	20,401		$	(12,028	)	$	292,651
Cost of revenues *		217,552			1,319			(11,750	)		207,121
Cost of revenues—benefit for special excess inventory and related costs		(28,265	)		—			—			(28,265	)
Research & development, selling, marketing, general & adminstrative expenses		85,031			20,602			(465	)		105,168
Amortization of intangible assets		1,796			1,551			—			3,347
Separation costs		—			—			—			—
Restructuring charges		—			—			—			—

Operating income (loss)		8,164			(3,071	)		187			5,280
Interest and other income (expenses), net		(797	)		(148	)		—			(945	)

Segment income (loss) before income taxes	$	7,367		$	(3,219	)	$	187		$	4,335

	Nine months ended February 28, 2003 (in thousands)
	Solutions Group			PalmSource			Eliminations			Total Palm
Revenues	$	620,491		$	56,111		$	(30,414	)	$	646,188
Cost of revenues *		465,571			4,211			(30,433	)		439,349
Research & development, selling, marketing, general & adminstrative expenses		203,956			53,879			(411	)		257,424
Amortization of intangible assets		1,127			4,521			—			5,648
Separation costs		2,655			2,853			—			5,508
Impairment charges		102,540			—			—			102,540
Restructuring charges		35,348			2,172			—			37,520

Operating income (loss)		(190,706	)		(11,525	)		430			(201,801	)
Interest and other income (expenses), net		2,409			(4,759	)		—			(2,350	)

Segment income (loss) before income taxes	$	(188,297	)	$	(16,284	)	$	430		$	(204,151	)

	Nine months ended March 1, 2002 (in thousands)
	Solutions Group			PalmSource			Eliminations			Total Palm
Revenues	$	777,994		$	51,350		$	(31,796	)	$	797,548
Cost of revenues *		622,581			3,451			(32,090	)		593,942
Cost of revenues—benefit for special excess inventory and related costs		(86,415	)		—			—			(86,415	)
Research & development, selling, marketing, general & adminstrative expenses		273,804			63,419			191			337,414
Amortization of intangible assets		4,752			4,432			—			9,184
Separation costs		275			101			—			376
Restructuring charges		25,562			426			—			25,988

Operating income (loss)		(62,565	)		(20,479	)		103			(82,941	)
Interest and other income (expenses), net		2,673			(160	)		—			2,513

Segment income (loss) before income taxes	$	(59,892	)	$	(20,639	)	$	103		$	(80,428	)

* Segment cost of revenues excludes the applicable portion of amortization of intangibles which is included in the line “amortization of intangibles assets” to determine segment income (loss) before income taxes.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report contains forward-looking statements within the meaning of the federal securities laws. These statements include those concerning Palm’s expectations, beliefs and/or intentions regarding the following: (a) the timing, costs and method of the separation of the PalmSource and Solutions Group businesses; (b) actions to reduce costs and savings resulting from restructuring; (c) the use of proceeds from the potential sale of securities under Palm’s universal shelf registration statement; (d) the sufficiency of Palm’s cash, cash equivalents, short term investments and credit facility to satisfy its anticipated cash requirements; (e) strategic alliances and the benefits of such strategic alliances; (f) the effects of changes in market interest rates; (g) investment activities and the use of Palm’s financial instruments; (h) Palm’s defenses to legal proceedings and litigation matters; (i) provisions in Palm’s charter documents and Delaware law and the potential effects of a stockholder rights plan; (j) the development and introduction of new products and services; and (k) competitors and competition in the markets in which Palm operates. 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 “Business Environment and Risk Factors” section of this report. Palm undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview

Palm, Inc. is the leading global provider of handheld computing devices and operating systems for handheld devices. For purposes of this report, we refer to the devices designed and sold by Palm as Palm Branded devices, and we refer to devices running on the Palm operating system (the “Palm OS”) as Palm Powered devices. Palm Powered devices include Palm Branded devices as well as devices designed and sold by third parties licensing the Palm OS.

We were founded in 1992 as Palm Computing Inc. In 1995, we were acquired by U.S. Robotics Corporation (“U.S. Robotics”) and we sold our first handheld product in 1996, quickly establishing a leadership role in the handheld device industry. In 1997, 3Com Corporation (“3Com”) acquired U.S. Robotics and in 1999, 3Com announced the intent to separate the Palm business into an independent company. In preparation for becoming an independent, publicly traded company, Palm Computing, Inc. changed its name to Palm, Inc. and was incorporated in Delaware in December 1999. In March 2000, approximately 6% of the shares of our common stock were sold in an initial public offering and concurrent private placements and in July 2000, 3Com distributed the remaining approximately 94% of our common stock outstanding to 3Com’s stockholders.

Today, we are organized into two operating segments—PalmSource, Inc. (“PalmSource”), a subsidiary of Palm, Inc., and the Solutions Group. In the first quarter of fiscal year 2002, we announced our strategy to separate our Palm OS business (PalmSource) and our device business (Solutions Group) into two, independent companies. We believe this independence will bring greater clarity of mission and focus to both units and better serve our existing and future licensees. We intend to achieve external separation between the two businesses in the summer of calendar year 2003 by making PalmSource an independent public company. In December 2002, Palm received a ruling from the Internal Revenue Service that a distribution of PalmSource stock to Palm stockholders, if it occurs in accordance with the terms of the ruling, will be tax-free to the Company and its U.S. stockholders.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in Palm’s consolidated financial statements and the accompanying notes. The amounts of assets and liabilities reported in our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions which are used for, but not limited to, the accounting for product returns, allowance for doubtful accounts, warranty and technical service costs, goodwill and intangible asset impairments, restructurings, inventory and income taxes. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the consolidated financial statements.

Revenue is recognized when earned in accordance with applicable accounting standards, including AICPA Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended. We recognize revenues from sales of handheld device products upon shipment, net of estimated returns, provided that collection is determined to be probable and no significant obligations remain. Sales to resellers are subject to agreements allowing for limited rights of return, rebates, and price protection. Accordingly, we reduce revenues for our estimates of liabilities related to these rights at the time the related sale is recorded. The estimates for returns are adjusted periodically based upon historical rates of returns, inventory levels in the channel and other related factors. The estimates and reserves for rebates and price protection are based on specific programs, expected usage and historical experience. Actual results could differ from these estimates. Revenue from wireless Internet access service subscriptions is recognized over the service period.

Within PalmSource, revenue from software license agreements with manufacturers of handheld devices are generally recognized on a per-unit or volume royalty basis, and any prepaid royalties received under the license agreements are generally deferred and recognized as earned based on contractually reported information from our licensees. Upfront license fees from subscription license arrangements are generally recognized ratably over the term of the subscription period. Within Solutions Group, revenue from software license agreements with end-users is recognized upon delivery of the software provided that persuasive evidence of an arrangement exists, collection is determined to be probable and no significant obligations remain. 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.

The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and an assessment of international, political and economic risk as well as the aging of the accounts receivable. If there is a change in a major customer’s credit worthiness or actual defaults differ from our historical experience, our estimates of recoverability of amounts due us could be affected.

We accrue for warranty costs based on historical rates of usage as a percentage of shipment levels and the expected repair cost per unit, service policies and specific known issues. If we experience claims or significant changes in costs of services, such as third party vendor charges, materials or freight, which could be higher or lower than our historical experience, our cost of revenues could be affected.

Long-lived assets such as land, property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not ultimately be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its ultimate disposition.

We perform goodwill impairment tests on at least an annual basis, in the fourth quarter, in accordance with the guidance in Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”).

Effective for calendar year 2003, in accordance with SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” which supersedes Emerging Issues Task Force (“EITF”) Issue 94-3, Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), we record liabilities for costs associated with exit or disposal activities when the liability is incurred instead of at the date of commitment to an exit or disposal activity. Prior to calendar year 2003, in accordance with EITF Issue 94-3, we accrued for restructuring costs when we made a commitment to a firm exit plan that specifically identified all significant actions to be taken. We reassess restructuring accruals on a quarterly basis to reflect changes in the costs of the restructuring activities, and we record new restructuring accruals as liabilities are incurred.

Inventory purchases and purchase commitments are based upon forecasts of future demand. We value our inventory at the lower of standard cost (which approximates first-in, first-out cost) or market. If we believe that demand no longer allows us to sell our inventory above cost or at all, then we write down that inventory to market or write off excess inventory levels. If customer demand subsequently differs from our forecasts, requirements for inventory write-offs could differ from our estimates.

Our deferred tax assets represent net operating loss carryforwards and temporary differences that will result in deductible amounts in future years. Based on estimates and certain tax planning strategies, the carrying value of our net deferred tax assets assumes that it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions. If these estimates and related assumptions change in the future, we may be required to increase our valuation allowance against the deferred tax assets resulting in additional income tax expense.

Our key accounting estimates and policies are reviewed with the Audit Committee of the Board of Directors.

Results of Operations

The following table sets forth consolidated statement of operations data and is also expressed as a percentage of consolidated revenues for the quarters indicated:

	Three Months Ended
	February 28, 2003					March 1, 2002
Revenues
Solutions Group	$	197,864		94.6	%	$	284,278		97.1	%
PalmSource		26,273		12.6			20,401		7.0
Eliminations		(15,121	)	(7.2	)		(12,028	)	(4.1	)

Total revenues		209,016		100.0			292,651		100.0
Costs and operating expenses:
Cost of revenues (excluding the applicable portion of amortization of intangible assets)
Solutions Group		150,792		*			217,552		*
PalmSource		1,405		*			1,319		*
Eliminations		(8,523	)	*			(11,750	)	*

Subtotal		143,674		68.7			207,121		70.8
Cost of revenues-benefit for special excess inventory and related costs—Solutions Group		—		—			(28,265	)	(9.6	)
Sales and marketing		46,827		22.4			56,528		19.3
Research and development		26,200		12.5			33,767		11.5
General and administrative		13,506		6.5			14,873		5.1
Amortization of intangible assets (^)		1,419		0.7			3,347		1.1
Separation costs		1,725		0.8			—		—
Impairment charges		102,540		49.1			—		—
Restructuring charges		40,182		19.2			—		—

Total costs and operating expenses		376,073		179.9			287,371		98.2
Operating income (loss)		(167,057	)	(79.9	)		5,280		1.8
Interest and other income (expense), net		(3,219	)	(1.6	)		(945	)	(0.3	)

Income (loss) before income taxes		(170,276	)	(81.5	)		4,335		1.5
Income tax provision (benefit)		2,060		1.0			1,387		0.5

Net income (loss)	$	(172,336	)	(82.5	)%	$	2,948		1.0	%

(^) Amortization of intangible assets:
Cost of revenues	$	1,315		0.7	%	$	1,763		0.6	%
Sales and marketing		—		—			—		—
Research and development		71		—			1,551		0.5
General and administrative		33		—			33		—

Total amortization of intangible assets	$	1,419		0.7	%	$	3,347		1.1	%

	Nine Months Ended
	February 28, 2003					March 1, 2002
Revenues
Solutions Group	$	620,491		96.0	%	$	777,994		97.6	%
PalmSource		56,111		8.7			51,350		6.4
Eliminations		(30,414	)	(4.7	)		(31,796	)	(4.0	)

Total revenues		646,188		100.0			797,548		100.0
Costs and operating expenses
Cost of revenues (excluding the applicable portion of intangible assets)
Solutions Group		465,571		*			622,581		*
PalmSource		4,211		*			3,451		*
Eliminations		(30,433	)	*			(32,090	)	*

Subtotal		439,349		67.9			593,942		74.5
Cost of revenues-benefit for special excess inventory and related costs—Solutions Group		—		—			(86,415	)	(10.8	)
Sales and marketing		136,947		21.2			183,626		23.0
Research and development		83,217		12.9			111,280		13.9
General and administrative		37,260		5.8			42,508		5.3
Amortization of intangible assets (^)		5,648		0.9			9,184		1.2
Separation costs		5,508		0.9			376		—
Impairment charges		102,540		15.8			—		—
Restructuring charges		37,520		5.8			25,988		3.3

Total costs and operating expenses		847,989		131.2			880,489		110.4
Operating loss		(201,801	)	(31.2	)		(82,941	)	(10.4	)
Interest and other income (expense), net		(2,350	)	(0.4	)		2,513		0.3

Loss before income taxes		(204,151	)	(31.6	)		(80,428	)	(10.1	)
Income tax provision (benefit)		223,410		34.6			(25,737	)	(3.2	)

Net loss	$	(427,561	)	(66.2	)%	$	(54,691	)	(6.9	)%

(^) Amortization of intangible assets:
Cost of revenues	$	4,841		0.8	%	$	4,543		0.6	%
Sales and marketing		—		—			11		—
Research and development		708		0.1			4,586		0.6
General and administrative		99		—			44		—

Total amortization of intangible assets	$	5,648		0.9	%	$	9,184		1.2	%

* Cost of revenues by segment, including eliminations, expressed as a percentage of consolidated revenues are not meaningful.

Solutions Group cost of revenues (excluding the applicable portion of amortization of intangibles) as a percentage of Solutions Group

revenues were 76.2% and 75.0% for the three and nine months ended February 28, 2003 and were 76.5% and 80.0% in the three and

nine months ended March 1, 2002, respectively. PalmSource cost of revenues as a percentage of PalmSource revenues were 5.3% and 7.5% in the three and nine months ended February 28, 2003 and were 6.5% and 6.7% in the three and nine months ended March 1, 2002, respectively.

Revenues

Total revenues for Palm in the third quarter ended February 28, 2003 were $209.0 million, a decrease of $83.6 million or 29% from revenues for the comparable period ended March 1, 2002. International revenues for the third quarter of fiscal year 2003 were 36% of revenues compared with 34% of revenues in the same period of fiscal year 2002.

Total revenues for Palm for the nine months ended February 28, 2003 were $646.2 million, a decrease of $151.4 million or 19% from revenues for the comparable period ended March 1, 2002. International revenues for the first nine months of fiscal year 2003 were 28% of revenues compared with 34% of revenues in the same period of fiscal year 2002.

Solutions Group—Revenues in the third quarter ended February 28, 2003 were $197.9 million, a decrease of $86.4 million or 30% from revenues for the comparable period ended March 1, 2002. The decrease in revenues was primarily driven by a decline in unit shipments reflecting a continued weak economy in both the consumer and enterprise segments and a decline in average selling price reflective of a price sensitive and increasingly competitive market. Net unit shipments in the third quarter of fiscal year 2003 were 1.0 million units compared to 1.3 million units in the comparable period of fiscal year 2002, with the average selling price decreasing to $169 for the quarter ended February 28, 2003, from $183 in the comparable period of fiscal year 2002. Revenues from accessory sales were also down for the quarter ended February 28, 2003 compared to the quarter ended March 1, 2002, reflective of the decrease in core device sales.

Revenues for the nine months ended February 28, 2003 were $620.5 million, a decrease of $157.5 million or 20% from revenues for the comparable period ended March 1, 2002. The decrease in revenues was primarily driven by a decrease in average selling price reflective of a price sensitive and increasingly competitive market. The average selling price declined to $165 for the nine months ended February 28, 2003, from $183 in the comparable period of fiscal year 2002. Unit shipments for the nine months ended February 28, 2003 and March 1, 2002 were 3.3 million and 3.6 million, respectively. Revenues from accessory sales were down for the nine months ended February 28, 2003 compared to the nine months ended March 1, 2002, reflective of the decrease in core device sales.

PalmSource—Revenues in the quarter ended February 28, 2003 were $26.3 million, an increase of $5.9 million or 29% from revenues for the comparable period ended March 1, 2002. Revenues from the Solutions Group were $15.1 million in the quarter ended February 28, 2003 compared to $12.5 million for the comparable period ended March 1, 2002. This increase was due to certain licensing commitments for the contract year ended in December 2002. Revenues for licensees other than the Solutions Group were $11.2 million for the quarter ended February 28, 2003 compared to $8.0 million for the quarter ended March 1, 2002 primarily reflecting the expanding set of Palm OS products. Intersegment royalties earned from the Solutions Group are eliminated in consolidation.

We have reported segment information for PalmSource as if it had existed historically, and we have applied the terms of the Solutions Group licensing agreement effective in the third quarter of fiscal year 2002 to the prior periods presented. On this basis, total PalmSource revenues for the nine months ended February 28, 2003 were $56.1 million, an increase of $4.8 million or 9% from revenues for the comparable period ended March 1, 2002. Revenues earned from the Solutions Group were $30.6 million for the nine months ended February 28, 2003 compared to $31.8 million for the same period ended March 1, 2002. Revenues for licensees other than the Solutions Group were $25.5 million for the nine months ended February 28, 2003 compared to $19.6 million for the same period ended March 1, 2002.

This increase was primarily due to an expanding set of Palm OS products. Intersegment royalties earned from the Solutions Group are eliminated in consolidation.

Cost of Revenues

In the third quarter of fiscal year 2003, our total cost of revenues was $145.0 million. “Total cost of revenues” is comprised of “cost of revenues (excluding the applicable portion of intangible assets),” “cost of revenues—benefit for special excess inventory and related costs” and the applicable portion of “amortization of intangible assets.” Total cost of revenues as a percentage of revenues was 69.4% in the quarter ended February 28, 2003 compared to 61.8% in the comparable period ended March 1, 2002.

For the nine months ended February 28, 2003, total cost of revenues was $444.2 million. Total cost of revenues as a percentage of revenues was 68.7% for the nine months ended February 28, 2003 compared to 64.3% in the comparable period ended March 1, 2002.

Solutions Group—Cost of revenues before eliminations, which primarily consists of costs to produce and deliver our devices, accessories and related services, was $150.8 million in the quarter ended February 28, 2003 compared to $217.6 million for the comparable period ended March 1, 2002. Cost of revenues as a percentage of revenues was 76.2% in the third quarter of fiscal year 2003 compared to 76.5% in the comparable period of fiscal year 2002. This decrease as a percentage of revenue was primarily due to improvement in component and transformation costs. Intersegment cost of revenues for royalties to PalmSource for the quarters ended February 28, 2003 and March 1, 2002 of $8.5 million and $11.8 million, respectively, are included in Solutions Group cost of revenues but eliminated in consolidation. Cost of revenues—benefit for special excess inventory and related costs was $28.3 million for the three months ended March 1, 2002. This reduction in cost of revenues resulted from the sale of products that were previously written down.

Cost of revenues before eliminations for the nine months ended February 28, 2003 was $465.6 million compared to $622.6 million for the comparable period ended March 1, 2002. Cost of revenues as a percentage of revenues was 75.0% for the nine month period ended February 28, 2003 compared to 80.0% for the comparable period of fiscal year 2002. This decrease as a percentage of revenue was primarily due to lower component and transformation costs as well as lower warranty expenses as a result of lower repair costs per unit and reduced excess and obsolete costs resulting from improved inventory management. Intersegment cost of revenues for royalties to PalmSource for the nine months ended February 28, 2003 and March 1, 2002 of $30.2 million and $31.9 million, respectively, are included in Solutions Group cost of revenues but eliminated in consolidation. Cost of revenues-benefit for special excess inventory and related costs was $86.4 million for the nine months ended March 1, 2002. This reduction in cost of revenues resulted from the sale of products that were previously written down.

PalmSource—Cost of revenues, which primarily consists of royalties for third party software included in the Palm OS and costs to service licensees, was $1.4 million in the quarter ended February 28, 2003 compared to $1.3 million for the comparable period ended March 1, 2002. Cost of revenues as a percentage of revenues was 5.3% in the third quarter of fiscal year 2003 compared to 6.5% in the comparable period in fiscal year 2002. The decrease in cost of revenues as a percentage of total revenues was primarily due to increased revenues in relation to the relatively fixed level of costs for the licensing business.

Cost of revenues for the nine months ended February 28, 2003 was $4.2 million compared to $3.5 million for the comparable period ended March 1, 2002. Cost of revenues as a percentage of revenues

was 7.5% for the nine months ended February 28, 2003 compared to 6.7% for the comparable period ended March 1, 2002. The increase in cost of revenues as a percentage of total revenues was primarily due to increased royalties to new third party technology vendors and costs associated with the delivery of professional services.

Sales and Marketing

Sales and marketing expenses consist principally of advertising and marketing programs, salaries and benefits for sales and marketing personnel, sales commissions, travel expenses and related information technology and facilities costs. Sales and marketing expenses were $46.8 million in the quarter ended February 28, 2003 compared to $56.5 million in the comparable period ended March 1, 2002, a decrease of $9.7 million or 17%. Sales and marketing expenses as a percentage of revenues were 22.4% in the third quarter of fiscal year 2003 compared to 19.3% for the comparable period in fiscal year 2002. Sales and marketing spending decreased in absolute dollars as a result of decreased spending across all marketing areas. Marketing expenses including national cable television advertising, trade show expenses, billboard advertising and holiday promotion media and the PalmSource developer conference were significantly reduced in the three months ended February 28, 2003 as compared to the comparable period in fiscal year 2002 to better align our spending with current revenue levels.

Sales and marketing expenses were $136.9 million for the nine months ended February 28, 2003, compared to $183.6 million in the comparable period ended March 1, 2002, a decrease of $46.7 million or 25%. Sales and marketing expenses as a percentage of revenues were 21.2% for the nine months ended February 28, 2003 compared to 23.0% for the comparable period in fiscal year 2002. The decrease in sales and marketing expenses as a percentage of revenues and in absolute dollars was primarily the result of decreased spending across all marketing areas. Marketing expenses including national cable television advertising, certain billboard advertising, trade show expenses and holiday promotion media and the PalmSource developer conference were significantly reduced in the nine months ended February 28, 2003 as compared to the same period in fiscal year 2002 to better align our spending with current revenue levels.

Research and Development

Research and development expenses consist principally of employee related costs, third party development costs, program materials, depreciation, and related information technology and facilities costs. Research and development expenses were $26.2 million for the quarter ended February 28, 2003 compared to $33.8 million for the comparable period ended March 1, 2002, a decrease of $7.6 million or 22%. Research and development expenses as a percentage of revenues were 12.5% for the third quarter of fiscal year 2003 compared to 11.5% for the comparable period in fiscal year 2002. The research and development spending decrease in absolute dollars was primarily due to decreased third party development costs, reduced program materials expenses, decreased consulting expenses and a reduction in headcount resulting from cost containment efforts initiated to align our cost structure with current revenue levels.

Research and development expenses were $83.2 million for the nine months ended February 28, 2003 compared to $111.3 million in the comparable period ended March 1, 2002, a decrease of $28.1 million or 25%. Research and development expenses as a percentage of revenues were 12.9% for the nine months ended February 28, 2003 compared to 13.9% in the comparable period in fiscal year 2002. The decrease in research and development expenses as a percentage of revenues and in absolute dollars was primarily due to decreased third party development costs, reduced program materials expenses related to

project management, decreased consulting expenses and a reduction in headcount resulting from cost containment efforts initiated to align our cost structure with current revenue levels.

General and Administrative

General and administrative expenses consist principally of employee related costs for the finance, legal, human resources and executive functions, outside legal and accounting fees, business insurance costs, provision for doubtful accounts, and related information technology and facilities costs. General and administrative expenses were $13.5 million for the quarter ended February 28, 2003 compared to $14.9 million for the comparable period ended March 1, 2002, a decrease of $1.4 million or 9%. General and administrative expenses as a percentage of revenues were 6.5% in the third quarter of fiscal year 2003 compared to 5.1% in the comparable period in fiscal year 2002. The absolute dollar decrease in general and administrative expenses was due primarily to lower legal, professional and employee related expenses due to headcount reductions resulting from cost containment efforts initiated to align our cost structure with current revenue levels, partially offset by an increased provision for doubtful accounts.

General and administrative expenses were $37.3 million for the nine months ended February 28, 2003 compared to $42.5 million in the comparable period ended March 1, 2002, a decrease of $5.2 million, or 12%. General and administrative expenses as a percentage of revenues were 5.8% for the nine months ended February 28, 2003, compared to 5.3% in the comparable period in fiscal year 2002. The absolute dollar decrease in general and administrative expenses was due primarily to lower legal, professional and employee related expenses due to headcount reductions resulting from cost containment efforts initiated to align our cost structure with current revenue levels, partially offset by an increased provision for doubtful accounts.

Segment Operating Expenses

Solutions Group—Segment operating expenses, consisting of research & development, selling, marketing, general & administrative expenses were $68.3 million and $204.0 million for the three and nine months ended February 28, 2003, respectively, compared to $85.0 million and $273.8 million in the comparable periods ended March 1, 2002. The decrease in operating expenses in absolute dollars was the result of overall decreased spending. The primary reductions in spending included reduced advertising and promotional spending, decreased third party development costs, decreased consulting expenses for software integration, reduced equipment and program material expenses, lower legal, professional and employee related expenses partially offset by an increased provision for doubtful accounts.

PalmSource—Segment operating expenses, consisting of research & development, selling, marketing, general & administrative expenses were $18.2 million and $53.9 million for the three and nine months ended February 28, 2003, respectively, compared to $20.6 million and $63.4 million for the three and nine months ended March 1, 2002. The decrease in operating expenses in absolute dollars resulted primarily from a decrease in consulting expenses, reduced spending related to the PalmSource Developer Conference and lower employee related expenses due to fewer employees.

Amortization of Intangible Assets

Amortization of intangible assets was $1.4 million in the quarter ended February 28, 2003 compared to $3.3 million in the comparable period ended March 1, 2002, a decrease of $1.9 million resulting from certain intangible assets becoming fully amortized and the impairment of certain other intangible assets.

Amortization of intangible assets were $5.6 million for the nine months ended February 28, 2003 compared to $9.2 million in the comparable period ended March 1, 2002, a decrease of $3.6 million resulting from certain intangible assets becoming fully amortized and the impairment of certain other intangible assets.

Separation Costs

Separation costs were $1.7 million in the quarter ended February 28, 2003. Separation costs reflect costs that are generally one-time in nature, such as consulting and professional fees, related to our intended establishment of PalmSource as a separate independent company.

Separation costs were $5.5 million for the nine months ended February 28, 2003 compared to $0.4 million in the comparable period ended March 1, 2002. Separation costs in the nine months ended March 1, 2002 consisted of final costs related to our separation from 3Com. Separation costs in the nine months ended February 28, 2003 consist of costs related to the separation of PalmSource. We expect to continue to incur separation costs relating to the PalmSource separation.

Impairment Charges

During the third quarter of fiscal year 2003, the Solutions Group incurred an impairment charge of $102.5 million. This charge includes $100 million related to approximately 39 acres of land owned by the Company in San Jose, California. Market conditions for commercial real estate in the Silicon Valley have deteriorated since the land was acquired in May 2001; and, during the third quarter of fiscal year 2003, the Company determined that it no longer expects to hold the land as long as would be required to realize the $160 million carrying value. As a result, Palm has adjusted the carrying value to the current fair market value of $60 million. In addition, a $2.5 million impairment charge was recorded in accordance with SFAS No. 144, related to the core technology acquired from ThinAirApps. The core technology is no longer considered useful, and its carrying value is not considered to be recoverable. The fair value of the core technology was determined using the discounted cash flow method.

Restructuring Charges

Restructuring charges of $40.2 million recorded during the third quarter of fiscal year 2003 consist of $18.9 million related to the restructuring actions taken during the third quarter of fiscal year 2003 plus $21.3 million of restructuring adjustments related to restructuring actions taken in prior quarters.

The third quarter fiscal year 2003 restructuring actions consisted of workforce reductions, primarily in the U.S., of approximately 140 regular employees from the Solutions Group and approximately 60 regular employees from PalmSource, facilities and property and equipment disposed of or removed from service, and canceled projects. Restructuring charges relate to the implementation of a series of actions to better align our expense structure with our revenues. As of February 28, 2003, approximately 120 regular employees from Solutions Group and 60 regular employees from PalmSource had been terminated as a result of this restructuring. Estimated future savings resulting from these restructuring actions are expected to be approximately $40 million per year.

Restructuring charges taken in prior periods included:

•

Interest and Other Income (Expense), Net

Interest and other expense, on a net basis, was ($3.2) million for the quarter ended February 28, 2003 compared to ($0.9) million for the comparable period ended March 1, 2002. The increase in interest and other expense, net for fiscal year 2003 is due primarily to the settlement of two lawsuits.

Interest and other expense, on a net basis, was ($2.4) million for the nine months ended February 28, 2003 compared to interest and other income of $2.5 million for the comparable period ended March 1, 2002. The shift from interest and other income to interest and other expense is due to lower interest income reflecting lower cash balances and reduced interest rates on investments, increased interest expense due to our convertible note, costs related to letters of credit, the write down of investments in equity securities and the settlement of two lawsuits partially offset by the receipt of $5.2 million in proceeds from an insurance settlement.

Income Tax Provision (Benefit)

The income tax provision for the three months ended February 28, 2003 reflects the Company’s income taxes in foreign jurisdictions, which are not offset by operating loss carryforwards. The income tax provision for the nine months ended February 28, 2003 also includes an increase in the valuation

allowance for deferred tax assets. During the first quarter of fiscal year 2003, there were changes in both the valuation and the nature of our tax planning strategies that necessitated an increase in the valuation allowance of $219.6 million. The deferred tax assets, which are largely net operating loss carryforwards, remain available for us to utilize against future profits. For the three and nine months ended March 1, 2002, the effective tax rate was 32%.

Liquidity and Capital Resources

Cash and cash equivalents at February 28, 2003 were $259.4 million, compared to $278.6 million at May 31, 2002. The decrease of $19.2 million in cash and cash equivalents was attributable to cash used in operating activities of $43.0 million, cash provided by investing activities of $2.0 million and cash provided by financing activities of $21.8 million. Cash used in operating activities consisted primarily of the net loss of $427.6 million reduced by non-cash charges of $354.2 million and an increase in accrued restructuring and other liabilities of $27.5 million. In connection with investing activities, we received $12.9 million in net proceeds from the sale of short-term investments, offset by the use of $9.6 million to purchase property and equipment and $1.0 million to purchase an equity investment. Cash provided by financing activities consisted primarily of $20.0 million received from Sony for a 6.25% ownership position in PalmSource and $1.3 million of proceeds from the issuance of Palm common stock, net.

In December 2001, we issued a subordinated convertible note in the principal amount of $50.0 million. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into our common stock at an effective conversion price of $92.64 per share. We may force a conversion, provided our common stock has traded above $142.65 per share for a defined period of time. In the event Palm distributes significant assets, we may be required to repay a portion of the note. The note agreement defines certain events of default pursuant to which the full amount of the note plus interest could become due and payable.

In June 2001, we obtained a two-year asset-backed borrowing-base credit facility from a group of financial institutions for up to a maximum of $150 million with the actual amount available determined by eligible accounts receivable and inventory as well as a real estate line of credit less the amount of any outstanding cash advances and letters of credit. The credit facility is secured by accounts receivable, inventory, and certain fixed assets including real estate and property and equipment. The interest rate may vary based on fluctuations in market rates and margin borrowing levels. We are subject to certain financial covenant requirements and restrictions under the agreement including restrictions that require us to obtain prior consent from the lenders before we engage in certain specified actions such as incurring certain indebtedness, making certain investments or distributions, making certain acquisitions, making certain capital expenditures or causing a change in control of Palm. As of February 28, 2003, we had used our credit facility to support the issuance of letters of credit of $53.0 million. The collateral for the $50 million letter of credit relative to a litigation matter expires on April 30, 2003. If the letter of credit is still required subsequent to April 30, 2003, it will have to be collateralized with either cash or with some other form of credit. The remaining $3.0 million of letters of credit expire in June 2003, upon the termination of our credit facility.

We denominate our sales to certain European customers in the Euro and in Pounds Sterling. We also incur expenses in a variety of currencies. We hedge certain balance sheet exposures and intercompany balances against future movements in foreign currency exchange rates by using foreign exchange forward contracts. Gains and losses on the contracts are intended to offset foreign exchange gains or losses from the revaluation of assets and liabilities denominated in currencies other than the functional

currency of the reporting entity. All such gains and losses are included in interest and other income (expense) in our consolidated statements of operations. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes.

We lease our facilities and certain equipment under capital and operating lease arrangements which expire at various dates through September 2011. As of February 28, 2003, future minimum lease payments under noncancelable operating leases are $5.2 million in the remaining three months of fiscal year 2003, $12.2 million in fiscal year 2004, $10.6 million in fiscal year 2005, $6.2 million in fiscal year 2006, $4.9 million in fiscal year 2007 and an aggregate of $22.6 million thereafter.

The Company has patent cross license agreements under which the Company is committed to pay up to $0.8 million for the remaining 3 months in fiscal year 2003, $3.9 million in fiscal year 2004, $4.7 million in fiscal year 2005, $2.1 million in fiscal year 2006, $0.4 million in fiscal year 2007 and $0.2 million in fiscal year 2008.

In March 2002, we filed a universal shelf registration statement to give us the flexibility to sell up to $200 million of debt securities, common stock, preferred stock, depository shares and warrants in one or more offerings and in any combination thereof. The net proceeds from the sale of securities offered are intended for general corporate purposes, including to meet working capital needs and for capital expenditures. We have not sold any securities under this universal shelf registration statement as of February 28, 2003.

Based on current plans and business conditions, we believe that our existing cash, cash equivalents and short-term investments will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months. We cannot be certain, however, that our underlying assumed levels of revenues and expenses will be accurate. If our operating results do not meet our expectations or if inventory, accounts receivable or other assets require a greater use of cash than is currently anticipated, we could be required to seek additional funding through public or private financings or other arrangements. In such event, adequate funds may not be available when needed or may not be available on favorable terms, which could have a negative effect on our business and financial condition.

Stock Option Information

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. We consider our option program critical to productivity and all of our employees participate in the program. The program consists of two plans: one stock option plan under which options to purchase shares of common stock may be granted to employees, directors and consultants; and a second stock option plan under which options to purchase common stock may be granted to non-employee members of the Board of Directors. Option vesting periods range from 1 to 4 years. On October 15, 2002, Palm effected a 1-for-20 reverse stock split. All share information reflects this reverse stock split.

See the “Report Of The Compensation Committee Of The Board of Directors On Executive Compensation” appearing in our proxy statement dated August 26, 2002 for further information concerning the policies and procedures of the Company and the Compensation Committee regarding the use of stock options.

The following table provides information about stock options granted for fiscal year 2001, fiscal year 2002 and fiscal year-to-date 2003 for certain executive officers. For fiscal year 2001 and fiscal year 2002, the stock option data relates to the named executive officers in the executive compensation table of the Proxy Statement for the respective fiscal year. For fiscal year-to-date 2003, the stock option data is for our Chief Executive Officer and the four other most highly compensated individuals who are currently serving as executive officers of Palm.

Employee and Named Executive Officer Option Grants

	2003 YTD		2002		2001
Net grants during the period as a % of outstanding shares	6.6	%	2.1	%	3.8	%
Grants to top five executive officers during the period as a % of total options granted	7.6	%	15.9	%	7.7	%
Grants to top five executive officers during the period as a % of outstanding shares	0.6	%	0.9	%	0.3	%
Cumulative options held by named executive officers as a % of total options outstanding	9.4	%	11.4	%	14.9	%

During the nine months ended February 28, 2003, we granted options to purchase approximately 2.5 million shares, and options to purchase approximately 0.5 million shares were forfeited. The net grants represented 6.6% of shares outstanding at the beginning of this fiscal year.

Activity under all stock option plans

	Nine months ended February 28, 2003				Year ended May 31, 2002
	Number of Shares		Weighted average exercise price		Number of Shares		Weighted average exercise price
(shares in thousands)
Outstanding at beginning of period	2,325		$	239.96	1,709		$	479.29
Granted	2,475		$	14.26	1,611		$	91.01
Exercised	(18	)	$	13.00	(2	)	$	23.47
Cancelled	(544	)	$	209.78	(993	)	$	399.47

Outstanding at end of period	4,238		$	112.96	2,325		$	239.96

In-the-Money and Out-of-the-Money Option Information

As of February 28, 2003

	Exercisable			Unexercisable			Total
	Shares	Weighted average exercise price		Shares	Weighted average exercise price		Shares	Weighted average exercise price
(shares in thousands)
In-the-Money	3	$	5.84	5	$	0.85	8	$	2.51
Out-of-the-Money (1)	1,730	$	186.63	2,500	$	62.32	4,230	$	113.16

Total Options Outstanding	1,733	$	186.35	2,505	$	62.18	4,238	$	112.96

(1) Out-of-the money options are those options with an exercise price equal to or greater than the closing price of $11.60 per share at the end of the quarter.

Option Exercises of Named Executive Officers

For the nine months ended February 28, 2003(1)

				Number of Shares Underlying Unexercised Options at February 28, 2003		Value of Unexercised In-the-Money Options at February 28, 2003(2) ($)
Name	Number of Shares Acquired on Exercise	Dollar Gain Realized		Exercisable	Unexercisable	Exercisable	Unexercisable
Eric A. Benhamou	—	$	—	51,751	63,499	—	—
R. Todd Bradley	—	$	—	33,853	118,647	—	—
Judy Bruner	—	$	—	41,459	49,807	—	—
David Nagel	—	$	—	1,834	916	—	—

(1) This list represents the Named Executive Officers who appeared in the Proxy Statement dated August 26, 2002. and who are employees of the Company.

(2) Based on a fair market value of $11.60 per share as of February 28, 2003, the closing sale price per share of Palm’s common stock on that date as reported on the Nasdaq National Market.

In addition to the option activity in the table above, we issued shares of restricted stock to two of the executive officers listed in the table above during the first three quarters of fiscal year 2003. In the first quarter of fiscal year 2003, Mr. Bradley was granted 5,000 shares of restricted stock and Ms. Bruner was granted 2,500 shares of restricted stock. The value of these shares was based upon the closing price per share on the date of grant, August 5, 2002, as reported on the Nasdaq National Market and is recognized as an expense over the vesting period.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes our equity compensation plans as of February 28, 2003:

	Equity Compensation Plan Information
Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights(a)	Weighted average exercise price of outstanding options, warrants and rights(b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column(a))
Equity compensation plans approved by security holders	4,242,278	$	115.16	2,460,927	(1)(2)
Equity compensation plans not approved by security holders (3)	—		—	—

Total	4,242,278	$	115.16	2,460,927

(1)

This number of shares includes approximately 1.5 million shares of our common stock reserved for future issuance under our 1999 Employee Stock Purchase Plan, as amended.

(2)

Our 1999 Stock Plan, as amended, (the “1999 Stock Plan”) also provides for annual increases in the number of shares available for issuance under the 1999 Stock Plan on the first day of each fiscal year equal to 5% of the outstanding shares of our common stock on such date, or a lesser amount determined by our Board of Directors. In addition, our 1999 Employee Stock Purchase Plan, as amended, (the “1999 ESPP”) provides for annual increases in the number of shares available for issuance under the 1999 ESPP on the first day of each fiscal year equal to the lesser of (i) 500,000 shares, (ii) 2% of the outstanding shares of our common stock on such date, or (iii) a lesser amount determined by our Board of Directors.

(3)

This does not include outstanding options to purchase 9,482 shares of our common stock assumed through various mergers and acquisitions. At February 28, 2003, these assumed options had a weighted average exercise price of $124.62 per share. In the event that any such assumed option is not exercised, no further option to purchase shares of our common stock will be issued in place of such unexercised option.

BUSINESS ENVIRONMENT AND RISK FACTORS

You should carefully consider the risks described below before making any investment decisions with respect to our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline, and you could lose all or part of your investment.

Risks Related to Our Business

If we fail to develop and introduce new products and services successfully and in a timely manner, we will not be able to compete effectively and our ability to generate revenues will suffer.

We operate in a highly competitive, rapidly evolving 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 our customers and end users with acceptable prices and terms, we will not be able to compete effectively and our ability to generate revenues will 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 or technological trends accurately or are unable to complete the development of products and services in a cost effective and timely fashion, we will be unable to introduce new products and services into the market or successfully compete with other providers. As a result, our revenues and cost of revenues could be adversely affected.

As we introduce new or enhanced products or integrate new technology into new or existing products, we face risks relating to such transitions including, among other things, disruption in customers’ ordering patterns, excessive levels of older product inventories, delivering sufficient supplies of new products to meet customers’ demand, possible product and technology defects arising from the integration of new technology, and a potentially different sales and support environment relating to any new technology. Our failure to manage the transition to newer products or the integration of newer technology into new or existing products could adversely affect our business and financial results.

If we do not correctly anticipate demand for our products, we could have costly excess production or inventories or we may not be able to secure sufficient quantities or cost-effective production of our handheld devices and our cost of revenues could be adversely impacted.

The demand for our products depends on many factors, including pricing levels, and is difficult to forecast due in part to competition, variations in economic conditions, seasonality, changes in consumer and enterprise preferences and relatively short product life cycles. It is particularly difficult to forecast demand by individual product. Significant unanticipated fluctuations in demand could result in costly excess production or inventories or the inability to secure sufficient quantities or cost-effective production of our handheld devices. This could adversely impact our cost of revenues and financial condition.

Our operating results are subject to fluctuations, 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 operating results may fluctuate significantly and may not meet our expectations or those of securities analysts or investors. If this occurs, the price of our stock will likely decline. Factors that may cause fluctuations in our operating results include, but are not limited to, the following:

•

Changes in consumer and enterprise spending levels;

•

Changes in general economic conditions and specific market conditions;

•

Changes in consumer and enterprise preferences for our products and services;

•

Price and product competition from other handheld devices or other devices with similar functionality;

•

Seasonality of demand for our products and services;

•

Variations in product costs or the mix of products sold;

•

Quality issues with our products;

•

Changes in pricing or promotional programs;

•

Manufacturing lead times may affect our third party manufacturers’ ability to produce quality products on time;

•

Failure to achieve targeted product cost reductions and operating expense reductions;

•

The timely introduction and market acceptance of new products and services;

•

Excess inventory or insufficient inventory to meet demand;

•

Unpredictability of our licensee’s product introductions or market acceptance; and

•

Litigation brought against us.

Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition.

We rely on third party manufacturers to design and manufacture our handheld devices and third party pack-out distribution centers to distribute our handheld devices, and our reputation and revenues could be adversely affected if these third parties fail to meet their performance obligations.

We outsource most of our hardware design to third party manufacturers. We depend on their design expertise and we rely on them to design our products at satisfactory quality levels. If our third party manufacturers fail to provide quality hardware design, our reputation and revenues could suffer.

We outsource all of our manufacturing to third party manufacturers. We depend on them to produce a 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 could suffer. In addition, we rely on our third party manufacturers to place orders with suppliers for the components they need to manufacture our products. If they fail to place timely and sufficient orders with suppliers, our revenues could suffer.

Our device products are manufactured by our third party manufacturers at their international facilities predominantly located in China. 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 party manufacturers exposes us to risks, which are not in our control and our revenues or cost of revenues could be negatively impacted. For example, the Severe Acute Respiratory Syndrome (SARS) outbreak in China could result in quarantines or closures of our third party manufacturers or their suppliers. In the event of such a quarantine or closure, if we were unable to very quickly identify alternate supply or manufacturing facilities, our revenues, cost of revenues and results of operations would be negatively impacted.

We do not have a manufacturing agreement with one of our primary third party manufacturers upon which we rely to manufacture our device products. We presently order our products on a purchase order basis from this manufacturer. The absence of a manufacturing agreement means that, with little or no notice, this manufacturer 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 this manufacturer 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 this manufacturer were to change the terms under which it manufactures for us, our manufacturing costs could increase and our cost of revenues could increase.

Our contract distribution facilities are physically separated from our contract manufacturing locations. This requires additional lead-time to move products to customers. If we are shipping products near the end of the quarter, this extra time could result in us not meeting anticipated shipment volumes for that quarter, which may negatively impact our revenues.

Changes in transportation schedules due to terrorist threats or attacks, military activity, labor disruptions or carrier financial difficulties could cause transportation delays and increase our costs for both receipt of

inventory and shipment of products to our customers. For instance, our primary domestic freight carrier filed for bankruptcy immediately after the close of our first quarter of fiscal year 2003. This led to delayed deliveries to our customers. Additionally, labor disputes of West coast dockworkers in the second quarter of fiscal year 2003 led to less capacity and higher costs for the transportation alternatives we normally use. If these types of disruptions occur, our results of operations could be adversely impacted.

We depend on our suppliers, some of which are the sole source for certain components and elements of our technology, and our production or reputation could be seriously harmed if these suppliers were unable to meet our demand on a cost effective basis with adequate quality and alternative sources were not available.

Our device products contain components, including liquid crystal displays, touch panels, memory chips, microprocessors and batteries, 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.

Some components, such as displays and certain integrated circuits, digital signal processors, microprocessors, radio frequency components and other discrete components, come from sole source suppliers, one of which is also a competitor of ours in certain markets. Alternative sources are not always available or may be financially prohibitive. If suppliers were unable or unwilling 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 will be seriously harmed.

We enter into agreements for the development and licensing of third party technology to be incorporated into some of our products. Our ability to release and sell our products could be seriously harmed if the third party technology is not delivered to us in a timely manner or contains errors or defects which are not discovered and fixed prior to release of our products and we are unable to obtain alternative technology to use in our products. Our inability to obtain alternative technology could result in damage to our reputation as well as lost revenues and divert our development resources from other business objectives.

We rely on our handheld device products as the primary source of our revenues.

Our revenues and our results of operations depend substantially on the commercial success of our Palm handheld devices. If revenues from our Palm handheld devices fail to meet expectations, our other revenue sources will likely not be able to compensate for this shortfall and our results of operations may suffer. Through the third quarter of fiscal year 2003, revenues from sales of devices and accessories constituted more than 90% of our quarterly consolidated revenues.

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.

Our distributors, retailers and resellers sell products offered by our competitors. 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. If we are unable to maintain successful relationships with distributors, retailers and resellers or to expand our distribution channels, our business will suffer.

Because we sell our products primarily to distributors, retailers and resellers, we are subject to many risks, including risks related to product returns, either through the exercise of contractual return rights or as a result of our strategic interest in assisting them in balancing inventories. In addition, our distributors, retailers or resellers could modify their business practices, such as payment terms or inventory levels. Unexpected changes in return requests, inventory levels, payment terms or other practices by our channel customers could negatively impact our revenues or our financial condition.

Distributors, retailers and traditional resellers experience competition from Internet-based resellers that distribute directly to end-user customers, and there is also competition among Internet-based resellers. We also sell our products directly to end-user customers from our Palm.com web site. These varied sales channels could cause conflict among our channels of distribution, which could 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, and our results of operations and financial condition would suffer.

We compete in the handheld device and operating system software 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 us 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.

Some competitors sell or license server, desktop and/or laptop computing products in addition to handheld computing products and may choose to market and sell or license their handheld products at a discounted price or give them away for free with their other products, which could negatively affect our revenues, sales and marketing expenses and financial condition.

Certain competitors may have longer and closer relationships with the senior management of enterprise customers who decide which products and technologies will be deployed in their enterprises. Moreover, these competitors may have larger and more established sales forces calling upon potential enterprise customers and therefore could contact a greater number of potential customers with more frequency. Consequently, these competitors could have a better competitive position than we do, which could result in potential enterprise customers deciding not to choose our products and services, which would adversely impact our business, revenues, sales and marketing expenses and financial condition.

Our handheld computing device products compete with a variety of handheld devices, including keyboard-based devices, sub-notebook computers, smart phones and two-way pagers. Our principal handheld device competitors include Casio, Danger, Dell, Garmin, Hewlett-Packard, Nokia, Research in Motion Limited (“RIM”), Sharp, Sony Ericsson, Toshiba and PalmSource licensees such as Acer, HandEra, Handspring, Kyocera, Samsung and Sony, who compete either directly or indirectly with our handheld computing devices. The separation of our Solutions Group and PalmSource businesses into two independent companies may result in more competition for our Solutions Group’s handheld devices as PalmSource may license the Palm OS to device companies who compete directly or indirectly with our Solutions Group’s business. For example, PalmSource has recently signed Palm OS license agreements with HuneTech, Legend and Group Sense (International) Limited, located in the Asia Pacific region. If the revenues of our Solutions Group business suffer because of competition from third party licensees of our Palm OS platform, our revenues and results of operations could be negatively impacted.

Our Palm OS platform competes primarily with operating systems from Microsoft and Symbian. Additionally, there are proprietary operating systems; open source operating systems, such as Linux; and

other software technologies, such as Java and RIM’s licensed technology, which could be integrated into devices that compete with Palm Powered devices. Microsoft offers several operating systems focused on different markets including: Windows CE for sub-PC computers, Pocket PC for handheld devices, SmartPhone and Pocket PC Phone Edition for voice enabled handhelds or communication devices. Manufacturers shipping handheld devices and SmartPhones with Microsoft’s operating system include Casio, Dell, Hewlett Packard, NEC and Toshiba. Symbian offers an operating system that is used in products that are currently shipping from manufacturers such as Nokia and Sony-Ericsson, and Symbian has recently signed licenses with Mitsubishi, Samsung and Sendo, a British mobile phone manufacturer. In addition, RIM licenses its “reference platform” for other companies to design devices based on its software and hardware specifications. Licensees of our Palm OS platform are under no obligation to introduce new products based on our operating system and may elect to use an alternative operating system instead, in which case we may not be able to increase our revenues from licensing the Palm OS platform or expand the Palm economy. In addition, handheld devices depend upon good interoperability with software running on personal computers and network servers in order to acquire and back-up information. If Microsoft or other companies interfered with the interoperability of Palm OS devices, the marketability of the Palm OS could be adversely affected.

Successful new product introductions or enhancements by our competitors, or increased market acceptance of competing products, such as Pocket PC and RIM devices or devices offered by our licensees, such as Handspring and Sony, could reduce the sales and market acceptance of our products and services, cause intense price competition or could 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.

Our Palm OS platform and handheld devices may contain errors or defects, which could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources and increased service costs and warranty claims.

Our Palm OS 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 and operating system markets. 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. 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, which could harm our business, revenues, cost of revenues and financial condition.

If we are unable to obtain key technology from third parties on a timely basis free from errors or defects, we may have to cancel or delay the release of certain features in our Palm OS platform and product shipments or incur increased costs.

We license third party software for use in the Palm OS platform as well as to provide software development tools to enable applications to be written for our Palm OS platform. In addition to third party licensed software, we may enter into joint development agreements with certain licensees of the Palm OS platform whereby a licensee will develop a specific feature for our Palm OS platform that we

will then own and may later incorporate into new releases of the Palm OS platform. If such third party technology is not delivered to us in a timely manner or contains errors or defects that are not discovered and fixed prior to release of our products, our product shipments could be delayed, our offering of features could be reduced and our ability to release and sell our products could be seriously harmed, which could adversely affect our business or results of operations. Furthermore, a third party or joint developer may improperly use or disclose the software, which could adversely affect our competitive position. In addition, because we license some of our development tools from third parties, our business would suffer if we could no longer obtain those tools from those third parties or if the tools developers wanted to use were not available. If we are unable to offer technology to our licensees that they need to build successful Palm Powered products, our business may suffer.

For example, we recently modified the Graffiti handwriting recognition system in our Palm OS to include a subcomponent of the Jot technology licensed from the Communication Intelligence Corporation, or CIC. If the technology we license from CIC contains errors or defects or cannot be seamlessly integrated into the products of our licensees, our licensees’ ability to market their products may be harmed. Further, if after expiration or termination of the Jot license from CIC, we are unable to renegotiate the license on favorable terms, we would be required to license other third party solutions or develop aspects of the functionality ourselves. This may result in higher licensing costs to us and delay the shipment of products based on our Palm OS, which could adversely affect our business, results of operations and financial condition.

We have internally separated our business into two independent businesses by transferring our Palm OS platform and licensing business to our PalmSource subsidiary. If we fail to manage our separate businesses effectively, our on-going business prospects and overall financial performance may suffer.

In December 2001, we internally separated our business into two independent businesses and formed our PalmSource subsidiary to hold our Palm OS platform and licensing business with the intent to make PalmSource an independent public company in 2003. We may be unable to successfully complete the allocation of certain assets, liabilities and commitments between the two companies or operate the separate companies profitably. For example, we are currently evaluating how each independent business will brand itself. Failure to properly implement a successful branding effort by both businesses could harm our revenues. Failure to effectively manage two independent business operations or failure of the two businesses to sustain efficient operations or to successfully implement their business strategies could cause a decline in our revenues, compromise our on-going business prospects and impair our overall financial performance.

If we do not externally separate our PalmSource and Solutions Group businesses, our business, results of operations and stock price could suffer.

While we have organized our operations into the PalmSource and Solutions Group businesses, we have also stated our objective to externally separate the PalmSource subsidiary as an independent public company through a distribution of PalmSource stock to Palm stockholders. If we do not distribute PalmSource stock to Palm stockholders, our business may be adversely affected because we may lose current licensees and/or attract fewer new licensees to the Palm OS platform due to concern about lack of independence from the products of our Solutions Group. This could result in the Palm OS platform being less competitive. In addition, we may face challenges managing our two independent businesses in a single company without compromising business opportunities for one business because of potentially conflicting business priorities with the other business. We may also have difficulty attracting

and retaining key employees without an external separation. In addition, if the distribution of PalmSource stock to Palm stockholders is delayed or not completed, our stock price could decline.

PalmSource currently derives its revenue from a small number of licensees of the Palm OS platform, and the failure of one or more of them to build a successful, sustained business selling products from which PalmSource derives revenue could significantly harm PalmSource’s results of operations or future business prospects.

PalmSource currently derives its revenue from a small number of licensees of the Palm OS platform. If one or more of them fails to build a successful, sustained business selling products from which PalmSource derives revenue, PalmSource could lose a significant portion of its revenue. In addition, the failure of a Palm OS platform licensee to continue developing, marketing and selling products based on the Palm OS platform could make the Palm OS platform appear to be less attractive and deter prospective PalmSource customers from licensing the Palm OS platform, thereby reducing the actual or perceived market opportunity available to licensees and PalmSource. Furthermore, the failure or loss of one or more current licensees or the inability to attract new licensees could make PalmSource less attractive to potential investors, which could limit our ability to externally separate the PalmSource business, result in the Palm OS platform being less competitive and cause our business and revenues to suffer.

If we do not deliver the wireless functionality and solutions that the market desires or if we fail to provide our devices or services on additional wireless networks, including carrier networks in international markets, our results of operations could suffer.

We must continue to develop new services and solutions to compete in the evolving wireless space, which includes solutions for wide area networks (“WAN”) with carriers, local area networks (“LAN”) with 802.11 technology and personal area networks (“PAN”) with Bluetooth technology. While we currently have offerings in each of these areas, it is uncertain which of these technologies will be adopted in sufficient volumes to enable us to successfully operate this part of our business. We offer a subscription-based wireless access service that enables users of our Palm VII and i705 handheld devices to access Internet content, communicate via electronic mail, and, in the case of the i705 handheld, communicate using instant messaging. We rely on a sole carrier for our Palm VII and i705 handheld devices which are configured around the frequency standard used by this carrier. If this carrier failed to provide us with service at rates acceptable to us or at all, we may not be able to provide wireless access to our users which could cause our business and results of operations to suffer.

We recently introduced two new wireless products for the PAN and WAN, the Tungsten T and Tungsten W. The Tungsten T incorporates Bluetooth technology, allowing communication with other Bluetooth enabled devices in a PAN. The Tungsten T’s success depends in part upon the broader adoption of the Bluetooth standard. The Tungsten W, which operates on GSM/GPRS WAN networks, is subject to lengthy certification processes with wireless carriers and governmental or regulatory authorities. These certification requirements could delay the offering of the Tungsten W on additional carrier networks. If we are unsuccessful in developing relationships with additional carriers or if we are unsuccessful in developing new wireless devices, our revenues and results of operations could be adversely affected.

Competitors have introduced or developed, or are in the process of introducing or developing, competing wireless handheld solutions. We cannot assure that there will be demand for the wireless solutions provided by us or that individuals will widely adopt our handheld devices as a means of accessing wireless services. If acceptance of our wireless solutions is less than anticipated, our revenues and results of operations could be adversely affected.

Our success largely depends on our ability to hire, retain, integrate and motivate sufficient qualified personnel.

Our future success depends on our ability to attract and retain highly skilled personnel. Volatility or lack of positive performance in our stock price may also affect our ability to retain key employees, all of whom have been granted stock options.

Palm’s practice has been to provide incentives to all of its employees through the use of broad based stock option plans. In the future, our use of stock options may be curtailed by future accounting rules concerning the expensing of these options. Our ability to hire, retain and motivate our personnel may suffer as a result.

In recent quarters, we have initiated reductions in our workforce of both employees and contractors to balance the size of our employee base with our anticipated revenue base. These reductions have resulted in reallocations of employee duties, which could result in employee and contractor uncertainty. Reductions in our workforce could make it difficult to motivate and retain the remaining employees and contractors, which could affect our ability to deliver our products in a timely fashion and negatively affect our business.

Third parties have claimed and may claim in the future that 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, our customers, or Palm OS platform licensees, are infringing or contributing to the infringement of their intellectual property rights, and we may be found to infringe or contribute to the infringement of 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.

Any litigation regarding patents or other intellectual property could be costly and time consuming and could 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 customers or Palm OS 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 or our products.

For information concerning pending matters, see Item 1. entitled “Legal Proceedings” in Part II of this quarterly report.

If third parties infringe our intellectual property or if we are unable to secure and protect 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 our employees and us. This computer equipment has contained proprietary information and intellectual property. In addition, there have been leaks of proprietary information associated with our intellectual property. We have formulated a security plan to reduce the risk of future thefts and leaks of proprietary information. We may not be successful in preventing future thefts, in preventing those responsible for past thefts from using our technology to produce competing products or in preventing future leaks of proprietary information. The unauthorized use of our technology or of our proprietary information by competitors could have a material adverse effect on our ability to sell our products.

We are subject to general commercial litigation and other litigation claims as part of our operations, and we could suffer significant litigation expenses in defending these claims and could be subject to significant damages or remedies.

In the course of our business, we occasionally receive claims of consumer protection, general commercial claims related to the conduct of our business and the performance of our products and services and other litigation claims. Any litigation regarding these consumer, commercial, and other claims could be costly and time-consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of consumer, commercial and other litigation increase these risks. We also may be subject to significant damages or equitable remedies regarding the development and sale of our products and operation of our business.

For information concerning pending matters, see Item 1. entitled “Legal Proceedings” in Part II of this quarterly report.

Our future results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.

Because we sell our products worldwide and most of the facilities where our devices are manufactured and distributed are located outside the United States, our business is subject to risks associated with doing business internationally, such as:

changes in foreign currency exchange rates;

changes in a specific country’s or region’s political or economic conditions, particularly in emerging markets;

changes in international relations;

trade protection measures and import or export licensing requirements;

potentially negative consequences from changes in tax laws;

difficulty in managing widespread sales operations;

difficulty in managing a geographically dispersed workforce in compliance with diverse local laws and customs; and

less effective protection of intellectual property.

In addition, we are subject to changes in demand for our products resulting from exchange rate fluctuations that make our products relatively more or less expensive in international markets. If exchange rate fluctuations occur, our business and results of operations could be harmed by decreases in demand for our products or reductions in margins.

We may pursue strategic acquisitions and investments which could have an adverse impact on our business if they are unsuccessful.

Within the last two and a half years, we have acquired ThinAirApps, Inc., certain assets of Be Incorporated, peanutpress.com, Inc., WeSync.com, Inc., AnyDay.com, Inc., and Actual Software Corporation. We will evaluate other acquisition opportunities that could provide us with additional product or service offerings or additional industry expertise as they arise. 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 companies may result in problems related to integration of technology and management teams. We may not successfully integrate 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. In addition, our acquisitions may not be successful in achieving our desired strategic objectives, which would also cause our business to suffer. These transactions may result in the diversion of capital and management’s attention away from other business issues and opportunities. In addition, we have made strategic venture investments in other companies that provide products and services that are complementary to ours. If these investments are unsuccessful, this could have an adverse impact on our results of operations and financial position.

Our flexibility to operate our business may be constrained by the requirements of our credit facility.

certain actions and our business may suffer. Failure to meet certain covenants or the occurrence of certain events would result in an event of default, which confers additional rights on our lenders and could cause us to suffer adverse financial and business consequences. As of February 28, 2003, we had used our credit facility to support the issuance of letters of credit of $53.0 million. The collateral for the $50 million letter of credit relative to a litigation matter expires on April 30, 2003. If the letter of credit is still required subsequent to April 30, 2003, it will have to be collateralized with either cash or with some other form of credit. The remaining $3.0 million of letters of credit expire in June 2003, upon the termination of our credit facility. If we are unable to obtain replacement letters of credit on favorable terms, our results of operation and financial position could be negatively impacted.

The Company owns land that is not currently being utilized in its business. If we are ultimately unable to recover the carrying value of this land we would incur a non-cash charge to operations.

The Company owns approximately 39 acres of land in San Jose, California which it does not plan to develop. In the third quarter of fiscal year 2003, we reported an impairment charge to adjust the carrying cost of the land to its then current fair market value. While the Company currently has no immediate plans to sell this property, a future sale or other disposition of the land at less than its carrying value would result in a non-cash charge which would negatively impact our results of operations.

Business interruptions could adversely affect our business.

Our operations and those of our suppliers and customers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks, wars, health epidemics and other events beyond our control. In addition, the business interruption insurance we carry may not be sufficient to compensate us fully for losses or damages that may occur as a result of such events. Any such losses or damages incurred by us could have a material adverse effect on our business.

War, terrorist attacks or other threats beyond our control could negatively impact consumer confidence, which could harm our operating results.

The war in Iraq, threats of war elsewhere, terrorist attacks or other threats beyond our control could have an adverse impact on the U.S. and world economy in general and consumer confidence and spending in particular, which could harm our revenues and results of operations.

Risks Related to the Securities Markets and Ownership of Our Common Stock

Our common stock price may be subject to significant fluctuations and volatility.

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 revenues 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, financial analysts or market indices;

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 high 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 and our adoption of a stockholder rights plan may delay or prevent acquisition of us, which could decrease the value of shares of our common stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult 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. 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. 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. 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.

Our board of directors adopted a stockholder rights plan, pursuant to which we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of November 6, 2000. Unless redeemed by us prior to the time the rights are exercised, upon the occurrence of certain events, the rights will entitle the holders to receive upon exercise thereof shares of our preferred stock, or shares of an acquiring entity, having a value equal to twice the then-current exercise price of the right. The issuance of the rights could have the effect of delaying or preventing a change in control of us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk.

We currently maintain an investment portfolio consisting mainly of debt securities with maturities of less than one year. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. 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 limited exposure to any one issue or issuer. We do not use derivative financial instruments in our investment portfolio. If market interest rates were to increase immediately and uniformly by 10 percent from levels at February 28, 2003, the fair value of the portfolio would decline by an immaterial amount. We would not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

Foreign Currency Exchange Risk

losses from the revaluation of assets and liabilities denominated in currencies other than the functional currency of the reporting entity. All such gains and losses are included in interest and other income (expense) in our consolidated statements of operations. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes.

Equity Price Risk

We have investments in public and private companies valued at approximately $4.4 million as of February 28, 2003. Investments in publicly traded companies are subject to market price volatility, and investments in privately held companies are illiquid and inherently risky, as their technologies or products are typically in the early stages of development and may never materialize. We could experience declines in the value of our investments or even lose the entire value of these investments.

Item 4. Controls and Procedures

(a)

Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) were effective as of such date to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

(b)

Changes in internal controls. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

permanently enjoin the defendants from infringing the patent in the future. In 2000, the District Court dismissed the case, ruling that the patent is not infringed by the Graffiti handwriting recognition system used in handheld computers using Palm’s operating systems. Xerox appealed the dismissal to the United States Court of Appeals for the Federal Circuit (“CAFC”). On October 5, 2001, the CAFC affirmed-in-part, reversed-in-part and remanded the case to the District Court for further proceedings. On December 20, 2001, the District Court granted Xerox’s motion for summary judgment that the patent is valid, enforceable, and infringed. The defendants filed a Notice of Appeal on December 21, 2001. On February 22, 2002, the court denied a request for an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The court also rejected a request by Xerox to set a trial date to determine damages Xerox claims it is owed. In connection with the denial of Xerox’s request to set a trial date on damages, the court required Palm to post a $50 million bond, which was satisfied with a letter of credit from a financial institution. A Notice of Appeal from the District Court’s order of February 22, 2002 was filed by Palm on March 15, 2002. A cross-appeal from the District Court’s order of February 22, 2002 was filed by Xerox on March 4, 2002. A hearing on the appeal and cross-appeal was held on January 6, 2003 before the CAFC. The CAFC has remanded the case to the District Court for a determination on the issue of invalidity of the ‘656 patent. Xerox petitioned the CAFC for reconsideration of its determination on the appeal and cross-appeal, but the CAFC has denied this petition. If Palm is not successful regarding the remand to the District Court, the CAFC has noted that an injunction will apply. If an injunction is sought by Xerox and issued, it could result in business interruption for Palm that would have a significant adverse impact on Palm’s operations and financial condition if Palm has not transitioned to a handwriting recognition system outside the scope of Xerox’s asserted claims. In addition, if Palm is not successful with regard to this remand to the District Court, Xerox has stated in its court pleadings that it will seek at a trial, a significant compensatory and punitive damage award or license fees from Palm. Furthermore, if Palm is not successful with regard to this remand to the District Court, Palm might be liable to Palm’s licensees and other third parties under contractual obligations or otherwise sustain adverse financial impact if Xerox seeks to enforce its patents claims against Palm’s licensees and other third parties. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation.

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 No. 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. The case was transferred to the U.S. District Court for the Northern District of California. In an Order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. The issues on appeal before the CAFC have been fully briefed by the parties, and the oral argument is scheduled for May 6, 2003. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the E-Pass litigation.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, entitled, respectively, “Portable Personal Terminal for Use in a System for Handling Transactions” and “System for Handling Transactions Including a Portable Personal Terminal.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. The case was referred to Magistrate Judge Mary P. Thynge. In a Memorandum Opinion dated July 11, 2002, the Magistrate Judge indicated that she would recommend that the District Court grant the defendants’ motion for summary judgment that there was no infringement. NCR filed objections to the recommendations of the Magistrate Judge, and Palm has filed a response to NCR’s objections. The parties are now awaiting a decision from District Court Judge Kent Jordan.

On January 23, 2003, Peer-to-Peer Systems LLC filed a complaint against Palm in the United States District Court for the District of Delaware. The case is captioned Peer-to-Peer Systems, LLC vs. Palm, Inc., Civil Action No. 03-115. The complaint alleges infringement of U.S. Patent No. 5,618,045 entitled “Interactive Multiple Player Game System and Method of Playing a Game Between at Least Two Players”. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendant from infringing the patent in the future. Palm believes that the claims are without merit and intends to defend against them vigorously. Palm is scheduled to respond to the complaint by April 18, 2003.

In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with plaintiffs. Palm joined the motion to dismiss filed on behalf of all issuers, which the court denied with respect to Palm. Palm believes that it has meritorious defenses to the claims against it and intend to defend the action vigorously.

consumer fraud regarding Palm’s representations that its m100, III, V, and VII handheld personal digital assistant, as sold, would provide wireless access to the Internet and e-mail accounts, and would perform common business functions including data base management, custom form creation, and viewing Microsoft Word and Excel documents, among other tasks. The case seeks unspecified actual damages and indemnification of certain costs. Palm responded to the Complaint and the case is in its early stages. No trial date has been set.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

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 3 Com and the Registrant.
2.12(1)		Form of Non-U.S. Plan.
3.1(14)		Amended and Restated Certificate of Incorporation.
3.2(9)		Amended and Restated Bylaws.
3.3(5)		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock.
4.1		Reference is made to Exhibits 3.1, 3.2 and 3.3 hereof.
4.2*		Specimen Stock Certificate.
4.3(5)		Preferred Stock Rights Agreement between the Registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank).
4.4(11)		5% Convertible Subordinated Note Due 2006, dated as of December 6, 2001.
10.1(15)		1999 Stock Plan, as amended.
10.2(1)		Form of 1999 Stock Plan Agreements.
10.3(15)		1999 Employee Stock Purchase Plan, as amended.
10.4(1)		Form of 1999 Employee Stock Purchase Plan Agreements.
10.5(3)		Amended and Restated 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 Cingular Wireless) 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 (now AOL Time Warner) 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, signed by Judy Bruner.
10.15(4)		Agreement for Purchase and Sale of Land between 3Com Corporation and the Registrant.
10.16(6)		Master Lease dated as of November 16, 2000 by and between the Registrant and Societe Generale Financial Corporation, as supplemented.
10.17(6)		Participation Agreement dated as of November 16, 2000 by and among the Registrant, Societe Generale Financial Corporation, Societe Generale and certain other parties.
10.18(6)		Guaranty dated as of November 16, 2000 by and between the Registrant and Societe Generale, New York Branch.
10.19(7)**		First Amendment to Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the Registrant.
10.20(8)		Amended and Restated Lease, dated as of May 31, 2001, between the Registrant and Societe Generale Financial Corporation, as supplemented.
10.21(8)		Termination Agreement, dated as of May 31, 2001, between the Registrant, Societe Generale Financial Corporation, Societe Generale and certain other parties.
10.22(9)**		Loan and Security Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of June 25, 2001.
10.23(9)**		Amendment Number One to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of August 6, 2001.
10.24(9)		Employment Offer Letter for David C. Nagel dated September 13, 2001.
10.25(11)**		Agreement and General Release of All Claims between the Registrant and Carl J. Yankowski dated as of November 8, 2001.
10.26(11)**		Convertible Note Purchase Agreement dated December 6, 2001.
10.27(11)**		Registration Rights Agreement dated as of December 6, 2001.
10.28(11)**		Amendment Number Two to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.29(11)**		Loan Agreement by and among Palm Europe Limited, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.30(10)**		Guarantee and Debenture by and between Palm Europe Limited and Foothill Capital Corporation dated as of March 1, 2002.
10.31(10)		General Continuing Guaranty by the Registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.32(10)		Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of March 1, 2002.
10.33(11)**		Loan Agreement by and among Palm Global Operations Ltd., Foothill Capital Corporation, Heller Financial, Inc., and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.34(10)		Guarantee and Debenture by and between Palm Global Operations Limited and Foothill Capital Corporation dated as of January 7, 2002.

10.35(10)		General Continuing Guaranty by the Registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.36(10)		Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of March 1, 2002.
10.37(12)**		Amendment Number One to Value Added Reseller Agreement between Cingular Interactive, L.P. (formerly known as BellSouth Wireless Data, L.P., which was formerly known as RAM Mobile Data USA Limited Partnership) and the Registrant.
10.38(13)**		Sublease Agreement by and between Cisco Systems Inc. and the Registrant.
10.39(13)		Lease Agreement between Network Appliance, Inc. and PalmSource, Inc.
10.40(13)		Amendment No.1 to Lease Agreement and Work Letter Agreement.
10.41(14)		Amendment Number Three to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.42(14)		Amendment Number Four to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.43(14)		Management Retention Agreement between the Registrant and R. Todd Bradley, dated as of September 17, 2002.
10.44(14)		Form of Severance Agreement for Executive Officers, signed by Judy Bruner, Marianne Jackson and Theodore Theophilos.
10.45(14)		Management Retention Agreement between the Registrant and Marianne Jackson, dated as of February 12, 2002.
10.46(15)		2001 Stock Option Plan for Non-Employee Directors, as amended
10.47(15)		Management Retention Agreement between the Registrant and Theodore Theophilos, dated as of August 31, 2002.
10.48*		Management Retention Agreement between the Registrant and Judy Bruner, dated as of January 20, 2003.
99.1*		Certification of Chief Executive Officer and Chief Financial Officer.

* –

Filed herewith

** –

Confidential treatment granted on portions of this exhibit.

(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 Quarterly Report on Form 10-Q filed with the Commission on April 10, 2000.

(3) –

Incorporated by reference from the Registration Statement on Form S-8 filed with the Commission on October 2, 2000.

(4) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 12, 2000.

(5) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on November 22, 2000.

(6) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on December 1, 2000.

(7) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on April 11, 2001.

(8) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on June 15, 2001.

(9) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 15, 2001, as amended.

(10) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on January 14, 2002, as amended.

(11) –

Incorporated by reference from the Registrant’s Form 10-Q/A filed with the Commission on April 17, 2002.

(12) –

Incorporated by reference from the Registrant’s Form 10-Q/A filed with the Commission on February 26, 2002.

(13) –

Incorporated by reference from the Registrant’s Annual Report on Form 10-K filed with the Commission on July 30, 2002, as amended.

(14) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 11, 2002.

(15) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on January 10, 2003.

(b) Reports on Form 8-K

None.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Palm, Inc. (Registrant)

Dated:	April 14, 2003	By:	/s/ JUDY BRUNER
			Judy Bruner Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Certifications

I, Eric A. Benhamou, Chairman and Chief Executive Officer of Palm, Inc., certify that:

I have reviewed this quarterly report on Form 10-Q of Palm, Inc.;

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date:

April 14, 2003

By:

/s/ ERIC A. BENHAMOU

Eric A. Benhamou

Chairman and

Chief Executive Officer

Certifications

I, Judy Bruner, Senior Vice President and Chief Financial Officer of Palm, Inc., certify that:

I have reviewed this quarterly report on Form 10-Q of Palm, Inc.;

evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date:

April 14, 2003

By:

/s/ JUDY BRUNER

Judy Bruner

Senior Vice President and

Chief Financial Officer

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 between3Com 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(14)		Amended and Restated Certificate of Incorporation.
3.2(9)		Amended and Restated Bylaws.
3.3(5)		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock.
4.1		Reference is made to Exhibits 3.1, 3.2 and 3.3 hereof.
4.2*		Specimen Stock Certificate.
4.3(5)		Preferred Stock Rights Agreement between the Registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank).
4.4(11)		5% Convertible Subordinated Note Due 2006, dated as of December 6, 2001.
10.1(15)		1999 Stock Plan, as amended.
10.2(1)		Form of 1999 Stock Plan Agreements.
10.3(15)		1999 Employee Stock Purchase Plan, as amended.
10.4(1)		Form of 1999 Employee Stock Purchase Plan Agreements.
10.5(3)		Amended and Restated 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 Cingular Wireless) 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 (now AOL Time Warner) 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, signed by Judy Bruner.
10.15(4)		Agreement for Purchase and Sale of Land between 3Com Corporation and the Registrant.
10.16(6)		Master Lease dated as of November 16, 2000 by and between the Registrant and Societe Generale Financial Corporation, as supplemented.
10.17(6)		Participation Agreement dated as of November 16, 2000 by and among the Registrant, Societe Generale Financial Corporation, Societe Generale and certain other parties.
10.18(6)		Guaranty dated as of November 16, 2000 by and between the Registrant and Societe Generale, New York Branch.
10.19(7)**		First Amendment to Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the Registrant.
10.20(8)		Amended and Restated Lease, dated as of May 31, 2001, between the Registrant and Societe Generale Financial Corporation, as supplemented.
10.21(8)		Termination Agreement, dated as of May 31, 2001, between the Registrant, Societe Generale Financial Corporation, Societe Generale and certain other parties.
10.22(9) **		Loan and Security Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of June 25, 2001.
10.23(9) **		Amendment Number One to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of August 6, 2001.
10.24(9)		Employment Offer Letter for David C. Nagel dated September 13, 2001.
10.25(11)**		Agreement and General Release of All Claims between the Registrant and Carl J. Yankowski dated as of November 8, 2001.
10.26(11)**		Convertible Note Purchase Agreement dated December 6, 2001.
10.27(11)**		Registration Rights Agreement dated as of December 6, 2001.
10.28(11)**		Amendment Number Two to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.29(11)**		Loan Agreement by and among Palm Europe Limited, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.30(10)**		Guarantee and Debenture by and between Palm Europe Limited and Foothill Capital Corporation dated as of March 1, 2002.
10.31(10)		General Continuing Guaranty by the Registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.32(10)		Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of March 1, 2002.
10.33(11)**		Loan Agreement by and among Palm Global Operations Ltd., Foothill Capital Corporation, Heller Financial, Inc., and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.34(10)		Guarantee and Debenture by and between Palm Global Operations Limited and Foothill Capital Corporation dated as of January 7, 2002.
10.35(10)		General Continuing Guaranty by the Registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.36(10)		Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of March 1, 2002.

10.37(12)**		Amendment Number One to Value Added Reseller Agreement between Cingular Interactive, L.P. (formerly known as BellSouth Wireless Data, L.P., which was formerly known as RAM Mobile Data USA Limited Partnership) and the Registrant.
10.38(13)**		Sublease Agreement by and between Cisco Systems Inc. and the Registrant.
10.39(13)		Lease Agreement between Network Appliance, Inc. and PalmSource, Inc.
10.40(13)		Amendment No.1 to Lease Agreement and Work Letter Agreement.
10.41(14)		Amendment Number Three to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.42(14)		Amendment Number Four to Loan Agreement by and among the Registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 1, 2002.
10.43(14)		Management Retention Agreement between the Registrant and R. Todd Bradley, dated as of September 17, 2002.
10.44(14)		Form of Severance Agreement for Executive Officers, signed by Judy Bruner, Marianne Jackson and Theodore Theophilos.
10.45(14)		Management Retention Agreement between the Registrant and Marianne Jackson, dated as of February 12, 2002.
10.46(15)		2001 Stock Option Plan for Non-Employee Directors, as amended
10.47(15)		Management Retention Agreement between the Registrant and Theodore Theophilos, dated as of August 31, 2002.
10.48*		Management Retention Agreement between the Registrant and Judy Bruner, dated as of January 20, 2003.
99.1*		Certification of Chief Executive Officer and Chief Financial Officer.

* –

Filed herewith

** –

Confidential treatment granted on portions of this exhibit.

(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 Quarterly Report on Form 10-Q filed with the Commission on April 10, 2000.

(3) –

Incorporated by reference from the Registration Statement on Form S-8 filed with the

Commission on October 2, 2000.

(4) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 12, 2000.

(5) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on November 22, 2000.

(6) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on December 1, 2000.

(7) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on April 11, 2001.

(8) –

Incorporated by reference from the Registrant’s Current Report on Form 8-K filed with the Commission on June 15, 2001.

(9) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 15, 2001, as amended.

(10) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on January 14, 2002, as amended.

(11) –

Incorporated by reference from the Registrant’s Form 10-Q/A filed with the Commission on April 17, 2002.

(12) –

Incorporated by reference from the Registrant’s Form 10-Q/A filed with the Commission on February 26, 2002.

(13) –

Incorporated by reference from the Registrant’s Annual Report on Form 10-K filed with the Commission on July 30, 2002, as amended.

(14) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on October 11, 2002.

(15) –

Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on January 10, 2003.