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Palm, Inc.

Condensed Consolidated Balance Sheets
(In thousands, except par value amounts)
(Unaudited)


	August 31,			May 31,
	2005			2005
ASSETS
Current assets:
Cash and cash equivalents	$	147,597		$	128,164
Short-term investments		263,745			234,535
Accounts receivable, net of allowance for doubtful accounts of $5,590 and $6,874, respectively		128,491			140,162
Inventories		38,268			35,544
Investment for committed tenant improvements		5,375			6,182
Prepaids and other		9,669			8,225

Total current assets		593,145			552,812
Restricted investments		775			775
Land held for sale		60,000			—
Land not in use		—			60,000
Property and equipment, net		22,088			19,158
Goodwill		248,319			249,161
Intangible assets, net		28,095			30,373
Deferred income taxes		36,794			36,217
Other assets		1,532			1,536

Total assets	$	990,748		$	950,032

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	138,996		$	135,720
Accrued restructuring		14,196			15,400
Provision for committed tenant improvements		5,375			6,182
Other accrued liabilities		177,270			164,450

Total current liabilities		335,837			321,752
Non-current liabilities:
Long-term convertible debt		35,000			35,000
Other non-current liabilities		12,935			12,257
Stockholders’ equity:
Preferred stock, $0.001 par value, 125,000 shares authorized; none outstanding		—			—
Common stock, $0.001 par value, 2,000,000 shares authorized; outstanding: 49,975 shares and 49,488 shares, respectively		50			49
Additional paid-in capital		1,414,855			1,406,935
Unamortized deferred stock-based compensation		(2,433	)		(2,422	)
Accumulated deficit		(806,074	)		(824,251	)
Accumulated other comprehensive income		578			712

Total stockholders’ equity		606,976			581,023

Total liabilities and stockholders’ equity	$	990,748		$	950,032

See notes to condensed consolidated financial statements.

Palm, Inc.

Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.		Basis of Presentation

		The accompanying unaudited condensed consolidated financial statements have been prepared by Palm, Inc. (formerly palmOne, Inc.) (“Palm,” the “Company,” “us,” “we” or “our”), without audit, pursuant to the rules of the Securities and Exchange Commission, or 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 August 31, 2005 and results of operations and cash flows for the three months ended August 31, 2005 and 2004. 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, 2005. The results of operations for the three months ended August 31, 2005 are not necessarily indicative of the operating results for the full fiscal year or any future period.

		Palm was incorporated in 1992 as Palm Computing, Inc. In 1995, the Company was acquired by U.S. Robotics Corporation. In 1996, the Company sold its first handheld computer, quickly establishing a significant position in the handheld computing industry. In 1997, 3Com Corporation, or 3Com, acquired U.S. Robotics. In 1999, 3Com announced its intent to separate the handheld device business from 3Com’s business to form an independent, publicly traded company. In preparation for that spin-off, Palm Computing, Inc. changed its name to Palm, Inc., or Palm, and was reincorporated in Delaware in December 1999. In March 2000, Palm sold shares in an initial public offering and concurrent private placements. In July 2000, 3Com distributed its remaining shares of Palm common stock to 3Com stockholders.

		In December 2001, Palm formed PalmSource, Inc., or PalmSource, a stand-alone subsidiary for its operating system business. On October 28, 2003, Palm distributed all of the shares of PalmSource common stock held by Palm to Palm stockholders. On October 29, 2003 Palm acquired Handspring, Inc. and changed its name to palmOne, Inc., or palmOne.

		In connection with the spin-off of PalmSource, the Palm Trademark Holding Company, LLC, was formed to hold all trade names, trademarks, service marks and domain names containing the word or letter string “palm”. In May 2005, the Company acquired PalmSource’s interest in the Palm Trademark Holding Company, LLC, including the Palm trademark and brand, for $30.0 million, payable over 3.5 years. In July 2005, the Company changed its name back to Palm, Inc., or Palm.

		Palm’s 52-53 week fiscal year ends on the Friday nearest to May 31, with each fiscal quarter ending on the Friday generally nearest to August 31, November 30 and February 28. Fiscal year 2006 contains 52 weeks and fiscal year 2005 contains 53 weeks. For presentation purposes, the periods are shown as ending on August 31, November 30, February 28 and May 31, as applicable.

2.		Stock-Based Compensation

		Palm has employee stock plans, which are described more fully in the notes to consolidated financial statements included in Palm’s Annual Report on Form 10-K for the fiscal year ended May 31, 2005. Palm accounts for awards under its employee stock plans under the intrinsic value method prescribed by Accounting Principles Board Opinion, or APB, No. 25, Accounting for Stock Issued to Employees, and Financial Accounting Standards Board Interpretation, or FIN, No. 44, Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB No. 25), and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation. The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and related guidance.

		In accordance with APB No. 25, Palm generally recognizes no compensation expense with respect to shares issued under its employee stock purchase plan and options granted to employees and directors under its stock option plans, collectively referred to as “options.” The Company’s stock option plan also allows for the issuance of restricted stock awards, under which shares of common stock are issued at par value to key employees, subject to certain restrictions, and for which compensation expense equal to the fair market value on the date of the grant is recognized over the vesting period.

		Pursuant to FIN No. 44, options assumed in a purchase business combination are valued at the date of acquisition at their fair value calculated using the Black-Scholes option valuation model. The fair value of the assumed options is included as part of the purchase price. The intrinsic value attributable to the unvested options is recorded as unearned stock-based compensation and amortized over the remaining vesting period of the related options.

The following table illustrates the effect on net income and net income per share if Palm had elected to recognize stock-based compensation expense based on the fair value of the options granted to employees at the date of grant as prescribed by SFAS No. 123. For the purpose of this pro forma disclosure, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods, using the multiple option approach (in thousands, except per share amounts):


	Three Months Ended
	August 31,
	2005			2004(1)
Net income, as reported	$	18,177		$	19,594
Add: Stock-based compensation expense included in reported net income, net of related tax effects		730			401
Less: Stock-based compensation expense determined under fair value method for all awards, net of related tax effects		(8,953	)		(5,234	)

Pro forma net income	$	9,954		$	14,761

Net income per share, as reported:
Basic	$	0.37		$	0.41

Diluted	$	0.35		$	0.38

Pro forma net income per share:
Basic	$	0.20		$	0.31

Diluted	$	0.19		$	0.29


(1)		Stock-based compensation expense determined under fair value method for the three months ended August 31, 2004 includes amortization related to options cancelled in connection with the option exchange program initiated on March 1, 2004.

The fair value of each option grant during the three months ended August 31, 2005 and 2004 was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:


	Three Months Ended
	August 31,
	2005			2004
Risk-free interest rate		3.7	%		3.1	%
Volatility		75	%		75	%
Option term (in years)		3.47			3.46
Dividend yield		0.0	%		0.0	%

The weighted average estimated fair value of stock options granted were $15.73 per share and $18.77 per share during the three months ended August 31, 2005 and 2004, respectively.

3.		Recent Accounting Pronouncements

		In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment. This statement replaces SFAS No. 123, Accounting for Stock-Based Compensation and supersedes APB No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires companies to apply a fair-value-based measurement method in accounting for shared-based payment transactions with employees and to record compensation cost for all stock awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. In addition, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS 123(R) will be effective for years beginning after June 15, 2005, which is Palm’s fiscal year 2007. Management has not yet determined the impact that SFAS 123(R) will have on its financial position, results of operations and statement of cash flows, but expects that the impact will be material.

4.		Net Income Per Share

		Basic net income per share for the three months ended August 31, 2005 and 2004 are calculated based on the weighted average shares of common stock outstanding during the period, excluding shares of restricted stock subject to repurchase. Diluted net income per share for the three months ended August 31, 2005 and 2004 are calculated based on the weighted average shares of common stock outstanding during the period, plus the dilutive effect of shares of restricted stock subject to repurchase, stock options and warrants outstanding, calculated using the treasury stock method.

The following table sets forth the computation of basic and diluted net income per share for the three months ended August 31, 2005 and 2004 (in thousands, except per share amounts):


	Three Months Ended
	August 31,
	2005		2004

Net income	$	18,177	$	19,594

Basic and diluted net income:
Shares used to compute basic income per share (weighted average shares outstanding during the period, excluding shares of restricted stock subject to repurchase)		49,627		47,629
Dilutive common equivalent shares:
Restricted stock subject to repurchase		19		125
Stock options and warrants		2,161		3,251

Shares used to compute diluted income per share		51,807		51,005

Basic net income per share	$	0.37	$	0.41

Diluted net income per share	$	0.35	$	0.38

		For the three months ended August 31, 2005 and 2004, approximately 2,988,000 and 464,000, respectively, weighted options to purchase Palm common stock were excluded from the computations of diluted net income per share because these options’ exercise prices were above the average market price during the period and the effect of including such stock options would have been anti-dilutive.

5.		Comprehensive Income

		The components of comprehensive income are (in thousands):


	Three Months Ended
	August 31,
	2005			2004
Net income	$	18,177		$	19,594
Other comprehensive income (loss):
Unrealized gain (loss) on available-for-sale investments		(42	)		280
Recognized loss included in earnings		—			109
Accumulated translation adjustments		(92	)		4

	$	18,043		$	19,987

6.		Cash and Available-for-Sale and Restricted Investments

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


			August 31, 2005							May 31, 2005
	Adjusted		Unrealized			Carrying		Adjusted		Unrealized			Carrying
	Cost		Loss			Value		Cost		Loss			Value
Cash	$	66,832	$	—		$	66,832	$	44,341	$	—		$	44,341
Cash equivalents, money market funds		80,765		—			80,765		83,823		—			83,823

Total cash and cash equivalents	$	147,597	$	—		$	147,597	$	128,164	$	—		$	128,164

Short-term investments:
Federal government obligations	$	93,175	$	(333	)	$	92,842	$	86,936	$	(292	)	$	86,644
State and local government obligations		21,250		—			21,250		12,000		—			12,000
Corporate notes/bonds		138,560		(160	)		138,400		120,796		(159	)		120,637
Foreign corporate notes/bonds		11,263		(10	)		11,253		15,263		(9	)		15,254

	$	264,248	$	(503	)	$	263,745	$	234,995	$	(460	)	$	234,535

Investment for committed tenant improvements, money market funds	$	5,375	$	—		$	5,375	$	6,182	$	—		$	6,182

Restricted investments, certificates of deposit	$	775	$	—		$	775	$	775	$	—		$	775

		Due to the short-term nature of these investments, the carrying value approximates fair value. The unrealized losses on these investments were primarily due to interest rate fluctuations and are considered to be temporary in nature.

		In the third quarter of fiscal year 2005, the Company reclassified its investment in auction-rate securities as short-term investments. These investments were included in cash and equivalents in previous periods and such amounts have been reclassified to conform to the current period classification in the condensed consolidated cash flows for the three months ended August 31, 2004 ($109.5 million at August 31, 2004 and $104.5 million at May 31, 2004).

7.		Inventories

		Inventories consist of the following (in thousands):


	August 31,		May 31,
	2005		2005
Finished goods	$	37,492	$	33,567
Work-in-process and raw materials		776		1,977

	$	38,268	$	35,544

8.		Land held for sale

		In August 2005, the Company entered into an agreement with a real estate broker to market for sale the 39 acres of land owned by Palm in San Jose, California by the direction of management. The Company expects to enter into an agreement to sell the land within the next twelve months. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company has reclassified the land not in use to land held for sale. The Company believes the land’s carrying value is less than the fair value or the expected sales price less any selling costs as of August 31, 2005.

9.		Business Combinations

		On October 29, 2003, Palm acquired Handspring, a leading provider of smartphones and communicators, exchanging 0.09 of a share of Palm common stock for each outstanding share of Handspring common stock and assuming outstanding options and warrants to purchase Handspring common stock based on this same exchange ratio. Palm derived the exchange ratio for the acquisition based on an arm’s length negotiation. The Handspring acquisition resulted in the issuance of approximately 13.6 million shares of Palm common stock. The purchase price of $249.9 million is comprised of (a) approximately $209.2 million representing the fair value of Palm common stock issued to former Handspring stockholders, (b) $28.0 million representing the estimated fair value of Handspring options and warrants assumed using the Black-Scholes option valuation model, (c) $6.5 million of direct transaction costs and (d) $6.2 million of other liabilities directly related to the acquisition.

		The $6.2 million of other liabilities directly related to the Handspring acquisition includes $1.8 million related to workforce reductions primarily in the United States, of approximately 50 Handspring employees, $3.7 million related to Handspring facilities not intended for use for Palm operations and therefore considered excess, and $0.7 million related to other miscellaneous charges incurred as a result of the acquisition which will not benefit Palm in the future. During fiscal year 2004, the Company adjusted the initial estimate of liabilities directly related to the acquisition as a result of greater costs than originally estimated for employee termination benefits and costs to exit certain facilities, then further refined those estimates in fiscal year 2005 as the result of lower costs than estimated during fiscal year 2004. Adjustments to the other liabilities directly related to the Handspring acquisition were recorded as a net increase in goodwill.

		Accrued liabilities recognized in connection with the Handspring acquisition consist of (in thousands):


	Initial Liability
	Recognized at							Balance at					Balance at
	October 29,		Cash					May 31,		Cash			August 31,
	2003		Payments			Adjustments		2005		Payments			2005
Workforce reduction costs	$	1,805	$	(2,029	)	$	224	$	—	$	—		$	—
Excess facilities costs		3,689		(3,303	)		1,776		2,162		(92	)		2,070
Other		660		(673	)		13		—		—			—

	$	6,154	$	(6,005	)	$	2,013	$	2,162	$	(92	)	$	2,070

10.		Goodwill

		Changes in the carrying amount of goodwill are (in thousands):


	Total
Balances, May 31, 2004	$	257,363
Goodwill adjustments		(8,202	)

Balances, May 31, 2005		249,161
Goodwill adjustments		(842	)

Balances, August 31, 2005	$	248,319

Goodwill adjustments during fiscal year 2005 of approximately $8.2 million are primarily the result of the release of the valuation allowance on a portion of the deferred tax assets associated with the Handspring acquisition and adjustments to the initial estimate of liabilities directly related to the Handspring acquisition as a result of lower costs than originally estimated for employee termination benefits and costs to exit certain facilities partially offset by the settlement of pre-acquisition litigation and adjustment to the Company’s estimated royalty obligations. Goodwill adjustments during the three months ended August 31, 2005 of approximately $0.8 million are the result of the release of the valuation allowance on a portion of the deferred tax assets associated with the Handspring acquisition and adjustments to the pre-acquisition tax liabilities related to Handspring. The Company will continue to adjust goodwill as required for changes in the value of deferred tax assets associated with the Handspring acquisition.

11.		Intangible Assets

		Intangible assets consist of the following (dollars in thousands):


				August 31, 2005								May 31, 2005
		Gross								Gross
	Amortization	Carrying			Accumulated					Carrying			Accumulated
	Period	Amount			Amortization			Net		Amount			Amortization			Net
Brand	240 months	$	27,200		$	(397	)	$	26,803	$	27,200		$	(57	)	$	27,143
Contracts and customer relationships	24 months		11,900			(10,908	)		992		11,900			(9,420	)		2,480
Customer backlog	4 months		4,200			(4,200	)		—		4,200			(4,200	)		—
Product technology	24 months		1,800			(1,650	)		150		1,800			(1,425	)		375
Trademarks	24 months		1,400			(1,283	)		117		1,400			(1,108	)		292
Non-compete covenants	24 months		400			(367	)		33		400			(317	)		83

		$	46,900		$	(18,805	)	$	28,095	$	46,900		$	(16,527	)	$	30,373

		Amortization expense related to intangible assets was $2.3 million and $1.9 million for the three months ended August 31, 2005 and 2004, respectively. Estimated future amortization expense is $2.3 million for the remaining nine months of fiscal year 2006 and approximately $1.4 million for each year thereafter through fiscal year 2025.

12.		Deferred Income Taxes

		As of August 31, 2005, Palm’s deferred tax assets were comprised of net operating loss carryforwards, deferred expenses and tax credit carryforwards of $446.8 million offset by a valuation allowance of $410.0 million. The valuation allowance reduces deferred tax assets to their estimated realizable value, based on estimates and certain tax planning strategies. The carrying value of Palm’s net deferred tax assets assumes that it is more likely than not that Palm will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the net carrying value. The valuation allowance is reviewed quarterly and will be maintained until sufficient positive evidence exists to support the reversal of the valuation allowance based upon current and preceding years results of operations and anticipated profit levels in future years.

		The income tax provision for the three months ended August 31, 2005 represented approximately 9% of pretax income, which includes foreign and state income taxes of approximately $1.4 million and acquisition accounting adjustments to goodwill of approximately $0.4 million. The acquisition accounting adjustments to goodwill are related to the recognition of Handspring deferred tax assets, including net operating loss carryforwards that are projected to be realized in the current year to offset taxable income. The tax benefit associated with the utilization of these deferred tax assets is reflected as a goodwill reduction.

13.		Commitments

		Palm facilities are leased under operating leases that expire at various dates through January 2013.

		In December 2001, Palm issued a subordinated convertible note in the principal amount of $50.0 million to Texas Instruments. In connection with the PalmSource distribution on October 28, 2003, the note was canceled and divided into two separate obligations, Palm retained $35.0 million and the remainder was assumed by PalmSource. The note was transferred from Texas Instruments to Metropolitan Life Insurance Company as of August 26, 2005 and retained the same terms. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into Palm common stock at an effective conversion price of $64.60 per share. Palm may force a conversion at any time, provided its common stock has traded above $99.48 per share for a defined period of time. In the event Palm distributes significant assets, Palm 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 May 2005, Palm acquired PalmSource’s 55 percent share of the Palm Trademark Holding Company resulting in full rights to the brand name Palm. The rights to the brand had been co-owned by the two companies since the October 2003 spin-off of PalmSource from Palm, Inc. Palm will pay $30.0 million in five installments due in May 2005, 2006, 2007 and 2008 and November 2008, and has granted PalmSource certain rights to Palm trademarks for PalmSource and its licensees for a four-year transition period. The remaining amount due to PalmSource was $22.5 million as of both August 31, 2005 and May 31, 2005.

		Palm has an agreement with PalmSource that grants Palm certain licenses to develop, manufacture, test, maintain and support its products. This agreement was renewed in May 2005, providing for continued development and marketing of Palm products based on the PalmSource operating system through 2009. Under the agreement, Palm agreed to pay PalmSource license and royalty fees based upon net revenue of its products which incorporate PalmSource’s software, as well as a source code license and maintenance and support fees. The initial source code license fee was $6.0 million paid in three equal annual installments of $2.0 million each in June 2003, June 2004 and June 2005. The continuing source code license fee was reduced under the amended license agreement to $1.2 million and is payable in three equal annual installments of $0.4 million each in June 2006, June 2007 and June 2008. Annual maintenance and support fees are approximately $0.7 million per year. The renewed agreement includes a minimum annual royalty and license commitment of $41.0 million, $42.5 million, $35.0 million, $20.0 million and $10.0 million for the contract years ending December 3, 2005 through 2009, respectively.

		In addition to the PalmSource agreement described above, Palm accrues for royalty obligations for its mobile communications and handheld devices based on either unit shipments or a percentage of applicable revenue for the net sales of products using certain software technologies. Palm recognizes royalty obligations as determinable in accordance with license agreement terms. Where agreements are not finalized, accrued royalty obligations represent management’s current best estimates using appropriate assumptions and projections based on negotiations with the third parties. Palm has accrued royalty obligations of $34.9 million and $32.0 million as of August 31, 2005 and May 31, 2005, respectively, which are reported in other accrued liabilities and includes $32.1 million and $29.7 million, respectively, of estimated royalties. The status of each negotiation differs, and the amounts accrued as the expected royalty obligations are not necessarily the same as the amounts requested by the licensors as of that date. When agreements are finalized, the estimates will be revised accordingly. While the amounts ultimately agreed upon may be more or less than the current accrual, management does not believe that finalization of the agreements would have had a material impact on the amounts reported for its financial position as of August 31, 2005 and May 31, 2005 or for the reported results for the three months then ended; however, the effect of finalization in the future may be significant in the interim period in which it is recorded.

		Palm utilizes contract manufacturers to build its products. These contract manufacturers acquire components and build product based on demand forecast information supplied by Palm, which typically covers a rolling 12-month period. Consistent with industry practice, Palm acquires inventories through a combination of formal purchase orders, supplier contracts and open orders based on projected demand information. Such formal and informal purchase commitments typically cover Palm’s forecasted component and manufacturing requirements for periods ranging from 30 to 90 days. In certain instances, these agreements allow Palm the option to cancel, reschedule and adjust its requirements based on its business needs prior to firm orders being placed. Consequently, only a portion of Palm’s purchase commitments arising from these agreements may be non-cancelable and unconditional commitments. As of August 31, 2005, Palm’s commitments to third party manufacturers for inventory on-hand and component purchase commitments related to the manufacture of Palm products were approximately $146.3 million.

		In August 2003, Palm entered into a two-year, $30.0 million revolving credit line with Silicon Valley Bank, or SVB, which was amended and restated to extend the term one more year through September 30, 2005. The credit line is secured by assets of Palm, including but not limited to cash and cash equivalents, short-term investments, accounts receivable, inventory and property and equipment. The interest rate is equal to SVB’s prime rate (6.5% at August 31, 2005) or, at Palm’s election subject to specific requirements, equal to LIBOR plus 1.75% (5.47% at August 31, 2005). The interest rate may vary based on fluctuations in market rates. Palm is subject to a financial covenant requirement under the credit line agreement to maintain cash on deposit and short-term investments in the United States of not less than $100.0 million. As of August 31, 2005 Palm had used its credit line to support the issuance of letters of credit of $9.2 million. The Company is currently negotiating a new credit line and has made arrangements with SVB to cover its letters of credit in the interim.

		As part of the agreements with 3Com relating to Palm’s separation from 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. (See Note 15 to condensed consolidated financial statements.)

		As part of the agreements with PalmSource relating to the PalmSource distribution, Palm agreed to assume liabilities arising out of the Xerox litigation and to indemnify PalmSource and PalmSource’s licensees if any claim is brought against either of them alleging infringement of the Xerox patent by covered operating system versions for any damages it may incur related to this case. (See Note 15 to condensed consolidated financial statements.)

		Under the indemnification provisions of Palm’s standard reseller agreements and software license agreements, Palm agrees to defend the reseller/licensee against third party claims asserting infringement by Palm’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.

		Under the indemnification provisions with respect to representations and covenants in Palm’s purchase agreement for the Palm brand and with respect to trademark infringement in the amended and restated trademark license agreement with PalmSource, Palm agrees to defend and indemnify PalmSource and its affiliates for losses incurred, limited at $25.0 million for each agreement.

		We indemnify our directors and certain of our current and former officers for third-party claims. Certain costs incurred for providing such indemnification may be recovered under various insurance policies. We are unable to reasonably estimate the maximum amount that could be payable under these arrangements since these exposures are not capped and due to the conditional nature of our obligations and the unique facts and circumstances involved in each agreement. Historically, payments made under these agreements have not had a material effect on our business, financial condition, or results of operations and cash flows.

		Palm’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 are (in thousands):


	Three Months Ended
	August 31,
	2005			2004
Balance, beginning of period	$	19,653		$	27,839
Payments made		(21,674	)		(13,713	)
Change in liability for product sold during the period		23,385			9,160
Change in liability for pre-existing warranties		6,749			583

Balance, end of period	$	28,113		$	23,869

14.		Restructuring Charges

		In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, restructuring costs are recorded as incurred. Restructuring charges for employee workforce reductions are recorded upon employee notification for employees whose required continuing service period is 60 days or less, and ratably over the employee’s continuing service period for employees whose required continuing service period is greater than 60 days.

		The third quarter of fiscal year 2004 restructuring actions consisted of workforce reductions, in the United States and United Kingdom, of approximately 100 regular employees and was completed during the year ended May 31, 2005. Restructuring charges related to the implementation of actions to streamline the Company consistent with its strategic plan. Cost reduction actions initiated in the third quarter of fiscal year 2004 were completed during the year ended May 31, 2005.

		The first quarter of fiscal year 2004 restructuring actions consisted of workforce reductions, primarily in the United States, of approximately 45 regular employees, facilities and property and equipment disposed of or removed from service and canceled projects. Restructuring charges related to the implementation of a series of actions to adjust the business consistent with Palm’s future wireless plans. Cost reduction actions initiated in the first quarter of fiscal year 2004 were substantially completed by the end of fiscal year 2004, except for remaining contractual payments for excess facilities.

		The third quarter of fiscal year 2003 restructuring actions consisted of workforce reductions, primarily in the United States, of approximately 140 regular employees, facilities and property and equipment disposed of or removed from service and canceled projects. Restructuring charges related to the implementation of a series of actions to better align the Company’s expense structure with its revenues. Cost reduction actions initiated in the third quarter of fiscal year 2003 were completed during the year ended May 31, 2005.

		The fourth quarter of fiscal year 2001 restructuring actions 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 205 regular employees and were completed during the year ended May 31, 2003. As of August 31, 2005, the balance consists of lease commitments, payable over approximately six years, offset by estimated sublease proceeds of approximately $20.9 million.

Accrued liabilities related to restructuring actions consist of (in thousands):


	Q3 2004												Q4 2001
	Action			Q1 2004 Action			Q3 2003 Action						Action
				Excess						Excess
				Facilities						Facilities
	Workforce			and			Discontinued			and			Excess
	Reduction			Equipment			Project			Equipment			Facilities
	Costs			Costs			Costs			Costs			Costs			Total
Balance, May 31, 2004	$	708		$	805		$	2,367		$	317		$	19,402		$	23,599
Restructuring expense		(98	)		—			(342	)		80			—			(360	)
Cash payments		(610	)		(461	)		(1,980	)		(397	)		(6,508	)		(9,956	)
Write-offs		—			—			(45	)		—			—			(45	)

Balance, May 31, 2005		—			344			—			—			12,894			13,238
Cash payments		—			(91	)		—			—			(1,021	)		(1,112	)

Balance, August 31, 2005	$	—		$	253		$	—		$	—		$	11,873		$	12,126

		Accrued restructuring as of August 31, 2005 includes accrued liabilities recognized in connection with the Handspring acquisition. (See Note 9 to condensed consolidated financial statements.)

15.		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, and accordingly no provision for any potential loss which may result from the resolution of these matters has been recorded in the accompanying condensed consolidated financial statements except with respect to those cases where preliminary settlement agreements have been reached. An unfavorable resolution of these lawsuits could materially adversely affect Palm’s business, results of operations or financial condition. (Although Palm, Inc. was palmOne, Inc. and is now Palm, Inc. again and Handspring has been merged into Palm, the pleadings in the pending litigation continue to use former company names, including Palm Computing, Inc., Palm, Inc., palmOne, Inc. and Handspring, Inc.)

		In April 1997, Xerox Corporation filed suit in the United States District Court for the Western District of New York. As a result of subsequent amendments, the case currently names as defendants 3Com Corporation, U.S. Robotics Corporation, U.S. Robotics Access Corp., Palm Computing, Inc., Palm, Inc., PalmSource, Inc., and palmOne Inc. The complaint alleges willful infringement of U.S. Patent No. 5,596,656 (the “656 patent”), entitled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint seeks 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. The CAFC remanded the case to the District Court for a determination on the issue of invalidity of the ‘656 patent. On May 21, 2004 the District Court granted palmOne’s motion for summary judgment that the ‘656 patent is invalid. Palm filed a Motion for Clarification of the ruling and Xerox filed a Motion for Alteration or Amendment of and Relief from Judgment. In February 2005 the District Court granted Palm’s motion, finding the patent invalid and denied Xerox’s motion. Xerox has appealed the ruling to the CAFC. If Palm is not successful, Palm may be liable as well under an indemnity flowing to PalmSource and/or its licensees if Xerox seeks to enforce its patent claims against them. In connection with Palm’s separation from 3Com, Palm may be required to indemnify and hold 3Com harmless for any damages or losses that may arise out of the Xerox litigation.

		In February 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 was transferred to the United States District Court for the Northern District of California. 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” and inducement to infringe the same patent. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patent in the future. On August 21, 2003, the CAFC issued a ruling reversing summary judgment in favor of Palm and 3Com and remanded the case to the District Court for further proceedings. On February 9, 2004, E-Pass filed another lawsuit in the United States District Court for the Northern District of California naming palmOne, Handspring and PalmSource as defendants. This second suit alleges infringement, contributory infringement and inducement of infringement of the same patent, but identifies additional products as infringing and seeks unspecified compensatory damages, treble damages and a permanent injunction against future infringement. Palm filed motions for summary judgment which are pending before the Court. In connection with Palm’s separation from 3Com, Palm may be required to indemnify and hold 3Com harmless for any damages or losses that may arise out of the E-Pass litigation.

		In June 2001, the first of several putative stockholder class action lawsuits was filed in the United States District Court for the 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, Case 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. Similar complaints were filed against Handspring in August and September 2001 in regard to Handspring’s June 2000 initial public offering. Other actions have been filed making similar allegations regarding the initial public offerings of more than 300 other companies. 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. The Court denied Palm’s motion to dismiss. Special committees of both Palm’s and Handspring’s respective Boards of Directors approved a tentative settlement proposal from plaintiffs, which includes a guaranteed recovery to be paid by the issuer defendants’ insurance carriers and an assignment of certain claims the issuers, including Palm and Handspring, may have against the underwriters. There is no guarantee that the settlement will become final, however, as it is subject to a number of conditions, including Court approval. The terms of the settlement would result in a resolution that is not material to Palm’s financial position.

		In September 2005, four purported consumer class action lawsuits were filed against Palm, three in the U.S. District Court for the Northern District of California (Moya v. Palm, Berliner v. Palm, and Loew v. Palm) and one in the Superior Court of California for Santa Clara County (Palza v. Palm), on behalf of all purchasers of Palm Treo 600 and Treo 650 products. All four complaints allege in substance that Palm made false or misleading statements regarding the reliability of its Treo 600 and 650 products in violation of various California laws and breached its warranty of these products. The complaints seek unspecified damages, restitution, disgorgement of profits and injunctive relief. In September 2005, a purported consumer class action lawsuit entitled Gans v. Palm was filed against Palm in the U.S. District Court for the Northern District of California on behalf of all purchasers of the Treo 650 product. The complaint alleges that, in violation of various California laws, Palm made false or misleading statements regarding automatic email delivery to the Treo 650 product. The complaint seeks unspecified damages, restitution, disgorgement of profits and injunctive relief.

16.		Related Party Transactions

		Transactions with PalmSource

		In December 2001, Palm entered into a software license agreement with PalmSource which was amended and restated in May 2005. The agreement includes a minimum annual royalty and license commitment of $41.0 million, $42.5 million, $35.0 million, $20.0 million and $10.0 million for the contract years ending December 3, 2005 through 2009, respectively. Under the software license and source code agreement, Palm incurred expenses of $11.9 million and $10.3 million during the three months ended August 31, 2005 and 2004, respectively. As of August 31, 2005 and May 31, 2005, Palm had accounts payable to PalmSource of $11.5 million and $11.1 million, respectively, as the result of the software license agreement. Palm’s Chairman of the Board, Eric Benhamou, was also the Chairman of the Board of PalmSource through October 2004.

		Other Transactions and Relationships

		Palm has a $30.0 million line of credit from Silicon Valley Bank, dating from August 2003, as amended, against which Palm had $9.2 million in letters of credit issued as of August 31, 2005 to cover leases and other arrangements. Eric Benhamou, Chairman of Palm’s Board of Directors, became a member of Silicon Valley Bank’s Board of Directors during the third quarter of Palm’s fiscal year 2005.

		Palm has related party relationships with the following entities with which Palm engages in only nominal amounts of business transactions:

		Palm has a relationship with RealNetworks in connection with bundling of products, web site referrals and engineering assistance. Eric Benhamou, Chairman of Palm’s Board of Directors, is also a member of RealNetworks’ Board of Directors.

		Palm is involved in a co-promotional sales and marketing relationship with Good Technology. Good Technology is a value-added reseller of Palm products. Bruce Dunlevie, a current member of Palm’s Board of Directors, also serves as a member of Good Technology’s Board of Directors and is a partner at Benchmark Capital, which owns more than 5% of the Good Technology stock.

		Palm purchased software licenses and services from Kontiki, Inc. during the three months ended August 31, 2005 and 2004. Michael Homer, a current member of Palm’s Board of Directors, is the Chairman of Kontiki, Inc. Bruce Dunlevie, a current member of Palm’s Board of Directors, is a partner at Benchmark Capital, which owns more then 10% of the Kontiki stock.

		In fiscal year 2005, Palm made a $1.0 million equity investment in and entered into an agreement to host Palm’s software sales with Motricity, Inc. This equity investment is included in other assets. Palm paid service fees to Motricity for hosting Palm’s software sales during the three months ended August 31, 2005.

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

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes to those financial statements included in this Form 10-Q. Our 52-53 week fiscal year ends on the Friday nearest to May 31, with each quarter ending on the Friday generally nearest August 31, November 30 and February 28. For presentation purposes, the periods have been presented as ending on August 31.

This quarterly report contains forward-looking statements within the meaning of the federal securities laws, including, without limitation, statements concerning Palm’s expectations, beliefs and/or intentions regarding the following: demand for Palm’s products; Palm’s market position; shifts in Palm’s average selling price, product mix and geographic revenue mix; the development and introduction of new products and services; competitors and competition in the markets in which Palm operates; trends in revenues, gross margin, operating income, royalty rates, technical services expenses, warranty costs, sales and marketing expenses, research and development expenses, employee related expenses and other expenses, headcount, return rates, accounts receivable and other assets and cash generation; the use of proceeds from the potential sale of securities under Palm’s universal shelf registration statement; the sufficiency of Palm’s cash, cash equivalents and credit facility to satisfy its anticipated cash requirements; the effects of changes in market interest rates; investment activities, the value of investments and the use of Palm’s financial instruments; realization of, and actions which Palm may implement to realize, the tax benefits associated with Palm’s net operating loss carryforwards; the timing of reversal of our deferred tax asset valuation allowance; Palm’s defenses to legal proceedings and litigation matters; provisions in Palm’s charter documents and Delaware law and the potential effects of a stockholder rights plan; and the potential impact of our critical accounting policies and changes in financial accounting standards or practices. Actual results and events could differ materially from those contemplated by these forward-looking statements due to various risks and uncertainties, including those discussed in the “Business Environment and Risk Factors” section and elsewhere in this quarterly report. Palm undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview and Executive Summary

Palm, Inc. is a global provider of mobile computing solutions. Our objective is to be the leader in mobile computing. In order to accomplish our objective, we have defined the following strategy: develop market-defining products that deliver a great user experience, capitalize on industry trends, manage a diversified portfolio of mobile computing products and build our brand. During fiscal year 2005, we introduced new innovative products, increased our reported product sell-through, launched our smartphone on numerous carrier networks, acquired unencumbered rights to the Palm brand and returned to profitability.

Management periodically reviews certain key business metrics in order to evaluate our strategy and operational efficiency, allocate resources and maximize the financial performance of our business. These key business metrics include the following:

Revenue—Management reviews many elements to understand our revenue stream. These include supply availability, unit shipments, average selling prices and channel inventory levels. Revenue growth is impacted by increased unit shipments and variations in average selling prices. Unit shipments are determined by supply availability, end-user and channel demand, and channel inventory. We monitor average selling prices throughout the product life cycle, taking into account market demand and competition. To avoid empty shelves at retail store locations and to minimize product returns and obsolescence, we strive to maintain channel inventory levels within a desired range.

Margins—We review gross margin in conjunction with revenues to maximize operating performance. We strive to improve our gross margin through disciplined cost and product life-cycle management, supply/demand management and control of our warranty and technical support costs. To achieve desired operating margins, we also monitor our operating expenses closely to keep them in line with our projected revenue.

Cash flows—We strive to convert operating results to cash. To that effect, we carefully manage our working capital requirements through balancing accounts receivable and inventory with accounts payable. We monitor our cash balances to maintain cash available to support our operating and capital expenditure requirements.

We believe the mobile computing solutions market dynamics are generally favorable to us.

• While the market for handheld computers is maturing, our leadership position and our ability to develop high quality products enable us to produce solid operating performance from this product line. The handheld computing device product line also provides a brand and scale that can be leveraged across our entire product portfolio.

• The emerging high-speed wireless networks which enable true “always-on” connectivity are fueling the growth of the handheld communications device market. With our computing heritage, we are able to work closely with carriers to deploy advanced wireless data applications that take advantage of their recently deployed wireless data networks.

We expect to experience revenue and operating income growth as a result of our smartphone product line. The smartphone market is in its infancy and people are just beginning to understand the personal and professional benefits of being able to access email or browse the web on a smartphone. We expect this market to expand and we expect to capitalize on this expansion.

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 condensed consolidated financial statements and accompanying notes. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. 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 rebates, price protection, product returns, allowance for doubtful accounts, warranty and technical service costs, royalty obligations, 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 our condensed consolidated financial statements.

Revenue is recognized when earned in accordance with applicable accounting standards and guidance, including Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, as amended, and AICPA Statement of Position, or SOP, No. 97-2, Software Revenue Recognition, as amended. We recognize revenues from sales of mobile computing devices under the terms of the customer agreement upon transfer of title to the customer, net of estimated returns, provided that the sales price is fixed and determinable, collection of the resulting receivable is probable and no significant obligations remain. For one of our web sales distributors, we recognize revenue based on a sell-through method utilizing information provided by the distributor. 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, channel inventory levels 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 software arrangements with end users of our devices is recognized upon delivery of the software, provided that 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 software arrangements is based on the price determined by management having the relevant authority when the element is not yet sold separately, but is expected to be sold in the marketplace within six months of the initial determination of the price by management.

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 repair as a percentage of shipment levels and the expected repair cost per unit, service policies and any 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.

Palm accrues for royalty obligations for its mobile communications and handheld devices based on either unit shipments or a percentage of applicable revenue for the net sales of products using certain software technologies. Palm recognizes royalty obligations as determinable in accordance with license agreement terms. Where agreements are not finalized, accrued royalty obligations represent management’s current best estimates using appropriate assumptions and projections based on negotiations with the third parties. Palm has accrued royalty obligations of $34.9 million and $32.0 million as of August 31, 2005 and May 31, 2005, respectively, which are reported in other accrued liabilities and includes $32.1 million and $29.7 million, respectively, of estimated royalties. The status of each negotiation differs, and the amounts accrued as the expected royalty obligations are not necessarily the same as the amounts requested by the licensors as of that date. When agreements are finalized, the estimates will be revised accordingly. While the amounts ultimately agreed upon may be more or less than the current accrual, management does not believe that finalization of the agreements would have had a material impact on the amounts reported for its financial position as of August 31, 2005 and May 31, 2005 or for the reported results for the three months then ended; however, the effect of finalization in the future may be significant in the interim period in which it is recorded.

Long-lived assets such as land held for sale, 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 evaluate the recoverability of goodwill annually or more frequently if impairment indicators arise, as required under Statement of Financial Accounting Standards, or SFAS, No. 142, Goodwill and Other Intangible Assets. Goodwill is reviewed for impairment by applying a fair-value-based test at the reporting unit level within our single reporting segment. A goodwill impairment loss is recorded for any goodwill that is determined to be impaired. Under SFAS No. 144, Accounting for the Disposal of Long-Lived Assets, intangible assets are evaluated whenever events or changes in circumstances indicate that the carrying value of the asset may be impaired. An impairment loss is recognized for an intangible asset to the extent that the asset’s carrying value exceeds its fair value, which is determined based upon the estimated undiscounted future cash flows expected to result from the use of the asset, including disposition. Cash flow estimates used in evaluating for impairment represent management’s best estimates using appropriate assumptions and projections at the time.

Effective for calendar year 2003, in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supersedes Emerging Issues Task Force, or EITF, Issue No. 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 No. 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 record initial restructuring charges based on assumptions and related estimates that we deem appropriate for the economic environment at the time these estimates are made. 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 if we have taxable income. A valuation allowance reduces deferred tax assets to estimated realizable value, 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 to realize the net carrying value. The valuation allowance is reviewed quarterly and will be maintained until sufficient positive evidence exists to support the reversal of the valuation allowance based upon current and preceding years’ results of operations and anticipated profit levels in future years. If these estimates and related assumptions change in the future, we may be required to adjust our valuation allowance against the deferred tax assets resulting in additional provision/(benefit) to income tax expense. The Company believes that if it continues to experience profitable results of operations, it may have enough evidence to reverse some or all if its valuation allowance during fiscal year 2006.

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

Results of Operations

Revenues


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Revenues	$	342,200		100.0	%	$	273,145		100.0	%	$	69,055

We derive our revenues from sales of our handheld computing and communications devices, add-ons and accessories as well as related services. Revenues for the three months ended August 31, 2005 increased approximately 25% from the three months ended August 31, 2004. During the three months ended August 31, 2005, net device units shipped were 996,000 units at an average selling price of $324. During the three months ended August 31, 2004, net device units shipped were 981,000 units at an average selling price of $259. The unit shipments were up approximately 2% and the average selling price was up approximately 25% in the three months ended August 31, 2005. Of this 25% increase in revenues, unit shipments contributed approximately 2 percentage points and the increase in average selling prices contributed approximately 23 percentage points. The increase in average selling price reflects a shift towards smartphones, which carry a higher average selling price, in our product mix during fiscal year 2006. We closed our Internet access services in September 2004 in part due to broader availability of competing data network service plans from large wireless carriers. Related revenues during the first quarter of fiscal year 2006 were $0, compared to approximately $2.3 million during the comparable period a year ago.

International revenues were approximately 25% of worldwide revenues in the three months ended August 31, 2005 compared with approximately 30% in the three months ended August 31, 2004. Of the 25% increase in worldwide revenues from the three months ended August 31, 2004 as compared to the three months ended August 31, 2005, approximately 23 percentage points resulted from an increase in United States revenues and approximately 2 percentage points resulted from an increase in international revenues. Average selling prices for our devices increased in the United States by 22% and internationally by 28% during the three months ended August 31, 2005 from the three months ended August 31, 2004. The increase in average selling prices is primarily the result of broader penetration of the Treo 650 smartphone with carriers both in the United States and internationally. Net units sold increased approximately 13% in the United States and decreased 19% internationally. The increase in the United States is primarily due to broader penetration of our smartphones on additional carriers during the three months ended August 31, 2005 as compared to the three months ended August 31, 2004, partially offset by a decrease in traditional handheld unit sales. The decrease in net unit sales internationally is primarily the result of a decline in unit sales of our traditional handheld units partially offset by an increase in smartphone unit sales.

Total Cost of Revenues


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Cost of revenues	$	237,844		69.5	%	$	181,803		66.6	%	$	56,041
Applicable portion of amortization of intangible assets and deferred stock-based compensation		230		0.1			312		0.1			(82	)

Total cost of revenues	$	238,074		69.6	%	$	182,115		66.7	%	$	55,959

‘Total cost of revenues’ is comprised of ‘Cost of revenues’ and the applicable portion of ‘Amortization of intangible assets and deferred stock-based compensation’ as shown in the table above. ‘Cost of revenues’ principally consists of material and transformation costs to manufacture our products, OS royalty expense, warranty and technical support costs, freight, scrap and rework costs, the cost of excess or obsolete inventory, and manufacturing overhead which includes manufacturing personnel related costs, depreciation, and allocated information technology and facilities costs. ‘Cost of revenues’ as a percentage of revenues increased by 2.9% to 69.5% for the three months ended August 31, 2005 from 66.6% for the three months ended August 31, 2004. The increase is primarily the result of approximately 5.3 percentage points of increased warranty expenses due to a shift in our product mix towards smartphones which constituted 67% of our revenues during the first quarter of fiscal year 2006 compared to 47% in the year ago period. Smartphones carry higher warranty costs than handheld computing devices as a percentage of their respective revenues. In addition, the increase in warranty expenses was impacted by an increase in our current estimate of return rates of our earlier model smartphones and higher per unit repair costs. Partially offsetting this increase was a reduction of excess, obsolete, scrap and rework charges contributing approximately 1.0 percentage points, due to more favorable inventory management results and reduced scrap experience. Other costs of revenues decreased by approximately 0.9 percentage points primarily due to reduced depreciation costs as the result of our tooling becoming fully depreciated and reduced freight expedite charges. We also experienced reduced Palm OS royalty rates during the three months ended August 31, 2005 compared to the same period last year, consistent with the terms of our software license agreement with PalmSource, contributing approximately 0.5 percentage points.

The ‘Amortization of intangible assets and deferred stock-based compensation’ applicable to the cost of revenues decreased in absolute dollars during the three months ended August 31, 2005 compared to the three months ended August 31, 2004, primarily due to the cancellation of certain restricted stock awards forfeited upon termination of employment of certain employees during fiscal year 2005.

Sales and Marketing


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Sales and marketing	$	45,301		13.2	%	$	37,555		13.7	%	$	7,746

Sales and marketing expenses consist principally of advertising and marketing programs, salaries and benefits for sales and marketing personnel, sales commissions, travel expenses and allocated information technology and facilities costs. The decrease in sales and marketing expenses as a percentage of revenues is primarily due to our increased revenues during the three months ended August 31, 2005 compared to the same quarter a year ago. Sales and marketing expenses in the three months ended August 31, 2005 increased approximately 21% from the three months ended August 31, 2004. The increase in absolute dollars is primarily due to increased marketing development expenses with our retail and carrier customers of approximately $5.1 million as a result of our increased revenues, increased employee related expenses of approximately $2.0 million primarily due to an increase in our headcount during the three months ended August 31, 2005 by approximately 36 employees compared to the comparable quarter a year ago. There were further increases in product promotional programs of approximately $1.0 million and increased consulting expenses of approximately $0.8 million. The increase in consulting expense is due to using consulting assistance during the quarter to complete marketing activities until full-time employees are hired to sustain these activities. Facilities costs and allocations increased by approximately $0.8 million during the three months ended August 31, 2005 as a result of the increased headcount. These increases were partially offset by reduced marketing spending of approximately $2.2 million primarily due to an ad campaign that ran in select markets during the three months ended August 31, 2004, which was not repeated during the three months ended August 31, 2005.

Research and Development


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Research and development	$	28,966		8.5	%	$	18,568		6.8	%	$	10,398

Research and development expenses consist principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. Research and development expenses during the three months ended August 31, 2005 increased approximately 56% from the comparable quarter a year ago. The increase in research and development expenses as a percentage of revenues and in absolute dollars during the three months ended August 31, 2005 is primarily due to an increase in employee related expenses of approximately $8.3 million reflecting an increase of 187 additional employees hired to support our commitment to the development of smartphone products and increased allocated information technology and facilities costs of approximately $2.2 million as a result of the increased headcount. In addition, consulting expense increased by approximately $1.6 million to further support our efforts in the smartphone space until we hire full-time employees. These increases were partially offset by a decrease in project materials and non-recurring engineering costs of approximately $1.7 million primarily due to recognition of payments received from a third party to perform development work on its behalf.

General and Administrative


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
General and administrative	$	8,905		2.6	%	$	9,799		3.6	%	$	(894	)

General and administrative expenses consist of employee related costs, travel expenses and allocated information technology and facilities costs for finance, legal, human resources and executive functions, outside legal and accounting fees, provision for doubtful accounts and business insurance costs. The decrease in general and administrative expenses as a percentage of revenues during the three months ended August 31, 2005 is primarily due to increased revenues during the three months ended August 31, 2005 as compared to the three months ended August 31, 2004. The decrease in absolute dollars is primarily due to a reduction in our allowance for doubtful accounts of $1.0 million because of improvements in the condition of our accounts receivable at August 31, 2005 in comparison to August 31, 2004.

Amortization of Intangible Assets and Deferred Stock-Based Compensation


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Amortization of intangible assets and deferred stock-based compensation	$	2,874		0.8	%	$	2,339		0.9	%	$	535

The increase in amortization of intangible assets and deferred stock-based compensation in absolute dollars is primarily due to the amortization of the Palm brand which was acquired in May 2005, contributing approximately $0.3 million and an increase in the amortization of restricted stock awards of approximately $0.2 million.

Interest and Other Income (Expense), Net


	Three Months Ended August 31,
	2005		% of Revenue			2004			% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Interest and other income (expense), net	$	1,703		0.5	%	$	(34	)		—	%	$	1,737

Interest and other income (expense), on a net basis, was $1.7 million of net income for the three months ended August 31, 2005 compared to $34 thousand of net expense for the three months ended August 31, 2004. Interest and other income for the first quarter of fiscal year 2006 primarily consisted of approximately $2.9 million of interest income on our cash, cash equivalent and short-term investment balances, partially offset by $1.2 million of interest expense and bank and other charges. Interest and other expense for the first quarter of fiscal year 2005 primarily consisted of $0.9 million of interest expense and bank and other charges partially offset by approximately $0.9 million of interest income on our cash, cash equivalent and short-term investment balances. Interest income increased primarily as a result of increased cash, cash equivalents and short-term investments and increased interest rates during the three months ended August 31, 2005 as compared to the comparable period a year ago. Interest expense and bank and other charges increased primarily due to increased interest expense recognized as a result of the debt incurred in connection with the acquisition of the Palm brand.

Income Tax Provision


	Three Months Ended August 31,
	2005		% of Revenue			2004		% of Revenue			Increase/(Decrease)
	(dollars in thousands)
Income tax provision	$	1,836		0.5	%	$	3,453		1.3	%	$	(1,617	)

The income tax provision for the three months ended August 31, 2005 represented approximately 9% of pretax income, which includes foreign and state income taxes of approximately $1.4 million and acquisition accounting adjustments to goodwill of approximately $0.4 million. The acquisition accounting adjustments to goodwill are related to the recognition of deferred tax assets, including net operating loss carryforwards, relating to Handspring that are projected to be realized in the current year to offset taxable income. The tax benefit associated with the utilization of these deferred tax assets is reflected as a goodwill reduction. We continue to maintain our valuation allowance which is reviewed quarterly and will be preserved until sufficient positive evidence exists to support the reversal of the valuation allowance based upon current and preceding years results of operations and anticipated profit levels in future years. We believe that if we continue to experience profitable results of operations, we may have enough evidence to reverse some or all of our valuation allowance during fiscal year 2006. The income tax provision for the three months ended August 31, 2004, which included foreign and state income taxes of approximately $1.1 million and acquisition accounting adjustments to goodwill of approximately $2.4 million, represented approximately 15% of pretax income.

Liquidity and Capital Resources

Cash and cash equivalents at August 31, 2005 were $147.6 million, compared to $128.2 million at May 31, 2005. The increase of $19.4 million in cash and cash equivalents was primarily attributable to net income of $18.2 million, non-cash charges of $6.2 million, changes in assets and liabilities of $24.0 million and proceeds of $7.2 million from employee stock plan activity. This was offset by $29.3 million in net purchases of short-term investments and cash used for the purchase of property and equipment of $6.9 million.

We anticipate our August 31, 2005 total cash, cash equivalents and short-term investments balance of $411.3 million will satisfy our operational cash flow requirements for at least the next twelve months. Based on our current forecast, we do not anticipate any short-term or long-term deficiencies.

Net accounts receivable were $128.5 million at August 31, 2005, a decrease of 11.7 million or 8% from $140.2 million at May 31, 2005. Days sales outstanding, or DSO, of receivables decreased to 34 days at August 31, 2005 from 38 days at May 31, 2005, primarily due to the linearity of our quarterly sales as compared to the sales at the end of the fourth quarter of fiscal year 2005.

Palm facilities are leased under operating leases that expire at various dates through January 2013.

In December 2001, Palm issued a subordinated convertible note in the principal amount of $50.0 million to Texas Instruments. In connection with the PalmSource distribution on October 28, 2003, the note was canceled and divided into two separate obligations, Palm retained $35.0 million and the remainder was assumed by PalmSource. The note was transferred from Texas Instruments to Metropolitan Life Insurance Company as of August 26, 2005 and retained the same terms. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into Palm common stock at an effective conversion price of $64.60 per share. Palm may force a conversion at any time, provided its common stock has traded above $99.48 per share for a defined period of time. In the event Palm distributes significant assets, Palm 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 May 2005, Palm acquired PalmSource’s 55 percent share of the Palm Trademark Holding Company resulting in full rights to the brand name Palm. The rights to the brand had been co-owned by the two companies since the October 2003 spin-off of PalmSource from Palm, Inc. Palm will pay $30.0 million in five installments due in May 2005, 2006, 2007 and 2008 and November 2008 and has granted PalmSource certain rights to Palm trademarks for PalmSource and its licensees for a four-year transition period. The remaining amount due to PalmSource was $22.5 million as of both August 31, 2005 and May 31, 2005.

Palm has an agreement with PalmSource that grants Palm certain licenses to develop, manufacture, test, maintain and support its products. This agreement was renewed in May 2005, providing for continued development and marketing of Palm products based on the PalmSource operating system through 2009. Under the agreement, Palm agreed to pay PalmSource license and royalty fees based upon net revenue of its products which incorporate PalmSource’s software, as well as a source code license and maintenance and support fees. The initial source code license fee was $6.0 million paid in three equal annual installments of $2.0 million each in June 2003, June 2004 and June 2005. The continuing source code license fee was reduced under the amended license agreement to $1.2 million and is payable in three equal annual installments of $0.4 million each in June 2006, June 2007 and June 2008. Annual maintenance and support fees are approximately $0.7 million per year. The renewed agreement includes a minimum annual royalty and license commitment of $41.0 million, $42.5 million, $35.0 million, $20.0 million and $10.0 million for the contract years ending December 3, 2005 through 2009, respectively.

In addition to the PalmSource agreement described above, Palm accrues for royalty obligations for its mobile communications and handheld devices based on either unit shipments or a percentage of applicable revenue for the net sales of products using certain software technologies. Palm recognizes royalty obligations as determinable in accordance with license agreement terms. Where agreements are not finalized, accrued royalty obligations represent management’s current best estimates using appropriate assumptions and projections based on negotiations with the third parties. Palm has accrued royalty obligations of $34.9 million and $32.0 million as of August 31, 2005 and May 31, 2005, respectively, which are reported in other accrued liabilities and includes $32.1 million and $29.7 million, respectively, of estimated royalties. The status of each negotiation differs, and the amounts accrued as the expected royalty obligations are not necessarily the same as the amounts requested by the licensors as of that date. When agreements are finalized, the estimates will be revised accordingly. While the amounts ultimately agreed upon may be more or less than the current accrual, management does not believe that finalization of the agreements would have had a material impact on the amounts reported for its financial position as of August 31, 2005 and May 31, 2005 or for the reported results for the three months then ended; however, the effect of finalization in the future may be significant in the interim period in which it is recorded.

Palm utilizes contract manufacturers to build its products. These contract manufacturers acquire components and build product based on demand forecast information supplied by Palm, which typically covers a rolling 12-month period. Consistent with industry practice, Palm acquires inventories through a combination of formal purchase orders, supplier contracts and open orders based on projected demand information. Such formal and informal purchase commitments typically cover Palm’s forecasted component and manufacturing requirements for periods ranging from 30 to 90 days. In certain instances, these agreements allow Palm the option to cancel, reschedule and adjust its requirements based on its business needs prior to firm orders being placed. Consequently, only a portion of Palm’s purchase commitments arising from these agreements may be non-cancelable and unconditional commitments. As of August 31, 2005, Palm’s commitments to third party manufacturers for inventory on-hand and component purchase commitments related to the manufacture of Palm products were approximately $146.3 million.

In August 2003, Palm entered into a two-year, $30.0 million revolving credit line with Silicon Valley Bank, or SVB, which was amended and restated to extend the term one more year, through September 30, 2005. The credit line is secured by assets of Palm, including but not limited to cash and cash equivalents, short-term investments, accounts receivable, inventory and property and equipment. The interest rate is equal to SVB’s prime rate (6.5% at August 31, 2005) or, at Palm’s election subject to specific requirements, equal to LIBOR plus 1.75% (5.47% at August 31, 2005). The interest rate may vary based on fluctuations in market rates. Palm is subject to a financial covenant requirement under the credit line agreement to maintain cash on deposit and short-term investments in the United States of not less than $100.0 million. As of August 31, 2005 Palm had used its credit line to support the issuance of letters of credit of $9.2 million. The Company is currently negotiating a new credit line and has made arrangements with SVB to cover its letters of credit in the interim.

We denominate our sales to certain European customers in the Euro, in Pounds Sterling, in Brazilian Real and in Swiss Francs. 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. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes.

Business Environment and Risk Factors

You should carefully consider the risks described below and the other information in this Form 10-Q. The business, results of operations or financial condition of Palm could be seriously harmed, and the trading price of Palm common stock may decline due to any of these risks.

Risks Related to Our Business

Our operating results are subject to fluctuations, and if we fail to meet the expectations of securities analysts or investors, our stock price may decrease significantly.

Our operating results are difficult to forecast. 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. Many factors may cause fluctuations in our operating results including, but not limited to, the following:

• changes in general economic conditions and specific market conditions;

• changes in consumer and enterprise spending levels;

• changes in consumer, enterprise and carrier preferences for our products and services;

• competition from other handheld or wireless communications devices or other devices with similar functionality;

• competition for consumer and enterprise spending on other products;

• seasonality of demand for our products and services;

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

• variations in product costs or the mix of products sold;

• quality issues with our products;

• changes in terms, pricing or promotional programs;

• loss or failure of key sales channel partners;

• failure by our third party manufacturers or suppliers to meet our quantity and quality requirements for products or product components on time;

• failure to add or replace third party manufacturers or suppliers in a timely manner;

• failure to achieve product cost and operating expense targets;

• excess inventory or insufficient inventory to meet demand; and

• litigation brought against us.

Any of the foregoing factors could have a material adverse effect on our business, results of operations and financial condition.

If we do not correctly forecast demand for our products, we could have costly excess production or inventories or we may not be able to secure sufficient or cost effective quantities of our products or production materials and our cost of revenues and financial condition 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 variations in economic conditions, changes in consumer and enterprise preferences, relatively short product life cycles, changes in competition, seasonality and reliance on key sales channel partners. It is particularly difficult to forecast demand by individual product. Significant unanticipated fluctuations in demand, the timing and disclosure of new product releases or the timing of key sales orders could result in costly excess production or inventories or the inability to secure sufficient, cost-effective quantities of our products or production materials. This could adversely impact our cost of revenues and financial condition.

The market for mobile communications and computing devices is volatile, and changing market conditions, or failure to adjust to changing market conditions, may adversely affect our revenues, results of operations and financial condition, particularly given our size, limited resources and lack of diversification.

We operate in the mobile communications and computing industry which includes both handheld and smartphone devices. Over the last few years, we have seen year-over-year declines in the volume of handheld devices while demand for smartphone devices has increased. Although we are the leading provider of handheld products and while we intend to maintain this leadership position, we are rebalancing investment towards smartphone products in response to forecasted market demand trends. We cannot assure you that declines in the volume of handheld device units will not continue or that the growth of smartphone devices will offset any decline in handheld device sales. If we are unable to adequately respond to changes in demand for handheld and smartphone devices, our revenues and results of operations could be adversely affected. In addition, as our products and product categories mature and face greater competition, we may experience pressure on our product pricing to preserve demand for our products, which would adversely affect our margins, results of operations and financial condition.

This reliance on the success of and trends in our industry is compounded by the size of our organization and our focus on mobile communications and computing devices. These factors also make us more dependent on investments of our limited resources. For example, we face many resource allocation decisions, such as where to focus our research and development, geographic sales and marketing and partnering efforts; which aspects of our business to outsource; which operating systems and email solutions to support; and the balance between our handheld and smartphone products. Our smartphone products-related revenue grew from approximately 47% of our total revenue during the first quarter of fiscal year 2005 to approximately 67% during the first quarter of fiscal year 2006, causing us to shift the focus of a large portion of our engineering resources towards the smartphone opportunity as well as hire and integrate new employees. Given the size and undiversified nature of our organization, any error in investment strategy could harm our business, results of operations and financial condition.

If we fail to develop and introduce new products and services successfully and in a cost effective and 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 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 quality, 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 we introduce new or enhanced products or integrate new technology into new or existing products, we face risks 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, and a potentially different sales and support environment. Premature announcements or leaks of new products, features or technologies may exacerbate some of these risks. 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, results of operations and financial condition.

We rely on third parties to design, manufacture, distribute, warehouse and support our handheld and smartphone devices, and our reputation, revenues and results of operations 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. These third party designers and manufacturers have access to our intellectual property which increases the risk of infringement or misappropriation of such intellectual property. In addition, these third parties may claim ownership in certain of the intellectual property developed for our products, which may limit our ability to have these products manufactured by others.

We outsource all of our manufacturing requirements to third party manufacturers at their international facilities, which are located primarily in China, Taiwan and Brazil. In general our products are manufactured by sole source providers. We depend on these third parties to produce a sufficient volume of our products in a timely fashion and at satisfactory quality levels. 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 and cost of revenues could suffer. Our reliance on third party manufacturers in foreign countries exposes us to risks that are not in our control, including outbreaks of disease (such as an outbreak of Severe Acute Respiratory Syndrome, or SARS, or bird flu in China), economic slowdowns, labor disruptions, trade restrictions and other events that could result in quarantines, shutdowns or closures of our third party manufacturers or their suppliers. The cost, quality and availability of third party manufacturing operations are essential to the successful production and sale of our handheld and smartphone devices. If our third party manufacturers fail to produce quality products on time and in sufficient quantities, our reputation, business and results of operations could suffer.

These manufacturers could refuse to continue to manufacture all or some of the units of our devices that we require or change the terms under which they manufacture our device products. If these manufacturers 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. If these manufacturers were to change the terms under which they manufacture for us, our manufacturing costs and cost of revenues could increase. While we may have contractual remedies under manufacturing agreements, our business and reputation could be harmed. In addition, our contractual relationships are principally with the manufacturers of our products, and not with component suppliers. In the absence of a contract with the manufacturer that requires it to obtain and pass through warranty and indemnity rights with respect to component suppliers, we may not have recourse to any third party in the event of a component failure.

We may choose from time to time to transition to or add new third party manufacturers. If we transition the manufacturing of any product to a new manufacturer, there is a risk of disruption in manufacturing and revenues and our results of operations could be adversely impacted. The learning curve and implementation associated with adding a new third party manufacturer may adversely impact revenues and our results of operations.

We rely on third party distribution and warehouse services providers to warehouse and distribute our products. Our contract warehouse facilities are physically separated from our contract manufacturing locations. This requires additional lead-time to deliver products to customers. If we are shipping products near the end of a fiscal quarter, this extra time could result in us not meeting anticipated shipment volumes for that quarter, which may negatively impact our revenues for that fiscal quarter.

As a result of economic conditions or other factors, our distribution and warehouse services providers may close or move their facilities with little notice to us, which could cause disruption in our ability to deliver products. With little or no notice, these distribution and warehouse services providers could refuse to continue to provide distribution and warehouse services for all or some of our devices or change the terms under which they provide such services. Any disruption of distribution and warehouse services could have a negative impact on our revenues and results of operations.

Changes in transportation schedules due to terrorist threats or attacks, military activity, labor disruptions, acts of nature or carrier financial difficulties could cause transportation delays and increase our costs for both receipt of inventory and shipment of products to our customers. If these types of disruptions occur, our results of operations could be adversely impacted.

We outsource most of the warranty support, product repair and technical support for our products to third party providers, which are located around the world. We depend on their expertise, and we rely on them to provide satisfactory levels of service. If our third party providers fail to provide consistent quality service in a timely manner and sustain customer satisfaction, our reputation and results of operations could suffer.

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

Our handheld and wireless communications devices are complex and must meet stringent user requirements. In addition, we warrant that our products will be free of defect for 90 to 365 days after the date of purchase, depending on the product. In Europe, we are required by law in some countries to provide a two-year warranty for certain defects. In addition, certain of our contracts with wireless carriers include epidemic failure clauses with low thresholds that we have in some instances exceeded. If invoked, these clauses may entitle the carrier to return or obtain credits for products and inventory, or to cancel outstanding purchase orders.

In addition, we must develop our hardware and software application products quickly to keep pace with the rapidly changing mobile communications and computing market, and we have a history of frequently introducing new products. Products as sophisticated as ours are likely to contain undetected errors or defects, especially when first introduced or when new models or versions are released. In general, our handheld and wireless communications 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, increased customer service and support costs and warranty claims and litigation which could harm our business, results of operations and financial condition.

If we are unable to compete effectively with existing or new competitors, we could experience price reductions, reduced demand for our products and services, reduced margins and loss of market share, and our business, results of operations and financial condition would be adversely affected.

The mobile communications and computing device market is highly competitive, and we expect increased competition in the future, particularly as companies from established industry segments, such as mobile handset, personal computer and consumer electronics, enter this market or increasingly expand and market their competitive product offerings or both.

Some of our competitors or potential competitors possess capabilities developed over years of serving customers in their respective markets that might enable them to compete more effectively than us in certain segments. In addition, many of our competitors have significantly greater engineering, manufacturing, sales, marketing and financial resources and capabilities than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements, including introducing a greater number and variety of products than we can. They may also devote greater resources to the development, promotion and sale of their products. They may have lower costs and be better able to withstand lower prices in order to gain market share at our expense. Finally, these competitors bring with them customer loyalties, which may limit our ability to compete despite superior product offerings.

Our devices compete with a variety of mobile devices. Our principal competitors include:

• personal computer companies, such as Acer, ASUSTek, BenQ, Dell, Hewlett-Packard, Medion and MiTac, and consumer electronics companies, such as Garmin, NEC and Yakumo, which also develop and sell handheld computing products, mobile managers and/or smartphone products running on the Palm OS and/or other operating systems, such as Microsoft’s Windows Mobile operating system, Linux or proprietary operating systems;

• mobile handset manufacturers, such as High Tech Computer (HTC), Kyocera, LG, Motorola, Nokia, Research in Motion, Samsung, Sanyo, Siemens and Sony-Ericsson, which also develop smartphones, other wireless products and/or mobile managers running on the Palm OS and/or other operating systems, such as Microsoft’s Windows Mobile operating system, Linux or proprietary operating systems; and

• a variety of early-stage technology companies.

Some of these competitors, such as HTC, produce smartphones as carrier-branded devices. As technology advances, we also expect to compete with mobile phones without branded operating systems that synchronize with personal computers, as well as ultramobile personal computers and laptop computers with VoIP, and WiFi phones with VoIP.

In addition, our devices compete for a share of disposable income and enterprise spending on consumer electronic, telecommunications and computing products such as MP3 players, Apple’s iPod, media/photo views, digital cameras, personal media players, handheld gaming devices, GPS devices and other such devices.

Some competitors sell or license server, desktop and/or laptop computing products, software and/or recurring services in addition to mobile communications and computing products and may choose to market their mobile communications and computing products at a discounted price or give them away for free with their other products or services, which could negatively affect our ability to compete.

A number of our competitors have longer and closer relationships with the senior management of enterprise customers who decide which products and technologies will be deployed in their enterprises. Many competitors have larger and more established sales forces calling upon 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 revenues.

Successful new product introductions or enhancements by our competitors could cause intense price competition or make our products obsolete. To remain 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, reduced demand for our products and services, increased expenses, reduced margins and loss of market share. Failure to compete successfully against current or future competitors could harm our business, results of operations and financial condition.

We are highly dependent on wireless carriers for the success of our wireless handheld and smartphone products.

The success of our wireless business strategy and our wireless communications products is highly dependent on our ability to establish new relationships and build on our existing relationships with domestic and international wireless carriers. We cannot assure you that we will be successful in establishing new relationships or advancing existing relationships with wireless carriers or that these wireless carriers will act in a manner that will promote the success of our wireless communications products. Factors that are largely within the control of wireless carriers, but which are important to the success of our wireless communications products, include:

• testing of our wireless communications products on wireless carriers’ networks;

• quality and coverage area of wireless voice and data services offered by the wireless carriers;

• the degree to which wireless carriers facilitate the introduction of and actively promote, distribute and resell our wireless communications products;

• the extent to which wireless carriers require specific hardware and software features on our wireless communications products to be used on their networks;

• timely build out of advanced wireless carrier networks such as Universal Mobile Telecommunications System, or UMTS, Enhanced Data GSM Evolution, or EDGE, and Evolution Data Optimized, or EVDO, which enhance the user experience for email and other services through higher speed and “always on” functionality;

• contractual terms and conditions imposed on us by wireless carriers that, in some circumstances, could limit our ability to make similar products available through competitive carriers in some market segments;

• wireless carriers’ pricing requirements and subsidy programs; and

• pricing and other terms and conditions of voice and data rate plans that the wireless carriers offer for use with our wireless communications products.

For example, flat data rate pricing plans offered by some wireless carriers may represent some risk to our relationship with such carriers. While flat data pricing helps customer adoption of the data services offered by carriers and therefore highlights the advantages of the data applications of our wireless communications products, such plans may not allow our smartphones to contribute as much average revenue per user, or ARPU, to wireless carriers as when they are priced by usage, and therefore reduces our differentiation from other, non-data devices in the view of the carriers. In addition, if wireless carriers charge higher rates than consumers are willing to pay, the acceptance of our wireless solutions could be less than anticipated and our revenues and results of operations could be adversely affected.

Wireless carriers have a lot of bargaining power as we enter into agreements with them. They may require contract terms that are difficult for us to satisfy and could result in higher costs to complete certification requirements and negatively impact our results of operations and financial condition. Wireless carriers also significantly affect our ability to develop and launch products for use on their wireless networks. If we fail to address the needs of wireless carriers, identify new product and service opportunities or modify or improve our wireless communications products in response to changes in technology, industry standards or wireless carrier requirements, our products could rapidly become less competitive or obsolete. If we fail to timely develop wireless communications products that meet carrier product planning cycles or fail to deliver sufficient quantities of products in a timely manner to wireless carriers, those carriers may choose to emphasize similar products from our competitors and thereby reduce their focus on our products which would have a negative impact on our business, results of operations and financial condition.

As we build strategic relationships with wireless carriers, we could be exposed to significant fluctuations in revenue for our wireless communications products.

Because of their large sales channels, wireless carriers may purchase large quantities of our products prior to launch so that the products are widely available. Reorders of products may fluctuate quarter to quarter, depending upon end-customer demand and inventory levels required by the carriers. As we develop new strategic relationships and launch new products with wireless carriers, our wireless communications products-related revenue could be subject to significant fluctuation based upon the timing of carrier product launches, carrier inventory requirements and our ability to forecast and satisfy carrier and end-customer demand.

The amount of future wireless carrier subsidies is uncertain, and wireless carriers are free to reduce or eliminate their subsidies with little notice to us, which could negatively impact our revenue and results of operations.

When we sell our wireless products on our own website, we sometimes have the opportunity to earn end-customer acquisition subsidies from wireless carriers if the end-customer also purchases a voice or data plan from the wireless carrier. Today the wireless industry is generally decreasing subsidies on voice services. Moreover, the wireless carriers that currently provide Palm with subsidies may reduce or discontinue these subsidies with little notice. While we believe wireless carriers will continue to offer subsidies to Palm, if these subsidies were reduced or eliminated, the gross margins for the affected products sold through our web site would decline and we would be more limited in our ability to price our products competitively to cost sensitive consumers.

If carriers move away from subsidizing the purchase of wireless devices, this could significantly reduce the sales or growth rate of sales of wireless devices. This could have an adverse impact on our business, revenues and results of operations.

If our wireless products do not meet wireless carrier and governmental or regulatory certification requirements, we will not be able to compete effectively and our ability to generate revenues will suffer.

We are required to certify our wireless products with governmental and regulatory agencies and with the wireless carriers for use on their networks. The certification process can be time consuming, could delay the offering of our wireless device products on carrier networks and affect our ability to timely deliver products to customers. As a result, carriers may choose to offer, or consumers may choose to buy, similar products from our competitors and thereby reduce their focus on our products, which would have a negative impact on our wireless communications products sales volumes, our revenues and our cost of revenues.

We rely on third parties to sell and distribute our products, and we rely on their information to manage our business. Disruption of our relationship with these channel partners, changes in their business practices, their failure to provide timely and accurate information or conflicts among our channels of distribution could adversely affect our business, results of operations and financial condition.

The wireless carriers, distributors, retailers and resellers who sell and distribute our products also sell products offered by our competitors. If our competitors offer our sales channel partners more favorable terms or have more products available to meet their needs or utilize the leverage of broader product lines sold through the channel, those wireless carriers, distributors, retailers and resellers may de-emphasize or decline to carry our products. In addition, certain of our sales channel partners could decide to de-emphasize the product categories that we offer in exchange for other product categories that they believe provide higher returns. If we are unable to maintain successful relationships with these sales channel partners or to expand our distribution channels, our business will suffer.

Because we sell our products primarily to wireless carriers, 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, these sales channel partners could modify their business practices, such as inventory levels, or seek to modify their contractual terms, such as return rights or payment terms. Unexpected changes in product return requests, inventory levels, payment terms or other practices by these sales channel partners could negatively impact our business, results of operations and financial condition.

We rely on wireless carriers, distributors, retailers and resellers to provide us with timely and accurate information about their sales and inventory levels of products purchased from us. We use this information as one of the factors in our forecasting process to plan future production and sales levels, which in turn influences our public financial forecasts. We also use this information as a factor in determining the levels of some of our financial reserves. If we do not receive this information on a timely and accurate basis, our results of operations and financial condition may be adversely impacted.

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

We are dependent on a concentrated number of significant customers, and the loss or credit failure of any of those customers could have an adverse affect on our business, results of operation and financial condition.

Our three largest customers of the first quarter of fiscal year 2006 accounted for 54% of our revenues during the period compared 32% for our largest customers during the fourth quarter of fiscal year 2005. We expect this trend of increased revenue concentration with our largest customers, particularly with wireless carriers, to continue. If any significant customer discontinues its relationship with us for any reason, or reduces or postpones current or expected purchases from us, it could have an adverse impact on our business, results of operation and financial condition.

In addition, our three largest customers during the three months ended August 31, 2005 accounted for 46% of our accounts receivable as of August 31, 2005 and the two largest customers accounted for 24% of our accounts receivable at the end of fiscal year 2005. We expect this trend of increased credit concentration with our largest customers, particularly with wireless carriers, to continue, increasing our bad debt risks and the costs of mitigating those risks. We routinely monitor the financial condition of our customers and review the credit history of each new customer. While we believe that our allowances for doubtful accounts adequately reflect the credit risk of our customers, as well as historical trends and other economic factors, we cannot assure you that such allowances will be accurate or sufficient. If any of our significant customers defaults on its account, or if we experience significant credit expense for any reason, it could have an adverse impact on our business, results of operation and financial condition.

We rely on third parties to manage and operate our e-commerce web store and related telesales call center, and disruption to this sales channel could adversely affect our revenues and results of operations.

We outsource the operations of our e-commerce web store and related telesales call centers to third parties. We depend on their expertise and rely on them to provide satisfactory levels of service. If these third party providers fail to provide consistent quality service in a timely manner and sustain customer satisfaction, our e-commerce web store and revenues could suffer. If these third parties were to stop providing these services, we may be unable to replace them on a timely basis and our e-commerce web store and results of operations could be harmed. In addition, if these third parties were to change the terms and conditions under which they provide these services, our selling costs could increase.

We depend on our suppliers, some of which are the sole source for certain components and elements of our technology and some of which are competitors, and our production or reputation could be harmed if these suppliers were unable or unwilling to meet our demand or technical requirements on a timely and/or a cost effective basis.

Our handheld and wireless communications products contain components, including liquid crystal displays, touch panels, memory chips, microprocessors, cameras, radios and batteries, which 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 screens and related integrated circuits, digital signal processors, microprocessors, radio frequency components and other discrete components, come from sole source suppliers. Alternative sources are not always available or may be prohibitively expensive. In addition, even when we have multiple qualified suppliers, we may compete with other purchasers for allocation of scarce components. Some components come from companies with whom we compete in the mobile communications and computing industry. If suppliers are unable or unwilling to meet our demand for components and if we are unable to obtain alternative sources or if the price for alternative sources is prohibitive, our ability to maintain timely and cost-effective production of our handheld and wireless communications device products will be harmed. For example, through the fourth quarter of fiscal year 2004, we experienced a critical shortage of screens and related integrated circuits. Shortages affect the timing and volume of production for some of our products as well as increasing our costs due to premium prices paid for those components. Some of our suppliers may be capacity-constrained due to high industry demand for some components and relatively long lead times to expand capacity.

Our product strategy is substantially dependent on the Palm OS, which is owned by PalmSource, a former subsidiary of Palm that recently announced it is being acquired by Access Co. We have also recently announced a product which utilizes the Microsoft OS, which could affect our relationship with PalmSource or its acquirer or successor.

We have a license agreement with PalmSource which extends through December 2009. Our license of the Palm OS from PalmSource is critical to the operation of many of our products, including all of our existing products. While we have announced a product which utilizes the Microsoft operating system, we currently rely exclusively on PalmSource to provide the operating system for all of our handheld and wireless communications device products, and we cannot predict how well the market will receive products based on the Microsoft or any other operating system. In addition, PalmSource has recently announced that it will be acquired by Access Co., likely bringing the Palm OS under new management and control.

Termination of the Palm OS license, an adverse change in our relationship with PalmSource or its acquirer or successor, failure by PalmSource or its acquirer or successor to supply a competitive platform, retain employees or otherwise remain viable, or an unfavorable outcome in any material lawsuit involving the Palm OS, could harm our business. Additionally, we are contractually obligated to make minimum annual payments to PalmSource, or its acquirer or successor, regardless of the volume of devices we sell containing the Palm OS. Our business could be harmed if:

	•		we were to breach the license agreement and PalmSource, or its acquirer or successor, terminated the license;

	•		PalmSource, or its acquirer or successor, does not continuously upgrade the Palm OS and otherwise maintain the competitiveness of the Palm OS platform;

	•		our Palm OS-based devices drop in volume, yet we still owe PalmSource, or its acquirer or successor, minimum royalties; or

	•		our announcement of a product on the Microsoft operating system, or our development of other devices on the Microsoft or any other operating system, impacts our volumes of Palm OS-based devices or impacts the perception of the Palm OS’s viability in the market, which could cause a deterioration of our volume of Palm OS-based devices.

While we have an existing relationship with Access as a supplier of the web browser in many of our products, we do not yet know the direction in which Access will take the Palm OS or whether that direction will be compatible with our plans and needs. Furthermore, the acquisition of PalmSource was initially contested by other suitors, and we cannot be certain that Access, regardless of its intentions, will be the eventual acquirer or that the Palm OS or other PalmSource intellectual property important to our business will not eventually fall to an acquirer less strategically aligned with us than PalmSource has been. While our license and other agreements with PalmSource include certain protections for us if PalmSource or its acquirer or successor is acquired, these protections may not be adequate to fully protect our interests, which may reduce our ability to compete in the marketplace and cause us to incur significant costs.

Other than the restrictions on the use of certain trademarks and domain names, nothing prohibits PalmSource, or its acquirer or successor, from competing with Palm or offering the PalmSource operating system to competitors of Palm. Palm and PalmSource, or its acquirer or successor, may not be able to resolve any potential conflicts that may arise between us, which may damage our relationship with PalmSource or its acquirer or successor.

Palm is a defendant in at least one intellectual property lawsuit involving the Palm OS. Although PalmSource generally indemnifies us for damages arising from such lawsuits, other than with respect to the litigation with Xerox, and from damages relating to intellectual property infringement by the Palm OS that occurred prior to the spin-off of PalmSource from Palm, we could still be adversely affected by a determination adverse to PalmSource, or its successor, as a result of market uncertainty, or product changes that may be advisable or required due to such lawsuits, or the failure of PalmSource or its acquirer or successor to adequately indemnify us.

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

We license third-party software and hardware for use in our handheld and smartphone products, including the Palm OS and third-party software embedded in the Palm OS. Our ability to release and sell our products, as well as our reputation, could be harmed if the third-party technology is not delivered to us in a timely manner, on acceptable business terms or contains errors or defects that are not discovered and fixed prior to release of our products and we are unable to obtain alternative technology on a timely and cost effective basis to use in our products. As a result, our product shipments could be delayed, our offering of features could be reduced or we may need to divert our development resources from other business objectives, any of which could adversely affect our reputation, business and results of operations.

Our success largely depends on our ability to hire, retain, integrate and motivate sufficient numbers of qualified personnel, including senior management. Our strategy and our ability to innovate, design and produce new products, sell products, maintain operating margins and control expenses depend on key personnel that may be difficult to replace.

Our success depends on our ability to attract and retain highly skilled personnel, including senior management. Over the past twelve months, we have experienced turnover in some of our senior management positions. We filled some of these positions and are actively recruiting to fill the remainder. We compensate our employees through a combination of salary, bonuses, benefits and equity compensation. Recruiting and retaining skilled personnel, including software and hardware engineers, is highly competitive, particularly in the San Francisco Bay Area where we are headquartered. If we fail to provide competitive compensation to our employees, it will be difficult to retain, hire and integrate qualified employees and contractors and we may not be able to maintain and expand our business. If we do not retain our senior managers or other key employees for any reason, we risk losing institutional knowledge and experience, expertise and other benefits of continuity. In addition, we must carefully balance the growth of our employee base with our current infrastructure, management resources and anticipated revenue growth. For example, we have recently moved into, invested in and committed ourselves to a six-year headquarters lease, but that space may not be adequate for our needs over the full term of the lease. If we are unable to manage the growth of our employee base, particularly software and hardware engineers, we may fail to develop and introduce new products successfully and in a cost effective and timely manner. If our revenue growth or employee levels vary significantly, our results of operations and financial condition could be adversely affected. 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 or other equity incentives, or both.

Palm’s practice has been to provide incentives to all of its employees through the use of broad based stock option plans, but the number of shares available for new option grants is limited and new accounting rules from the Financial Accounting Standards Board and other agencies concerning the expensing of stock options, which will require us and other companies to record substantial charges to earnings, may cause us to re-evaluate our use of stock options as an employee incentive. Therefore, we may find it difficult to provide competitive stock option grants or other equity incentives and our ability to hire, retain and motivate key personnel may suffer.

In past 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 or areas of focus and we have seen some turnover in our workforce. These reductions have resulted in reallocations of duties, which could result in employee and contractor uncertainty. Reductions in our workforce could make it difficult to attract, motivate and retain 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 upon 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. For example, as our focus has shifted to wireless communication devices, we have received, and expect to continue to receive communications from holders of patents related to GSM, GPRS, CDMA and other mobile communication standards. We evaluate the validity and applicability of these intellectual property rights, and determine in each case whether we must negotiate licenses to incorporate or use the proprietary technologies in our products. Third parties may claim that our customers or we 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 may be required to pay significant damages and obligated either to refrain from the further sale of our products, or to license the right to sell our products on an ongoing basis. 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 litigation generally increase the risks associated with intellectual property litigation. Moreover, patent litigation has increased due to the increased numbers of cases asserted by intellectual property licensing entities as well as increasing competition and overlap of product functionality in our markets. Claims of intellectual property infringement may also require us to enter into costly royalty or license agreements or to indemnify our customers. 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 the development and sale of our products.

If we are unsuccessful in our litigation with Xerox, our results of operations and financial condition could be harmed.

We are engaged in a civil action brought by Xerox Corporation in 1997 in New York federal district court alleging willful infringement of a Xerox patent by the Graffiti handwriting recognition system employed in handheld devices operating the Palm OS, as described in Note 15 to the condensed consolidated financial statements in this quarterly report. We cannot assure you that Palm will prevail against this claim and we may be required to pay Xerox significant damages or license fees and pay significant amounts with respect to Palm OS licensees for their losses. We are also contractually obligated to indemnify PalmSource for the amount of any damages awarded in, or agreed to in settlement of this litigation or for any claims brought against PalmSource by its licensees as a result of this alleged infringement. It may also result in other indirect costs and expenses, such as significant diversion of management resources, loss of reputation and goodwill, damage to our customer relationships and declines in our stock price. In addition, Xerox, unsuccessfully sought, but might again seek, an injunction preventing us or Palm OS licensees from offering products with Palm OS which include Graffiti handwriting recognition software, even though we have largely transitioned our products to a handwriting recognition software that does not use Graffiti as well as to physical keyboards. Accordingly, if Xerox is successful, our results of operations and financial condition could be harmed.

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 damage awards or other remedies.

In the course of our business, we receive consumer protection claims, general commercial claims related to the conduct of our business and the performance of our products and services, employment claims and other litigation claims. Any litigation resulting from these claims could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of consumer, commercial, employment 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.

Our products are subject to increasingly stringent laws, standards and other regulatory requirements, and the costs of compliance or failure to comply may adversely impact our business, results of operations and financial condition.

Our products must comply with a variety of laws, standards and other requirements governing, among other things, safety, materials usage, packaging and environmental impacts and must obtain regulatory approvals and satisfy other regulatory concerns in the various jurisdictions where our products are sold. Many of our products must meet standards governing, among other things, interference with other electronic equipment and human exposure to electromagnetic radiation. Failure to comply with such requirements can subject us to liability, additional costs and reputational harm and in severe cases prevent us from selling our products in certain jurisdictions.

For example, many of our products are subject to laws and regulations that restrict the use of lead and other substances and require producers of electrical and electronic equipment to assume responsibility for collecting, treating, recycling and disposing of our products when they have reached the end of their useful life. In Europe, substance restrictions will apply to the products we sell beginning July 1, 2006, and new recycling, labeling, financing and related requirements came into effect with respect to certain of our products in August 2005. Failure to comply with applicable environmental requirements can result in fines, civil or criminal sanctions and third-party claims. If products we sell in Europe after July 1, 2006 are found to contain more than the permitted percentage of lead or another listed substance, it is possible that we could be forced to recall the products, which could lead to substantial replacement costs, contract damage claims from customers, and reputational harm. We are now and expect in the future to become subject to similar requirements in the United States, China and other parts of the world.

As a result of these new European requirements and anticipated developments elsewhere, we are now facing increasingly complex procurement and design challenges, which, among other things, require us to incur additional costs identifying suppliers and contract manufacturers who can provide compliant materials, parts and end products and re-designing products so that they comply with these and the many other requirements applicable to them.

Allegations of health risks associated with electromagnetic fields and wireless communications devices, and the lawsuits and publicity relating to them, regardless of merit, could adversely impact our business, results of operations and financial condition.

There has been public speculation about possible health risks to individuals from exposure to electromagnetic fields, or radio signals, from base stations and from the use of mobile devices. While a substantial amount of scientific research by various independent research bodies has indicated that these radio signals, at levels within the limits prescribed by public health authority standards and recommendations, present no evidence of adverse effect to human health, we cannot assure you that future studies, regardless of their scientific basis, will not suggest a link between electromagnetic fields and adverse health effects. Government agencies, international health organizations and other scientific bodies are currently conducting research into these issues. In addition, other mobile device companies have been named in individual plaintiff and class action lawsuits alleging that radio emissions from mobile phones have caused or contributed to brain tumors and the use of mobile phones pose a health risk. Although our products are certified as meeting applicable public health authority safety standards and recommendations, even a perceived risk of adverse health effects from wireless communications devices could adversely impact use of wireless communications devices and our reputation, business, results of operations and financial condition.

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 and other intellectual property rights. We recently made a significant investment in acquiring the rights to the Palm and related trademarks and will continue to invest in that brand and in our patent portfolio.

We rely on a combination of patents, copyrights, trademarks and trade secrets, confidentiality provisions and licensing arrangements to establish and protect our proprietary rights. Our intellectual property, particularly our patents, may not provide us a significant competitive advantage. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.

Our pending patent and trademark applications for registration may not be allowed, or others may challenge the validity or scope of our patents or trademarks, including patent or trademark applications or registrations. Even if our patents or trademark registrations are issued and maintained, these patents or trademarks may not be of adequate scope or benefit to us or may be held invalid and unenforceable against third parties.

We may be required to spend significant resources to monitor and police our intellectual property rights. Effective policing of the unauthorized use of our products or intellectual property is difficult and litigation may be necessary in the future to enforce our intellectual property rights. Intellectual property litigation is not only expensive, but time-consuming, regardless of the merits of any claim, and could divert attention of our management from operating the business. Despite our efforts, 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 leaks of proprietary information associated with our intellectual property. We have implemented a security plan to reduce the risk of future leaks of proprietary information. We may not be successful in preventing those responsible for past leaks of proprietary information from using our technology to produce competing products or in preventing future leaks of proprietary information.

Despite our efforts to protect our proprietary rights, existing laws, contractual provisions and remedies afford only limited protection. Intellectual property lawsuits are subject to inherent uncertainties due to, among other things, the complexity of the technical issues involved, and we cannot assure you that we will be successful in asserting intellectual property claims. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we cannot assure you that we will be able to protect our proprietary rights against unauthorized third party copying or use. The unauthorized use of our technology or of our proprietary information by competitors could have an adverse effect on our ability to sell our products.

We have an international presence in countries whose laws may not provide protection of our intellectual property rights to the same extent as the laws of the United States, which may make it more difficult for us to protect our intellectual property.

As part of our business strategy, we target countries with large populations and propensities for adopting new technologies. However, many of these targeted countries do not address misappropriation of intellectual property or deter others from developing similar, competing technologies or intellectual property. Effective protection of patents, copyrights, trademarks, trade secrets and other intellectual property may be unavailable or limited in some foreign countries. In particular, the laws of some foreign countries in which we do business may not protect our intellectual property rights to the same extent as the laws of the United States. As a result, we may not be able to effectively prevent competitors in these regions from infringing our intellectual property rights, which would reduce our competitive advantage and ability to compete in those regions and negatively impact our business.

Our ability to utilize our net operating losses may be limited if we engage in transactions which bring cumulative change in ownership for Palm to 50% or more.

As a result of the acquisition of Handspring, we experienced a change in our ownership of approximately 30%. If over a rolling three-year period, the cumulative change in our ownership exceeds 50%, our ability to utilize our net operating losses to offset future taxable income may be limited. This would limit the net operating loss available to offset taxable income each year following the cumulative change in our ownership over 50%. In the event the usage of these net operating losses is subject to limitation and we are profitable, our earnings and cash flows could be adversely impacted due to our increased tax liability.

Recently enacted and proposed changes in securities laws and regulations have increased and will continue to increase our costs.

The Sarbanes-Oxley Act of 2002 along with other recent and proposed rules from the SEC and Nasdaq have required changes in our corporate governance, public disclosure and compliance practices. Many of these new requirements increase our legal and financial compliance costs, and make some corporate actions more difficult, such as proposing new or amendments to stock option plans, which now require stockholder approval. For example, compliance with Section 404 of the Sarbanes-Oxley Act requires the commitment of significant resources to document and review internal controls over financial reporting.

In addition, these developments could make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments also could make it more difficult for us to attract and retain qualified executive officers and qualified members of our Board of Directors, particularly to serve on our audit committee.

Changes in financial accounting standards or practices may cause unexpected fluctuations in and adversely affect our reported results of operations.

Any change in financial accounting standards or practices that cause us to change the methodology or procedures by which we track, calculate, record and report our results of operations or financial condition or both could cause fluctuations in and adversely affect our reported results of operations and cause our historical financial information to not be reliable as an indicator of future results. For example, in December 2004, the FASB issued SFAS No. 123(R), which requires companies to apply a fair-value-based measurement method in accounting for shared-based payment transactions with employees and to record compensation cost for all stock awards granted after the required effective date and to awards modified, repurchased, or cancelled after that date. In addition, the Company is required to record compensation expense (as previous awards continue to vest) for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS 123(R) will be effective for fiscal years beginning after June 15, 2005, which is Palm’s fiscal year 2007. The adoption of SFAS 123(R) is expected to have a material impact on our results of operations. If investors attempt to compare our results with the results of other companies, our company and valuation may appear less attractive, which could adversely affect the market price of our common stock.

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

We have made acquisitions in the past and will continue to evaluate other acquisition opportunities that could provide us with additional product or service offerings or with additional industry expertise, assets and capabilities. Acquisitions could result in difficulties integrating acquired operations and products, technology, internal controls, personnel and management teams and result in the diversion of capital and management’s attention away from other business issues and opportunities. If we fail to successfully integrate acquisitions, including timely integration of internal controls to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, our business could be harmed. In addition, our acquisitions may not be successful in achieving our desired strategic objectives, which would also cause our business to suffer. Acquisitions can also lead to large non-cash charges that can have an adverse effect on our results of operations as a result of write-offs for items such as acquired in-process research and development, impairment of goodwill or the recording of deferred stock-based compensation. 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 condition.

We may need or find it advisable to seek additional funding which may not be available or which may result in substantial dilution of the value of our common stock.

We currently 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 could be required to seek additional funding if our expectations are not met.

Even if our expectations are met, we may find it advisable to seek additional funding. If we seek additional funding, adequate funds may not be available on favorable terms, or at all. If adequate funds are not available on acceptable terms, or at all, we may be unable to adequately fund our business plans and it could have a negative effect on our business, results of operations and financial condition. In addition, if funds are available, the issuance of equity securities or securities convertible into equity could dilute the value of shares of our common stock and cause the market price to fall and the issuance of debt securities could impose restrictive covenants that could impair our ability to engage in certain business transactions.

Our historical financial information may not be reliable as an indicator of future results due to the spin-off of PalmSource and the acquisition of Handspring. In addition, charges to earnings resulting from the application of the purchase method of accounting may adversely affect our results of operations.

The historical financial information for Palm, which includes results of the PalmSource business as discontinued operations, does not necessarily reflect what Palm’s financial condition, results of operations and cash flows would have been had the PalmSource business not been a part of Palm during historical periods.

In accordance with United States generally accepted accounting principles, we accounted for the acquisition of Handspring using the purchase method of accounting. Under the purchase method of accounting, we allocated the total purchase price to Handspring’s net tangible assets and amortizable intangible assets, based on their fair values as of the effective date of the acquisition of Handspring, and recorded the excess of the purchase price over those fair values as goodwill. We will incur depreciation and amortization expense over the useful lives of certain of the net tangible and intangible assets acquired in connection with the acquisition of Handspring which will have an adverse effect on our results of operations. In addition, to the extent the value of goodwill becomes impaired, we may be required to incur material charges relating to the impairment of those assets that may adversely affect our results of operations.

We own land that is not currently being utilized in our business. If our expected ability to ultimately recover the carrying value of this land is impaired, we would incur a non-cash charge against our results of operations.

We own approximately 39 acres of land in San Jose, California which we do 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. We are actively marketing this land for sale, and a future sale or other disposition of the land at less than its carrying value, or a further deterioration in market values that impacts our expected recoverable value, would result in a non-cash charge which would negatively impact our results of operations.

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, distributed and supported 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;

• changes in tax laws;

• compliance with a wide variety of laws and regulations which may have civil and/or criminal consequences for us and our officers and directors who we indemnify;

• difficulty in managing widespread sales operations; and

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

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.

While we sell our products worldwide, one component of our strategy is to expand our sales efforts in China, India and other countries with large populations and propensities for adopting new technologies. We have limited experience with sales and marketing in some of these countries. There can be no assurance that we will be able to market and sell our products in all of our targeted international markets. If our international efforts are not successful, our business growth and results of operations could be harmed.

We use third parties to provide significant operational and administrative services, and our ability to satisfy our customers and operate our business will suffer if the level of services is interrupted or does not meet our requirements.

We use third parties to provide services such as data center operations, desktop computer support and facilities services. Should any of these third parties fail to deliver an adequate level of service on a timely basis, our business could suffer. Some of our operations rely upon electronic data systems interfaces with third parties or upon the Internet to communicate information. Interruptions in the availability and functionality of systems interfaces or the Internet could adversely impact the operations of these systems and consequently 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, hurricanes, earthquake, power loss, telecommunications failure, computer viruses, computer hackers, terrorist attacks, wars, health epidemics and other natural disasters and events beyond our control. For example, a significant part of our third-party manufacturing is based in Taiwan that has experienced earthquakes and is considered seismically active. 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 an adverse effect on our business.

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

Wars, terrorist attacks or other threats beyond our control could have an adverse impact on the United States and world economy in general, and consumer confidence and spending in particular, which could harm our business, results of operations and financial condition.

PalmSource may be required to indemnify us for tax liabilities we may incur in connection with the distribution of PalmSource common stock to our stockholders, and we may be required to indemnify PalmSource for specified taxes.

We received a private letter ruling from the Internal Revenue Service, or IRS, to the effect that the distribution of the shares of PalmSource common stock held by us to our stockholders would not be taxable to our U.S. stockholders or us. This ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. Although some facts have changed since the issuance of the ruling, in the opinion of our tax counsel, these changes will not adversely affect us. We are not aware of any material change in the facts and circumstances of the distribution that would call into question the validity of the ruling. Notwithstanding the receipt of the ruling described above, the distribution may nonetheless be taxable to us under Section 355(e) of the Internal Revenue Code of 1986, as amended, if 50% or more of our stock or PalmSource stock is acquired as part of a plan or series of related transactions that include the PalmSource distribution.

Under the tax sharing agreement between PalmSource and us, PalmSource would be required to indemnify us if the sale of PalmSource’s common stock caused the distribution of PalmSource’s common stock to be taxable to us. In addition, under the tax sharing agreement, Palm has agreed to indemnify PalmSource for certain taxes and similar obligations that PalmSource could incur under certain circumstances. PalmSource may not be able to adequately satisfy its indemnification obligation under the tax sharing agreement. Finally, although under the tax sharing agreement PalmSource is required to indemnify us for taxes of PalmSource, we may be held jointly and severally liable for taxes determined on a consolidated basis.

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, our customers, our suppliers or our competitors, such as new product announcements, acquisitions or restructurings;

• actions by institutional stockholders or financial analysts;

• 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 outstanding 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 of the rights 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 Sensitivity

We currently maintain an investment portfolio consisting mainly of cash equivalents and short-term investments. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase. The objectives of our investment activities are to maintain the safety of principal, assure sufficient liquidity and achieve appropriate returns. This is accomplished by investing in marketable investment grade securities and by limiting exposure to any one issuance or issuer. We do not use derivative financial investments in our investment portfolio. Our cash equivalents are primarily money market funds and an immediate and uniform increase in market interest rates of 100 basis points from levels at August 31, 2005 would cause an immaterial decline in the fair value of our cash equivalents. As of August 31, 2005, we had short-term investments of $263.7 million. Our investment portfolio primarily consists of highly liquid investments with original maturities at the date of purchase of greater than three months, and of marketable equity securities. These available-for-sale investments, consisting primarily of auction-rate securities, including government, domestic and foreign corporate debt securities and marketable equity securities, are subject to interest rate and interest income risk and will decrease in value if market interest rates increase. An immediate and uniform increase in market interest rates of 100 basis points from levels at August 31, 2005 would cause a decline of less than 1% in the fair market value of our short-term investment portfolio. We would expect our operating results or cash flows to be similarly affected by such a change in market interest rates.

Foreign Currency Exchange Risk

We denominate our sales to certain European customers in the Euro, in Pounds Sterling, in Brazilian Real and in Swiss Francs. Expenses and other transactions are also incurred 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. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes. Movements in currency exchange rates could cause variability in our revenues, expenses or interest and other income (expense).

Equity Price Risk

As of August 31, 2005 we do not own any material equity investments. Therefore, we do not currently have any material direct equity price risk.

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report were effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the first quarter of fiscal year 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The information set forth in Note 15 of the condensed consolidated financial statements of this Form 10-Q is incorporated herein by reference.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table summarizes employee stock repurchase activity for the three months ended August 31, 2005:


	Total Number		Average Price
	of Shares		Paid Per
	Purchased		Share
June 1, 2005—June 30, 2005		—	$	—
July 1, 2005—July 31, 2005		4,468		29.10
August 1, 2005—August 31, 2005		1,377		31.37

		5,845	$	29.63

The total number of shares repurchased include those shares of Palm common stock that employees deliver back to the Company to satisfy tax-withholding obligations at the settlement of restricted stock exercises and the forfeiture of restricted shares upon the termination of an employee. As of August 31, 2005 a total of approximately 100,000 shares may still be repurchased. Palm does not have a publicly announced plan to repurchase any of its shares of common stock.

Item 6. Exhibits


		Incorporated by Reference
Exhibit							Filed
Number	Exhibit Description	Form	File No.	Exhibit		Filing Date	Herewith
2.1	Master Separation and Distribution Agreement between 3Com and the registrant effective as of December 13, 1999, as amended.	S-1/A	333-92657		2.1	1/28/00

2.2	Tax Sharing Agreement between 3Com and the registrant.	10-Q	000-29597		2.7	4/10/00

2.3	Indemnification and Insurance Matters Agreement between 3Com and the registrant.	10-Q	000-29597		2.11	4/10/00

2.4	Form of Non-U.S. Plan.	S-1	333-92657		2.12	12/13/99

2.5	Agreement and Plan of Reorganization between the registrant, Peace Separation Corporation, Harmony Acquisition Corporation and Hand- spring, Inc., dated June 4, 2003.	8-K	000-29597		2.1	6/6/03

2.6	Amended and Restated Master Separation Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.14	8/18/03

2.7	Amended and Restated Indemnification and Insurance Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.17	8/18/03

2.8	Amended and Restated Tax Sharing Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.23	8/18/03

2.9	Master Patent Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.30	8/18/03

2.10	Xerox Litigation Agreement between the registrant and PalmSource, Inc., as amended.	10-K/A	000-29597		2.34	9/26/03

3.1	Amended and Restated Certificate of Incorporation.	10-Q	000-29597		3.1	10/11/02

3.2	Amended and Restated Bylaws.	8-K	000-29597		3.2	10/5/05

4.1	Reference is made to Exhibits 3.1 and 3.2 hereof.	N/A	N/A		N/A	N/A	N/A

4.2	Specimen Stock Certificate.	10-K	000-29597		4.2	7/29/05

4.3	Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank), as amended.	8-K	000-29597		4.1	11/22/00

4.4	5% Convertible Subordinated Note, dated as of November 4, 2003.	10-Q	000-29597		4.4	4/6/04

4.5	Amendment to Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A.	8-A/A	000-29597		4.2	11/18/04

4.6	Certificate of Ownership and Merger Merging Palm, Inc. into palmOne, Inc.	10-K	000-29597		4.6	7/29/05

10.1	Amended and Restated 1999 Stock Plan.	10-K	000-29597		10.1	7/29/05


		Incorporated by Reference
Exhibit							Filed
Number	Exhibit Description	Form	File No.	Exhibit		Filing Date	Herewith

10.2	Form of 1999 Stock Plan Agreements.	S-1/A	333-92657		10.2	1/28/00

10.3	Amended and Restated 1999 Employee Stock Purchase Plan.	S-8	000-29597		10.2	11/18/04

10.4	Form of 1999 Employee Stock Purchase Plan Agreements.	S-1/A	333-92657		10.4	1/28/00

10.5	Amended and Restated 1999 Director Option Plan.	S-8	333-47126		10.5	10/2/00

10.6	Form of 1999 Director Option Plan Agreements.	S-1/A	333-92657		10.6	1/28/00

10.7	Form of Indemnification Agreement entered into by the registrant with each of its directors and executive officers.	S-1/A	333-92657		10.8	1/28/00

10.8**	RAM Mobile Data USA Limited Partnership Value Added Reseller Agreement between RAM Mobile Data USA Limited Partnership (now Cingular Wireless) and the registrant.	S-1/A	333-92657		10.9	2/25/00

10.9	Form of Management Retention Agreement.	S-1/A	333-92657		10.14	2/28/00

10.10	Amendment Number One to Value Added Re- seller 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-Q/A	000-29597		10.37	2/26/02

10.11**	Sublease Agreement by and between Cisco Systems Inc. and the registrant.	10-K	000-29597		10.38	7/30/02

10.12	Management Retention Agreement by and between the registrant and R. Todd Bradley dated as of September 17, 2002.	10-Q	000-29597		10.43	10/11/02

10.13	Form of Severance Agreement for Executive Officers.	10-Q	000-29597		10.44	10/11/02

10.14	Amended and Restated 2001 Stock Option Plan for Non-Employee Directors.	424(b)(3)	333-106829	ANN E		9/29/03

10.15**	Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597		10.39	10/14/03

10.16	Handspring, Inc. 1998 Equity Incentive Plan, as amended.	S-8	333-110055		10.1	10/29/03

10.17	Handspring, Inc. 1999 Executive Equity Incentive Plan, as amended.	S-8	333-110055		10.2	10/29/03

10.18	Handspring, Inc. 2000 Equity Incentive Plan, as amended.	S-8	333-110055		10.3	10/29/03

10.19	Separation Agreement between the registrant and R. Todd Bradley dated as of January 24, 2005.	10-Q	000-29597		10.26	4/5/05

10.20	Amendment No. 1 to the Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597		10.27	4/5/05

EXHIBIT INDEX


		Incorporated by Reference
Exhibit							Filed
Number	Exhibit Description	Form	File No.	Exhibit		Filing Date	Herewith
2.1	Master Separation and Distribution Agreement between 3Com and the registrant effective as of December 13, 1999, as amended.	S-1/A	333-92657		2.1	1/28/00

2.2	Tax Sharing Agreement between 3Com and the registrant.	10-Q	000-29597		2.7	4/10/00

2.3	Indemnification and Insurance Matters Agreement between 3Com and the registrant.	10-Q	000-29597		2.11	4/10/00

2.4	Form of Non-U.S. Plan.	S-1	333-92657		2.12	12/13/99

2.5	Agreement and Plan of Reorganization between the registrant, Peace Separation Corporation, Harmony Acquisition Corporation and Hand- spring, Inc., dated June 4, 2003.	8-K	000-29597		2.1	6/6/03

2.6	Amended and Restated Master Separation Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.14	8/18/03

2.7	Amended and Restated Indemnification and Insurance Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.17	8/18/03

2.8	Amended and Restated Tax Sharing Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.23	8/18/03

2.9	Master Patent Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829		2.30	8/18/03

2.10	Xerox Litigation Agreement between the registrant and PalmSource, Inc., as amended.	10-K/A	000-29597		2.34	9/26/03

3.1	Amended and Restated Certificate of Incorporation.	10-Q	000-29597		3.1	10/11/02

3.2	Amended and Restated Bylaws.	8-K	000-29597		3.2	10/5/05

4.1	Reference is made to Exhibits 3.1 and 3.2 hereof.	N/A	N/A		N/A	N/A	N/A

4.2	Specimen Stock Certificate.	10-K	000-29597		4.2	7/29/05

4.3	Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank), as amended.	8-K	000-29597		4.1	11/22/00

4.4	5% Convertible Subordinated Note, dated as of November 4, 2003.	10-Q	000-29597		4.4	4/6/04

4.5	Amendment to Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A.	8-A/A	000-29597		4.2	11/18/04

4.6	Certificate of Ownership and Merger Merging Palm, Inc. into palmOne, Inc.	10-K	000-29597		4.6	7/29/05

10.1	Amended and Restated 1999 Stock Plan.	10-K	000-29597		10.1	7/29/05


		Incorporated by Reference
Exhibit							Filed
Number	Exhibit Description	Form	File No.	Exhibit		Filing Date	Herewith
10.2	Form of 1999 Stock Plan Agreements.	S-1/A	333-92657		10.2	1/28/00

10.3	Amended and Restated 1999 Employee Stock Purchase Plan.	S-8	000-29597		10.2	11/18/04

10.4	Form of 1999 Employee Stock Purchase Plan Agreements.	S-1/A	333-92657		10.4	1/28/00

10.5	Amended and Restated 1999 Director Option Plan.	S-8	333-47126		10.5	10/2/00

10.6	Form of 1999 Director Option Plan Agreements.	S-1/A	333-92657		10.6	1/28/00

10.7	Form of Indemnification Agreement entered into by the registrant with each of its directors and executive officers.	S-1/A	333-92657		10.8	1/28/00

10.8**	RAM Mobile Data USA Limited Partnership Value Added Reseller Agreement between RAM Mobile Data USA Limited Partnership (now Cingular Wireless) and the registrant.	S-1/A	333-92657		10.9	2/25/00

10.9	Form of Management Retention Agreement.	S-1/A	333-92657		10.14	2/28/00

10.10	Amendment Number One to Value Added Re- seller 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-Q/A	000-29597		10.37	2/26/02

10.11**	Sublease Agreement by and between Cisco Systems Inc. and the registrant.	10-K	000-29597		10.38	7/30/02

10.12	Management Retention Agreement by and between the registrant and R. Todd Bradley dated as of September 17, 2002.	10-Q	000-29597		10.43	10/11/02

10.13	Form of Severance Agreement for Executive Officers.	10-Q	000-29597		10.44	10/11/02

10.14	Amended and Restated 2001 Stock Option Plan for Non-Employee Directors.	424(b)(3)	333-106829	ANN E		9/29/03

10.15**	Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597		10.39	10/14/03

10.16	Handspring, Inc. 1998 Equity Incentive Plan, as amended.	S-8	333-110055		10.1	10/29/03

10.17	Handspring, Inc. 1999 Executive Equity Incentive Plan, as amended.	S-8	333-110055		10.2	10/29/03

10.18	Handspring, Inc. 2000 Equity Incentive Plan, as amended.	S-8	333-110055		10.3	10/29/03

10.19	Separation Agreement between the registrant and R. Todd Bradley dated as of January 24, 2005.	10-Q	000-29597		10.26	4/5/05

10.20	Amendment No. 1 to the Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597		10.27	4/5/05

10.21	Amendment No. 2 to the Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597		10.28	4/5/05


	Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Statements of Operations Three months ended August 31, 2005 and 2004		3

Condensed Consolidated Balance Sheets August 31, 2005 and May 31, 2005		4

Condensed Consolidated Statements of Cash Flows Three months ended August 31, 2005 and 2004		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		15

Item 3. Quantitative and Qualitative Disclosures About Market Risk		35

Item 4. Controls and Procedures		36

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		36

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		36

Item 6. Exhibits		37

Signatures		40
EXHIBIT 10.28
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


(*)		Cost of revenues excludes the applicable portion of amortization of intangible assets and deferred stock-based compensation.

(**)		Amortization of intangible assets and deferred stock-based compensation:


	Three Months Ended
	August 31,
	2005			2004
Cash flows from operating activities:
Net income	$	18,177		$	19,594
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		3,976			4,690
Amortization		2,874			2,339
Deferred income taxes		(577	)		—
Changes in assets and liabilities:
Accounts receivable		11,671			(12,552	)
Inventories		(2,724	)		(5,122	)
Prepaids and other		(570	)		994
Accounts payable		3,276			15,559
Accrued restructuring		(1,204	)		(4,887	)
Other accrued liabilities		13,575			10,722

Net cash provided by operating activities		48,474			31,337

Cash flows from investing activities:
Purchase of property and equipment		(6,906	)		(2,760	)
Sale of restricted investments		—			400
Sale of short-term investments		42,036			47,564
Purchase of short-term investments		(71,351	)		(82,466	)

Net cash used in investing activities		(36,221	)		(37,262	)

Cash flows from financing activities:
Proceeds from issuance of common stock ,employee stock plans		7,180			8,822

Net cash provided by financing activities		7,180			8,822

Change in cash and cash equivalents		19,433			2,897
Cash and cash equivalents, beginning of period		128,164			98,569

Cash and cash equivalents, end of period	$	147,597		$	101,466

Other cash flow information:
Cash paid for income taxes	$	241		$	859

Cash paid for interest	$	883		$	907


		Palm, Inc.
		(Registrant)

Date: October 7, 2005	By:	/s/ Andrew J. Brown

		Andrew J. Brown
		Senior Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)


Dated:		Ms. Celeste Baranski
		palmOne, Inc.

		By:
Dated:		Ed Colligan, CEO


Delaware (State or other jurisdiction of incorporation or organization)		94-3150688 (I.R.S. Employer Identification No.)


Cost of revenues	$	230	$	312
Sales and marketing		2,045		1,654
Research and development		64		64
General and administrative		535		309

	$	2,874	$	2,339


**		Confidential treatment granted on portions of this exhibit.

	•		a single lump sum payment in the amount of 52 weeks pay at your base rate of pay as of the date of this letter, less all applicable payroll taxes and withholding, payable on the Effective Date as defined in the attached agreement;

	•		if you elect continued group health insurance coverage provided under COBRA within the prescribed time period, Company payment of COBRA premiums otherwise payable by you for 52 weeks following the Separation Date, as defined in the attached agreement, or until such time as you become eligible for other group insurance benefits, whichever is earlier; and

	a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

	b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: October 7, 2005	By:	/s/ Edward T. Colligan

	Name:	Edward T. Colligan
	Title:	President and Chief Executive Officer