10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended February 27, 2004

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File No. 000-29597

palmOne, Inc.

(Exact name of registrant as specified in its charter)

Delaware	94-3150688
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
400 N. McCarthy Blvd. Milpitas, California 95035
(Address of principal executive offices and zip code)

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes x No ¨

As of March 26, 2004, 46,598,803 shares of the Registrant’s Common Stock were outstanding.

This report contains a total of 67 pages of which this page is number 1.

palmOne, Inc.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Statements of Operations Three and Nine months ended February 28, 2004 and 2003	3
	Condensed Consolidated Balance Sheets February 28, 2004 and May 31, 2003	4
	Condensed Consolidated Statements of Cash Flows Nine months ended February 28, 2004 and 2003	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55
Item 4.	Controls and Procedures	56
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	56
Item 6.	Exhibits and Reports on Form 8-K	61
Signatures		67

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

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

palmOne, the palmOne logo, Zire, the Zire logo, Tungsten, the Tungsten logo, Handspring, the Handspring logo, Treo, Palm, the Palm logo, Palm OS, Graffiti, HotSync, the HotSync logo, and stylizations and design marks associated with all the preceding, and trade dress associated with palmOne, Inc.’s products, are among the trademarks or registered trademarks owned by or licensed to palmOne, Inc. or its subsidiaries. All other brand and product names are or may be trademarks of, and are used to identify products or services of, their respective owners. palmOne, Inc. uses the Bluetooth wireless technology trademark under express license from Bluetooth SIG, Inc. All other brand and product names are or may be trademarks of, and are used to identify products or services of, their respective owners.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

palmOne, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended February 28,						Nine Months Ended February 28,
	2004			2003			2004			2003
Revenues	$	242,485		$	197,864		$	682,308		$	620,491
Costs and operating expenses:
Cost of revenues (**)		172,169			150,725			491,132			465,363
Sales and marketing		38,582			42,199			116,869			123,528
Research and development		19,831			15,702			51,607			51,178
General and administrative		9,170			9,977			27,219			27,556
Amortization of intangible assets and stock-based compensation (*)		5,414			530			7,473			3,029
Impairment charges		—			102,540			—			102,540
Restructuring charges		4,522			37,952			8,110			35,348
Total costs and operating expenses		249,688			359,625			702,410			808,542
Operating loss		(7,203	)		(161,761	)		(20,102	)		(188,051	)
Interest and other income (expense), net		(486	)		(2,574	)		965			2,409
Loss before income taxes		(7,689	)		(164,335	)		(19,137	)		(185,642	)
Income tax provision		1,633			1,413			4,415			221,858
Loss from continuing operations		(9,322	)		(165,748	)		(23,552	)		(407,500	)
Loss from discontinued operations (net of taxes of $0, $647, $252 and $1,552, respectively)		—			(6,588	)		(11,634	)		(20,061	)
Net loss	$	(9,322	)	$	(172,336	)	$	(35,186	)	$	(427,561	)
Loss per share - basic and diluted:
Continuing operations	$	(0.20	)	$	(5.70	)	$	(0.63	)	$	(14.04	)
Discontinued operations		—			(0.23	)		(0.31	)		(0.69	)
Net loss	$	(0.20	)	$	(5.93	)	$	(0.94	)	$	(14.73	)
Shares used in computing per share amounts:
Basic and diluted		46,073			29,082			37,373			29,032
(*)    Amortization of intangible assets and stock-based compensation:
Cost of revenues	$	243		$	67		$	331		$	842
Sales and marketing		4,709			205			6,366			598
Research and development		68			126			132			1,188
General and administrative		394			132			644			401
Total amortization of intangible assets and stock-based compensation	$	5,414		$	530		$	7,473		$	3,029

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

See notes to condensed consolidated financial statements.

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palmOne, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except par value amounts)

(Unaudited)

	February 28, 2004			May 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	190,550		$	204,967
Short-term investments		49,261			—
Accounts receivable, net of allowance for doubtful accounts of $8,274 and $4,635, respectively		101,452			96,784
Inventories		27,042			22,748
Investment for committed tenant improvements		7,197			—
Prepaids and other		10,404			9,039
Current assets of discontinued operations		—			37,485
Total current assets		385,906			371,023
Restricted investments		775			948
Land not in use		60,000			60,000
Property and equipment, net		22,809			31,204
Goodwill		255,327			13,815
Intangible assets, net		12,917			—
Deferred income taxes		34,800			34,800
Other assets		1,331			1,720
Non-current assets of discontinued operations		—			63,116
Total assets	$	773,865		$	576,626
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	111,033		$	89,371
Accrued restructuring		33,230			34,886
Provision for committed tenant improvements		7,197			—
Other accrued liabilities		115,623			100,519
Current liabilities of discontinued operations		—			12,570
Total current liabilities		267,083			237,346
Non-current liabilities:
Long-term convertible debt		35,000			35,000
Other non-current liabilities		1,750			165
Non-current liabilities of discontinued operations		—			48,329
Stockholders’ equity:
Preferred stock, $.001 par value, 125,000 shares authorized; outstanding: none		—			—
Common stock, $.001 par value, 2,000,000 shares authorized; outstanding: 46,191 shares and 29,230 shares, respectively		46			29
Additional paid-in capital		1,375,196			1,123,819
Unamortized deferred stock-based compensation		(2,434	)		(508	)
Accumulated deficit		(903,975	)		(868,789	)
Accumulated other comprehensive income		1,199			1,235
Total stockholders’ equity		470,032			255,786
Total liabilities and stockholders’ equity	$	773,865		$	576,626

See notes to condensed consolidated financial statements.

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palmOne, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Nine Months Ended February 28,
	2004			2003
Cash flows from operating activities:
Loss from continuing operations	$	(23,552	)	$	(407,500	)
Adjustments to reconcile loss from continuing operations to net cash used in operating activities:
Depreciation		15,994			17,749
Amortization		8,203			3,990
Deferred income taxes		—			219,625
Impairment charges		—			102,540
Changes in assets and liabilities, net of effect of business combination:
Accounts receivable		5,321			(27,838	)
Inventories		(244	)		31,711
Prepaids and other		1,444			8,920
Accounts payable		(1,112	)		(8,451	)
Accrued restructuring		(7,811	)		16,145
Other accrued liabilities		(17,660	)		8,946
Net cash used in operating activities		(19,417	)		(34,163	)
Cash flows from investing activities:
Purchase of property and equipment		(4,229	)		(6,983	)
Purchase of equity investments		—			(1,000	)
Spin-off of PalmSource, additional cash distribution		(6,000	)		—
Acquisition of Handspring, net cash acquired		16,114			—
Sale of restricted investments		2,937			—
Purchase of restricted investments		(2,764	)		(173	)
Purchase of short-term investments		(98,762	)		(9,841	)
Sales/maturities of short-term investments		49,501			22,748
Net cash provided by (used in) investing activities		(43,203	)		4,751
Cash flows from financing activities:
Proceeds from issuance of common stock:
Through private placements		37,015			—
Under employee stock plans, net		11,188			1,306
Net cash provided by financing activities		48,203			1,306
Change in cash and cash equivalents		(14,417	)		(28,106	)
Cash and cash equivalents, beginning of period		204,967			247,859
Cash and cash equivalents, end of period	$	190,550		$	219,753

See notes to condensed consolidated financial statements.

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palmOne, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by palmOne, Inc. (formerly Palm, Inc.) (“palmOne,” the “Company,” “us,” “we” or “our”), without audit, pursuant to the rules of the Securities and Exchange Commission (“SEC”). In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments necessary for a fair presentation of palmOne’s financial position as of February 28, 2004 and results of operations for the three and nine months ended February 28, 2004 and 2003 and cash flows for the nine months ended February 28, 2004 and 2003. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in palmOne’s Annual Report on Form 10-K/A for the fiscal year ended May 31, 2003 and included in palmOne’s Current Report on Form 8-K filed on March 2, 2004 giving retroactive effect to the distribution of PalmSource, Inc. The results of operations for the nine months ended February 28, 2004 are not necessarily indicative of the operating results for the full fiscal year or any future period.

On October 28, 2003, the Company’s stockholders formally approved a plan to spin-off the Company’s Palm operating system (“OS”) platform and licensing business through the distribution of all of the shares it owned of its majority-owned subsidiary, PalmSource, Inc. (“PalmSource”), and acquire Handspring, Inc. (“Handspring”). Immediately following the transaction, Palm, Inc. changed its name to palmOne, Inc. and we refer to the Company as palmOne throughout the financial statements. The Company completed the spin-off by issuing approximately 0.3098 of a share of PalmSource common stock for each share of Palm, Inc. common stock outstanding as of October 28, 2003. The distribution of the shares of PalmSource common stock was intended to be tax-free to palmOne and to the Company’s stockholders. As a result of the distribution, the Company’s historical condensed consolidated financial statements have been retroactively adjusted to account for PalmSource as discontinued operations for all periods presented in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. While these reclassifications result in changes to certain previously reported amounts, the total and per share net loss amounts have not changed from the amounts previously reported. Unless otherwise indicated, the Notes to Condensed Consolidated Financial Statements relate to the discussion of the Company’s continuing operations (See Note 4 to condensed consolidated financial statements). Immediately following the PalmSource distribution, palmOne acquired Handspring through a merger transaction between Handspring and a wholly-owned subsidiary of palmOne. In the Handspring acquisition, the stockholders of Handspring received 0.09 of a share of palmOne common stock for each share of Handspring common stock held (an aggregate of approximately 13.6 million shares of palmOne common stock). Commencing with the date of acquisition, October 29, 2003, the Handspring assets acquired and liabilities assumed, as well as the results of Handspring’s operations are included in the condensed consolidated financial statements. (See Note 9 to condensed consolidated financial statements.)

Prior to the spin-off of PalmSource and the acquisition of Handspring, the Company’s business comprised two reporting segments; the Solutions Group business and the PalmSource business. As a result of the PalmSource distribution, the PalmSource reporting segment was eliminated as of the quarter ended November 30, 2003. The continuing business of palmOne operates in one reportable segment which develops, designs and markets handheld computing and communication devices and related accessories, services and software.

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

palmOne’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. Both fiscal years 2004 and 2003 contain 52 weeks. For presentation purposes, the periods are shown as ending on August 31, November 30, February 28 and May 31, as applicable.

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2. Stock-Based Compensation

palmOne has employee stock plans, which are described more fully in the notes to consolidated financial statements included in palmOne’s Annual Report on Form 10-K/A for the fiscal year ended May 31, 2003. palmOne accounts for its employee stock plans under the intrinsic value method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and Financial Accounting Standards Board Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB No. 25), and has adopted the disclosure-only provisions of 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.

Pursuant to APB No. 25, palmOne 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 called “options.” Concurrently, 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 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 business combination accounted for as a purchase 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 loss and net loss per share if palmOne had elected to recognize stock-based compensation expense based on the fair value of the options granted at the date of grant as prescribed by SFAS No. 123. As a result of the PalmSource distribution, to preserve the intrinsic value of palmOne’s employee stock options, the exercise prices and the number of shares underlying the options were adjusted in accordance with the methodology set forth in FIN No. 44. For the purposes 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.

	Three Months Ended February 28,						Nine Months Ended February 28,
(In thousands, except per share amounts)	2004			2003			2004			2003
Net loss, as reported	$	(9,322	)	$	(172,336	)	$	(35,186	)	$	(427,561	)
Add: Stock-based compensation expense included in net loss, as reported, net of related tax effects (1)		325			725			2,443			3,046
Less: Stock-based compensation expense determined under fair value method for all awards, net of related tax effects (1)		(8,833	)		(9,886	)		(22,662	)		(36,927	)
Pro forma net loss	$	(17,830	)	$	(181,497	)	$	(55,405	)	$	(461,442	)
Net loss per share, as reported - basic and diluted	$	(0.20	)	$	(5.93	)	$	(0.94	)	$	(14.73	)
Pro forma net loss per share - basic and diluted	$	(0.39	)	$	(6.24	)	$	(1.48	)	$	(15.89	)

⁽¹⁾ Amounts include compensation related to options held by PalmSource employees through the distribution date.

SFAS No. 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because options held by palmOne employees and directors have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of these options.

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The fair value of each option grant during the three and nine months ended February 28, 2004 and 2003 was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:

	Three Months Ended February 28,				Nine Months Ended February 28,
	2004		2003		2004		2003
Assumptions applicable to stock options:
Risk-free interest rate	2.5	%	2.5	%	1.8	%	2.4	%
Volatility	100	%	100	%	100	%	100	%
Options term (in years)	3.42		3.46		2.47		3.07
Dividend yield	0.0	%	0.0	%	0.0	%	0.0	%

The weighted average estimated fair value of stock options granted were $7.38 per share, $7.05 per share, $6.94 per share and $6.22 per share, during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively.

In connection with the PalmSource distribution, to preserve the intrinsic value of palmOne’s employee stock options, the number of shares subject to stock options outstanding as of October 28, 2003 and their related exercise prices were adjusted in accordance with the methodology set forth in FIN No. 44. As a result, on October 28, 2003, outstanding options to purchase approximately 5.0 million shares of Palm, Inc. common stock were adjusted into options to purchase approximately 7.1 million shares of palmOne common stock. This includes options to purchase approximately 0.4 million shares of palmOne common stock held by PalmSource employees. Options held by PalmSource employees ceased vesting on October 28, 2003 and unexercised options held by PalmSource employees were cancelled on January 28, 2004.

3. Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FIN No. 46, Consolidation of Variable Interest Entities and a revised interpretation of FIN No. 46R in December 2003. These require an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from the other parties. palmOne adopted FIN No. 46 as of September 1, 2003, and the adoption of this interpretation did not have an impact on the Company’s historical financial position or results of operations. palmOne does not expect the adoption of FIN No. 46R to have an impact on the Company’s historical financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly and clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative and when a derivative contains a financing component. SFAS No. 149 also amends the definition of an underlying to conform it to language used in FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, with certain exceptions. palmOne adopted SFAS No. 149 as of June 1, 2003, and the adoption of this statement did not have an impact on the Company’s historical financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires

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that an issuer classify a financial instrument that falls within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. palmOne adopted SFAS No. 150 as of June 1, 2003, and the adoption of this statement did not have an impact on the Company’s historical financial position or results of operations.

4. Discontinued Operations

On October 28, 2003, the Company’s stockholders formally approved a plan that included the PalmSource distribution and the Handspring acquisition. Accordingly, the historical condensed consolidated financial statements of palmOne have been retroactively adjusted to account for PalmSource as discontinued operations for all periods presented in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The discontinued operations data reflects the historical assets and liabilities, results of operations and cash flows of PalmSource, the Palm OS platform and licensing business segment of palmOne, as of and during each respective period presented. No gain or loss was recorded as a result of this transaction.

Loss from discontinued operations included PalmSource net revenues of $11.2 million, $11.1 million and $25.7 million for the three months ended February 28, 2003 and the nine months ended February 28, 2004 and 2003, respectively. PalmSource net revenues included $3.8 million, $2.2 million and $8.8 million from Sony Corporation, a minority stockholder of PalmSource, for the three months ended February 28, 2003 and the nine months ended February 28, 2004 and 2003, respectively. Also included in loss from discontinued operations are allocated corporate expenses and historical consolidated separation costs that ceased after the PalmSource distribution of $1.7 million, $5.2 million and $5.5 million for the three months ended February 28, 2003 and the nine months ended February 28, 2004 and 2003, respectively. Because of the PalmSource distribution, PalmSource was not included as a part of palmOne’s results during the three months ended February 28, 2004.

Upon the PalmSource distribution, palmOne contributed an additional $6.0 million of cash, forgave a $20.0 million intercompany note receivable and assigned $15.0 million of its convertible note to PalmSource. The net assets of PalmSource disposed of as of October 28, 2003 and reported as discontinued operations as of May 31, 2003 were (in thousands):

	October 28, 2003			May 31, 2003
Cash and cash equivalents	$	33,834		$	37,465
Other current assets		7,688			20
Property and equipment, net		2,907			3,418
Goodwill		54,970			54,970
Intangible assets, net		267			976
Other assets		2,750			3,752
Current liabilities		(26,087	)		(12,570	)
Long-term convertible debt		(15,000	)		(15,000	)
Deferred revenue and other non-current liabilities		(12,290	)		(13,329	)
Redeemable convertible preferred stock		(20,000	)		(20,000	)
Net assets of discontinued operations	$	29,039		$	39,702

5. Net Loss Per Share

Basic loss from continuing operations, loss from discontinued operations and net loss per share is calculated based on the weighted average shares of common stock outstanding during the period, excluding shares of restricted stock subject to repurchase. Diluted loss from continuing operations, loss from discontinued operations and net loss per share are calculated based on the weighted average shares of common stock outstanding excluding shares subject to repurchase, because the effect of restricted stock subject to repurchase and stock options and warrants outstanding, calculated using the treasury stock method, would have been anti-dilutive. For the three and nine months ended February 28, 2004 approximately 1,156,000 and 1,182,000 common equivalent shares, respectively, and for the three and nine months ended February 28, 2003, approximately 170,000 and 71,000 common equivalent shares, respectively, were excluded from the

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computations of diluted loss from continuing operations, diluted loss from discontinued operations and diluted net loss per share.

6. Comprehensive Loss

The components of comprehensive loss are (in thousands):

	Three Months Ended February 28,						Nine Months Ended February 28,
	2004			2003			2004			2003
Net loss	$	(9,322	)	$	(172,336	)	$	(35,186	)	$	(427,561	)
Other comprehensive loss:
Unrealized gain (loss) on investments		115			(798	)		80			(1,384	)
Accumulated translation adjustments		130			346			334			501
Total comprehensive loss	$	(9,077	)	$	(172,788	)	$	(34,772	)	$	(428,444	)

7. Cash and Available for Sale and Restricted Investments

The Company’s cash and available for sale and restricted investments consist of (in thousands):

	February 28, 2004							May 31, 2003
	Adjusted Cost		Unrealized Gain (Loss)			Carrying Value		Adjusted Cost		Unrealized Gain (Loss)		Carrying Value
Cash	$	47,369	$	—		$	47,369	$	30,394	$	—	$	30,394
Cash equivalents:
Money market funds		74,181		—			74,181		37,673		—		37,673
State and local government obligations		—		—			—		93,900		—		93,900
Corporate notes/bonds		61,000		—			61,000		33,000		—		33,000
Foreign corporate notes/bonds		8,000		—			8,000		10,000		—		10,000
		143,181		—			143,181		174,573		—		174,573
Total cash and cash equivalents	$	190,550	$	—		$	190,550	$	204,967	$	—	$	204,967
Short-term investments:
U.S. government agency obligations	$	31,683	$	64		$	31,747	$	—	$	—	$	—
Corporate notes/bonds		17,405		109			17,514		—		—		—
Total short-term investments	$	49,088	$	173		$	49,261	$	—	$	—	$	—
Equity investments in publicly traded companies	$	253	$	(87	)	$	166	$	253	$	—	$	253
Investment for committed tenant improvements, money market funds	$	7,197	$	—		$	7,197	$	—	$	—	$	—
Restricted investments:
Certificates of deposit	$	775	$	—		$	775	$	775	$	—	$	775
U.S. government agency obligations		—		—			—		173		—		173
Total restricted investments	$	775	$	—		$	775	$	948	$	—	$	948

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8. Inventories

Inventories consist of (in thousands):

	February 28, 2004		May 31, 2003
Finished goods	$	20,299	$	16,835
Work-in-process and raw materials		6,743		5,913
	$	27,042	$	22,748

9. Business Combinations

On October 29, 2003, palmOne acquired Handspring, a leading provider of smartphones and communicators, exchanging 0.09 of a share of palmOne 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. The goal of the Handspring acquisition was to enhance palmOne’s competitive position in the wireless handheld market and strengthen relationships with wireless carriers, allowing the Company to broaden its product offering, distribution channels and achieve certain cost synergies. palmOne 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 palmOne common stock. The purchase price of $249.9 million is comprised of (a) approximately $209.2 million representing the fair value of palmOne 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 methodology, (c) $6.5 million of direct transaction costs and (d) $6.2 million of other liabilities directly related to the acquisition.

The fair value of the palmOne common stock issued was determined using a per share price based upon the closing prices of palmOne common stock within a range of trading days beginning with the first trading day subsequent to the PalmSource distribution (October 29, 2003 - November 4, 2003), or $15.4060 per share.

The fair value of the vested options, unvested options and warrants assumed were valued using the Black-Scholes option valuation model with the following weighted average assumptions:

	Vested Options		Unvested Options		Warrants
Weighted average assumptions:
Risk-free interest rate	1.3	%	2.4	%	3.2	%
Volatility	100	%	100	%	100	%
Options term (in years)	1.00		3.00		4.25
Dividend yield	0.0	%	0.0	%	0.0	%

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 palmOne 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 palmOne in the future. As of February 28, 2004, the workforce reductions were substantially complete.

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

	Initial Liability Recognized at October 29, 2003		Cash Payments			Balance at February 28, 2004
Workforce reduction costs	$	1,805	$	(1,805	)	$	—
Excess facilities costs		3,689		(1,201	)		2,488
Other		660		(660	)		—
	$	6,154	$	(3,666	)	$	2,488

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The Handspring acquisition was accounted for as a purchase pursuant to SFAS No. 141, Business Combinations. Pursuant to SFAS No. 142, Goodwill and Other Intangible Assets, goodwill related to the acquisition is not amortized and will be tested at least annually for impairment. The goodwill for the Handspring acquisition is not deductible for tax purposes. The condensed consolidated financial statements of palmOne include the operating results of the acquired Handspring business from the date of acquisition.

The purchase price of this business combination was allocated to tangible assets net of assumed liabilities and to identifiable intangible assets based on the valuation, generally using a discounted cash flow approach, of contracts and customer relationships, customer backlog, product technology, trademarks and non-compete covenants as follows (in thousands):

	Amortization Period	Amount
Net tangible assets:
Current assets		$	40,591
Property and equipment			3,370
Other assets			15,403
Total assets acquired			59,364
Total liabilities assumed			(72,870	)
Net tangible liabilities assumed			(13,506	)
Deferred stock-based compensation			2,233
Goodwill			241,512
Intangible assets:
Contracts and customer relationships	24 months		11,900
Customer backlog	4 months		4,200
Product technology	24 months		1,800
Trademarks	24 months		1,400
Non-compete covenants	24 months		400
Total purchase price		$	249,939

The following unaudited pro forma financial information presents the combined results of operations of palmOne and Handspring as if the Handspring acquisition had occurred as of the beginning of the periods presented. Due to different historical fiscal period ends for palmOne and Handspring, the pro forma results combine the results of palmOne with the historical results of Handspring as follows:

palmOne Reporting Period	Handspring Period Included in Pro Forma Data
Three Months Ended February 28, 2004	*
Three Months Ended February 28, 2003	Three Months Ended March 31, 2003
Nine Months Ended February 28, 2004	June 1, 2003 - October 28, 2003 *
Nine Months Ended February 28, 2003	Nine Months Ended March 31, 2003

* Results from operations of the former Handspring business are included in palmOne results of operations since the date of acquisition (October 29, 2003).

This unaudited pro forma financial information includes an adjustment of $2.2 million, $6.8 million and $10.8 million for the three months ended February 28, 2003 and the nine months ended February 28, 2004 and 2003, respectively, to the combined results of operations, reflecting amortization of purchased intangible assets and deferred stock based-compensation, that would have been recorded if the acquisition had occurred at the beginning of the periods presented. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations or financial condition of palmOne that would have been reported had the acquisition been completed as of the beginning of the periods presented, and should not be

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taken as representative of the future consolidated results of operations or financial condition of palmOne. Pro forma results for the three and nine months ended February 28, 2004 and 2003 were (in thousands, except per share amounts):

	Three Months Ended February 28,						Nine Months Ended February 28,
	2004			2003			2004			2003
Pro forma revenues	$	242,485		$	228,712		$	718,388		$	753,284
Pro forma net loss	$	(9,322	)	$	(264,956	)	$	(66,925	)	$	(556,329	)
Pro forma net loss per share, basic and diluted	$	(0.20	)	$	(6.21	)	$	(1.79	)	$	(13.06	)
Shares used in computing per share amounts, basic and diluted		46,073			42,659			37,373			42,609

10. Goodwill

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

	Total
Balances, May 31, 2003	$	13,815
Acquisition of Handspring		241,512
Balances, February 28, 2004	$	255,327

11. Intangible Assets

Intangible assets consist of (in thousands):

		February 28, 2004
	Amortization Period	Gross Carrying Amount		Accumulated Amortization			Net
Contracts and customer relationships	24 months	$	11,900	$	(1,983	)	$	9,917
Customer backlog	4 months		4,200		(4,200	)		—
Product technology	24 months		1,800		(300	)		1,500
Trademarks	24 months		1,400		(233	)		1,167
Non-compete covenants	24 months		400		(67	)		333
		$	19,700	$	(6,783	)	$	12,917

Amortization expense related to intangible assets was $5.1 million, $0 million, $6.8 million and $1.1 million for the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively. Estimated future amortization expense for the remaining three months of fiscal year 2004, for fiscal year 2005 and for fiscal year 2006 is $1.9 million, $7.8 million and $3.2 million, respectively.

The net book value of the intangible assets of PalmSource have been reclassified and are included in non-current assets from discontinued operations in the condensed consolidated balance sheet as of May 31, 2003; palmOne had no other net intangible assets as of that date.

12. Deferred Income Taxes

As of February 28, 2004, palmOne’s deferred tax assets were comprised of net operating loss carryforwards, deferred expenses and tax credit carryforwards of $444.7 million offset by a valuation allowance of $409.9 million. The valuation allowance reduces deferred tax assets to estimated realizable value, based on estimates and certain tax planning strategies. The carrying value of palmOne’s net deferred tax assets assumes that it is more likely than not that palmOne will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the net carrying value.

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As of the end of fiscal year 2002, palmOne had recorded a net deferred tax asset of $254.4 million. The realization of the net deferred tax asset was supported by certain identified tax strategies, involving the potential sale or transfer of appreciated assets, which were prudent and feasible and which management would implement, if necessary, to realize the related tax benefits before palmOne’s net operating loss carryforwards expired. The identified tax strategies included the potential sale or transfer of certain identified business operations, consisting of palmOne’s PalmSource, Inc. subsidiary and wireless access service operations, as well as the transfer of certain intellectual property from a foreign subsidiary to the United States, on a taxable basis. During the first quarter of fiscal year 2003, there was a significant decline in the value of these identified business operations and assets. In addition, the Company’s business plans had developed such that the potential sale or transfer of PalmSource, Inc. and its wireless access service operations on a taxable basis were no longer feasible tax planning strategies. As a result, during the quarter ended August 31, 2002, the Company recorded a tax provision of $219.6 million to increase its valuation allowances reflecting these changes and to reduce the net deferred tax assets to $34.8 million, which is the amount supported by the value of its intellectual property transfer strategy which, as of that date and at February 28, 2004 continues to be prudent, feasible and one that management would implement, if necessary, to realize the related tax benefits before palmOne’s net operating loss carryforwards expired. The valuation allowance also increased as a result of the operating losses incurred during the quarter ended February 28, 2004.

13. Commitments and Guarantees

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

In December 2001, palmOne 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 divided into two separate obligations, a portion retained by palmOne and the remainder assumed by PalmSource. palmOne issued a subordinated convertible note in the principal amount of $35.0 million to Texas Instruments. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into palmOne common stock at an effective conversion price of $64.60 per share. palmOne 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 palmOne distributes significant assets, palmOne may be required to repay a portion of the note. The PalmSource distribution did not represent a significant distribution of assets under the terms 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 connection with the Handspring acquisition, palmOne assumed two notes with remaining principal amounts of $2.5 million and $0.8 million. The notes bear interest at 6% per annum and are payable in equal monthly installments through January 2007. As of February 28, 2004, the remaining principal amounts of the notes are $2.4 million and $0.8 million.

palmOne has a patent and license agreement with a third party vendor under which palmOne is committed to pay $2.4 million in fiscal year 2004 and $2.7 million in fiscal year 2005.

palmOne has an agreement with PalmSource that grants the Company certain licenses to develop, manufacture, test, maintain and support its products. Under this agreement, palmOne has agreed to pay PalmSource license and royalty fees based upon net shipment revenue of its products which incorporate PalmSource’s software, a source code license and maintenance and support fees. The source code license fee is $6.0 million paid in three equal annual installments in June 2003, June 2004 and June 2005. Annual maintenance and support fees are approximately $0.7 million per year. The agreement includes a minimum annual royalty and license commitment of $39.0 million, $41.0 million and $42.5 million during each of the contract years in the period ending December 3, 2006.

palmOne utilizes contract manufacturers to build its products. These contract manufacturers acquire components and build product based on demand forecast information supplied by palmOne, which typically covers a rolling 12-month period. Consistent with industry practice, palmOne 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 palmOne’s forecasted component

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and manufacturing requirements for periods ranging from 30 to 90 days. As of February 28, 2004, palmOne’s third party manufacturers had inventory on-hand and component purchase commitments related to the manufacture of palmOne products of approximately $164.3 million.

In August 2003, palmOne entered into a two-year, $30.0 million revolving credit line with Silicon Valley Bank (“SVB”). The credit line is secured by assets of palmOne, 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 (4.0% at February 28, 2004) or, at palmOne’s election subject to specific requirements, equal to LIBOR plus 1.75% (2.86% at February 28, 2004). The interest rate may vary based on fluctuations in market rates. palmOne is subject to a financial covenant requirement under this agreement to maintain cash on deposit in the United States of not less than $100.0 million. As of February 28, 2004 palmOne had used its credit line to support the issuance of letters of credit of $8.5 million.

As part of the agreements with 3Com relating to palmOne’s separation from 3Com, palmOne 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 17 to condensed consolidated financial statements.)

As part of the agreements with PalmSource relating to the PalmSource distribution, palmOne 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 17 to condensed consolidated financial statements.)

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

palmOne’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):

	Nine Months Ended February 28,
	2004			2003
Balance, beginning of period	$	17,911		$	30,008
Payments made		(28,392	)		(31,073	)
Accrual related to product sold during the period		31,333			30,342
Change in estimated liability for pre-existing warranties		350			(11,870	)
Balance, end of period	$	21,202		$	17,407

14. Common Stock Issued

During the first quarter of fiscal year 2004, the Company sold an aggregate of 2.4 million shares of its common stock under its universal shelf registration statement. The Company sold 1.2 million shares to an institutional investor at $15.00 per share, with proceeds of $18.0 million, and an additional 1.2 million shares to a group of institutional investors at $15.90 per share, with proceeds of approximately $19.1 million. The net proceeds of the offering are being used for general corporate purposes, including capital expenditures and to meet working capital needs

15. Restructuring Charges

Restructuring charges of $4.5 million, recorded during the three months ended February 28, 2004, relate to restructuring actions taken during the third quarter of fiscal year 2004 and include workforce reductions, in the

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United States and United Kingdom, of approximately 100 regular employees. Restructuring charges relate to the implementation of actions to streamline the Company consistent with its strategic plan. 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. As of February 28, 2004, approximately 65 regular employees have been terminated as a result of this restructuring.

Accrued liabilities related to the third quarter of fiscal year 2004 restructuring actions consist of (in thousands):

	Workforce Reduction Costs
Restructuring expense	$	4,522
Cash payments		(957	)
Balance, February 28, 2004	$	3,565

Cost reduction actions initiated in the third quarter of fiscal year 2004 are expected to be substantially complete by the third quarter of fiscal year 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 relate to the implementation of a series of actions to adjust the business consistent with palmOne’s future wireless plans. As of February 28, 2004, substantially all the headcount reductions have been completed.

Accrued liabilities related to the first quarter of fiscal year 2004 restructuring actions consist of (in thousands):

	Discontinued Project Costs			Excess Facilities and Equipment Costs			Workforce Reduction Costs			Total
Restructuring expense	$	680		$	1,515		$	1,655		$	3,850
Cash payments		(304	)		(474	)		(1,462	)		(2,240	)
Write-offs		—			(23	)		(107	)		(130	)
Balances, February 28, 2004	$	376		$	1,018		$	86		$	1,480

Cost reduction actions initiated in the first quarter of fiscal year 2004 are expected to be substantially complete by the end of fiscal year 2004.

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 relate to the implementation of a series of actions to better align the Company’s expense structure with its revenues. During the second quarter of fiscal year 2004, adjustments of $0.3 million were recorded to reflect the changes in the estimated costs of certain actions from the original estimates. As of February 28, 2004, substantially all of the headcount reductions have been completed.

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

	Discontinued Project Costs			Excess Facilities and Equipment Costs			Workforce Reduction Costs			Total
Restructuring expense	$	10,577		$	2,445		$	6,085		$	19,107
Cash payments		(4,700	)		(106	)		(4,580	)		(9,386	)
Fixed asset write-offs		(3,510	)		(743	)		(131	)		(4,384	)
Balances, May 31, 2003		2,367			1,596			1,374			5,337
Restructuring expense		—			355			(617	)		(262	)
Cash payments		—			(682	)		(757	)		(1,439	)
Balances, February 28, 2004	$	2,367		$	1,269		$	—		$	3,636

Cost reduction actions initiated in the third quarter of fiscal year 2003 are substantially complete except for remaining contractual payments for excess facilities and project termination fees which are expected to continue through the first quarter of fiscal year 2006.

The fourth quarter of fiscal year 2001 restructuring charges related to carrying and development costs related to the land on which palmOne 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 February 28, 2004, the balance consists of lease commitments, payable over approximately eight years, offset by estimated net sublease proceeds of approximately $13.8 million.

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

	Excess Facilities and Equipment Costs			Workforce Reduction Costs			Total
Balances, May 31, 2002	$	16,552		$	325		$	16,877
Restructuring adjustments		21,358			(284	)		21,074
Cash payments		(8,361	)		(41	)		(8,402	)
Balances, May 31, 2003		29,549			—			29,549
Cash payments		(7,488	)		—			(7,488	)
Balances, February 28, 2004	$	22,061		$	—		$	22,061

Accrued restructuring as of February 28, 2004 includes accrued liabilities recognized in connection with the Handspring acquisition. (See Note 9 to condensed consolidated financial statements.)

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16. Supplemental Cash Flow Information

Supplemental cash flow information for the nine months ended February 28, 2004 and 2003 are as follows (in thousands):

	Nine Months Ended February 28,
	2004		2003
Other cash flow information:
Cash paid for income taxes	$	1,727	$	1,720
Cash paid for interest	$	2,484	$	2,659
Non-cash investing and financing activities are as follows:
Fair value of stock options and warrants assumed in business combination	$	28,064	$	—
Common stock issued for business combination	$	209,173	$	—

17. Litigation

palmOne 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. palmOne believes that it has defenses to the cases set forth below and is vigorously contesting these matters. palmOne is not currently able to estimate, with reasonable certainty, the possible loss, or range of loss, if any, from the cases listed below, but an unfavorable resolution of these lawsuits could materially adversely affect palmOne’s business, results of operations or financial condition. (Although Palm, Inc. is now palmOne, Inc. and Handspring has been merged into palmOne, the pleadings in the pending litigation continue to use former company names, including Palm Computing, Inc., Palm, Inc. and Handspring, Inc.)

On April 28, 1997, Xerox Corporation filed suit in the United States District Court for the Western District of New York. The case came to be captioned Xerox Corporation v. 3Com Corporation, U.S. Robotics Corporation, U.S. Robotics Access Corp., and Palm Computing, Inc., Civil Action No. 97-CV-6182T. The complaint alleged willful infringement of U.S. Patent No. 5,596,656 (the “‘656 patent”), entitled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint sought unspecified damages and to permanently enjoin the defendants from infringing the patent in the future. In 2000, the District Court dismissed the case, ruling that the patent is not infringed by the Graffiti handwriting recognition system used in handheld computers using Palm’s operating systems. Xerox appealed the dismissal to the United States Court of Appeals for the Federal Circuit (“CAFC”). On October 5, 2001, the CAFC affirmed-in-part, reversed-in-part and remanded the case to the District Court for further proceedings. On December 20, 2001, the District Court granted Xerox’s motion for summary judgment that the patent is valid, enforceable and infringed. The defendants filed a Notice of Appeal on December 21, 2001. On February 22, 2002, the Court denied a request for an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The Court also rejected a request by Xerox to set a trial date to determine damages Xerox claims it is owed. In connection with the denial of Xerox’s request to set a trial date on damages, the Court required Palm to post a $50.0 million bond, which was satisfied with a letter of credit from a financial institution. A Notice of Appeal from the District Court’s order of February 22, 2002 was filed by Palm on March 15, 2002. A cross-appeal from the District Court’s order of February 22, 2002 was filed by Xerox on March 4, 2002. A hearing on the appeal and cross-appeal was held on January 6, 2003 before the CAFC. The CAFC has remanded the case to the District Court for a determination on the issue of invalidity of the ‘656 patent. Xerox petitioned the CAFC for reconsideration of its determination on the appeal and cross-appeal, but the CAFC has denied this petition and eliminated the requirement for the $50 million bond from Palm. If palmOne is not successful in the proceedings in the District Court, the CAFC has noted that an injunction will apply. If an injunction is sought by Xerox and issued, it could result in business interruption for palmOne that would have a significant adverse impact on palmOne’s operations and financial condition if palmOne has not transitioned to a handwriting recognition system outside the scope of Xerox’s asserted claims. In addition, if palmOne is not successful with regard to this remand to the District Court, Xerox has stated in its Court pleadings that it will seek at a trial, a significant

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compensatory and punitive damage award or license fees from palmOne. Furthermore, if palmOne is not successful with regard to this remand to the District Court, palmOne might be liable to PalmSource’s licensees and other third parties under contractual obligations or otherwise sustain adverse financial impact if Xerox seeks to enforce its patents claims against PalmSource’s licensees and other third parties. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation. On December 10, 2003 the District Court heard oral arguments on palmOne’s motion for summary judgment due to invalidity and Xerox’s motion for summary judgment that the patent is not invalid. A decision on such motions is pending.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against “3Com, Inc.” in the United States District Court for the Southern District of New York and later filed, on March 6, 2000, an amended complaint against Palm and 3Com. The case is now captioned E-Pass Technologies, Inc. v. 3Com Corporation, a/k/a 3Com, Inc. and Palm, Inc., Civil Action No. 00 CIV 1523. The amended complaint alleges willful infringement of U.S. Patent No. 5,276,311, entitled “Method and Device for Simplifying the Use of Credit Cards, or the Like” 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. The case was transferred to the United States District Court for the Northern District of California. In an order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. On August 21, 2003, the CAFC issued a ruling reversing the claim construction of the District Court and the attendant summary judgment motion and remanded the case to the District Court for further proceedings. On February 9, 2004 E-Pass filed another lawsuit in the Northern District of California naming palmOne, Handspring and PalmSource as defendants, a case captioned E-Pass Technologies, Inc. v. palmOne, Inc., PalmSource, Inc. and Handspring, Inc., Civil Action C04-0528. This recently filed suit alleges infringement, contributory infringement and inducement of infringement of the same patent, but identified additional products as infringing and seeks unspecified compensatory damages, treble damages and a permanent injunction against future infringement. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the E-Pass litigation.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, entitled, respectively, “Portable Personal Terminal for Use in a System for Handling Transactions” and “System for Handling Transactions Including a Portable Personal Terminal.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. On August 28, 2003, the District Court granted both Palm’s and Handspring’s motions for summary judgment, ruling that neither parties’ products infringe the NCR patents, and denied NCR’s motion. NCR appealed the ruling to the Court of Appeals for the Federal Circuit and the parties are in the briefing phase of that appeal.

In June 2001, the first of several putative stockholder class action lawsuits was filed in United States District Court, Southern District of New York against certain of the underwriters for Palm’s initial public offering, Palm and several of its officers. The complaints, which have been consolidated under the caption In re Palm, Inc. Initial Public Offering Securities Litigation, 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. All of these various consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with plaintiffs. The Court denied Palm’s motion to dismiss. Special committees of both Palm’s and Handspring’s respective Boards of Directors recently 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

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the issuers, including palmOne 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. palmOne believes that it has meritorious defenses to the claims against it and against Handspring and intends to defend the action vigorously if the case does not settle.

On June 19, 2001, DataQuill Limited filed suit against Handspring in the United States District Court for the Northern District of Illinois, case no. 01-CV-4635. The complaint alleges infringement of one U.S. patent and seeks unspecified compensatory and treble damages and to permanently enjoin future infringement. Handspring filed an answer on August 1, 2001, denying DataQuill’s allegations and asserting counterclaims for declaratory judgments that Handspring did not infringe the patent in suit, that the patent in suit is invalid, and that it is unenforceable. On August 7, 2002, Handspring filed motions for summary judgment for non-infringement and invalidity, which were renewed in filings made on October 29, 2002. On February 28, 2003, the Court granted in part and denied in part the summary judgment motions. DataQuill then filed a motion for this ruling to be reconsidered, which on April 16, 2003 the Court granted in part and denied in part. The case is expected to go to trial in 2004.

On August 7, 2001, a purported consumer class action lawsuit was filed against Palm and 3Com in California Superior Court, San Francisco County. The case is captioned Connelly et al v. Palm, Inc., 3Com Corp et al, Case No. 323587. An amended complaint alleging breach of warranty and violation of California’s Unfair Competition Law was filed and served on Palm on August 15, 2001. The amended complaint, filed on behalf of purchasers of Palm III, IIIc, V and Vx handhelds, alleges that certain Palm handhelds may cause damage to PC motherboards by permitting an electrical charge, or “floating voltage,” from either the handheld or the cradle to be introduced into the PC via the serial and/or USB port on the PC. The plaintiffs allege that this damage is the result of a design defect in one or more of the following: HotSync software, handheld, cradle and/or the connection cable. The complaint seeks restitution, rescission, damages, an injunction mandating corrective measures to protect against future damage as well as notifying users of potential harm. Discovery is closed. The parties engaged in mediation and reached settlement, which received preliminary Court approval in December 2003 and the settlement class members received notification in early 2004 pursuant to the Court order. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Connelly litigation.

On January 23, 2002, a purported consumer class action lawsuit was filed against Palm in California Superior Court, San Francisco County. The case is captioned Eley et al v. Palm, Inc., Case No. 403768. The unverified complaint, filed on behalf of purchasers of Palm m500 and m505 handhelds, alleges (1) that the HotSync function in certain Palm handhelds does not perform as advertised and the products are therefore defective and (2) that upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty. The complaint alleges Palm’s actions are a violation of California’s Unfair Competition Law and a breach of express warranty. The complaint seeks alternative relief including an injunction to have Palm desist from selling and advertising the handhelds, to recall the defective handhelds, to restore the units to their advertised functionality, to pay restitution or disgorgement of the purchase price of the units and/or damages and attorneys’ fees. Palm filed its answer denying the allegations and the parties engaged in document and deposition discovery. Plaintiff and Palm engaged in mediation and reached a settlement which received final Court approval in February 2004.

On March 11, 2002, a purported consumer class action lawsuit was filed against Palm in the Wayne County Circuit Court, Detroit, Michigan. The case is captioned Hayman, et al. v Palm, Inc., Case No. 02-208249-CP. Plaintiffs allege that certain of Palm’s advertisements for its Palm III, V and m100 handheld devices were false or misleading regarding the ability of the device to wirelessly and remotely access emails or the Internet without the need for additional hardware or software sold separately. Plaintiffs allege violations of the Michigan Consumer Protection Act, breach of express and implied warranties and Michigan common law, and seek to recover the purchase price of the device from Palm for themselves and a class of all similarly situated consumers. Palm filed a motion to dismiss the lawsuit in its entirety which the Court granted in March 2004.

In August and September 2002, four purported consumer class action lawsuits were filed against Palm in California Superior Court, Santa Clara County; California Superior Court, San Diego County; Illinois Circuit Court, Cook County; and Illinois Circuit Court, St. Clair County. The respective cases are captioned Lipner and

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Ouyang v. Palm, Inc., Case No. CV-810533; Veltman v. Palm, Inc., Case No. 02CH16143; Wireless Consumer’s Alliance, Inc. v. Palm, Inc., Case No. GIC-794940; and Cokenour v. Palm, Inc., Case No. 02L0592. All four cases allege consumer fraud regarding Palm’s representations that its m130 handheld personal digital assistant supported more than 65,000 colors. Certain of the cases also allege breach of express warranty and unfair competition. In general, the cases seek unspecified damages and/or to enjoin Palm from continuing it’s allegedly misleading advertising. The parties agreed to a settlement which received final Court approval in February 2004.

In October 2002, a purported consumer class action lawsuit was filed against Palm in Illinois Circuit Court, Cook County. The case is captioned Goldstein v. Palm, Inc., Case No. 02CH19678. The case alleges consumer fraud regarding Palm’s representations that its m100, III, V, and VII handheld personal digital assistant, as sold, would provide wireless access to the Internet and email accounts, and would perform common business functions including data base management, custom form creation and viewing Microsoft Word and Excel documents, among other tasks. The case seeks unspecified actual damages and indemnification of certain costs. In September 2003, the Court granted Palm’s motion to dismiss the complaint, but allowed the plaintiff the opportunity to amend and refile which plaintiff did in October 2003. Palm made another motion to dismiss, which motion is currently pending.

On January 23, 2003, Peer-to-Peer Systems LLC filed a complaint against Palm in the United States District Court for the District of Delaware. The case is captioned Peer-to-Peer Systems, LLC vs. Palm, Inc., Civil Action No. 03-115. The complaint alleges infringement, contributory infringement, inducement of infringement of U.S. Patent No. 5,618,045 entitled “Interactive Multiple Player Game System and Method of Playing a Game Between at Least Two Players”. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendant from infringing the patent in the future. palmOne believes that the claims are without merit and intends to defend against them vigorously. The case is scheduled for trial in 2004.

On February 27, 2003, a purported consumer class action lawsuit was filed against Palm in California Superior Court, Santa Clara County. The case is captioned Hemmingsen et al v. Palm, Inc., Case No. CV815074. The unverified complaint, filed on behalf of purchasers of Palm m515 handhelds, alleges that such handhelds fail at unacceptably high rates, and in particular that instant updating and synchronization of data with PCs often will not occur. The complaint further alleges that, upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty, among other things. The complaint alleges that Palm’s actions violate California’s Unfair Competition Law and constitute a breach of warranty. The complaint seeks restitution, disgorgement, damages, an injunction mandating corrective measures including a full replacement program for all allegedly defective m515s or, alternatively mandating a refund to all purported class members of the full purchase price for their m515s, and attorneys’ fees. The parties have begun the discovery process and also engaged in mediation of the claims.

On or about June 17 and 19, 2003, respectively, two putative class action lawsuits were filed in the Court of Chancery in the State of Delaware in and for the County of New Castle against Palm, Handspring and various officers and directors of Handspring. The cases are captioned Goldhirsch v. Handspring, Inc., et. al, Civil Action No. 20376-NC and Majarian v. Handspring, Inc., et. al, Civil Action No. 20381-NC. The Majarian complaint was amended on or about June 23, 2003 to, among other things, delete certain previously named officer defendants. Both complaints allege that the officers and directors of Handspring breached their fiduciary duties to Handspring stockholders by, among other things, failing to undertake an appropriate evaluation of Handspring’s net worth as a merger or acquisition candidate and failing to maximize Handspring stockholder value by not engaging in a meaningful auction of Handspring. The Majarian complaint also alleges, among other things, that the officers and directors of Handspring breached their fiduciary duties by failing to act independently so that the interests of Handspring’s public stockholders would be protected and enhanced. Both complaints allege that Palm aided and abetted the alleged breaches of fiduciary duty of Handspring’s officers and directors. Both complaints seek, among other things, a preliminary and permanent injunction against the transaction, a rescission of the transaction if it is consummated and unspecified damages. The Goldhirsch complaint also requests, among other things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or a market check. The cases were consolidated and a tentative settlement was reached in October 2003 subject to appropriate documentation, confirmatory discovery and Court approval.

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18. Related Party Transactions

Transactions with 3Com Corporation

Subsequent to the date of separation of palmOne from 3Com, palmOne paid 3Com for certain leased facilities through the first quarter of fiscal year 2004 and for transitional services required while palmOne established its independent infrastructure, with transitional services being completed in the third quarter of fiscal year 2002.

A Tax Sharing Agreement allocates 3Com’s and palmOne’s responsibilities for certain tax matters. The agreement requires palmOne to pay 3Com for the incremental tax costs of palmOne’s inclusion in consolidated, combined or unitary tax returns with affiliated corporations. The agreement also provides for compensation or reimbursement as appropriate to reflect re-determinations of palmOne’s tax liability for periods during which palmOne joined in filing consolidated, combined or unitary tax returns with affiliated corporations.

Each member of a consolidated group for United States federal income tax purposes is jointly and severally liable for the group’s federal income tax liability. Accordingly, palmOne could be required to pay a deficiency in the group’s federal income tax liability for a period during which palmOne was a member of the group even if the Tax Sharing Agreement allocates that liability to 3Com or another member.

Effective as of the date of separation of palmOne from 3Com, subject to specified exceptions, palmOne and 3Com each released the other from any liabilities arising from their respective businesses or contracts, as well as liabilities arising from a breach of the separation agreement or any ancillary agreement.

Transactions with PalmSource

palmOne’s Chairman of the Board, Eric Benhamou, is also the Chairman of the Board of PalmSource. In December 2001, palmOne entered into a software license agreement with PalmSource which was amended and restated in June 2003. The agreement includes a minimum annual royalty and license commitment of $39.0 million, $41.0 million and $42.5 million during each of the contract years in the period ending December 3, 2006. Under the software license agreement, palmOne incurred expenses of $9.2 million, $8.3 million, $28.8 million and $29.7 million during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively.

Subsequent to the date of separation of PalmSource from palmOne, PalmSource will continue to pay palmOne for certain transitional services. During the three and nine months ended February 28, 2004, palmOne recognized $0.1 million and $0.3 million for these transitional services.

Upon the PalmSource distribution, palmOne contributed an additional $6.0 million of cash, forgave a $20.0 million intercompany note receivable and assigned $15.0 million of its convertible note to PalmSource.

As part of the agreements with PalmSource relating to the PalmSource distribution, palmOne 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. In the event that any damages are not paid by palmOne as prescribed by the agreement, PalmSource is obligated to pay any shortfall amounts; however, palmOne is not relieved of its obligation to make the payment or reimburse PalmSource. (See Note 17 to condensed consolidated financial statements.)

A Tax Sharing Agreement allocates palmOne’s and PalmSource’s responsibilities for certain tax matters. palmOne has the responsibility to prepare and file all consolidated tax returns for PalmSource through the date of distribution including final consolidated federal income tax returns of the group. PalmSource’s tax liability will generally be calculated as if PalmSource is a stand-alone corporation. Consistent with the stand-alone methodology, PalmSource will not receive any payments for use by palmOne of any PalmSource operating losses. To the extent those losses reduce PalmSource’s tax liability as a stand-alone corporation in a future period, any required payment to palmOne would be reduced.

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PalmSource will indemnify palmOne for increases (as a result of an amended return or audit or other dispute) in PalmSource’s stand-alone income tax liability or other consolidated tax liability attributable to periods after December 3, 2001, for increases in certain non-income taxes (including payroll and employee withholding taxes) attributable to PalmSource’s business whether before or after December 3, 2001, and for transfer taxes, if any, incurred on the transfer of assets by palmOne to PalmSource. PalmSource will indemnify palmOne for any taxes resulting from an acquisition of PalmSource stock.

Other Transactions and Relationships

In fiscal year 2003, palmOne made a $1.0 million equity investment in and entered into a product procurement agreement with Mobile Digital Media, Inc., a company founded by Barry Cottle, the former Senior Vice President and Chief Internet Officer of palmOne until his employment with palmOne terminated in February 2002. This equity investment is included in other assets. palmOne paid $2.7 million, $2.6 million, $9.9 million and $2.6 million for products purchased under the product procurement agreement during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively. These products were purchased by palmOne for resale.

palmOne purchased $0, $2,000, $41,000 and $111,000 of products from SanDisk Corporation during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively, through a series of purchase orders and without further obligations on the part of palmOne. Judy Bruner, palmOne’s Senior Vice President and Chief Financial Officer, serves as a member of SanDisk’s Board of Directors.

palmOne purchased $0, $140,000, $86,000 and $315,000, of software licenses and services from Kontiki, Inc. during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003. Michael Homer, a current member of palmOne’s Board of Directors, is the Chairman of Kontiki, Inc. Bruce Dunlevie, a current member of palmOne’s Board of Directors, is a partner at Benchmark Capital, which owns more than 10% of the Kontiki stock and has a partner, Kevin Harvey, on the Board of Directors of Kontiki, Inc.

palmOne has entered into business consulting agreements starting in June 2002, with Satjiv Chahil, who was formerly palmOne’s Chief Marketing Officer and is currently a member of the Board of Directors of PalmSource. Under this consulting agreement, palmOne has paid Mr. Chahil approximately $29,000, $56,000, $156,000 and $215,000 in consulting fees during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively. Mr. Chahil assists in positioning the Company and its executives with prospective partners and in representing the interests of the Company with industry and analyst relations activities.

palmOne recorded revenues of $1.6 million and $3.7 million during the three and nine months ended February 28, 2004 from certain subsidiaries of the France Telecom Group. Jean-Jacques Damlamian, a current member of palmOne’s Board of Directors, is the Senior Vice President, Group Technology and Innovation at France Telecom.

palmOne recorded revenues of $2.5 million during the three and nine months ended February 28, 2004 from T-Mobile USA, Inc. Susan Swenson, a current member of palmOne’s Board of Directors and the chairperson of palmOne’s Audit Committee, is the Chief Operating Officer of T-Mobile USA, Inc.

palmOne paid $0, $125,000, $36,000 and $175,000 during the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively, to RealNetworks in connection with bundling of products, web site referrals and engineering assistance. Eric Benhamou, Chairman of palmOne’s Board of Directors, is also a member of RealNetworks’ Board of Directors.

palmOne is involved in a co-promotional sales and marketing relationship with Good Technology. Good Technology is also an indirect distributor and reseller of palmOne products. John Doerr, a current member of palmOne’s Board of Directors, serves as a member of Good Technology’s Board of Directors and is a partner at Klein Perkins Caufield & Byers, which owns more than 10% of the Good Technology stock. Bruce Dunlevie, a current member of palmOne’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 10% of the Good Technology stock.

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19. Subsequent Events

On March 1, 2004, palmOne filed a Tender Offer Statement on Schedule TO which relates to an offer by palmOne to exchange all unexercised options to purchase shares of palmOne’s common stock that are held by eligible employees, whether vested or unvested, that have exercise prices equal to or greater than $20.00 per share (the “Eligible Options”). An “eligible employee” refers to all persons who are employees of palmOne or one of its subsidiaries as of March 1, 2004 and remain employees through the date on which the Eligible Options are cancelled, but does not include members of palmOne’s Board of Directors or palmOne’s Section 16 officers (which term shall mean any persons who are required to file Forms 3, 4 or 5 with respect to palmOne’s securities under the Securities Exchange Act of 1934, as amended).

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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. This quarterly report contains forward-looking statements within the meaning of the federal securities laws, including, without limitation, statements concerning palmOne’s expectations, beliefs and/or intentions regarding the following: demand for our products; our market share; shifts in our average selling price and product mix; the development and introduction of new products and services; competitors and competition in the markets in which palmOne operates; forecasts of revenues and expenses and inventory, accounts receivable and other assets; actions to reduce costs and palmOne’s ability to achieve savings resulting from restructuring; the use of proceeds from the potential sale of securities under palmOne’s universal shelf registration statement; the sufficiency of palmOne’s cash, cash equivalents and credit facility to satisfy its anticipated cash requirements; strategic alliances and the benefits of such strategic alliances; the effects of changes in market interest rates; investment activities, the value of investments and the use of palmOne’s financial instruments; realization of, and actions which palmOne may implement to realize, the tax benefits associated with palmOne net operating loss carryforwards; palmOne’s defenses to legal proceedings and litigation matters; provisions in palmOne’s charter documents and Delaware law and the potential effects of a stockholder rights plan; and the potential impact of our critical accounting policies. 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. palmOne undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Overview

palmOne, Inc. is the leading global provider of handheld computing and communications devices. Our product offerings within the handheld computing and communications device industry include both handheld and smartphone devices. We define a handheld device as a handheld personal computing device, such as a personal digital assistant (“PDA”), that may have wireless data capability but does not have telephony capability. Smartphone devices refer to products combining PDA capability and telephony capability. Our current product offering includes the Zire and Tungsten handheld device product lines and the Treo smartphone device product line.

palmOne was founded in 1992 as Palm Computing, Inc. It was acquired by U.S. Robotics Corporation in 1995 and sold its first handheld product in 1996, quickly establishing a leadership role in the handheld device industry. In 1997, 3Com Corporation (“3Com”) acquired U.S. Robotics. In 1999, 3Com announced the intent to separate the Palm business into an independent company. In preparation for becoming an independent, publicly traded company, Palm Computing, Inc. changed its name to Palm, Inc. (“Palm”) and was reincorporated in Delaware in December 1999. In March 2000, approximately 6% of the shares of Palm common stock were sold in an initial public offering and concurrent private placements, and in July 2000, 3Com distributed the remaining shares of Palm common stock it owned, approximately 94% of Palm’s common stock then outstanding, to 3Com’s stockholders. In December 2001, Palm formed PalmSource, Inc., a stand-alone subsidiary for its operating system business. On October 28, 2003, Palm’s stockholders formally approved a plan to spin-off the Company’s Palm operating system (“OS”) licensing and platform business through the distribution of all of the shares Palm owned of its majority-owned subsidiary, PalmSource, Inc. (“PalmSource”), and acquire Handspring, Inc. (“Handspring”). Immediately following the transaction, Palm, Inc. changed its name to palmOne, Inc. (“palmOne”). The Company completed the spin-off by issuing approximately 0.3098 of a share of PalmSource common stock for each share of Palm common stock outstanding as of October 28, 2003. The distribution of the shares of PalmSource common stock is intended to be tax-free to palmOne and to the Company’s stockholders. Immediately following the PalmSource distribution, palmOne acquired Handspring through a merger transaction between Handspring and a wholly-owned subsidiary of palmOne. In the Handspring acquisition, the stockholders of Handspring received 0.09 of a share of palmOne common stock for each share of Handspring common stock held (an aggregate of approximately 13.6 million shares of palmOne common stock). Commencing with the date of acquisition, October 29, 2003, the Handspring assets acquired and liabilities assumed, as well as the results of Handspring’s operations are included in our condensed consolidated financial statements.

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palmOne’s total revenue has grown from approximately $1 million in fiscal year 1995 to $837.6 million in fiscal year 2003. Substantially all of palmOne’s revenues to date have been generated from sales of its handheld devices and related add-ons and accessories. As of February 28, 2004, palmOne had shipped approximately 25.3 million devices.

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 palmOne’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, 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 guidance and accounting standards, including Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements, as amended, and AICPA Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended. We recognize revenues from sales of handheld computing and communication 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 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, inventory levels in the channel and other related factors. The estimates and reserves for rebates and price protection are based on specific programs, expected usage and historical experience. Actual results could differ from these estimates.

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

Long-lived assets such as land not in use, 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.

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We evaluate the recoverability of goodwill annually or more frequently if impairment indicators arise, as required under Statement of Financial Accounting Standards (“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 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 (“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. If these estimates and related assumptions change in the future, we may be required to increase our valuation allowance against the deferred tax assets resulting in additional income tax expense.

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

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Results of Operations

Our 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. For presentation purposes, the periods are shown as ending on February 28.

The following table sets forth, for the periods indicated, the dollars and percentage of total revenues represented by the line items reflected in palmOne’s condensed consolidated statements of operations. These amounts reflect the reclassification of PalmSource operating results to discontinued operations as a result of the spin-off on October 28, 2003 and include the results of Handspring’s operations commencing with the date of acquisition, October 29, 2003 (dollars and shares in thousands):

	Three Months Ended February 28,
	2004					2003
Revenues	$	242,485		100.0	%	$	197,864		100.0	%
Costs and operating expenses:
Cost of revenues (**)		172,169		71.0			150,725		76.2
Sales and marketing		38,582		15.9			42,199		21.3
Research and development		19,831		8.2			15,702		7.9
General and administrative		9,170		3.8			9,977		5.0
Amortization of intangible assets and stock-based compensation (*)		5,414		2.2			530		0.3
Impairment charges		—		—			102,540		51.8
Restructuring charges		4,522		1.9			37,952		19.3
Total costs and operating expenses		249,688		103.0			359,625		181.8
Operating loss		(7,203	)	(3.0	)		(161,761	)	(81.8	)
Interest and other income (expense), net		(486	)	(0.2	)		(2,574	)	(1.3	)
Loss before income taxes		(7,689	)	(3.2	)		(164,335	)	(83.1	)
Income tax provision		1,633		0.6			1,413		0.7
Loss from continuing operations		(9,322	)	(3.8	)		(165,748	)	(83.8	)
Loss from discontinued operations (net of taxes of $0 and $647, respectively)		—		—			(6,588	)	(3.3	)
Net loss	$	(9,322	)	(3.8	)%	$	(172,336	)	(87.1	)%
Loss per share - basic and diluted:
Continuing operations	$	(0.20	)			$	(5.70	)
Discontinued operations		—					(0.23	)
Net loss	$	(0.20	)			$	(5.93	)
Shares used in computing per share amounts:
Basic and diluted		46,073					29,082
(*) Amortization of intangible assets and stock-based compensation:
Cost of revenues	$	243		0.1	%	$	67		—	%
Sales and marketing		4,709		1.9			205		0.1
Research and development		68		—			126		0.1
General and administrative		394		0.2			132		0.1
Total amortization of intangible assets and stock-based compensation	$	5,414		2.2	%	$	530		0.3	%

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

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	Nine Months Ended February 28,
	2004					2003
Revenues	$	682,308		100.0	%	$	620,491		100.0	%
Costs and operating expenses:
Cost of revenues (**)		491,132		72.0			465,363		75.0
Sales and marketing		116,869		17.1			123,528		19.9
Research and development		51,607		7.6			51,178		8.2
General and administrative		27,219		4.0			27,556		4.4
Amortization of intangible assets and stock-based compensation (*)		7,473		1.1			3,029		0.5
Impairment charges		—		—			102,540		16.5
Restructuring charges		8,110		1.1			35,348		5.8
Total costs and operating expenses		702,410		102.9			808,542		130.3
Operating loss		(20,102	)	(2.9	)		(188,051	)	(30.3	)
Interest and other income (expense), net		965		0.1			2,409		0.4
Loss before income taxes		(19,137	)	(2.8	)		(185,642	)	(29.9	)
Income tax provision		4,415		0.7			221,858		35.8
Loss from continuing operations		(23,552	)	(3.5	)		(407,500	)	(65.7	)
Loss from discontinued operations (net of taxes of $252 and $1,552, respectively)		(11,634	)	(1.7	)		(20,061	)	(3.2	)
Net loss	$	(35,186	)	(5.2	)%	$	(427,561	)	(68.9	)%
Loss per share - basic and diluted:
Continuing operations	$	(0.63	)			$	(14.04	)
Discontinued operations		(0.31	)				(0.69	)
Net loss	$	(0.94	)			$	(14.73	)
Shares used in computing per share amounts:
Basic and diluted		37,373					29,032
(*) Amortization of intangible assets and stock-based compensation:
Cost of revenues	$	331		0.1	%	$	842		0.1	%
Sales and marketing		6,366		0.9			598		0.1
Research and development		132		—			1,188		0.2
General and administrative		644		0.1			401		0.1
Total amortization of intangible assets and stock-based compensation	$	7,473		1.1	%	$	3,029		0.5	%

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

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Revenues

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 February 28, 2004 were $242.5 million, an increase of $44.6 million or approximately 23% from revenues for the three months ended February 28, 2003. The increase in revenues was primarily driven by an increase in our average selling price. During the third quarter of fiscal year 2004, net units shipped were 0.938 million units at an average selling price of $233. During the third quarter of fiscal year 2003, net units shipped were 1.006 million units at an average selling price of $169. The average selling price was up approximately 38% during the third quarter of fiscal year 2004, which was partially offset by the 7% decrease in unit sales. The increase in average selling price reflects a shift in our product mix, particularly due to the addition of the Treo 600 smartphone, and a more favorable pricing environment.

International revenues were approximately 38% of revenues for the three months ended February 28, 2004 compared to approximately 46% of revenues for the three months ended February 28, 2003. The 23% increase in total revenues reflects a 40% increase in United States revenues and a 2% increase in international revenues. The 40% increase in United States revenues is a result of a 51% increase in average selling price, attributable to sales of higher-end products, particularly the Treo 600 smartphone. The 2% increase in international revenues is a result of a 23% increase in average selling price from the sales of higher-end products, partially offset by a 15% decrease in units shipped. The higher increase in United States average selling price as compared to international average selling price is primarily the result of earlier penetration of the Treo 600 smartphone with United States carriers.

Revenues for the nine months ended February 28, 2004 were $682.3 million, an increase of $61.8 million or approximately 10% from revenues for the nine months ended February 28, 2003. The increase in revenues was primarily driven by an increase in our average selling price. During the nine months ended February 28, 2004, net units shipped were 2.997 million units at an average selling price of $204. During the nine months ended February 28, 2003, net units shipped were 3.262 million units at an average selling price of $165. The average selling price was up approximately 24% during the first nine months of fiscal year 2004 which was partially offset by the 8% decrease in unit sales. The increase in average selling price reflects a shift in our product mix during the first nine months of fiscal year 2004, particularly due to the addition of the Treo 600 smartphone, and a more favorable pricing environment.

International revenues were approximately 40% of revenues for the nine months ended February 28, 2004 compared to approximately 39% of revenues for the nine months ended February 28, 2003. The 10% increase in total revenues in the first nine months of fiscal year 2004, as compared to the comparable period in fiscal year 2003, reflects a 12% increase in international revenues and a 9% increase in United States revenues. The 12% increase in international revenues is a result of a 25% increase in average selling price, partially offset by a 10% decrease in units shipped. The 9% increase in United States revenues is a result of a 10% increase in average selling price and a 3% increase in units shipped.

Total Cost of Revenues

‘Total cost of revenues’ is comprised of ‘Cost of revenues’ and the applicable portion of ‘Amortization of intangible assets and stock-based compensation’ as shown in the results of operations table. ‘Cost of revenues’ consists principally of the 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 personnel related costs, depreciation, and related information technology and facilities costs. ‘Total cost of revenues’ was $172.4 million and $150.8 million for the three months ended February 28, 2004 and 2003, respectively. ‘Total cost of revenues’ as a percentage of revenues decreased by 5.1% to 71.1% for the third quarter of fiscal year 2004 from 76.2% for the same period in fiscal year 2003. The decrease is primarily the result of lower product costs as a percentage of revenues for the products introduced during the three months ended February 28, 2004 compared to the products introduced during the prior year, of approximately 6.0%, and a 0.5% decrease in costs due to lower OS royalty expense, partially offset by an approximately 1.3% increase in costs resulting from higher freight charges and other period costs incurred due to product backlog for certain products.

‘Total cost of revenues’ was $491.5 million and $466.2 million for the nine months ended February 28, 2004 and 2003, respectively. ‘Total cost of revenues’ was 72.1% of revenues for the nine months ended February 28, 2004 compared to 75.1% for the same period in fiscal year 2003. The decrease is primarily the result of lower product

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costs as a percentage of revenues for the products introduced during the nine months ended February 28, 2004 compared to the products introduced during the prior year.

Sales and Marketing

Sales and marketing expenses consist principally of advertising and marketing programs, salaries and benefits for sales and marketing personnel, sales commissions, sales support costs, travel expenses and related information technology and facilities costs. Sales and marketing expenses were $38.6 million for the three months ended February 28, 2004 compared to $42.2 million for the three months ended February 28, 2003, a decrease of $3.6 million or approximately 9%. Sales and marketing expenses as a percentage of revenues were 15.9% for the third quarter of fiscal year 2004 compared to 21.3% for the comparable period in fiscal year 2003. The decrease in sales and marketing expenses as a percentage of revenues and in absolute dollars reflects decreased spending related to marketing programs and promotions of approximately $3.4 million reflecting decreased media advertising and marketing development spending, and reduced consulting costs of approximately $1.4 million primarily due to cost containment efforts. The cost decreases were partially offset by increased employee related and travel costs of approximately $0.9 million.

Sales and marketing expenses were $116.9 million for the nine months ended February 28, 2004 compared to $123.5 million for the nine months ended February 28, 2003, a decrease of $6.6 million or approximately 5%. Sales and marketing expenses as a percentage of revenues were 17.1% for the first nine months of fiscal year 2004 compared to 19.9% for the comparable period in fiscal year 2003. The decrease in sales and marketing expenses as a percentage of revenues and in absolute dollars is primarily due to an $8.3 million decrease in consulting, personnel and related costs and depreciation reflecting cost controls and restructuring actions to better align our cost structure with our business operations. These decreases were partially offset by increased sales support costs of $1.3 million consistent with our increased revenues, and increased advertising and market development spending of approximately $0.6 million.

Research and Development

Research and development expenses consist principally of employee related costs, third party development costs, program materials, depreciation and related information technology and facilities costs. Research and development expenses were $19.8 million for the three months ended February 28, 2004 compared to $15.7 million for the three months ended February 28, 2003, an increase of $4.1 million or approximately 26%. Research and development expenses as a percentage of revenues were 8.2% for the third quarter of fiscal year 2004 compared to 7.9% for the comparable period in fiscal year 2003. The increase in research and development expenses as a percentage of revenues and in absolute dollars is primarily due to a $4.0 million increase in consulting and non-recurring engineering costs for development of our smartphone products.

Research and development expenses were $51.6 million for the nine months ended February 28, 2004 compared to $51.2 million for the nine months ended February 28, 2003, an increase of $0.4 million. Research and development expenses as a percentage of revenues were 7.6% for the first nine months of fiscal year 2004 compared to 8.2% for the comparable period in fiscal year 2003. The decrease in research and development expenses as a percentage of revenue is due to higher revenues during the first nine months of fiscal year 2004 compared to the same period of fiscal year 2003. The increase in research and development expenses in absolute dollars is primarily due to non-recurring engineering costs related to our smartphone product of approximately $3.0 million and increased consulting costs of $1.8 million, partially offset by approximately $4.5 million of savings primarily due to restructuring actions initiated to align our cost structure with our business operations.

General and Administrative

General and administrative expenses consist of employee related costs, travel expenses and related 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. General and administrative expenses were $9.2 million for the three months ended February 28, 2004 compared to $10.0 million for the three months ended February 28, 2003, a decrease of $0.8 million or approximately 8%. General and administrative expenses as a percentage of revenues were 3.8% for the third quarter of fiscal year 2004 compared to 5.0% for the comparable period in fiscal year 2003. The decrease in general and administrative expenses in absolute dollars and as a

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percentage of revenues was primarily due to a decrease in our provision for doubtful accounts of $1.3 million partially offset by increased professional services expenses of $0.4 million related to ongoing litigation.

General and administrative expenses were $27.2 million for the nine months ended February 28, 2004 compared to $27.6 million for the nine months ended February 28, 2003, a decrease of $0.4 million. General and administrative expenses as a percentage of revenues were 4.0% for the first nine months of fiscal year 2004 compared to 4.4% for the comparable period in fiscal year 2003. The decrease as a percentage of revenues and in absolute dollars was primarily due to reduced facilities and site services expenses of $1.3 million, decreased consulting expenses of $0.4 million and lower employee related costs of $0.3 million. These decreases were partially offset by increased professional services expenses of $1.5 million related to ongoing litigation and an increase in our provision for doubtful accounts of $0.2 million related to the overall higher balance of gross accounts receivable.

Amortization of Intangible Assets and Stock-Based Compensation

Amortization of intangible assets and stock-based compensation was $5.4 million for the three months ended February 28, 2004 compared to $0.5 million for the three months ended February 28, 2003, an increase of $4.9 million. The acquisition of Handspring as of October 29, 2003 resulted in the recording of certain intangible assets and deferred stock-based compensation for which $5.3 million of amortization was included in the three months ended February 28, 2004. Amortization of stock-based compensation not related to the Handspring acquisition was $0.1 million for the three months ended February 28, 2004, a decrease of $0.4 million from the three months ended February 28, 2003 primarily due to certain restricted stock awards becoming fully amortized during fiscal year 2003.

Amortization of intangible assets and stock-based compensation was $7.5 million for the nine months ended February 28, 2004 compared to $3.0 million for the nine months ended February 28, 2003, an increase of $4.5 million. The acquisition of Handspring as of October 29, 2003 resulted in the recording of certain intangible assets and deferred stock-based compensation for which $7.0 million of amortization was included in the nine months ended February 28, 2004. Amortization of intangible assets for the nine months ended February 28, 2003 was $1.1 million which related to certain intangible assets that became fully amortized or were fully impaired during the fiscal year ended May 31, 2003. Amortization of stock-based compensation not related to the Handspring acquisition decreased $1.4 million primarily due to certain restricted stock awards becoming fully amortized during fiscal year 2003.

Impairment Charges

During the third quarter of fiscal year 2003, we incurred an impairment charge of $102.5 million. This charge includes $100.0 million related to approximately 39 acres of land owned by the Company in San Jose, California. Market conditions for commercial real estate in the Silicon Valley have deteriorated since the land was acquired in May 2001; and, during the third quarter of fiscal year 2003, the Company determined that it no longer expected to hold the land as long as would be required to realize the $160.0 million carrying value. As a result, palmOne had adjusted the carrying value to the then current fair market value of $60.0 million. In addition, a $2.5 million impairment charge was recorded in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, related to the core technology acquired from ThinAirApps. The core technology was no longer considered useful, and its carrying value was not considered to be recoverable. The fair value of the core technology was determined using the discounted cash flow method.

Restructuring Charges

Restructuring charges of $4.5 million recorded during the third quarter of fiscal year 2004 relate to restructuring actions initiated during the quarter, including workforce reductions, in the United States and United Kingdom, of approximately 100 regular employees to streamline the Company consistent with our strategic plan. As of February 28, 2004, approximately 65 regular employees have been terminated as a result of this restructuring.

Restructuring charges of $38.0 million recorded during the third quarter of fiscal year 2003 consist of $16.7 million of charges related to the restructuring actions taken during the third quarter of fiscal year 2003 and a $21.3 million charge related to a change in the estimated costs of the restructuring actions taken in the fourth quarter of fiscal year 2001 primarily due to changes in estimates of sublease income for excess facilities.

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Restructuring charges of $8.1 million recorded during the first nine months of fiscal year 2004 consist of $4.5 million of charges related to restructuring actions taken during the third quarter of fiscal year 2004 and $3.9 million of charges related to the restructuring actions taken during the first quarter of fiscal year 2004 less $0.3 million of net adjustments related to the restructuring actions initiated in the third quarter of fiscal year 2003:

• The first quarter of fiscal year 2004 restructuring actions included workforce reductions, primarily in the United States, of approximately 45 regular employees, facilities and property and equipment disposed of or removed from service during the first quarter of fiscal year 2004 and canceled projects related to the implementation of a series of actions to adjust our business consistent with our future wireless plans. As of February 28, 2004, substantially all of these headcount reductions have been completed.

• The third quarter of fiscal year 2003 restructuring actions included workforce reductions, primarily in the United States, of approximately 140 employees, facilities and property and equipment disposed of or removed from service during the third quarter of fiscal year 2003 and canceled programs related to a series of actions to better align our expense structure with our revenues. As of February 28, 2004, substantially all of these headcount reductions had been completed.

Restructuring charges of $35.3 million recorded during the first nine months of fiscal year 2003 consist of $16.7 million of charges related to the third quarter of fiscal year 2003 restructuring actions and $21.1 million of net charges related to the fourth quarter of fiscal year 2001 restructuring actions, net of $1.5 million of adjustments related to the second quarter of fiscal year 2002 restructuring actions and $1.0 million of adjustments related to the fourth quarter of fiscal year 2002 restructuring actions.

The restructuring actions taken prior to fiscal year 2004 are substantially complete as of the end of the third quarter of fiscal year 2004, except for remaining contractual payments for excess facilities and project termination fees.

Interest and Other Income (Expense), Net

Interest and other income (expense), on a net basis, was $0.5 million of net expense for the three months ended February 28, 2004 compared to $2.6 million of net expense for the three months ended February 28, 2003. Interest and other expense for the third quarter of fiscal year 2004 primarily consisted of $0.6 million of interest income on our cash, cash equivalent and short-term investment balances reduced by a $0.7 million legal settlement and $0.4 million interest expense and bank and other charges. Interest and other expense for the third quarter of fiscal year 2003 primarily consisted of $0.8 million of interest income on our cash balances reduced by $2.6 million of legal settlements and $0.8 million of interest expense and bank and other charges. Interest income decreased primarily as a result of reduced interest rates on our investments. Interest expense and bank and other charges decreased primarily due to a smaller and more cost effective credit facility.

Interest and other income (expense), on a net basis, was $1.0 million of income for the nine months ended February 28, 2004 compared to $2.4 million of income for the nine months ended February 28, 2003. Interest and other income for the first nine months of fiscal year 2004 primarily consisted of $2.0 million of interest income on our cash, cash equivalent and short-term investment balances and $2.3 million of proceeds from reimbursement for a legal settlement, offset by $2.6 million interest expense and bank and other charges and a $0.7 million legal settlement. Interest and other income for the first nine months of fiscal year 2003 primarily consisted of $3.4 million of interest income on our cash balances and $6.3 million of insurance proceeds from a partial insurance settlement of a business interruption claim, offset by $2.6 million of legal settlements and $4.7 million of interest expense and bank and other charges. Interest income decreased primarily as the result of reduced interest rates on our investments. Interest expense and bank and other charges decreased primarily due to a smaller and more cost effective credit facility.

Loss from Discontinued Operations

Loss from discontinued operations was $6.6 million for the three months ended February 28, 2003 and $11.6 million and $20.1 million for the nine months ended February 28, 2004 and 2003, respectively. Included in loss from discontinued operations are the results of operations of PalmSource through the October 28, 2003 distribution date and the historical consolidated separation costs incurred to affect the PalmSource distribution. Loss from

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PalmSource operations was $4.9 million for the three months ended February 28, 2003 and $6.4 million and $14.6 million for the nine months ended February 28, 2004 and 2003, respectively. Historical consolidated separation costs were $1.7 million for the three months ended February 28, 2003 and $5.2 million and $5.5 million for the nine months ended February 28, 2004 and 2003, respectively.

Liquidity and Capital Resources

Cash and cash equivalents at February 28, 2004 were $190.6 million, compared to $205.0 million at May 31, 2003. The decrease of $14.4 million in cash and cash equivalents was primarily attributable to net purchases of short term investments of $49.3 million reduced by approximately $37.0 million of proceeds from the issuance of our common stock to institutional investors under our universal shelf registration statement. Additional changes in our cash and cash equivalents balances include proceeds of $11.2 million from employee stock plan activity and $16.1 million of cash from the Handspring acquisition, offset by $6.0 million in cash paid to PalmSource as a result of the distribution, cash used in operating activities of $19.4 million and cash used for purchase of property and equipment of $4.2 million. Cash used in operating activities consisted primarily of the net loss from continuing operations of $23.6 million, reduced by non-cash charges of $24.2 million, and a net $20.0 million use of cash related to the changes in assets and liabilities, net of the effect of the business combination.

Net accounts receivable were $101.5 million at February 28, 2004, an increase of $4.7 million or 5% from $96.8 million at May 31, 2003. The increase in net accounts receivable was due to an increase in revenues of approximately $25.3 million in the third quarter of fiscal year 2004 compared to the fourth quarter of fiscal year 2003 offset by a decrease in days sales outstanding of receivables (“DSO”) to 38 days at February 28, 2004 from 40 days at May 31, 2003.

The following is a summary of the contractual commitments associated with our debt and lease obligations, as well as our purchase commitments as of February 28, 2004 (in thousands):

	Three Months Ending May 31, 2004		Year Ending May 31,
			2005		2006		2007		2008		Thereafter
Operating lease commitments	$	3,189	$	11,275	$	7,226	$	5,844	$	5,891	$	17,619
Capital lease commitments		223		149		—		—		—		—
Long-term convertible note		—		—		—		35,000		—		—
Other debt obligations		200		800		800		800		533		—
Minimum purchase commitments:
Patent and license		2,400		2,700		—		—		—		—
License and other fees due PalmSource		—		39,000		41,000		42,500		—		—
Total contractual commitments	$	6,012	$	53,924	$	49,026	$	84,144	$	6,424	$	17,619

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

In December 2001, palmOne 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 divided into two separate obligations, a portion retained by palmOne and the remainder assumed by PalmSource. palmOne’s note was issued in the principal amount of $35.0 million. The note bears interest at 5.0% per annum, is due in December 2006 and is convertible into our common stock at an effective conversion price of $64.60 per share. palmOne may force a conversion at any time, provided our common stock has traded above $99.48 per share for a defined period of time. In the event palmOne distributes significant assets, we may be required to repay a portion of the note. The PalmSource distribution did not represent a significant distribution of assets under terms of the note. The PalmSource distribution did not represent a significant distribution of assets under the terms 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 connection with the Handspring acquisition, palmOne assumed two notes with remaining principal amounts of

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$2.5 million and $0.8 million. The notes bear interest at 6% per annum and are payable in equal monthly installments through January 2007. As of February 28, 2004, the remaining principal amounts of the notes are $2.4 million and $0.8 million.

palmOne has a patent and license agreement with a third party vendor under which palmOne is committed to pay $2.4 million in fiscal year 2004 and $2.7 million in fiscal year 2005.

palmOne has an agreement with PalmSource that grants the Company certain licenses to develop, manufacture, test, maintain and support its products. Under this agreement, palmOne has agreed to pay PalmSource license and royalty fees based upon net shipment revenue of its products which incorporate PalmSource’s software, a source code license and maintenance and support fees. The source code license fee is $6.0 million paid in three equal annual installments in June 2003, June 2004 and June 2005. Annual maintenance and support fees are approximately $0.7 million per year. The agreement includes a minimum annual royalty and license commitment of $39.0 million, $41.0 million and $42.5 million during each of the contract years in the period ending December 3, 2006.

palmOne utilizes contract manufacturers to build its products. These contract manufacturers acquire components and build product based on demand forecast information supplied by palmOne, which typically covers a rolling 12-month period. Consistent with industry practice, palmOne 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 palmOne’s forecasted component and manufacturing requirements for periods ranging from 30 to 90 days. As of February 28, 2004, palmOne’s third party manufacturers had inventory on-hand and component purchase commitments related to the manufacture of palmOne products of approximately $164.3 million.

In August 2003, palmOne entered into a two-year, $30.0 million revolving credit line with Silicon Valley Bank (“SVB”). The credit line is secured by assets of palmOne, 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 (4.0% at February 28, 2004) or, at palmOne’s election subject to specific requirements, equal to LIBOR plus 1.75% (2.86% at February 28, 2004). The interest rate may vary based on fluctuations in market rates. palmOne is subject to a financial covenant requirement under this agreement to maintain cash on deposit in the United States of not less than $100.0 million. As of February 28, 2004 palmOne had used its credit line to support the issuance of letters of credit of $8.5 million.

In March 2002, we filed a universal shelf registration statement to give us the flexibility to sell up to $200 million of debt securities, common stock, preferred stock, depository shares and warrants in one or more offerings and in any combination thereof. The net proceeds from the sale of securities offered are intended for general corporate purposes, including to meet working capital needs and for capital expenditures. During August 2003, we sold 2.4 million shares of palmOne common stock under the shelf registration statement to institutional investors for net proceeds of approximately $37.0 million.

We denominate our sales to certain European customers in the Euro, in Pounds Sterling 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. The net result of gains or losses on contracts and revaluation was a gain of $0.4 million, $0.8 million, $0.3 million and $0.2 million for the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively, which is included in interest and other income (expense) in our consolidated statements of operations. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes.

Based on current plans and business conditions, we believe that our existing cash and cash equivalents will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months. The net cash provided by operating activities during the third quarter of fiscal year 2004 was approximately $20.7 million. We anticipate our February 28, 2004 total cash and cash equivalents and short term investments balance of $239.8 million will satisfy our operational cash flow requirements over the next 12 months. Based on our current forecast, we do not anticipate any short-term or long-term liquidity deficiencies. We cannot be certain, however, that our underlying assumed

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levels of revenues and expenses will be accurate. If our operating results do not meet our expectations or if inventory, accounts receivable or other assets require a greater use of cash than is currently anticipated, we could be required to seek additional funding through public or private financings or other arrangements. In such event, adequate funds may not be available when needed or may not be available on favorable terms, which could have a negative effect on our business and financial condition.

Stock Option Information

Our stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and align stockholder and employee interests. We consider our option program critical to employee retention and motivation, and all of our employees participate in the program. The program consists of two plans: one stock option plan under which options to purchase shares of common stock may be granted to employees, directors and consultants; and a second stock option plan under which options to purchase common stock may be granted to non-employee members of the Board of Directors. Option vesting periods typically range from one to four years.

See the “Report Of The Compensation Committee Of The Board of Directors On Executive Compensation” appearing in our joint proxy statement/prospectus dated September 26, 2003 for further information concerning the policies and procedures of palmOne and the Compensation Committee regarding the use of stock options.

The following table provides information about stock options granted for fiscal year-to-date 2004, fiscal year 2003 and fiscal year 2002 for certain executive officers. For fiscal year-to-date 2004, the stock option data is for our current and former Chief Executive Officers and the four individuals who are expected to be the most highly compensated individuals in fiscal year 2004 and who are currently serving as executive officers of palmOne. For fiscal years 2003 and 2002, the stock option data relates to the named executive officers in the executive compensation table of the Proxy Statement for the respective fiscal year.

Employee and Named Executive Officer Option Grants

	2004 YTD		2003		2002
Net grants during the period as a % of outstanding shares	7.6	%	5.9	%	2.1	%
Grants to top five executive officers during the period as a % of total options granted	9.3	%	7.6	%	15.9	%
Grants to top five executive officers during the period as a % of outstanding shares	1.2	%	0.7	%	0.9	%
Cumulative options held by named executive officers as a % of total options outstanding	14.8	%	13.5	%	11.4	%

During the nine months ended February 28, 2004, we granted options to purchase approximately 3.8 million shares of palmOne common stock and assumed 1.9 million options in connection with the Handspring acquisition. Options to purchase approximately 2.2 million shares of palmOne common stock were forfeited. The net grants exclusive of options assumed in the Handspring acquisition represented 6.2% of shares outstanding at the beginning of this fiscal year.

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Activity Under All Stock Option Plans

	Nine Months Ended February 28, 2004				Year Ended May 31, 2003 (2)
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
	(Shares in thousands)
Outstanding, beginning of period	5,783		$	76.92	3,331		$	167.29
Granted (1)	5,739		$	12.42	3,773		$	9.80
Exercised	(1,032	)	$	9.92	(26	)	$	9.05
Cancelled	(2,220	)	$	87.26	(1,295	)	$	115.15
Outstanding, end of period	8,270		$	37.75	5,783		$	76.92

⁽¹⁾ Options granted during the nine months ended February 28, 2004 includes 3.8 million options granted to palmOne employees and directors and 1.9 million options assumed in the Handspring acquisition.

⁽²⁾ As a result of the PalmSource distribution, the exercise prices and number of shares underlying the options were adjusted and restated to preserve the intrinsic value.

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

As of February 28, 2004

	Exercisable			Unexercisable			Total
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
	(Shares in thousands)
In-the-money	1,200	$	5.67	1,284	$	9.24	2,484	$	7.52
Out-of-the-money (1)	2,326	$	95.55	3,460	$	20.59	5,786	$	50.72
Total options outstanding	3,526	$	64.97	4,744	$	17.52	8,270	$	37.75

⁽¹⁾ Out-of-the money options are those options with an exercise price equal to or greater than the closing price of $10.03 per share at the end of the quarter.

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Option Exercises of Named Executive Officers ⁽¹⁾

	Nine Months Ended February 28, 2004			Number of Shares Underlying Unexercised Options at February 28, 2004		Value of Unexercised In-the-Money Options at February 28, 2004 (2)
Name	Number of Shares Acquired on Exercise	Dollar Gain Realized		Exercisable	Unexercisable	Exercisable		Unexercisable
R. Todd Bradley	—	$	—	146,205	287,483	$	18,787	$	22,790
Eric A. Benhamou	—	$	—	163,200	40,740	$	136,773	$	—
Judy Bruner	—	$	—	98,806	102,934	$	8,124	$	9,080
Angel Mendez	24,191	$	205,728	29,121	106,184	$	2,390	$	11,350
Ken Wirt	7,168	$	62,323	47,266	101,478	$	7,288	$	11,350
Mary Doyle	—	$	—	7,168	93,189	$	—	$	184,084

⁽¹⁾ This list represents our current and former Chief Executive Officers and the four individuals who are expected to be the most highly compensated individuals for fiscal year 2004 and who are currently serving as executive officers of palmOne.

⁽²⁾ Based on a fair market value of $10.03 per share as of February 28, 2004, the closing sale price per share of palmOne’s common stock on that date as reported on the Nasdaq National Market.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes our equity compensation plans as of February 28, 2004:

Equity Compensation Plan Information

	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a)		Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (b)		Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
Equity compensation plans approved by security holders	6,719,560	(3)	$	43.63	2,804,197	(1)(2)
Equity compensation plans not approved by security holders	—			—	—
Total	6,719,560		$	43.63	2,804,197

⁽¹⁾ This number of shares includes approximately 1.8 million shares of our common stock reserved for future issuance under our 1999 Employee Stock Purchase Plan, as amended, (the “1999 ESPP”), 0.9 million shares of our common stock reserved for future issuance under our 1999 Stock Plan, as amended, (the “1999 Stock Plan”) and 0.1 million shares of our common stock reserved for future issuance under our Non-Employee Director Stock Option Plan.

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

⁽³⁾ This number of shares does not include outstanding options to purchase 1,549,957 shares of our common stock assumed through various mergers and acquisitions. At February 28, 2004, these assumed options had a weighted average exercise price of $12.28 per share. Except for shares of our common stock underlying the options outstanding

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under these plans, there are no shares of palmOne common stock reserved under these plans, including shares for new grants. In the event that any such assumed option is not exercised, no further option to purchase shares of our common stock will be issued in place of such unexercised option. However, we do have the authority, if necessary, to reserve additional shares of palmOne common stock under these plans to the extent such shares are necessary to effect an adjustment to maintain option value, including intrinsic value, of the outstanding options under these plans in specific circumstances, for example: the PalmSource distribution.

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Business Environment and Risk Factors

You should carefully consider the risks described below and the other information in this Form 10-Q. The risks and uncertainties described below are not the only ones facing palmOne, and there may be additional risks that we do not presently know of or that we currently deem immaterial. The business, results of operations or financial condition of palmOne could be seriously harmed if any of these risks materialize. The trading price of shares of palmOne common stock may also 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 predict. Our future operating results may fluctuate significantly and may not meet our expectations or those of securities analysts or investors. If this occurs, the price of our stock will likely decline. Factors that may cause fluctuations in our operating results include, but are not limited to, the following:

• changes in consumer and enterprise spending levels;

• changes in general economic conditions and specific market conditions;

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

• price and product competition from other handheld or smartphone devices or other devices with similar functionality;

• seasonality of demand for our products and services;

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

• quality issues with our products;

• changes in terms, pricing or promotional programs;

• competition for consumer discretionary spending by other products;

• loss of key distributors or other channel customers;

• inability of our third party manufacturers or suppliers to produce sufficient quantities of quality products or product components on time;

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

• failure to achieve targeted product cost reductions and operating expense reductions;

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

• excess inventory or insufficient inventory to meet demand; and

• litigation brought against us.

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

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If we fail to develop and introduce new products and services successfully and in a timely manner, or 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 operate in a highly competitive, rapidly evolving environment, and our future success depends on our ability to develop and introduce new products and services that our customers and end-users choose to buy. If we are unsuccessful at developing and introducing new products and services that are appealing to our customers and end-users with acceptable prices and terms, we will not be able to compete effectively and our ability to generate revenues will suffer.

The development of new products and services can be very difficult and requires high levels of innovation. The development process is also lengthy and costly. If we fail to anticipate our end users’ needs or technological trends accurately or are unable to complete the development of products and services in a cost effective and timely fashion, we will be unable to introduce new products and services into the market or successfully compete with other providers. In addition, if we fail to timely develop wireless products that meet carrier product planning cycles, our wireless device sales volumes may be negatively impacted. As a result, our revenues and cost of revenues could be adversely affected.

Wireless carriers significantly affect the ability of smartphone providers such as us 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 smartphone 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 deliver sufficient quantities of product in a timely manner to wireless carriers, those carriers may choose to offer similar products from our competitors and thereby reduce their focus on our products. In addition, 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 additional carrier networks and affect our ability to timely deliver products to customers.

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 arising from the integration of new technology, and a potentially different sales and support environment relating to any new technology. Our failure to manage the transition to newer products or the integration of newer technology into new or existing products could adversely affect our business and financial results.

Changes in demand for handheld computing and communications devices may adversely affect our revenues and results of operations.

We operate in the handheld computing and communications industry which incorporates both handheld and smartphone devices. Over the last couple of years, we have seen year-over-year declines in the volume of handheld devices sold while demand for smartphone devices has continued to develop. 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 operation could be adversely affected.

If we are unable to compete effectively with existing or new competitors, our resulting loss of competitive position could result in price reductions, fewer customer orders, reduced margins and loss of market share, and our results of operations and financial condition would suffer.

We compete in the handheld computing and communications industry with both handheld and smartphone solutions. The market for these products and services is highly competitive, and we expect increased competition in the future, particularly as companies from various established industry segments, such as mobile handset, personal computer and consumer electronics, increasingly develop and market products that compete with our products. Some of our competitors or potential competitors possess capabilities developed over years of serving customers in their

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respective markets that might enable them to compete more effectively than us in certain customer segments. In addition, many of our competitors have significantly greater financial, technical and marketing resources 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. They may also devote greater resources to the development, promotion and sale of their products. They may also be better able to withstand lower prices in order to gain market share at our expense. Finally, these competitors bring with them customer loyalties, and such loyalties may limit our ability to attract new users despite superior product offerings.

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

• personal computer companies which also develop and sell handheld computing products, such as Acer, Apple, Dell, Hewlett-Packard and Toshiba;

• consumer electronics companies which also develop and sell handheld computing products, such as Casio, Sharp and Sony;

• Research In Motion Limited (“RIM”), a leading provider of wireless email, instant messaging and Internet connectivity;

• mobile handset manufacturers which also develop and sell wireless handheld and smartphone products such as Audiovox, HTC Corporation, Kyocera, LG, Motorola, Nokia, Samsung, Sanyo and Sony-Ericsson; and

• a variety of privately held start-up companies looking to compete in our current and future markets, such as Danger and Tapwave.

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

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

The recent separation of PalmSource into an independent company may result in more competition for our handheld and smartphone devices as PalmSource may license the Palm OS to companies who compete directly or indirectly with us. For example, PalmSource has a license agreement with Sony and has signed Palm OS license agreements with HuneTech, Lenovo (formerly known as Legend) and Group Sense (International) Limited, located in the Asia Pacific region. Increased competition from licensees of the Palm OS platform could negatively impact our revenues, gross margins and results of operations.

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, fewer customer orders, reduced margins and loss of market share. Failure to compete successfully against current or future competitors could seriously harm our business, financial condition and results of operations.

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

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

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

Because of their large sales channels, strategic 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 customer demand and inventory levels required by the carriers. As we develop new strategic relationships and launch new products with new and existing strategic partners, our smartphone 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 customer demand.

We are primarily a device solutions company and do not have the diversification that we had prior to spinning off PalmSource’s operating system and software business.

We develop, market and sell handheld and smartphone devices, add-ons and accessories as well as related services and software. Developing and licensing operating system software, personal information management software and software development tools is the business of PalmSource, which is now an independent public company outside of our control, though we are not precluded from re-entering the operating system and software licensing markets. As a result, we lack the diversification that PalmSource provided and are more dependent on the hardware side of the mobile device industry and its fluctuations, and our stock price is subject to greater volatility.

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

We outsource most of our hardware design to third party manufacturers. We depend on their design expertise and we rely on them to design our products at satisfactory quality levels. If our third party manufacturers fail to provide quality hardware design, our reputation and revenues could suffer. In addition, these third party designers and manufacturers have access to our intellectual property which increases the risk of infringement or misappropriation of such intellectual property.

We outsource all of our manufacturing requirements to third party manufacturers. We depend on them to produce a sufficient volume of our products in a timely fashion and at satisfactory quality levels. If our third party manufacturers fail to produce quality products on time and in sufficient quantities, our reputation and results of operations could suffer. In addition, we rely on our third party manufacturers to place orders with suppliers for the components they need to manufacture our products. If they fail to place timely and sufficient orders with suppliers, our revenues could suffer.

Our handheld and smartphone device products are currently manufactured by our third party manufacturers at their international facilities, which are located primarily in China and Mexico. In addition, we have entered into an agreement with a third party manufacturer to manufacture and sell our handheld device products in Brazil. The cost, quality and availability of third party manufacturing operations are essential to the successful production and sale of our handheld and smartphone devices. Our reliance on third party manufacturers exposes us to risks, which are not in our control and our revenues or cost of revenues could be negatively impacted. For example, an outbreak of Severe Acute Respiratory Syndrome (SARS) in China could result in quarantines or closures of our third party

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manufacturers or their suppliers. In the event of such a quarantine or closure, our revenues, or cost of revenues and results of operations, could be negatively impacted.

We do not have manufacturing agreements with all of the third party manufacturers upon which we rely to manufacture our device products. The absence of a manufacturing agreement means that, with little or no notice, 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. In addition, if these manufacturers were to change the terms under which they manufacture for us, our manufacturing costs could increase and our cost of revenues could increase.

We outsource most of the warranty support, product repair and technical services for our products to third party providers. 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 revenues could suffer. We are currently in the process of transitioning the majority of our customer and product support to a new third party provider and if this transition is not completed in a timely and seamless manner, the satisfaction of our customers and our results of operations could suffer.

As a result of the Handspring acquisition, we may choose to rationalize 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.

Our contract distribution 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 facility providers may close or move their facilities with little notice to us, which could cause disruption in our ability to deliver products. In addition, we do not have contracts with all of our third party distribution providers. The absence of agreements means that, with little or no notice, these distribution facility providers could refuse to continue to provide warehouse and distribution services for all or some of our devices or change the terms under which they provide such services. Any disruption of distribution facility services could have a negative impact on our revenues and results of operations. For example, we have recently transferred our outsourced distribution and warehouse services for the United States, Canada and most of Latin America, to a new provider. Any interruption or delay in delivery of our products could have a significant, adverse impact on our market share, revenues, results of operations and financial condition.

Changes in transportation schedules due to terrorist threats or attacks, military activity, labor disruptions or carrier financial difficulties could cause transportation delays and increase our costs for both receipt of inventory and shipment of products to our customers. For instance, our primary domestic freight carrier filed for bankruptcy immediately after the close of our first quarter of fiscal year 2003. This led to delayed deliveries to our customers. Additionally, labor disputes of West coast dockworkers in the second quarter of fiscal year 2003 led to less capacity and higher costs for the transportation alternatives we normally use. If these types of disruptions occur, our results of operations could be adversely impacted.

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

Our handheld and smartphone products contain components, including liquid crystal displays, touch panels, memory chips, microprocessors, cameras, radios and batteries, that are procured from a variety of suppliers. The cost, quality and availability of components are essential to the successful production and sale of our device products.

Some components, such as screens and related integrated circuits, digital signal processors, microprocessors, radio frequency components and other discrete components, come from sole source suppliers, one of which is also a competitor of ours in certain markets. Alternative sources are not always available or may be financially prohibitive. In addition, even when we have multiple qualified suppliers, we may compete with other purchasers for allocation of scarce components. If suppliers were unable or unwilling to meet our demand for components and if we are unable

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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 smartphone device products will be seriously harmed. For example, we are currently experiencing a shortage of screens and related integrated circuits that is affecting 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 are currently capacity constrained due to high industry demand for some components and relatively long lead times to expand capacity.

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

Our product strategy is substantially dependent on the Palm OS, and PalmSource, the owner of Palm OS, is now an independent public company no longer under our control. We will not benefit from any previous synergies or shared resources. Our relationship with PalmSource may also have an adverse impact on the willingness of third parties to do business with us.

We have a license agreement with PalmSource, which extends through December 2006. Our license of the Palm OS from PalmSource is critical to the operation of our products. While we are not contractually precluded from licensing or developing an alternative operating system, doing so could be less desirable and could be costly in terms of cash and other resources. We currently rely exclusively on PalmSource to provide the operating system for all of our handheld and smartphone device products. Termination of this license, an adverse change in our relationship with PalmSource, PalmSource’s failure to supply a competitive platform or an unfavorable outcome in any material lawsuit involving the Palm OS could seriously harm our business. Additionally, we are contractually obligated to make minimum annual payments to PalmSource regardless of the volume of devices we sell containing the Palm OS. Our business could be seriously harmed if:

• we were to breach the license agreement and PalmSource terminated the license;

• PalmSource were to be acquired and the acquiring company was not as strategically aligned with us as PalmSource;

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

• we were to develop devices on alternative OS platforms, yet still owe PalmSource minimum royalties.

Our business would also be harmed if PalmSource were not able to successfully implement its business strategy or is otherwise unsuccessful as a stand-alone company. In addition, we cannot assure you that PalmSource will remain an independent public company now that the distribution has occurred. While our software license agreement with PalmSource includes certain protections for us if PalmSource 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.

Given our historical and ongoing relationships with PalmSource other operating system companies may decline to do business with us or may do business with us on less favorable terms, which could adversely affect our business and results of operations.

Other than restrictions on the use of certain trademarks and domain names, nothing prohibits palmOne from competing with PalmSource or offering products based on a competing operating system, and, other than the restrictions on the use of certain trademarks and domain names, nothing prohibits PalmSource from competing with palmOne or offering PalmSource’s operating system to competitors of palmOne. palmOne and PalmSource may not be able to resolve any potential conflicts that may arise between us, which may damage our relationship with PalmSource.

palmOne is a defendant in several intellectual property lawsuits 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, we could still be adversely affected by a determination adverse to PalmSource as a result of market

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uncertainty, or product changes that may be advisable or required due to such lawsuits, or failure of PalmSource to adequately indemnify us.

We rely on wireless carriers, distributors, retailers and resellers to sell our products and provide us with timely and accurate information, and disruptions to these channels or their failure to provide timely and accurate information could adversely affect our results of operations and financial condition.

Our wireless carriers, distributors, retailers and resellers sell products offered by our competitors. If our competitors offer our wireless carriers, distributors, retailers and resellers 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 channel customers could decide to de-emphasize the product categories that we offer in exchange for other product categories that they believe provide higher returns. For example, we were recently notified by one of our significant retail customers that it plans to de-emphasize handheld devices. If we are unable to maintain successful relationships with carriers, distributors, retailers and resellers 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, our wireless carriers, distributors, retailers or resellers could modify their business practices, such as payment terms or inventory levels. Unexpected changes in return requests, inventory levels, payment terms or other practices by our channel customers could negatively impact our revenues or our financial condition.

We rely on our 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 in our forecasting process as one of the factors 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-user customers, and there is also competition among Internet-based resellers. We also sell our products directly to end-user customers from our palmOne.com web site and our Palm cafes. These varied sales channels could cause conflict among our channels of distribution, which could harm our revenues and results of operations.

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

We outsource the operations of our e-commerce web store 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 under which they provide these services, our selling costs could increase.

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

The success of our smartphones and wireless business strategy is highly dependent on our ability to establish new relationships and build on our existing relationships with strategic 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 smartphones. Factors that are largely within the control of wireless carriers but which are important to the success of our smartphones, include:

• the wireless carriers’ interest in testing our smartphones on their networks;

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• the quality and coverage area of voice and data services offered by the wireless carriers for use with our smartphones;

• the degree to which wireless carriers will facilitate the successful introduction of our smartphones and actively promote, distribute and resell our smartphones;

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

• the timely build out of advanced wireless carrier networks such as Universal Mobile Telecommunications System (“UMTS”) and Evolution Data Only (“EVDO”), which are expected to enhance the user experience for email and other services through higher speed and “always on” functionality;

• the conditions imposed on us in our agreements with wireless carriers that, in some circumstances, could limit our ability to make similar products available through competitive carriers in some markets;

• the wireless carriers’ pricing requirements and subsidy programs; and

• the pricing and terms of voice and data rate plans that the wireless carriers will offer for use with our smartphones.

For example, flat data rate pricing plans offered by some wireless carriers may expose us to risk. 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 smartphones, such plans may not allow our smartphones to contribute as much average revenue per user (ARPU) to wireless carriers as when they are priced incrementally, and therefore reduces our differentiation from other products. 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.

The amount of future wireless carrier subsidies is uncertain, and wireless carriers are free to lower or reduce their subsidies with little notice to us.

When we sell our wireless products on our own website, we sometimes have the opportunity to earn subsidies from wireless carriers if the 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 palmOne with subsidies may reduce or discontinue these subsidies with little notice. While we believe wireless carriers will continue to offer subsidies to palmOne, 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 sell at prices that are attractive to cost sensitive consumers.

More broadly, 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 revenues and our results of operations.

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

Our handheld and smartphone 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. We must develop our hardware and software application products quickly to keep pace with the rapidly changing handheld computing and communications market, and we have a history of frequently introducing new products. Products and services as sophisticated as ours are likely to contain undetected errors or defects, especially when first introduced or when new models or versions are released. We invested significantly in the acquisition of Handspring which recently introduced the Treo 600 smartphone. We believe that the Treo 600 is critical to our success in the smartphone device business and our overall future success, but it is still a new product. Our handheld and smartphone 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, revenues, cost of revenues and financial condition.

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We have limited use and control of the Palm and palmOne brands following the PalmSource distribution, which could adversely affect our revenues and results of operations.

We believe that the Palm brand is a valuable asset. Prior to the PalmSource distribution, all Palm and PalmSource trade names, trademarks, service marks and domain names containing the word or letter string “palm” were assigned to the Palm Trademark Holding Company, LLC, a holding company owned by palmOne and PalmSource for the purpose of receiving, holding, maintaining, registering, enforcing and defending such intellectual property. Following the PalmSource distribution, we changed our branding strategy and corporate name to palmOne and Nasdaq ticker symbol to “PLMO”. While we will continue to use elements of the Palm brand pursuant to a trademark license from the holding company, we will have limited use of the Palm and Palm related brands and we cannot assure you that these changes will not have an adverse impact on our business. If we develop a product based on an OS platform other than the Palm OS, we would not be able to use the word or letter string “palm” in the branding of that product. Because our company name includes the letter string “palm”, such a product may result in the need to modify our corporate structure, which could be costly, and incur significant marketing expenses to establish a new brand. In addition, if we are unable in the future to license the Palm-related trademarks, service marks, domain names and trade names from the Palm Trademark Holding Company, LLC, or if the holding company fails to enforce its intellectual property rights in them successfully, our competitive position could suffer, which could harm our business.

Third parties have claimed and may claim in the future that we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling products if these claims are successful.

In the course of our business, we frequently receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. For example, as our focus has shifted to wireless communicators, 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 or cross-licenses to incorporate or use the proprietary technologies in our products. Third parties may claim that we or our customers are infringing or contributing to the infringement of their intellectual property rights, and we may be found to infringe or contribute to the infringement of those intellectual property rights and require a license to use those rights. We may be unaware of intellectual property rights of others that may cover some of our technology, products and services.

Any litigation regarding patents or other intellectual property could be costly and time consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of litigation generally increase the risks associated with intellectual property litigation. Moreover, patent litigation has increased due to the current uncertainty of the law and the increasing competition and overlap of product functionality in our markets. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements or 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 development and sale or our products.

If we are unsuccessful in our litigation with Xerox, our business, results of operations and financial condition could be significantly 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. While the District Court dismissed the case in 2000, ruling that the Xerox patent is not infringed by the Graffiti handwriting recognition system, Xerox appealed the dismissal. The Appellate Court reversed and remanded the case to the District Court for further proceedings. The District Court subsequently found the patent valid, enforceable and infringed. Palm appealed the judgment in December 2001.

In February 2002, the District Court rejected an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The Court also rejected a request by Xerox for a trial date to determine damages, but required us to post a $50 million bond, a decision from which we appealed; Xerox filed a cross-appeal. The Federal Appeals Court decided in February 2003 that the Xerox patent is infringed by the

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Graffiti handwriting recognition system, but remanded the case to the District Court to determine whether the patent is valid, thereby lifting the requirement that Palm post a bond. In its opinion, however, the Appellate Court directed that, in the event the patent is held valid, Xerox would be entitled to an injunction. Proceedings on the issue of the validity of the patent are now pending in the District Court.

We cannot assure you that palmOne will be successful in the litigation. If we are not successful, 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. 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. Accordingly, if Xerox is successful, our business, results of operations and financial condition could be significantly harmed and we may be rendered insolvent. In addition, Xerox might again seek an injunction preventing us or Palm OS licensees from offering products with Palm OS with Graffiti handwriting recognition software. We have largely transitioned our products to a handwriting recognition software, as well as to physical keyboards, that does not use Graffiti.

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 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 operating results.

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. The unauthorized use of our technology or of our proprietary information by competitors could have a material adverse effect on our ability to sell our products.

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 a proprietary. Accordingly, we cannot assure you that we will be able to protect our proprietary rights against unauthorized third party copying or use. Use by others of our proprietary rights could materially harm our business.

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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 are active 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.

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 additional industry expertise. Acquisitions could result in difficulties assimilating acquired operations and products, and result in the diversion of capital and management’s attention away from other business issues and opportunities. Integration of acquired companies may result in problems related to integration of technology and management teams. We may not successfully integrate operations, personnel or products that we have acquired or may acquire in the future. If we fail to successfully integrate acquisitions, our business could be materially harmed. In addition, our acquisitions may not be successful in achieving our desired strategic objectives, which would also cause our business to suffer. These transactions may result in the diversion of capital and management’s attention away from other business issues and opportunities. Acquisitions can also lead to large non-cash charges that can have a material 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 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 position.

Although we expect that our acquisition of Handspring will result in benefits, we may not realize those benefits because of integration and other challenges.

Our failure to meet the challenges involved in successfully integrating the operations of Handspring or to realize any of the anticipated benefits of the acquisition of Handspring, including the anticipated annual cost savings of approximately $25 million from improved operating efficiencies, could seriously harm our results of operations. Realizing the benefits of the transaction will depend in part on the integration of technology, operations and personnel. The integration of the companies is a complex, time-consuming and expensive process that, without proper planning and implementation, could significantly disrupt our business. The challenges involved in this integration include the following:

• retaining key employees, and their technical expertise and customer relationships, and maintaining employee morale for both employees of our historical business and employees from Handspring;

• overcoming any perceived adverse changes in business focus, including demonstrating to our customers that the acquisition of Handspring will not result in adverse changes in customer service standards or business focus and helping customers conduct business easily with palmOne;

• consolidating operations, including rationalizing corporate information technology and administrative infrastructures;

• combining product offerings;

• coordinating sales and marketing efforts to effectively communicate the capabilities of palmOne;

• coordinating and rationalizing research and development activities to enhance introduction of new products and technologies with reduced cost;

• balancing investment between our handheld solutions and the smartphone solutions acquired from Handspring;

• preserving distribution, manufacturing, supplier, marketing and other important relationships of both our historical business and Handspring and resolving potential conflicts that may arise;

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• minimizing the diversion of management attention away from regular business responsibilities and ongoing business concerns due to their integration activities;

• overcoming potential incompatibility of the business cultures of our historical business and Handspring; and

• coordinating and combining foreign operations, relationships and facilities, which may be subject to additional constraints imposed by local laws and regulations.

Failure to successfully integrate Handspring or to realize the anticipated benefits and synergies of the acquisition could seriously harm our results of operations and future business prospects.

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 and the market value of our common stock.

The historical financial information for palmOne, which includes results of the PalmSource business as discontinued operations, does not necessarily reflect what palmOne’s financial position, results of operations and cash flows would have been had the PalmSource business not been a part of Palm during historical periods. The results of operations and financial position of PalmSource were carved out of the historical results of operations of Palm and are not necessarily indicative of what each business would have represented as separate stand-alone companies. In addition, 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 or intangible assets with indefinite lives becomes impaired, we may be required to incur material charges relating to the impairment of those assets. These depreciation, amortization and potential impairment charges could have a material impact on our results of operations, which could adversely affect the market value of our common stock.

We need to obtain third-party consents for certain agreements Handspring had with third parties as a result of the acquisition of Handspring, and, if we cannot obtain these consents, we may not be able to maintain these relationships on favorable terms or at all.

We are currently attempting to obtain third-party consents for some agreements Handspring had with third parties providing for a consent right upon a change of control, but, if we are unable to do so, we may be forced to renegotiate these agreements or enter into new agreements with various third parties. The Handspring agreements requiring consent include certain agreements with carriers and other agreements with developers, strategic partners, distributors and suppliers. We cannot assure you that we will be able to negotiate new agreements on terms as favorable to us as those that Handspring had, or at all.

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

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%. As a result of the acquisition of Handspring, we experienced a change in our ownership of approximately 30%. In the event the usage of these net operating losses is subject to limitation and we are profitable, our cash flows could be adversely impacted due to our increased tax liability.

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

In the course of our business, we occasionally receive consumer protection claims, general commercial claims related to the conduct of our business and the performance of our products and services, employment claims and

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other litigation claims. Any litigation regarding these consumer, commercial, employment and other claims could be costly and time-consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of consumer, commercial, 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.

PalmSource may be required to indemnify us for tax liabilities we may incur in connection with the distribution of the 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 (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 us or our U.S. stockholders. 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 us and PalmSource, 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. PalmSource may not be able to adequately satisfy its indemnification obligation under the tax sharing agreement. In addition, under the tax sharing agreement, palmOne has agreed to indemnify PalmSource for certain taxes and similar obligations that PalmSource could incur under certain circumstances. 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.

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

We license third-party software and hardware for use in our handheld and smartphone device products. This includes the Palm OS and third-party software embedded in the Palm OS. Our ability to release and sell our products could be seriously harmed if the third-party technology is not delivered to us in a timely manner or contains errors or defects that are not discovered and fixed prior to release of our products and we are unable to obtain alternative technology to use in our products. As a result, our product shipments could be delayed or our offering of features could be reduced, which could adversely affect our business and results of operations.

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

Our future success depends on our ability to attract and retain highly skilled personnel. We compensate our employees through a combination of salary, bonuses, benefits and equity compensation. If we fail to provide competitive compensation to our employees, we may be unable to retain them. 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.

palmOne’s practice has been to provide incentives to all of its employees through the use of broad based stock option plans. Proposed accounting rules concerning the expensing of stock options may cause us to reevaluate our use of stock options as an employee incentive. Our ability to hire, retain and motivate our personnel may suffer as a result.

In addition, many key personnel and executives hold options that have exercise prices per share that are significantly above the market price of our common stock and the number of shares available for new option grants is limited. We may find it difficult to provide competitive stock option grants and the ability to hire, retain and motivate key personnel may suffer.

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In recent quarters, we have initiated reductions in our workforce of both employees and contractors to balance the size of our employee base with our anticipated revenue base. These reductions have resulted in reallocations of 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.

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;

• potentially negative consequences from 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 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 results of operations and business growth could be harmed.

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 and cash equivalents 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 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.

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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 to 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. While we currently have no immediate plans to sell this property, 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.

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

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

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 revenues and results of operations.

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 requires stockholder approval. 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.

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;

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• 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 thereof shares of our preferred stock, or shares of an acquiring entity, having a value equal to twice the then-current exercise price of the right. The issuance of the rights could have the effect of delaying or preventing a change in control of us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk.

We currently maintain an investment portfolio consisting mainly of 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 issue or issuer. Our investment portfolio is invested primarily in debt securities. We do not use derivative financial investments in our investment portfolio. Our cash and cash equivalents are primarily invested with maturities of less than 90 days, and an immediate and uniform increase in market interest rates of 100 basis points from levels at February 28, 2004 would cause an immaterial decline in the fair value of our cash and cash equivalents. Our short term investment portfolio is invested with maturities of greater than 90 days but less than two years, and an immediate and uniform increase in market interest rates of 100 basis points from levels at February 28, 2004, would cause a decline of less than 1.5% 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 and in Swiss Francs. Expenses and other transactions are also incurred in a variety of currencies. We hedge certain balance sheet

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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. The net of gains and losses from these contracts and the revaluation of the foreign denominated assets and liabilities was a gain of $0.4 million, $0.8 million, $0.3 million and $0.2 million for the three months ended February 28, 2004 and 2003 and the nine months ended February 28, 2004 and 2003, respectively, and is included in interest and other income (expense) in our condensed consolidated statements of operations. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes. Movements in currency exchange rates could cause variability in our revenues, expenses or interest and other income (expense).

Equity Price Risk

We have investments in public and private companies valued at approximately $1.2 million as of February 28, 2004. Investments in publicly traded companies are subject to market price volatility, and investments in privately held companies are illiquid and inherently risky, as their technologies or products are typically in the early stages of development and may never materialize. We could experience declines in the value of our investments or even lose the entire value of these investments.

Item 4. Controls and Procedures

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 quarterly 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 quarterly 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. We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

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 period covered by this report 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

palmOne 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. palmOne believes that it has defenses to the cases set forth below and is vigorously contesting these matters. palmOne is not currently able to estimate, with reasonable certainty, the possible loss, or range of loss, if any, from the cases listed below, but an unfavorable resolution of these lawsuits could materially adversely affect palmOne’s business, results of operations or financial condition. (Although Palm, Inc. is now palmOne, Inc. and Handspring has been merged into palmOne, the pleadings in the pending litigation continue to use former company names, including Palm Computing, Inc., Palm, Inc. and Handspring, Inc.)

On April 28, 1997, Xerox Corporation filed suit in the United States District Court for the Western District of New York. The case came to be captioned Xerox Corporation v. 3Com Corporation, U.S. Robotics Corporation, U.S. Robotics Access Corp., and Palm Computing, Inc., Civil Action No. 97-CV-6182T. The complaint alleged willful infringement of U.S. Patent No. 5,596,656 (the “‘656 patent”), entitled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint sought unspecified damages and to permanently enjoin the defendants from infringing the patent in the future. In 2000, the District Court dismissed the case, ruling that the patent is not infringed by the Graffiti handwriting recognition system used in handheld computers using Palm’s operating systems.

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Xerox appealed the dismissal to the United States Court of Appeals for the Federal Circuit (“CAFC”). On October 5, 2001, the CAFC affirmed-in-part, reversed-in-part and remanded the case to the District Court for further proceedings. On December 20, 2001, the District Court granted Xerox’s motion for summary judgment that the patent is valid, enforceable and infringed. The defendants filed a Notice of Appeal on December 21, 2001. On February 22, 2002, the Court denied a request for an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The Court also rejected a request by Xerox to set a trial date to determine damages Xerox claims it is owed. In connection with the denial of Xerox’s request to set a trial date on damages, the Court required Palm to post a $50.0 million bond, which was satisfied with a letter of credit from a financial institution. A Notice of Appeal from the District Court’s order of February 22, 2002 was filed by Palm on March 15, 2002. A cross-appeal from the District Court’s order of February 22, 2002 was filed by Xerox on March 4, 2002. A hearing on the appeal and cross-appeal was held on January 6, 2003 before the CAFC. The CAFC has remanded the case to the District Court for a determination on the issue of invalidity of the ‘656 patent. Xerox petitioned the CAFC for reconsideration of its determination on the appeal and cross-appeal, but the CAFC has denied this petition and eliminated the requirement for the $50 million bond from Palm. If palmOne is not successful regarding the remand to the District Court, the CAFC has noted that an injunction will apply. If an injunction is sought by Xerox and issued, it could result in business interruption for palmOne that would have a significant adverse impact on palmOne’s operations and financial condition if palmOne has not transitioned to a handwriting recognition system outside the scope of Xerox’s asserted claims. In addition, if palmOne is not successful with regard to this remand to the District Court, Xerox has stated in its Court pleadings that it will seek at a trial, a significant compensatory and punitive damage award or license fees from palmOne. Furthermore, if palmOne is not successful in the proceedings in the District Court, palmOne might be liable to PalmSource’s licensees and other third parties under contractual obligations or otherwise sustain adverse financial impact if Xerox seeks to enforce its patents claims against PalmSource’s licensees and other third parties. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation. On December 10, 2003 the District Court heard oral arguments on palmOne’s motion for summary judgment due to invalidity and Xerox’s motion for summary judgment that the patent is not invalid. A decision on such motions is pending.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against “3Com, Inc.” in the United States District Court for the Southern District of New York and later filed, on March 6, 2000, an amended complaint against Palm and 3Com. The case is now captioned E-Pass Technologies, Inc. v. 3Com Corporation, a/k/a 3Com, Inc. and Palm, Inc., Civil Action No. 00 CIV 1523. The amended complaint alleges willful infringement of U.S. Patent No. 5,276,311, entitled “Method and Device for Simplifying the Use of Credit Cards, or the Like” 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. The case was transferred to the United States District Court for the Northern District of California. In an order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. On August 21, 2003, the CAFC issued a ruling reversing the claim construction of the District Court and the attendant summary judgment motion and remanded the case to the District Court for further proceedings. On February 9, 2004 E-Pass filed another lawsuit in the Northern District of California naming palmOne, Handspring and PalmSource as defendants, a case captioned E-Pass Technologies, Inc. v. palmOne, Inc., PalmSource, Inc. and Handspring, Inc., Civil Action C04-0528. This recently filed suit alleges infringement, contributory infringement and inducement of infringement of the same patent, but identified additional products as infringing and seeks unspecified compensatory damages, treble damages and a permanent injunction against future infringement. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the E-Pass litigation.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, entitled, respectively, “Portable Personal Terminal for Use in a System for Handling Transactions” and “System for Handling Transactions Including a Portable Personal Terminal.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. On August 28, 2003, the District Court granted both Palm’s and Handspring’s motions for summary judgment, ruling that neither parties’ products infringe the NCR patents, and denied NCR’s motion. NCR appealed the ruling to the Court of Appeals for the Federal Circuit and the parties are in the briefing phase of that appeal.

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In June 2001, the first of several putative stockholder class action lawsuits was filed in United States District Court, Southern District of New York against certain of the underwriters for Palm’s initial public offering, Palm and several of its officers. The complaints, which have been consolidated under the caption In re Palm, Inc. Initial Public Offering Securities Litigation, 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. All of these various consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with plaintiffs. The Court denied Palm’s motion to dismiss. Special committees of both Palm’s and Handspring’s respective Boards of Directors recently 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 palmOne 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. palmOne believes that it has meritorious defenses to the claims against it and against Handspring and intends to defend the action vigorously if the case does not settle.

On June 19, 2001, DataQuill Limited filed suit against Handspring in the United States District Court for the Northern District of Illinois, case no. 01-CV-4635. The complaint alleges infringement of one U.S. patent and seeks unspecified compensatory and treble damages and to permanently enjoin future infringement. Handspring filed an answer on August 1, 2001, denying DataQuill’s allegations and asserting counterclaims for declaratory judgments that Handspring did not infringe the patent in suit, that the patent in suit is invalid, and that it is unenforceable. On August 7, 2002, Handspring filed motions for summary judgment for non-infringement and invalidity, which were renewed in filings made on October 29, 2002. On February 28, 2003, the Court granted in part and denied in part the summary judgment motions. DataQuill then filed a motion for this ruling to be reconsidered, which on April 16, 2003 the Court granted in part and denied in part. The case is expected to go to trial in 2004.

On August 7, 2001, a purported consumer class action lawsuit was filed against Palm and 3Com in California Superior Court, San Francisco County. The case is captioned Connelly et al v. Palm, Inc., 3Com Corp et al, Case No. 323587. An amended complaint alleging breach of warranty and violation of California’s Unfair Competition Law was filed and served on Palm on August 15, 2001. The amended complaint, filed on behalf of purchasers of Palm III, IIIc, V and Vx handhelds, alleges that certain Palm handhelds may cause damage to PC motherboards by permitting an electrical charge, or “floating voltage,” from either the handheld or the cradle to be introduced into the PC via the serial and/or USB port on the PC. The plaintiffs allege that this damage is the result of a design defect in one or more of the following: HotSync software, handheld, cradle and/or the connection cable. The complaint seeks restitution, rescission, damages, an injunction mandating corrective measures to protect against future damage as well as notifying users of potential harm. Discovery is closed. The parties engaged in mediation and reached settlement, which received preliminary Court approval in December 2003 and the settlement class members received notification in early 2004 pursuant to the Court order. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, palmOne may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Connelly litigation.

On January 23, 2002, a purported consumer class action lawsuit was filed against Palm in California Superior Court, San Francisco County. The case is captioned Eley et al v. Palm, Inc., Case No. 403768. The unverified complaint, filed on behalf of purchasers of Palm m500 and m505 handhelds, alleges (1) that the HotSync function in certain Palm handhelds does not perform as advertised and the products are therefore defective and (2) that upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty. The complaint alleges Palm’s actions are a violation of California’s Unfair Competition Law and a breach of express warranty. The complaint seeks alternative relief including an injunction to have Palm desist from selling and advertising the handhelds, to recall the defective handhelds, to restore the units to their advertised functionality, to pay restitution or disgorgement of the purchase price of the units and/or damages and attorneys’ fees. Palm filed its answer denying the allegations and the parties engaged in document and deposition discovery. Plaintiff and Palm engaged in mediation and reached a settlement which received final Court approval in February 2004.

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On March 11, 2002, a purported consumer class action lawsuit was filed against Palm in the Wayne County Circuit Court, Detroit, Michigan. The case is captioned Hayman, et al. v Palm, Inc., Case No. 02-208249-CP. Plaintiffs allege that certain of Palm’s advertisements for its Palm III, V and m100 handheld devices were false or misleading regarding the ability of the device to wirelessly and remotely access emails or the Internet without the need for additional hardware or software sold separately. Plaintiffs allege violations of the Michigan Consumer Protection Act, breach of express and implied warranties and Michigan common law, and seek to recover the purchase price of the device from Palm for themselves and a class of all similarly situated consumers. Palm filed a motion to dismiss the lawsuit in its entirety which the Court granted in March 2004.

In August and September 2002, four purported consumer class action lawsuits were filed against Palm in California Superior Court, Santa Clara County; California Superior Court, San Diego County; Illinois Circuit Court, Cook County; and Illinois Circuit Court, St. Clair County. The respective cases are captioned Lipner and Ouyang v. Palm, Inc., Case No. CV-810533; Veltman v. Palm, Inc., Case No. 02CH16143; Wireless Consumer’s Alliance, Inc. v. Palm, Inc., Case No. GIC-794940; and Cokenour v. Palm, Inc., Case No. 02L0592. All four cases allege consumer fraud regarding Palm’s representations that its m130 handheld personal digital assistant supported more than 65,000 colors. Certain of the cases also allege breach of express warranty and unfair competition. In general, the cases seek unspecified damages and/or to enjoin Palm from continuing it’s allegedly misleading advertising. The parties agreed to a settlement which received final Court approval in February 2004.

In October 2002, a purported consumer class action lawsuit was filed against Palm in Illinois Circuit Court, Cook County. The case is captioned Goldstein v. Palm, Inc., Case No. 02CH19678. The case alleges consumer fraud regarding Palm’s representations that its m100, III, V, and VII handheld personal digital assistant, as sold, would provide wireless access to the Internet and email accounts, and would perform common business functions including data base management, custom form creation and viewing Microsoft Word and Excel documents, among other tasks. The case seeks unspecified actual damages and indemnification of certain costs. In September 2003, the Court granted Palm’s motion to dismiss the complaint, but allowed the plaintiff the opportunity to amend and refile which plaintiff did in October 2003. Palm made another motion to dismiss, which motion is currently pending.

On January 23, 2003, Peer-to-Peer Systems LLC filed a complaint against Palm in the United States District Court for the District of Delaware. The case is captioned Peer-to-Peer Systems, LLC vs. Palm, Inc., Civil Action No. 03-115. The complaint alleges infringement, contributory infringement, inducement of infringement of U.S. Patent No. 5,618,045 entitled “Interactive Multiple Player Game System and Method of Playing a Game Between at Least Two Players”. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendant from infringing the patent in the future. palmOne believes that the claims are without merit and intends to defend against them vigorously. The case is scheduled for trial in 2004.

On February 27, 2003, a purported consumer class action lawsuit was filed against Palm in California Superior Court, Santa Clara County. The case is captioned Hemmingsen et al v. Palm, Inc., Case No. CV815074. The unverified complaint, filed on behalf of purchasers of Palm m515 handhelds, alleges that such handhelds fail at unacceptably high rates, and in particular that instant updating and synchronization of data with PCs often will not occur. The complaint further alleges that, upon learning of the problem, Palm did not perform proper corrective measures for individual customers as set forth in the product warranty, among other things. The complaint alleges that Palm’s actions violate California’s Unfair Competition Law and constitute a breach of warranty. The complaint seeks restitution, disgorgement, damages, an injunction mandating corrective measures including a full replacement program for all allegedly defective m515s or, alternatively mandating a refund to all purported class members of the full purchase price for their m515s, and attorneys’ fees. The parties have begun the discovery process and also engaged in mediation of the claims.

On or about June 17 and 19, 2003, respectively, two putative class action lawsuits were filed in the Court of Chancery in the State of Delaware in and for the County of New Castle against Palm, Handspring and various officers and directors of Handspring. The cases are captioned Goldhirsch v. Handspring, Inc., et. al, Civil Action No. 20376-NC and Majarian v. Handspring, Inc., et. al, Civil Action No. 20381-NC. The Majarian complaint was amended on or about June 23, 2003 to, among other things, delete certain previously named officer defendants. Both complaints allege that the officers and directors of Handspring breached their fiduciary duties to Handspring stockholders by, among other things, failing to undertake an appropriate evaluation of Handspring’s net worth as a

59

merger or acquisition candidate and failing to maximize Handspring stockholder value by not engaging in a meaningful auction of Handspring. The Majarian complaint also alleges, among other things, that the officers and directors of Handspring breached their fiduciary duties by failing to act independently so that the interests of Handspring’s public stockholders would be protected and enhanced. Both complaints allege that Palm aided and abetted the alleged breaches of fiduciary duty of Handspring’s officers and directors. Both complaints seek, among other things, a preliminary and permanent injunction against the transaction, a rescission of the transaction if it is consummated and unspecified damages. The Goldhirsch complaint also requests, among other things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or a market check. The cases were consolidated and a tentative settlement was reached in October 2003 subject to appropriate documentation, confirmatory discovery and Court approval.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed 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	Assignment and Assumption Agreement between 3Com and registrant, as amended.	10-Q	000-29597	2.2	4/10/00
2.3	Master Technology Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.3	4/10/00
2.4	Master Patent Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.4	4/10/00
2.5	Master Trademark Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.5	4/10/00
2.6	Employee Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.6	4/10/00
2.7	Tax Sharing Agreement between 3Com and the registrant.	10-Q	000-29597	2.7	4/10/00
2.8	Master Transitional Services Agreement between 3Com and the registrant.	10-Q	000-29597	2.8	4/10/00
2.9	Real Estate Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.9	4/10/00
2.10	Master Confidential Disclosure Agreement between 3Com and the registrant.	10-Q	000-29597	2.10	4/10/00
2.11	Indemnification and Insurance Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.11	4/10/00
2.12	Form of Non-U.S. Plan.	S-1	333-92657	2.12	12/13/99
2.13	Agreement and Plan of Reorganization between the registrant, Peace Separation Corporation, Harmony Acquisition Corporation and Handspring, Inc., dated June 4, 2003.	8-K	000-29597	2.1	6/6/03
2.14	Amended and Restated Master Separation Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.14	8/18/03
2.15	General Assignment and Assumption Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.15	8/18/03
2.16	Amendment No. 1 to General Assignment and Assumption Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.16	8/18/03
2.17	Amended and Restated Indemnification and Insurance Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.17	8/18/03

61

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.18	Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.18	9/25/03
2.19	Amendment No. 1 to Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.19	8/18/03
2.20	Amendment No. 2 to Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.20	9/25/03
2.21	Elaine Software License and Software and Services Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.20	8/18/03
2.22	SDIO License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.21	8/18/03
2.23	Development Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.22	8/18/03
2.24	Amended and Restated Tax Sharing Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.23	8/18/03
2.25	Amended and Restated Intercompany Loan Agreement between the registrant and PalmSource Holding Company.	S-4/A	333-106829	2.24	8/18/03
2.26	Assignment and Assumption Agreement for the Amended and Restated Intercompany Loan Agreement between the registrant and PalmSource Holding Company and PalmSource, Inc.	S-4/A	333-106829	2.25	8/18/03
2.27	Master Technology Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.26	8/18/03
2.28	Amendment No. 1 to Master Technology Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.27	8/18/03
2.29	Master Confidential Disclosure Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.28	8/18/03
2.30	Amendment No. 1 to Master Confidential Disclosure Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.29	8/18/03
2.31	Master Patent Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.30	8/18/03
2.32	Strategic Collaboration Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.31	8/18/03
2.33	Amendment No. 1 to Strategic Collaboration Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.32	8/18/03
2.34	Xerox Litigation Agreement between the registrant and PalmSource, Inc., as amended.	10-K/A	000-29597	2.34	9/26/03
2.35	Employee Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.34	8/18/03

62

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.36	Letter Agreement Regarding Cash Contributions between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.35	8/18/03
2.37	Business Services Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.36	8/18/03
2.38	Amended and Restated Operating Agreement of Palm Trademark Holding Company, LLC.	S-4/A	333-106829	2.38	9/25/03
2.39	Amended and Restated Trademark License Agreement between the registrant and Palm Trademark Holding Company, LLC.	S-4/A	333-106829	2.39	9/26/03
2.40	Loan Agreement between the registrant and Handspring, Inc., dated as of June 4, 2003.	S-4	333-106829	2.37	7/3/03
3.1	Amended and Restated Certificate of Incorporation	10-Q	000-29597	3.1	10/11/02
3.2	Amended and Restated Bylaws	10-Q	000-29597	3.2	1/12/04
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-Q	000-29597	4.2	1/12/04
4.3	Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank)	8-K	000-29597	4.1	11/22/00
4.4	5% Convertible Subordinated Note, dated as of November 4, 2003					X
4.5	Certificate of Ownership and Merger Merging PLMO Merger Corporation into Palm, Inc.					X
10.1	1999 Stock Plan, as amended.	S-8	333-109302	10.1	9/30/03
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.	10-Q	000-29597	10.3	1/10/03
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**	Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the registrant.	S-1/A	333-92657	10.10	2/25/00

63

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
10.10	Common Stock Purchase Agreement between America Online (now AOL Time Warner) and the registrant.	S-1/A	333-92657	10.11	1/28/00
10.11	Common Stock Purchase Agreement between Motorola and the registrant.	S-1/A	333-92657	10.12	1/28/00
10.12	Common Stock Purchase Agreement Between Nokia and the registrant.	S-1/A	333-92657	10.13	1/28/00
10.13	Form of Management Retention Agreement.	S-1/A	333-92657	10.14	2/28/00
10.14**	First Amendment to Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the registrant.	10-Q	000-29597	10.19	4/11/01
10.15	Employment Offer Letter for David C. Nagel dated September 13, 2001.	10-Q	000-29597	10.24	10/15/01
10.16**	Agreement and General Release of All Claims between the registrant and Carl J. Yankowski dated as of November 8, 2001.	10-Q/A	000-29597	10.25	4/17/02
10.17**	Convertible Note Purchase Agreement dated December 6, 2001.	10-Q/A	000-29597	10.26	4/17/02
10.18	Registration Rights Agreement dated as of December 6, 2001.	10-Q/A	000-29597	10.27	4/17/02
10.19**	Amendment Number Two to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.28	4/17/02
10.20**	Loan Agreement by and among Palm Europe Limited, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.29	4/17/02
10.21**	Guarantee and Debenture by and between Palm Europe Limited and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.30	1/14/02
10.22	General Continuing Guaranty by the registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q	000-29597	10.31	1/14/02
10.23	Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.32	1/14/02
10.24**	Loan Agreement by and among Palm Global Operations Ltd., Foothill Capital Corporation, Heller Financial, Inc., and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.33	4/17/02
10.25	Guarantee and Debenture by and between Palm Global Operations Limited and Foothill Capital Corporation dated as of January 7, 2002.	10-Q	000-29597	10.34	1/14/02

64

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
10.26	General Continuing Guaranty by the registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q	000-29597	10.35	1/14/02
10.27	Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.36	1/14/02
10.28	Amendment Number One to Value Added Reseller Agreement between Cingular Interactive, L.P. (formerly known as BellSouth Wireless Data, L.P., which was formerly known as RAM Mobile Data USA Limited Partnership) and the registrant.	10-Q/A	000-29597	10.37	2/26/02
10.29**	Sublease Agreement by and between Cisco Systems Inc. and the registrant.	10-K	000-29597	10.38	7/30/02
10.30	Amendment Number Three to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 22, 2002.	10-Q	000-29597	10.41	10/11/02
10.31	Amendment Number Four to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of June 7, 2002.	10-Q	000-29597	10.42	10/11/02
10.32	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
10.33	Form of Severance Agreement for Executive Officers.	10-Q	000-29597	10.44	10/11/02
10.34	Management Retention Agreement between the registrant and Marianne Jackson dated as of February 12, 2002.	10-Q	000-29597	10.45	10/11/02
10.35	Amended and Restated 2001 Stock Option Plan for Non-Employee Directors.	10-Q	000-29597	10.46	1/10/03
10.36	Management Retention Agreement between the registrant and Judy Bruner dated as of March 17, 2000.	10-Q	000-29597	10.48	4/14/03
10.37†	Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597	10.39	10/14/03
10.38	Severance Agreement between the registrant and Marianne Jackson dated as of September 18, 2003.	10-Q	000-29597	10.40	10/14/03
10.39	Handspring, Inc. 1998 Equity Incentive Plan, as amended.	S-8	333-110055	10.1	10/29/03
10.40	Handspring, Inc. 1999 Executive Equity Incentive Plan, as amended.	S-8	333-110055	10.2	10/29/03
10.41	Handspring, Inc. 2000 Equity Incentive Plan, as amended.	S-8	333-110055	10.3	10/29/03
31.1	Certification of Chief Executive Officer under Rule 13a-14(a)					X

65

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
31.2	Certification of Chief Financial Officer under Rule 13a-14(a)					X
32.1	Certification of Chief Executive Officer and Chief Financial Officer under Rule 13a-14(b)					X

** Confidential treatment granted on portions of this exhibit.

† Confidential treatment requested on portions of this exhibit. Unredacted versions of this exhibit have been filed separately with the Commission.

(b) Reports on Form 8-K

(1) On December 18, 2003, the registrant furnished a Current Report on Form 8-K reporting under Item 12 of Form 8-K that on December 18, 2003, the registrant was issuing a press release and holding a conference call regarding its financial results for the second quarter of fiscal year 2004 and including such press release as an exhibit under Item 7 of Form 8-K.

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Signatures

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

		palmOne, Inc. (Registrant)
Date:	April 6, 2004	By:	/s/    JUDY BRUNER
			Judy Bruner Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed 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	Assignment and Assumption Agreement between 3Com and registrant, as amended.	10-Q	000-29597	2.2	4/10/00
2.3	Master Technology Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.3	4/10/00
2.4	Master Patent Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.4	4/10/00
2.5	Master Trademark Ownership and License Agreement between 3Com and the registrant.	10-Q	000-29597	2.5	4/10/00
2.6	Employee Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.6	4/10/00
2.7	Tax Sharing Agreement between 3Com and the registrant.	10-Q	000-29597	2.7	4/10/00
2.8	Master Transitional Services Agreement between 3Com and the registrant.	10-Q	000-29597	2.8	4/10/00
2.9	Real Estate Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.9	4/10/00
2.10	Master Confidential Disclosure Agreement between 3Com and the registrant.	10-Q	000-29597	2.10	4/10/00
2.11	Indemnification and Insurance Matters Agreement between 3Com and the registrant.	10-Q	000-29597	2.11	4/10/00
2.12	Form of Non-U.S. Plan.	S-1	333-92657	2.12	12/13/99
2.13	Agreement and Plan of Reorganization between the registrant, Peace Separation Corporation, Harmony Acquisition Corporation and Handspring, Inc., dated June 4, 2003.	8-K	000-29597	2.1	6/6/03
2.14	Amended and Restated Master Separation Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.14	8/18/03
2.15	General Assignment and Assumption Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.15	8/18/03
2.16	Amendment No. 1 to General Assignment and Assumption Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.16	8/18/03
2.17	Amended and Restated Indemnification and Insurance Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.17	8/18/03

68

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.18	Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.18	9/25/03
2.19	Amendment No. 1 to Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.19	8/18/03
2.20	Amendment No. 2 to Amended and Restated Software License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.20	9/25/03
2.21	Elaine Software License and Software and Services Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.20	8/18/03
2.22	SDIO License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.21	8/18/03
2.23	Development Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.22	8/18/03
2.24	Amended and Restated Tax Sharing Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.23	8/18/03
2.25	Amended and Restated Intercompany Loan Agreement between the registrant and PalmSource Holding Company.	S-4/A	333-106829	2.24	8/18/03
2.26	Assignment and Assumption Agreement for the Amended and Restated Intercompany Loan Agreement between the registrant and PalmSource Holding Company and PalmSource, Inc.	S-4/A	333-106829	2.25	8/18/03
2.27	Master Technology Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.26	8/18/03
2.28	Amendment No. 1 to Master Technology Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.27	8/18/03
2.29	Master Confidential Disclosure Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.28	8/18/03
2.30	Amendment No. 1 to Master Confidential Disclosure Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.29	8/18/03
2.31	Master Patent Ownership and License Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.30	8/18/03
2.32	Strategic Collaboration Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.31	8/18/03
2.33	Amendment No. 1 to Strategic Collaboration Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.32	8/18/03
2.34	Xerox Litigation Agreement between the registrant and PalmSource, Inc., as amended.	10-K/A	000-29597	2.34	9/26/03
2.35	Employee Matters Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.34	8/18/03

69

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
2.36	Letter Agreement Regarding Cash Contributions between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.35	8/18/03
2.37	Business Services Agreement between the registrant and PalmSource, Inc.	S-4/A	333-106829	2.36	8/18/03
2.38	Amended and Restated Operating Agreement of Palm Trademark Holding Company, LLC.	S-4/A	333-106829	2.38	9/25/03
2.39	Amended and Restated Trademark License Agreement between the registrant and Palm Trademark Holding Company, LLC.	S-4/A	333-106829	2.39	9/26/03
2.40	Loan Agreement between the registrant and Handspring, Inc., dated as of June 4, 2003.	S-4	333-106829	2.37	7/3/03
3.1	Amended and Restated Certificate of Incorporation	10-Q	000-29597	3.1	10/11/02
3.2	Amended and Restated Bylaws	10-Q	000-29597	3.2	1/12/04
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-Q	000-29597	4.2	1/12/04
4.3	Preferred Stock Rights Agreement between the registrant and EquiServe Trust Company, N.A. (formerly Fleet National Bank)	8-K	000-29597	4.1	11/22/00
4.4	5% Convertible Subordinated Note, dated as of November 4, 2003					X
4.5	Certificate of Ownership and Merger Merging PLMO Merger Corporation into Palm, Inc.					X
10.1	1999 Stock Plan, as amended.	S-8	333-109302	10.1	9/30/03
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.	10-Q	000-29597	10.3	1/10/03
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**	Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the registrant.	S-1/A	333-92657	10.10	2/25/00

70

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
10.10	Common Stock Purchase Agreement between America Online (now AOL Time Warner) and the registrant.	S-1/A	333-92657	10.11	1/28/00
10.11	Common Stock Purchase Agreement between Motorola and the registrant.	S-1/A	333-92657	10.12	1/28/00
10.12	Common Stock Purchase Agreement Between Nokia and the registrant.	S-1/A	333-92657	10.13	1/28/00
10.13	Form of Management Retention Agreement.	S-1/A	333-92657	10.14	2/28/00
10.14**	First Amendment to Supply Agreement between Manufacturers’ Services Salt Lake City Operations, Inc. and the registrant.	10-Q	000-29597	10.19	4/11/01
10.15	Employment Offer Letter for David C. Nagel dated September 13, 2001.	10-Q	000-29597	10.24	10/15/01
10.16**	Agreement and General Release of All Claims between the registrant and Carl J. Yankowski dated as of November 8, 2001.	10-Q/A	000-29597	10.25	4/17/02
10.17**	Convertible Note Purchase Agreement dated December 6, 2001.	10-Q/A	000-29597	10.26	4/17/02
10.18	Registration Rights Agreement dated as of December 6, 2001.	10-Q/A	000-29597	10.27	4/17/02
10.19**	Amendment Number Two to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.28	4/17/02
10.20**	Loan Agreement by and among Palm Europe Limited, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.29	4/17/02
10.21**	Guarantee and Debenture by and between Palm Europe Limited and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.30	1/14/02
10.22	General Continuing Guaranty by the registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q	000-29597	10.31	1/14/02
10.23	Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.32	1/14/02
10.24**	Loan Agreement by and among Palm Global Operations Ltd., Foothill Capital Corporation, Heller Financial, Inc., and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q/A	000-29597	10.33	4/17/02
10.25	Guarantee and Debenture by and between Palm Global Operations Limited and Foothill Capital Corporation dated as of January 7, 2002.	10-Q	000-29597	10.34	1/14/02

71

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
10.26	General Continuing Guaranty by the registrant in favor of Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of November 30, 2001.	10-Q	000-29597	10.35	1/14/02
10.27	Share Charge by and between Palm Ireland Investment and Foothill Capital Corporation dated as of November 30, 2001.	10-Q	000-29597	10.36	1/14/02
10.28	Amendment Number One to Value Added Reseller Agreement between Cingular Interactive, L.P. (formerly known as BellSouth Wireless Data, L.P., which was formerly known as RAM Mobile Data USA Limited Partnership) and the registrant.	10-Q/A	000-29597	10.37	2/26/02
10.29**	Sublease Agreement by and between Cisco Systems Inc. and the registrant.	10-K	000-29597	10.38	7/30/02
10.30	Amendment Number Three to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of March 22, 2002.	10-Q	000-29597	10.41	10/11/02
10.31	Amendment Number Four to Loan Agreement by and among the registrant, Foothill Capital Corporation, Heller Financial, Inc. and The CIT Group/Business Credit, Inc. dated as of June 7, 2002.	10-Q	000-29597	10.42	10/11/02
10.32	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
10.33	Form of Severance Agreement for Executive Officers.	10-Q	000-29597	10.44	10/11/02
10.34	Management Retention Agreement between the registrant and Marianne Jackson dated as of February 12, 2002.	10-Q	000-29597	10.45	10/11/02
10.35	Amended and Restated 2001 Stock Option Plan for Non-Employee Directors.	10-Q	000-29597	10.46	1/10/03
10.36	Management Retention Agreement between the registrant and Judy Bruner dated as of March 17, 2000.	10-Q	000-29597	10.48	4/14/03
10.37†	Loan and Security Agreement between the registrant and Silicon Valley Bank.	10-Q	000-29597	10.39	10/14/03
10.38	Severance Agreement between the registrant and Marianne Jackson dated as of September 18, 2003.	10-Q	000-29597	10.40	10/14/03
10.39	Handspring, Inc. 1998 Equity Incentive Plan, as amended.	S-8	333-110055	10.1	10/29/03
10.40	Handspring, Inc. 1999 Executive Equity Incentive Plan, as amended.	S-8	333-110055	10.2	10/29/03
10.41	Handspring, Inc. 2000 Equity Incentive Plan, as amended.	S-8	333-110055	10.3	10/29/03
31.1	Certification of Chief Executive Officer under Rule 13a-14(a)					X

72

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	File No.	Exhibit	Filing Date	Filed Herewith
31.2	Certification of Chief Financial Officer under Rule 13a-14(a)					X
32.1	Certification of Chief Executive Officer and Chief Financial Officer under Rule 13a-14(b)					X

** Confidential treatment granted on portions of this exhibit.

† Confidential treatment requested on portions of this exhibit. Unredacted versions of this exhibit have been filed separately with the Commission.

73

EX-4.4

Exhibit 4.4

THIS SECURITY AND THE COMMON STOCK ISSUABLE UPON ITS CONVERSION HAVE NOT BEEN REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN AVAILABLE EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT AND IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES AND OTHER JURISDICTIONS.

palmOne, Inc.

5% CONVERTIBLE SUBORDINATED NOTE DUE 2006

No. A-2 $ 35,000,000

palmOne, Inc., a Delaware corporation (the “Company”), for value received, hereby promises to pay to Texas Instruments Incorporated, or registered assigns, the principal sum of Thirty-Five Million Dollars ($35,000,000) on December 6, 2006 and to pay interest thereon, from December 6, 2001, or from the most recent interest payment date under the Prior Note (as defined below) to which interest has been paid, semi-annually on June 15 and December 15 in each year, commencing June 15, 2002, at the rate of 5% per annum until the principal hereof is due. The interest so payable on any interest payment date will be paid to the Person in whose name this Security (or one or more predecessor Securities) is registered at 5:00 p.m., San Francisco time, on the regular record date for such interest, which shall be the date five (5) Business Days immediately prior to the interest payment date. Payment of the principal of (and premium, if any, on) this Security shall be made upon the surrender of this Security to the Company, at its chief executive office (or such other office within the United States as shall be designated by the Company to the holder hereof) (the “Designated Office”), in such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts. Payment of interest and all other amounts payable with respect to this Security shall be made by wire transfer to the holder, provided that if the holder shall not have furnished wire instructions in writing to the Company on or prior to the third Business Day immediately prior to the date on which the Company makes such payment, such payment may be made by U.S. dollar check mailed to the address of the Person entitled thereto as such address shall appear in the Company security register. Capitalized terms used and not otherwise defined herein, shall have the respective meanings given to those terms in Section 7 hereof. This Security may not be redeemed, in whole or in part, at the election of the Company prior to the stated maturity date set forth above. This Security is one of the notes issued pursuant to Section 3(g) of the 5% Convertible Subordinated Note due 2006 (the “Prior Note”) issued by the Company.

1. Conversion.

(a) (1) Subject to the terms and conditions of Section 1(a)(5) hereof, the holder of this Security is entitled at any time and from time to time before the close of business on December 6, 2006 (or, in case the holder hereof has exercised its right to require the Company to repurchase this Security or a portion hereof pursuant to Section 2 hereof, then in respect of this Security or such portion hereof, as the case may be, until and including, but (unless the Company defaults in making the payment due upon repurchase) not after, 5:00 p.m., New York City time, on the Business Day prior to the the Repurchase Date), to convert this Security (or any portion of the principal amount hereof that is an integral multiple of $1,000), into fully paid and nonassessable Common Stock (as hereinafter defined) (calculated as to each conversion to the nearest 1/1000 of a share) of the Company at the rate of 15.48 shares of Common Stock for each $1,000 principal amount of Security (or at the then current adjusted rate if an adjustment has been made as provided below) (the “Conversion Rate”) by surrender of this Security, duly endorsed or assigned to the Company or in blank to the Company at the Designated Office, accompanied by written notice to the Company that the holder hereof elects to convert this Security (or if less than the entire principal amount hereof is to be converted, specifying the portion hereof to be converted).

(2) Subject to the terms and conditions of Section 1(a)(5) hereof, the Company is entitled by giving written notice as specified below at any time on or after December 6, 2002 to cause this Security to be converted in whole but not in part into fully paid and nonassessable shares of Common Stock (calculated as to the nearest 1/1000 of a share) of the Company at the Conversion Rate then in effect (the “Company Conversion”) if the Closing Price of the Common Stock of the Company shall have exceeded 154% of the then applicable Conversion Price (i) for twenty (20) Trading Days in any thirty (30) consecutive Trading Days ending on any Trading Day within five (5) Business Days immediately prior to the date of notice and (ii) on the last Trading Day of such thirty (30) consecutive Trading Day period referred to in the preceding clause (i). The Company shall give to all holders of Securities, in the manner provided in Section 8(b) hereof, notice (the “Company Conversion Notice”) of the Company Conversion. Each Company Conversion Notice shall state (i) the date of the Company Conversion which shall be a date no more than thirty (30) but not less than fifteen (15) days after the date of the mailing of the Company Conversion Notice (the “Company Conversion Date”), (ii) the amount of interest, if any, to be paid by the Company on the Company Conversion Date, (iii) the place or places where such Securities are to be surrendered for conversion, and (iv) the Conversion Rate then in effect. The holder shall surrender this Security to the Company, duly endorsed or assigned to the Company or in blank, at the Designated Office on or prior to the close of business on the Company Conversion Date; provided that any failure of the holder to surrender the Security as provided herein shall not invalidate the conversion or the effective date thereof. The Company shall deliver to the holders of this Security not more than five (5) Trading Days after delivery by the holder of this Security to the Company the certificates representing shares of Common Stock issuable upon conversion of this Security.

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(3) Upon surrender of this Security for conversion, the holder will be entitled to payment in cash of the interest accruing on the principal amount of this Security then being converted and unpaid to such date of conversion.

(4) Subject to Section 1(b) below, no payment or adjustment is to be made on conversion for dividends on the Common Stock issued on conversion hereof. No fractions of shares or scrip representing fractions of shares will be issued on conversion, but instead of any fractional interest, the Company shall pay a cash adjustment, computed on the basis of the Closing Price of the Common Stock on the Trading Day immediately prior to the Company Conversion Date, or, at its option, the Company shall round up to the next higher whole share.

The Company shall, if the holder so elects, deliver the Common Stock issuable upon conversion of this Security to any third party designated by the holder, subject to compliance with Sections 1(f) and 8(c) hereof.

(5) In the event that the conversion of this Security into shares of Common Stock would require the Company and the holder of this Security to file notification and report forms with the Federal Trade Commission and Antitrust Division of the Department of Justice (the “FTC”) pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), then the holder of this Security and the Company agree (i) to use their reasonable best efforts to complete promptly all applicable filings and provide all necessary information as required pursuant to the HSR Act, and (ii) such conversion of this Security into shares of Common Stock shall not occur until such time as the required filings are made pursuant to the HSR Act and the required waiting periods have passed or early termination notifications have been granted by the FTC.

(b) The Conversion Rate will be subject to adjustments from time to time as follows:

(1) In case the Company shall pay or make a dividend or other distribution on Common Stock of the Company payable in Common Stock, the Conversion Rate in effect at the opening of business on the day following the Determination Date (as hereinafter defined) for such dividend or other distribution shall be increased by dividing such Conversion Rate by a fraction of which the numerator shall be the number of shares of Common Stock outstanding at the close of business on such Determination Date and the denominator shall be the sum of such number of shares of Common Stock and the total number of shares of Common Stock constituting such dividend or other distribution, such increase to become effective immediately after the opening of business on the day following such Determination Date. For the purposes of this paragraph (1), the number of shares of Common Stock at any time outstanding shall not include Common Stock held in the treasury of the Company but shall include Common Stock issuable in respect of scrip certificates issued in lieu of fractions of Common Stock. The Company will not pay any dividend or make any distribution on Common Stock held in the treasury of the Company.

3

(2) In case the Company shall issue rights, options or warrants to all holders of its Common Stock entitling them to subscribe for or purchase Common Stock at a price per share less than the current market price per share (determined as provided in paragraph (7) of this Section 1(b)) of the Common Stock on the Determination Date for such distribution, the Conversion Rate in effect at the opening of business on the day following such Determination Date shall be increased by dividing such Conversion Rate by a fraction of which the numerator shall be the number of shares of Common Stock outstanding at the close of business on such Determination Date plus the number of shares of Common Stock which the aggregate of the offering price of the total number of shares of Common Stock so offered for subscription or purchase would purchase at such current market price and the denominator shall be the number of shares of Common Stock outstanding at the close of business on such Determination Date plus the number of shares of Common Stock so offered for subscription or purchase, such increase to become effective immediately after the opening of business on the day following such Determination Date. For the purposes of this paragraph (2), the number of shares of Common Stock at any time outstanding shall not include Common Stock held in the treasury of the Company but shall include Common Stock issuable in respect of scrip certificates issued in lieu of fractions of Common Stock. The Company will not issue any rights, options or warrants in respect of Common Stock held in the treasury of the Company. Upon the expiration of any right, option or warrant to purchase Common Stock the issuance of which resulted in an adjustment to the Conversion Rate pursuant to this paragraph (2) of Section 1(b), if any such right, option or warrant shall expire and shall not have been exercised, the Conversion Rate shall immediately upon such expiration be recomputed to the Conversion Rate which would have been in effect had the adjustment of the Conversion Rate made upon the issuance of such right, option or warrant been made on the basis of offering for subscription or purchase only that number of shares of Common Stock actually purchased upon the exercise of such right, option and warrant actually exercised.

(3) In case outstanding Common Stock shall be subdivided into a greater number of shares of Common Stock, the Conversion Rate in effect at the opening of business on the day following the day upon which such subdivision becomes effective shall be proportionately increased, and, conversely, in case outstanding Common Stock shall each be combined into a smaller number of shares of Common Stock, the Conversion Rate in effect at the opening of business on the day following the day upon which such combination becomes effective shall be proportionately reduced, such increase or reduction, as the case may be, to become effective immediately after the opening of business on the day following the day upon which such subdivision or combination becomes effective.

(4) In case the Company shall, by dividend or otherwise, distribute to all holders of its Common Stock evidences of its Indebtedness, shares of any class of capital stock, or other property, including securities, but excluding (i) any rights, options or warrants referred to in paragraph (2) of this Section 1(b), (ii) any dividend or distribution paid exclusively in cash, (iii) any dividend or distribution referred to in paragraph (1) of this Section 1(b) and (iv) any merger or consolidation to which Section 1(h) applies (the “Distributed Property”), the Conversion Rate shall be adjusted

4

so that the same shall equal the rate determined by dividing the Conversion Rate in effect immediately prior to the close of business on the Determination Date for such distribution by a fraction of which the numerator shall be the current market price per share (determined as provided in paragraph (7) of this Section 1(b)) of the Common Stock on such Determination Date less the then fair market value (as determined in good faith by the Board of Directors of the Company in accordance with the provisions of this paragraph (4) of Section 1(b)) of the portion of the assets, shares or evidences of Indebtedness so distributed applicable to one share of Common Stock and the denominator shall be such current market price per share of the Common Stock, such adjustment to become effective immediately prior to the opening of business on the day following such Determination Date. If the Board of Directors determines the fair market value of any distribution for purposes of this paragraph (4) by reference to the actual or when issued trading market for any securities constituting such distribution, it must in doing so consider the prices in such market over the same period used in computing the current market price per share pursuant to paragraph (7) of this Section 1(b). Notwithstanding the foregoing, if the distribution of Distributed Property is a Subsidiary Distribution (as defined in Section 3(g)), the Conversion Rate shall be adjusted under Section 3(g)(4).

Under the provisions of the Company’s Rights Plan, upon conversion of the Securities into Common Stock, to the extent that the Rights Plan is still in effect upon such conversion, the holder of this Security will receive, in addition to the Common Stock, the rights described therein (whether or not the rights have separated from the Common Stock at the time of conversion), subject to the limitations set forth in the Rights Plan. Any distribution of rights or warrants pursuant to the Rights Plan in compliance with the requirements set forth in the immediately preceding sentence of this paragraph shall not constitute a distribution of rights or warrants pursuant to this Section 1(b).

Rights or warrants distributed by the Company to all holders of Common Stock entitling the holders thereof to subscribe for or purchase shares of the Company’s capital stock (either initially or under certain circumstances), which rights or warrants, until the occurrence of a specified event or events (“Trigger Event”): (i) are deemed to be transferred with such shares of Common Stock; (ii) are not exercisable; and (iii) are also issued in respect of future issuances of Common Stock, shall be deemed not to have been distributed for purposes of this Section 1(b) (and no adjustment to the Conversion Rate under this Section 1(b) will be required) until the occurrence of the earliest Trigger Event, whereupon such rights and warrants shall be deemed to have been distributed and an appropriate adjustment (if any is required) to the Conversion Rate shall be made under this Section 1(b). If any such right or warrant, including any such existing rights or warrants distributed prior to the original issue date of this Security, are subject to events, upon the occurrence of which such rights or warrants become exercisable to purchase different securities, evidences of Indebtedness or other assets, then the date of the occurrence of any and each such event shall be deemed to be the date of distribution and record date with respect to new rights or warrants with such rights (and a termination or expiration of the existing rights or warrants without exercise by any of the holders thereof). In addition, in the event of any distribution (or deemed distribution) of rights or

5

warrants, or any Trigger Event or other event (of the type described in the preceding sentence) with respect thereto that was counted for purposes of calculating a distribution amount for which an adjustment to the Conversion Rate under this Section was made, (x) in the case of any such rights or warrants which shall all have been redeemed or repurchased without exercise by any holders thereof, the Conversion Rate shall be readjusted upon such final redemption or repurchase to give effect to such distribution or Trigger Event, as the case may be, as though it were a cash distribution, equal to the per share redemption or repurchase price received by a holder or holders of Common Stock with respect to such rights or warrants (assuming such holder had retained such rights or warrants), made to all holders of Common Stock as of the date of such redemption or repurchase, and (y) in the case of such rights or warrants which shall have expired or been terminated without exercise by any holders thereof, the Conversion Rate shall be readjusted as if such rights and warrants had not been issued.

(5) In case the Company shall, by dividend or otherwise, distribute to all holders of its Common Stock cash (excluding any cash that is distributed as part of a distribution referred to in paragraph (4) of Section 1(b)) in aggregate amount that, combined together with (I) the aggregate amount of any other cash distributions to all holders of its Common Stock made exclusively in cash within the twelve (12) months preceding the date of payment of such distribution and in respect of which no adjustment pursuant to this paragraph (5) of Section 1(b) has been made and (II) the aggregate of any cash plus the fair market value (as determined by the Board of Directors, whose determination shall be conclusive and described in a board resolution) of consideration payable in respect of any tender offer by the Company or any of its subsidiaries for all or any portion of the Common Stock concluded within the twelve (12) months preceding the date of payment of such distribution and in respect of which no adjustment pursuant to paragraph (6) of Section 1(b) has been made (the “combined cash and tender amount”), exceeds ten percent (10%) of the product of the current market price per share of the Common Stock (determined as provided in paragraph (7) of this Section 1(b)) on the date for the determination of holders of shares of Common Stock entitled to receive such distribution times the number of shares of Common Stock outstanding on such date (the “aggregate current market price”), then, and in each such case, immediately after the close of business on such date for determination, the Conversion Rate shall be adjusted so that the same shall equal the rate determined by dividing the Conversion Rate in effect immediately prior to the close of business on the date fixed for determination of the stockholders entitled to receive such distribution by a fraction (i) the numerator of which shall be equal to the current market price per share of the Common Stock on the date fixed for such determination less an amount equal to the quotient of (x) the excess of such combined cash and tender amount over ten percent (10%) of such aggregate current market price divided by (y) the number of shares of Common Stock outstanding on such date for determination and (ii) the denominator of which shall be equal to the current market price per share of the Common Stock on such date for determination.

(6) In case of a tender offer made by the Company or any Subsidiary of the Company for all or any portion of the Common Stock shall expire and such tender offer or exchange (as amended upon the expiration thereof) shall require the payment to stockholders (based on the acceptance (up to any maximum specified in the

6

terms of the tender offer) of Purchased Shares (as defined below)) of an aggregate consideration having a fair market value (as determined by the Board of Directors, whose determination shall be conclusive and described in a board resolution), that combined together with (I) the aggregate of the cash plus the fair market value (as determined by the Board of Directors, whose determination shall be conclusive and described in a board resolution), as of the expiration of such tender or exchange offer, of consideration payable in respect of any other tender or exchange offer by the Company or any Subsidiary of the Company for all or any portion of the Common Stock expiring within the 12 months preceding the expiration of such tender or exchange offer and in respect of which no adjustment pursuant to this paragraph (6) of Section 1(b) has been made and (II) the aggregate amount of any cash distributions to all holders of the Company’s Common Stock within twelve (12) months preceding the expiration of such tender or exchange offer and in respect of which no adjustment pursuant to paragraph (5) of Section 1(b) has been made (the “combined tender and cash amount”) exceeds ten percent (10%) of the product of the current market price per share of the Common Stock (determined as provided in paragraph (7) of this Section 1(b)) as of the last time (the “Expiration Time”) tenders or exchange could have been made pursuant to such tender or exchange offer (as it may be amended) times the number of shares of Common Stock outstanding (including any tendered or exchange shares) as of the Expiration Time, then, and in each such case, immediately prior to the opening of business on the day after the date of the Expiration Time, the Conversion Rate shall be adjusted so that the same shall equal the rate determined by dividing the Conversion Rate immediately prior to close of business on the date of the Expiration Time by a fraction (i) the numerator of which shall be equal to (A) the product of (I) the current market price per share of Common Stock on the date of the Expiration Time multiplied by (II) the number of shares of Common Stock outstanding (including any tendered or exchanged shares) on the date of the Expiration Time less (B) the combined tender and cash amount, and (ii) the denominator of which shall be equal to the product of (A) the current market price per share of the Common Stock as of the Expiration Time multiplied by (B) the number of shares of Common Stock outstanding (including any tendered or exchanged shares) as of the Expiration Time less the number of all shares validly tendered or exchanged and not withdrawn as of the Expiration Time (the shares deemed so accepted up to and any such maximum, being referred to as the “Purchased Shares”).

(7) For the purpose of any computation under paragraphs (2), (4), (5) or (6) of this Section 1(b), the current market price per share of Common Stock on any date shall be calculated by the Company and be deemed to be the average of the daily Closing Prices for the five (5) consecutive Trading Days commencing ten (10) Trading Days before the earlier of (i) the day in question and (ii) the day before the “ex” date with respect to the issuance or distribution requiring such computation. For purposes of this paragraph, the term “ex date”, when used with respect to any issuance or distribution, means the first date on which the Common Stock trades regular way in the applicable securities market or on the applicable securities exchange without the right to receive such issuance or distribution.

(8) No adjustment in the Conversion Rate shall be required unless such adjustment (plus any adjustments not previously made by reason of this

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paragraph (8)) would require an increase or decrease of at least one percent (1%) in such rate; provided, however, that any adjustments which by reason of this paragraph (8) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 1 shall be made to the nearest cent or to the nearest one-hundredth of a share, as the case may be.

(9) The Company may make such increases in the Conversion Rate, for the remaining term of the Securities or any shorter term, in addition to those required by paragraphs (1), (2), (3), (4), (5) and (6) of this Section 1(b) as it considers to be advisable in order to avoid or diminish any income tax to any holders of Common Stock resulting from any dividend or distribution of stock or issuance of rights or warrants to purchase or subscribe for stock or from any event treated as such for income tax purposes.

(c) Whenever the Conversion Rate is adjusted as provided in Section 1(b), the Company shall compute the adjusted Conversion Rate in accordance with Section 1(b) and shall prepare a certificate signed by an officer of the Company setting forth the adjusted Conversion Rate and showing in reasonable detail the facts upon which such adjustment is based, and shall promptly deliver such certificate to the holder of this Security.

(d) In case:

(1) the Company shall declare a dividend or other distribution on its Common Stock that would require any adjustment pursuant to Section 1(b); or

(2) the Company shall authorize the granting to the holders of its Common Stock of rights, options or warrants to subscribe for or purchase any shares of capital stock of any class or of any other rights; or

(3) of any reclassification of the Common Stock of the Company, or of any consolidation, merger or share exchange to which the Company is a party and for which approval of any shareholders of the Company is required, or of the conveyance, sale, transfer or lease of all or substantially all of the assets of the Company; or

(4) of the voluntary or involuntary dissolution, liquidation or winding up of the Company; or

(5) the Company or any Subsidiary shall commence a tender offer for all or a portion of the Company’s outstanding Common Stock (or shall amend any such tender offer);

then the Company shall cause to be delivered to the holder of this Security, at least twenty (20) days (or ten (10) days in any case specified in clause (1) or (2) above) prior to the applicable record, expiration or effective date hereinafter specified, a notice stating (x) the date on which a record is to be taken for the purpose of such dividend, distribution, rights, options or warrants, or, if a record is not to be taken, the date as of

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which the holders of Common Stock of record to be entitled to such dividend, distribution, rights, options or warrants are to be determined, (y) the date on which the right to make tenders under such tender offer expires or (z) the date on which such reclassification, consolidation, merger, conveyance, transfer, sale, lease, dissolution, liquidation or winding up is expected to become effective, and the date as of which it is expected that holders of Common Stock of record shall be entitled to exchange their Common Stock for securities, cash or other property deliverable upon such reclassification, consolidation, merger, conveyance, transfer, sale, lease, dissolution, liquidation or winding up. Neither the failure to give such notice nor any defect therein shall affect the legality or validity of the proceedings described in clauses (1) through (5) of this Section 1(d).

(e) The Company shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Stock, for the purpose of effecting the conversion of the Security, the full number of shares of Common Stock then issuable upon the conversion of this Security.

(f) Except as provided in the next sentence, the Company will pay any and all taxes and duties that may be payable in respect of the issue or delivery of Common Stock on conversion of the Security. The Company shall not, however, be required to pay any tax or duty which may be payable in respect of any transfer involved in the issue and delivery of Common Stock in a name other than that of the holder of this Security, and no such issue or delivery shall be made unless and until the Person requesting such issue has paid to the Company the amount of any such tax or duty, or has established to the satisfaction of the Company that such tax or duty has been paid.

(g) The Company agrees that all Common Stock which may be delivered upon conversion of the Security, upon such delivery, will have been duly authorized and validly issued and will be fully paid, nonassessable and free of preemptive rights (and shall be issued out of the Company’s authorized but unissued Common Stock) and, except as provided in Section 1(f), the Company will pay all taxes, liens and charges with respect to the issue thereof.

(h) In case of any recapitalization or reclassification of the Common Stock (other than a change in par value or as a result of a subdivision or combination covered by paragraph (3) of Section 1(b)), or any consolidation of the Company with any other Person, any merger of the Company into another Person or of another Person into the Company (other than a merger which does not result in a reclassification, conversion, exchange or cancellation of the outstanding Common Stock), or any conveyance, sale, transfer or lease of all or substantially all of the properties and assets of the Company (collectively, a “Capital Reorganization”), the Company or the Person formed by such Capital Reorganization, as the case may be, shall execute and deliver to the holder of this Security a supplemental agreement providing that such holder has the right thereafter, during the period this Security shall be convertible as specified in Section 1(a), to convert this Security only into the kind and amount of securities, cash and other property receivable upon such Capital Reorganization by a holder of the number of shares of Common Stock of the Company into which this Security might have been converted

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immediately prior to such Capital Reorganization, assuming such holder of Common Stock of the Company (i) is not a Person with which the Company consolidated, into which the Company merged or which merged into the Company or to which any conveyance, sale, transfer or lease was made, as the case may be (a “Constituent Person”), or an Affiliate of a Constituent Person and (ii) failed to exercise its rights of election, if any, as to the kind or amount of securities, cash and other property receivable upon such Capital Reorganization (provided that if the kind or amount of securities, cash and other property receivable upon such Capital Reorganization is not the same for each share of Common Stock of the Company held immediately prior to such Capital Reorganization by others than a Constituent Person or an Affiliate thereof and in respect of which such rights of election shall not have been exercised (“Non-electing Share”), then for the purpose of this Section 1(h) the kind and amount of securities, cash and other property receivable upon such Capital Reorganization by the holders of each Non-electing Share shall be deemed to be the kind and amount so receivable per share by a plurality of the Non-electing Shares). Such supplemental agreement shall provide for adjustments which, for events subsequent to the effective date of such supplemental agreement, shall be equivalent to the adjustments provided for in this Section 1. The above provisions of this Section 1(h) shall similarly apply to successive Capital Reorganizations. If this Section 1(h) applies to any event or occurrence, then the other provisions of Section 1(b) shall not apply.

(i) The Company (i) will effect all registrations with, and obtain all approvals by, all governmental authorities that may be necessary under any United States Federal or state law (including the Securities Act, the Securities Exchange Act of 1934 and state securities and Blue Sky laws) for the Common Stock issuable upon conversion of this Security to be lawfully issued and delivered as provided herein, and thereafter publicly traded (if permissible under the Securities Act) and qualified or listed as contemplated by clause (ii) (it being understood that the Company shall not be required to register the Common Stock issuable on conversion hereof under the Securities Act except pursuant to the Registration Rights Agreement between the Company and the initial holder of this Security); and (ii) if required, will list the Common Stock required to be issued and delivered upon conversion of Securities, prior to such issuance or delivery, on each national securities exchange on which outstanding Common Stock is listed or quoted at the time of such delivery, or if the Common Stock is not then listed on any securities exchange, to qualify the Common Stock for quotation on the Nasdaq National Market or such other inter-dealer quotation system, if any, on which the Common Stock is then quoted.

2. Right to Require Repurchase.

(a) In the event that a Change in Control (as hereinafter defined) shall occur, then the holder of this Security shall have the right, at such holder’s option, to require the Company to repurchase, and upon the exercise of such right the Company shall repurchase, this Security, or any portion of the principal amount hereof that is equal to $1,000 or any integral multiple thereof, on the date (the “Repurchase Date”) that is thirty (30) Trading Days (or such longer period as required by applicable law) after the date on which the Company gives notice of such Change of Control to the holder of this

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Security, at a purchase price equal to the Repurchase Price (as hereinafter defined). The Company agrees to give the holder of this Security notice, in the manner provided in Section 8(b), of any Change in Control, promptly and in any event within five (5) Trading Days of the occurrence thereof.

(b) To exercise a repurchase right, the holder shall deliver to the Company on or before the third (3rd) Business Day prior to the Repurchase Date, together with this Security, written notice of the holder’s exercise of such right, which notice shall set forth the name of the holder, the principal amount of this Security to be repurchased (and, if this Security is to be repurchased in part, the portion of the principal amount thereof to be repurchased) and a statement that an election to exercise the repurchase right is being made thereby. Such written notice shall be irrevocable, except that the right of the holder to convert this Security (or the portion hereof with respect to which the repurchase right is being exercised) shall continue until the close of business on the Trading Day prior to the Repurchase Date.

(c) In the event a repurchase right shall be exercised in accordance with the terms hereof, the Company shall pay or cause to be paid to the holder the Repurchase Price in cash on the Repurchase Date in the manner set forth in the introductory paragraph to this Security.

(d) If this Security is to be repurchased only in part, it shall be surrendered to the Company at the Designated Office (with, if the Company so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company duly executed by, the holder hereof or his attorney duly authorized in writing), and the Company shall execute and make available for delivery to the holder without service charge, a new Security or Securities, containing identical terms and conditions, each in an authorized denomination in aggregate principal amount equal to and in exchange for the unrepurchased portion of the principal of the Security so surrendered.

(e) For purposes of this Section 2:

(1) the term “beneficial owner” shall be determined in accordance with Rule 13d-3 promulgated by the Securities and Exchange Commission pursuant to the Exchange;

(2) a “Change in Control” shall be deemed to have occurred at the time, after the original issuance of this Security, of:

(i) the acquisition by any Person of beneficial ownership, directly or indirectly, through a purchase, merger or other acquisition transaction or series of transactions, of shares of capital stock of the Company entitling such Person to exercise 50% or more of the total voting power of all shares of capital stock of the Company entitled to vote generally in the elections of directors (any shares of voting stock of which such Person is the beneficial owner that are not then outstanding being deemed outstanding for purposes of calculating such percentage) other than any such acquisition by the Company or any employee benefit plan of the Company; or

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(ii) any consolidation or merger of the Company with or into, any other Person, any merger of another Person with or into the Company, or any conveyance, transfer, sale, lease or other disposition of all or substantially all of the assets of the Company to another Person (other than (a) any such transaction pursuant to which holders of Common Stock immediately prior to such transaction have the entitlement to exercise, directly or indirectly, 50% or more of the total voting power of all shares of capital stock entitled to vote generally in the election of directors of the continuing or surviving Person immediately after such transaction and (b) any merger (x) which does not result in any reclassification, conversion, exchange or cancellation of outstanding Common Stock or (y) which is effected solely to change the jurisdiction of incorporation of the Company and results in a reclassification, conversion or exchange of outstanding Common Stock into solely shares of common stock); or

(iii) the occupation of a majority of the seats (other than vacant seats) on the board of directors of the Company by Persons who were neither (i) nominated by the board of directors of the Company nor (ii) appointed by directors so nominated.

However, a Change in Control will not be deemed to have occurred if (i) the Closing Price per share of the Company’s Common Stock for any five (5) Trading Days within the period of ten (10) consecutive Trading Days ending immediately after the later of the Change in Control or the public announcement of the Change in Control, in the case of a Change in Control relating to an acquisition of capital stock, or the period of ten (10) consecutive Trading Days ending immediately before the Change in Control, in the case of Change in Control relating to a merger, consolidation or asset sale, equals or exceeds 105% of the conversion price of the Securities (for purposes hereof the Conversion Price being equal to $1,000 divided by the Conversion Rate then in effect); or (ii) 95% of the consideration (excluding cash payments for fractional shares and cash payments made pursuant to dissenters’ appraisal rights) in a merger or consolidation otherwise constituting the Change of Control described in clause (ii) above consists of shares of common stock traded or to be traded immediately following such Change of Control on a national securities exchange or quoted on the Nasdaq National Market and as a result of such transaction or transactions this Security becomes convertible solely into such common stock.

(3) the “current market price” of a share of Common Stock shall be the Closing Price of the Common Stock on the Trading Day immediately preceding the Repurchase Date; and

(4) “Repurchase Price” means the sum of (a) 100% of the principal amount of this Security to be repurchased pursuant to this Section 2 and (b) accrued and unpaid interest on this Security to the date of payment.

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3. Covenants of the Company.

(a) The Company covenants and agrees that it will duly and punctually pay or cause to be paid the principal of, premium (if any) and interest on this Security, at the respective times and in the manner provided for herein.

(b) Unless otherwise permitted herein, the Company will do or cause to be done all things necessary to preserve and keep in full force and effect its existence and rights (charter and statutory).

(c) The Company will cause all properties used or useful in the conduct of its business or the business of any Subsidiary to be maintained and kept in good condition, repair and working order and supplied with all necessary improvements thereof, all as in the reasonable judgment of the Company may be necessary so that the business carried on in connection therewith may be properly and advantageously conducted at all times, provided, however, that nothing in this paragraph (c) shall prevent the Company from discontinuing the operation and maintenance of any such properties if such discontinuance is, in the reasonable judgment of the Company, desirable in the conduct of its business or the business of any Subsidiary and not disadvantageous in any respect to the holder of this Security.

(d) Within the period prior to the expiration of the holding period applicable to sales of this Security or any Common Stock issuable upon conversion of this Security under Rule 144(k) under the Securities Act (or any successor provision), the Company covenants and agrees that it shall, during any period in which it is not subject to Section 13 or 15(d) of the Exchange Act, make available to any holder or beneficial holder of this Security or such Common Stock which continue to be “Restricted Securities” as defined in Rule 144 in connection with any sale thereof and any purchaser of this Security or such Common Stock designated by such holder or beneficial holder, the information required pursuant to Rule 144A(d)(4) under the Securities Act upon request of any holder or beneficial holder of this Security or such Common Stock and it will take such further action as any holder or beneficial holder of this Security or such Common Stock may reasonably request, all to the extent required from time to time to enable such holder or beneficial holder to sell this Security or such Common Stock without registration under the Securities Act within the limitation of the exemption provided by Rule 144A, as such rule may be amended from time to time. Upon the request of any holder or any beneficial holder of this Security or such Common Stock, the Company will deliver to such holder a written statement as to whether it has complied with such requirements.

(e) The Company covenants that it shall not at any time insist upon, plead, or in any manner whatsoever claim or take the benefit or advantage of, any stay, extension or usury law or other law which would prohibit or forgive the Company from paying all or any portion of the principal of, premium (if any) or interest on this Security as contemplated herein, whenever enacted, now or at any time hereinafter in force, or which may affect the covenants of performance in this Security and the Company hereby expressly waives all benefit or advantage of any such law, and covenants that it will not,

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be resort to any such law, hinder, delay or impede the execution of any power granted herein to the holder of this Security, but will suffer and permit the execution of every such power as though no such law had been enacted.

(f) The Company shall not issue or incur any Indebtedness which is convertible into Common Stock or other capital stock of the Company and by its terms is senior in right or payment to this Security.

(g) If the Company determines at any time while this Security is outstanding to distribute to all holders of its Common Stock shares of capital stock of a Subsidiary (a “Subsidiary Distribution”), then the following provisions shall apply:

(1) The Company shall have prepared and filed a registration statement or an information statement or other applicable document (the “SEC Document”) with the Commission describing the proposed Subsidiary Distribution including the expected valuation of such Subsidiary in relation to the expected valuation of the Company after the Subsidiary Distribution.

(2) In the SEC Document, the Company shall have described its choice of one of the following options (the “Company Election”) with respect to this Security:

(i) Causing this Security to be exchanged as of the date of the Subsidiary Distribution for two convertible notes, (A) one of which shall be issued by the Company and shall have terms and conditions identical to this Security other than the principal amount (the “New Company Note”), and (B) one of which the Company shall cause to be issued by such Subsidiary and which shall be convertible into the common stock of such Subsidiary but which shall otherwise have terms and conditions identical to this Security other than the principal amount (the “New Subsidiary Note”). The combined principal amounts of the New Company Note and the New Subsidiary Note shall equal the principal amount of this Security and the principal amounts shall be divided between the New Company Note and such New Subsidiary Note based upon pro-forma valuations of the Company and such new Subsidiary (collectively, the “Valuations”) prepared by a nationally recognized investment bank chosen by the Company. Upon the Subsidiary Distribution, the conversion rate of the New Company Note shall be adjusted from the Conversion Rate then applicable to this Security pursuant to the terms of Section 3(g)(4). The conversion rate of the New Subsidiary Note shall be equal to the product of (A) (I) 1,000 divided by (II) the product of (x) the Subsidiary FMV Per Share and (y) one minus a fraction, the numerator of which is the difference between the Company Prior FMV Per Share and the Conversion Price (before giving effect to any adjustment of the Conversion Price resulting from the Subsidiary Distribution) and the denominator of which is the Company Prior FMV Per Share multiplied by (B) the number of shares of Subsidiary capital stock issued in respect of each share of Common Stock in the Subsidiary Distribution. For purposes of this paragraph, the following terms shall have the following meanings:

(A) “Company Ex FMV Per Share” means the average of the daily Closing Prices for the five (5) consecutive Trading Days commencing on the “ex date” with respect to the Subsidiary Distribution;

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(B) “Company Prior FMV Per Share” means the average of the daily Closing Prices for the five (5) consecutive Trading Days before the “ex date” with respect to the Subsidiary Distribution;

(C) “Subsidiary FMV Per Share” means the difference between (i) the Company Prior FMV Per Share and (ii) the Company Ex FMV Per Share; and

(D) “ex date”, with respect to the Subsidiary Distribution, means the first date on which the Common Stock trades regular way in the applicable securities market or on the applicable securities exchange without the right to receive the Subsidiary Distribution.

(ii) Repurchasing that percentage of this Security as is equal to a fraction (expressed as a percentage), the numerator of which is the Subsidiary FMV Per Share and the denominator of which is equal to the Company Prior FMV Per Share. If this paragraph becomes applicable to this Security, then the Company shall make the required repurchase in cash in the manner set forth in the introductory paragraph of this Security on the date which is the later of (A) the fifth (5^th) Trading Day after the date of the Subsidiary Distribution or (B) the date on which this Security is surrendered to the Company at the Designated Office (with, if the Company so requires, due endorsement by, or a written instrument of transfer in form satisfactory to the Company duly executed by, the holder hereof or its attorney duly authorized in writing). Promptly, thereafter, the Company shall execute and make available for delivery to the holder without service charge, a new Security or Securities, containing identical terms and conditions, each in an authorized denomination in aggregate principal amount equal to and in exchange for the unrepurchased portion of the principal of the Security so surrendered. Upon the Subsidiary Distribution, the conversion rate of this Note shall be adjusted from the Conversion rate then applicable to this Security pursuant to the terms of Section 3(g)(4).

(iii) If (A) the Closing Price of the Common Stock of the Company shall have exceeded 154% of the then applicable Conversion Price (aa) for twenty (20) Trading Days in any thirty (30) consecutive Trading Days ending on any Trading Day within the thirty (30) day period ending on the date of filing of the SEC Document and (bb) on the last Trading Day of such thirty (30) consecutive Trading Day period referred to in the preceding clause (i) and (B) a shelf registration statement with respect to the resale by the holder of the Common Stock of the Company issuable upon conversion of this Security has been declared effective under the Securities Act by the Commission in accordance with the Registration Rights Agreement and remains effective, causing this Security to be converted effective as of the date of the Subsidiary Distribution, in whole but not in part, into fully paid and nonassessable shares of Common Stock (calculated as to the nearest 1/1000 of a share) of the Company at the

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Adjusted Conversion Rate which would be effective upon the date of the Subsidiary Distribution. Upon the conversion of this Security pursuant to this Section 3(g)(2)(iii), the holder of the Common Stock issuable upon conversion of this Security shall receive the shares of capital stock distributed in the Subsidiary Distribution that it would have received had such conversion occurred immediately prior to the record date for the Subsidiary Distribution. For purposes of this paragraph, the term “Adjusted Conversion Rate” shall mean the product of (A) the Conversion Rate in effect immediately prior to the date of the Subsidiary Distribution and (B) 1.04.

(3) Contemporaneously with the filing of the SEC Document with the Securities and Exchange Commission, the Company shall deliver the SEC Document to the holder of this Security together with a statement briefly describing the Company Election with a reference to the more detailed description set forth in the SEC Document. The terms of the Company Election under Section 3(g)(2) as described in the SEC Document shall be applicable to and shall be deemed a part of this Security unless, on or prior to 5:00 p.m., New York City time, on the 20^th day (or if such day is not a Business Day the next Business Day thereafter) after receipt of the SEC Document together with the statement described in the previous sentence, the holder of this Security gives notice to the Company in the manner specified in Section 8(b) to the effect that the holder elects not to make this Security subject to the Company Election. If the holder of this Security elects not to make this Security subject to the Company Election, then, upon the occurrence of the Subsidiary Distribution, the Company Election shall not be applicable to this Security and the Conversion Rate of this Note shall be adjusted according to the provisions of Section 3(g)(4). Notwithstanding anything contained in this Section 3(g), if the holder of this Security disagrees with the Valuations referred to in Section 3(g)(2)(i), then such holder may retain, at such holder’s expense, a nationally recognized investment bank to provide additional pro-forma valuations of the Company and such new Subsidiary (collectively, the “Additional Valuations”). Such holder shall deliver the Additional Valuations to the Company on or prior to the 10^th day after receipt of the SEC Document and the Company shall in good faith take into account such Additional Valuations in determining changes, if any, to the final allocation of the principal amounts of the New Company Note and the New Subsidiary Note and shall notify such holder of any changes in the allocation of the principal amounts of the New Company Note and the New Subsidiary Note on or prior to the 15^th day after receipt of the SEC Document.

(4) Upon the Subsidiary Distribution, the conversion rate of the New Company Note shall be adjusted by dividing the Conversion rate in effect immediately prior to the “ex-date” by a fraction, the numerator of which is the Company Ex FMV Per Share and the denominator of which is the Company Prior FMV Per Share.

(5) Notwithstanding the foregoing provisions of this Section 3(g), in the event that in calculating the adjustment of its outstanding employee stock options or other securities that are convertible into Common Stock in connection with the Subsidiary Distribution (the “Option Adjustment”), the Company uses, in the calculation of the pre- and post-Subsidiary Distribution value of the Common Stock, a different date than the “ex date” and/or a different number of trading days or trading

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prices than those used in the calculation of the Company Ex FMV Per Share and the Company Prior FMV Per Share as set forth above, then such different date, number of trading days or prices shall instead be employed in the calculation of the Company Ex FMV Per Share and the Company Prior FMV Per Share. Upon a determination of the methodology for any Option Adjustment, the Company shall promptly provide such methodology and any related information to the holder of this Security.

4. Events of Default.

(a) “Event of Default”, wherever used herein, means any one of the following events (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body):

(1) default in the payment of principal on this Security when due at its stated maturity or upon required repurchase under Section 2 hereof; or

(2) a default in the payment of any interest or premium (if any) upon this Security when it becomes due and payable, and the continuance of such default for a period of 30 days; or

(3) default by the Company in the performance of its obligations in respect of any conversion of this Security (or any portion hereof) in accordance with Section 1 for a period of 10 days; or

(4) default by the Company in the performance, or breach, of any representation, warranty, covenant or agreement of the Company (other than a default in the performance, or breach, of any representation, warranty, covenant or agreement of the Company which is specifically dealt with elsewhere in this Section 4(a)) contained in (i) this Security, (ii) the Convertible Note Purchase Agreement, dated as of the date hereof, between the Company and the initial holder of this Security, or (iii) Section 4(a) of the Registration Rights Agreement, dated as of the date hereof, between the Company and the initial holder of this Security, and continuance of such default or breach for a period of sixty (60) days after there has been given, by registered or certified mail, to the Company by the holder of this Security a written notice specifying such default or breach and requiring it to be remedied and stating that such notice is a “Notice of Default” hereunder; or

(5) any indebtedness under any bond, debenture, note or other evidence of indebtedness for money borrowed by the Company in a principal amount then outstanding in excess of $10,000,000 is not paid at final maturity thereof (either at its stated maturity or upon acceleration thereof), and such indebtedness is not discharged, or such acceleration is not rescinded or annulled, within a period of 30 days after there has been given, by registered or certified mail, to the Company by the holder of this Security a written notice specifying such default and requiring the Company to cause

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such indebtedness to be discharged or cause such acceleration to be rescinded or annulled and stating that such notice is a “Notice of Default” hereunder; or

(6) the entry by a court having jurisdiction in the premises of (A) a decree or order for relief in respect of the Company in an involuntary case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or (B) a decree or order approving as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Company under any applicable Federal or State law, or appointing a custodian, receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or of any substantial part of its property, or ordering the winding up or liquidation of its affairs, and the continuance of any such decree or order for relief or any such other decree or order unstayed and in effect for a period of sixty (60) consecutive days; or

(7) the commencement by the Company of a voluntary case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or of any other case or proceeding to be adjudicated a bankrupt or insolvent, or the consent by the Company to the entry of a decree or order for relief in respect of the Company in an involuntary case or proceeding under any applicable Federal or State bankruptcy, insolvency, reorganization or other similar law or to the commencement of any bankruptcy or insolvency case or proceeding against the Company, or the filing by the Company of a petition or answer or consent seeking reorganization or similar relief under any applicable Federal or State law, or the consent by it to the filing of such petition or to the appointment of or taking possession by a custodian, receiver, liquidator, assignee, trustee, sequestrator or other similar official of the Company or of any substantial part of the property of the Company, or the making by the Company of an assignment for the benefit of creditors, or the admission by the Company in writing of its inability to pay its debts generally as they become due, or the taking of corporate action by the Company in furtherance of any such action.

(8) a judgment in excess of $10,000,000 (not covered by insurance) is rendered against the Company and, within sixty (60) days after the entry thereof, such judgment is not discharged or execution thereof is not stayed pending appeal, or within sixty (60) days after the expiration of any such stay, such judgment is not discharged or void.

(b) If an Event of Default (other than an Event of Default specified in Sections 4(a)(6) or 4(a)(7)) occurs and is continuing, then in every such case the holders of at least twenty-five percent (25%) of the outstanding principal amount of all then outstanding Securities may declare the principal amount of this Security and all other Securities then outstanding to be due and payable immediately, by a notice in writing to the Company, and upon any such declaration such principal and all accrued interest thereon shall become immediately due and payable. If an Event of Default specified in Section 4(a)(6) or 4(a)(7) occurs and is continuing with respect to the Company, the principal of, and accrued interest on, this Security shall ipso facto become immediately due and payable without any declaration or other act of the holders. During the continuance of an Event of Default specified in Sections 4(a)(1) or 4(a)(2), the principal,

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premium (if any) and interest that is due and payable (collectively, the “Overdue Amount”) shall, until paid, bear interest from the date of the occurrence of such Event of Default at the rate of 7.5% per annum, payable in cash, and this Security shall remain convertible into Common Stock until the Overdue Amount and any interest thereon shall have been paid or duly provided for. The holder of this Security need not provide, and the Company hereby waives, and presentment, demand, protest or other notice of any kind, and the holder of this Security may immediately and without the expiration of any grace period (other than any grace period specified in any Event of Default) enforce any and all rights and remedies hereunder. The holder of this Security shall also have, upon the occurrence and during the continuance of an Event of Default, any other rights which such holder may have pursuant to applicable law or contract.

(c) The Company will give the holder of this Security notice, within ten (10) Trading Days of the occurrence thereof, of any Event of Default or any event that, with the giving of notice or passage of time or both, would become an Event of Default. Such notice shall be given in the manner provided in Section 8(b).

5. Consolidation, Merger, Etc.

(a) The Company shall not consolidate with or merge into any other Person or, directly or indirectly, convey, transfer, sell or lease all or substantially all of its properties and assets to any Person, and the Company shall not permit any Person to consolidate with or merge into the Company or, directly or indirectly, convey, transfer, sell or lease all or substantially all of its properties and assets to the Company, unless:

(1) in case the Company shall consolidate with or merge into another Person or convey, transfer, sell or lease all or substantially all of its properties and assets to any Person, the Person formed by such consolidation or into which the Company is merged or the Person which acquires by conveyance, transfer or sale, or which leases, all or substantially all the properties and assets of the Company shall be a corporation, limited liability company, partnership or trust, shall be organized and validly existing under the laws of the United States of America, any State thereof or the District of Columbia, and shall expressly assume, if other than the Company, by an agreement supplemental hereto, executed and delivered to the holder of this Security in form satisfactory to the holder, the due and punctual payment of the principal of and any interest on this Security and the performance or observance of every covenant of this Security on the part of the Company to be performed or observed, including the conversion rights provided herein;

(2) immediately after giving effect to such transaction, no Event of Default, and no event which, after notice or lapse of time or both, would become an Event of Default, shall have happened and be continuing; and

(b) Upon any consolidation of the Company with, or merger of the Company into, any other Person or any conveyance, transfer, sale or lease of all or substantially all of the properties and assets of the Company in accordance with Section 4(a), the successor Person formed by such consolidation or into which the

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Company is merged or to which such conveyance, transfer, sale or lease is made shall succeed to, and be substituted for, and may exercise every right and power of, the Company under this Security with the same effect as if such successor Person had been named as the Company herein, and thereafter, except in the case of a lease, the predecessor Person shall be relieved of all obligations and covenants under this Security.

6. Subordination.

(a) The Company covenants and agrees, and the holder of this Security by its acceptance hereof likewise covenants and agrees, that this Security is subject to the provisions of this Section 6; and each Person holding this Security, whether upon original issue or upon transfer, assignment or exchange thereof, accepts and agrees to be bound by such provisions.

The payment of the principal of, premium, if any, and interest on this Security (including, but not limited to, the repurchase price with respect to this Security) shall, to the extent and in the manner hereinafter set forth, be subordinated in right of payment to the prior payment in full, in cash or in such other form of payment as may be acceptable to the holders of Senior Indebtedness, of all Senior Indebtedness, whether outstanding at the date of original issuance of this Security or thereafter incurred or created.

The expression “payment in full” or “paid in full” or any similar term or phrase when used in this Security with respect to Senior Indebtedness shall mean the payment in full of all such Senior Indebtedness in cash or such other form of payment as may be acceptable to the holders of Senior Indebtedness, or, in the case of Senior Indebtedness consisting of contingent obligations in respect of letters of credit or other reimbursement obligations, the setting apart of cash sufficient to discharge such portion of Senior Indebtedness in an account for the exclusive benefit of the holders thereof, in which account such holders shall be granted a first priority perfected security interest in a manner reasonably acceptable to such holders

No provision of this Section 6 shall prevent the occurrence of any default or Event of Default under this Security.

(b) Payments to Holders. No payment (including pursuant to any repurchase of this Security) shall be made with respect to the principal of, or premium, if any, or interest on this Security, if:

(1) a default in the payment of principal, premium, if any, or interest or other payment due on Senior Indebtedness occurs and is continuing beyond any applicable period of grace (a “Payment Default”); or

(2) a default, other than a Payment Default, occurs and is continuing with respect to Designated Senior Indebtedness that then permits holders of the Designated Senior Indebtedness as to which such default related to accelerate its maturity and the holder of this Security and the Company receive a written notice of such default (a “Payment Blockage Notice”) from a representative of Designated Senior

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Indebtedness or a holder of Designated Senior Indebtedness or the Company (a “Non-Payment Default”).

The Company may and shall resume payments on this Security (1) in the case of a Payment Default, on the date upon which such default is cured or waived or ceases to exist, and (2) in the case of a Non-Payment Default with respect to Designated Senior Indebtedness, on the earlier of the date on which the Non-Payment Default is cured or waived or ceases to exist or 179 days have passed after the date on which the applicable Payment Blockage Notice is received.

No new period of payment blockage may be commenced pursuant to a Payment Blockage Notice unless at least 365 days shall have elapsed since the Company’s receipt of the immediately prior Payment Blockage Notice. No default (whether or not such event of default is on the same issue of Designated Senior Indebtedness) that existed or was continuing on the date of delivery of any Payment Blockage Notice to the holder of this Security shall be, or be made, the basis for a subsequent Payment Blockage Notice.

If payment of this Security is accelerated because of an Event of Default, the Company shall promptly notify holders of Senior Indebtedness of the acceleration.

(c) Bankruptcy and Dissolution, Etc. Upon any payment by the Company, or distribution of assets of the Company of any kind or character, whether in cash, property or securities, to creditors upon any dissolution, winding-up, liquidation or reorganization of the Company, whether voluntary or involuntary or in bankruptcy, insolvency, receivership or other proceedings, all amounts due or to become due upon all Senior Indebtedness shall first be paid in full, in cash or in such other form of payment as may be acceptable to the holders of Senior Indebtedness, before any payment is made on account of the principal or premium, if any, and interest on this Security; and upon any such dissolution, winding-up, liquidation or reorganization or bankruptcy, insolvency, receivership or other such proceedings, any payment by the Company, or distribution of assets of the Company of any kind or character, whether in cash, property or securities, to which the holders of this Security would be entitled, except for the provisions of this Section 5, shall (except as aforesaid) be paid by the Company or by any receiver, trustee in bankruptcy, liquidating trustee, agent or other Person making such payment or distribution, or by the holder of this Security if received by it, directly to the holders of Senior Indebtedness (pro rata to such holders on the basis of the respective amounts of Senior Indebtedness held by such holders, or as otherwise required by law or a court order) or their respective representative or representatives, or to the trustee or trustees under any indenture pursuant to which any instruments evidencing any Senior Indebtedness may have been issued, as their respective interests may appear, to the extent necessary to pay all Senior Indebtedness in full in cash or in such other form of payment as may be acceptable to the holders of Senior Indebtedness after giving effect to any concurrent payment or distribution to or for the holders of Senior Indebtedness, before any payment or distribution is made to the holder of this Security.

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Notwithstanding the foregoing, in the event that the holder of this Security receives any payment or distribution of assets of the Company of any kind in contravention of any term of this Security, whether in cash, property or securities, including, without limitation, by way of setoff or otherwise, before all Senior Indebtedness is paid in full, in cash or such other form of payment as may be acceptable to the holders of Senior Indebtedness, then such payment or distribution shall be held by the recipient or recipients in trust for the benefit of, and shall immediately be paid over or delivered to, the holders of Senior Indebtedness or their respective representative or representatives, or to the trustee or trustees under any indenture pursuant to which any instruments evidencing any Senior Indebtedness may have been issued, as their respective interests may appear, as calculated by the Company, for application to the payment of all Senior Indebtedness remaining unpaid to the extent necessary to make payment in full, in cash or such other form of payment as may be acceptable to the holders of Senior Indebtedness, of all Senior Indebtedness remaining unpaid, after giving effect to any concurrent payment or distribution, or provision therefor, to or for the holders of such Senior Indebtedness.

For purposes of Section 6(b) hereof and this Section 6(c), the words “cash, property or securities” shall not be deemed to include shares of stock of the Company as reorganized or readjusted, or securities of the Company or any other corporation provided for by a plan of reorganization or readjustment, the payment of which is subordinated (at least to the extent provided in this Section 6 with respect to this Security) to the payment of all Senior Indebtedness which may at the time be outstanding. The consolidation of the Company with, or the merger of the Company into, another corporation or the liquidation or dissolution of the Company following the conveyance or transfer of its property as an entirety, or substantially as an entirety, to another corporation upon the terms and conditions provided for in Section 5 shall not be deemed a dissolution, winding-up, liquidation or reorganization for the purposes of this Section 6(c) if such other corporation shall, as a part of such consolidation, merger, conveyance or transfer, comply with the conditions stated in Section 5.

(d) Subrogation. Subject to the payment in full in cash, or in such other form of payment as may be acceptable to the holders of Senior Indebtedness, of all Senior Indebtedness, the rights of the holder of this Security shall be subrogated to the extent of the payments or distributions made to the holders of such Senior Indebtedness pursuant to the provisions of this Section 6 (equally and ratably with the holders of all Indebtedness of the Company which by its express terms is subordinated to other Indebtedness of the Company to substantially the same extent as this Security is subordinated and is entitled to like rights of subrogation) to the rights of the holders of Senior Indebtedness to receive payments or distributions of cash, property or securities of the Company applicable to the Senior Indebtedness until the principal of, and premium, if any, and interest on this Security shall be paid in full; and, for the purposes of such subrogation, no payments or distributions to the holders of the Senior Indebtedness of any cash, property or securities to which the holder of this Security would be entitled except for the provisions of this Section 6, and no payment over pursuant to the provisions of this Section 6, to or for the benefit of the holders of Senior Indebtedness by holders of this Security, shall, as between the Company, its creditors other than holders of Senior Indebtedness, and the

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holder of this Security, be deemed to be a payment by the Company to or on account of the Senior Indebtedness; and no payments or distributions of cash, property or securities to or for the benefit of the holder of this Security pursuant to the subrogation provisions of this Section 6, which would otherwise have been paid to the holders of Senior Indebtedness shall be deemed to be a payment by the Company to or for the account of this Security. It is understood that the provisions of this Section 6 are and are intended solely for the purposes of defining the relative rights of the holder of this Security, on the one hand, and the holders of the Senior Indebtedness, on the other hand.

Nothing contained in this Section 6 or elsewhere in this Security is intended to or shall impair, as among the Company, its creditors other than the holders of Senior Indebtedness, and the holder of this Security, the obligation of the Company, which is absolute and unconditional, to pay to the holder of this Security the principal of, and premium, if any, and interest on the Security as and when the same shall become due and payable in accordance with their terms, or is intended to or shall affect the relative rights of the holder of this Security and creditors of the Company other than the holders of the Senior Indebtedness, nor shall anything herein or therein prevent the holder of this Security from exercising all remedies otherwise permitted by applicable law upon default under this Security, subject to the rights, if any, under this Section 6 of the holders of Senior Indebtedness in respect of cash, property or securities of the Company received upon the exercise of any such remedy.

Upon any payment or distribution of assets of the Company referred to in this Section 6, the holder of this Security shall be entitled to rely upon any order or decree made by any court of competent jurisdiction in which such bankruptcy, dissolution, winding-up, liquidation or reorganization proceedings are pending, or a certificate of the receiver, trustee in bankruptcy, liquidating trustee, agent or other Person making such payment or distribution, delivered to the holder of this Security, for the purpose of ascertaining the Persons entitled to participate in such distribution, the holders of the Senior Indebtedness and other Indebtedness of the Company, the amount thereof or payable thereon, the amount or amounts paid or distributed thereon and all other facts pertinent thereto or to this Section 6.

(e) Notice. The Company shall give prompt written notice to the holder of this Security of any fact known to the Company which would prohibit the making of any payment of monies to in respect of this Security pursuant to the provisions of this Section 6.

The holder of this Security shall be entitled to rely on the delivery to it of a written notice by a Person representing itself to be a holder of Senior Indebtedness (or a trustee on behalf of such holder) to establish that such notice has been given by a holder of Senior Indebtedness or a trustee on behalf of any such holder or holders. In the event that the holder of this Security determines in good faith that further evidence is required with respect to the right of any Person as a holder of Senior Indebtedness to participate in any payment or distribution pursuant to this Section 6, the holder of this Security may request such Person to furnish evidence to the reasonable satisfaction of the holder of this Security as to the amount of Senior Indebtedness held by such Person, the extent to which

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such Person is entitled to participate in such payment or distribution and any other facts pertinent to the rights of such Person under this Section 6, and if such evidence is not furnished the holder of this Security may defer any payment to such Person pending judicial determination as to the right of such Person to receive such payment.

(f) No Impairment of Subordination. No right of any present or future holder of any Senior Indebtedness to enforce subordination as herein provided shall at any time in any way be prejudiced or impaired by any act or failure to act on the part of the Company or by any act or failure to act, in good faith, by any such holder, or by any noncompliance by the Company with the terms, provisions and covenants of this Security, regardless of any knowledge thereof which any such holder may have or otherwise be charged with.

Without in any way limiting the generality of the foregoing paragraph, the holders of the Senior Indebtedness may, at any time and from time to time, without the consent of or notice to the holder of this Security, without incurring responsibility to the holder of this Security, and without impairing or releasing the subordination provided in this Security or the obligations of the holder of this Security to the holders of the Senior Indebtedness, do any one or more of the following: (a) change the manner, place, or terms of payment (including any change in the rate of interest) or extend the time of payment of, or renew, amend, modify, alter, or grant any waiver or release with respect to, or consent to any departure from, any Senior Indebtedness or any instrument evidencing the same or any agreement evidencing, governing, creating, guaranteeing or securing any Senior Indebtedness; (b) sell, exchange, release, or otherwise deal with any property pledged, mortgaged or otherwise securing Senior Indebtedness; (c) release any Person liable under or in respect of the Senior Indebtedness; (d) fail or delay in the perfection of liens securing the Senior Indebtedness; (e) exercise or refrain from exercising any rights against Company and any other Person; or (f) amend, or grant any waiver or release with respect to, or consent to any departure from, any guarantee for all or any of the Senior Indebtedness.

(g) Certain Conversions Deemed Payment. For the purposes of this Section 6 only, (1) the issuance and delivery of junior securities upon conversion of this Security in accordance with Section 1 shall not be deemed to constitute a payment or distribution on account of the principal of (or premium, if any) or interest on this Security or on account of the purchase or other acquisition of this Security, and (2) the payment, issuance or delivery of cash (including cash paid for fractional shares upon conversion of this Security in accordance with Section 1), property or securities (other than junior securities) upon conversion of this Security in accordance with Section 1 shall be deemed to constitute payment on account of the principal of this Security. For the purposes of this Section, the term “junior securities” means (a) shares of any stock of any class of the Company and (b) securities of the Company which are subordinated in right of payment to all Senior Indebtedness which may be outstanding at the time of issuance or delivery of such securities to substantially the same extent as, or to a greater extent than, this Security is so subordinated as provided in this Section 6. Nothing contained in this Section 6 or elsewhere in this Security is intended to or shall impair, as among the Company, its creditors other than holders of Senior Indebtedness and the holder of this

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Security, the right, which is absolute and unconditional, of the holder of this Security to convert this Security in accordance with Section 1.

7. Definitions. Unless otherwise defined in this Security, the following capitalized terms shall have the following respective meanings when used herein:

“Affiliate” of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, “control”, when used with respect to any specified Person, means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms “controlling” and “controlled” have meanings correlative to the foregoing.

“Business Day” means any day except a Saturday, Sunday or other day on which the commercial banks in the State of California are required or authorized by law to close or be closed.

“Cash Distribution” means the distribution by the Company to all holders of its Common Stock of cash, other than any cash that is distributed upon a merger or consolidation to which Section 1(h) applies or as part of a distribution referred to in paragraph (4) of Section 1(b).

“Closing Price” means, with respect to the Common Stock of the Company, for any day, the reported last sale price per share on the Nasdaq National Market, or, if the Common Stock is not admitted to trading on the Nasdaq National Market, on the principal national securities exchange or inter-dealer quotation system on which the Common Stock is listed or admitted to trading, or if not admitted to trading on the Nasdaq National Market, or listed or admitted to trading on any national securities exchange or inter-dealer quotation system, the closing bid price per share in the over-the-counter market as furnished by any New York Stock Exchange member firm selected from time to time by the Company for that purpose.

“Commission” means the United States Securities and Exchange Commission, or any other federal agency at the time administering the Securities and Exchange Act of 1934, as amended, or the Securities Act, whichever is the relevant statute for the particular purpose.

“Common Stock” means the Common Stock, par value $.001 per share, of the Company authorized at the date of this instrument as originally executed. Subject to the provisions of this Section 7, shares issuable on conversion of this Security shall include only Common Stock or shares of any class or classes of common stock resulting from any reclassification or reclassifications thereof; provided, however, that if at any time there shall be more than one such resulting class, the shares so issuable on conversion of this Security shall include shares of all such classes, and the shares of each such class then so issuable shall be substantially in the proportion which the total number of shares

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of such class resulting from all such reclassifications bears to the total number of shares of all such classes resulting from all such reclassifications.

“Conversion Price” means 1,000 divided by the Conversion Rate in effect immediately prior to the applicable determination date.

“Credit Agreement” means that certain Loan and Security Agreement, dated as of June 25, 2001, among the Company, the lenders from time to time party thereto (the “Lenders”) and Foothill Capital Corporation, as agent for the Lenders, as such agreement may be amended, modified, restated or supplemented from time to time and any deferral, renewal, extension, refunding, refinancing or replacement thereof.

“Designated Senior Indebtedness” means the Company’s obligations under (i) any Senior Indebtedness outstanding from time to time under the Credit Agreement and (ii) any other Senior Indebtedness with a principal amount in excess of Twenty-Five Million Dollars ($25,000,000) in which the instrument creating or evidencing the same or the assumption or guarantee thereof (or related agreements or documents to which the Company is a party) expressly provides that such Senior Indebtedness shall be “Designated Senior Indebtedness” for purposes of this Security (provided that such instrument, agreement or other document may place limitations and conditions on the right of such Senior Indebtedness to exercise the rights of Designated Senior Indebtedness).

“Determination Date” means, in the case of a dividend or other distribution, including the issuance of rights, options or warrants, to shareholders, the date fixed for the determination of shareholders entitled to receive such dividend or other distribution and, in the case of a tender offer, the last time that tenders could have been made pursuant to such tender offer.

“Exchange Act” means the Securities Exchange Act of 1934, as amended.

“Indebtedness” means, with respect to any Person:

(a) All obligations, contingent or otherwise, of such Person (i) for borrowed money (whether or not the recourse of the lender is to the whole of the assets of such Person or only to a portion thereof), (ii) evidenced by a note, debenture, bond or written instrument (including a purchase money obligation), (iii) in respect of leases of such Person required, in conformity with generally accepted accounting principles, to be accounted for as capitalized lease obligations on the balance sheet of such Person and all obligations and other liabilities (contingent or otherwise) under any lease or related document (including a purchase agreement) in connection with the lease of real property which provides that such Person is contractually obligated to purchase or cause a third party to purchase the leased property and thereby guarantee a minimum residual value of the leased property to the lessor and the obligations of such Person under such lease or related document to purchase or to cause a third party to purchase such leased property; or (iv) in respect of letters of credit (including

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reimbursement obligations with respect thereto), local guarantees or bankers’ acceptances;

(b) All obligations secured by a mortgage, pledge, lien, encumbrance, charge or adverse claim affecting title or resulting in an encumbrance to which the property or assets of such Person are subject, whether or not the obligations secured thereby shall have been assumed by or shall otherwise be such Person’s legal liability;

(c) To the extent not otherwise included, all obligations of such Person under interest rate and currency swap agreements, cap, floor and collar agreements, spot and forward contracts and similar agreements and arrangements;

(d) All obligations of others of the type described in clauses (a), (b), or (c) above assumed by or guaranteed in any manner by such Person or in effect guaranteed by such Person through an agreement to purchase, contingent or otherwise (and the obligations of such Person under any such assumptions, guarantees or other such arrangements); and

(e) All obligations, contingent or otherwise, of such Person under or in respect of any and all deferrals, renewals, extensions and refundings of, or amendments, modifications or supplements to, any liability of the kinds described in any of the preceding clauses (a), (b), (c) or (d);

“Person” shall mean and include an individual, a partnership, a corporation (including a business trust), a joint stock company, a limited liability company, an unincorporated association, a joint venture or other entity or a governmental authority.

“Registration Rights Agreement” means the Registration Rights Agreement, dated as of December 6, 2001, between the Company and the initial holder of this Security.

“Repurchase Date” has the meaning given to such term in Section 2(a) hereof.

“Rights Plan” means the Company’s Preferred Stock Rights Agreement, dated as of September 25, 2000, between the Company and Fleet National Bank.

“Securities Act” means the Securities Act of 1933, as amended.

“Senior Indebtedness” means the principal of, premium, if any, interest on (including any interest accruing after the filing of a petition by or against the Company under any bankruptcy law, whether or not allowed as a claim after such filing in any proceeding under such bankruptcy law) and any other payment due pursuant to, any Indebtedness, whether outstanding on the date of this Security or thereafter incurred or created; provided that Senior Indebtedness shall not include (i) any indebtedness of any kind of the Company to any Subsidiary of the Company, (ii) any liability for federal, state, foreign, local or other taxes owed or owing by the Company or any Subsidiary, (iii) indebtedness for trade payables or constituting the deferred purchase price of assets or services incurred in the ordinary course of business, (iv) any Indebtedness which by its

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terms is pari passu in right of payment with or subordinate in right of payment to this Security, or (v) any Indebtedness incurred in violation of the provisions of this Security.

“Subsidiary” shall mean (a) any corporation of which more than 50% of the issued and outstanding equity securities having ordinary voting power to elect a majority of the board of directors of such corporation is at the time directly or indirectly owned or controlled by the Company, (b) any partnership, joint venture, limited liability company or other association of which more than 50% of the equity interests having the power to vote, direct or control the management of such partnership, joint venture, limited liability company or other association is at the time directly or indirectly owned and controlled by the Company, and (c) any other entity included in the financial statements of the Company on a consolidated basis.

“Trading Day” means (i) if the Common Stock is admitted to trading on the Nasdaq National Market or any other system of automated dissemination of quotations of securities prices, a day on which trades may be effected through such system; (ii) if the Common Stock is listed or admitted for trading on the New York Stock Exchange or any other national securities exchange, a day on which such exchange is open for business; or (iii) if the Common Stock is not admitted to trading on the Nasdaq National Market or listed or admitted for trading on any national securities exchange or any other system of automated dissemination of quotation of securities prices, a day on which the Common Stock is traded regular way in the over-the-counter market and for which a closing bid and a closing asked price for the Common Stock are available.

8. Miscellaneous.

(a) No provision of this Security shall alter or impair the obligation of the Company, which is absolute and unconditional, to pay the principal of and interest, if any, on this Security at the times, places and rate, and in the coin or currency, herein prescribed or to convert this Security as herein provided.

(b) The Company will give prompt written notice to the holder of this Security of any change in the location of the Designated Office. Any notice to the Company or to the holder of this Security shall be given in the manner set forth in the Convertible Note Purchase Agreement, dated as of December 6, 2001, among the Company and the initial holder of this Security, provided that the holder of this Security, if not a party to such Convertible Note Purchase Agreement, may specify alternative notice instructions to the Company.

(c) (1) The transfer of this Security is registrable on the register maintained by the Company upon surrender of this Security for registration of transfer at the Designated Office, duly endorsed by, or accompanied by a written instrument of transfer in form satisfactory to the Company duly executed by, the holder hereof or such holder’s attorney duly authorized in writing, and thereupon one or more new Securities, of authorized denominations and for the same aggregate principal amount, will be issued to the designated transferee or transferees. Such Securities are issuable only in registered form without coupons in denominations of $1,000 and any integral multiple thereof. No

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service charge shall be made for any such registration of transfer, but the Company may require payment of a sum sufficient to recover any tax or other governmental charge payable in connection therewith. Prior to due presentation of this Security for registration of transfer, the Company and any agent of the Company may treat the Person in whose name this Security is registered as the owner thereof for all purposes, whether or not this Security be overdue, and neither the Company nor any such agent shall be affected by notice to the contrary.

(2) This Security and the Common Stock issuable upon conversion of this Security have not been registered under the Securities Act, or the securities laws of any state or other jurisdiction. Neither this Security nor the Common Stock issuable upon conversion of this Security nor any interest or participation herein may be reoffered, sold, assigned, transferred, pledged, encumbered or otherwise disposed of (a “Transfer”) in the absence of such registration or unless such transaction is exempt from, or not subject to, registration. The holder by its acceptance of this Security or the Common Stock issuable upon conversion of this Security agrees that it shall not offer, sell, assign, transfer, pledge, encumber or otherwise dispose of this Security or any portion thereof or interest therein other than in a minimum denomination of $5,000,000 principal amount (or any integral multiple of $1,000,000 in excess thereof) and then (other than with respect to a Transfer pursuant to a registration statement that is effective at the time of such Transfer) only (a) to the Company, (b) pursuant to a person it reasonably believes to be an institutional “accredited investor” within the meaning of Rule (501(a)(1)(2)(3) or (7) under the Securities Act or a qualified institutional buyer (as defined in Rule 144A under the Securities Act), and in the case of (b) above in which the transferor furnishes the Company with such certifications, legal opinions or other information as the Company may reasonably request to confirm that such transfer is being made pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act.

(3) Upon presentation of this Security for registration of transfer at the office of the Company specified herein accompanied by (i) certification by the transferor that such transfer is in compliance with the terms hereof and (ii) by a written instrument of transfer in a form approved by the Company executed by the registered holder, in person or by such holder’s attorney thereunto duly authorized in writing, and including the name, address and telephone and fax numbers of the transferee and name of the contact person of the transferee, such Security shall be transferred on the Security register, and a new Security of like tenor and bearing the same legends shall be issued in the name of the transferee and sent to the transferee at the address and c/o the contact person so indicated. Transfers and exchanges of Securities shall be subject to such additional restrictions as are set forth in the legends on the Securities and to such additional reasonable regulations as may be prescribed by the Company as specified in Section 8(c)(2) hereof. Successive registrations of transfers as aforesaid may be made from time to time as desired, and each such registration shall be noted on the Security register.

(4) Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of this Security, and in the

29

case of loss, theft or destruction, receipt of indemnity or security reasonably satisfactory to the Company, and upon reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of such Security, if mutilated, the Company will deliver a new Security of like tenor and dated as of such cancellation, in lieu of such Security.

(5) Such holder represents that it is an institutional “accredited investor” within the meaning of Rule 501(a)(1)(3)(5) or (7) of the Securities Act or a qualified institutional buyer (as defined in Rule 144A under the Securities Act). Such holder has been advised that this Security has not been registered under the Securities Act, or any state securities laws and, therefore, cannot be resold unless it is registered under the Securities Act and applicable state securities laws or unless an exemption from such registration requirements is available. Such holder is aware that the Company is under no obligation to effect any such registration or to file for or comply with any exemption from registration. Such holder has not been formed solely for the purpose of making this investment and is acquiring the Security for its own account for investment, and not with a view to, or for resale in connection with, the distribution thereof.

(6) Neither this Security nor any term hereof may be amended or waived orally or in writing, except that any term of the Securities may be amended and the observance of any term of the Securities may be waived (either generally or in a particular instance and either retroactively or prospectively), and such amendment or waiver shall be applicable to all of the Securities, upon the approval of the Company and the holders of fifty percent (50%) or more of the outstanding principal amount of all then outstanding Securities; provided, however, that any amendment that would (i) reduce the outstanding principal amount or premium (if any) of the Securities, (ii) reduce the rate of interest borne by the Securities, (iii) change the date of maturity or interest payment dates of the Securities, (iv) reduce any amount payable upon repurchase of the Securities, (v) impair the right of any holder of this Security to institute suit for the payment thereof, (vi) make the principal, premium (if any) or interest payable on the Securities in a coin or currency other than as set forth in the Securities, (vii) modify the provisions of the Securities with respect to subordination or seniority of the Securities in a manner adverse to the holders of the Securities in any material respect, (viii) change in any respect the obligation of the Company to repurchase the Securities, (ix) impair the right of the holders of the Securities to convert the Securities into Common Stock or (x) modify this Section 9 shall require the approval of the holder of each Security to which such amendment shall apply. The Company will not amend any provision of any other Security in a manner favorable to any holder thereof unless a similar amendment is made or offered with respect to all of the Securities. Each holder of this Security by its acceptance hereof acknowledges and agrees that the subordination provisions of this instrument are for the benefit of the holders of the Senior Indebtedness and that, accordingly, no provision of Section 6 hereof may be amended or otherwise modified without the prior written consent of each holder of Senior Indebtedness at such time outstanding.

(d) THIS SECURITY SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW

30

YORK, INCLUDING, WITHOUT LIMITATION, SECTION 5-1401 AND 5-1402 OF THE NEW YORK GENERAL OBLIGATIONS LAW AND NEW YORK CIVIL PRACTICE LAWS AND RULES 327(B). THE COMPANY AND EACH HOLDER OF THIS SECURITY IRREVOCABLY AND UNCONDITIONALLY CONSENTS TO SUBMIT TO THE EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK AND OF THE UNITED STATES OF AMERICA, IN EACH CASE LOCATED IN THE COUNTY OF NEW YORK, FOR ANY DISPUTE ARISING OUT OF OR RELATING TO THIS SECURITY.

[Remainder of page intentionally left blank.]

31

IN WITNESS WHEREOF, the Company has caused this Security to be duly executed.

Dated: November 4, 2003

palmOne, Inc.
By:	/s/    JUDY BRUNER
Name:	Judy Bruner
Title:	Senior Vice President and Chief Financial Officer

Attest:	/s/    PHILIPPE MORALI
Name:	Philippe Morali
Title:	Vice President and Treasurer, Corporate Development and Treasury

[Signature Page to palmOne, Inc. 5% Convertible Subordinated Note due 2006]

ELECTION OF HOLDER TO REQUIRE REPURCHASE

1. Pursuant to Section 2(a) of this Security, the undersigned hereby elects to have all or a portion of this Security repurchased by the Company.

2. The undersigned hereby directs the Company to pay [choose one] (a) it or (b) Name:                             ; address:                             ; Social Security or Other Taxpayer Identification Number, if any:                     , an amount in cash equal to the Repurchase Price, as provided herein.

Dated: _____________________________________

[Holder]

By:

Name:

Title:

Number of shares of Common Stock

owned by the holder and its affiliates:                                                      

Principal amount to be repurchased

(an integral multiple of $1,000):                                              

Remaining principal amount following

such repurchase (not less than $1,000):                                         

NOTICE: The signature to the foregoing Election must correspond to the name as written upon the face of this Security in every particular, without alteration or any change whatsoever.

CONVERSION NOTICE

The undersigned holder of this Security hereby irrevocably exercises the option to convert this Security, or any portion of the principal amount hereof (which is an integral multiple of $1,000) below designated, into Common Stock in accordance with the terms of this Security, and directs that such shares, together with a check in payment for any fractional share and any Security representing any unconverted principal amount hereof, be delivered to and be registered in the name of the undersigned unless a different name has been indicated below. If Common Stock or Securities are to be registered in the name of a Person other than the undersigned, the undersigned will pay all transfer taxes payable with respect thereto.

Dated: _____________________________________

[Holder]

By:

Name:

Title:

If shares or Securities are to be registered in the name of a Person other than the holder, please print such Person’s name and address:

Name

Address

Social Security or other Taxpayer Identification Number, if any

If only a portion of the Securities is to be converted, please indicate:

1. Principal amount to be converted: $                    

2. Principal amount and denomination of Security representing unconverted principal amount to be issued:

Amount: $                

Denominations: $                 (any integral multiple of $1,000)

EX-4.5

Exhibit 4.5

CERTIFICATE OF OWNERSHIP AND MERGER

MERGING

PLMO MERGER CORPORATION

INTO

PALM, INC.

Pursuant to Section 253 of the General Corporation Law of the State of Delaware, Palm, Inc. (the “Company”), a corporation organized and existing under the laws of Delaware,

DOES HEREBY CERTIFY:

FIRST: That the Company was incorporated on December 17, 1999 pursuant to the General Corporation Law of the State of Delaware.

SECOND: That the Company owns all of the outstanding shares of the capital stock of PLMO Merger Corporation, a corporation incorporated on October 24, 2003 pursuant to the General Corporation Law of the State of Delaware.

THIRD: That the Company, by the following resolutions of its Board of Directors, duly adopted at a meeting on October 28, 2003, determined to merge PLMO Merger Corporation with and into the Company:

WHEREAS, the Company owns all of the outstanding capital stock of PLMO Merger Corporation, a Delaware corporation (“PLMO”).

WHEREAS, the Company desires to merge PLMO with and into the Company pursuant to Section 253 of the Delaware General Corporation Law to change the Company’s name to “palmOne, Inc.”

NOW THEREFORE BE IT RESOLVED, that the Board of Directors hereby authorizes the Company to merge into itself PLMO Merger Corporation, a Delaware corporation and a wholly owned subsidiary of the Company, and to assume all of PLMO Merger Corporation’s liabilities and obligations (the “Merger”).

RESOLVED FURTHER, that the Merger shall be effective at 12:02 a.m. Eastern Standard Time on October 29, 2003.

RESOLVED FURTHER, that upon the effectiveness of the Merger, the name of the Company shall be changed to “palmOne, Inc.” and Article I of the Amended and Restated Certificate of Incorporation of the Company shall be amended to read in its entirety as follows:

“ARTICLE I

The name of the Corporation is palmOne, Inc. (the “Corporation”).”

RESOLVED FURTHER, that the Board of Directors hereby authorizes and directs the appropriate officers of the Company, and each of them, to execute and file all documents, including a Certificate of Ownership and Merger, and to take all other actions which they deem necessary or desirable to carry out the intent or accomplish the purposes of the foregoing resolutions.

RESOLVED FURTHER, that all actions taken previously by any current or former officer of the Company intended to carry out the intent or accomplish the purposes of the foregoing resolutions, including, without limitation, the acquisition by the Company of all of the outstanding capital stock of PLMO, are hereby confirmed, ratified, approved and adopted.

IN WITNESS WHEREOF, Palm Inc. has caused this certificate to be signed by Mary E. Doyle, its Senior Vice President, this 28^th day of October 2003. The undersigned hereby acknowledges that it is the act and deed of such person and that the facts stated herein are true.

PALM, INC.
By:	/s/    Mary E. Doyle
Name:	Mary E. Doyle
Title:	Senior Vice President

-2-

EX-31.1

Exhibit 31.1

Certifications

I, R. Todd Bradley, Chief Executive Officer of palmOne, Inc., certify that:

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

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

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

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

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) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]

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

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

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: April 6, 2004	By:	/s/    R. TODD BRADLEY
	Name:	R. Todd Bradley
	Title:	President and Chief Executive Officer

EX-31.2

Exhibit 31.2

Certifications

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

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

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

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

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

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) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]

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

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

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: April 6, 2004	By:	/s/    JUDY BRUNER
	Name:	Judy Bruner
	Title:	Senior Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER

PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, R. Todd Bradley, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of palmOne, Inc. on Form 10-Q for the fiscal quarter ended February 27, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of palmOne, Inc.

By:	/s/    R. TODD BRADLEY
Name:	R. Todd Bradley
Title:	President and Chief Executive Officer

I, Judy Bruner, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report of palmOne, Inc. on Form 10-Q for the fiscal quarter ended February 27, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of palmOne, Inc.

By:	/s/    JUDY BRUNER
Name:	Judy Bruner
Title:	Senior Vice President and Chief Financial Officer