UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended June 3, 2005.

For the fiscal year ended May 28, 2004

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Commission File Number: 0000-50402

PALMSOURCE, INC.

(Exact name of registrant as specified in its charter)


DELAWARE		77-0586278
(State or other jurisdiction of Incorporation or organization)		(I.R.S. Employer Identification No.)

~~1240~~1188 ~~Crossman~~East Arques Avenue

Sunnyvale, California ~~94089~~94085-~~1116~~4602

(Address of principal executive offices)

(408) 400-3000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock $0.001 par value

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes ¨x No x¨

As of November 2826, ~~2003,~~2004 based on the closing sales price as quoted by the Nasdaq, 1014,~~687~~549,~~761~~673 shares of common stock, having an aggregate market value of approximately $~~274~~235,~~247~~704,~~947~~702 were held by non-affiliates. For purposes of the above statement only, all directors and executive officers of the registrant are assumed to be affiliates.

The number of shares of common stock outstanding at July 2325, ~~2004~~2005 was 1516,~~101~~806,~~231~~946 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Certain sections of the Registrant’s definitive Proxy Statement for the ~~2004~~2005 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K to the extent stated herein.

PalmSource, Inc.

Form 10-K

For The Fiscal Year Ended ~~May~~June 283, ~~2004~~2005

Table of Contents

		Page
Part I
Item 1.	Business	13
Item 2.	Properties	2312
Item 3.	Legal Proceedings	2312
Item 4.	Submission of Matters to a Vote of Security Holders	2514
Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	2615
Item 6.	Selected Financial Data	2716
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2818
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	6250
Item 8.	Financial Statements and Supplementary Data	6351
Item 9.	Changes in and ~~Disagreements~~Disagreement with Accountants on Accounting and Financial Disclosures	~~103~~95
Item 9A.	~~Control~~Controls and Procedures	~~103~~95
Item 9B.	Other Information	95
Part III
Item 10.	Directors and Executive Officers ~~of the Registrant~~	~~104~~96
Item 11.	Executive Compensation	~~104~~96
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	~~104~~96
Item 13.	Certain Relationships and Related Transactions	~~104~~96
Item 14.	Principal Accounting Fees and Services	~~104~~96
Part IV
Item 15.	Exhibits, Financial Statements Schedules, and Reports on Form 8-K	105
Item 15	Exhibits and Financial Statements Schedules	97
	Signatures	~~110~~102

Special Note Regarding Forward-Looking Statements

Certain statements set forth or incorporated by reference in this Form 10-K, as well as in our Annual ~~Report~~Reports to Stockholders for the year ended ~~May~~June 283, ~~2004~~2005, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks and uncertainties that could cause our industry’s results, level of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in this Form 10-K. In some cases, you can identify forward-looking statements by terminology such as “anticipates,” “believes,” “ continue,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “will,” or the negative of any of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this Form 10-K to conform these statements to actual results.

PART I

Item 1. Business

~~Overview~~Company Overview

We are a leading developer and licensor of ~~platform~~ software ~~that enables~~for mobile information devices. Our software platform, Palm OS®, consists of operating system software, ~~or Palm OS,~~ and software development tools. Wethat ~~have~~operate ~~also~~the ~~enhanced~~features ~~our platform with applications such as personal information management software, web browsers~~ and ~~e-mail.~~functions Aon ~~wide range of smart mobile devices incorporate our solutions, including~~ personal digital assistants, or (PDAs;), smartphones; ~~location-aware~~and ~~devices;~~other ~~entertainment~~handheld devices; ~~and~~such as industrial and industry-specific ~~devices~~PDAs used in ~~industries such as~~ education, ~~hospitality~~healthcare and ~~healthcare~~hospitality industries. We ~~license~~have also enhanced the Palm OS toplatform ~~leading~~with ~~smart~~applications ~~mobile~~such ~~information~~as ~~device~~personal ~~manufacturers,~~information ~~including~~management ~~palmOne,~~(PIM) ~~Sony~~software, ~~Garmin,~~web ~~GSPDA,~~browsers ~~Kyocera,~~ and ~~Samsung~~e-mail. ~~Products~~There ~~using~~have ~~Palm~~been ~~OS,~~over or39 million Palm Powered™ ~~products~~devices sold, ~~have~~which ~~held the number~~has ~~one~~attracted ~~PDA~~a ~~market~~large ~~share~~and ~~position~~loyal infollowing ~~each~~among ofcustomers ~~the~~and ~~reports~~Palm ~~filed~~OS insoftware ~~the past six years by IDC, as measured in units sold~~developers.

~~Our primary product offering,~~ Palm OS, ~~provides~~was aoriginally ~~flexible~~designed ~~platform~~for ~~that enables~~ the ~~creation~~PDA ~~of powerful~~market, ~~innovative~~which ~~and~~represented ~~easy-to-use smart mobile devices. Historically,~~ the majority of our ~~licensees~~business ~~have~~in ~~developed~~fiscal ~~PDAs~~2005. ~~and~~However, ~~Palm~~over OSthe ~~has~~past ~~attracted~~few ~~a large and loyal following~~years, ~~with~~the ~~approximately~~growth 34in ~~million~~wireless ~~Palm~~data ~~Powered~~networks ~~products sold to date. We have begun to license Palm OS to smartphone manufacturers~~ and ~~intend~~wireless toapplications ~~continue to build on our leadership position~~ and services ~~experience~~have insimultaneously ~~PDAs~~contributed to ~~become~~the amaturation, ~~leading licensor~~ of ~~platform~~this ~~software~~market ~~for~~as ~~smartphones~~well ~~and~~as ~~other~~strong ~~next~~demand ~~generation~~for ~~smart~~converged mobile ~~products.~~devices Ansuch ~~increasing~~as ~~portion of our revenue and units shipped are coming from these smartphone licensees~~smartphones. ~~There~~As ~~are~~a ~~approximately 300~~result,~~000~~ ~~registrants~~ in ~~our~~fiscal ~~Palm OS developer program which offers Palm OS developer tools~~2005, ~~programs,~~we ~~and~~saw ~~support~~a tosignificant ~~enable~~shift ~~the~~in ~~creation of software applications for~~ our ~~platform.~~product ~~According~~mix totoward ~~PalmGear.com~~converged mobile devices, awhere ~~leading~~reported ~~online~~unit ~~provider~~volumes ofshipped ~~handheld~~by ~~applications~~our ~~with~~licensees ~~whom~~increased weby ~~have~~94% acompared ~~strategic~~to ~~relationship,~~fiscal ~~there~~2004 ~~are~~and ~~currently~~represented ~~more~~over ~~than~~27% ~~20,000~~of ~~software~~the ~~titles~~total ~~available for~~ Palm ~~Powered~~OS ~~products.~~unit ~~To further promote our software platform, we provide professional services and support for our licensees and developers~~volume.

~~Company~~In ~~Background~~January 2005, we acquired China MobileSoft Ltd. (CMS), a Nanjing, China-based developer and licensor of software for mobile phones. Through this acquisition, we gained local sales and marketing resources, and a suite of applications and software platforms that address the mobile phone opportunity in China, which is the largest market for mobile phones in the world. Additionally, the acquisition brought us highly skilled engineering resources in a low cost environment that expand, as well as complement our product development efforts in Sunnyvale, California and Montpellier, France.

We ~~were~~ ~~incorporated~~intend onto ~~December~~leverage 3,the ~~2001~~work asalready adone ~~wholly-owned~~on ~~subsidiary of~~ Palm, ~~Inc.,~~OS ~~or Palm, an event that we refer~~ to inoptimize ~~this~~it ~~report~~for smartphones, ~~as the separation~~ and the ~~date~~work ofdone ~~which~~by weour ~~refer~~operations toin asChina ~~the~~in ~~separation date. The purpose of~~ the ~~separation~~feature ~~was~~phone ~~to establish~~market ~~PalmSource as an independent company~~ to ~~conduct~~develop ~~substantially~~two ~~all~~next ofgeneration ~~Palm’s operating system software group business. In October 2003~~platforms, ~~Palm~~both ~~distributed~~of towhich ~~its~~will ~~stockholders~~run on a ~~pro-rata~~variety ~~basis all~~ of ~~the~~Linux ~~outstanding shares of our common stock owned by Palm, an event that we refer to in this report as the distribution~~distributions. AtWe ~~the~~intend ~~same~~for ~~time~~these asplatforms ~~the distribution, Palm acquired Handspring, Inc., an event that we refer~~ to inconform ~~this~~with ~~report~~global ~~as the Handspring merger, and the combined~~wireless ~~entity changed its name to palmOne~~standards, ~~Inc.~~which Inwill ~~this~~allow document, we refer to palmOne, Inc. as “palmOne” or “Palm” interchangeably, depending upon the time and context of the event described. References in this report to “PalmSource,” “we,” “our,” and “us” ~~refer~~ to ~~PalmSource,~~market ~~Inc.~~them ~~Our~~on ~~principal~~a ~~executive~~worldwide ~~offices are located at 1240 Crossman Avenue, Sunnyvale, California 94089-1116 and our telephone number is (408) 400-3000~~basis. ~~Our~~ ~~website can be found at www.palmsource.com.~~

~~Industry~~We ~~Background~~currently have more than a dozen Palm OS licensees including palmOne Inc., LG Electronics, Garmin Ltd., Symbol Technologies Inc. and GSPDA. Additionally, as of May 31, 2005, we have 24 licensees shipping individual or bundled applications, such as a multi-media messaging service (MMS) client or wireless application protocol (WAP) browser into the China market. These licensees include: Haier Group, Konka Group Company Ltd, China TechFaith and Wireless Communication Technology Ltd.

~~The~~We ~~Proliferation~~were incorporated on December 3, 2001 as a wholly-owned subsidiary of ~~Mobile~~Palm, ~~Information~~Inc. ~~Devices~~In October of 2003, Palm distributed our common stock to its shareholders, since which we have been a separate public company traded on NASDAQ under the symbol “PSRC.” Our principal executive offices are located at 1188 East Arques Avenue, Sunnyvale, California 94085 and our telephone number is (408) 400-3000. Our website can be found at www.palmsource.com.

~~For~~A ~~both~~copy ~~professionals~~of ~~and~~our ~~individual~~annual ~~consumers,~~reports iton ~~has become~~Form ~~increasingly~~10-K, ~~important~~quarterly toreports ~~have~~on ~~personal~~Form ~~and professional information such as addresses, calendars, to~~10-~~do lists~~Q, ~~customer~~current ~~information~~reports ~~and~~on ~~other~~Form ~~reference~~8-K ~~information close at hand~~ and ~~easily~~amendments ~~managed~~ to ~~facilitate~~these ~~better~~reports ~~communications.~~pursuant Asto ~~people~~Section ~~have~~13(a) ~~become~~or ~~increasingly~~15(d) ~~mobile,~~of the ~~need~~Securities ~~for~~Exchange ~~convenient,~~Act ~~portable~~of ~~devices to store~~1934, ~~manage~~as ~~and~~amended ~~communicate~~(the ~~information~~“Exchange ~~has~~Act”) ~~grown~~are ~~rapidly. Traditionally~~available, ~~storing~~free ~~and~~of ~~managing personal and professional information was accomplished using paper-based products~~charge, ~~and~~on ~~later,~~our ~~stand-alone~~Web ~~portable~~site ~~computers~~as orsoon ~~specialized~~as ~~electronic~~reasonably ~~devices.~~practicable ~~These~~after ~~tools~~such ~~often~~material ~~are~~is ~~cumbersome,~~electronically ~~expensive,~~filed ~~difficult~~with tothe ~~use~~ Securities and ~~offer~~Exchange ~~limited~~Commission ~~functionality~~(SEC). ~~The invention of the pen-based PDA in the early 1990s provided consumers a more useful electronic option for holding and~~

1Industry and Market Overview

~~Table~~Mobile information device manufacturers face the significant challenge of developing ~~Contents~~products to appeal to a variety of customers with diverse needs, preferences and budgets. Consumers, from school-age children to

organizing information and allowed users to synchronize the information in the handheld device with information on a personal computer. As new types of smart mobile devices that include PDA functionality come to market, sales are shifting away from traditional PDAs. According to an IDC report dated August 2004, annual worldwide shipments of pen-based handheld devices are projected to decrease from approximately 10.4 million units in 2003 to an estimated 9.6 million units in 2008, representing a 2% decline, compounded annually.

In addition, professionals and individual consumers increasingly need to communicate while mobile, as evidenced by the rapid adoption of mobile phones and PDAs throughout the world. In an effort to reduce the number of devices that they need to carry to stay connected to critical information, users have begun to adopt a new class of smart mobile devices that provide the combined functionality of mobile phones and traditional PDAs. According to the August 2004 IDC report, annual worldwide shipments of smartphones, which IDC refers to as “converged mobile devices,” are projected to increase from approximately 9.4 million units in 2003 where Palm OS powered 8.0% of these devices, to an estimated 94.0 million units in 2008, representing a 58% compound annual growth rate, and Palm OS is projected to power 5.5% of these devices by 2008. In addition, manufacturers are incorporating information capabilities into a wide range of other devices, including location-aware devices and other consumer products such as wristwatches and game devices.

While most mobile information devices historically have been purchased by individuals, continued pressure to raise productivity is causing enterprises to seek new ways to enable professionals and other workers to be more connected and more efficient in both traditional and non-traditional work settings. As a result, information technology managers are playing an increasing role in purchase decisions by setting standards for mobile computing within their organizations. Direct enterprise purchases of smart mobile devices are also expected to rise, driven in part by high interest in mobile e-mail.

The Needs and Preferences of Mobile Information Device Users, Mobile Information Device Manufacturers and Wireless Carriers

Mobile information device manufacturers face the significant challenge of developing products to appeal to a variety of customers with diverse needs, preferences and budgets. Consumers, from school-age children to retirees, are using mobile information devices for personal uses. Employees in a wide range of industries, from manufacturing to travel to health care, are using mobile information devices in lieu of traditional inventory, booking and other operational systems to perform a variety of work-related tasks. For example, many retail stores now use mobile information devices to locate and special order items for customers, rather than using traditional inventory and information systems. Professionals increasingly require devices with communications capabilities coupled with information management functions. In addition, enterprises have different needs than individuals, including a greater emphasis on security and integration with other systems.

Users demand that manufacturers create devices that are easy to use, affordable, reliable and interoperable with other productivity tools. Mobile information devices must operate quickly and efficiently, have long battery lives, support a broad set of powerful applications and allow users to retain data regardless of the device that they are using.

Mobile information device manufacturers have taken advantage of technological advances that already have led to substantial reductions in the size and weight of mobile information devices, as well as improvements in battery life, reliability, storage capacity and display quality. These changes fueled rapid growth in the PDA market for many years. However, we believe that to attract new customers and generate new upgrade sales, manufacturers will need to meet the needs and preferences of users by incorporating communications capabilities, Internet connectivity or multimedia capabilities into mobile information devices.

Due to the proliferation of mobile phone users and the highly competitive nature of the mobile phone service market, wireless operators are constantly seeking methods of attracting and retaining customers and generating additional revenues from users. Wireless operators work with mobile information device

manufacturers to develop innovative mobile devices that offer user functionality that promotes consumer adoption and loyalty. In addition, in some cases wireless carriers are able to exploit new mobile device functionality, such as e-mail access and Internet connectivity, to derive additional revenues from users. In addition, wireless carriers are concerned about the support burden these new devices and services may cause so ease of use for the devices is increasingly important. We believe that mobile device manufacturers will have to continue to produce innovative products with enhanced functionality to meet the demands of wireless operators.

Limitations of Existing Software Solutions

Traditionally, mobile information device manufacturers have adopted one of two software approaches to meet the needs of their customers. Some manufacturers have chosen to license a relatively rigid software platform to offer a consistent user experience and get their products to market more rapidly. However, this platform constrains the way in which the devices can be used and limits the ability of device manufacturers to customize and differentiate their products. Others have attempted to design software for each device that can meet a customer’s precise specifications. However, this approach can be time-consuming and costly and requires users to learn different operating environments for each new type of device. Further, the resulting product generally is not interoperable with existing applications and is not likely to attract third-party application development since most software developers are looking to design applications that will run on the largest number of devices with the fewest modifications. We believe that device manufacturers, application developers and consumers prefer a software solution that offers a common user experience and a consistent platform, yet is easily customizable to meet the needs of a variety of end users.

Our Solution

We develop, license and support a leading software platform that enables mobile information device manufacturers to rapidly and efficiently create products that meet diverse customer needs. Our platform consists of Palm OS and software development tools, as well as applications such as personal information management applications, e-mail and web browsers that enable mobile information device manufacturers to develop products based on our platform. We also provide professional services and product development support for our licensees. In addition, we have a large and loyal following of third-party developers building applications for our platform. Our solution has emerged as a highly flexible, efficient platform for mobile information devices. Key benefits of our solution are:

Flexible Platform that Enables Mass Customization. Palm OS was designed for mobile information devices, for which ease of use, instant access to information, low power consumption and wireless capabilities are important design characteristics. As a result of this focus, the Palm OS architecture enables mobile information device manufacturers to develop a variety of products at a wide range of price points with the customized applications that their customers require. Palm OS is comprised of easily configurable components, which provide device manufacturers a high degree of design flexibility, enabling them to develop a wide variety of handheld systems, ranging from basic PDAs to high-end multimedia and game devices, smartphones, wristwatches and industrial handhelds. At the same time, Palm OS offers users a consistent operating experience and the ability to run a common set of applications on any Palm Powered device.

Intuitive and Familiar User Interface. We designed Palm OS with a focus on productivity and ease of use, and we believe that the Palm Powered ingredient brand is associated with these attributes. From the first version of our software released in 1996 in the Palm Pilot, our designers have studied how mobile information devices are actually used and how to make devices simple and efficient to operate. We believe that Palm Powered products can more easily penetrate new markets because learning to use Palm OS does not require prior familiarity with PC operating systems, which means users of Palm OS need less training to use their Palm Powered devices. This ease of use can directly related to lower support costs for the manufacturers of these devices and the wireless carriers that deploy these devices into their networks.

~~Efficiency~~ retirees, ~~Performance~~are ~~and~~using ~~Reliability.~~these ~~Palm~~devices OSfor ~~has~~personal ~~been designed to provide significant power and performance advantages over competitive solutions~~use. ~~These~~Employees ~~advantages~~in ~~include~~a ~~significantly~~wide ~~lower~~range ~~operating~~of ~~system~~industries, ~~memory~~from ~~and~~manufacturing ~~processor~~to ~~requirements~~travel ~~than~~to ~~competitive~~health ~~solutions.~~care, ~~Device~~are ~~manufacturers that build products based on our platform can therefore achieve similar device features and functionality while lowering component cost beyond that achievable~~ using ~~competing operating systems. For example, a complete and fully featured version of our operating system will fit within a device~~these asdevices ~~small~~in aslieu ~~a wristwatch with as little as two megabytes~~ of ~~storage~~traditional ~~memory~~inventory, ~~while~~booking ~~a comparable version of our closest competitor’s currently available offering would require sixteen megabytes of storage memory~~ and aother ~~substantially~~operational ~~larger~~systems ~~device. In addition, our platform architecture is specifically designed~~ to ~~provide~~perform a ~~highly~~variety ~~reliable~~of ~~operating~~work-related ~~environment for mobile information devices~~tasks. For example, ~~our~~many ~~operating~~retail ~~system~~stores isnow ~~designed~~use tomobile ~~cope~~information ~~with~~devices ~~power~~to ~~loss~~locate and ~~other~~special ~~unplanned~~order ~~events~~items infor acustomers, rather ~~manner~~than ~~that~~using ~~will~~traditional ~~not~~inventory ~~compromise~~and ~~data~~information systems.

~~Cooperative Development~~These ~~that~~users ~~Speeds~~demand ~~Innovation.~~that Wemanufacturers ~~work~~create ~~with~~devices ~~our licensees and other technology providers to speed the introduction of new and innovative products. We provide to our licensees support and professional services~~ that ~~enable~~are ~~them~~easy to ~~bring products~~use, ~~to market more quickly and effectively. As our licensees develop technology enhancements~~affordable, ~~the~~reliable ~~terms of our licensing~~ and ~~support~~interoperable ~~agreements~~with ~~ensure~~other ~~that~~productivity ~~we maintain the right to include most of the broadly applicable technology advancements in future versions of Palm OS~~tools. ~~This~~These ~~approach~~devices ~~allows~~must usoperate toquickly ~~more rapidly develop next generations of Palm OS~~ and ~~make~~efficiently, ~~technology advancements available to the broader community of Palm OS licensees and their customers. We also~~ have ~~introduced~~long ~~the~~battery ~~Palm OS Ready program~~lives, ~~through~~support ~~which we license~~ a subset of our software tool kit to a select number of industry-leading technology providers that supply components, such as processors and graphics chips, to mobile information device manufacturers. Bybroad ~~having~~set ~~access to these tools, members~~ of ~~the~~powerful ~~program~~applications ~~can customize their technology for Palm OS~~ and ~~subsequently~~allow ~~sell~~users ~~those products directly~~ to ~~our~~retain ~~licensees~~data ~~earlier~~regardless ~~in the design cycle. The objectives~~ of the ~~Palm~~device OSthat ~~Ready~~they ~~program and our cooperative development approach~~ are ~~a time-to-market advantage for our licensees and reduced support costs~~using.

~~Extensive~~In ~~Community~~order ofto ~~Third-Party~~meet ~~Developers~~the ~~and~~needs ~~Applications.~~of ~~The Palm OS platform has attracted a large and loyal following~~end-users, ~~with~~manufacturers ~~approximately 34~~of ~~million~~these ~~Palm Powered~~ devices ~~sold~~have totaken ~~date.~~advantage ~~Our broad user base has also attracted a large community~~ of ~~third-party~~technological ~~developers~~advances ~~creating~~that ~~software~~have ~~applications,~~already ~~peripherals~~led ~~and~~to substantial ~~accessories~~reductions ~~that~~in ~~increase~~ the ~~performance~~size and ~~functionality~~weight of ~~Palm Powered~~these devices., ~~There~~as ~~are~~well ~~approximately~~as ~~300,000~~improvements ~~registrants~~ in ~~our~~battery ~~Palm OS developer program which offers Palm OS developer tools~~life, ~~program~~reliability, ~~and~~storage ~~support~~capacity toand ~~enable~~display ~~the creation of software applications for our platform~~quality. ~~According~~These tochanges ~~PalmGear.com,~~fueled ~~a leading~~rapid ~~online~~growth ~~provider~~in ofthe ~~handheld~~PDA ~~applications,~~market ~~there are currently more than 20,000 software titles available~~ for ~~Palm~~many ~~Powered devices~~years. ~~We make development tools available for our developer community~~However, ~~and~~ we ~~share~~believe ~~select parts of the Palm OS~~that ~~source code~~ to ~~enable~~attract ~~developers~~new tocustomers ~~optimize~~and ~~the~~generate ~~interface~~new ofsales, ~~their~~manufacturers ~~applications~~will ~~with~~need ~~our~~to ~~software~~meet ~~platform.~~the Weneeds ~~believe~~and ~~that~~preferences ~~the existence~~ of ~~these~~users ~~third-party~~by ~~software~~incorporating ~~applications,~~communications ~~peripherals~~ and ~~accessories~~multimedia ~~increases~~capabilities ~~the value to the end-user of Palm Powered devices~~ and ~~helps~~Internet toconnectivity ~~expand~~into ~~the~~these ~~market for our licensees’ products and services~~devices.

~~Our~~According ~~Strategy~~to Canalys, the PDA market in the United States declined by 21% to 3.8 million units in 2004. As this market continues to mature, the competitive environment among device manufacturers has led to market consolidation around a few large players such as palmOne and Hewlett Packard. For example, in 2004, Sony, a licensee and stockholder of ours, announced that it would discontinue the Clie® PDA product line. Several other manufacturers of PDA products based on other operating systems have also left the market or substantially curtailed their product plans. We believe some of the major factors contributing to the maturing of this market are the growth in other wireless mobile devices such as smartphones, the introduction of multi-media devices with hard drives and competition from other converged devices that typically compete with the PDA for customer purchases.

~~Our~~As wireless carriers build out 2.5 and 3G ~~objective~~networks is(wireless tonetworks bewith ahigh-speed ~~leading~~capabilities ~~licensor~~ideal for surfing the Internet or sending large amounts of ~~platform~~data) ~~software~~throughout the world, the ability to stay “connected” all the time has led to increased demand for ~~smartphone~~services and devices that allow for real-time communications. Businesses and other ~~next~~end-users ~~generation~~looking ~~smart~~for ~~mobile~~value-added, ~~products.~~advanced ~~The~~communications ~~key~~features ~~elements~~have recognized the increasing importance of ~~our~~being ~~strategy~~able to ~~achieve~~access ~~this~~personal ~~objective~~and ~~include~~professional information such as corporate e-mail, addresses, calendars, to-do lists, location-based applications and services, advanced messaging and multimedia capabilities, customer or patient information and other reference information in real-time when away from their desktop computers. Also, as businesses continually look for ways to increase productivity and reduce costs, the ~~following:~~ability to add third-party applications such as push e-mail or industry specific applications, combined with the ability to communicate with co-workers, partners and customers led to triple digit growth in the smartphones and PDA phones in 2004 according to market research firm ARC Group. As a result, information technology managers are playing an increasing role in purchase decisions by setting standards for mobile computing within their organizations. This has led to continued growth in direct enterprise purchases of these converged devices.

~~Extend~~From ~~Our~~the ~~Success~~wireless carrier’s perspective, they are looking for ways to earn a return on their network investments, and are constantly seeking ways in ~~PDAs~~which to ~~Smartphones~~attract and ~~Other~~retain ~~Next~~enterprise ~~Generation~~customers ~~Smart~~and individual consumers, as well as sell data services that generate incremental revenue. These carriers are working with mobile information device manufacturers to develop innovative mobile ~~Mobile~~devices ~~Products~~that offer the user functionality that promotes adoption and loyalty, as well as data services including e-mail access and Internet connectivity. This underscores the importance of a large wireless developer community, which can provide a variety of consumer and enterprise applications that drive additional demand for smartphones and data services. Finally, wireless carriers are concerned about the support burden these new devices and services may cause, so ease of use for the devices is increasingly important. We believe that mobile device manufacturers will have to continue to produce innovative products with enhanced functionality to meet the demands of wireless operators.

Palm Powered products have held the number one PDA market share position in each of the reports prepared in the past six years by IDC, as measured in units sold. We intend to continue to build on our leadership position and experience in PDAs to become the leading licensor of a software platform for smartphones and other next generation smart mobile products. For two out of the first four months of calendar year 2004, we have held the leading smartphone market share in the U.S. based on data by NPD. By working in a number of emerging product categories, we intend to increase our overall market opportunity and reduce our dependence on any given industry.

~~Increase~~According ~~Penetration~~to ARC Group, worldwide shipments of ~~Palm~~mobile ~~Powered~~phones ~~Products~~were estimated to be over 500 million units in 2004. It expects this market to grow to over 700 million units by 2009. At the ~~Enterprise~~high-end of this market are smartphones and PDA phones, powerful and feature-rich phones that require an advanced operating system that allows application extensibility. According to ARC Group, smartphones accounted for 27 million of the mobile phones sold worldwide in 2004. The mid-range of the mobile phone market consists mainly of feature phones. These phones have value-added features such as cameras, advanced messaging, personal e-mail, basic PIM applications and ring tones. These phones tend to be heavily subsidized by wireless carriers, or even given away for free when associated with a voice or data contract. ARC Group estimated that over 280 million phones were sold worldwide in 2004. On the low-end of this market are the voice-only phones, which tend to have voice mail and basic messaging and contact management capabilities. These phones tend to be given away for free when associated with a voice or data contract. ARC Group expects voice-only phone sales to decline.

WeCompetition intend to facilitate greater adoption of Palm Powered products by enterprise customers. To increase our overall presence in the enterprise, we will continue to target market-leading device manufacturers as new licensees and develop software features attractive to both end-users and the decision makers responsible for the deployment of mobile information devices throughout the enterprise. For example, Palm OS Colbalt, released to licensees in December 2003, features enhanced security, integration and performance features that further enable enterprise solutions. In addition, we plan to continue to work with leading enterprise solutions, applications and service providers, such as IBM and Novell, to provide business-critical solutions that enable handheld computing in the enterprise. In May 2004, we announced that we entered into a distribution agreement with RIM to create and distribute a BlackBerry connectivity solution for Palm OS licensees that we expect to release in the second half of 2004.

~~Expand~~The ~~Internationally~~market for mobile phone software platforms is intensely competitive and subject to rapid technological change and evolving industry requirements. Additionally, the widespread and increasing adoption of open industry standards may make it easier for new market entrants and existing competitors to introduce new products that compete with our software.

WeIn ~~intend~~the tosmartphone ~~expand~~product ~~our~~category, ~~international~~we ~~presence~~face bysubstantial ~~targeting~~competition ~~countries~~from ~~with large~~Microsoft ~~populations~~ and ~~propensities for adopting new technologies~~Symbian. ~~For~~As ~~example,~~ we ~~have~~migrate ~~developed~~our aproducts ~~version~~to ofuse ~~Palm~~Linux OStechnologies, ~~that~~we expect ~~supports~~competition ~~simplified~~from ~~Chinese~~other ~~character~~suppliers ~~sets.~~of WeLinux-based ~~intend~~mobile tophone ~~aggressively~~platforms, ~~pursue~~such ~~licensees~~as ~~that~~Trolltech. ~~are~~In ~~well~~the ~~positioned~~market tofor ~~capitalize on~~feature ~~these~~phones, ~~emerging~~we ~~opportunities~~compete ~~and~~against ~~encourage~~software ~~our~~platform ~~developer~~offerings ~~community~~from toOpenwave, ~~focus~~Teleca, onTTPCom, ~~providing~~IXI ~~solutions~~Mobile ~~for~~and ~~these~~Sky ~~regions~~MobileMedia.

~~Pursue~~We ~~Additional~~believe ~~Opportunities~~that we can compete favorably in ~~Vertical~~these ~~Industries~~market segments due to the flexible nature of our platform, which will allow licensees to build differentiated and easy to use products, the large number of third-party developers and innovative software applications available for our platform as well as the loyal installed base of customers using Palm OS.

WeOur ~~believe that Palm OS is particularly well suited to meet the demands of licensees, technology providers and application developers in a number of~~Strategy vertical industries. For example, AlphaSmart introduced a Palm Powered word processor and productivity device targeted at the K-12 education market, Garmin recently introduced a Palm Powered location-aware device and Tapwave has developed and commenced shipment of next generation game devices based on Palm OS. We plan to continue to identify new industries that will benefit from deploying specialized mobile information devices with an operating system that is both intuitive to use and powerful enough to satisfy end-user requirements without compromising the battery life or size of the device.

~~Continue~~Our objective is to ~~Extend~~be ~~Our~~the ~~Technological~~leading ~~Advantages~~developer and licensor of platform software for mobile phones and other next generation smart mobile devices. The key elements of our strategy to achieve this objective include the following:

WeDevelop ~~believe that the performance~~ and ~~flexibility~~offer ofleading ~~our~~edge software ~~architecture~~platforms ~~represent~~based ~~significant~~on ~~competitive~~Linux ~~advantages.~~for ~~We plan to continue to invest in research and development to further these competitive advantages. Additionally, under our licensing arrangements, we have~~ the ~~right~~broader tomobile ~~incorporate~~phone ~~broadly~~market applicable technology advancements that our licensees develop into future versions of our operating system. We also intend to continue to build upon the technology advances of our licensees to extend our technological advantage relative to our competitors. For example, by supporting an industry leading level of interoperability, we provide the ability to seamlessly migrate applications across various hardware platforms provided by multiple device manufacturers.

~~Continue~~We believe that the performance and flexibility of our software architecture represents significant competitive advantages, and we plan to ~~Grow~~continue to invest in research and ~~Support~~development to further these competitive advantages. Our ~~Developer~~research ~~Community~~and development efforts are currently focused on developing new Linux versions of our smartphone and feature phone platforms, as well as supporting custom development for licensees. We supplement our research and development efforts with our licensing strategy, which specifies that our licensees contribute the derivative development work they develop and give us the rights to include these works back into the Palm OS platform.

We ~~believe~~intend ~~that~~to leverage the ~~Palm~~work ~~Powered~~already ~~ingredient~~done ~~brand~~on ~~has~~Palm ~~become~~OS ato ~~symbol~~optimize it for ~~quality~~smartphones, ~~ease of use,~~ and ~~elegant~~the ~~simplicity~~work indone ~~the~~by ~~mobile~~our ~~information~~operations ~~device industry.~~in ~~This~~China ~~brand~~in ~~identity~~the ~~has~~feature ~~enabled~~phone market us to ~~create~~develop atwo ~~large~~next ~~and~~generation ~~loyal~~platforms, ~~user~~both ~~base~~of ~~worldwide~~which ~~that~~will ~~represents~~run anon ~~attractive~~a ~~opportunity~~variety ~~for~~of ~~our~~Linux ~~global developer community~~distributions. We intend tofor ~~continue~~these platforms to ~~invest~~conform inwith ~~the~~global ~~tools,~~wireless ~~marketing~~standards, ~~and~~which ~~programs~~will ~~offered to~~allow ~~our~~us ~~developers~~to somarket ~~that~~them weon ~~may continue to offer~~ a ~~wide~~worldwide ~~selection~~basis. ofIn addition ~~applications~~ to ~~our~~the ~~licensees~~work ~~and~~done in the ~~end~~open-~~users~~source ofcommunity, ~~Palm Powered products. As~~ we ~~continue~~intend to ~~evolve~~design ~~our~~these ~~platform,~~platforms ~~we intend~~ to ~~maintain~~leverage ~~the~~many ~~compatibility,~~common ~~tools~~technology ~~and~~elements ~~support necessary~~between ~~for~~platforms. aWe ~~large~~believe ~~number~~this ofwill ~~applications~~allow tous ~~continue~~ to beprovide ~~available~~a tocomplete, ~~our~~integrated ~~users.~~solution Weon ~~believe~~Linux ~~the~~that ~~availability~~is ofnot available atoday. ~~wide~~Our ~~selection~~goal ofwill ~~Palm~~be OSto ~~applications~~speed isup ~~important~~the time-to-market ~~attracting~~for ~~and~~handset ~~retaining~~original ~~loyal~~equipment ~~end~~manufacturers ~~users.~~(OEM) as

~~Products~~ new silicon platforms, screens sizes, graphics requirements and other technologies continue to become more complex. Additionally, we expect the open and flexible nature of these platforms will give OEMs the ability to customize and differentiate their products.

~~Palm~~One OSof our platforms will be targeted at the high-end of the market, where we believe the move to Linux will allow us to innovate faster, as resources typically dedicated to driver development can now focus on user interface or user experience development, as many of the device drivers necessary to keep up with advances in features and functionality will be made available from the Linux community. We believe this will give us more flexibility and will allow us to also dedicate resources to individual licensees or carriers in order to help them customize their offering in order to offer differentiated phones based on our platform. ARC Group expects the number of smartphones to increase from 27 million in 2004 to 125 million phones by 2009.

WeThe ~~license~~other toplatform ~~our~~will ~~customers~~address athe ~~product~~mid-range ~~development~~and ~~kit,~~low-end orof ~~PDK,~~the ~~that~~mobile ~~enables~~phone ~~them~~market. We also intend this platform to ~~build~~run on a ~~version~~variety of ~~Palm~~Linux distributions, OSincluding ~~specifically~~our ~~tailored~~own. toWhile ~~their~~this ~~products. The~~platform ~~PDK~~will ~~includes~~run on the same Linux operating ~~system~~systems ~~and~~as ~~supporting~~the ~~technology~~first, ~~components~~other elements, such as ~~applications~~the ~~and~~user ~~tools~~interface, ~~and~~will ~~reference~~be ~~materials,~~designed ~~which~~specifically ~~are~~for ~~the~~this ~~foundation~~platform ~~for~~and ~~Palm~~customizable ~~Powered~~to ~~devices~~the ~~manufactured~~specific requirements byof our licensees. WeARC ~~allow~~Group ~~licensees~~estimated tothat ~~customize~~over ~~the platform~~500 ~~and~~million ~~applications,~~feature ~~including~~and ~~through~~voice-only ~~limited~~phones ~~access~~were tosold ~~source~~worldwide ~~code.~~in ~~Palm~~2004 OSand ~~has~~expects ~~been~~this ~~optimized~~market ~~for~~segment ~~mobile~~to ~~information~~grow ~~devices, for which instant access~~ to ~~information,~~over ~~low~~600 ~~power~~million ~~consumption~~phones ~~and~~by ~~wireless capabilities are critical~~2009.

~~Palm~~In OSgeneral, ~~consists~~we ofintend ~~several~~to ~~components~~contribute certain technology improvements back to the open-source community in the following ways:

• aBy ~~kernel,~~meeting ~~which~~our isobligation ~~a core of software that resides in memory and performs basic and essential operating system tasks. The kernel is separated from the hardware layer by an abstraction layer that we provide~~ to ~~hardware~~release ~~partners~~modified togeneral ~~make~~public itlicense ~~easier~~(GPL) tosource ~~port to new hardware architectures~~code;

• ~~software~~By ~~that~~contributing ~~performs~~non-GPL ~~critical~~technology ~~functions~~to ~~such~~the ascommunity ~~data~~from ~~management,~~time ~~communications,~~to ~~power management, telephony call management, pen input, graphics and other capabilities~~time;

• ~~Palm~~By OScontributing ~~user~~back ~~interface,~~patches ~~which~~and ~~enables~~fixes ~~users~~ to ~~interact~~GPL ~~with~~source acode ~~Palm~~that ~~Powered~~we ~~device~~have indeveloped afor ~~consistent,~~open ~~simple~~source ~~and efficient manner using common input methods such as buttons, a stylus, a keyboard or voice~~projects;

• aBy ~~compatibility~~bringing ~~layer~~in ~~that~~a ~~allows~~new ~~the~~group ~~majority~~ of ~~existing~~developers ~~applications~~into ~~that were written for older versions of Palm OS to run on~~ the ~~newest~~Linux ~~version of Palm OS~~community;

• aBy ~~collection~~developing ofand ~~application~~offering ~~programming~~a ~~interfaces,~~complete orturnkey ~~APIs,~~mobile ~~that~~phone ~~allow~~solution ~~licensees,~~based ~~application~~on ~~developers~~Linux—we ~~and~~hope ~~other~~this ~~technology~~will ~~providers~~help topromote ~~develop~~the ~~solutions~~use ~~for~~of ~~Palm~~Linux ~~Powered~~in ~~devices~~the mobile phone industry;

• ~~HotSync~~By ~~data~~working ~~synchronization~~with ~~technology,~~standards ~~which~~organizations ~~enables~~and apartners ~~mobile information device~~ to ~~synchronize~~help ~~information~~reduce ~~with~~fragmentation ~~personal~~of ~~computers~~embedded ~~or enterprise databases~~Linux; and

• ~~localized~~By ~~versions~~generally ofencouraging ~~Palm~~the OSuse ~~for~~of ~~English, French, Italian, Spanish, German, Japanese, and simplified Chinese~~Linux.

WeLeverage ~~currently offer two versions of Palm OS, Palm OS 5, which we now market under~~ the ~~name~~CMS ofacquisition ~~Palm OS Garnet, and Palm OS Cobalt, each designed for smart mobile devices. Palm OS 5 brought among other features, a port~~ to ~~the~~grow ARM processor family, increased performance, end-to-end security for both the device and network, multimedia and integrated communications to the platform. Palm OS 5 can run in a very small memory footprint on most ARM-based microprocessors and is targeted for mainstream PDAs. We have designed Palm OS 5 to run applications that were written for prior versions of our ~~operating~~business ~~system. The first products using Palm OS 5 shipped~~ in ~~October~~China ~~2002.~~

~~Palm~~China ~~OS Cobalt~~ is anthe ~~extensive~~world’s ~~redesign~~largest ofwireless ~~Palm~~market OSwith ~~including~~over a400 ~~full~~million ~~multi-tasking,~~wireless ~~multi-threaded~~subscribers ~~architecture~~ and ~~introduces~~5.5 amillion ~~framework~~new ~~construct for~~additions ~~multimedia,~~every ~~security,~~month ~~messaging~~according ~~and~~to ~~device~~the ~~management.~~China ~~This~~Ministry ~~framework~~of ~~allows~~Information ~~our licensees~~ and ~~developers to extend~~ the ~~platform~~China ~~functionality~~Daily toin ~~address~~November ~~their~~of ~~specific~~2004. ~~product~~The ~~needs~~size byand ~~writing~~importance ~~plug-in~~of ~~modules~~this market for ~~each~~wireless ~~specific function. In addition~~devices, the ~~communication~~access ~~architecture has been redesigned~~ to ~~make~~highly itskilled ~~easier~~engineers, ~~to implement communication-centric solutions like phones~~ and ~~wireless~~a ~~devices.~~lower ~~Palm~~cost OSenvironment ~~Cobalt~~led ~~also~~us ~~runs~~to onacquire CMS, ~~most~~which ~~ARM-based~~had ~~microprocessors~~local ~~and~~sales, isproduct ~~first~~development ~~targeted at multimedia~~ and ~~enterprise~~marketing ~~smart~~resources, ~~mobile~~a ~~devices~~suite ~~including~~of ~~smartphones.~~core Asphone ~~with Palm OS 5~~applications, weand ~~have~~software ~~designed~~platforms ~~Palm OS Cobalt to run applications designed~~ for ~~previous~~smartphones ~~versions of the operating system. We delivered Palm OS Cobalt to licensees in December 2003~~ and, ~~based~~feature onphones ~~prior Palm OS introductions, we expect one or more licensees~~ to ~~begin~~address ~~initial shipments of products based on Palm OS Cobalt in~~ the ~~second~~broader ~~half~~Chinese ofwireless ~~calendar~~market ~~year 2004~~opportunity.

With these applications and platforms, we are currently targeting local Chinese OEMs and original design manufacturers (ODM) selling into the Chinese market, as well as non-Chinese companies trying to sell into China. The number of licensees shipping these applications into the China market increased from 10 in December of 2004 to 24 at the beginning of June 2005. These applications shipped on a total of 1.6 million phones during this period. Additionally, we have recently released feature and smartphone platforms in China to several licensees, which are in the latter stages of developing mobile phones based on these products. To support this growth, we have been investing in our China operations by hiring additional engineering, sales and marketing resources. Over the next few years, as our Linux-based next generation smartphone and feature phone

~~Applications~~ platforms become available globally, our strategy in China will be to help Chinese companies with global aspirations expand beyond China, help non-Chinese companies compete in China more cost effectively, and ~~Other~~expand ~~Products~~to other large, emerging markets such as India or more mature markets such as the Americas and Europe. Also, as our Chinese research and development operations become more tightly integrated with our global product development efforts, we see the opportunity to increase the amount of our development work being done in China.

WeLeverage ~~offer~~sales, abusiness ~~number~~development ofand ~~applications~~product ~~and~~marketing ~~other~~activities ~~products~~to ~~that~~continue ~~our~~to ~~licensees~~grow ~~can~~and ~~incorporate~~support ~~into~~the Palm Powered ~~products.~~Economy ~~These include:~~

•Our ~~familiar~~global ~~personal~~sales, ~~information~~business ~~management,~~development orand ~~PIM~~marketing activities are focused on developing relationships within the Palm Powered Economy. We have reorganized our sales, ~~applications~~business development, ~~including~~marketing ~~Date~~and ~~Book~~product development organizations by integrating these activities under one executive. This allowed us to streamline these activities and promote closer alignment between product development and our licensees, ~~Address~~developers ~~Book~~and partners, as well as take advantage of and Tocreate Dosynergies ~~List~~between these groups. ~~These~~For ~~applications~~example, ~~support~~we ~~synchronization~~sometimes ~~with~~promote ~~Microsoft~~emerging ~~Outlook~~smartphone licensees ~~via~~and ~~third-party~~their ~~solutions~~products to ~~ensure~~Tier ~~that~~1 wireless carriers and distributors around the ~~data~~world. onBecause we have an understanding of the technical and customer requirements of these carriers, we are able to assist licensees and ODMs, as needed, to help gain increased exposure to these Tier 1 carriers. In addition, PalmSource often assists in helping these licensees and ODMs gain a ~~user’s~~better ~~personal~~understanding ~~computer~~with isthe ~~consistent~~carrier’s “go-to-market” requirements, with the ~~data~~goal onof obtaining a design win by the ~~user’s~~licensee ~~smart~~or ~~mobile~~ODM ~~device;~~to these carriers.

• a number of utilities and smaller applications for Palm OS, including the launcher, a customizable program that shows the applications loaded on a device; a preferences utility that enables the setting of the key settings and preferences for a device; and a simple calculator and Memo Pad for taking quick notes;Products

• Palm ~~Desktop,~~OS an application that resides on the user’s personal computer and allows for access to the PIM information. The Palm Desktop also controls our HotSync functions that can synchronize commonly used data on the PC with the user’s device. This function is also used to add new applications to a user’s smart mobile device;

•We ~~Mobile~~license ~~Mail,~~a andevelopment ~~e-mail~~kit ~~application~~to our customers that ~~incorporates~~enables ~~popular~~them ~~e-mail~~to ~~protocols~~build a version of Palm OS specifically tailored to their devices. This product development kit, or PDK, includes the operating system, applications and istools, ~~interoperable~~as ~~with~~well ~~Microsoft~~as ~~Exchange~~reference materials. The PDK forms the foundation for all Palm Powered devices manufactured by our licensees. We allow licensees to fully customize the platform and ~~other~~applications, ~~messaging~~including ~~servers;~~limited access to source code. Palm OS has been optimized for smart mobile devices where quick access to information, low power consumption and wireless capabilities are critical. Palm OS has also been localized into French, Italian, Spanish, German, Japanese, and Chinese.

•Palm ~~Web~~OS ~~Browser,~~consists anof ~~application~~several ~~that~~major ~~supports~~components: ~~standard industry protocols and software languages for Internet access; and~~

• ~~Palm~~The ~~Reader,~~kernel ais ~~software~~the ~~application~~core software that ~~enables~~performs ~~published~~basic ~~content~~and toessential beoperating ~~read~~system ontasks. ~~Palm~~It ~~Powered~~is ~~devices,~~separated ~~PocketPC~~from ~~devices~~the hardware layer by an abstraction layer or Linux kernel and ~~desktop~~device ~~computers.~~drivers that enable third parties to port to new microprocessor architectures;

In• ~~addition,~~Middleware wethat ~~offer~~performs acritical ~~number~~functions ofsuch ~~sample applications~~ as ~~examples~~data ~~for~~management, ~~our customers~~communications, ~~and~~power ~~developers~~management, totelephony ~~use~~services, asuser ainput, ~~starting~~multimedia ~~point~~and ~~for~~other ~~creating their own customized solutions.~~ capabilities;

We• ~~also~~The ~~released~~user ~~Bluetooth~~interface ~~support~~enables ~~for~~users ~~Palm OS in spring 2002. Bluetooth is an industry standard local area networking technology used~~ to ~~enable~~interact with devices ~~within~~ in a ~~short~~consistent, ~~range~~simple ~~of each other to communicate~~ and ~~interoperate~~efficient ~~with~~manner ~~one~~using ~~another. A~~ common ~~application~~interaction ~~for~~methods ~~this~~such ~~technology~~as ~~with~~buttons, ~~our~~stylus, ~~licensees~~keyboard isor ~~to facilitate wireless communication between a handheld and a separate mobile phone.~~ voice;

~~Tools~~• The compatibility environment allows many existing, older applications to run on newer versions of Palm OS;

We• ~~provide~~Application aprogramming ~~comprehensive~~interfaces, ~~suite~~or ofAPIs, ~~tools to our customers and developers~~ that ~~enable~~allow ~~them~~licensees ~~to create powerful applications customized for their product offerings. We believe our suite of tools speeds the introduction of new~~ and ~~innovative~~application ~~products~~developers ~~and provides our licensees with a time-~~to~~-market~~ ~~advantage.~~develop ~~These~~solutions ~~tools include SDKs~~ for Palm OSPowered 5,devices; ~~Palm OS Cobalt~~ and Palm Desktop, Palm OS Simulator, Palm OS Emulator and the conduit development kit. In February 2004, we announced that our tools for applications developers would be based on the Eclipse framework. We expect to ship the first version of those tools during mid calendar year 2004.

~~The~~• ~~Palm~~HotSync OSdata ~~software development~~synchronization ~~kit,~~technology orlets Palm ~~OS SDK, is a set of libraries and headers for building applications for Palm~~ Powered ~~handhelds.~~devices ~~The~~synchronize ~~Palm~~information OSwith ~~SDK~~personal ~~includes a number of sample applications~~computers, ~~including~~enterprise ~~the~~databases ~~PIM~~or ~~applications,~~network ~~for developers to use as a starting point for development~~servers.

The Palm Desktop SDK includes the tools necessary for original equipment manufacturers, or OEMs, and original device manufacturers, or ODMs, to customize the Palm Desktop for their products, including extending the Palm Desktop feature set and adding helper applications for showing photos or synchronizing music libraries.

The Palm OS Emulator is software that emulates the hardware of the various models of Palm Powered handhelds for writing, testing and debugging applications.

~~The~~In ~~Palm~~addition OSto ~~Simulator~~the is Palm OS, ~~running~~we inare aincreasingly ~~Windows~~offering ~~environment~~a ~~and~~number isof ~~available~~applications ~~to test~~ and ~~debug~~other products ~~applications~~that onour ~~Palm~~licensees OScan ~~and~~include toin ~~test~~their ~~for~~Palm ~~compatibility~~Powered products. These include:

~~The conduit~~• ~~development~~PIM ~~kit~~applications ~~includes~~such ~~the~~as ~~libraries~~date and ~~header~~address ~~files~~books, ~~necessary~~memos and to ~~develop~~do ~~HotSync~~lists. ~~conduits~~These ~~for~~applications synch with Palm Desktop ~~and~~or ~~allows~~Microsoft ~~our~~Outlook ~~customers~~(via ~~and~~third-party ~~developers~~solutions) to ~~enable~~ensure ~~applications~~that tothe ~~communicate~~data ~~with~~on ~~the~~a ~~desktop~~user’s topersonal ~~provide~~computer ais ~~synchronized~~consistent with the data ~~set~~ on ~~both~~the ~~devices.~~user’s smart mobile device;

~~The~~• ~~Eclipse~~Mobile ~~Integrated~~Mail, ~~Development Environment is~~ an ~~open~~e-mail ~~source~~application ~~framework~~that ~~designed~~uses topopular ~~support~~standard ae-mail ~~variety~~protocols ofand ~~software tools. The Palm OS Developer Suite, or PODS,~~ is ~~the~~interoperable ~~product~~with ~~name~~Microsoft ~~for~~Exchange ~~the~~and ~~suite~~other ofmessaging ~~products based on the Eclipse framework that enable our developers to create applications for Palm OS.~~ servers;

~~Customers~~• Browser, an application that supports standard industry protocols for efficient mobile Internet access; and

~~Our~~• ~~licensees~~A ~~who~~number ~~were~~of ~~actively~~utilities ~~shipping~~and orspecialized ~~developing~~applications for Palm ~~Powered~~OS, ~~products as~~including ofthe ~~July~~Launcher, 23a customizable program that provides easy access to all applications on a device; Preferences, ~~2004~~a ~~include~~utility ~~those~~that incontrols the ~~following~~key ~~table.~~settings and preferences; and Security, a utility which provides several methods of security protection for a device.

Licensee	Device Category	Target Market
Aceeca	Industrial measurement device	Vertical industry
AlphaSmart	Word processor and productivitydevices with full keyboard andlandscape screen	Educational market, primarilykindergarten through grade 12
Fossil	Branded and private labelwristwatches	Consumer retail
Garmin	Handheld GPS devices	GPS and location-aware servicesfor consumer products
GSPDA	PDAs and smartphones	Asia, Europe, Middle East, NorthAmerica
Kyocera	Smartphones	Consumer and enterprise
palmOne	PDAs and smartphones	Consumer and enterprise
Samsung	Smartphones	Consumer
Sony	PDAs	Entertainment management withenhanced multimedia in Japan
Symbol	Vertical industry devices	Vertical industries, includinghospitality, healthcare,transportation and retail
Tapwave	Game device	Entertainment market

PC Applications

~~Individual~~We ~~customers~~ also offer applications that ~~accounted~~help ~~for~~a ~~10%~~user ormanage ~~more~~the ofdata ~~total~~on ~~revenues~~their ~~for~~device ~~the~~from ~~fiscal~~a ~~year~~PC. ~~ended~~Palm ~~May~~Desktop ~~31,~~resides ~~2003~~on the user’s personal computer and allows ~~2004~~input ~~were~~and back-up of the PIM information. The Palm~~/palmOne~~ Desktop also controls our HotSync functions and ~~Sony~~can synchronize data on the PC with the user’s device. This function is also used to quickly and easily add new applications to a user’s smart mobile device.

~~Strategic Relationships~~ Tools

We ~~have~~provide ~~forged~~a ~~strategic~~comprehensive ~~relationships~~suite ~~with~~of ~~several~~powerful ~~technology~~tools ~~providers~~to ~~through~~our licensees ~~the~~and ~~Palm~~developers OSthat ~~Ready~~enable ~~program.~~them ~~Through this program, we license a subset of our toolkits~~ to acreate ~~select~~applications ~~number~~customized offor ~~industry~~their ~~leading~~product ~~component manufacturers~~offerings. ByWe ~~having~~believe ~~access~~our tosuite ~~these~~of tools, ~~these~~which ~~manufacturers~~highly ~~can~~leverage ~~invest in~~ the ~~development~~open ~~and~~source ~~tuning~~community, ofspeeds ~~their~~the ~~technology~~introduction ~~for~~of ~~Palm~~innovative OSproducts and ~~can~~provides ~~subsequently sell those products directly to~~ our licensees. ~~The~~with ~~objective is~~ a time-to-market advantage. ~~and~~These ~~reduced~~tools ~~support~~include ~~costs~~software ~~for~~development ~~our~~kits ~~mutual~~(SDKs) ~~customers.~~for Palm OS ~~Ready~~and ~~partners~~Palm ~~currently include ATI Technologies~~Desktop, ~~Inc.,~~Palm ~~Intel~~OS ~~Corporation~~Simulator, ~~M-Systems~~debuggers, ~~Inc.,~~compilers ~~Motorola,~~and ~~Inc.,~~an ~~nVidia Corporation,~~integration ~~Samsung, SyChip, Inc~~environment., ~~and Texas Instruments.~~

Products for the China Market

We currently offer our licensees selling into the China market a wide range of software for mobile phones, including more than a dozen phone applications (including a WAP browser, email and MMS), and a software platform for simple and advanced feature phones. We have also done development work on a version of a Linux OS optimized for smartphones.

InCustomers addition, we have a number of other strategic relationships to further our overall business. For example, in May 2004, we announced a joint distribution agreement with RIM to create and distribute a BlackBerry connectivity solution for Palm OS licensees that we expect to release in the second half of 2004. This solution will be designed to provide Palm OS licensees the ability to connect their Palm Powered wireless handhelds and smartphones to the BlackBerry Enterprise Server, the push-based wireless architecture and infrastructure used by enterprises and the BlackBerry Web Client, a wireless Internet e-mail service for individuals and small businesses that does not require server software.

The following list details some of our licensees who were actively shipping or developing Palm Powered products as of July 20, 2005:


Licensee	Device Category	Target Market
AlphaSmart	Word processor and productivity devices with full keyboard and landscape screen	Educational market, primarily kindergarten through grade 12

Fossil	Branded and private label wristwatches	Consumer retail

Garmin	Handheld GPS devices	GPS and location-aware services for consumer products

GSPDA	PDAs and smartphones	Asia, Europe, Middle East, North America

Kyocera	Smartphones	Consumer and enterprise

palmOne	PDAs and smartphones	Consumer and enterprise

Samsung	Smartphones	Consumer

Symbol	Vertical industry devices	Vertical industries, including hospitality, healthcare, transportation and retail

palmOne is the only customer that accounted for 10% or more of total revenue for the fiscal year ended May 31, 2005.

Developer Community

The combination of our large user base and the architecture of Palm OS ~~has~~have attracted a large and growing community of third-party developers. This community has created a broad selection of software applications that allow further customization of Palm Powered products by the end -user. There are ~~approximately~~over ~~300~~400,000 registrants in our Palm OS developer program, which offers Palm OS developer tools, programs, and support to enable the creation of software applications for our platform. According to PalmGear.com, a leading online provider of handheld applications, there are currently more than 2025,000 applications available for Palm Powered products in a broad range of categories, including web browsers, e-mail and Internet communications, sales force and field automation, personal productivity, groupware, financial management and games.

We have ~~approximately~~over 100,000 registrants in our Palm OS Developer program that have self identified as enterprise applications developers. These ~~developers~~ developers include system integrators, enterprise independent software vendors, and corporate in-house developers.

We also provide a range of marketing and co-marketing programs to our developer community to facilitate the development applications that extend the Palm OS platform. These programs include marketing efforts such as print, online, public relations and events. We also host regional developer conferences in North America, Europe and Asia with the intent to facilitate communication between our engineering team and our key developers. We held developer conferences in China in December 2002 and 2003, and we held our first European developer conference in Germany in September 2003.

Online Store

We operate an online software store that is accessed via our home web page. The infrastructure that powers the store is managed by a separate company called PalmGear, Inc. or PalmGear, which manages the relationship with the individual developers. In addition, PalmGear is responsible for fulfilling and managing the e-commerce portion of the store. For each software title purchased, we, PalmGear and the developer each receive a portion of the total purchase price. Periodically, we send e-mails to our customer base notifying them of promotions or information about the store. The purpose of these e-mails is to continue to inform our customer base and drive traffic to the site.

Sales and Marketing

WeOur ~~license~~direct ~~and~~sales ~~market~~force ~~our~~targets ~~products~~potential OEM and ~~services~~ ~~primarily~~ODM ~~through~~licensees to grow our ~~direct~~presence ~~sales~~in ~~force~~the smartphone and ~~marketing~~feature ~~team~~phone markets. ~~For~~In ~~further~~targeting ~~discussion~~potential ~~regarding~~licensees, ~~geographic~~we ~~information,~~consider ~~see~~a ~~Note~~partner’s 16brand ofidentity, ~~Notes~~distribution tochannels, ~~Combined~~unit volumes and ~~Consolidated~~technical ~~Financial Statements~~capabilities. Our sales ~~activities~~cycle ~~are~~can ~~focused~~be a lengthy process, spanning 12 months or longer for smartphones depending on ~~developing relationships~~the ~~with~~size ~~potential~~of ~~licensees~~the ~~through~~licensee ~~our~~and ~~direct~~the complexity of the solution. For feature phones, the sales ~~force~~cycle tends to be shorter. In addition, ~~which~~once isa ~~located~~prospect inbecomes a licensee, the ~~United~~licensee ~~States~~must then develop a product and, ~~France~~providing the product development efforts are successful, ~~Hong~~commence ~~Kong~~commercial ~~and~~shipment ~~Japan~~of the product. AsThis ofproduct ~~July~~development 23and commercial shipment process by our licensees is often eight to 12 months or longer, ~~2004~~depending upon the complexity of the product, wethe ~~employed~~licensee’s 13experience ~~sales~~with ~~professionals~~our platforms, and other factors such as a ~~majority~~delay in product release due to the uncertainty related to the carrier certification process. Because of ~~whom~~the ~~are~~length inof time our licensees must spend to first develop, and then commence shipment of the ~~United~~product, ~~States~~the period before we receive revenue, if any, from a new licensee can be lengthy.

Our direct sales force targets customers who we believe will expand the market for our Palm Powered devices. Our sales cycle can be a lengthy process, spanning 12 months or longer depending on the size of the licensee and the complexity of the solution. In addition, once a prospect becomes a licensee, the licensee must then develop a product and, providing the product development efforts are successful, commence commercial

~~shipment~~Increasingly, ofwe ~~the~~see ~~product.~~that ~~This~~other ~~product~~partners ~~development~~such ~~and~~as ~~commercial~~ODMs ~~shipment~~will ~~process~~be byimportant ~~our~~to ~~licensees~~deliver isPalm ~~often~~Powered ~~eight~~devices to 12licensees, ~~months~~as orwireless ~~longer,~~carriers ~~depending~~and ~~upon~~OEMs ~~the~~utilize ~~complexity~~these ofcompanies ~~the~~to ~~product,~~bring ~~the~~new ~~licensee’s~~products ~~experience~~to ~~with~~market ~~Palm~~in ~~OS,~~a ~~and~~more ~~other~~cost ~~factors~~effective manner. ~~Because~~Our ofglobal ~~the~~sales, ~~length~~business ofdevelopment ~~time~~and ~~our~~marketing ~~licensees~~activities ~~must~~are ~~spend~~focused toon ~~first~~developing ~~develop,~~relationships ~~and~~with ~~then~~various ~~commence~~segments ~~shipment~~ of the ~~product,~~Palm ~~the~~Powered ~~period~~Economy. ~~before~~During ~~we receive revenue, if~~fiscal ~~any,~~2005 ~~from~~and aearly ~~new licensee can be lengthy. In targeting potential licensees~~2006, we ~~consider~~reorganized aour ~~partner’s~~sales, ~~brand~~business ~~identity~~development, ~~distribution~~marketing ~~channels~~ and ~~technical~~product ~~capabilities.~~development Weorganizations ~~typically~~by ~~focus~~integrating onthese ~~large,~~activities ~~well-established~~under ~~device~~one ~~manufacturers~~executive. ~~and distributors~~This ~~and~~allows ~~have~~us ~~begun~~ to ~~explore~~streamline ~~new~~these ~~markets~~activities ~~with~~and ~~licensees~~promote ~~such~~closer asalignment ~~AlphaSmart,~~with product ~~Fossil~~development, ~~Garmin,~~our ~~GSPDA~~licensees, ~~Lenovo~~developers and ~~Tapwave. Increasingly~~partners, weas ~~see~~well ~~that other partners such~~ as ~~ODMs~~take ~~will~~advantage beof, ~~important~~and tocreate ~~deliver~~synergies ~~Palm~~between ~~Powered~~those ~~devices to licensees~~groups.

Our marketing team promotes our company, our licensees’ products and our developer’s applications through global marketing and co-marketing programs. These marketing efforts are designed to create demand for Palm Powered devices and applications, to educate the market and create awareness for the Palm OS value proposition in key market segments and to re-position and strengthen the Palm Powered ingredient brand worldwide. Our licensees are generally required to include the Palm Powered ingredient brand in their mass-media and targeted advertising. In addition, we conduct public relations efforts and market our products at industry tradeshows and on our website. We also receive feedback from the end users of Palm Powered products and the third-party developer community through market research. As of July 23, 2004, we employed 41 marketing professionals.

Support and Services

We provide a variety of support and professional services to our licensees and third-party developers designed to accelerate the development and proliferation of Palm Powered products and customized third-party applications. We provide both direct development support and professional services to our licensees and professional and technical support services to third-party developers.

Our licensee support programs generally provide three types of maintenance and support: an annual program that is tied to a specific master Palm OS license agreement, a Palm OS Ready partner support program, and a custom support program. As part of the maintenance agreement, licensees generally also receive updated versions of the Palm OS software that are available as part of the Palm OS PDK. ~~Maintenance updates are charged separately.~~ Our licensee support also consists of issue resolution and post-development support to address issues ~~escalated by our licensees~~ after a product has been shipped by our licensee.

Licensees may also purchase professional services ~~from~~when ~~us for~~ needing assistance in the design and development of their products, custom development of applications or system software and education and training ~~of the licensee~~ on our platform and tools.

Third-party developers may purchase project-level support ~~from our professional services organization~~, or alternatively, may purchase per-incident ~~support~~or specialized ~~from~~support ~~our~~packages ~~developer~~for ~~services~~Small ~~organization~~Businesses and Enterprise Developers. We also provide online support, training and development tools for our developer community through our developer support programs.

Our licensee support, developer services and professional services organizations consisted of 11 employees as of July 23, 2004. These employees are supplemented by our internal engineering organization and a network of sub-contractors to our professional services team for expertise in specific markets or technologies.

Research and Development

Our research and product development efforts are focused on enhancing the available features and functions of the Palm OS PDK, including improving its capability and efficiency, and developing next generation Linux platforms. These enhancements are intended to reduce time-to-market for our licensees. In addition, we work with licensees and third-party developers to increase the proliferation of Palm OS-based solutions. We supplement our research and development efforts with our licensing strategy, which specifies that our licensees contribute the derivative development work they develop and give us the rights to include these works back into the Palm OS platform. We believe that our success will depend, in part, on our ability to develop and introduce new versions of the Palm OS platform that continue to address the rapidly expanding needs of the mobile information device market. In the past, we have made, and we intend to continue to make, significant investments in research and development in response to the fluctuations of market conditions and economic trends. As of July 20, 2005, we had 383 employees engaged in engineering and product development activities.

Business Development

Our business development activities are focused on developing relationships with wireless carriers, infrastructure and middleware technology providers, silicon providers and other technology partners. Our Palm Powered Mobile World program connects wireless operators, infrastructure and middleware providers, third party software developers and handset manufacturers to bring innovative Palm OS wireless solutions to market. PalmSource works closely with members to assist them at different stages of solution development, testing, sales,

~~increase~~marketing ~~the proliferation of Palm OS-based solutions. We supplement our research~~ and ~~development efforts with our licensing strategy~~support, ~~which~~in ~~specifies~~order ~~that our~~to ~~licensees~~increase ~~contribute~~revenue ~~their~~opportunities, ~~broadly~~accelerate ~~applicable~~time-to-market ~~derivative development works~~ and ~~give~~deliver usa ~~the~~superior ~~rights~~user toexperience ~~include~~for ~~these works back into the~~ Palm OSPowered ~~platform~~phones. We ~~believe~~currently ~~that~~have ~~our~~over ~~success~~15 ~~will~~partners ~~depend,~~ in ~~part, on our ability to develop and introduce new versions of~~ the Palm OSPowered ~~platform~~Mobile ~~that~~World ~~continue~~program toincluding ~~address~~operators ~~the~~such ~~rapidly~~as ~~expanding needs of the mobile information device market. In the past~~Cingular, ~~we have made~~Sprint, ~~and we intend to continue to make~~Orange, ~~significant~~Telefonica ~~investments~~Moviles inEspana ~~research~~ and ~~development~~China ~~in response~~Unicom toNewSpace, ~~the~~a ~~fluctuations~~wholly-owned ofsubsidiary ~~market conditions and economic trends. As~~ of ~~July~~China ~~23,~~Unicom ~~2004, we had 189 employees engaged in engineering and product development activities~~Limited.

~~Competition~~Another important part of the Palm Powered Economy is our Palm OS Ready program, which focuses on building relationships with silicon providers. Through this program, we license a subset of our toolkits to a select number of industry leading component manufacturers. By having access to these tools, these manufacturers can invest in the development and tuning of their technology for Palm OS and can subsequently sell those products directly to our licensees. The objective is a time-to-market advantage and reduced support costs for our mutual customers. Palm OS Ready partners currently include Intel Corporation, M-Systems Technology Inc., Freescale Semiconductor Inc., nVidia Corporation, Samsung Electronics, Sychip Inc., and Texas Instruments Inc.

~~Competition~~PalmSource inhas ~~the~~also ~~market~~established ~~for~~strategic ~~platform software for mobile information devices is intense and characterized by rapid change and complex~~ technology. ~~We compete~~relationships ~~primarily~~ with Microsoft and Symbian. Microsoft offers several operating systems focused on markets in which we compete, including handheld devices and voice-enabled handhelds or communication devices being utilized by customers such as ~~Hewlett~~industry-~~Packard~~leading ~~and~~technology ~~Motorola.~~partners ~~Symbian~~to ~~offers~~complement anthe ~~operating system that is predominantly being utilized today by Nokia and Sony Ericsson for smartphones.~~ Palm OS ~~also competes with the proprietary operating systems of other companies~~platform, including ~~the proprietary~~Research ~~systems~~in ofMotion ~~our potential licensees. In addition~~(RIM), weIBM ~~anticipate increased competition from alternative operating systems, such as Linux~~ and ~~Java for handheld devices~~Access.

We believe that the principal competitive factors affecting the market for platform software that runs on mobile information devices are the architecture of the operating system, technological features and capabilities of the operating system, number and quality of third-party applications available for use on the operating system, overall number of end users, the ability to efficiently develop compatible applications, price, customer ease of use, interoperability between different hardware platform devices and flexible licensing terms. We believe that we compete favorably due to our large and loyal base of customers using Palm Powered products, the architecture of Palm OS that may be adapted across multiple device platforms in a way that some of our competitors’ products cannot, large number of third-party developers and software applications available for Palm OS and our brand recognition.

Intellectual Property

We ~~rely~~seek onto establish and ~~benefit~~maintain ~~from~~our aproprietary ~~portfolio~~rights ofin ~~intellectual~~our ~~property.~~technology ~~We currently~~and ~~have~~products ~~numerous~~through ~~patents issued in~~ the ~~United~~use ~~States~~of ~~and~~patents, ~~abroad~~copyrights, trademarks and ~~numerous~~trade secret Ulaws.S. ~~and~~We ~~foreign~~have ~~patent~~a program to file applications ~~pending.~~for ~~Our~~and ~~issued~~obtain patents, ~~expire~~copyrights, ~~anywhere~~and ~~from~~trademarks ~~July~~in ~~2014~~the toUnited ~~September~~States ~~2020.~~and ~~Palm~~in ~~Trademark~~selected ~~Holding~~foreign ~~Company~~countries ~~has~~where ~~over~~we ~~25 trademark~~believe ~~registrations~~filing ~~and~~for ~~several~~such ~~pending~~protection ~~applications~~is inappropriate. ~~the~~We ~~United~~also ~~States~~seek ~~for~~to ~~trademarks~~maintain ~~associated~~our trade ~~with~~secrets ~~the~~and ~~business~~confidential ofinformation ~~PalmSource.~~by ~~Abroad,~~nondisclosure itpolicies ~~has~~and ~~over~~through ~~200~~the ~~trademark~~use ~~registrations~~of ~~and~~appropriate ~~numerous~~confidentiality ~~pending~~agreements. ~~applications,~~We ~~most~~have ofobtained ~~which~~numerous ~~are~~patents ~~intended for~~and ~~exclusive~~trademarks ~~use~~in bythe ~~PalmSource~~United States and in ~~its~~other ~~businesses~~countries. ~~Subject~~There tocan ~~certain~~be ~~restrictions~~no assurance, wehowever, ~~have~~that anthe ~~exclusive~~rights ~~license~~thereby ~~from~~obtained ~~Palm~~can ~~Trademark~~be ~~Holding~~successfully ~~Company~~enforced toagainst ~~use~~competitive ~~“Palm”~~products ~~marks,~~in ~~other~~every ~~than~~jurisdiction. ~~palmOne~~Although ~~and~~we ~~certain~~believe ~~transition~~the ~~marks,~~protection inafforded ~~connection~~by ~~with~~ our ~~business~~patents, ~~including~~copyright, ~~various~~trademarks, ~~usages~~and oftrade ~~Palm,~~secrets ~~PalmSource,~~has ~~Palm OS~~value, the rapidly ~~Palm~~changing ~~logo,~~technology ~~Palm~~in ~~Powered~~the software industry and ~~Palm~~uncertainties ~~Computing.~~in Wethe ~~also~~legal ~~have~~process make our ~~own~~future ~~trademarks~~success ~~registered~~dependent inprimarily on the ~~United~~innovative ~~States~~skills, technological expertise, and ~~abroad.~~management Weabilities ~~also~~of ~~own~~our ~~copyrights~~employees ~~relating~~rather tothan ~~our~~on ~~software~~the ~~development~~protection ~~applications~~afforded ~~including~~by ~~HotSync~~patent, ~~Manager~~copyright, ~~Palm~~trademark, OS and ~~other~~trade ~~software~~secret laws.

WeIn ~~also~~addition, ~~license~~certain products or technologies ~~from~~acquired ~~third~~or ~~parties~~developed ~~for~~by ~~integration~~us, ~~into~~may ~~our~~incorporate ~~products~~so-called “open source” software. WeOpen ~~believe~~source ~~that~~software is typically licensed for use at no initial charge, but certain open source software licenses impose on the ~~licensing~~licensee of ~~complementary~~the ~~technologies~~applicable ~~from~~open ~~parties~~source ~~with~~software ~~specific~~certain ~~expertise~~requirements isto anlicense ~~effective~~or ~~means~~make ofavailable ~~expanding~~ to others both the ~~features~~open ~~and~~source ~~functionality~~software ofas ~~our~~well ~~products~~as the software that relates to, or interacts with, the open source software.

WeMany ~~rely~~of onour aproducts are designed to ~~combination~~include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of ~~patent~~our products, ~~trademark~~we believe, ~~copyright~~based upon past experience and ~~trade~~standard ~~secret~~industry practice, ~~laws~~that ~~and~~such ~~restrictions~~licenses ongenerally ~~disclosure~~could tobe ~~protect~~obtained ~~our~~on ~~intellectual~~commercially ~~property~~reasonable ~~rights~~terms. ~~While~~Nonetheless, wethere ~~rely~~can onbe ~~these~~no ~~methods~~assurance tothat ~~protect~~the ~~our~~necessary ~~intellectual~~licenses ~~property~~would be available on acceptable terms, weif ~~also~~at ~~believe~~all. ~~that~~Our ~~factors~~inability ~~such~~to asobtain certain licenses or other rights on favorable terms, or the ~~technological~~need ~~and~~to ~~creative~~engage ~~skills~~in oflitigation ~~our~~regarding ~~personnel~~these matters, ~~new~~could ~~product~~have ~~developments~~a ~~and~~material ~~enhancements~~adverse ~~are~~effect ~~essential~~on toour ~~establishing~~business, operating results and ~~maintaining~~financial acondition. ~~technology~~Moreover, ~~leadership~~inclusion ~~position.~~in Weour ~~cannot~~products ~~assure~~of ~~you~~software ~~that~~or other ~~others~~intellectual ~~will~~property ~~not~~licensed ~~develop~~from ~~technologies~~third ~~that~~parties ~~are similar~~on ora ~~superior~~nonexclusive basis can limit our ability to protect our ~~technology~~proprietary rights in our products.

Business Transition Period

In fiscal 2005, recognizing the maturing of our core PDA business, we began transitioning our business model to address potential new growth opportunities in the broader phone market. As part of this transition, we announced a restructuring on June 29, 2005 that had two objectives. The first was to focus and streamline our

product development activities and accelerate the integration of our China-based engineering resources into our global product development efforts.

The second objective was to align our cost structure with the anticipated revenue decline in fiscal 2006. This included a 16 percent reduction in our U.S. headcount, over half of which were middle to senior managers, mainly in our product development groups. In addition to the cost savings related to the headcount reductions, we took steps to reduce discretionary spending in areas such as travel and the use of contractors and consultants, which when combined with a decline in stock compensation expense, is expected to substantially reduce overall expenses in fiscal 2006 when compared to fiscal 2005. A $2.7 million charge for employee termination benefits was taken in the fourth quarter of fiscal 2005 related to our cost cutting initiatives.

The Separation and Distribution

~~Description~~We were incorporated on December 3, 2001 as a wholly-owned subsidiary of Palm, Inc., or Palm, an event that we refer to in this report as the ~~Separation~~separation and ~~Distribution~~the date of which we refer to as the separation date. The purpose of the separation was to establish PalmSource as an independent company to conduct substantially all of Palm’s operating system software group business. In October 2003, Palm distributed to its stockholders on a pro-rata basis all of the outstanding shares of our common stock owned by Palm, an event that we refer to in this report as the distribution. At the same time as the distribution, Palm acquired Handspring, Inc., an event that we refer to in this report as the Handspring merger, and the combined entity changed its name to palmOne, Inc. In this document, we refer to palmOne, Inc. as “palmOne” or “Palm” interchangeably, depending upon the time and context of the event described. References in this report to “PalmSource,” “we,” “our,” and “us” refer to PalmSource, Inc.

~~Effective~~Employees as of the separation date, Palm and we entered into certain agreements to generally provide for the assignment by Palm of assets, except for the Palm brands, trademarks and certain other related intellectual property which were transferred at a later date, and the assumption by us of liabilities, related to the business of licensing Palm OS. We refer to the business of licensing Palm OS as the PalmSource business. The purpose of the separation was to establish PalmSource as an independent company. In June 2003, Palm and we entered into additional agreements, some of which amended or amended and restated separation agreements previously entered into by the parties, and others further allocated assets and liabilities between Palm and us in light of circumstances existing at that time. On October 28, 2003, Palm distributed all of the outstanding shares of PalmSource common stock owned by Palm to its stockholders on a pro rata basis.

AAs ~~summary description~~ of ~~the~~July ~~provisions~~20, of2005, ~~the~~we ~~principal~~had ~~separation~~a ~~agreements~~total ~~that~~of ~~relate~~518 toemployees, ~~our~~of ~~current~~which, ~~and~~383 ~~future~~were ~~operations is set forth below. The~~in ~~following~~engineering ~~summary~~and ~~describes~~product ~~some~~development, of66 ~~the~~were ~~provisions~~in offinance, ~~the~~administration ~~principal~~and ~~separation agreements~~operations, ~~but~~43 ~~the~~were ~~provisions~~in ofsales ~~the~~and ~~separation~~marketing ~~agreements~~and ~~are~~26 ~~complicated~~were ~~and~~in ~~not~~support ~~easily~~and ~~summarized~~service. ~~This~~Our ~~summary~~future ~~may~~performance ~~not~~depends, ~~contain~~in ~~all~~significant ofpart, ~~the~~on ~~information~~our ~~about~~ability ~~the separation~~to ~~agreements~~attract ~~that~~new ispersonnel and ~~important~~retain toexisting ~~you.~~personnel ~~Each~~in ~~separation~~key ~~agreement~~areas ~~has~~including ~~been~~engineering ~~filed~~and ~~with~~sales. ~~the~~We ~~Securities~~consider ~~and~~our ~~Exchange~~relationship ~~Commission~~with ~~and~~our isemployees ~~available~~ to ~~you~~be ~~upon request~~good.

~~Amended~~ Item ~~and~~2. ~~Restated~~Properties ~~Master Separation Agreement~~

~~The~~Our ~~amended~~principal offices ~~and~~are ~~restated~~located ~~master~~in ~~separation agreement~~Sunnyvale, orCalifornia ~~master~~and ~~separation~~consist ~~agreement,~~of ~~outlines~~approximately ~~the~~71,000 ~~general~~square ~~terms~~feet ~~and conditions~~under ofa ~~the~~lease ~~separation~~term of usfive ~~from~~years. ~~Palm~~In ~~and~~addition ~~these~~to ~~matters~~our ~~were~~principal ~~undertaken~~office ~~and~~space ~~completed.~~in InSunnyvale, ~~addition~~California, ~~the~~we ~~agreement~~lease ~~outlines~~a ~~future~~development ~~obligations~~facility ofin ~~palmOne~~Montpellier France and uslease ~~related~~several tosmall ~~the~~sales ~~separation~~offices internationally. We also lease facilities in Nanjing, China.

~~The~~We ~~Separation.~~believe ~~The~~that ~~separation~~our ~~was~~existing ~~effected~~facilities asare ofadequate ~~December~~for 3,our ~~2001.~~current ~~As of~~needs ~~the~~or ~~effective~~that ~~date~~suitable ~~of the separation, Palm and we entered into~~ additional ~~ancillary~~or ~~agreements~~alternative ~~with~~space ~~each~~will ~~other~~be ~~that~~available ~~govern~~in the future ~~transfer~~on ofcommercially ~~assets~~reasonable ~~and liabilities from Palm to us and the various relationships between Palm and us following the separation~~terms.

~~Covenants. In addition to transferring~~ ~~control~~Item ~~and~~3. ~~ownership~~Legal ofProceedings ~~various assets and liabilities from Palm to us, Palm and we agreed to exchange certain information, limit the solicitation of each party’s employees and resolve disputes in particular ways.~~

~~Accounting~~On February ~~Practices.~~9, So2004, ~~long~~a suit was filed in the United States District Court for the Northern District of California naming the Company, palmOne, and Handspring as ~~Palm~~defendants. The case is ~~required~~captioned toE-Pass ~~consolidate~~Technologies, ~~our results~~Inc. ofv. ~~operations~~palmOne, Inc., PalmSource, Inc. and ~~financial~~Handspring, ~~position~~Inc., weCase ~~agreed~~No. toC04-0528. ~~cooperate~~The ascase ~~appropriate~~alleges tothat ~~allow~~the ~~Palm~~three todefendants ~~prepare~~have ~~its~~engaged ~~financial~~in ~~statements~~willful infringement, both direct and ~~other~~contributory ~~related~~and ~~matters~~inducement of infringement, of U.S. ~~Palm~~Patent ~~agreed~~No. to5,276,311, ~~provide~~titled, us“Method ~~with~~and ~~all~~Device for ~~relevant~~Simplifying ~~information~~the toUse ~~enable~~of usa Plurality of Credit Cards, or the Like,” with respect to ~~prepare~~certain ~~our financial~~hardware ~~statements~~products allegedly offered for sale by palmOne, PalmSource and toHandspring. ~~grant~~The ~~our~~complaint ~~auditors~~seeks ~~access~~injunctive torelief, ~~Palm~~unspecified damages and attorneys’s ~~records~~fees. E-Pass filed claims against 3Com and Palm in 2000 alleging infringement of the same patent; however, the suit naming the Company identifies additional products as infringing and seeks unspecified

Expenses. Palm and we agreed to bear our respective costs and expenses incurred in connection with the separation, except that certain separation costs and expenses were allocated between Palm and us.

Dispute Resolution. We agreed with Palm to the following procedures to settle any disputes under the separation agreements:

• unless the dispute relates to confidentiality or intellectual property claims or if a delay in initiating litigation would cause serious and irreparable damage, Palm and we will each make a good faith effort to first resolve the dispute through informal negotiation;

• then, through non-binding mediation; and

• if these efforts fail, Palm and we may then submit the dispute to final, binding arbitration.

The other agreements between Palm and us relating to the separation contain similar dispute resolution provisions.

No compensatory ~~Representations~~damages, treble damages and ~~Warranties~~a permanent injunction against future infringement. ~~Palm~~On ~~did~~February ~~not~~25, ~~make~~2005, ~~any~~the ~~representations~~court issued its claim construction order. The Court has scheduled a hearing on September 23, 2005 to consider motions for summary judgment relating to infringement or ~~warranties~~non-infringement. The parties are engaged in discovery directed to usthese and other issues. The Company intends to ~~regarding:~~defend vigorously against the claim.

•On July 16, 2003, a suit was filed in the ~~value~~Los ofAngeles ~~any~~County ~~asset~~Superior Court naming PalmSource as a defendant. The case is captioned Chet Taylor, et al. v. Palm, Inc., PalmSource, Inc., and Solutions Group, et al., No. BC299134. The complaint alleges that persons who purchased Palm ~~transferred~~PDAs ~~under~~with customer-accessible batteries after June 1999 lost data upon battery replacement. The complaint alleges unfair and deceptive business practices in alleged violation of California’s unfair competition statute and Consumer Legal Remedies Act, breach of express and implied warranties and fraud. The complaint seeks unspecified compensatory and punitive damages, restitution and an injunction prohibiting the ~~separation~~defendants ~~agreements;~~from similar conduct in the future. palmOne is managing this litigation, and believes it has good defenses for all parties. On March 28, 2005, palmOne, on behalf of itself and its unincorporated department Solutions Group and PalmSource, Inc. (for the purpose of this paragraph, “Palm”) entered into a Settlement Agreement and General Release (the “Settlement”) which settlement has been preliminary approved by the court. palmOne is responsible for the Palm obligations agreed to in the settlement and will not look to PalmSource for contribution or reimbursement related to this matter.

•On ~~whether~~April ~~there~~28, is1997, Xerox Corporation filed suit in the United States District Court for the Western District of New York. As a ~~lien~~result of subsequent amendments, the case currently names as defendants 3Com Corporation, U.S. Robotics Corporation, U.S. Robotics Access Corp., Palm Computing, Inc., Palm, Inc., PalmSource, Inc., and palmOne Inc. The complaint alleges willful infringement of U.S. Patent No. 5,596,656, or ~~encumbrance~~‘656 onpatent, ~~any~~titled ~~asset~~“Unistrokes for Computerized Interpretation of Handwriting” and seeks unspecified damages and an order permanently enjoining the defendants from infringing the ‘656 patent in the future. In 2000, the District Court granted summary judgment to the defendants, ruling that the ‘656 patent is not infringed by the Graffiti handwriting recognition software then used in handheld computers using Palm ~~transferred~~OS. ~~under~~Xerox appealed the dismissal to the United States Court of Appeals for the Federal Circuit, or CAFC, and the CAFC 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 ‘656 patent is valid, enforceable, and infringed. The defendants appealed and the CAFC again remanded the case to the District Court for a determination of the issues of invalidity and enforceability of the ‘656 patent. On May 21, 2004, the District Court granted the defendants’ motion for summary judgment on invalidity and denied Xerox’s motion for summary judgment that the patent is not invalid. On June 1, 2004, the defendants filed a motion for clarification of the ruling regarding the District Court’s summary judgment decision and on June 10, 2004, Xerox filed a motion to alter or amend that decision. On February 16, 2005, the District Court granted defendants’ motion for consideration and ordered that the asserted claims for the ‘656 patent are invalid and denied plaintiff’s motion for reconsideration and/or relief for judgment. As part of PalmSource’s separation agreements; with palmOne, palmOne is required to indemnify PalmSource for certain damages that PalmSource may incur due to the Xerox litigation. Although palmOne has prevailed at the current stage of the litigation on the claims made by Xerox, there can be no assurance that palmOne will be ultimately successful or that an adverse outcome will not significantly harm PalmSource’s business.

•In the ~~absence~~course of ~~defenses~~palmOne’s business, it occasionally receives claims related to consumer protection, general commercial claims related to the conduct of its business and the performance of its products and services and other litigation claims, such as stockholder derivative class action lawsuits. In the course of palmOne’s business, it also receives claims of infringement or ~~freedom~~otherwise ~~from~~becomes ~~counterclaim~~aware ~~with~~of ~~respect~~potentially relevant patents or other intellectual property rights held by other parties. palmOne is currently subject to ~~any~~a ~~claim~~number ~~Palm~~of ~~transferred~~these ~~under~~claims. Although the majority of the claims currently do not name PalmSource as a defendant, the substance of their claims may implicate PalmSource and result in claims against PalmSource in the future or require that PalmSource indemnify palmOne pursuant to the separation agreements;. PalmSource currently is not able to estimate, with reasonable certainty, the possible loss, or range of loss, if any, from these cases, but an unfavorable resolution of these lawsuits could materially adversely affect PalmSource’s business, results of operations or financial condition.

• the legal sufficiency of any conveyance of title to any asset Palm transferred under the separation agreements.

Palm transferred the assets to us “as is,” which means that we bear the risk that a conveyance was insufficient to transfer the legal title of an asset free of any lien or encumbrance and without infringement of the rights of third parties.

The master separation agreement provided that Palm and we would not solicit or recruit, without the other party’s consent, the other party’s employees for a period of two years. This non-solicitation period expired on December 3, 2003.

General Assignment and Assumption Agreement

The general assignment and assumption agreement, as amended, identifies the assets and liabilities relating to the PalmSource business that Palm transferred to us and we accepted from Palm as part of the separation. The assets that were transferred and the liabilities that were assumed were listed in the agreement.

Amended and Restated Software License Agreement

The amended and restated software license agreement, or software license agreement, entered into between Palm and us governs the license of the PalmSource operating system software and additional applications from us to Palm.

Development and Distribution Licenses. We granted to Palm a license to develop and distribute Palm Powered hardware products that use the operating system software as the primary operating system, and to distribute the operating system software and additional applications in object code form only, embedded into or bundled solely for use with those Palm Powered hardware products. We also granted to Palm a license to distribute updates, upgrades and new versions of the operating system software and certain additional applications in object code form only, on a stand-alone basis, solely to existing customers of Palm Powered hardware products that use the operating system software as the primary operating system.

Source Code Licenses. The software license agreement provides for three mechanisms by which we provide Palm access and license rights to certain source code, subject to confidentiality obligations. Under the license agreement, we provide: (i) a copy of the source code for alpha, beta and gold master releases of the operating system software, which may be modified for error corrections and certain types of optimizations and (ii) limited sets of modules of source code specified in source code attachments, which may be modified for the specific purpose identified in the attachment. In addition, the parties may enter into co-development agreements whereby we will grant controlled live access to source code under development for new versions of the operating system software.

Compatibility Testing Requirement and Changes to Test Criteria. Under the license agreement, Palm Powered hardware products that use the licensed software may not be distributed unless the products have satisfied compatibility testing requirements. We will use reasonable discretion in determining the test criteria for new functionality and will follow a procedure to provide Palm with the test criteria, and to limit changes to the

~~test~~From ~~criteria~~time to time, inPalmSource ~~connection~~also ~~with~~may ~~alpha~~be subject to other legal proceedings, ~~beta~~as well as demands, claims and ~~gold~~threatened ~~master~~litigation, ~~releases~~that ofarise in the ~~operating~~normal ~~system~~course ~~software~~of its business. WeThe ~~retain~~ultimate ~~broad~~outcome ~~discretion~~of ~~under~~any ~~the~~litigation ~~agreement~~is ~~to determine~~uncertain, ~~whether~~and ~~source~~either ~~code~~unfavorable ~~modifications~~or ~~made~~favorable byoutcomes ~~Palm~~could ~~may~~have bea ~~released~~material ~~and~~negative ~~the~~impact. ~~test~~Regardless ~~criteria~~of ~~that~~outcome, ~~will~~litigation can ~~apply~~have toan ~~those~~adverse ~~modifications~~impact on PalmSource because of defense costs, diversion of management resources and other factors.

~~Source Code Escrow. For applications licensed under the software license agreement where source code is not otherwise provided, we have deposited~~ ~~into~~Item ~~escrow the source code for those applications and are required to deposit source code updates, upgrades and new versions~~4. ~~The~~Submission ~~escrow material will be released to Palm if: (i) we reject the software license agreement in bankruptcy; (ii) Microsoft acquires more than 50%~~ of ~~our~~Matters ~~voting equity; or (iii) we or our successor materially breaches our support or maintenance obligations; and (a) fails~~ to ~~cure 30 days after notice or (b) has materially breached the software license agreement at least three times in the preceding 12 months. Palm is granted~~ a ~~license~~Vote toof ~~use~~Security ~~the~~Holders ~~released escrow material to make error corrections.~~

~~Acquisition of PalmSource~~None. If Microsoft acquires more than 50% of our voting stock: (i) the minimum annual payment obligations of Palm under the software license agreement will cease to apply; (ii) the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension; (iii) the escrow material will be released to Palm as described above; and (iv) Palm will have a license to modify (for any purpose without restriction) the escrow material and the source code for releases of the operating system software licensed to Palm under the software license agreement. If a hardware competitor of Palm (as defined in the software license agreement) acquires more than 50% of our voting stock, the minimum annual payment obligations of Palm under the software license agreement will cease to apply and the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension. If an entity, other than those described above, acquires more than 50% of our voting stock, Palm will have the option of extending the software license agreement for two years, with the royalty rate and minimum annual payment obligations for Palm during the extension being the same as during the final contract year.

Sublicenses, Private Label Partners and Contractors. Palm may sublicense its development and distribution rights under the software license agreement to its wholly-owned subsidiaries and to majority-owned subsidiaries (subject to prior agreement by Palm and us on a reasonable per unit minimum royalty to be applied to the majority-owned subsidiary). Royalties paid by majority-owned subsidiaries only count towards Palm’s minimum annual payments in proportion to Palm’s ownership interest.

Palm may permit private label partners to distribute Palm Powered hardware products supplied to the partner by Palm that use the operating system software as the primary operating system under the partner’s own label, provided that such products are versions of Palm’s standard hardware products and are supplied to the partners by Palm.

Palm may request the right to sublicense certain rights to third-party contractors for developing, manufacturing, testing and supporting Palm Powered hardware products that use the operating system software as its primary operating system. We will not unreasonably withhold approval of contractors, provided that no sublicensing shall be permitted unless and until expressly approved in writing by us. Palm may not permit a contractor to exercise these sublicense rights and also act as a distributor (other than a single contract manufacturer/distributor in Brazil that is permitted due to local tax regulations).

Royalties. The software license agreement also establishes fees for bundled sales and stand-alone sales of products with respect to the operating system software and additional applications, which fees are calculated based on percentages of net revenue and/or a per unit basis. In addition, Palm pays to us a non-refundable royalty of $6.0 million for the source code licenses for the period of June 4, 2003 to December 3, 2006, $4.0 million of which has been paid and $2.0 million of which is payable on June 4, 2005.

Maintenance and Support Fees. The software license agreement provides for annual maintenance and support fees through December 3, 2006 with respect to the operating system software and certain additional applications, subject to increase after the first contract year by up to 10% per year. Annual maintenance and support fees are approximately $0.6 million per year and are subject to reduction in some circumstances.

~~Minimum Annual Payment. Palm is obligated to make a minimum annual payment of certain royalties~~ ~~and~~PART ~~support~~II and maintenance fees. If Palm does not reach the minimum annual payments required by the software license agreement in any contract year, Palm must make a payment equal to the amount of the shortfall. The royalty fee is 4.5%, 4.0%, 3.5% and 3.5% of net shipment revenue of Palm products which incorporate PalmSource’s software for each of the contract years ending December 3, 2003, 2004, 2005 and 2006, respectively. The minimum annual payment for contract year 2003 was $37.5 million, for contract year 2004 is $39.0 million, for contract year 2005 is $41.0 million and for contract year 2006 is $42.5 million, with each contract year ending on December 3.

~~Updates,~~ Item ~~Upgrades and New Versions~~5. WeMarket ~~will~~for ~~deliver~~Registrant’s toCommon ~~Palm all updates~~Equity, ~~upgrades~~Related ~~and~~Stockholder ~~new~~Matters ~~versions to the operating system software~~ and ~~certain~~Issuer ~~additional~~Purchases ~~applications,~~of ~~provided~~Equity ~~Palm~~Securities ~~has paid us the applicable maintenance and support fees.~~

~~Most~~Our ~~Favored~~common ~~Licensee~~stock has traded on the NASDAQ stock market under the symbol PSRC since our separation from Palm on October 28, 2003. The following ~~preference~~table ~~provisions~~sets forth ~~are~~the ~~conditioned~~high ~~upon~~and ~~Palm’s~~low ~~continued~~sales ~~obligation~~prices toas ~~pay~~reported on the ~~minimum~~NASDAQ ~~annual~~stock ~~payments under~~market for the ~~software~~periods ~~license agreement~~indicated.

• If we grant a most favored licensee clause to another licensee, Palm may amend the software license agreement to adopt the same clause for the same duration (but not longer than the termination or expiration date of the software license agreement) so long as Palm also agrees to any materially less favorable terms in the other licensee’s agreement.


	High		Low
Fiscal year 2005
First quarter	$	25.18	$	15.27
Second quarter	$	27.20	$	15.12
Third quarter	$	17.00	$	9.61
Fourth quarter	$	10.40	$	8.25
Fiscal year 2004
October 28, 2003 to November 30, 2003	$	48.00	$	24.56
Third quarter	$	26.29	$	17.35
Fourth quarter	$	24.99	$	16.20

•As If we make a new product generally available on its price list which is a PalmSource software application or operating system for handheld/mobile computing or communications devices (excluding any separate products or product lines of ~~any~~July ~~third party that acquires or merges with us)~~25, 2005, we ~~will~~had ~~make~~approximately ~~such~~2,400 ~~product~~registered ~~available~~stockholders toof ~~Palm~~record. ~~For~~PalmSource ~~180~~has ~~days~~not ~~after~~paid weand ~~first~~does ~~make~~not ~~the~~anticipate ~~new~~paying ~~product~~cash ~~available~~dividends toin ~~Palm, we must make~~ the ~~product~~near ~~available to Palm on pricing terms no less favorable than those that have been granted to any other licensee at similar volumes and under similar terms and conditions~~future.

•Repurchases ~~Palm’s license does not include some types~~ of ~~dual~~Equity ~~boot~~Securities products. If we authorize a third party to distribute dual boot products that are competitive with Palm’s licensed products and that use the “Palm” trademark, upon Palm’s request we will reasonably negotiate with Palm for a license for the same type of product. If we authorize a third party to distribute such a product without authorizing the use of the “Palm” trademark, upon Palm’s request we will negotiate in good faith with Palm for 30 days regarding a license for the same type of product.

Proprietary Rights. We own the operating system software and additional applications licensed under the software license agreement, and all derivative works and discrete modifications to such software and additional applications made by or for Palm, including modifications and extensions to the application program interface, or APIs, and applications that operate with operating system software through unpublished system APIs. We grant a license back to Palm under inventions and patents assigned by Palm to us in connection with those modifications. Subject to our ownership of these items, Palm owns the Palm Powered hardware products that use the operating system software as its primary operating system and Palm software. Palm also retains ownership of certain replacement fragments and independently developed applications that interact with the operating system software solely through published system APIs. Palm also covenants not to assert intellectual property rights retained by Palm that are embodied in whole or in part in its modifications, or certain replacement fragments and modules used with the operating system software.


	(a) Total Number of Shares Purchased ⁽¹⁾	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	(d) Maximum Number (or Approximated Dollar Value) of Shares that May Yet Be Purchased Under the Plan or Program
Period
March 1, 2005—March 31, 2005	183	$	0.00	—	—
April 1, 2005—April 30, 2005	895	$	0.00	—	—
May 1, 2005—May 31, 2005	198	$	0.00	—	—

~~Indemnification~~(1) byAll ~~PalmSource.~~of ~~Except for~~ the ~~Xerox~~repurchases ~~litigation~~were ~~described~~pursuant ~~more fully in this report and subject~~ to ~~the~~contractual ~~limitation~~rights onof ~~liability~~PalmSource ~~in the software license agreement, we agreed~~ to ~~defend~~repurchase ~~Palm,~~shares ~~and pay any settlements or damages awarded, for claims alleging that an unmodified production release~~ of ~~the~~its ~~licensed~~capital ~~operating~~stock ~~system~~from ~~software,~~employees ~~additional~~in ~~applications,~~connection ~~other~~with ~~than a specified e-mail product, end-user documentation or compatibility trademarks, as delivered, infringe: (i) patents in~~ the ~~United~~termination ~~States~~of ~~and~~employment. ~~other~~PalmSource ~~specified~~does ~~countries;~~not ~~(ii)~~have ~~worldwide~~any ~~copyrights~~publicly orannounced ~~trade-secrets;~~plans or ~~(iii)~~programs ~~registered trademark rights in the United States and other specified countries. If an injunction requires Palm~~ to ~~recall products~~repurchase ~~from~~shares ~~its~~of ~~own inventory or~~ its ~~own~~common stock.

Use of Proceeds from Sale of Registered Securities

In April 2004, we completed a firm commitment underwritten public offering of 3,450,000 shares of our Common Stock including 450,000 shares related to the underwriter’s over-allotment option. The effective date of our registration statement, filed on Form S-1 under the Securities Act of 1933 (File Nos. 333-111871 and 333-114150) relating to the public offering of our Common Stock was April 1, 2004. The offering commenced and was completed on April 2, 2004, at a public offering price of $18.00 per share. The offering resulted in gross proceeds of $62.1 million. After deducting underwriting discounts and commissions of approximately $3.4 million and estimated offering expenses of approximately $1.3 million, the net proceeds from the offering were approximately $57.4 million.

From the time of receipt through May 31, 2005, we have invested the net proceeds from the public offering in short- and long-term investments in order to meet our anticipated cash needs for future working capital. We invested our available cash principally in high-quality government securities with maturities no greater than 2 years. In June 2004, we applied $13.1 million of the net proceeds of the offering held in money market funds to

~~distribution~~prepay ~~channels,~~the ~~which~~5% ~~products~~convertible ~~have~~subordinated ~~not~~note ~~been~~due ~~sold~~ to ~~end-users,~~Texas ~~then~~Instruments. weNo ~~will~~offering ~~indemnify~~expenses ~~Palm~~or ~~for~~proceeds ~~its~~were ~~out-of-pocket~~paid ~~costs~~directly ~~for~~or ~~retrieving~~indirectly ~~and re-working such products, up~~ to ~~the~~any ~~per~~of ~~unit~~our directors ~~royalty~~or ~~actually~~officers ~~paid~~(or bytheir ~~Palm for such specific units recalled. If an injunction causes a shortfall against a minimum annual payment~~associates), ~~that~~to ~~minimum~~persons ~~annual~~owning ~~payment~~ten ~~will~~percent be(10%) ~~reasonably~~or ~~reduced~~more onof aany ~~pro~~class ~~rata basis as reasonably adjusted for seasonality, if no other versions~~ of ~~the~~our ~~licensed~~equity ~~operating~~securities ~~system software~~ or ~~additional applications are available that would permit Palm~~ to ~~continue~~any ~~shipping products~~affiliates.

~~Indemnification by Palm. Subject to the limitation on liability in the~~ ~~software~~Item license agreement, Palm agreed to defend us, and pay any settlements or damages awarded, for claims alleging that: (i) the Palm Powered hardware products that use the operating system software as its primary operating system, Palm software, or Palm trademarks infringe: (a) patents in the United States and other specified countries; (b) worldwide copyrights or trade-secrets; or (c) registered trademark rights in the United States and other specified countries; or (ii) certain developments to the operating system software made by Palm, or any Palm pre-existing material incorporated into those developments or our source code tree, infringe the copyrights or misappropriate the trade secrets of a third party6. InSelected ~~addition, subject~~Financial toData the limitation on liability in the software license agreement, Palm will indemnify and defend us for claims for bodily injury, death and damage to tangible property as a result of the Palm Powered hardware products that use the operating system software as its primary operating system.

~~Limitation~~The onfollowing ~~Liability.~~condensed ~~Except~~selected ~~for~~consolidated ~~each~~financial ~~party’s~~data ~~indemnity~~of ~~obligations~~PalmSource ~~and~~reflect ~~breach~~our ofhistorical ~~the~~results ~~confidentiality~~of ~~provisions,~~operations ~~neither~~and ~~party~~balance issheet ~~liable~~data. ~~for~~Our ~~any~~52-53 ~~incidental,~~week ~~consequential,~~fiscal ~~indirect,~~year ~~special~~ends oron ~~punitive~~the ~~damages,~~Friday ~~loss~~nearest ~~of revenues,~~to orMay ~~loss of business~~31. ~~Except~~Fiscal ~~for~~years ~~express~~2003 ~~payment obligations~~ and ~~breach~~2004 byeach contained ~~Palm~~52 ofweeks. ~~the~~Fiscal ~~scope~~year or2005 ~~confidentiality~~contained ~~obligations~~53 ofweeks. ~~the~~For ~~source~~presentation ~~code license~~purposes, ~~each~~the ~~party’s~~annual ~~total~~periods ~~cumulative~~have ~~liability~~been ~~under~~presented ~~the~~as ~~software~~ending ~~license~~on ~~agreement~~May ~~is limited to $50~~31.0 ~~million.~~

~~Assignability.~~Our ~~Each party~~consolidated ~~may~~statement ~~assign the software license agreement to a successor~~ of ~~all~~operations ordata ~~substantially~~set ~~all~~forth ofbelow ~~its~~for ~~stock or assets, except that~~ the ~~source~~years ~~code~~ended ~~licenses~~May ~~will terminate upon an assignment by Palm. Most other assignments require consent from the other party. If a competitor of ours~~31, ~~as defined in the software license agreement~~2003, ~~acquires~~2004 ~~more than a 50% interest in Palm, then the source code access~~ and ~~license~~2005 ~~provisions, provisions providing for customer technology briefings~~ and the ~~most~~consolidated ~~favored licensee~~balance ~~provisions~~sheet ~~terminate.~~data ~~If a competitor of Palm,~~ as ~~defined in the software license agreement, acquires more than a 50% interest in us, then provisions providing for customer technology briefings and sharing~~ of ~~customer~~May data terminate. Upon Palm’s merger with Handspring: (i) Handspring products were included under the software license agreement as Palm Powered hardware products that use the operating system software as its primary operating system31, ~~and~~2004 ~~no further payments accrued under our operating system license agreement with Handspring; (ii) maintenance~~ and ~~support~~2005 ~~fees~~are ~~for~~derived ~~the~~from ~~operating system software were increased to $600,000 annually; (iii) the existing Handspring source code attachment survived; and (iv)~~ our ~~operating~~ ~~system~~audited ~~license~~consolidated ~~agreement~~financial ~~with~~statements ~~Handspring~~included ~~was~~in ~~otherwise~~this ~~terminated~~report.

~~Palm~~The ~~Digital~~consolidated ~~Media.~~statement ~~Palm~~of ~~agreed~~operations todata ~~use~~for ~~good~~the ~~faith~~years ~~efforts~~ended toMay ~~include~~31, a2001 ~~certain~~and ~~application~~2002 ~~related~~and tothe ~~our~~combined ~~Palm~~and ~~Digital~~consolidated ~~Media~~balance ~~subsidiary~~sheet indata aas ~~Palm~~of ~~hardware~~May ~~product~~31, ~~and provide certain marketing services for~~ ~~that~~2001, ~~application.~~2002, Weand ~~agreed~~2003 toare ~~supply~~derived ~~upgrades~~from ~~and~~our ~~new~~audited ~~versions~~consolidated offinancial ~~that~~statements ~~application~~ that are ~~generally~~not ~~released~~included byin usthis ~~to licensees free of charge~~report. ~~In connection with the sale of the Palm Digital Media product line to PalmGear on August 29, 2003, we assigned these rights and obligations to PalmGear.~~

Term and Termination. The term of the software license agreement is five years, from December 3, 2001 until December 3, 2006. Each party has the right to terminate: (i) for certain bankruptcy-related events; and (ii) for material breach by the other party which remains uncured 30 days after notice, and which the parties are unable to resolve after an additional 30 days of good faith discussions. The software license agreement includes a wind-down period that varies depending on which party causes the termination. Except in the case of partial termination by us or a termination by Palm, Palm shall pay a pro rata portion of the minimum annual payment for the then current contract year, based on the percentage of the contract year for which the software license agreement was in effect prior to the effective date of termination and no further minimum annual payments will

beThe ~~due.~~financial Ininformation ~~the~~presented ~~event~~below may not be indicative of aour ~~material~~future ~~breach~~performance byand ~~Palm~~does ~~that~~not necessarily reflect what our financial position and results of operations would ~~entitle~~have usbeen tohad ~~terminate~~we ~~the~~operated ~~software~~as ~~license~~a ~~agreement~~separate, westand-alone entity during the periods presented. Our historical financial information may ~~elect~~not tobe ~~terminate~~representative ~~only~~of aour ~~subset~~results as a stand-alone company and, therefore, may not be reliable as an indicator of ~~the~~future ~~provisions~~results. ~~under~~For periods prior to December 3, 2001, there are no revenues recorded from Palm, as the software license agreement, ~~including~~with ~~source~~Palm ~~code~~was ~~access~~not effective until December 3, ~~right~~2001. toIn ~~sublicense~~addition, due to ~~private~~the ~~label~~acquisitions ~~partners~~of certain assets by Palm that were assigned to us, or ~~subsidiaries~~that we have made, and the ~~most~~change ~~favored~~in ~~licensee~~our ~~clauses.~~method Inof ~~such~~accounting ~~case,~~for ~~Palm~~goodwill ~~shall~~and ~~remain~~intangible ~~obligated~~assets toin ~~continue~~accordance ~~making~~with Statement of Financial ~~all~~Accounting ~~minimum~~Standards ~~annual~~No. ~~payments~~142, ~~remaining~~Goodwill ~~under~~and Other Intangible Assets effective June 1, 2001, our results of operations are not necessarily comparable between the ~~software~~periods ~~license~~presented. ~~agreement~~In addition, our historical combined and ~~may~~consolidated ~~continue~~balance tosheet data ~~distribute~~are not comparable to the ~~Palm~~post-distribution ~~Powered~~balance ~~hardware~~sheet ~~products~~data ~~that~~due ~~use~~to the ~~operating~~transactions ~~system~~that ~~software~~occurred as ~~its~~of ~~primary~~the ~~operating~~distribution ~~system~~date. You should also read the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which describes a number of factors that have affected our financial results.

Side Letter. There is a side letter to the software license agreement relating to indemnification which extends the intellectual property indemnity to additional countries and states that the parties will revisit royalty and maintenance fee provisions in the event a claim for infringement is settled by our taking on a royalty-bearing license with a third party.


	Year Ended May 31,
	2001			2002			2003			2004			2005
	(in thousands, except per share amounts)
Consolidated Statement of Operations Data:
Related party revenues	$	1,235		$	23,682		$	50,539		$	25,532		$	2,370
Third-party revenues		25,017			21,268			22,875			47,585			69,541

Total revenues		26,252			44,950			73,414			73,117			71,911
Cost of revenues		5,449			10,603			10,221			6,174			4,919

Gross margin		20,803			34,347			63,193			66,943			66,992
Total operating expenses		104,823			84,496			77,399			79,742			77,233

Loss from operations		(84,020	)		(50,149	)		(14,206	)		(12,799	)		(10,241	)
Interest expense		(65	)		(256	)		(507	)		(654	)		(31	)
Interest and other income (expense), net		76			(421	)		(4,627	)		(264	)		1,187
Gain on the sale of an asset		—			—			—			—			26,693
Gain on early extinguishment of debt		—			—			—			—			1,875
Income (loss) before income taxes		(84,009	)		(50,826	)		(19,340	)		(13,717	)		19,483
Income tax provision		9			421			2,420			1,530			1

Net Income (loss)	$	(84,018	)	$	(51,247	)	$	(21,760	)	$	(15,247	)	$	19,482

Basic net earnings (loss) per share	$	(8.40	)	$	(5.12	)	$	(2.18	)	$	(1.40	)	$	1.30

Shares used in computing basic net earnings (loss) per share		10,000			10,000			10,000			10,878			14,980

Diluted net earnings (loss) per share	$	(8.40	)	$	(5.12	)	$	(2.18	)	$	(1.40	)	$	1.27

Shares used in computing diluted net earnings (loss) per share		10,000			10,000			10,000			10,878			15,323


	As of May 31,
	2001			2002			2003⁽¹⁾			2004⁽¹⁾			2005
	(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	383		$	30,688		$	13,465		$	27,144		$	22,228
Working capital (deficit)		(21,457	)		16,890			20,750			59,948			55,571
Total assets		61,490			107,316			104,607			152,792			187,864
Note payable to palmOne, including accrued interest		—			20,238			20,744			—			—
Long-term convertible subordinated note		—			—			—			15,000			—
Series A redeemable convertible preferred stock		—			—			20,000			—			—
Total stockholders’ equity / net investment	$	29,611		$	48,299		$	26,280		$	108,991		$	154,665

~~Trademark~~(1) ~~Agreements~~Cash and cash equivalents amounts reclassified. See Note 2 of the Notes to Consolidated Financial Statements.

The use of trade names, trademarks, service marks and domain names that contain the word or letter string “palm” (including “palmOne”) are controlled by Holding Company, a holding company established and owned by palmOne and us for the purpose of receiving, holding, maintaining, registering, enforcing and defending such intellectual property. Holding Company’s administration of the intellectual property is governed by its operating agreement and by trademark license agreements between the Holding Company and each of palmOne and us.

Various facets of the operating structure of the Holding Company are described below. Based on its operating structure, the holding company arrangement is essentially a cost sharing mechanism between palmOne and us to administer the intellectual property rights attributed to the “Palm” trademark and, as a result, the adoption of FIN No. 46, Consolidation of Variable Interest Entities, is not expected to have a material impact on either Palm’s or our respective consolidated financial statements. All material revenues (such as recoveries from litigation), costs, assets and liabilities are specifically identified with either Palm or us and consolidated into its or our respective financial statements.

Administration of Trademarks Through Holding Company. Under Holding Company’s operating agreement, palmOne and we contributed and assigned the palmOne mark and all Palm marks respectively owned, registered, claimed or used by each of palmOne and us to Holding Company. Holding Company, among other things, administers such contributed marks and enhances and maintains the integrity of, and promotes the expansion of the value of and goodwill associated with such marks for the benefit of palmOne and us. Holding Company operates independently of palmOne and us, but palmOne owns 45% and we own 55% of Holding Company’s equity. Additionally, palmOne and we are each responsible for contributing funds to cover: (i) costs associated with certain of the marks, such as litigation and trademark prosecution expenses; and (ii) its and our share of Holding Company’s operating expenses, which shall be divided based on palmOne’s and our ownership interest in the Holding Company.

A board of directors initially consisting of three members—two appointed by us and one appointed by palmOne—manages Holding Company. The board of directors generally takes action by simple majority, except in the case of certain specified actions, such as the entry of Holding Company into a transaction with Palm or us, which require approval of a supermajority of the board of directors, or in some cases, supermajority approval of the members of Holding Company. Some actions by Holding Company specifically require the approval of either Palm or us. Holding Company’s board of directors appoints a brand manager who is responsible for administering the contributed intellectual property and identifying areas of potential conflict caused by requests or actions of palmOne and us. We nominate the brand manager, subject to palmOne’s approval. Disputes relating to the licensed marks or between palmOne and us will be subject to a dispute resolution process, whereby the parties must attempt to resolve the matter internally, and, if that fails, submit it to final and binding arbitration.

Trademark License Agreements. Holding Company licenses the marks contributed by palmOne and us by entering into a trademark license agreement with each of us. Under the trademark license agreement with us, Holding Company grants to us an exclusive, royalty-free and non-transferable license to use the Palm marks

~~(other~~Item than palmOne and other marks using “palm” with any number) on or in connection with the PalmSource business and all products and services associated with its business, as an element in domain names and in connection with its corporate identity7. ~~This license, however, is subject to several restrictions. For example, we cannot use any Palm mark other than the Palm Powered mark or its successor mark on products that compete with palmOne~~Management’s, ~~and~~Discussion ~~we cannot use any corporate name comprising only “Palm”~~ and aAnalysis ~~designation~~ of ~~entity~~Financial ~~status,~~Condition ~~that is an entity name historically used by Palm, that uses Palm~~ and ~~any~~Results ~~number, or~~of ~~that~~Operations ~~has a space between the elements “palm” and “source.”~~

~~Under~~The ~~the~~following ~~trademark~~should ~~license~~be ~~agreement~~read in conjunction with ~~palmOne,~~the ~~subject~~combined and consolidated financial statements and the related notes that appear elsewhere in this report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain ~~restrictions~~factors, ~~Holding~~including those ~~Company~~discussed ~~grants~~below, toin ~~palmOne:~~“Risk Factors” and elsewhere in this report.

•Overview ~~an exclusive, royalty-free and non-transferable license (subject to certain limited exceptions) to use the palmOne mark and domain name:~~

•In onfiscal 2005, the majority of our business came from the traditional PDA market. We have seen this part of our business decline over the past few years, as the growth in wireless data networks and wireless applications and services have simultaneously contributed to the maturation of this market and increased demand for converged mobile devices such as smartphones. As a result, in ~~which~~fiscal ~~Palm~~2005, OSwe issaw a significant shift in our product mix towards smartphones, where our licensees reported unit volumes increased by 94% compared to fiscal 2004 and represented 27% of the ~~primary~~total ~~platform;~~Palm OS unit volume.

•Outlook for fiscal year 2006: We anticipate revenue will be negatively impacted on ~~products~~a year-over-year basis by factors such as Sony’s exit from the PDA market, the pre-pay of one licensee’s royalty minimum, and the expiration of certain prepaid royalties that dowere ~~not~~being ~~incorporate~~amortized ~~traditional~~on ~~personal~~a ~~information~~quarterly ~~manager~~basis. ~~functionality;~~

•While onwe ~~products~~are continually evaluating ways to reduce operating expenses, we cannot assure that ~~contain~~reductions ~~none~~can ofbe ~~the~~achieved ~~elements~~or that, ofif awe ~~computer~~do ~~platform;~~achieve them, that they will not be offset by other increases in operating expense. In addition to headcount reductions, we anticipate reductions in other areas such as travel, and consulting services.

•Business ~~if we license palmOne to use the PALM POWERED logo on or in connection with a dual boot device, on or in connection with such dual boot devices;~~

•Our onrevenues ~~software~~consist ~~applications~~of ~~that~~royalty ~~run~~and onlicense fees from our licensees; support and service fees from our licensees and from the Palm OS Ready program participants; and income from our online software store. Prior to the distribution, we presented revenues from Palm and Sony, a PalmSource stockholder, separately as related party revenues. Subsequent to the distribution, we present only revenues from Sony as related party revenues.

•Historically, our licensee agreements generally provided for upfront payments to be retained in future contracts. We recognize license and royalty revenues when a signed contract exists, the software has been shipped or electronically delivered, the license fee is fixed or determinable, and collection of the resulting receivable is probable. Royalty revenues are generally recognized on a per-unit or net sales basis, based on contractually reported information from licensees. Currently, the majority of our royalty revenue stream is derived on a net sales basis. Historically, the royalty rate generally ranges from 3% to 6% of net sales based on the average selling price of the licensee’s Palm Powered product, although we are increasingly seeing a trend in ~~connection~~the industry towards fixed per unit dollar amounts. Payments received in advance of royalties being earned are recorded as deferred revenues. Our license agreements with ~~related~~licensees ~~services~~may contain minimum commitments. We calculate any minimum commitment shortfalls on a quarterly or annual basis, based on the terms of the respective license agreement, and ~~merchandising~~record the ~~products;~~related revenue in the period that the minimum commitment becomes due to us.

•Support anrevenues ~~exclusive,~~consist ~~royalty-free~~primarily of fees for providing software updates and ~~non-transferable~~technical ~~license~~support to ~~use~~our ~~the Palm~~licensees.~~net~~ ~~domain~~Service ~~name~~revenues ~~and~~represent ~~mark~~product indevelopment, ~~connection~~engineering ~~with~~services, ~~wireless~~consulting ~~services~~and training for ~~Palm~~our licensees ~~products~~ and, to a ~~supporting~~lesser ~~website~~extent, ~~until~~to third-party application developers. Support revenues are deferred and recognized ratably over the ~~earlier~~term of ~~May~~the ~~31,~~agreement. ~~2005~~Service orrevenues ~~such~~are generally billed on a time-and-materials asbasis, ~~Palm.net~~and ~~has~~the ~~fewer~~revenues ~~than~~are generally ~~50,000~~recognized ~~subscribers;~~as the services are performed.

•Historically, aour ~~non-exclusive,~~licensees ~~royalty-free~~have ~~and~~experienced ~~non-transferable~~higher ~~license~~seasonal todemand ~~use~~for ~~PALM~~their ~~STORE~~products, ~~PALM~~particularly ~~SOFTWARE CONNECTION~~PDAs, during our second and ~~the~~third ~~www~~fiscal quarters.~~store.palm.com~~ ~~domain~~This ~~name~~seasonality inwas ~~connection~~primarily ~~with~~the ~~online~~result ~~sales~~of ~~and~~the ~~information~~end ~~until~~of ~~August~~year ~~31,~~gift-giving ~~2005;~~

• a non-exclusive, royalty-free and non-transferable license to use PALM CAFÉ in connection with sales services until January 31, 2005;

• a non-exclusive, royalty-free and non-transferable license through May 31, 2006 the transition marks Palm and DESIGNED FOR PALM HANDHELDS;

• a non-exclusive, royalty-free and non-transferable license to use the BenMai marks in China, Hong Kong and Taiwan; and

• an exclusive, royalty-free and non-transferable license to use the palmOne name as a corporate identifier.

Sublicensability. Both palmOne and we may sublicense any of the marks (subject to some limitations) licensed to us under the respective trademark license agreement, so long as any sublicensee complies with the same restrictions and quality control requirements applicable to Palm or us, respectively. palmOne and we are responsible to Holding Company for ensuring that their respective sublicensees comply with such restrictions and requirements. Holding Company will not assess any royalty for sublicensing by either Palm or us. In addition, palmOne and we are entitled to honor the terms of any existing licenses granted by either of them that relate to the Palm marks and predate the respective trademark license agreement.

The sublicense rights granted to Palm and us in the trademark license agreements are subject to certain restrictions. For example, palmOne may not sublicense marks for use on products that compete with ours and we may not sublicense any Palm marks (other than the Palm Powered mark and any successor mark) for use on products that compete with palmOne’s.

~~Palm.com~~ season ~~Website;~~in ~~Links~~many countries. ~~Holding~~In ~~Company~~addition, ~~owns~~if necessary, certain licensees, including palmOne, satisfy the ~~palm~~remaining amount of their yearly minimum commitments, in our third fiscal quarter.~~com~~ ~~site~~Historically, these factors have resulted in a substantial increase in revenues for our third fiscal quarter as compared to other quarters in the fiscal year. ~~After~~In ~~February~~fiscal ~~2004~~2005, we did not see the ~~sole~~same level of seasonality ~~purpose~~as we did in previous years, and we expect this trend to continue to moderate going forward as mobile phones become a larger part of ~~the~~our ~~palm~~total revenue.~~com~~ ~~site~~Specifically, ~~will~~smartphones bedo tonot ~~redirect~~have ~~users~~the tosame seasonality as PDAs, and as our licensees’ product mix shifts toward smartphones, we believe that the ~~websites~~seasonality of ~~Palm~~our ~~and~~revenue ~~PalmSource~~may be reduced or eliminated.

~~Trademark~~Current ~~Prosecution.~~Trends ~~Even~~Affecting ~~though~~Our ~~Holding~~Operating ~~Company~~Results owns all Palm marks, under the trademark license agreements, each of palmOne and us, subject to Holding Company’s responsibility to maintain the integrity value and goodwill of the Palm marks, effectively directs prosecution of applications and maintenance of registrations for the marks it is licensed by requesting that the brand manager implement palmOne’s or our instructions concerning such prosecution and maintenance.

~~palmOne~~Concentration ~~and~~of weOur ~~are~~Customers. ~~each responsible~~We ~~for~~currently ~~all~~depend ~~costs~~on ~~related~~palmOne tofor ~~trademark~~the ~~prosecution~~majority ~~and~~of ~~maintenance, and domain name registration, for~~ our ~~licensed marks~~revenues. ~~Additionally,~~The ~~each~~palmOne ofrevenues uswere ~~must~~recognized ~~indemnify~~as ~~the~~related party ~~other~~revenues ~~and~~prior ~~Holding~~to ~~Company~~the ~~for~~distribution ~~liabilities~~of ~~resulting~~October ~~from~~28, ~~uses~~2003 ofand ~~licensed marks~~as bythird-party usrevenues orsubsequent ~~our~~to ~~sublicensees~~the indistribution ~~jurisdictions~~of orOctober on28, or2003. inSony ~~connection~~is ~~with~~a ~~goods~~related orparty ~~services~~because ~~beyond~~they ~~the~~are ~~scope~~a ofstockholder. ~~then-existing~~These ~~applications~~amounts orhave ~~registrations,~~been orincluded ~~palmOne’s~~in orrelated ~~our~~party revenues ~~filing~~in ofthe ~~trademark~~combined ~~applications~~and ~~for~~consolidated ~~Palm~~financial ~~marks~~statements.

~~Indemnification;~~Revenues ~~Control Over Sublicensees. palmOne~~ and ~~we respectively~~percentage ~~are obligated to indemnify Holding Company for liability incurred by Holding Company as a result~~ of ~~Palm’s~~total orrevenues ~~our~~from palmOne (~~and~~including ~~any respective sublicensee’s~~Handspring), ~~use~~and ofSony ~~the~~for ~~palmOne marks or breach of~~ the ~~respective~~fiscal ~~trademark~~years ~~license agreements.~~ended IfMay a31, ~~sublicensee of Palm or us does not cure a breach within 30 days~~2003, ~~that~~2004 ~~licensee~~and ~~must~~2005 ~~terminate~~were ~~the~~as ~~rights~~follows ~~granted~~(in tothousands): ~~the sublicensee.~~

Litigation. Subject to the other’s right of participation discussed below, either we or palmOne can request that Holding Company enforce the Palm marks against third parties. Upon such a request, the brand manager will cause Holding Company to act as requested unless doing so would compromise the integrity of, value of or goodwill associated with the marks. In addition, if either we or palmOne learn of any actual, potential or threatened outgoing claims relating to a Palm mark, we or palmOne will promptly notify the brand manager, who will then promptly notify the other licensee.


	For the Year-Ended May 31,
	2003				2004				2005
	Revenues		% of total Revenues		Revenues		% of total Revenues		Revenues		% of total Revenues
Related party:
Palm	$	39,299	53.5	%	$	17,309	23.7	%	$	—	0.0	%
Sony	$	11,240	15.3	%	$	8,178	11.2	%	$	2,370	3.3	%

Third party:
palmOne	$	—	0.0	%	$	21,509	29.4	%	$	46,889	65.2	%
Handspring	$	6,428	8.8	%	$	3,473	4.7	%	$	—	0.0	%

~~When~~We ~~either~~expect that palmOne will orcontinue ~~we initiate an action, the other can assert its right~~ to ~~exclusive~~account orfor ~~limited control, depending on which marks the action concerns. If an action concerns only~~ a ~~party’s~~substantial ~~licensed~~portion ~~marks, then that party has the right to exclusive control~~ of ~~the~~our ~~action.~~revenues Infor ~~cases of limited control—such as when~~ the ~~action~~foreseeable ~~at hand concerns marks licensed to both palmOne and us—the other party’s instructions to the brand manager are subject to the consent of the party who has asserted its limited control rights~~future. IfOn ~~either~~May ~~palmOne~~23, ~~or we exercises exclusive control over a matter~~2005, ~~palmOne or~~ we, ~~as applicable, will pay all costs related to the matter~~ and ~~will be entitled to all recoveries. If either we or~~ palmOne ~~asserts~~entered ainto ~~right of limited participation,~~ the ~~party~~Second ~~asserting~~Amended ~~the~~and ~~right~~Restated ~~will~~Software ~~be responsible~~License ~~for~~Agreement ~~45% of all recoveries, while~~ (the ~~party controlling the matter will be responsible for 55% of all costs and entitled to 55% of all recoveries~~“SARSLA”). IfThe aprinciple ~~party~~changes made ~~elects~~ to ~~have limited participation in a matter,~~ the ~~controlling~~Software ~~party~~License ~~cannot settle~~Agreement ~~the~~were ~~matter without~~ the ~~consent~~following: ~~of the participating party.~~

~~With~~• ~~respect to litigation matters initiated by third parties relating to a licensee’s (or its sublicensee’s) use of licensed marks, that licensee controls~~ the ~~claim.~~term Inwas ~~addition,~~extended iffor Holding Company is a party to the claim regarding a licensed mark, that licensee is empowered to make requests to the brand manager regarding conduct and settlement of the claim. Both palmOne and we, however, have a right of limited defense in any actions initiated by third parties. If either we or palmOne assert our right of limited defense when an ~~action~~additional isthree ~~initiated~~years ~~against the other, then the other party’s decisions concerning the defense~~ and possible settlement of the claim are subject to palmOne or our consent. The party asserting its right of limited defense shall pay 45% of all costs and expenses, and shall be entitled to 45% of all recoveries. The brand manager will ~~act~~expire asDecember ~~requested unless doing so would compromise the integrity of~~2, ~~value of or goodwill associated with the marks~~2009. Subject to the other’s right of limited defense, the party whose use is at issue pays all costs and expenses, and is entitled to all recoveries, unless a court or tribunal allocates such costs, expenses and recoveries differently.

~~All~~• ~~actions~~the ~~existing~~minimum asannual ofroyalty ~~December 2002~~ and ~~listed~~ ~~on a schedule to the trademark~~ license ~~agreements~~commitments ~~shall~~was beextended ~~paid~~in ~~for~~each byof ~~palmOne and are to remain under~~ the ~~exclusive~~additional ~~control~~three ofyears ~~palmOne,~~provided ~~except~~ that ~~palmOne’s~~certain ~~right~~development tomilestones ~~modify~~between ~~claims, appeal awards or judgments, or settle~~ the ~~existing actions~~parties isare ~~subject~~met toby ~~our reasonable consent~~PalmSource.

•

The amounts, if any, spent by palmOne on professional services will be credited towards the annual royalty and license minimum commitments on the basis of $1 credit for every $2 spent on professional services.

•

palmOne’s access to the Palm OS source code was extended for the three additional years for a fee of $400,000 per year. This provision gives palmOne more extensive access to the code, expanded rights to request bug fixes in the software platform with time frames for accepting or rejecting these bug fixes.

See Note 14 of Notes to Consolidated Financial Statements.

PalmOne can cease selling Palm Powered products at any time, which could be due to their withdrawal from the market or their use of a competing operating system. The Handspring agreement expired upon the closing of its merger with palmOne.

~~Term~~Although ~~of Licenses; Termination. The terms of the licenses granted under the trademark license agreements are perpetual. palmOne and we can terminate its or~~ our ~~respective trademark~~ license agreement with ~~180~~Sony ~~days’~~runs ~~notice.~~through ~~Holding~~October ~~Company~~2012, ~~cannot~~Sony ~~terminate~~has ~~any~~announced of the ~~trademark~~termination ~~agreements~~of its ~~other~~Clie® ~~than~~PDA ~~for~~product ~~cause.~~line, ~~Holding~~and ~~Company~~has ~~can~~not ~~terminate~~announced ~~palmOne’s~~plans ~~trademark agreement~~ for ~~cause~~any ifadditional ~~palmOne~~Palm ~~fails~~Powered toproducts. ~~cure~~As a ~~material breach within 120 days of final determination of a material breach~~result, ifour ~~palmOne’s~~revenues ~~Palm~~from OSSony ~~license~~in ~~terminates,~~fiscal or2005 ifdeclined ~~palmOne~~by ~~abandons~~71 ~~the~~percent ~~palmOne~~to ~~mark~~$2.4 ~~Holding Company~~million. ~~can~~In ~~terminate~~May ~~our~~of ~~trademark~~2005, ~~agreement~~Sony ~~for~~paid ~~cause~~its ifremaining wemaintenance ~~fail~~commitments tothrough ~~cure~~2012 ato ~~material~~us ~~breach~~in ~~within~~advance ~~120~~which ~~days~~will ofbe recognized ~~final~~on ~~determination of~~ a ~~material~~pro-rata ~~breach,~~basis ifthrough ~~we no longer develop or support palmOne OS Software, or if we abandon the Palm marks~~2012.

~~Intellectual~~In ~~Property~~November ~~Agreements~~2004, we entered into a mutual release and settlement agreement with Acer for a settlement payment by Acer of $2.6 million, of which approximately $2.1 million was applied to license revenue and approximately $0.5 million was applied against operating expense.

~~Under~~During ~~the~~fiscal ~~master technology ownership and license agreement~~2005, aswe ~~amended,~~saw ~~and the~~several ~~master~~licensee ~~patent ownership and license agreement, or the intellectual property agreements, Palm grants, conveys and assigns to us all its right, title and interest in and to~~ specific events ~~technology~~that ~~and~~will ~~data~~negatively ~~related~~impact tofuture ~~the~~revenues. ~~PalmSource~~These ~~business,~~events orinclude the ~~PalmSource~~ ~~technology,~~expiration ~~as well as all causes~~ of ~~action~~a ~~and~~license ~~rights~~agreement ofwithout ~~recovery~~renewal, ~~for~~the ~~past~~end ~~infringement~~ of ~~copyrights and database rights in and to~~ the ~~PalmSource~~amortization ~~technology and~~ for ~~misappropriation~~a oflicensee’s ~~trade~~prepaid ~~secrets~~royalty incommitment, and to the ~~PalmSource~~prepay ~~technology. Palm also grants, conveys and assigns to us all~~ of ~~its~~minimum ~~right,~~royalty commitments ~~title~~from ~~and~~another ~~interest~~licensee inresulting ~~and~~from tothat ~~specific~~licensee ~~data~~being ~~related~~acquired toby ~~our~~another ~~business~~company. ~~and to specific patents~~Additionally, ~~patent~~following ~~applications and invention disclosures related to~~ the ~~PalmSource~~first ~~business~~fiscal asquarter ~~well as causes~~ of ~~action~~2006, ~~and~~we ~~rights~~will ofsee ~~recovery~~another ~~for~~licensee’s ~~past~~prepaid ~~infringement~~royalty ofcommitment ~~our~~become ~~patents~~fully ~~and~~amortized. Including the ~~right~~revenue todecline ~~claim priority~~ from ~~our~~Sony ~~patents. The agreements confirm that Palm~~ and ~~we jointly own all right~~Acer, ~~title~~we ~~and~~expect ~~interest in and to~~ the ~~certain~~total ~~data,~~impact orof ~~the~~these ~~joint data,~~events ~~and~~will ~~Palm~~negatively ~~grants,~~impact ~~conveys~~revenue ~~and~~for ~~assigns~~fiscal to2006 uswhen ancompared ~~undivided one-half interest in and~~ to the ~~joint~~fiscal ~~data~~2005.

InWe ~~addition~~have a number of other licensees, ~~Palm~~but ~~and~~to date, the sales volume for their products has not been as high as that of palmOne. Although we ~~grant~~have ~~licenses~~recently toadded ~~each~~new ~~other~~licensees onsuch ~~certain~~as ~~copyrights~~LG Electronics, ~~trade~~these ~~secrets,~~new ~~database~~licensees ~~rights,~~have ~~patents~~yet ~~and~~to ~~other~~introduce ~~intellectual~~products ~~property rights~~into inthe market that generate revenue for us. The product development and tocommercial shipment process for our ~~licensed~~licensees is ~~technology~~generally ~~and~~eight to twelve months, and sometimes substantially longer, depending upon the ~~licensed~~complexity ~~Palm~~of ~~technology~~the ~~which~~product, ~~were~~the ~~jointly~~licensee’s ~~developed~~experience with usPalm OS, and other factors. ~~Both~~Smartphones ~~Palm~~generally ~~and~~take wean ~~have~~especially ~~agreed~~long ~~not~~time to ~~disclose~~develop ~~confidential~~and ship, ~~information~~because they are complex and because they must be tested and approved by wireless operators before they are shipped to users. Because of this long development time, the ~~other~~period ~~party~~between ~~except~~signing ina ~~specific~~licensee ~~circumstances~~and receiving royalty revenue from them can be lengthy.

~~The~~Industry ~~master~~Dynamics. ~~confidential~~The ~~disclosure~~mobile ~~agreement provides that Palm and we~~device ~~agree~~industry ~~not~~is tocharacterized ~~disclose~~by ~~the~~several ~~confidential~~trends ~~information of the other, except in certain circumstances,~~ that ~~was~~may ~~known~~have ~~prior~~a tomaterial ~~the~~impact ~~separation~~on orour ~~disclosed~~strategic ~~pursuant to the master separation agreement agreements~~planning, ~~other~~results ~~than~~of ~~with~~operations ~~respect~~and tofinancial ~~certain agreements that contain separate confidentiality requirements~~condition. ~~Under~~As the ~~master~~traditional ~~confidential~~PDA ~~disclosure~~market ~~agreement~~matures, ~~the~~we ~~receiving~~are ~~party~~seeing isan ~~required~~increasingly tocompetitive ~~use~~environment ~~the~~among device ~~same~~manufacturers, ~~degree~~and some of ~~care~~them toare ~~prevent~~exiting the ~~unauthorized~~market. ~~use,~~For ~~dissemination~~example, orin ~~publication~~2004, ofSony, ~~the confidential~~a ~~information~~licensee asand ~~the~~stockholder ~~receiving~~of ~~party~~ours, ~~uses~~announced tothat ~~protect~~it ~~its~~would ~~own~~discontinue ~~confidential~~the ~~information~~Clie® ofPDA aproduct ~~like nature~~line. ~~The~~Several ~~receiving~~manufacturers ~~party will not use such confidential information in violation~~ of ~~any~~PDA ~~use~~products ~~restriction~~based inon ~~any~~other ~~transaction~~operating ~~agreement~~systems ~~and not~~have ~~disclose~~also ~~such~~left ~~confidential information to any third party without~~ the ~~prior~~market ~~written~~or substantially ~~consent~~curtailed oftheir ~~the~~product ~~disclosing party, except as expressly permitted under agreements entered between the parties~~plans. ~~The~~There ~~confidentiality period~~ is ~~five~~no ~~years,~~assurance ~~except~~ that, ~~with~~other ~~respect~~licensees toof ~~highly~~Palm ~~confidential~~Powered ~~information~~products ~~(such~~will asnot ~~source~~also ~~code),~~reduce ~~the~~or ~~confidentiality~~cease ~~period~~the issale ~~perpetual~~of PDAs.

~~Amended~~Our product mix is shifting toward converged mobile devices, but not yet fast enough to fully offset the decline in PDAs. For example, in the three months ended May 31, 2005, smartphones were 37% of our unit shipment mix, compared to 18% in the same period a year before. In the 12 months ended May 31, 2005, smartphones were over 27% of our product mix, compared to 12% in the same period a year before. Our overall unit shipments declined from 1.1 million to 0.7 million in the three month period, and ~~Restated~~from ~~Tax~~5.2 ~~Sharing~~million ~~Agreement~~to 3.6 million in the 12 month period. The shift toward smartphones has also offset a large part of the decline in revenue associated with lower PDA sales. This is because smartphones tend to sell at higher average selling prices than do PDAs, leading to higher per unit royalty revenue from our licensees.

~~The amended and restated tax sharing agreement~~Additionally, orour ~~the~~strategic ~~tax~~plans ~~sharing~~focus ~~agreement,~~our ~~sets~~product ~~forth~~development ~~the~~toward ~~principal~~offering ~~arrangements~~platforms ~~between~~for ~~palmOne and us regarding~~ the ~~filing~~ ofmobile ~~tax~~phone ~~returns~~market, ~~the~~which is ~~payment of taxes and the conduct of tax audits or other disputes~~growing. ~~The~~We ~~tax~~believe ~~sharing agreement provides for~~ the ~~calculation~~high-end of ~~our tax liability as if we were a stand-alone corporation. This means that to~~ the ~~extent~~mobile ~~that~~phone ~~we would~~market ~~have~~is ~~been~~in ~~liable~~its ~~for~~early ~~taxes on a stand-alone basis~~stages, weand ~~will~~there ~~pay~~is ~~Palm~~no ~~for~~guarantee ~~this tax liability. Conversely, to the extent~~ that ~~any of our operating losses reduce our tax liability as a stand-alone company in a future period, any required payment to palmOne under~~ the ~~agreement~~market will begrow ~~reduced~~as forecasted.

~~Under~~Historically, ~~the~~we ~~tax sharing~~have ~~agreement,~~generated ~~Palm~~revenues isfrom ~~required~~a tomix ~~prepare~~of ~~and~~upfront ~~file~~license ~~all~~fees ~~consolidated~~and ~~Palm/PalmSource~~per ~~federal~~unit ~~income~~royalties. ~~tax~~Recently, ~~returns~~we ~~for~~have ~~taxable~~witnessed ~~periods~~a ~~through~~trend in the ~~distribution~~software industry ~~date,~~away ~~including~~from the ~~final~~payment ~~consolidated~~of ~~palmOne~~upfront ~~federal~~license ~~income~~fees ~~tax~~in ~~return~~favor of royalty fees based upon units sold. We have ~~the right~~experienced toa ~~review~~significant decline in our upfront license fees and, ~~consent~~as a result, we expect our deferred revenues to ~~any~~continue ~~palmOne/PalmSource~~to decline over time.

~~consolidated~~Critical ~~return~~Accounting ~~filed~~Policies ~~after the distribution date, provided that we do not withhold such consent unreasonably. In addition, palmOne has sole~~ and ~~complete authority~~Use toof ~~control~~Estimates and resolve all tax audits and other disputes relating to any palmOne and PalmSource consolidated returns filed before and after the distribution. After the distribution, however, palmOne may not enter into any dispute settlement that would materially increase our liability under the tax sharing agreement without our consent.

Use of Estimates. The ~~tax~~preparation ~~sharing~~of ~~agreement~~financial ~~also~~statements ~~contains~~and ~~provisions~~related disclosures ~~requiring~~in usconformity towith ~~indemnify~~accounting ~~palmOne~~principles ~~for,~~generally ~~among~~accepted ~~other~~in ~~things~~the United States of America requires management to make judgments, ~~(i)~~assumptions ~~any~~and ~~increases~~estimates inthat ~~our~~affect ~~stand-alone~~the ~~income tax~~amounts ~~liability~~reported orin ~~other~~PalmSource’s consolidated ~~tax~~financial statements ~~liabilities~~and ~~arising~~the asaccompanying anotes. ~~result~~The amounts of ~~any~~assets ~~amended~~and ~~return,~~liabilities ~~audit~~reported oron ~~other~~our ~~dispute~~balance sheets and ~~attributable~~the toamounts ~~periods~~of ~~after~~revenues ~~December~~and 3,expenses ~~2001,~~reported ~~(ii)~~for ~~any~~each ~~increases~~of inour ~~certain~~fiscal ~~non-income~~periods ~~taxes,~~are ~~including~~affected ~~payroll~~by estimates and ~~employee withholding~~assumptions, ~~taxes~~which are used for, ~~attributable~~but not limited to, the ~~PalmSource~~accounting ~~business,~~for ~~(iii)~~revenue ~~any~~recognition, ~~transfer~~goodwill ~~taxes~~impairment, ~~incurred~~loss oncontingencies, ~~the~~restructuring, ~~transfer~~and ofincome ~~assets~~taxes. byActual ~~Palm~~results tocould ~~us,~~differ ~~and~~from ~~(iv)~~these ~~any~~estimates. ~~tax~~The ~~liability~~following ~~incurred~~critical byaccounting ~~palmOne~~policies onare ~~account~~significantly affected ofby ~~the~~judgments, ~~sale~~assumptions ofand ~~our~~estimates ~~common~~used ~~stock~~ in ~~connection~~the ~~with~~preparation of the ~~distribution~~ consolidated financial statements.

~~Amended~~Revenue Recognition. The Company’s revenue recognition policy is in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended. When contracts contain multiple elements, wherein vendor specific objective evidence exists for all undelivered elements, the Company accounts for the delivered elements in accordance with the “Residual Method” prescribed by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Arrangements. Vendor specific objective evidence of fair value is determined based on the price charged when the same element is sold separately or the contractually stated substantive renewal rate. License and ~~Restated~~royalty ~~Indemnification~~revenue consists principally of revenue earned under software license agreements with manufacturers of hand-held devices. License and royalty revenue is ~~Insurance~~recognized ~~Matters~~when ~~Agreement~~a signed contract exists, the software has been shipped or electronically delivered, the license fee is fixed or determinable, and collection of the resulting receivable is probable. License and royalty revenues are generally recognized on a per-unit or net sales basis in the period information is reported by licensees, generally the month or quarter subsequent to the period of sale by the licensee. Upfront license fees from subscription license agreements are generally recognized ratably over the term of the subscription period. When arrangements include bundled professional services and the pattern of performance over the term of the agreement is not discernable or if an arrangement includes ongoing support for which vendor specific objective evidence of fair value does not exist, the entire fee is recognized ratably over the term of the arrangement. Arrangements generally do not allow for product returns and PalmSource has no history of product returns. Accordingly, no allowance for returns has been provided. Revenue from minimum commitment and other arrangements payable on extended payment terms are recognized in the period the payment becomes due. If an arrangement includes specified upgrade rights for which sufficient vendor specific objective evidence of fair value does not exist, revenue is deferred until the specified upgrade has been delivered.

~~Under~~Support ~~the amended~~ and ~~restated~~ ~~indemnification~~service ~~and~~revenue ~~insurance~~consists ~~matters~~primarily ~~agreement,~~of orfees ~~the~~for ~~indemnification~~providing ~~and~~unspecified ~~insurance~~software ~~agreement,~~updates ~~Palm~~when and weif ~~released~~available ~~each other from~~ and ~~agreed~~technical ~~not~~support tofor software ~~pursue~~products. ~~any~~Support ~~claim~~revenue ~~based~~is ondeferred ~~any~~and ~~liabilities~~recognized ~~arising~~ratably ~~from~~over ~~events occurring on or before~~ the ~~distribution~~ ~~date,~~term ~~including~~of ~~events occurring in connection with~~ the ~~activities to implement the separation and distribution~~agreement. ~~The~~Service ~~indemnification~~revenue ~~and~~consists ~~insurance~~primarily ~~agreement~~of ~~also~~fees ~~contains~~received ~~provisions~~for ~~governing~~providing ~~indemnification.~~product Indevelopment, ~~general~~engineering services, ~~Palm~~consulting and ~~we will~~training ~~each~~to ~~indemnify the other from liabilities arising from their respective businesses or contracts~~licensees and, asto ~~well as liabilities arising from~~ a ~~breach~~lesser ofextent, ~~the~~to ~~separation~~third-party ~~agreement~~application ~~or any ancillary agreement~~developers. InService ~~addition,~~revenue ~~Palm~~is ~~and~~generally webilled ~~will~~on ~~each~~a ~~indemnify the~~time-and-materials ~~other~~basis, ~~against liability for specified environmental actions~~ and ~~conditions.~~revenue Weis ~~will~~generally ~~reimburse~~recognized ~~Palm~~as ~~for~~ the ~~cost~~services ofare ~~any insurance premium expenses to be allocated between Palm and us according to our respective shared percentages~~performed.

~~Xerox~~PalmSource ~~Litigation~~has ~~Agreement~~recognized license and royalty fees based upon the shipment of Palm’s products which incorporate PalmSource’s software and maintenance and support fees from Palm since December 3, 2001, the effective date of the software license agreement with Palm.

The ~~Xerox~~accounting ~~litigation~~related ~~agreement~~to ~~governs~~revenue ~~palmOne’s~~recognition ~~and~~in ~~our~~the ~~obligations with~~software ~~respect~~industry tois complex ~~the~~and ~~current~~affected ~~patent~~by ~~litigation~~interpretations ~~with~~of ~~Xerox.~~the ~~Prior~~rules toand ~~the~~an ~~effectiveness~~understanding of ~~the~~industry ~~Xerox litigation agreement~~practices, ~~the~~both ~~responsibility~~of ~~for~~which ~~the~~are ~~defense~~subject ~~and~~to ~~indemnity~~change. ofConsequently, the ~~Xerox~~revenue ~~litigation~~recognition ~~rested~~accounting ~~with~~rules usrequire ~~and~~management weto ~~had~~make ~~been~~significant ~~paying~~judgments. ~~Palm’s~~We ~~defense~~recognize ~~costs~~revenues ~~and reimbursing Palm for any payments required~~ as adiscussed ~~result~~above ofand ~~its~~follow ~~posting~~the ofdetailed aguidelines ~~bond~~discussed ~~required~~ in ~~connection~~Note ~~with~~2 ~~the litigation through May 31, 2003. We reimbursed Palm for $1.1 million~~ of ~~expenses~~Notes ~~associated~~to ~~with Palm’s posting of such bond for~~ the ~~year~~Consolidated ~~ended~~Financial ~~May 31, 2003~~Statements.

~~Under~~Goodwill ~~the Xerox litigation agreement, palmOne assumes responsibility for managing the Xerox litigation, determining strategy and making most settlement decisions~~Impairment. ~~Additionally,~~We ifperform ~~any~~an ~~claim~~evaluation ~~is brought against us or our Palm OS licensees alleging infringement~~ of the ~~Xerox~~ ~~patent~~carrying byvalue ~~covered versions~~ of ~~Palm~~goodwill ~~OS,~~on ~~then~~an ~~Palm~~annual ~~also~~basis ~~must~~or ~~manage~~whenever ~~the~~an ~~defense,~~event ~~bear the costs and pay the damages awarded~~ or ~~agreed~~change to in ~~settlement of such claim. Although Palm has management control over the Xerox litigation, the Xerox~~circumstances ~~litigation~~occurs ~~agreement~~which ~~prohibits palmOne from consenting to any judgment or settlement that~~ would: ~~allow~~indicate ~~injunctive~~potential orimpairment. ~~declaratory~~We ~~relief~~anticipate ~~to be ordered against us, require us to pay any future royalties or otherwise require us to make any payment that~~ ~~is not fully indemnified, require us to license our intellectual property, or otherwise affect our business, financial condition or operations or those of our licensees in a material way.~~

Additionally, if any claim is brought against us or the PalmSource operating system licensees alleging infringement of the Xerox patent by covered operating system versions, then Palm also must manage the defense, bear the costs and pay the damages awarded or agreed to in settlement of such claim. The Xerox litigation agreement does not, however, affect our obligation to indemnify palmOne for any other infringements under the operating system license between palmOne and us, other than the Xerox litigation. The agreement also does not obligate Palm to assume other obligations that we may have to our licensees, other than defense and indemnity of a claim by Xerox related to the patent in question and covered Palm OS versions.

~~The~~ that ~~Xerox~~during ~~litigation~~fiscal ~~agreement~~year ~~also~~2006, ~~obligates~~we ~~palmOne~~will tobe ~~bear~~required ~~the~~to ~~costs~~test offor ~~the~~goodwill ~~Xerox~~impairment ~~litigation~~more ~~that~~frequently. ~~are incurred~~In ~~after~~response ~~June~~to 1,changes ~~2003,~~in ~~not~~industry ~~including~~and ~~the~~market ~~imputed costs of our personnel or of any independent advice~~ conditions, we may ~~choose~~strategically torealign ~~seek.~~our ~~palmOne~~resources ~~also~~in ~~must~~a ~~pay~~manner ~~the~~that ~~amount~~could ofresult ~~any damages awarded~~ in, oran ~~agreed~~impairment ~~to in settlement~~ of, ~~the~~goodwill. ~~Xerox~~We ~~litigation.~~cannot Inassure ~~the event~~you that ~~any~~future ~~damages~~impairment ~~are~~tests will not ~~paid~~result byin ~~palmOne~~a ~~within~~charge 60to ~~days~~earnings. ~~after~~At the ~~date~~end of ~~entry~~fiscal ~~of judgment or due date under a settlement agreement~~2005, weour ~~are~~goodwill ~~obligated~~balance ~~to pay any shoftfall amounts~~was $72.8 ~~Any~~million ~~such~~or ~~payment~~approximately by39% ~~us does not, however, relieve palmOne~~ of ~~its~~ ~~obligation~~total ~~either to make the payment or to reimburse us~~assets.

~~Strategic~~Loss Contingencies. ~~Collaboration~~We ~~Agreement~~are subject to various loss contingencies arising in the ordinary course of business including patent infringement claims and other litigation. We accrue for estimated loss contingencies, when a loss is probable and can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals are required or should be adjusted.

~~The~~Restructuring and Employee Termination Benefits. Effective in the fourth quarter of fiscal year 2005, PalmSource recorded a charge related to ~~strategic~~employee ~~collaboration~~severance ~~agreement~~benefits ~~provides~~in accordance with SFAS No. 112, Employers’ Accounting for ~~certain~~Postemployment ~~mutual~~Benefits ~~exchanges~~an amendment of ~~information~~FASB ~~between~~Statements ~~Palm~~No. 5 and us43. ~~and~~The ~~establishes~~charge was recorded under SFAS No. 112, as the Company has a ~~framework~~policy ~~for~~to ~~conducting~~pay severance ~~mutually~~benefits ~~agreed~~to ~~co-development~~employees ~~projects.~~that ~~Palm~~are involuntarily terminated, and wethe ~~agree~~Company’s past practice was sufficient to ~~exchange~~warrant ~~information~~the ~~our~~presumption ~~respective relevant~~that ~~business~~this ~~areas~~was onunderstood aby ~~regular~~the ~~basis,~~employees. ~~subject~~The charge related to ~~confidentiality~~employee severance benefits was recorded when the facts indicated that the liability was probable and ~~other~~the ~~obligations~~amount of the liability reasonably estimable. The restructuring charge was related to ~~third~~the ~~parties~~implementation of actions to better align the Company’s expense structure with its revenues.

~~Palm~~Previously isin ~~one of~~ the ~~two~~first ~~additional~~quarter ~~development~~of ~~partners~~fiscal ~~permitted~~year 2005, ~~under~~in ~~PalmSource’s~~accordance ~~existing agreement~~ with ~~Sony.~~Statement Weof ~~must~~Financial ~~notify~~Accounting ~~Palm~~Standards, ~~and~~or ~~provide Palm~~SFAS ~~with~~No. a146, ~~limited~~Accounting ~~opportunity~~ for ~~good~~Costs ~~faith~~Associated ~~discussion,~~with ~~before~~Exit ~~engaging~~or anDisposal ~~additional~~Activities, ~~licensee~~we ofrecorded ~~the~~liabilities ~~PalmSource~~for ~~operating~~costs ~~system~~associated ~~(other~~with ~~than~~exit ~~Sony)~~or indisposal aactivities ~~joint~~when ~~development agreement for new versions of Palm OS where~~ the ~~development partner: (i)~~liability ~~develops~~was ~~material~~incurred ~~portions~~instead of at the ~~source~~date ~~code for a new version~~ of ~~Palm~~commitment ~~OS; and (ii) has the right~~ to ~~access~~an ~~and~~exit ~~modify all~~ or ~~substantially~~disposal ~~all of the Palm OS source code to execute the joint development project~~activity.

~~Until~~Income ~~October~~Taxes. 7,Our ~~2005,~~operating results were historically included in the ~~parties~~tax ~~are~~returns ~~required~~of toPalm ~~meet~~and atcertain foreign subsidiaries. Prior to the ~~beginning~~distribution, ofour income tax provision had been determined on a separate ~~each~~return ~~contract~~basis ~~year~~as ~~and~~if ~~draft~~we had operated as a ~~mutually~~stand-alone ~~agreed~~entity. ~~plan~~We ~~outlining~~have ~~potential~~estimated ~~areas~~our ofincome ~~collaboration,~~taxes ~~with~~that ~~the~~would ~~objective~~have related to our business in each of ~~having~~the atjurisdictions ~~least~~in ~~one~~which ~~active~~we ~~collaboration~~operate ~~project~~as atif ~~any~~we ~~given~~had ~~time~~historically ~~during~~operated ~~the~~on ~~year~~a stand-alone basis. ~~All~~We have ~~co-development~~established ~~will~~a bevaluation ~~performed~~allowance ~~pursuant~~against our deferred tax assets for all periods presented based on our estimates of future taxable income. Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of assessing our ability to arealize ~~definitive~~any ~~written~~future ~~co-development~~benefit ~~agreement~~from our net deferred tax assets. We intend to bemaintain ~~mutually~~this ~~agreed~~valuation byallowance ~~the~~until ~~parties~~sufficient ~~prior~~positive evidence exists to support the ~~commencement~~reversal of the valuation allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a ~~given~~reversal ~~project~~of, or decrease in, our valuation allowance.

The strategic collaboration agreement is coterminous with the software license agreement, subject to termination for certain bankruptcy events, or a material breach uncured 30 days after notice. In addition, we may terminate the strategic collaboration agreement if: (i) Palm no longer includes Palm OS as its primary operating system software for applicable handheld and phone products; (ii) there are no active collaboration projects for any six-month period; (iii) Palm incorporates into its handheld and phone products operating system software that directly competes with Palm OS and the total number of such products sold within any year is greater than 50% of the total number of Palm handheld and phone products incorporating Palm OS that are sold in that same year; (iv) royalty payments from Palm to us for Palm OS in any year fall below 20% of our total operating system royalty revenue from handheld products; (v) the total royalties paid by Palm to us fail to increase year-over-year; or (vi) Palm is acquired by one of our competitors.

Palm may terminate the strategic collaboration agreement if: (i) Palm no longer includes Palm OS as its primary operating system software for applicable handheld and phone products and Palm OS is no longer in the top three operating system products for applicable handheld and phone products in worldwide market share; or (ii) we are acquired by a Palm competitor.

Each party disclaims all warranties with respect to any information or materials provided under the strategic collaboration agreement. Each party’s total liability under the strategic collaboration agreement other than for breach of confidentiality will be capped at $3.0 million.

Neither party may assign the strategic collaboration agreement without the other party’s prior written consent, provided that either party may assign to the successor to all or substantially all of its business or assets relating to the Palm OS or Palm devices incorporating Palm OS as its primary operating system, as applicable. In

~~the~~Results ~~event~~ of ~~such~~Operations a transfer, the non-assigning party will hold good faith discussions with the assignee whether to continue or terminate the strategic collaboration agreement, and if they do not agree to continue within 30 days, the strategic collaboration agreement will terminate.

~~Other~~Comparison ~~Agreements~~of Fiscal Years Ended May 31, 2003, 2004 and 2005 -

~~Palm~~The ~~and~~results ~~we have also entered into a number~~ of ~~other~~operations ~~agreements~~table ~~including~~presents ~~the~~operating ~~SDIO~~data ~~license~~as ~~agreement,~~a ~~the~~percentage ~~Elaine software license and services agreement, and the development agreement. These agreements generally cover the use~~ of ~~various~~total ~~internally~~revenues ~~developed software by both parties. In addition, Palm and we also entered into a strategic collaboration agreement~~ for the ~~development~~periods ~~of new versions of~~indicated: ~~Palm OS. Under the agreements, Palm has certain rights to first discussion prior to our entering into collaboration projects with other licensees.~~

Employees


	Years Ended May 31,
	2003		2004		2005
Revenues:
Related party license and royalty	66.9	%	34.1	%	2.8	%
Third-party license and royalty	25.0		58.2		91.0

Total license and royalty	91.9		92.3		93.8

Related party support and service	2.0		0.8		0.5
Third-party support and service	6.1		6.9		5.7

Total support and service	8.1		7.7		6.2

Total revenues	100.0		100.0		100.0
Cost of revenues:
License and royalty	10.2		5.5		4.1
Support and service	3.7		2.9		2.6

Total cost of revenues	13.9		8.4		6.7

Gross margin	86.1		91.6		93.3
Operating expenses:
Research and development	54.2		46.4		44.1
Sales and marketing	23.4		26.5		27.3
General and administrative	17.4		26.6		27.8
Amortization of intangibles	0.6		0.2		0.2
Restructuring charges and employee termination benefits	3.0		0.0		4.5
Executive severance	0.0		0.0		3.5
Separation costs	6.8		9.4		0.0

Total operating expenses	105.4		109.1		107.4

Loss from operations	(19.3	)	(17.5	)	(14.2	)
Interest expense	(0.7	)	(0.9	)	(0.0	)
Interest and other income (expense), net	(6.3	)	(0.4	)	1.6
Gain on the sale of an asset	0.0		0.0		37.1
Gain on early extinguishment of debt	0.0		0.0		2.6

Income (loss) before income taxes	(26.3	)	(18.8	)	27.1
Income tax provision	3.3		2.1		0.0

Net income (loss)	(29.6	)%	(20.9	)%	27.1	%

AsComparison of ~~July~~Fiscal ~~23,~~Years ~~2004, we had a total of 292 employees, of which 11 were in support and service, 189 were in engineering and product development, 54 were in~~Ended ~~sales~~May ~~and marketing and 38 were in finance~~31, ~~administration~~2004 and ~~operations.~~2005 Our future performance depends, in significant part, on our ability to attract new personnel and retain existing personnel in key areas including engineering and sales. We consider our relationship with our employees to be good.

Related party license and ~~Item~~royalty revenues. Related party license and royalty revenues were $24.9 million in fiscal year 2004 and $2.0 ~~Properties~~million in fiscal year 2005, representing a decrease of 92%. Prior to the distribution, we recognized revenues from Palm as related party revenues, and subsequent to the distribution, we recognized revenues from palmOne as third party revenues. License and royalty revenues from Palm, consisting primarily of royalty fees received from shipment of PDAs and smartphones were $17.1 million and $0 in fiscal years 2004, and 2005, respectively. License and royalty revenues from Sony were $7.8 million and $2.0 million in fiscal years 2004, and 2005, respectively. We recognize royalty revenues from Palm in the period royalty information is reported to us, generally one month subsequent to the ship date. The decrease from fiscal year 2004 to fiscal year 2005 is primarily due to Sony’s withdrawal for the Clie® handheld market as announced in June 2004.

In 2002, we entered into a lease, which terminates on February 28, 2005, but which has an option to renew for three years, for premises in Sunnyvale, California for a total of 88,096 square feet. In June 2004, we notified our lessor that we do not intend to exercise our option to renew for another three years. We are currently exploring various lease alternatives. We also lease a development facility in Montpellier, France and lease sales offices internationally. We believe that our existing facilities are adequate for our current needs. If we enter into a new property lease to replace the existing property lease which terminates on February 28, 2005, we anticipate that the new leased property will be of a similar size as the existing leased property, and such new lease will have similar, or more favorable terms as the existing lease.

Item 3. Legal Proceedings

On February 9, 2004, a suit was filed in the United States District Court for the Northern District of California naming us, palmOne, and Handspring as defendants. The case is captioned E-Pass Technologies, Inc. v. palmOne, Inc., PalmSource, Inc. and Handspring, Inc., Case No. C04-0528. The case alleges that the three defendants have engaged in willful infringement, both direct and contributory and inducement of infringement, of U.S. Patent No. 5,276,311, titled “Method and Device for Simplifying the Use of a Plurality of Credit Cards, or the Like,” with respect to certain hardware products allegedly offered for sale by palmOne, PalmSource and Handspring. The complaint seeks injunctive relief, unspecified damages and attorneys’ fees. E-Pass filed claims against 3Com and Palm in 2000 alleging infringement of the same patent; however, the suit naming us identifies additional products as infringing and seeks unspecified compensatory damages, treble damages and a permanent injunction against future infringement. The cases are in the claim construction phase. We intend to defend vigorously against the claim.

On December 3, 2003, a suit was filed in the United States District Court of Washington at Seattle naming us as a defendant along with palmOne, Inc. and PalmGear, Inc. The case is captioned Digeo, Inc. v. Palm, Inc., et al., No. C03-3822. The complaint alleges willful infringement of U.S. Patent No. 5,734,823, or the ‘823 patent, titled “Systems and Apparatus for Electronic Communication and Storage of Information.” The complaint sought preliminary and permanent injunction, unspecified damages and attorneys’ fees. We reached a settlement of this action in June 2004, and the action was dismissed in its entirety at that time.

OnThird-party ~~April~~license ~~23,~~and ~~2004,~~royalty werevenues. ~~filed~~Third-party ~~suit~~license ~~against~~and ~~Acer,~~royalty ~~Inc~~revenues were $42.6 million in ~~the~~fiscal ~~Superior~~year ~~Court~~2004, ofand ~~the~~$65.5 ~~State~~million ofin ~~California, County~~fiscal ofyear ~~Santa~~2005, ~~Clara.~~representing ~~The~~an ~~case~~increase isof ~~captioned~~55%. ~~PalmSource,~~License ~~Inc.,~~and aroyalty ~~Delaware~~revenues ~~corporation,~~from ~~and~~palmOne ~~PalmSource~~were ~~Overseas~~$21.0 ~~Limited,~~million ~~f/k/a~~in ~~Palm~~fiscal ~~Platform~~year ~~Overseas~~2004 ~~Limited,~~and a$45.9 ~~Cayman~~million ~~Islands~~in ~~corporation,~~fiscal ~~Plantiffs~~year v2005. ~~Acer,~~Prior ~~Incorporated~~to the distribution, Palm arevenues ~~Republic~~were ~~of China~~recognized ~~corporation,~~as ~~Defendant,~~related ~~Case~~party Norevenues. ~~104CV018484.~~License Inand ~~this~~royalty ~~breach-of-contract~~revenues ~~suit,~~from weHandspring ~~seek~~were ~~approximately~~ $43.54 million in ~~unpaid~~fiscal ~~royalties~~year 2004 and ~~maintenance~~$0 ~~and~~in ~~support~~fiscal ~~fees~~year ~~under~~2005. aThe ~~licensing~~decrease ~~agreement~~in ~~between~~Handspring uslicense and ~~Acer.~~royalty Onrevenues ~~May~~from ~~27,~~fiscal year 2004, ~~Acer~~to ~~served~~2005 anwas ~~answer~~due to the ~~complaint~~Handspring ~~and~~merger aon ~~cross-complaint~~October ~~against palmOne~~28, ~~Palm~~2003. ~~Ireland~~Prior ~~Investment~~to ~~and~~the usmerger, ~~seeking~~Handspring inhad ~~excess~~minimum license and royalty commitments of $41.95 million, ~~including~~for ~~amounts~~each ~~Acer~~of ~~paid~~Handspring’s ~~under~~fiscal ~~the~~quarters ~~contract~~through ~~and~~the ~~amounts~~term ~~paid~~of byits ~~unspecified~~license ~~competitors~~agreement ofwith ~~Acer to~~us. ~~palmOne,~~The ~~Palm~~Handspring ~~Ireland~~license ~~Investment~~agreement ~~and~~terminated usas ~~under~~a ~~separate~~result ~~licensing~~of ~~agreements.~~the Wemerger ~~filed~~and ~~our~~we ~~answer~~are onno ~~June~~longer ~~28,~~entitled ~~2004.~~to ~~While~~the we$1.5 ~~believe~~million wequarterly ~~have~~minimum ~~meritorious~~commitment ~~defenses~~through toApril ~~Acer’s claims~~2009, weand ~~cannot~~revenues ~~assure~~from ~~you~~the ~~that~~sale weof ~~will~~Handspring products may be ~~successful~~used inby ~~the~~palmOne ~~litigation~~to orsatisfy ~~that~~its anminimum ~~adverse~~commitments. ~~outcome~~During ~~will~~fiscal ~~not~~2005 ~~significantly~~we ~~harm~~saw ~~our~~several ~~business.~~licensee ~~This~~specific ~~case~~events ~~alleges~~that ~~the~~we ~~same~~expect ~~causes~~will ofnegatively ~~actions~~impact ~~that~~future ~~were~~revenues. These events include the ~~subject~~expiration of a ~~previous~~license ~~federal~~agreement ~~court~~without ~~action~~renewal, ~~captioned~~the ~~PalmSource,~~end ~~Inc.~~of v.the amortization ~~Acer,~~for ~~Incorporated,~~a ~~No.~~licensee’s ~~C03-04285~~prepaid ~~RMW~~royalty commitment, ~~filed~~ inand the ~~Northern~~prepayment ~~District~~ of ~~California~~minimum onroyalty ~~September~~commitments ~~19,~~from ~~2003.~~another Onlicensee ~~May~~resulting ~~11,~~from ~~2004,~~that ~~the~~licensee ~~court~~being inacquired ~~Case~~by Noanother company. ~~C03-04285~~Additionally, ~~RMW~~following ~~entered~~the anfirst ~~order~~fiscal ~~for~~quarter of ~~voluntary~~2006, ~~dismissal~~we ~~without~~will ~~prejudice~~see ~~pursuant~~another tolicensee’s aprepaid ~~stipulation~~royalty ~~between~~commitment ~~the~~become ~~parties~~fully amortized.

OnRelated ~~July~~party ~~16,~~support ~~2003,~~and aservice ~~suit~~revenues. ~~was~~Related ~~filed~~party insupport ~~the~~and ~~Los~~service ~~Angeles~~revenues ~~County~~were ~~Superior~~$0.6 ~~Court naming~~million usin asfiscal ayear ~~defendant.~~2004 ~~The~~and ~~case~~$0.3 ismillion ~~captioned~~in fiscal ~~Chet~~year ~~Taylor~~2005, etrepresenting ~~al.~~a v.decrease ~~Palm,~~of ~~Inc.,~~43% ~~PalmSource,~~from ~~Inc.,~~fiscal ~~and~~year ~~Solutions~~2004 ~~Group,~~to ~~et al~~2005., ~~No.~~Support ~~BC299134.~~and ~~The~~service ~~complaint~~revenues ~~alleges~~from ~~that~~Palm ~~persons~~were ~~who~~$0.2 ~~purchased~~million ~~Palm~~in ~~PDAs~~fiscal ~~with~~year ~~customer-accessible~~2004, ~~batteries after~~and ~~June~~$0 ~~1999~~in ~~lost~~fiscal ~~data~~year ~~upon battery replacement~~2005. ~~The~~Support ~~complaint alleges unfair~~ and ~~deceptive~~service ~~business~~revenues ~~practices~~from inSony ~~alleged~~were ~~violation~~$0.4 ofmillion ~~California’s~~in fiscal ~~unfair~~year ~~competition~~2004 ~~statute~~ and ~~Consumer~~$0.3 ~~Legal~~million ~~Remedies~~in ~~Act,~~fiscal ~~breach~~year ~~of express and implied warranties and fraud~~2005. The ~~complaint~~decrease ~~seeks~~from ~~unspecified~~fiscal ~~compensatory~~year ~~and~~2004 ~~punitive~~to ~~damages,~~2005 ~~restitution~~was ~~and~~primarily andue ~~injunction~~to ~~prohibiting~~recognizing ~~the~~palmOne ~~defendants~~revenues ~~from~~as ~~similar~~third ~~conduct~~party inrevenues ~~the~~subsequent ~~future.~~to ~~palmOne~~the isdistribution ~~managing~~of ~~this~~October ~~litigation~~28, ~~and believes it has good defenses for all parties~~2003.

OnThird-party ~~April~~support 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~~service ~~Computing, Inc~~revenues., ~~Civil Action No. 97~~Third-~~CV-6182T.~~party ~~The~~support ~~complaint alleged willful infringement of U.S. Patent No. 5,596,656, or ‘656 patent, titled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint sought unspecified damages~~ and to ~~permanently~~service ~~enjoin~~revenues ~~the~~were ~~defendants from infringing the ‘656 patent in the future~~$5.0 Inmillion ~~2000, the District Court granted summary judgment to the defendants, ruling that the ‘656 patent is not infringed by the Graffiti handwriting recognition software then used~~ in ~~handheld~~fiscal ~~computers~~year ~~using~~2004 ~~Palm~~and OS$4.1 ~~Xerox~~million ~~appealed the dismissal to the United States Court of Appeals for the Federal Circuit, or CAFC. On October 5, 2001, the CAFC affirmed-~~in~~-part~~ ~~and~~fiscal ~~reversed-in-part~~year ~~the District Court’s ruling~~2005, ~~and~~representing the CAFC 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 ‘656 patent is valid, enforceable, and infringed. The defendants appealed. The CAFC remanded the case to the District Court for a ~~determination~~decrease of ~~the issues of invalidity and enforceability of the ‘656 patent~~23%. Following the CAFC’s remand to the District Court, both parties filed motions for summary judgment with the District Court on the issue of invalidity, and the District Court heard those motions on December 10, 2003. On February 21, 2003, CAFC affirmed the finding that the defendants infringed the ‘656 patent, but reversed the district court’s finding that the ‘656 patent was valid, and enforceable, and remanded for further proceedings. The ~~CAFC~~decrease ~~denied~~from ~~Xerox’s~~fiscal ~~petition~~year ~~for a rehearing, and the case was remanded to the district court for a determination of whether the patent is valid and enforceable. On March 29,~~ 2004, ~~the District Court granted Xerox’s unopposed motion~~ to ~~amend~~2005 ~~its~~was ~~complaint naming PalmSource as a defendant. On May 21, 2004, the District Court granted the defendants’ motion for summary judgment~~ due to ~~invalidity~~expired ~~and~~contracts ~~denied~~partially ~~Xerox’s~~offset ~~motion~~by ~~for~~new ~~summary~~customers judgment that the patent is not invalid. On May 26, 2004, the District Court entered final judgment in favor of the defendants. On June 1, 2004, the defendants filed a motion for clarification of the ruling regarding the District Court’s summary judgment decision and onrevenue ~~June 10, 2004, Xerox filed a motion to alter or amend that decision. Both motions remain pending. On June 18, 2004, Xerox filed a~~from ~~Notice~~our ofChina ~~Appeal to the District Court’s summary judgment decision~~operation. ~~On July 15, 2004, the CFAC issued an order decertifying Xerox’s appeal pending resolution of Xerox’s motion to alter or amend the District Court’s summary judgment decision. The CAFC’s~~

Cost of license and royalty revenues. Cost of license and royalty revenues principally represents royalty payments to third-party technology vendors, payments to publishers for eBook content and amortization of purchased intangible assets. Cost of license and royalty revenues was $4.0 million in fiscal year 2004 and $3.1 million in fiscal year 2005, representing 5.5% and 4.1% of total revenues, respectively. The decreases in cost of license and royalty revenues in absolute dollars and as a percentage of total revenues were primarily due to a cessation of annual minimums in amortization of purchased intangibles as certain intangible assets became fully amortized, which was partially offset by the increase in royalty payments to new third-party technology vendors.

Cost of support and service revenues. Cost of support consists of costs to provide software updates and technical support for software products, and cost of service represents costs to provide product development, engineering services, consulting and training. The cost of service revenues varies by project, but is generally comparable for both third-party and related party service revenues. Cost of support and service revenues was $2.1 million in fiscal year 2004 and $1.9 million in fiscal year 2005, representing 2.9% and 2.6% of total revenues, respectively. The decreases in cost of support and service revenues in absolute dollars and a percentage of total revenues were primarily due to the a decrease in support costs as a result of expired contracts offset by an increase in professional services cost as a result of increased professional services revenues.

Research and development expenses. Research and development expenses consist primarily of personnel and related costs to support our product development and related information technology and facilities costs. Research and development expenses were $33.9 million in fiscal year 2004 and $31.7 million in fiscal year 2005, representing a decrease of 6% from fiscal year 2004 to 2005. Research and development expenses as a percentage of total revenues were 46.4% in fiscal year 2004 and 44.1% in fiscal year 2005. The decrease in

~~February 20, 2003~~research ~~decision~~and ~~indicates~~development ~~that~~expenses ~~the~~in ~~District~~absolute ~~Court~~dollars ~~should grant Xerox’s request for injunctive relief if the patent is valid~~ and ~~enforceable.~~ Ifas ~~an injunction is obtained by Xerox, it could have~~ a ~~significant~~percentage ~~adverse~~of ~~impact~~revenues onwas ~~PalmSource’s~~primarily ~~operations~~due ~~and financial condition if licensees have not transitioned~~ to areduction ~~handwriting~~of ~~recognition~~headcount ~~system~~resulting ~~outside~~from ~~the scope of~~attrition ~~Xerox’s~~and ~~asserted~~restructuring ~~claims. In addition~~efforts, ifoffset ~~palmOne~~by isincrease ~~not successful~~ in ~~establishing~~costs ~~that~~associated ~~the~~with ~~‘656~~our ~~patent~~operation ~~is invalid or unenforceable, Xerox has stated~~ in ~~its~~China. ~~court~~Our ~~pleadings~~research ~~that it will seek at trial a significant compensatory~~ and ~~punitive damage~~development ~~award~~expenses orare ~~license~~primarily ~~fees~~fixed ~~from~~employee ~~palmOne~~costs. ~~Furthermore,~~Although ifwe ~~palmOne~~believe isthat ~~not~~continued ~~successful~~investment in ~~establishing~~research ~~that the ‘656 patent is invalid or unenforceable, palmOne might be liable to palmOne’s licensees~~ and ~~other~~development ~~third parties under contractual~~is ~~obligations~~critical orin ~~otherwise~~attaining ~~sustain~~our ~~adverse~~strategic ~~financial impact if Xerox seeks to enforce its patent claims against palmOne’s licensees and other third parties. In connection with Palm’s separation from 3Com~~objectives, ~~pursuant~~we toannounced ~~the~~a ~~terms~~restructuring ~~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~~ that ~~may~~would ~~arise~~leverage ~~out of the Xerox litigation. As part of~~ our ~~separation~~existing ~~agreements~~offshore ~~with palmOne,~~research ~~palmOne is required to indemnify us for certain damages that we may incur due to the Xerox litigation. If palmOne is not successful in the Xerox litigation~~ and isdevelopment ~~unable~~centers ~~to or does not indemnify us~~and, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. In particular, pursuant to our separation agreements with palmOne, if palmOne is required to pay Xerox, as a result ~~of a judgment or in connection with a settlement~~, ~~and fails to do so within 60 days after the entry of such judgment or the due date under such settlement,~~ we ~~will~~expect beour ~~required~~research to pay any shortfall amounts. Any such payment by us does not, however, relieve palmOne of its obligation either to make the payment or to reimburse us. Damages in patent litigation of this nature can be calculated in a variety of ways, and ~~are~~development ~~subject~~costs to ~~factual~~decrease ~~determinations. We cannot easily predict the amount of these damages, but if palmOne is not successful~~ in the ~~litigation,~~next ~~damages could be substantial. Although palmOne has prevailed at the current stage of the litigation on the claims made by Xerox, we cannot assure you that palmOne will be successful or that an adverse~~fiscal ~~outcome will not significantly harm our business~~year.

InSales ~~the course~~and ofmarketing ~~palmOne’s~~expenses. ~~business,~~Sales itand ~~occasionally~~marketing expenses ~~receives~~consist ~~claims~~primarily ~~related~~of topersonnel ~~consumer~~and ~~protection,~~related ~~general~~costs ~~commercial~~of ~~claims~~our ~~related~~direct tosales ~~the~~force ~~conduct~~and ofmarketing ~~its~~staff ~~business~~ and the ~~performance~~cost of ~~its~~marketing ~~products~~programs, ~~and~~including ~~services~~advertising, ~~and~~trade ~~other~~shows, ~~litigation~~PalmSource ~~claims~~developer conferences, ~~such~~promotional asmaterials, customer ~~stockholder~~conferences ~~derivative~~and ~~class~~related ~~action~~information ~~lawsuits~~technology and facilities costs. InSales ~~the~~and ~~course~~marketing ofexpenses ~~palmOne’s~~were ~~business,~~$19.4 itmillion ~~also~~in ~~receives~~fiscal ~~claims~~year of2004 ~~infringement~~and or$19.6 ~~otherwise~~million ~~becomes~~in ~~aware~~fiscal ofyear ~~potentially~~2005, ~~relevant~~representing ~~patents~~an orincrease ~~other~~of ~~intellectual~~1% ~~property~~from ~~rights~~fiscal ~~held~~year by2004 ~~other~~to ~~parties~~2005. ~~palmOne~~ isSales ~~currently~~and marketing ~~subject~~expenses toas a ~~number~~percentage of ~~these~~total ~~claims.~~revenues ~~Although~~were ~~the~~26.5% ~~majority~~in offiscal ~~the~~year ~~claims~~2004 ~~currently~~and do27.3% ~~not~~in ~~name~~fiscal usyear as2005. aThe ~~defendant,~~increases ~~the~~in ~~substance~~absolute ofdollars ~~their~~and ~~claims~~as ~~may~~a ~~implicate~~percentage usof ~~and~~total ~~result~~revenues infrom ~~claims~~fiscal ~~against~~year us2004 into ~~the~~2005 ~~future~~were orprimarily ~~require~~due ~~that~~to wean ~~indemnify~~increase ~~palmOne~~in ~~pursuant~~outside toconsultants ~~our~~and ~~separation~~an ~~agreements.~~increase Wein ~~currently~~personnel ~~are~~costs. ~~not~~As ~~able~~a toresult ~~estimate~~of our restructuring, ~~with~~we ~~reasonable~~expect ~~certainty,~~sales ~~the~~and ~~possible~~marketing ~~loss,~~expenses orto ~~range~~decrease ofon ~~loss,~~an ifabsolute ~~any,~~dollar ~~from~~basis ~~these~~in ~~cases,~~fiscal ~~but~~year an2006, ~~unfavorable~~as ~~resolution~~we ofreduce ~~these~~marketing ~~lawsuits~~staff, ~~could~~marketing ~~materially~~expenditures ~~adversely~~associated ~~affect~~with ~~our~~trade ~~business,~~shows ~~results~~and ofreduce ~~operations~~the oruse ~~financial~~of ~~condition~~outside consultants.

~~From~~General ~~time~~and toadministrative ~~time,~~expenses. weGeneral ~~also~~and ~~may~~administrative beexpenses ~~subject~~consist toprimarily ~~other~~of ~~legal~~personnel ~~proceedings~~and related costs for general corporate functions, asincluding ~~well~~executive, aslegal, ~~demands~~finance, ~~claims~~accounting, human resources and ~~threatened~~related ~~litigation,~~information ~~that~~technology ~~arise~~and infacilities ~~the~~costs. ~~normal~~General ~~course~~and ofadministrative ~~our~~expenses ~~business~~were $19.4 ~~The~~million ~~ultimate~~in ~~outcome~~fiscal ofyear ~~any~~2004 ~~litigation~~and ~~is uncertain~~$20.0 million in fiscal year 2005, ~~and~~a ~~either~~2.7% ~~unfavorable~~increase orfrom ~~favorable~~fiscal ~~outcomes~~year ~~could~~2004 ~~have~~to fiscal year 2005. General and administrative expenses as a ~~material~~percentage ~~negative~~of ~~impact~~total revenues were 26.6% ~~Regardless~~in offiscal ~~outcome,~~year ~~litigation~~2004 ~~can~~and ~~have~~27.8% anin ~~adverse~~fiscal ~~impact~~year on2005. usThe ~~because~~increase in absolute dollars and as a percentage of ~~defense~~total revenue from fiscal year 2004 to 2005 was primarily due to increased personnel costs, ~~diversion~~including ofconsulting ~~management~~and ~~resources~~contract ~~and~~services ~~other~~related ~~factors~~to Sarbanes-Oxley Act compliance. This increase was partially offset by a decrease in stock-based compensation expenses.

Amortization of intangibles. Amortization of intangibles consisting of ~~Item~~amortization 4related to our acquisitions was $0.2 ~~Submission~~million in fiscal year 2004 and $0.1 million in fiscal year 2005. The decrease from fiscal year 2004 to fiscal year 2005 was due to amortization of ~~Matters~~prior acquisitions being completed during the second quarter of fiscal year 2004. This decrease was offset by amortization of intangibles related to aour ~~Vote~~acquisition of ~~Security~~CMS ~~Holders~~in January 2005.

~~None~~Restructuring charges and employee termination benefits. Restructuring charges and charges for employee termination benefits principally consisted of workforce reductions, including severance, benefits, and related expenses. These charges were $0 in fiscal year 2004 and $3.2 million in fiscal year 2005. In the first quarter of fiscal year 2005, we recorded a restructuring charge of $0.5 million related to workforce reductions of approximately 16 regular employees, primarily in the U.S. The charge was recorded as incurred in accordance with SFAS No. 146, Accounting for costs associated with Exit or Disposal Activities. In the fourth quarter of fiscal 2005, we recorded a charge for employee termination benefits of approximately $2.7 million in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits an amendment of FASB Statements No. 5 and 43, since the liability was probable, the amount of liability reasonably estimable, and because the Company has a policy to pay severance benefits to employees that are involuntarily terminated, and the Company’s past practice was sufficient to warrant the presumption that this was understood by the employees. The Q4 charge was primarily related to costs for severance, benefits and related costs associated with a reduction of 37 regular employees or 16% of our U.S. workforce. See Note 11 of Notes to Consolidated Financial Statements.

We will continue to realign resources as necessary to balance the size of our employee base with our current and anticipated revenue base. We anticipate that these actions will result in approximately $7.0 million of savings

~~PART~~in IIpayroll and payroll related expenses in the next fiscal year. We cannot provide assurance these savings will not be offset by reductions in revenue or increases in other costs during the next fiscal year. We may incur additional restructuring charges in the future to align our cost structure with anticipated future revenues.

~~Item~~Executive 5severance. ~~Market~~Effective ~~for~~as ~~Registrant~~of May 22, 2005, David C. Nagel terminated his services as the Company’s President, ~~Common~~Chief ~~Equity~~Executive Officer and director. Pursuant to the terms of the Severance Agreement entered into between PalmSource, ~~Related~~Inc. ~~Stockholder~~and ~~Matters~~Mr. Nagel on August 14, 2003 (the “Severance Agreement”), Mr. Nagel and ~~Issuer~~the ~~Purchases~~Company entered into a separation agreement (the “Separation Agreement”) on May 22, 2005. Pursuant to the Separation Agreement, Mr. Nagel agreed to release all claims against the Company (a “Release”) in exchange for the severance benefits provided for under the terms of ~~Equity~~his ~~Securities~~Severance Agreement. The Company recorded a charge of $2.5 million in the fourth quarter of fiscal 2005 in connection with this transaction.

~~Our~~Separation ~~common~~costs. ~~stock~~Separation ~~has~~costs ~~traded~~primarily onconsisted ~~the~~of ~~Nasdaq~~costs ~~stock~~related ~~market~~to ~~under~~ the ~~symbol~~establishment ~~PSRC~~of ~~since~~PalmSource ~~the~~as ~~distribution~~a separate onindependent ~~October~~company. ~~28,~~Separation ~~2003.~~costs ~~The~~were ~~following~~$6.9 ~~table~~million ~~sets~~in ~~forth the~~fiscal ~~high~~year 2004, and ~~low~~$18,000 ~~intraday~~in ~~prices~~fiscal asyear ~~reported~~2005. onThe ~~the~~PalmSource ~~Nasdaq~~distribution ~~stock~~was ~~market~~completed ~~for~~in the ~~periods~~second ~~indicated~~quarter of fiscal year 2004.

For Year Ending May 31, 2004	Second Quarter(from October 28, 2003)		Third Quarter		Fourth Quarter
High	$	48.00	$	26.29	$	24.99
Low	$	24.56	$	17.35	$	16.20

The costs subsequent to the distribution represent adjustments to settle remaining costs and wrap-up activities. On October 28, 2003, Palm’s stockholders approved the distribution of PalmSource from Palm. As the distribution was completed in the second quarter of fiscal year 2004, we incurred minimal separation costs for fiscal year 2005 and do not expect to incur substantial separation costs in future periods.

AsInterest ofexpense. ~~August~~Interest 2,expense was $0.7 million in fiscal year 2004 and $31,000 in fiscal year 2005. Interest expense increased after the ~~there~~distribution ~~were~~date ~~approximately~~due ~~249~~to interest on the $15.0 million 5% convertible subordinated note issued to Texas Instruments,~~000~~ ~~holders~~partially ofoffset ~~record~~by the decrease in interest paid to Palm as a result of the contribution to our ~~common~~capital ~~stock~~by Palm of the $20.0 million ~~PalmSource~~note ~~has~~payable ~~not~~to ~~paid~~Palm ~~and~~that ~~does~~bore ~~not~~interest ~~anticipate~~at ~~paying~~2.48%. ~~cash~~We ~~dividends~~expect ininterest expense to decrease as the ~~near~~$15.0 ~~future~~million 5% convertible subordinated note payable to Texas Instruments was repaid in June 2004 (see Note 6 of Notes to Consolidated Financial Statements).

WeInterest ~~made~~and noother ~~repurchases~~income of(expense), net. ~~our~~Other expense was $0.3 million in fiscal year 2004. Other income was $1.2 million in fiscal year 2005. Other expense from fiscal year 2004 was primarily due to a $0.3 million charge to write down an investment in a private equity ~~securities~~security, which ~~during~~had been carried at fair market value and for which we determined the current year decline in value of our ~~quarter~~entire ~~ended~~investment ~~May~~to ~~31,~~be ~~2004~~other than temporary. Other income in fiscal 2005 was primarily due to higher interest income of the cash held as a result of the public offering and favorable foreign exchange rates during the fiscal year, offset by an additional write down of an investment in a private equity security which we determined the decline in value was other than temporary.

~~Use~~Gain on Asset Sale. Gain on the sale of ~~Proceeds~~an asset was $26.7 million in fiscal 2005, and is related to the sale of our 55% interest in Palm Trademark Holding Company LLC (“PTHC”) to palmOne for $30 million in cash. In determining the amount of net gain, PalmSource’s basis in the net assets of PTHC and direct transaction costs (primarily legal fees and valuation expenses) have been deducted from ~~Sale~~the discounted proceeds (see Note 14 of ~~Registered~~Notes ~~Securities~~to Consolidated Financial Statements).

InGain ~~April~~on ~~2004,~~early weextinguishment ~~completed~~debt. aIn ~~firm~~June ~~commitment underwritten public offering of 3~~2004,~~450,000~~ ~~shares~~we ofprepaid ~~our Common Stock including 450,000 shares related to~~ the ~~underwriter’s over-allotment option~~$15.0 million ~~The~~convertible ~~effective~~subordinated ~~date~~note ofdue ~~our~~to ~~registration~~Texas ~~statement,~~Instruments ~~filed~~in onexchange ~~Form~~for ~~S-1~~a ~~under the Securities Act of 1933 (File Nos~~12.5% ~~333-111871~~discount and ~~333-114150)~~ ~~relating to~~ the ~~public~~PalmSource ~~offering~~note ~~of our Common Stock~~ was ~~April 1, 2004~~eliminated. ~~The~~We ~~offering~~paid ~~commenced~~approximately ~~and was completed on April 2, 2004, at a public offering price of~~ $1813.001 ~~per~~million ~~share.~~(plus ~~The~~accrued ~~offering~~interest) ~~resulted~~of inthe ~~gross~~original ~~proceeds of~~ $6215.10 million~~. After~~ ~~deducting~~principal ~~underwriting~~outstanding, resulting ~~discounts~~in ~~and~~a ~~commissions~~discount of approximately $31.49 million. ~~and~~See ~~estimated~~Note ~~offering~~6 ~~expenses~~ of ~~approximately~~Notes ~~$1.3~~to ~~million,~~Consolidated ~~the~~Financial ~~net~~Statements ~~proceeds~~for ~~from~~further ~~the offering were approximately $57~~discussion.4 ~~million.~~

~~From~~Income ~~the~~tax ~~time~~provision. ofIncome ~~receipt~~tax ~~through~~provision ~~May~~was ~~31,~~$1.5 ~~2004,~~million wein ~~have~~fiscal ~~invested~~year ~~the~~2004 ~~net proceeds from the public offering in short-~~ and ~~long-term~~$1,000 ~~investments~~ in ~~order~~fiscal toyear ~~meet our anticipated cash needs for future working capital~~2005. WeThe ~~invested~~decrease ~~our available cash principally~~ in ~~high-quality~~income ~~government securities with maturities no greater~~tax ~~than~~provision ~~2 years.~~from Infiscal ~~June~~year 2004, weto ~~applied~~2005 ~~$13.1~~was ~~million~~primarily ofdue ~~the~~to ~~net~~lower ~~proceeds~~foreign ofwithholding ~~the~~taxes ~~offering~~and ~~held~~a decrease in ~~money~~deferred ~~market~~taxes ~~funds~~related to ~~prepay~~ the 5%tax ~~convertible~~amortization ~~subordinated~~of ~~note due to Texas Instruments~~goodwill. NoOur ~~offering~~tax ~~expenses~~expense orin ~~proceeds~~fiscal ~~were~~year ~~paid~~2005 ~~directly~~was ~~or indirectly~~lower tothan ~~any~~tax ofat ~~our~~the ~~directors~~federal statutory orrate ~~officers~~due ~~(or their associates),~~ to ~~persons~~benefits ~~owning~~received ~~ten~~from ~~percent~~foreign ~~(10%)~~tax orcredits ~~more~~and ofa ~~any~~reduction ~~class~~in ofthe ~~our~~company’s ~~equity~~valuation ~~securities or to any affiliates~~allowance.

~~Item~~Comparison 6.of ~~Selected~~Fiscal ~~Financial~~Years ~~Data~~Ended May 31, 2003 and 2004

~~The~~Related ~~following~~party ~~selected~~license ~~combined~~ and ~~consolidated~~royalty ~~financial~~revenues. ~~data~~Related ofparty ~~PalmSource~~license ~~reflect~~and royalty ~~our~~revenues ~~historical~~$49.1 ~~results~~million ofin ~~operations~~fiscal ~~and~~year ~~balance~~2003 ~~sheet~~and ~~data~~$24.9 ~~Our~~million ~~combined~~in ~~and~~fiscal ~~consolidated~~year ~~statement~~2004, representing a decrease of ~~operations~~49% ~~data~~from ~~set~~fiscal ~~forth~~year ~~below~~2003 ~~for~~to 2004. Prior to the ~~years~~distribution, we recognized revenues from Palm as related party revenues, and ~~ended~~subsequent ~~May~~to 31the distribution, ~~2002~~we recognized revenues from palmOne as third party revenues. License and royalty revenues from Palm, consisting primarily of royalty fees received from shipment of PDAs were $38.1 million and $17.1 million in fiscal year 2003, and 2004, respectively. License and ~~the~~royalty ~~combined~~revenues from Sony were $10.9 million and ~~consolidated~~$7.8 ~~balance~~million ~~sheet~~in ~~data~~fiscal years 2003, and 2004, respectively. In fiscal year 2003, we received a payment of $3.6 million from Palm as a result of Palm’s ~~May~~shortfall 31under its minimum annual commitment for the annual contractual period ending December 3, ~~2003~~2002. The decrease in license and royalty revenues from fiscal year 2003 to 2004 ~~are~~was ~~derived~~due ~~from~~to ~~our~~six ~~audited~~months ~~combined~~of ~~and~~Palm ~~consolidated~~revenues ~~financial~~recorded ~~statements~~in ~~included~~fiscal year 2004 as a result of the distribution compared to a full year of Palm revenues recorded in ~~this~~fiscal ~~report~~year 2003.

	Year Ended May 31,
	2000			2001			2002			2003			2004
	(in thousands, except per share amounts)
Combined and Consolidated Statement of Operations Data:
Related party revenues	$	83		$	1,235		$	23,682		$	50,539		$	25,532
Third-party revenues		6,879			25,017			21,268			22,875			47,585
Total revenues		6,962			26,252			44,950			73,414			73,117
Cost of revenues		2,941			5,449			10,603			10,221			6,174
Gross margin		4,021			20,803			34,347			63,193			66,943
Total operating expenses		63,177			104,823			84,496			77,399			79,742
Loss from operations		(59,156	)		(84,020	)		(50,149	)		(14,206	)		(12,799	)
Interest expense		(12	)		(65	)		(256	)		(507	)		(654	)
Interest and other income (expense), net		(50	)		76			(421	)		(4,627	)		(264	)
Loss before income taxes		(59,218	)		(84,009	)		(50,826	)		(19,340	)		(13,717	)
Income tax provision		1,499			9			421			2,420			1,530
Net loss	$	(60,717	)	$	(84,018	)	$	(51,247	)	$	(21,760	)	$	(15,247	)
Basic and diluted net loss per share	$	(6.07	)	$	(8.40	)	$	(5.12	)	$	(2.18	)	$	(1.40	)
Shares used in computing basic and diluted net loss per share		10,000			10,000			10,000			10,000			10,878
	As of May 31,
	2000			2001			2002			2003			2004
	(In thousands)
Combined and Consolidated Balance Sheet Data:
Cash and cash equivalents	$	656		$	383		$	30,688		$	37,465		$	45,144
Working capital (deficit)		(15,669	)		(21,457	)		16,890			20,750			59,948
Total assets		16,992			61,490			107,316			104,607			152,792
Note payable to palmOne, including accrued interest		—			—			20,238			20,744			—
Long-term convertible subordinated note		—			—			—			—			15,000
Series A redeemable convertible preferred stock		—			—			—			20,000			—
Total stockholders’ equity / net investment (deficit)	$	(12,869	)	$	29,611		$	48,299		$	26,280		$	108,991

Third-party license and royalty revenues. Third-party license and royalty revenues were $18.4 million in fiscal year 2003, and $42.6 million in fiscal year 2004, representing an increase of 132% from fiscal year 2003 to 2004. License and royalty revenues from palmOne were $21.0 million in fiscal year 2004. Prior to the distribution, Palm revenues were recognized as related party revenues. License and royalty revenues from Handspring were $6.2 million in fiscal year 2003 and $3.4 million in fiscal year 2004. The increase in third party license and royalty revenues from fiscal year 2003 to 2004 were principally due to palmOne revenues being recognized as third party revenues subsequent to the distribution. The decrease in Handspring license and royalty revenues from fiscal year 2003 to 2004 was due to the Handspring merger on October 28, 2003.

Related party support and service revenues. Related party support and service revenues $1.5 million in fiscal year 2003 and $0.6 million in fiscal year 2004, representing a decrease of 59% from fiscal year 2003 to 2004. Support and service revenues from Palm were $1.2 million in fiscal year 2003 and $0.2 million in fiscal year 2004. Support and service revenues from Sony were $0.3 million in fiscal year 2003 and $0.4 million in fiscal year 2004. The decrease from fiscal year 2003 to 2004 was primarily due to recognizing palmOne revenues as third party revenues subsequent to the distribution.

Third-party support and service revenues. Third-party support and service revenues were $4.5 million in fiscal year 2003 and $5.0 million in fiscal year 2004, representing an increase of 12% from fiscal year 2003 to 2004. The increase from fiscal year 2003 to 2004 was due to palmOne support and service revenues classified as third party revenues subsequent to the distribution and increase in professional services revenue.

Cost of license and royalty revenues. Cost of license and royalty revenues was $7.5 million in fiscal year 2003 and $4.0 million in fiscal year 2004, representing 10.2% and 5.5% of total revenues, respectively. The decreases in cost of license and royalty revenues from fiscal year 2003 to 2004 in absolute dollars and as a percentage of total revenues were primarily due to a reduction of approximately $4.0 million in amortization of purchased intangibles as certain intangible assets became fully amortized, which was partially offset by the increase in royalty payments to new and existing third-party technology vendors.

Cost of support and service revenues. Cost of support and service revenues of $2.7 million in fiscal year 2003 and $2.1 million in fiscal year 2004, representing 3.7% and 2.9% of total revenues, respectively. The decrease as a percentage of total revenues from fiscal year 2003 to 2004 was due to the increase in total revenues in fiscal year 2003. The decreases in cost of support and service revenues in absolute dollars and a percentage of total revenues were primarily due to the decrease in professional services cost as a result of decrease in professional services revenues.

Research and development expenses. Research and development expenses were $39.8 million in fiscal year 2003 and $33.9 million in fiscal year 2004, representing a decrease of 15% from fiscal year 2003 to 2004. Research and development expenses as a percentage of total revenues were 54.2% in fiscal year 2003 and 46.4%

~~Item~~in 7fiscal year 2004. ~~Management’s~~The ~~Discussion~~decrease in research and ~~Analysis~~development ofexpenses ~~Financial~~in ~~Condition~~absolute ~~and~~dollars ~~Results~~for ofwas ~~Operations~~primarily due to restructuring efforts affected to realign our resources with our business plan. The decrease from fiscal year 2003 to 2004 was due to approximately $5.9 million decline in research and development expenses.

~~The~~Sales ~~following~~and ~~should~~marketing beexpenses. ~~read~~Sales inand ~~conjunction~~marketing ~~with~~expenses ~~the~~were ~~combined~~$17.2 ~~and~~million ~~consolidated~~in ~~financial~~fiscal ~~statements~~year 2003 and ~~the~~$19.4 ~~related~~million in ~~notes~~fiscal ~~that~~year ~~appear~~2004, ~~elsewhere~~representing inan ~~this report~~increase of 13% from fiscal year 2003 to 2004. ~~The~~Sales ~~following~~and ~~discussion~~marketing ~~contains~~expenses ~~forward-looking~~as ~~statements~~a ~~that~~percentage ~~involve~~of ~~risks~~total revenues were 23.4% in fiscal year 2003 and ~~uncertainties~~26.5% ~~Our~~in ~~actual~~fiscal ~~results~~year ~~could~~2004. ~~differ~~The ~~materially~~increases in absolute dollars and as a percentage of total revenues from ~~the~~fiscal ~~results~~year ~~contemplated~~2003 byto ~~these~~2004 ~~forward-looking~~were ~~statements~~primarily due to ~~certain~~an ~~factors,~~increase ~~including those~~in ~~discussed~~stock-based ~~below,~~compensation inexpense ~~“Risk~~of ~~Factors”~~$1.7 million and ~~elsewhere~~an increase in ~~this~~personnel ~~report~~costs of $0.9 million.

~~Overview~~General and administrative expenses. General and administrative expenses were $12.8 million in fiscal year 2003 and $19.4 million in fiscal year 2004, a 52% increase from fiscal year 2003 to 2004. General and administrative expenses as a percentage of total revenues were 17.4% in fiscal year 2003 and 26.6% in fiscal year 2004. The increases in absolute dollars and as a percentage of total revenues from fiscal year 2003 to 2004 were primarily due to an increase in stock-based compensation expense of $5.8 million and an increase in personnel costs of $1.4 million.

WeAmortization ~~are a leading developer and licensor~~ of ~~platform software that enables mobile information devices~~intangibles. WeAmortization ~~have~~of intangibles ~~begun~~consisting toof ~~license~~amortization ~~Palm~~related OS to ~~smartphone manufacturers and intend to continue to build on~~ our ~~leadership~~acquisitions ~~position~~was ~~and~~$0.4 ~~experience~~million in ~~PDAs~~fiscal toyear ~~become~~2003 ~~a leading licensor of platform software for smartphones~~ and ~~other next generation smart mobile products~~$0.2 ~~Our~~million ~~software~~in ~~platform~~fiscal ~~consists~~year ~~of operating system software, or Palm OS, and software development tools~~2004. WeThe ~~have~~decrease ~~also~~from ~~extended~~fiscal ~~our~~year ~~platform~~2003 ~~with~~to ~~applications~~2004 ~~such~~was ~~as personal~~due ~~information management software, web browsers and e-mail. We license Palm OS~~ to ~~leading~~amortization ~~smart~~of ~~mobile~~prior ~~information~~acquisitions ~~device~~being ~~manufacturers,~~completed during ~~including~~the ~~palmOne,~~second ~~Sony,~~quarter ~~Garmin, GSPDA, Kyocera, and Samsung. A wide range~~ of ~~smart~~fiscal ~~mobile~~year devices incorporate our solutions, including PDAs, smartphones, location-aware devices, entertainment devices, and industry-specific devices used in industries such as education, hospitality and healthcare2004.

~~Our~~Restructuring ~~52-53~~charges. ~~week~~Restructuring ~~fiscal~~charges ~~year~~principally ~~ends~~consisted onof ~~the~~workforce ~~Friday~~reductions, ~~nearest~~including toseverance, ~~May~~benefits, 31related expenses and facility closings. ~~Our~~Restructuring ~~fiscal quarters~~charges ~~end~~were on$2.2 amillion ~~Friday~~in ~~and~~fiscal ~~are~~year ~~generally~~2003 13and ~~weeks~~$0 in fiscal ~~length~~year 2004. ~~For~~The ~~presentation~~restructuring ~~purposes,~~charges wein ~~have~~fiscal ~~presented~~year ~~our~~2003 ~~fiscal~~were ~~quarters~~primarily asworkforce ~~ending~~reduction oncosts ~~August~~for 31severance, ~~November~~benefits ~~30,~~and ~~February~~related 28costs orassociated ~~February~~with 29a ~~and~~reduction ~~May~~of ~~31.~~60 ~~Unless~~regular ~~otherwise~~employees ~~stated, all years~~ and ~~dates refer~~were torecorded. ~~our~~in ~~fiscal~~accordance ~~year~~with ~~and~~SFAS ~~fiscal quarters~~No. 146

~~Our~~Separation costs. Separation costs primarily consisted of costs related to the establishment of PalmSource as a separate independent company. Separation costs were $5.0 million in fiscal year 2003 and $6.9 million in fiscal year 2004. The increase from ~~Palm~~fiscal year 2003 to 2004 was primarily due to $3.9 million in investment banking fees. The PalmSource distribution was completed in the second quarter of fiscal year 2004.

WeThe ~~were~~costs ~~incorporated~~subsequent ~~in December 2001 as a wholly-owned subsidiary of Palm~~ to ~~conduct substantially all of~~ the ~~business~~distribution ofrepresent ~~its~~adjustments ~~operating system software group. In connection with the separation of the two businesses, Palm contributed~~ to ussettle ~~substantially~~remaining ~~all~~costs ~~of the assets~~ and ~~liabilities~~ ~~comprising the Palm operating system software group, and issued to us an intercompany loan of $20.0 million, which was contributed as additional paid~~wrap-~~in-capital~~up ~~immediately prior to the distribution~~activities. ~~Since~~On ~~our~~October ~~incorporation~~28, ~~Palm also has made additional net capital contributions and transfers to us totaling $47.9 million~~2003, consisting of capital contributions and transfers of $38.1 million in fiscal year 2002 reduced by a capital distribution and transfers of $1.4 million during fiscal year 2003 and net capital contributions and transfers of $11.2 million from the beginning of fiscal year 2004 through the distribution date. In connection with Palm’s stockholders ~~capital~~approved ~~contributions and~~ the ~~distributions,~~distribution ~~we issued a $15.0 million 5% convertible subordinated note payable to Texas Instruments, due December 6, 2006. For a description~~ of ~~the~~PalmSource 5%from ~~convertible subordinated note see the sections titled “—Liquidity and Capital Resources—The Convertible Note~~Palm.” The 5% ~~convertible~~distribution ~~subordinated note~~ was ~~prepaid~~completed in ~~June~~the ~~2004~~second ~~(see~~quarter ~~Note 17~~ of ~~Notes~~fiscal toyear ~~the Combined and Consolidated Financial Statements for further discussion)~~2004.

WeInterest ~~have~~expense. ~~entered~~Interest ~~into~~expense awas ~~number of agreements that govern the separation of our business operations from Palm~~$0.5 Inmillion ~~general,~~in ~~these~~fiscal ~~agreements~~year ~~provide~~2003 ~~for the transfer from Palm to us of assets comprising our business~~ and ~~the~~$0.7 ~~assumption~~million byin usfiscal ofyear ~~liabilities relating to our business~~2004. The ~~separation~~decrease ~~agreements,~~ in ~~some~~interest ~~cases,~~expense ~~allocated~~from fiscal ~~various~~year ~~costs~~2003 ~~between~~to ~~the~~2004 ~~parties~~was ~~and~~due ~~require us~~ to ~~indemnify~~interest ~~Palm for~~on ~~certain~~the ~~liabilities Palm may incur~~$15.0 Wemillion ~~also~~5% ~~entered~~convertible ~~into~~subordinated annote ~~agreement~~issued ~~with Palm for the licensing~~ to ~~Palm~~Texas ofInstruments, ~~Palm~~partially OSoffset ~~for~~by ~~use~~the decrease in ~~the~~interest ~~manufacturing~~paid ofto Palm’s ~~mobile~~as ~~information~~a ~~devices.~~result ~~All~~ of the ~~agreements~~contribution weto ~~entered~~our ~~into~~capital ~~with~~by Palm ~~were entered into in the context~~ of ~~a parent-subsidiary relationship and were negotiated in~~ the ~~overall context of our separation from Palm~~ $20.0 Asmillion anote ~~result,~~payable ~~the terms of these agreements may be more or less favorable~~ to usPalm ~~than~~that ifbore ~~they~~interest ~~had~~at ~~been negotiated with unaffiliated third parties~~2.48%.

Interest and other income (expense), net. Other expense was $4.6 million in fiscal year 2003 and $0.3 million in fiscal year 2004. The decrease in other expense from fiscal years 2003 to 2004 was primarily due to a $3.2 million charge to write down an investment in a private equity security in fiscal year 2003, which had been carried at cost and for which we determined the decline in value of our entire investment to $0.8 million to be other than temporary. During fiscal year 2004, we determined the decline in the value of our entire investment in a private equity security to $0.3 million was other than temporary and we further wrote down the investment by $0.5 million. The increase in fiscal year 2003 was also due to $1.3 million paid to Palm for expenses relating to a $50.0 million bond posted by Palm pending resolution of the Xerox litigation. The bond was released in April 2003.

~~Our~~Income ~~operating~~tax ~~results historically have been included in Palm’s consolidated U~~provision.S. ~~income~~Income tax ~~return and~~provision ~~consolidated,~~was ~~combined~~$2.4 ormillion ~~unitary~~in ~~state~~fiscal ~~income~~year ~~returns~~2003 and $1.5 million in ~~tax~~fiscal ~~returns~~year ~~of certain foreign subsidiaries~~2004. ~~The~~We ~~income~~incurred ~~tax~~net ~~provision~~operating inlosses ~~our~~for ~~financial~~the ~~statements~~three ~~has~~fiscal ~~been~~years ~~determined~~and, onas a ~~separate-return~~result, ~~basis.~~we ~~Pursuant~~did tonot ~~our~~record ~~tax~~a ~~sharing~~benefit ~~agreement with~~for ~~Palm,~~temporary asdifferences ofand ~~the~~maintained ~~fiscal~~a ~~year~~full ~~ended~~valuation ~~2003, $65~~allowance.4 ~~million~~The ofdecrease ~~deferred~~in income tax ~~assets~~provision ~~are~~from ~~deemed~~fiscal ~~attributes~~year 2003 ofto ~~Palm.~~2004 ~~Accordingly,~~was weprimarily ~~will~~due ~~not be able~~ to ~~use~~French ~~these~~research ~~deferred~~and ~~tax~~development ~~assets~~credit toand ~~offset~~lower ~~our~~foreign ~~corresponding~~ tax ~~liabilities~~withholdings.

We have negotiated new or revised agreements with various third parties as a separate, stand-alone entity. In some instances, the terms we were able to negotiate were not as favorable as those we enjoyed as part of Palm. In addition, we benefited from various economies of scale as part of Palm, including shared administrative functions, facilities and sales and marketing organizations. We expect that our costs in some cases will increase as a result of the loss or renegotiation of these agreements, which may not be offset by cost savings in other areas. In addition, we expect that general and administrative expenses will increase in the future due to operating as a public company. In particular, as a result of the distribution as well as the public offering that was completed in April 2004 (see Note 9 of Notes to Combined and Consolidated Financial Statements for further discussion), we have a large stockholder base and expect to incur significant costs associated with routine shareholder communications, in addition to the potentially substantial legal and regulatory compliance costs associated with being a public company.

Business

Our revenues consist of license and royalty and support and service revenues. We primarily generate revenues by licensing Palm OS to mobile information device manufacturers. We also generate revenues from providing support and services to our licensees, from the Palm OS Ready program participants and from our online software store. Prior to the distribution, we presented revenues from Palm and Sony, a PalmSource stockholder, separately as related party revenues. Subsequent to the distribution, we present only revenues from Sony as related party revenues.

License and royalty revenues consist principally of revenues earned under software license agreements with manufacturers of mobile information devices. Historically, our license agreements with these manufacturers generally provided for an upfront license fee and additional royalties based on the number of units sold by the licensee incorporating Palm OS. However, we do not expect this trend of upfront payments to continue. We recognize license and royalty revenues when a signed contract exists, the software has been shipped or electronically delivered, the license fee is fixed or determinable, and collection of the resulting receivable is probable. License and royalty revenues from upfront license fees under our agreements are generally recognized over the term of the agreement. License and royalty revenues from royalty fees are generally recognized on a per-unit or net sales royalty basis based on contractually reported information from licensees. Currently, the majority of our royalty revenue stream is derived from licensees with a royalty fee that is calculated on a net sales basis. The royalty rate generally ranges from 3% to 6% of net sales based on the average selling price of the licensee’s Palm Powered product. Payments received in advance of royalties being earned are recorded as deferred revenues.

Our license agreements with licensees may contain minimum commitments. For example, under the Palm software license agreement, minimum annual license and royalty commitments consist of $40.0 million, $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring on December 3, 2002, 2003, 2004, 2005, and 2006, respectively. Prior to the Handspring merger, Handspring had minimum license and royalty commitments of $1.5 million for each of Handspring’s fiscal quarters through the term of its license agreement with us. As a result of the Handspring merger, the Handspring license agreement terminated, we are no longer entitled to the $1.5 million quarterly minimum commitments and revenues from the sale of Handspring products may be used by palmOne to satisfy its minimum commitments. Accordingly, we are losing $6.0 million in Handspring’s annual contractual minimum commitments through April 2009 and our combined revenues from

palmOne and Handspring will decline if the merger does not result in significant increased sales. We calculate minimum commitment shortfalls on a quarterly or annual basis based on the terms of the respective license agreement. Shortfalls, if any, are recorded in the period that the minimum commitment becomes due to us.

Support revenues consist primarily of fees for providing software updates and technical support for software products to our licensees and service revenues represent product development, engineering services, consulting and training for our licensees and, to a lesser extent, to third-party application developers. Support revenues are deferred and recognized ratably over the term of the agreement. Service revenues are generally billed on a time-and-materials basis, and the revenues are generally recognized as the services are performed.

Generally, our licensees experience higher seasonal demand for their products during our second and third fiscal quarters. We believe that this seasonality is primarily the result of the winter holiday season. In addition, certain licensees, including palmOne, satisfy the remaining amount of their yearly minimum commitments, if necessary, in our third fiscal quarter. Historically, these factors have resulted in a substantial increase in revenues for our third fiscal quarter as compared to other quarters in the fiscal year. Recently, we have seen the mix of the products our licensees are shipping shift towards smartphones and other products that do not have the high seasonal demand that we have experienced historically. As a consequence, we are uncertain if, in the future, the trend of higher seasonal demand during our second and third quarters will be as pronounced as it has been in the past, or whether it will be evident at all.

An important part of our strategy is to increase our international sales, particularly in the European and Asian markets. Certain countries in which we currently license or may in the future license our technology require significant withholding taxes on payments for intellectual property that we may not be able to offset against our U.S. tax obligations. In addition, international tax authorities may re-characterize some of our engineering fees as license fees, which could result in increased tax withholdings and penalties.

Current Trends Affecting Our Operating Results

Concentration of Our Customers. We currently depend on palmOne and, to a lesser extent, Sony for a large percentage of our revenues. Revenues and percentage of total revenues from palmOne, including Handspring, and Sony for the fiscal years ended May 31, 2002, 2003 and 2004 were as follows (in thousands):

	For the Year Ended May 31,
	2002				2003				2004
	Revenues		% ofTotalRevenues		Revenues		% ofTotalRevenues		Revenues		% ofTotalRevenues
Palm and palmOne	$	18,426	41.0	%	$	39,299	53.5	%	$	38,818	53.1	%
Sony	$	5,256	11.7	%	$	11,240	15.3	%	$	8,178	11.2	%
Handspring	$	9,981	22.2	%	$	6,428	8.8	%	$	3,473	4.7	%

Although we have recently added new licensees, these new licensees have yet to introduce products on the market that generate revenues for us. New licensees must develop a product and, providing the product development efforts are successful, commence commercial shipment of the product. This product development and commercial shipment process by our licensees is often six to 12 months or longer, depending upon the complexity of the product, the licensee’s experience with Palm OS, and other factors. Because of the length of time our licensees must spend to first develop, and then commence shipment of the product, the period before we receive revenue, if any, from a licensee can be lengthy.

From time to time, license agreements with our existing licensees expire without renewal, or terminate early due to financial constraints of the licensees or, in the case of Acer, due to a contractual dispute. For a description of the Acer contractual dispute, see the section titled “Business—Legal Proceedings.”

We expect that palmOne will continue to account for a substantial portion of our revenues for the foreseeable future. Our license agreement with palmOne will expire in December 2006, our license arrangement with Sony will expire in October 2012, and our license agreement with Handspring expired upon the closing of the Handspring merger. Royalties from the sale of Handspring products are now subject to the terms of our license agreement with palmOne and revenues from the sale of Handspring products may be used by palmOne to satisfy its minimum commitments. Both of these licensees can cease selling Palm Powered products at any time, which may be due to their withdrawal from the market or their use of a competing operating system such as an operating system based on Linux or as provided by Microsoft and Symbian. However, palmOne will remain subject to its minimum commitment requirements. We cannot assure you that we will be able to renegotiate these licensing agreements on favorable terms, if at all, once they expire.

Industry Dynamics. The software industry is characterized by several trends that may have a material impact on our strategic planning, results of operations and financial condition. One key trend has been the decline in spending on information technology by enterprises and consumers as a result of the weakened global economy. Simultaneously with this economic weakness, we are seeing an increasingly competitive environment among mobile information device manufacturers. Due to this increasingly competitive environment in a maturing market, certain of our licensees may reduce or cease to sell Palm Powered products. For example, in June 2004, Sony, a licensee and stockholder of ours, announced that it would discontinue the Clie® PDA product line in the U.S. and other markets outside of Japan for the rest of the year while it reassesses the market, which will affect our future revenue from Sony. As a result of a number of competitive factors, such as the timing of the release and the targeted markets of products, mobile device manufacturers are increasingly developing products at various price points. In addition, higher-end products are facing downward pricing pressures. Accordingly, some of our licensees are experiencing significant fluctuations in their average selling prices and declining volume. These pricing fluctuations and volume declines may adversely impact the royalties that we earn on licenses that are based on a percentage of Palm Powered device revenues. Currently, minimum commitments, primarily from palmOne, and to a lesser extent other licensees, may partially offset the impact of these royalty fluctuations on our operating results. We cannot assure you that we will be able to renegotiate new minimum commitments from these licensees when these contracts expire or that we will be able to sufficiently increase our revenues from other sources to offset this decline. The Handspring merger resulted in the termination of our license agreement with Handspring and the associated $1.5 million quarterly minimum commitment. Partially in response to these trends, we have undertaken a number of restructuring efforts to realign our cost structure with our business operations and may do so in the future. During the third quarter of fiscal year 2003, restructuring actions consisted of workforce reductions primarily in the United States and facilities and property and equipment disposed of or removed from service. Restructuring charges relate to the implementation of these actions to better align our expense structure with our revenues. Prior restructuring actions were taken in the second quarter of fiscal year 2002 and the fourth quarter of fiscal year 2002. Restructuring actions taken in the first quarter of fiscal year 2005 are discussed in Note 17 of Notes to Combined Consolidated Financial Statements.

Historically, we have generated revenues from a mix of upfront license fees and per unit royalties. We have generally recognized upfront license fees from subscription license agreements over the term of such agreements, which has provided us with more visibility about our revenue streams than royalty-based revenues, and has provided us with accelerated cash flows. Recently, we have witnessed a trend in the software industry away from the payment of upfront license fees in favor of royalty fees based upon products sold. We expect to experience a significant decline in our upfront license fees and, as a result, we expect our deferred revenues to decline over time.

As the market for PDAs matures, as seen by recent declines in unit sales, we expect that our future revenue growth will come from other mobile information devices, in particular smartphones that incorporate Palm OS. We believe the market for other mobile information devices is in its early stages, and the growth potential of these markets may not be realized. Additionally, we face heavy competition from Symbian and Microsoft, and anticipate further competition from other competing software platform providers, such as Linux. The smartphone market itself has a limited number of device manufacturers, and we may not be successful in engaging many of them as licensees. We may need to enter into collaborative relationships or acquire additional technology or

businesses to successfully compete in this market. If we are unsuccessful in penetrating the markets for smartphones and other new next generation smart mobile products or if such markets do not develop as anticipated, our revenues will suffer. To compete in these new markets and to continue to expand our product offerings into new markets and industries, we expect to enhance Palm OS by incorporating additional technologies licensed from third-party vendors. We will need to negotiate favorable terms on these third-party royalty contracts, or our cost of license revenues and our gross margins could decrease.

Acquisitions and Dispositions

On August 29, 2003, we consummated transactions with PalmGear related to a stock purchase agreement, strategic alliance and service provider agreement and a brand license agreement between the parties. There was no related party interest between either Palm or us, and PalmGear. In connection with the closing of the transaction, we sold to PalmGear all of the stock of Palm Digital Media, a wholly-owned subsidiary of ours whose assets comprised the Palm Digital Media product line. In addition, as part of the strategic alliance, PalmGear agreed to develop and support an online store, at our U.S. website, for Palm OS applications. Additionally, we provided PalmGear rights to a customer database. The initial term of the strategic alliance is three years. The transaction was for a total of $4.0 million, comprised of an initial payment from PalmGear to us of $3.7 million and a maximum contingent payment to us of $0.3 million. The contingent payment was subject to Palm Digital Media meeting certain financial targets for the five-month period ending January 31, 2004. The contingent payment has been settled for $0.2 million, resulting in total proceeds to us from the transaction of $3.9 million.

Non-Cash Compensation Charge

On August 1, 2003, in connection with the option exchange program approved by our board of directors on June 30, 2003, certain of our executives returned for cancellation 1,042,000 stock options to purchase our common stock. On August 4, 2003, in exchange for these cancelled options, these executive officers received 689,490 restricted shares of our common stock, subject to a repurchase right in our favor, at a per share price equal to $0.001, which lapses over two years from that date. On August 4, 2003, we also made grants of restricted stock to certain of our executive officers outside of the option exchange program in an aggregate amount of 243,475 shares, consisting of waiver grants of 170,300 shares and stock bonus grants of 73,175 shares at a price per share equal to the par value of our common stock, subject to a repurchase right in our favor, which lapses over two years from that date. Further, on November 7, 2003, we granted 30,572 shares of restricted stock to employees with a purchase price equal to the par value of a share of our common stock, subject to a repurchase right in our favor, which lapses over two years from that date. Together, the granting of such restricted stock at prices below the assumed fair market values of our common stock will result in a non-cash compensation charge of approximately $15.1 million. Amortization under the accelerated method over the period during which the repurchase rights lapse will result in stock-based compensation charges of approximately $5.2 million and $0.7 million in fiscal years 2005, and 2006, respectively. Any repurchases of these shares of unvested restricted stock would result in a reversal of a portion of this charge.

Option Exchange Program

On April 1, 2004, we offered eligible employees the right to exchange all vested and unvested options with exercise prices equal to or greater than $30.00 per share that were granted on or after November 7, 2003. The decline in the market value of our common stock since October 2003 has resulted in a stock price that is substantially below the strike price of many employee stock options granted since then. This voluntary exchange program was designed to retain our employees and provide them with a long-term incentive to maximize stockholder value. The offer ended on April 29, 2004. Options to purchase 956,040 shares of common stock were tendered for exchange, representing 86.5% of the options that were eligible to be tendered in the offer. Subject to the terms and conditions of the offer to exchange, we will issue new options to purchase 956,040 shares of our common stock in exchange for the options surrendered in the offer no sooner than November 1, 2004. The

exercise price of the new options will be equal to the last reported sale price per share of our common stock on the new option grant date as reported on the Nasdaq National Market during regular trading hours. All new options will vest in three equal amounts with the first vesting twenty-four weeks, the second vesting forty-eight weeks, and the third vesting seventy-two weeks after the new option grant date. The option exchange program has been structured to comply with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, and is not expected to result in any additional compensation charges or variable plan accounting. Our executives were not eligible to participate in the exchange program.

Basis of Presentation

We have historically operated as an integrated component of Palm’s business. For periods prior to our separation from Palm, our combined financial statements have been derived from the consolidated financial statements and accounting records of Palm using the historical results of operations and historical bases of the assets and liabilities of Palm and presented on a retroactive basis as if the separation had been in effect for all periods presented. Revenues from Palm have been presented based on the terms of the software license agreement effective on December 3, 2001. Our combined and consolidated statements of operations do not show what our revenues would have been had the software license agreement with Palm been in effect for periods prior to December 3, 2001 for sales by Palm of Palm Powered devices and for support and services provided by the PalmSource business group within Palm. Cost of sales has been derived based on the activities and functions in place at that time using the historical results of operations for all periods presented. The combined and consolidated financial statements include allocations to us of certain shared expenses, including centralized legal, finance and accounting, human resources, insurance, executive management, treasury, real estate, information technology, sales and marketing and engineering, and other Palm corporate services and infrastructure costs. The expense allocations have been determined on bases that Palm and we considered to be a reasonable reflection of the use of the services provided to us or the benefit received by us. These allocations and charges are calculated on a percentage of total corporate costs for the services provided, based on factors such as headcount, revenues, or the specific level of activity directly related to these costs. Our reliance on Palm for these services has gradually declined since our separation from Palm in December 2001 as we have established our own independent systems and infrastructure for administration, management and other services.

The financial information presented in this report is not necessarily indicative of our financial position, results of operations or cash flows in the future, nor is it necessarily indicative of what our financial position, results of operations or cash flows would have been had we been a separate, stand-alone entity for the periods presented.

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 PalmSource’s combined and consolidated financial statements and the accompanying notes. The amounts of assets and liabilities reported on 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 revenue recognition, allocations from Palm, goodwill impairment, loss contingencies, restructuring, and income taxes. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the combined and consolidated financial statements.

Revenue Recognition. The accounting related to revenue recognition in the software industry is complex and affected by interpretations of the rules and an understanding of industry practices, both of which are subject to change. Consequently, the revenue recognition accounting rules require management to make significant judgments. We recognize revenues based on the detailed guidelines discussed in Note 2 of Notes to Combined and Consolidated Financial Statements.

Many of our license contracts contain multiple elements including support. We have determined the fair value of our bundled support arrangements based on the price charged when the element is sold separately by us or the contractually stated renewal rate. Accordingly, when contracts contain multiple elements wherein vendor specific objective evidence of fair value exists for all undelivered elements and for which fair value has not been established for delivered elements, we recognize revenues on the delivered element using the “Residual Method” as defined by the American Institute of Certified Public Accountants Statement of Position No. 98-9. When arrangements include bundled professional services and the pattern of performance over the term of the agreement is not discernable or if an arrangement includes ongoing support for which vendor specific objective evidence of fair value does not exist, the entire fee is recognized ratably over the term of the arrangement.

Allocations from Palm. Significant assumptions and estimates have been used in the determination of cost allocations from Palm included in our combined and consolidated financial statements and the preparation of our historical financial information prior to our separation from Palm. These allocations and charges are calculated on a percentage of total corporate costs for the services provided, based on factors such as headcount, revenues, or the specific level of activity directly related to such costs. Accordingly, our combined and consolidated financial statements may not be representative of future performance or what they would have been had we operated as a separate stand-alone entity during the periods presented.

Goodwill Impairment. We perform an evaluation of the carrying value of goodwill on an annual basis or whenever an event or change in circumstances occurs which would indicate potential impairment. In response to changes in industry and market conditions, we may strategically realign our resources in a manner that could result in an impairment of goodwill. We cannot assure you that future impairment tests will not result in a charge to earnings.

Loss Contingencies. We are subject to various loss contingencies arising in the ordinary course of business including patent infringement claims and other litigation. We accrue for estimated loss contingencies, when a loss is probable and can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted.

Restructuring. Effective for calendar year 2003, in accordance with Statement of Financial Accounting Standards, or SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supersedes Emerging Issues Task Force Issue 94-3, or EITF Issue No. 94-3, Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), we record liabilities for costs associated with exit or disposal activities when the liability is incurred instead of at the date of commitment to an exit or disposal activity. Prior to calendar year 2003, in accordance with EITF Issue No. 94-3, we accrued for restructuring costs on commitment to a firm exit plan that specifically identified all significant actions to be taken. We reassess restructuring accruals on a quarterly basis to reflect changes in the costs of the restructuring activities and we record new restructuring accruals as liabilities are incurred.

Income Taxes. Our income tax provision has been determined on a separate return basis as if we had operated as a stand-alone entity. Our operating results were historically included in the tax returns of Palm and certain foreign subsidiaries. We have estimated our income taxes that would have related to our business in each of the jurisdictions in which we operate as if we had historically operated on a stand-alone basis. We have established a valuation allowance against our deferred tax assets for all periods presented based on our estimates of future taxable income.

Results of Operations

Comparison of Fiscal Years Ended May 31, 2002, 2003 and 2004

The results of operations table presents operating data as a percentage of total revenues for the periods indicated:

	Years Ended May 31,
	2002		2003		2004
Revenues:
Related party license and royalty	50.5	%	66.9	%	34.1	%
Third-party license and royalty	43.3		25.0		58.2
Total license and royalty	93.8		91.9		92.3
Related party support and service	2.2		2.0		0.8
Third-party support and service	4.0		6.1		6.9
Total support and service	6.2		8.1		7.7
Total revenues	100.0		100.0		100.0
Cost of revenues:
License and royalty	18.9		10.2		5.5
Support and service	4.7		3.7		2.9
Total cost of revenues	23.6		13.9		8.4
Gross margin	76.4		86.1		91.6
Operating expenses:
Research and development	110.3		54.2		46.4
Sales and marketing	43.0		23.4		26.5
General and administrative	28.4		17.4		26.6
Amortization of intangibles	0.7		0.6		0.2
Restructuring charges	4.4		3.0		0.0
Separation costs	1.2		6.8		9.4
Total operating expenses	188.0		105.4		109.1
Loss from operations	(111.6	)	(19.3	)	(17.5	)
Interest expense	(0.6	)	(0.7	)	(0.9	)
Interest and other income (expense), net	(0.9	)	(6.3	)	(0.4	)
Loss before income taxes	(113.1	)	(26.3	)	(18.8	)
Income tax provision	0.9		3.3		2.1
Net loss	(114.0	)%	(29.6	)%	(20.9	)%

Related party license and royalty revenues. Related party license and royalty revenues were $22.7 million in fiscal year 2002, $49.0 million in fiscal year 2003 and $24.9 million in fiscal year 2004, representing an increase of 116% from fiscal year 2002 to 2003 and a decrease of 49% from fiscal year 2003 to 2004. Prior to the distribution, we recognized revenues from Palm as related party revenues, and subsequent to the distribution, we recognized revenues from palmOne as third party revenues. License and royalty revenues from Palm, consisting primarily of royalty fees received from shipment of PDAs were $17.6 million, $38.1 million and $17.1 million in fiscal year 2002, 2003, and 2004, respectively. License and royalty revenues from Sony were $5.1 million, $10.9 million and $7.8 million in fiscal years 2002, 2003, and 2004, respectively. The increase in license and royalty revenues from fiscal year 2002 to 2003 was due to five months of Palm revenues being recorded in fiscal year 2002 subsequent to December 3, 2001, the effective date of the software license agreement, compared to a full year of Palm revenues being recorded in fiscal year 2003. In fiscal year 2003, we received a payment of $3.6 million from Palm as a result of Palm’s shortfall under its minimum annual commitment for the annual

contractual period ending December 3, 2002. The decrease in license and royalty revenues from fiscal year 2003 to 2004 was due to six months of Palm revenues recorded in fiscal year 2004 as a result of the distribution compared to a full year of Palm revenues recorded in fiscal year 2003. We recognize royalty revenues from Palm in the period royalty information is reported to us, generally one month subsequent to the ship date.

Our business principally supported the operating system for Palm Powered devices prior to December 3, 2001, which is the effective date of the software license agreement with Palm. No revenues from Palm prior to the effective date of the software license agreement have been imputed. For fiscal years 2002, 2003 and 2004, we believe the handheld market experienced an overall decline caused by reduced growth in the handheld industry. For example, handheld device shipments for Palm OS were 7.2 million units in calendar year 2001, 7.1 million units in calendar year 2002 and 5.5 million units in calendar year 2003 based on data by IDC. If the software license agreement with Palm had been in place prior to December 3, 2001, our revenues would have shown a corresponding decline reflective of the market conditions and our reliance on revenues from Palm.

Third-party license and royalty revenues. Third-party license and royalty revenues were $19.5 million in fiscal year 2002, $18.4 million in fiscal year 2003, and $42.6 million in fiscal year 2004, representing a decrease of 6% from fiscal year 2002 to 2003 and an increase of 132% from fiscal year 2003 to 2004. License and royalty revenues from palmOne were $21.0 million in fiscal year 2004. Prior to the distribution, Palm revenues were recognized as related party revenues. License and royalty revenues from Handspring were $9.8 million in fiscal year 2002, $6.2 million in fiscal year 2003 and $3.4 million in fiscal year 2004. The decreases in license and royalty revenues from fiscal year 2002 to 2003 were principally due to lower royalties received from Handspring, offset by increased license fees from new license agreements. The increase in third party license and royalty revenues from fiscal year 2003 to 2004 were principally due to palmOne revenues being recognized as third party revenues subsequent to the distribution. The decrease in Handspring license and royalty revenues from fiscal year 2003 to 2004 was due to the Handspring merger on October 28, 2003. Prior to the merger, Handspring had minimum license and royalty commitments of $1.5 million for each of Handspring’s fiscal quarters through the term of its license agreement with us. The Handspring license agreement terminated as a result of the merger and we are no longer entitled to the $1.5 million quarterly minimum commitment through April 2009, and revenues from the sale of Handspring products may be used by palmOne to satisfy its minimum commitments. Accordingly, our combined revenues from palmOne and Handspring will decline if the merger does not result in significant increased sales.

The combined license and royalty revenues from Palm and Handspring were $44.3 million for fiscal year 2003 compared to the combined license and royalty revenues from palmOne/Palm and Handspring of $41.5 million for fiscal year 2004. The decrease from fiscal year 2003 to 2004 was primarily due to $4.4 million in top-up payments received during fiscal year 2003, as Palm and Handspring did not meet their annual or quarterly royalty commitments. However, top-up payments from Handspring were $2.4 million during fiscal year 2004, due to lower minimum requirements.

Related party support and service revenues. Related party support and service revenues were $1.0 million in fiscal year 2002, $1.5 million in fiscal year 2003 and $0.6 million in fiscal year 2004, representing an increase of 48% from fiscal year 2002 to 2003 and a decrease of 59% from fiscal year 2003 to 2004. Support and service revenues from Palm were $0.8 million in fiscal year 2002, $1.2 million in fiscal year 2003 and $0.2 million in fiscal year 2004. Support and service revenues from Sony were $0.2 million in fiscal year 2002, $0.3 million in fiscal year 2003 and $0.4 million in fiscal year 2004. The increases from fiscal year 2002 to 2003 were primarily due to no Palm revenues being reported prior to December 3, 2001, the effective date of the software license agreement, compared to six months of Palm revenues reported in fiscal year 2002. In addition, the increase was also due to the establishment of the professional services business during the fourth quarter of fiscal year 2002. The decrease from fiscal year 2003 to 2004 was primarily due to recognizing palmOne revenues as third party revenues subsequent to the distribution. In addition, professional services revenues from Palm decreased by $0.6 million from fiscal year 2003 to 2004.

Third-party support and service revenues. Third-party support and service revenues were $1.8 million in fiscal year 2002, $4.5 million in fiscal year 2003 and $5.0 million in fiscal year 2004, representing an increase of 152% from fiscal year 2002 to 2003 and 12% from fiscal year 2003 to 2004. The increase from fiscal year 2002 to 2003 was due to the increase in the number of new and existing licensees with maintenance and support agreements and the establishment of the professional services business during the fourth quarter of fiscal year 2002. The increase from fiscal year 2003 to 2004 was due to palmOne support and service revenues classified as third party revenues subsequent to the distribution and increase in professional services revenue.

Cost of license and royalty revenues. Cost of license and royalty revenues principally represents royalty payments to third-party technology vendors, payments to publishers for eBook content and amortization of purchased intangible assets. Cost of license and royalty revenues was $8.5 million in fiscal year 2002, $7.5 million in fiscal year 2003 and $4.0, representing 18.9%, 10.2% and 5.5% of total revenues, respectively. The decreases in cost of license and royalty revenues from fiscal year 2002 to 2003 and from fiscal year 2003 to 2004 in absolute dollars and as a percentage of total revenues were primarily due to a reduction of approximately $1.1 million and $4.0 million, respectively, in amortization of purchased intangibles as certain intangible assets became fully amortized, which was partially offset by the increase in royalty payments to new and existing third-party technology vendors. The decrease from fiscal year 2003 to 2004 was also attributed to a $1.1 million decrease in costs associated with Palm Digital Media, as the product line was sold in August 2003.

Cost of support and service revenues. Cost of support consists of costs to provide software updates and technical support for software products, and cost of service represents costs to provide product development, engineering services, consulting and training. The cost of service revenues varies by project, but is generally comparable for both third-party and related party service revenues. Cost of support and service revenues was $2.1 million in fiscal year 2002, $2.7 million in fiscal year 2003 and $2.1 million, representing 4.7%, 3.7% and 2.9% of total revenues, respectively. The increase in cost of support and service revenues in absolute dollars from fiscal year 2002 to 2003 was primarily due to approximately $0.6 million in costs associated with the growth of our professional services business. The decrease as a percentage of total revenues from fiscal year 2002 to 2003 was due to the increase in total revenues in fiscal year 2003. The decreases in cost of support and service revenues in absolute dollars and a percentage of total revenues were primarily due to the decrease in professional services cost as a result of decrease in professional services revenues.

Research and development expenses. Research and development expenses consist primarily of personnel and related costs to support our product development and related information technology and facilities costs. Research and development expenses were $49.6 million in fiscal year 2002, $39.8 million in fiscal year 2003 and $33.9 million in fiscal year 2004, representing a decrease of 20% from fiscal year 2002 to 2003 and a decrease of 15% from fiscal year 2003 to 2004. Research and development expenses as a percentage of total revenues were 110.3% in fiscal year 2002, 54.2% in fiscal year 2003 and 46.4% in fiscal year 2004. The decrease in research and development expenses in absolute dollars for all years was primarily due to restructuring efforts effected to realign our resources with our business plan. The decrease in salary related and consulting expense from fiscal year 2002 to 2003 and from fiscal year 2003 to 2004 was $4.7 million for both years. The decrease in research and development expenses as a percentage of total revenues from fiscal year 2002 to 2003 was due to the approximately $9.8 million decline in research and development expenses and the increase in total revenues in fiscal year 2003, and the decrease from fiscal year 2003 to 2004 was due to approximately $5.9 million decline in research and development expenses. Our research and development expenses are primarily fixed employee costs. These costs are monitored and reviewed by management, and we expect to respond according to market conditions and economic trends.

Sales and marketing expenses. Sales and marketing expenses consist primarily of personnel and related costs of our direct sales force and marketing staff and the cost of marketing programs, including advertising, trade shows, PalmSource developer conferences, promotional materials, customer conferences and related information technology and facilities costs. Sales and marketing expenses were $19.3 million in fiscal year 2002, $17.2 million in fiscal year 2003 and $19.4 million in fiscal year 2004, representing a decrease of 11% from

fiscal year 2002 to 2003 and an increase of 13% from fiscal year 2003 to 2004. Sales and marketing expenses as a percentage of total revenues were 43.0% in fiscal year 2002, 23.4% in fiscal year 2003 and 26.5% in fiscal year 2004. The decreases in absolute dollars and as a percentage of total revenues from fiscal year 2002 to 2003 were due to lower expenses incurred in connection with the PalmSource developer conference. The cost of the PalmSource developer conference decreased approximately $2.7 million, from fiscal year 2002 to 2003, due to a shift in format from a large global conference to lower cost regional conferences. The increases in absolute dollars and as a percentage of total revenues from fiscal year 2003 to 2004 were primarily due to an increase in stock-based compensation expense of $1.7 million and an increase in personnel costs of $0.9 million. We expect sales and marketing expenses to fluctuate in response to market conditions, geographic expansion, economic trends and the cost and timing of future PalmSource developer conferences.

General and administrative expenses. General and administrative expenses consist primarily of personnel and related costs for general corporate functions, including executive, legal, finance, accounting, human resources and related information technology and facilities costs. General and administrative expenses were $12.8 million in both fiscal years 2002 and 2003 and $19.4 million in fiscal year 2004, representing no change from fiscal year 2002 to 2003 and a 52% increase from fiscal year 2003 to 2004. General and administrative expenses as a percentage of total revenues were 28.4% in fiscal year 2002, 17.4% in fiscal year 2003 and 26.6% in fiscal year 2004. The decrease in general and administrative expenses as a percentage of total revenues from fiscal year 2002 to 2003 was primarily due to an increase in total revenues in fiscal year 2003. The increases in absolute dollars and as a percentage of total revenues from fiscal year 2003 to 2004 were primarily due to an increase in stock-based compensation expense of $5.8 million and an increase in personnel costs of $1.4 million. We expect general and administrative expenses to decrease as stock-based compensation expense in connection with the issuance of our restricted stock on August 4, 2003 decreases based on the accelerated amortization schedule calculated under the multiple option approach. See the section titled “—Non-cash Compensation Charge.”

Amortization of intangibles. Amortization of intangibles consisting of amortization related to our acquisitions was $0.3 million in fiscal year 2002, $0.4 million in fiscal year 2003 and $0.2 million in fiscal year 2004. The increase in amortization of intangibles from fiscal year 2002 to 2003 was primarily due to a full year’s amortization cost in fiscal year 2003 related to our acquisition of Be, Inc. in November 2001. The decrease from fiscal year 2003 to 2004 was due to amortization of prior acquisitions being completed during the second quarter of fiscal year 2004.

Restructuring charges. Restructuring charges principally consisted of workforce reductions, including severance, benefits, related expenses and facility closings. Restructuring charges were $2.0 million in fiscal year 2002, $2.2 million in fiscal year 2003 and none in fiscal year 2004. The restructuring charges in fiscal year 2002 consisted of an estimated loss on lease commitments for excess facilities, as well as workforce reduction costs primarily related to severance, benefits and related costs. The restructuring actions initiated in fiscal year 2002 have been completed. The restructuring charges in fiscal year 2003 were primarily workforce reduction costs for severance, benefits and related costs associated with a reduction of 60 regular employees. In accordance with SFAS No. 146, 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. The restructuring actions initiated in fiscal year 2003 were completed in the second quarter of fiscal year 2004. We will continue to realign resources as necessary to balance the size of our employee base with our current and anticipated revenue base. We incurred additional restructuring charges in the first quarter of fiscal year 2005. See Note 17 of Notes to Combined Consolidated Financial Statements.

Separation costs. Separation costs primarily consisted of costs related to the establishment of PalmSource as a separate independent company. Separation costs were $0.5 million in fiscal year 2002, $5.0 million in fiscal year 2003, and $6.9 million in fiscal year 2004. The increase from fiscal year 2002 to 2003 was primarily due to increase in professional fees, and the increase from fiscal year 2003 to 2004 was primarily due to $3.9 million in investment banking fees. The PalmSource distribution was completed in the second quarter of fiscal year 2004.

The costs subsequent to the distribution represent adjustments to settle remaining costs and wrap-up activities. On October 28, 2003, Palm’s stockholders approved the distribution of PalmSource from Palm. As the distribution was completed in the second quarter of fiscal year 2004, we do not expect to incur substantial separation costs in future periods.

Interest expense. Interest expense was $0.3 million in fiscal year 2002, $0.5 million in fiscal year 2003 and $0.7 million in fiscal year 2004. The increase in interest expense from fiscal year 2002 to 2003 was due to interest on our $20.0 million 2.48% note payable to Palm. Interest expense increased after the distribution date due to interest on the $15.0 million 5% convertible subordinated note issued to Texas Instruments, partially offset by the decrease in interest paid to Palm as a result of the contribution to our capital by Palm of the $20.0 million note payable to Palm that bore interest at 2.48%. We expect interest expense to decrease as the $15.0 million 5% convertible subordinated note payable to Texas Instruments was repaid in June 2004 (see Note 17 of Notes to Combined and Consolidated Financial Statements).

Interest and other income (expense), net. Other expense was $0.4 million in fiscal year 2002, $4.6 million in fiscal year 2003 and $0.3 million in fiscal year 2004. The increase in other expense from fiscal years 2002 to 2003 was primarily due to a $3.2 million charge to write down an investment in a private equity security, which had been carried at cost and for which we determined the decline in value of our entire investment to $0.8 million to be other than temporary. During fiscal year 2004, we determined the decline in the value of our entire investment in a private equity security to $0.3 million was other than temporary and we further wrote down the investment by $0.5 million. The increase in fiscal year 2003 was also due to $1.3 million paid to Palm for expenses relating to a $50.0 million bond posted by Palm pending resolution of the Xerox litigation. The bond was released in April 2003.

Income tax provision. Income tax provision was $0.4 million in fiscal year 2002, $2.4 million in fiscal year 2003 and $1.5 million in fiscal year 2004. We incurred net operating losses for the three fiscal years and, as a result, we did not record a benefit for temporary differences and maintained a full valuation allowance. The increase in income tax provision from fiscal year 2002 to 2003 was primarily due to $2.0 million of foreign withholding taxes for which no credit is currently available against U.S. taxes due to our net loss position. The decrease in income tax provision from fiscal year 2003 to 2004 was primarily due to French research and development credit and lower foreign tax withholdings.

Liquidity and Capital Resources

Cash Flows

AtIn ~~May~~the ~~31,~~third ~~2004,~~quarter wefiscal ~~had cash and~~2005, ~~cash~~the ~~equivalents~~Company ofhad ~~$45.1~~determined ~~million,~~that ~~representing~~it ~~an increase of $7.7 million from May 31, 2003. Net cash used for operating activities~~ was ~~$45.4~~appropriate ~~million~~to inclassify ~~fiscal~~its ~~year~~investment ~~2002, $8.9 million~~ in ~~fiscal~~auction-rate ~~year~~securities ~~2003~~as ~~and~~short-term ~~$14~~investments.5 ~~million~~These ininvestments ~~fiscal~~were ~~year~~included ~~2004, resulting primarily from our net losses. The increase~~ in cash ~~used~~and incash ~~operating~~equivalents ~~activities for fiscal year 2004 compared to fiscal year 2003 was also due to a decrease~~ in ~~deferred~~previous ~~revenues~~10-K asfiling aand ~~result~~S-1 offor ~~higher~~periods ~~amortization~~ending ~~of deferred revenues than~~May ~~prepayment of revenues~~31, ~~offset~~2003 byand ~~a transaction with PalmGear during the first quarter of fiscal year~~ 2004 in($24 ~~which~~million weand ~~received net proceeds of~~ $~~3.5~~ 18 million. ~~Our~~at ~~arrangement~~May ~~with~~31, ~~PalmGear~~2003 ~~was~~and ~~classified~~2004, ~~as deferred revenues~~respectively), ~~which~~and issuch toamounts ~~be recognized ratably over the three-year term of the arrangement. Our net cash flows from operating activities~~ have ~~fluctuated~~been ~~significantly~~reclassified ~~between~~to ~~periods,~~conform ~~partially due~~ to the ~~timing~~current ~~and~~period ~~amount~~classification. of(See ~~upfront~~Note ~~license~~2 ~~fees~~of ~~and~~ the ~~timing~~Notes ~~of shortfall payments on minimums. If we are unable~~ to ~~obtain~~Consolidated ~~significant~~Financial ~~upfront fees or otherwise increase our revenues faster than our expenses, we may be unable to generate positive cash flows from operations in the future~~Statements).

At May 31, 2005, we had cash and cash equivalents of $22.2 million, representing a decrease of $4.9 million from May 31, 2004. Net cash used infor ~~investing~~operating activities was $28.69 million in fiscal year ~~2002~~2003, $314.45 million in fiscal year ~~2003,~~2004 and $423.28 million in fiscal year ~~2004~~2005, resulting primarily from our net losses. WeThe ~~have~~decrease ~~historically~~in net cash used in fiscal year 2005 compared to fiscal year 2004 is due to a slightly lower net loss and an increase in liabilities. The increase in cash used in operating activities for ~~acquisitions~~fiscal year 2004 compared to fiscal year 2003 was also due to a decrease in deferred revenues as a result of ~~businesses~~higher ~~with~~amortization ~~complementary~~of ~~technologies~~deferred ~~and~~revenues ~~for~~than prepayment of revenues, offset by a transaction with PalmGear during the ~~purchase~~first quarter of ~~property,~~fiscal ~~plant~~year ~~and~~2004 ~~equipment~~in which we received net proceeds of $3.5 ~~During~~million. Our net cash flows from operating activities have fluctuated significantly between periods, partially due to the ~~first~~timing ~~half~~and amount of upfront license fees and the timing of shortfall payments on minimums. If we are unable ~~fiscal~~to obtain significant upfront fees or otherwise increase our revenues faster than our expenses, we may be unable to generate positive cash flows from operations in the future. We believe that our current cash and cash equivalents, together with cash expected to be generated from operations will be sufficient to satisfy our working capital, capital expenditures and operating expense requirements for the next 12 months.

39Net cash used in investing activities was $27.4 million in fiscal year 2003, and $36.4 million in fiscal year 2004. Net cash provided by investing activities was $11.7 million in fiscal year 2005. We have historically used cash for acquisitions of businesses with complementary technologies and for the purchase of property, plant and equipment. The net cash provided by investing activities in fiscal year 2005 was primarily due to the payment received of approximately $7.5 million associated with the sale of our interest in the Palm trademark (See note 14 of Notes to Consolidated Financial Statements for further discussion) and $10.4 million net sales on investments offset by an increase in property and equipment due to tenant improvements and information technology infrastructure cost to relocate to our Sunnyvale facility in February 2005. The increase in fiscal year 2004 was due to purchase of investments using proceeds from our public offering that was completed in April 2004. See Note 9 of Notes to Consolidated Financial Statements for further discussion. We anticipate capital expenditures for property, plant and equipment to decrease in fiscal year 2006. We may use cash resources to pursue strategic acquisitions or investments in other companies that provide products and services that are complementary to ours.

Net cash provided by financing activities was $19.1 million in fiscal year 2003, and $64.6 million in fiscal year 2004. Net cash used in financing activities was $12.7 million for fiscal year 2005. Since the separation of the Palm and PalmSource businesses, Palm has made net capital contributions and transfers to us of $1.4 million in fiscal year 2003 and net capital contributions and transfers of $11.2 million from the beginning of fiscal year 2004 through the distribution date, October 28, 2003, which was net of the $15.0 million 5% convertible subordinated note due 2006 to Texas Instruments. The note was convertible into our common stock. Since the distribution, palmOne is no longer providing funds to finance our working capital or other cash requirements. In

~~year~~June ~~2002~~2004, ~~the~~we ~~increase~~prepaid inthe ~~property~~$15.0 ~~and~~million ~~equipment~~convertible ~~was~~subordinated ~~primarily~~note. ~~due~~See toNote ~~tenant~~6 ~~improvements~~of ~~and~~Notes ~~information~~to ~~technology~~Consolidated ~~infrastructure~~Financial ~~cost~~Statements tofor ~~relocate~~further todiscussion. ~~our~~In ~~Sunnyvale~~October ~~facility.~~2002, ~~The~~we ~~increase~~received inan ~~fiscal~~investment ~~year~~of ~~2004~~$20.0 ~~was~~million ~~due~~from toSony ~~purchase~~Corporation offor ~~investments~~3,333,333 ~~using~~shares ~~proceeds~~of ~~from~~ our ~~public~~Series ~~offering~~A ~~that~~preferred ~~was~~stock ~~completed~~at ina ~~April~~purchase ~~2004.~~price ~~See Note 9~~ of ~~Notes~~$6.00 toper ~~Combined~~share, ~~and~~which ~~Consolidated~~automatically ~~Financial~~converted ~~Statements~~into ~~for~~666,666 ~~further discussion.~~shares Weof ~~anticipate~~our ~~capital~~common ~~expenditures~~stock ~~for~~at ~~property,~~the time ~~plant~~of ~~and~~the ~~equipment to be approximately $2~~distribution.4 ~~million~~In inApril ~~fiscal~~2004, ~~year~~we ~~2005.~~sold We3,450,000 ~~may~~shares ~~use~~of ~~cash~~common ~~resources~~stock toat ~~pursue~~a ~~strategic~~public ~~acquisitions~~offering orfor ~~investments~~net inproceeds ~~other~~of ~~companies~~approximately ~~that~~$58.7 ~~provide~~million. ~~products and~~See ~~services~~Note ~~that~~9 ~~are~~of ~~complementary~~Notes to ~~ours~~Consolidated Financial Statements.

Net cash provided by financing activities was $78.3 million in fiscal year 2002, $19.1 million in fiscal year 2003, and $64.3 million for fiscal year 2004. Historically, Palm has been our principal source of cash from financing activities. Since the separation of the Palm and PalmSource businesses, Palm has made net capital contributions and transfers to us of $47.9 million, consisting of capital contributions and transfers of $38.1 million in fiscal year 2002 reduced by a capital distribution and transfers of $1.4 million during fiscal year 2003 and net capital contributions and transfers of $11.2 million from the beginning of fiscal year 2004 through the distribution date, October 28, 2003, which is net of the $15.0 million 5% convertible subordinated note due 2006 to Texas Instruments. The note is convertible into our common stock. See the section titled “—The Convertible Note” below for a more detailed description of the note. Since the distribution, palmOne is no longer providing funds to finance our working capital or other cash requirements. In June 2004, we prepaid the $15.0 million convertible subordinated note. See Note 17 of Notes to Combined and Consolidated Financial Statements for further discussion. In October 2002, we received an investment of $20.0 million from Sony Corporation for 3,333,333 shares of our Series A preferred stock at a purchase price of $6.00 per share, which automatically converted into 666,666 shares of our common stock at the time of the distribution. In April 2004, we sold 3,450,000 shares of common stock at a public offering for net proceeds of approximately $58.7 million. See Note 9 of Notes to Combined and Consolidated Financial Statements.

Short-Term and Long-Term Investments

At May 31, ~~2004~~2005, we had $2535.1 million of short-term and $1614.74 million of long-term investments in high quality financial government, and corporate securities, compared to ~~none~~$43.1 atmillion ~~May~~of ~~31,~~short-term ~~2003~~and $16.7 ~~The~~million ~~increase~~of ~~was~~long-term ~~due~~investments toin ~~the~~high ~~investment~~quality offinancial ~~the~~government, ~~proceeds~~and ~~from~~corporate ~~our~~securities ~~public~~at ~~offering~~May ~~completed~~31, ~~in April~~ 2004. Our investments are subject to interest rate risk and will fall in value if market interest rates increase substantially.

Line of Credit

We currently have no debt. In October 2003, we entered into an agreement with Silicon Valley Bank for a $15.0 million revolving line of credit, but never made any borrowings under the line of credit. In May 2004, we terminated the revolving line of credit agreement.

Our liquidity is affected by many factors, some of which are based on normal ongoing operations of our business and some of which arise from uncertainties related to global economies. We believe that our current cash and cash equivalents, together with cash expected to be generated from operations, will be sufficient to satisfy our working capital, capital expenditures and operating expense requirements for the next 12 months. However, we may require or choose to obtain additional debt or equity financing in the future. We cannot assure you that financing, if needed, will be available on favorable terms, if at all. Any equity financing will dilute the ownership interests of our stockholders, and any debt financing may contain restrictive covenants.

The Convertible Note

In December 2001, Palm issued a $50.0 million 5% convertible subordinated note due 2006, or the original Palm note, to Texas Instruments. The original Palm note had a conversion price of $92.6316 per Palm share or a conversion rate of 10.79545 Palm shares per $1,000 of principal amount (in each case, after giving effect to Palm’s one-for-twenty reverse stock split, which was effective October 15, 2002).

In connection with the distribution, Palm and Texas Instruments agreed that the original Palm note would be divided into and replaced by two notes: one issued by Palm, or the new Palm note, and one issued by us, or the PalmSource note. Immediately following the distribution, the new Palm note was issued in the principal amount of $35.0 million and the PalmSource note was issued in the principal amount of $15.0 million. In June 2004, in exchange for a 12.5% discount, we prepaid the $15.0 million convertible subordinated note due to Texas Instruments and the PalmSource note was eliminated. The note had an interest rate of 5% payable semi-annually, and the $15.0 million principal was scheduled to be paid upon maturity on December 6, 2006. We paid approximately $13.1 million (plus accrued interest) of the original $15.0 million principal outstanding, resulting in a discount of approximately $1.9 million. See Note 17 of Notes to Combined and Consolidated Financial Statements for further discussion.

Commitments

~~Future~~We ~~payments~~currently ~~under~~do ~~contractual~~not ~~obligations~~have ~~and~~any ~~other~~off-balance ~~commercial~~sheet ~~commitments,~~liabilities. ~~as of May 31, 2004, were as follows (in millions):~~

	Payments Due by Period
Contractual Obligations	TotalAmountsCommitted		Less than1 Year		1-3 Years		4-5 Years		Over5 Years
Operating Leases	$	2.3	$	2.2	$	0.1	$	—	$	—
Third-Party Royalty Commitments		2.5		0.5		1.2		0.8		—
Long-Term Convertible Subordinated Note (1)		15.0		—		15.0		—		—
Total Contractual Obligations	$	19.8	$	2.7	$	16.3	$	0.8	$	—

Our facility leases are under noncancelable lease agreements. Our facility leases expire at various dates through September 2010. Our equipment lease expires on March 2007.

~~(1)~~ In June 2002, we entered into two royalty agreements with third-party vendors, and in February 2004, we ~~repaid~~entered ~~the~~into ~~$15.0~~another ~~million~~royalty 5%agreement ~~convertible~~with ~~subordinated~~a ~~note~~third-party vendor for certain licensed technology, which include minimum commitments. ~~See~~In ~~Note~~December 172003, one of ~~Notes~~these toroyalty agreements ~~Combined~~was renegotiated and ~~Consolidated~~the ~~Financial~~minimum ~~Statements~~commitment was eliminated.

~~Our~~Future ~~facility~~payments ~~leases are~~ under ~~noncancelable lease~~contractual ~~agreements.~~obligations ~~Our~~and ~~facility~~other ~~leases~~commercial ~~expire~~commitments, atas ~~various~~of ~~dates~~May ~~through~~31, ~~September~~ 2005., ~~Our~~were ~~equipment~~as ~~lease~~follows ~~expires~~(in onmillions): ~~March 2007.~~

In June 2002, we entered into two royalty agreements with third-party vendors, and in February 2004, we entered into another royalty agreement with a third-party vendor for certain licensed technology, which include minimum commitments. In December 2003, one of these royalty agreements was renegotiated and the minimum commitment was eliminated. Future minimum commitments under these agreements are $0.6 million in fiscal year 2005, $0.6 million in fiscal year 2006, $0.6 million in fiscal year 2007, $0.4 million in fiscal year 2008, and $0.3 million in fiscal year 2009.


	Payments Due by Period
Contractual Obligations	Total Amounts Committed		Less than 1 Year		1-3 Years		4-5 Years		Over 5 Years
Operating Leases	$	5.6	$	1.5	$	3.4	$	0.7	$	—
Third-Party Royalty Commitments		2.4		0.9		1.5		—		—

Total Contractual Obligations	$	8.0	$	2.4	$	4.9	$	0.7	$	—

In addition, we have certain payments due to palmOne under the business services and other agreements that we entered into with Palm, including indemnification of palmOne under the tax sharing agreement for, among other matters, any tax liability incurred by palmOne on account of the sale of our common stock in connection with the distribution (See Note 14 of Notes to Combined and Consolidated Financial Statements).

Under the indemnification provisions of our standard software license agreements, we agree to defend the licensee against third-party claims asserting infringement by our 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 licensee.

We30 have agreements whereby we indemnify our executive officers and directors for certain events or occurrences while the executive officer or director is, or was, serving at our request in such capacity. The term of the indemnification period is for the executive officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, our directors and executive officers are currently covered under our director and officer insurance policy.

AsWe ~~part~~have ofagreements ~~our~~whereby ~~separation~~we ~~agreements,~~indemnify ~~palmOne~~our isexecutive ~~required~~officers toand ~~indemnify~~directors us for certain ~~damages~~events ~~that we may~~or ~~incur~~occurrences ~~due~~while to the ~~Xerox~~executive ~~litigation.~~officer Ifor ~~palmOne~~director is, ~~not successful in the Xerox litigation and is unable to~~ or ~~does not indemnify us~~was, weserving ~~might~~at ~~be required to pay Xerox significant damages or license fees or pay~~ our ~~licensees~~request ~~significant~~in ~~amounts~~such ~~to indemnify them for their losses~~capacity. InThe ~~particular,~~term ~~pursuant~~of tothe ~~our~~indemnification ~~separation~~period ~~agreements, if palmOne~~ is ~~required~~for tothe ~~pay~~executive ~~Xerox,~~officer’s ~~as a result of a judgment~~ or indirector’s ~~connection~~lifetime. ~~with~~The amaximum ~~settlement,~~potential ~~and~~amount ~~fails to do so within 60 days after the entry~~ of ~~such~~future ~~judgment~~payments ~~or the due date under such settlement,~~ we ~~will~~could be required to ~~pay any shortfall amounts. Any such payment by us does not, however, relieve palmOne of its obligation either to~~ make ~~the~~under ~~payment or to reimburse us. Damages in patent litigation of this nature can be calculated in a variety of ways, and are subject to factual determinations. We cannot easily predict the amount of~~ these ~~damages,~~indemnification ~~but~~agreements ~~if palmOne~~ is ~~not~~unlimited; ~~successful in the litigation~~however, ~~damages~~our ~~could~~directors beand ~~substantial.~~executive ~~While~~officers ~~we believe that there~~ are ~~adequate~~currently ~~defenses~~covered tounder ~~the claims made by Xerox, we cannot assure you that palmOne will be successful or that an adverse outcome will not significantly harm,~~ our ~~business,~~director ~~results of operations~~ and ~~financial~~officer ~~condition~~insurance ~~would be significantly harmed, and we may be rendered insolvent~~policy. ~~For further discussion, see the section titled “Business—Legal Proceedings.”~~

As part of our separation agreements, palmOne is required to indemnify us for certain damages that we may incur due to the Xerox litigation. If palmOne is not successful in the Xerox litigation and is unable to or does not indemnify us, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. For further discussion, see the section titled “Business—Legal Proceedings.”

Effect of Recent Accounting Pronouncements

In ~~January~~March ~~2003~~2004, the ~~FASB~~Emerging ~~issued~~Issues ~~FIN~~Task ~~No.~~Force ~~46,~~(EITF) ~~Consolidation~~reached ofa ~~Variable~~consensus ~~Interest~~on ~~Entities~~Issue No. ~~In general~~03-1, a“The ~~variable~~Meaning ~~interest~~of ~~entity,~~Other-Than-Temporary orImpairments ~~VIE,~~and ~~is a~~Its ~~corporation,~~Application ~~partnership,~~to ~~trust,~~Certain orInvestments” ~~any other legal structure used for business purposes that either:~~ (i)“EITF ~~does not have equity investors with voting rights; or (ii~~03-1”). ~~has~~EITF ~~equity~~03-1 ~~investors~~provides ~~that~~a dothree-step ~~not~~impairment ~~provide~~model ~~sufficient financial resources~~ for ~~the entity~~determining towhether ~~support~~an ~~its~~investment ~~activities.~~is ~~FIN~~other-than-temporarily ~~No.~~impaired 46and requires athe ~~VIE~~Company to berecognize ~~consolidated~~such byimpairments aas ~~company~~an impairment ifloss ~~that~~equal ~~company is subject~~ to ~~a majority of~~ the ~~risk~~difference ofbetween ~~loss from~~ the ~~VIE~~investment’s ~~activities~~cost orand isfair ~~entitled~~value toat ~~receive a majority of~~ the ~~VIE’s~~reporting ~~residual returns or both~~date. The ~~consolidation requirements of FIN No. 46 are~~ effective ~~immediately~~date ~~for VIEs created after January 31, 2003. The consolidation requirements for older VIEs are effective for financial statements~~ of ~~interim or annual periods beginning after June 15, 2003. However, in October 2003,~~ the ~~FASB~~recognition ~~deferred~~and ~~the~~measurement ~~effective~~guidance ~~date~~has ofbeen ~~FIN~~delayed 46by ~~for older VIEs to~~ the ~~end of the first interim or annual period ending after December 15, 2003~~EITF. ~~Certain~~We ofdo ~~the~~not ~~disclosure~~believe ~~requirements~~that ~~are effective for all financial statements issued after January 31, 2003, regardless of when~~ the ~~VIE was established. The~~ adoption of ~~FIN~~EITF 03-1 ~~No.~~will ~~46 did not~~ have a material ~~impact~~effect on ~~our~~its financial ~~position and results of operations~~statements.

In ~~April~~October ~~2003~~2004, the ~~FASB~~American ~~issued~~Jobs ~~SFAS~~Creation ~~No.~~Act ~~149, Amendment~~ of ~~Statement~~2004 ~~133~~was ~~on Derivative~~signed ~~Instruments~~into ~~and~~law. ~~Hedging~~The ~~Activities,~~Act ~~which~~introduced ~~amends~~a ~~and~~special ~~clarifies~~one-time ~~financial~~dividends ~~accounting~~received ~~and~~deduction ~~reporting~~on ~~for~~the ~~derivative~~repatriation ~~instruments,~~of ~~including~~ certain ~~derivative~~foreign ~~instruments~~earnings ~~embedded~~to ina ~~other~~U.S. ~~contracts,~~taxpayer ~~and~~(repatriation ~~for hedging activities under SFAS No. 133~~provision), provided ~~Accounting~~certain ~~for~~criteria ~~Derivative~~are ~~Instruments and Hedging Activities~~met. ~~SFAS~~Although ~~No.~~we ~~149~~have ~~requires~~not ~~that~~yet ~~contracts~~completed ~~with~~our ~~comparable~~evaluation ~~characteristics~~of ~~be accounted for similarly and clarifies under what circumstances a contract with an initial net investment meets~~ the ~~characteristic~~impact of athe ~~derivative~~repatriation ~~and~~provisions ~~when~~of athe ~~derivative~~Jobs ~~contains~~Act, ~~a financing component. SFAS No. 149 also amends~~ the ~~definition~~company ofdoes annot ~~underlying~~expect tothat ~~conform~~these itprovisions towill ~~language~~have ~~used~~a inmaterial ~~FIN~~impact ~~No.~~on ~~45,~~its ~~Guarantor’s Accounting and Disclosure Requirements~~consolidated ~~for~~financial ~~Guarantees~~position, ~~Including~~consolidated ~~Indirect~~results ~~Guarantees~~ of ~~Indebtedness~~operations, ofor ~~Others~~liquidity. ~~SFAS~~For ~~No.~~more ~~149~~information isregarding ~~effective~~the ~~for~~repatriation ~~contracts~~of ~~entered~~foreign ~~into or modified after June 30~~earnings, ~~2003,~~refer ~~with~~to ~~certain~~Note ~~exceptions.~~10 ~~The adoption~~ of ~~SFAS~~the ~~No.~~Consolidated ~~149~~Financial ~~did not have an impact on our financial position or results of operations~~Statements.

In ~~May~~December ~~2003~~2004, the FASB issued SFAS No. ~~150~~123 (Revised 2004), “Share-Based ~~Accounting~~Payment” ~~for~~(“SFAS ~~Certain~~123R”). ~~Financial~~This ~~Instruments~~statement ~~with~~replaces ~~Characteristics~~FASB ofStatement ~~Both~~No. ~~Liabilities~~123, ~~and~~“Accounting ~~Equity~~for Stock-Based Compensation,” ~~which~~and ~~establishes~~supersedes ~~standards~~APB Opinion No. 25, “Accounting for ~~how~~Stock anIssued ~~issuer~~to ~~classifies~~Employees.” SFAS ~~and~~123R ~~measures~~requires ~~certain~~all ~~financial~~companies ~~instruments~~to ~~with~~measure ~~characteristics~~compensation ~~of both~~cost ~~liabilities~~for ~~and~~all ~~equity~~share-based payments, including stock options, at fair value. Under the terms of SFAS ~~No.~~123R ~~150~~the ~~requires~~fair ~~that~~value anof ~~issuer~~any ~~classify~~equity aaward ~~financial~~will ~~instrument~~be ~~that~~estimated ~~falls~~at ~~within~~the ~~its~~grant ~~scope~~date and this fair value will be recognized as acompensation ~~liability,~~cost orover anthe ~~asset~~service inperiod ~~some~~for ~~circumstances~~all awards that are subject to a vesting period. SFAS ~~No.~~123R ~~150~~requires isthat ~~effective~~fair ~~for~~value ~~financial~~be ~~instruments~~estimated ~~entered~~using an option pricing model that takes into ~~or modified~~account ~~after~~at ~~May~~least ~~31,~~the ~~2003~~following items—the exercise price, ~~and~~the ~~otherwise~~expected isterm ~~effective~~of atthe option, the ~~beginning~~current price of the ~~first~~underlying ~~interim~~share, ~~period~~the ~~beginning~~expected ~~after~~volatility ~~June~~of 15the price of the underlying share, ~~2003~~the expected dividends on the underlying share and the risk free rate of interest. The ~~adoption~~statement ofwill ~~SFAS~~be Noeffective for the Company beginning in fiscal 2007. ~~150~~The ~~did~~Company ~~not~~is ~~have~~currently aevaluating ~~material~~the ~~impact~~effect onthat ~~our~~SFAS ~~financial~~123R ~~position~~will orhave ~~results~~on ofits ~~operations~~financial statements.

42On March 29, 2005, the SEC issued Staff Accountants Bulletin (SAB) 107 which expresses the views of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provides the SEC’s views regarding the valuation of share-based payments arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payments transactions with nonemployees, the transition from nonpublic to public entity status, valuations methods (including assumptions such as expected volatility and expected term), the accounting of certain redeemable financial instrument issues under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payments arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R, and

disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. We are currently evaluating the impact that SAB 107 will have on our results of operations and financial position when we adopt it in fiscal 2007.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”. SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes”, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements” and is effective for fiscal years beginning after December 15, 2005. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. We do not expect the adoption of SFAS No. 154 in fiscal 2007 to have a material impact on our consolidated financial statements.

RISK FACTORS

Risks ~~Associated~~Relating ~~With~~to Our Business

We have a history of losses, negative cash flows and limited cash ~~resources~~resource, and we may never achieve or sustain profitability or positive cash flows.

We have not been continuously profitable during ~~any~~all of the periods for which we have prepared historical financial statements. During the fiscal ~~year~~years ended May 31, 2003 and May 31, 2004, we had net losses of approximately $21.8 million and $15.2 million, respectively, on revenues of $73.4 million and $73.1 million, respectively. During fiscal year ended May 31, 2005 we had an operating loss (excluding the gain on asset sale) of approximately $10.2 million on revenues of $71.9 million. Cash flow used for operations (negative cash flow) for the ~~fiscal~~years ~~year~~ ended May 31, 2003, 2004 ~~was~~and 2005 were $8.9 million, $14.5 million and $3.8 million, respectively. While we have historically received upfront, initial license fees, which partially funded our negative cash flow from operations, we do not expect this trend to continue. We have historically had negative cash flow from operations and may not achieve positive cash flow in the future.

We may incur losses and negative cash flows for the foreseeable future, particularly if our revenues do not increase substantially, if our expenses increase faster than our revenues, for example, as may be the case in connection with our recent acquisition of CMS, or if we make unanticipated capital expenditures or if, as we expect, we experience a significant decline in upfront license fees. Our ability to increase revenues and achieve and sustain profitability will also be affected by other risks and uncertainties described in this report. If we do not increase revenues substantially or cannot raise additional capital, which may not be available on reasonable terms or at all, we may not be able to fund operations in the future.

WeAt ~~currently~~the ~~derive~~end of fiscal 2005, our ~~revenues~~goodwill ~~from~~asset abalance ~~small~~was ~~number~~$72.8 ofmillion ~~licensees~~or approximately 39% of ~~Palm~~total ~~OS,~~assets. ~~and~~We ~~there~~review ~~are~~goodwill afor ~~number~~potential ofimpairment ~~developments~~at ~~that~~least ~~have~~annually ~~occurred~~or more frequently, whenever an event or change ~~may~~in ~~occur~~circumstances occurs which would indicate potential impairment. In response to changes in ~~the~~industry ~~future,~~and ~~with~~market ~~one~~conditions, orwe ~~more~~may ofstrategically realign our ~~licensees~~resources in a manner that could ~~significantly~~result ~~harm~~in ~~our~~an ~~future~~impairment ~~business~~of ~~prospects~~goodwill. ~~including~~The ~~(but~~review ~~not~~of goodwill ~~limited~~is ~~to):~~based ~~the~~on ~~loss~~financial orprojections ~~reduction~~ of ~~purchases~~undiscounted ~~from~~and ~~one~~discounted ornet ~~more~~cash ~~licensees;~~flows. ~~the~~These ~~full~~financial orprojections ~~partial~~involve ~~withdrawal of~~significant ~~one~~estimates orwith ~~more~~inherent ~~licensees,~~uncertainties orregarding ~~their~~future ~~respective products~~revenues, ~~from~~expenses aand ~~segment~~cash offlows. ~~the~~We ~~market;~~cannot ~~the~~provide assurance ~~introduction~~that offuture ~~new~~net ~~products~~cash ~~from~~flows ~~palmOne~~will orbe ~~other~~sufficient ~~licensees~~to ~~incorporating~~avoid afuture ~~competing~~impairment ~~operating~~charges, ~~system~~and, ~~such~~ as a ~~Microsoft~~result, ~~Symbian~~in orthe ~~Linux~~future, ~~offering~~we may incur significant non-cash impairment charges, ~~and~~which ~~the renegotiation~~could orhave ~~renewal~~a ofmaterially adverse impact on the ~~license~~results ~~agreements~~of ~~that~~our operations, ~~result~~our infinancial ~~less~~condition ~~favorable~~or ~~terms~~our stock price.

We currently derive most of our revenues from a small number of licensees of Palm OS. ~~Revenues from palmOne/Palm were $38.8 million, or 53.1% of total revenues, for fiscal year 2004~~ and ~~$39.3~~there ~~million,~~are ora ~~53.5%~~number of ~~total revenues,~~developments ~~for~~that ~~fiscal~~have ~~year~~occurred ~~2003. Revenues from Sony were $8.2 million,~~ or ~~11.2%~~may ofoccur ~~total~~in ~~revenues, for fiscal year 2004 and $11.2 million, or 15.3% of total revenues, for~~ the ~~fiscal year 2003. Revenues from Handspring were $3.5 million~~future, orwith ~~4.7%~~one ~~of total revenues, for fiscal year 2004 and $6.4 million,~~ or ~~8.8%~~more of ~~total~~our ~~revenues,~~licensees ~~for fiscal year 2003. In June 2004, Sony announced~~ that itcould ~~will~~significantly ~~discontinue~~harm ~~the~~our ~~Clie®~~future ~~PDA~~business ~~product line in the U.S. and other markets outside of Japan for the rest of the year while it reassesses the~~prospects ~~market.~~including ~~Additionally,~~(but ~~the~~not ~~acquisition~~limited ~~of Handspring by Palm has increased our customer concentration. We expect that palmOne will continue~~ to): ~~account~~the ~~for~~loss aor ~~substantial~~reduction ~~portion~~ of ~~our~~purchases ~~revenues for the foreseeable future. If revenues~~ from ~~palmOne~~one or ~~our~~ ~~other~~more licensees; dothe ~~not~~full ~~grow~~or aspartial wewithdrawal ~~anticipate,~~of ifone ~~some~~ or ~~all~~more ~~of our~~ licensees, ~~experience delays~~ or ~~decide not to incorporate Palm OS into~~ their ~~future~~respective products, ~~or if palmOne experiences financial difficulties and is not able to satisfy its annual minimum royalty commitments, we will need to significantly reduce our expenses or increase our revenues~~ from ~~other~~a ~~sources~~segment toof stay in business. Our license agreement with palmOne will expire in December 2006, our license arrangement with Sony will expire in October 2012 and our license agreement with Handspring was terminated following the ~~Handspring~~market; ~~merger. Nothing restricts these licensees from competing with us or offering products based on competing operating systems and these licensees may stop incorporating Palm OS in their products during~~ the ~~term~~introduction of ~~their~~new ~~agreements with limited notice to us. Some of our licensees already offer~~ products ~~that utilize competing operating systems. For example, Samsung and Fossil offer~~from ~~products~~palmOne ~~that~~or ~~utilize a Microsoft operating system. We expect that these licensees will continue to offer products which utilize competing operating systems, and~~ other licensees, ~~such~~incorporating ~~as palmOne, may begin to offer products that incorporate~~ a competing operating system ~~such as a Microsoft, Symbian or Linux offering~~. However, in the event that palmOne chose to offer products based on competing operating systems, palmOne would still be required to pay the minimum annual payments pursuant to the license agreement. Once these license arrangements expire, we may not be able to renegotiate them on favorable terms, or at all. Although we have entered into license agreements with new licensees in fiscal year 2003 and fiscal year 2004, most of these new licensees have yet to

43We currently derive most of our revenues from a small number of licensees of Palm OS. Revenues from palmOne were $46.9 million or 65% of total revenue for fiscal year 2005. In June 2004, Sony announced that it would discontinue the Clie® PDA product line. Additionally, the acquisition of Handspring by Palm has increased our customer concentration. We expect that palmOne will continue to account for a substantial portion of our revenues for the foreseeable future.

If revenues from palmOne or our other licensees do not grow as we anticipate, if some or all of our licensees experience delays or decide not to incorporate Palm OS into their future products, or if palmOne experiences financial difficulties and is not able to satisfy its annual minimum royalty commitments, we will need to significantly reduce our expenses or increase our revenues from other sources to stay in business. Our license

~~introduce~~agreement ~~products~~with onpalmOne ~~the~~will ~~market~~expire ~~that~~in ~~generate~~December ~~revenues~~2009 ~~for~~and ~~us.~~our Inlicense ~~fiscal~~agreement ~~year~~with ~~2004,~~Handspring wewas ~~have~~terminated ~~renegotiated~~following the ~~existing~~Handspring ~~license~~merger. ~~agreements with a few of our~~Nothing restricts licensees, ~~and~~from wecompeting ~~expect~~with ~~that~~us inor ~~the~~offering ~~future,~~products webased ~~will~~on ~~renegotiate~~competing ~~the~~operating ~~existing~~systems ~~license~~and ~~agreements of additional~~ licensees. ~~Such~~may ~~renegotiations~~stop ~~have~~incorporating ~~resulted~~Palm OS in ~~changes~~their toproducts ~~some~~during of the ~~terms~~term of ~~the~~their ~~license~~ agreements, ~~some~~with oflimited ~~which~~notice ~~are less favorable~~ to us. ~~than~~Some ~~before~~of ~~the~~our ~~renegotiations,~~licensees already ~~and~~offer weproducts ~~expect~~ that ~~future~~utilize ~~renegotiations~~competing ofoperating ~~license~~systems. ~~agreements~~For ~~will~~example, ~~also~~Samsung ~~result~~and inFossil ~~changes~~offer toproducts ~~some~~that ofutilize ~~the~~a ~~terms~~Microsoft ofoperating ~~the~~system. ~~license~~We ~~agreements,~~expect ~~some~~that ofthese ~~which~~licensees ~~are~~will ~~expected~~continue to beoffer ~~less~~products ~~favorable~~which toutilize ~~us than before the~~competing ~~renegotiations.~~operating ~~Additionally~~systems, ~~the~~and ~~renegotiations~~other ~~have~~licensees, ~~resulted~~such inas ~~the~~palmOne, ~~acceleration~~may ofbegin ~~the~~to ~~receipt~~offer ofproducts ~~payments~~that ~~from~~incorporate ~~licensees~~a ~~(which~~competing ~~has~~operating ~~had~~system. ~~the~~palmOne ~~effect~~would ofstill ~~earlier~~be ~~recognition~~required ofto ~~revenues)~~pay inthe ~~exchange~~minimum ~~for~~annual ~~more~~payments ~~favorable~~pursuant ~~terms~~ to the ~~licensees~~license ~~and~~agreement, athrough ~~reduction~~December of2006, ~~payments~~but ~~due from licensees in later periods (which has had~~ the ~~effect~~minimum ofannual ~~reducing~~payments ~~revenues~~for toDecember be2007 ~~recognized~~through inDecember ~~later~~2009 ~~periods). If we do not continue to generate significant revenues from palmOne or if we~~ are ~~unable~~contingent toupon ~~generate~~us ~~an increased~~attaining ~~percentage~~certain ofkey ~~our~~milestones ~~revenues~~with ~~from other licensees, our business, results of operations and financial condition will be significantly harmed~~palmOne.

If palmOne chose to offer products based on competing operating systems, our future revenues will suffer. Once these license arrangements expire, we may not be able to renegotiate them on favorable terms, or at all. Although we have entered into license agreements with new licensees in fiscal year 2003 and fiscal year 2004, most of these new licensees have yet to introduce products on the market that generate revenues for us. In fiscal year 2004 and in the first half of fiscal year 2005, we have renegotiated the existing license agreements with a few of our licensees, and we expect that in the future, we will renegotiate the existing license agreements of additional licensees. Such renegotiations have resulted in changes to some of the terms of the license agreements, some of which are less favorable to us than before the renegotiations, and we expect that future renegotiations of license agreements will also result in changes to some of the terms of the license agreements, some of which are expected to be less favorable to us than before the renegotiations. Additionally, the renegotiations have resulted in the acceleration of the receipt of payments from licensees (which has had the effect of earlier recognition of revenues) in exchange for more favorable terms to the licensees and a reduction of payments due from licensees in later periods (which has had the effect of reducing revenues to be recognized in later periods). If we do not continue to generate significant revenues from palmOne or if we are unable to generate an increased percentage of our revenues from other licensees, our business, results of operations and financial condition will be significantly harmed.

Our operating results may fluctuate.

Our operating results are difficult to predict. We do not have a long history of operations, our operating results have fluctuated significantly and we have only operated separately from palmOne since October 28, 2003. Factors that may cause fluctuations in our operating results, in addition to those disclosed elsewhere in this section ~~titled~~entitled “Risk Factors,” include the following:

•

shortfall payments from licensees in a given quarter to satisfy minimum quarterly or annual license and royalty commitments, as such payments are recorded in the period that the minimum commitment becomes due to us;

• ~~delays~~delay inor ~~the~~change ~~development~~in orcompletion ~~launch~~ of ~~Palm~~new ~~Powered~~ products ~~by our licensees~~;

•

delays or cancellations in the development or launch of Palm Powered products by our licensees;

•

changes in consumer and enterprise spending levels, which may fail to meet our expectations;

•

a shifting mix in the balance between license fees derived from upfront royalty payments, license fees calculated as a percentage of revenues derived from Palm Powered products and license fees based on fixed dollar amounts per unit sold;

•

changes in general economic conditions and specific market conditions that may impact demand for our products and services;

•

seasonality of demand for Palm Powered products and services that may cause our revenues to fluctuate on a quarter to quarter basis;

•

licensee withdrawal of Palm Powered products from some or all markets;

•34 ~~changes in licensing fees due to third parties for technologies incorporated in the Palm OS platform; and~~

• an increase in reliance on third-party software licenses.

Because our revenues fluctuate and are difficult to predict, and our expenses are largely independent of revenues in any particular period, it is difficult for us to accurately forecast revenues and profitability. Any of these factors could cause our results of operations to fall below the expectations of analysts, our stockholders or others, resulting in a significant decrease in our stock price and harming our business, results of operations, and financial condition.

In connection with our separation agreements, palmOne has agreed to indemnify us for damages incurred due to certain litigation with Xerox Corporation; if palmOne is unsuccessful in the litigation and is unable to or does not indemnify us, our business, results of operations, financial condition and cash flows would be significantly harmed, we may not be able to stay in business, and our licensees may not be able to ship products with Graffiti handwriting recognition software.

palmOne and PalmSource are defendants in a civil action brought by Xerox Corporation in 1997 relating to the Graffiti handwriting recognition software then used in handheld computers using Palm OS. The complaint by

~~Xerox~~• ~~alleged~~changes willful infringement of U.S. Patent No. 5,596,656, or the ‘656 patent, titled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint seeks unspecified damages and to permanently enjoin the defendants from infringing the patent in ~~the~~licensing ~~future.~~fees Indue December 2001, the trial court held that the ‘656 patent was valid, enforceable and infringed. The December 2001 ruling was appealed, and in a February 2003 decision the appellate court remanded the case to ~~the~~third trial court for a determination of the issues of invalidity and enforceability of the ‘656 patent. On December 10, 2003 the trial court heard motions from Xerox and the defendants for summary judgment on the issue of invalidity of the ‘656 patent. On May 21, 2004, the trial court granted summary judgment that the asserted claims of Xerox’s patents were invalid. Both parties ~~have moved~~ for atechnologies ~~clarification~~incorporated orin ~~reconsideration of that ruling, and those motions remain pending. Xerox has appealed~~ the ~~ruling.~~Palm OS platform;

As• part of our separation agreements, palmOne has agreed to indemnify us for certain damages that we may incur due to the Xerox litigation, whether or not we are a defendant. palmOne has indicated that it intends to continue to defend itself vigorously against these claims. However, we cannot assure you that palmOne will continue to defend itself or be successful. In 2002, we licensed technology which we used to create an ~~alternative~~increase ~~handwriting recognition system for use~~ in ~~Palm~~reliance ~~OS,~~on ~~referred~~third-party ~~to as Graffiti 2, which we now offer to all of our licensees. At the end of 2002, we began offering this alternative~~ software tolicenses; ~~our existing licensees,~~ and disclaimed responsibility for any damages resulting from any shipments after that time of the original versions of Graffiti handwriting recognition software by our licensees. In this report, we refer to Graffiti handwriting recognition software released by us prior to Graffiti 2 as the original version or versions of Graffiti. However, under our license agreements with our licensees we have agreed to indemnify them for any damages they incur due to infringement by our or palmOne’s intellectual property, and accordingly we could be liable for damages resulting from use of the original version of the Graffiti handwriting recognition software prior to our offering of Graffiti 2. If palmOne is not successful in the litigation, Xerox will likely seek an injunction from the court preventing our licensees from offering products with the original versions of Graffiti handwriting recognition software. If the court issues an injunction in favor of Xerox, we would lose any additional royalties that might have been due from those licensees that are continuing to ship the original version of Graffiti. As a result, and if palmOne is unable to or does not indemnify us, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. In particular, pursuant to our separation agreements with palmOne, if palmOne is required to pay Xerox, as a result of a judgment or in connection with a settlement, and fails to do so within 60 days after the entry of the judgment or the due date under the settlement, we will be required to pay any shortfall amounts to Xerox. Any such payment by us does not, however, relieve palmOne of its obligation either to make the payment or to reimburse us. Damages in patent litigation of this nature can be calculated in a variety of ways, and are subject to factual determinations. We cannot easily predict the amount of these damages, but if palmOne is not successful in the litigation, these damages could be substantial. Although palmOne has prevailed at the current stage of litigation on the claims made by Xerox, we cannot assure you that palmOne will be successful or that an adverse outcome will not significantly harm our business.

~~The~~• ~~pending litigation~~increased ~~may also result in other indirect~~ costs ~~and~~associated ~~expenses,~~with ~~such as significant diversion of management resources~~acquisitions, ~~loss~~including ofintegration ~~reputation and goodwill~~costs, ~~damage to our customer and licensee relationships and substantial declines in our~~ stock-based ~~price. In addition~~compensation, ifacquired ~~palmOne is required to pay damages to Xerox, they may no longer be able to pay us the minimum annual commitments due under our license agreement with palmOne. Accordingly, if Xerox is successful~~ in-process ~~its~~research ~~claims against palmOne,~~ and ~~palmOne~~ ~~does~~development ~~not or is unable to indemnify us for these claims~~costs, ~~our~~amortization ~~business, results~~ of ~~operations,~~purchased ~~financial~~intangibles ~~condition~~ and ~~cash~~asset ~~flows~~impairment ~~could be significantly harmed, and we may be rendered insolvent~~charges. ~~For further discussion, including detail regarding the nature of the claim and the procedural history of the case, see “Business—Legal Proceedings.”~~

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

We compete principally in the ~~operating~~mobile ~~system~~telephony ~~software~~and ~~platform~~handheld ~~and~~software and services markets. These markets are highly competitive, and we expect competition to increase in the future. We compete primarily with Microsoft and Symbian in smartphones. For example, Microsoft may use its leading position in the enterprise applications market to gain competitive advantage in the markets on which we focus. Furthermore, Microsoft may package product offerings that compete with us together with other product offerings which we could not match. Microsoft has substantially more resources than we do. Symbian, which is invested in and supported by companies such as Nokia Corporation, Ericsson AB, Sony Ericsson Mobile Communications AB, Panasonic, Siemens and Samsung, has a substantial portion of the worldwide smartphone market, a market that we believe is important to our future success. Furthermore, in July 2004, Symbian announced that it had received an additional 50 million Pounds Sterling investment from some of its shareholders and thus now has greater resources with which to compete. Some of our competitors in the feature phone software market, like Openwave, also offer server infrastructure to mobile phone network operators. Others, such as TTPCom, design and license intellectual property for mobile phone hardware components. By vertically integrating their products, these competitors may be able to offer features and pricing advantages that we could have difficulty meeting. In addition, there are proprietary operating systems; open source operating systems, such as Linux; and other software technologies, such as Java or technology licensed from RIM which could be integrated into devices that compete with devices powered by our software. Some of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we 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 and services and to promoting their products within the third-party developer community.

and Symbian. For example, Microsoft may use its leading position in the enterprise applications market to gain competitive advantage in the markets on which we focus. Furthermore, Microsoft may package product offerings that compete with us together with other product offerings which we could not match. Microsoft has substantially more resources than we do. Symbian, which is invested in and supported by companies such as Nokia Corporation, Ericsson AB, Sony Ericsson Mobile Communications AB, Panasonic, Siemens and Samsung, has a substantial portion of the worldwide smartphone market, a market that we believe is important to our future success. Furthermore, in July 2004, Symbian announced that it had received an additional 50 million Pounds Sterling investment from some of its’ shareholders and thus now has greater resources with which to compete. In addition, there are proprietary operating systems; open source operating systems, such as Linux; and other software technologies, such as Java or technology licensed from RIM which could be integrated into devices that compete with Palm Powered devices. Some of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we 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 and services and to promoting their products within the third-party developer community.

Successful new product introductions or enhancements by our competitors, or increased market acceptance of competing platforms, could reduce the sales and market acceptance of our products and services, cause intense price competition or make our products and services 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 remain competitive. Increased competition could result in price reductions, decreased license and royalty revenues, decreased customer demand, reduced margins and loss of market share. Our failure to compete successfully against current or future competitors could seriously harm our business, results of operations and financial condition and cause our operating results to fluctuate.

We believe that the market for PDAs, our traditional strength, is maturing. If we are unable to successfully penetrate new device markets or new markets do not develop as anticipated, our business will not grow as expected and our revenues will suffer.

We believe the market for PDAs, our traditional strength, is maturing. As a result, we anticipate that our future revenue growth will come from other mobile information devices, in particular ~~smartphones~~mobile phones and other wireless devices that incorporate ~~Palm~~our OSsoftware. However, we cannot assure you that our new product development efforts in this area will be successful. The ~~smartphone~~mobile ~~operating~~software ~~system~~ market is highly competitive, with Microsoft and Symbian devoting significant resources to compete against us in smartphones and several well-established competitors, such as Openwave, TTPCom, and Teleca, in feature phones. If we are unsuccessful in penetrating the markets for ~~smartphones~~phones or other devices or these markets do not develop as anticipated, our business will not grow as expected and our revenues will suffer. ToFor ~~compete~~example, in the smartphone ~~and~~market ~~other~~is ~~new~~particularly ~~markets,~~difficult ~~we expect~~ to ~~enhance~~forecast ~~Palm~~because it OSis bynew ~~licensing~~and ~~additional~~is ~~technologies~~not ~~from~~well ~~third-party~~defined ~~vendors~~or understood. ~~However,~~There weappears ~~cannot~~to ~~assure you that we will~~ be ~~able~~several todifferent ~~successfully~~segments ~~license~~within ~~this~~the ~~technology~~market, ~~that~~and weit ~~will~~is bevery ~~able~~difficult to ~~negotiate~~predict ~~favorable~~which ~~terms~~products ~~on these third-party royalty contracts or that we~~ will besell ~~able to generate sufficient royalty revenues to offset the additional costs associated with these contracts~~well. If we ~~are~~and ~~unable to do so,~~ our ~~cost~~licensees offail ~~license~~to ~~revenues~~properly ~~and~~position ~~cost~~products offor ~~sales~~the right ~~will increase~~segments, ~~and~~we ~~our~~might ~~gross~~fail ~~margins~~to ~~could~~achieve ~~be materially impacted, which would adversely affect~~ our ~~business,~~growth ~~results of operations and financial condition~~objectives.

To compete in the mobile phone and other new markets, we expect to enhance our product portfolio by licensing additional technologies or acquiring businesses, an example of which is our recent acquisition of CMS. However, we cannot assure you that we will be able to successfully license or acquire technologies or businesses, that we will be able to negotiate favorable terms or that we will be able to generate sufficient revenues to offset the additional costs. If we are unable to do so, our cost of license revenues and cost of sales will increase, and our gross margins could be materially impacted, which would adversely affect our business, results of operations and financial condition.

Our success depends on the development, sales and marketing efforts of our licensees.

Our ability to generate revenues is largely dependent on the development, sales and marketing efforts of our licensees. If one or more of our licensees fails to develop or generate sales of ~~Palm~~products ~~Powered~~containing ~~products,~~our software our revenues could be harmed. We are subject to many risks beyond our control that influence the success or failure of a particular licensee, including, but not limited to:

•

competition faced by the licensee in its particular market;

•

technical challenges unrelated to our technology that are faced by the licensee in developing its products;

•

the ability of our licensees to sell into wireless carriers and to obtain carrier network certification;

•

market acceptance of the licensee’s products in the face of shifting consumer and enterprise preferences;

•

the engineering, sales and marketing and management capabilities of the licensee; and

•

the financial and other resources of the licensee.

If our licensees do not successfully develop, market and sell ~~Palm~~products ~~Powered~~with ~~products~~our software, our revenues and profitability will suffer and our business will be be harmed.

We depend on wireless carriers accepting our platform software intended for smartphones and feature phones.

The acceptance of smartphones and feature phones by the market is highly dependent upon the procedures of wireless carriers. Wireless carriers are relatively few in number and their qualification, network certification and adoption procedures are long and stringent. We have limited experience in developing platform software intended for use in smartphones that comply with such procedures. Our competitors already have established relationships with a number of the wireless carriers. We cannot assure you that we will succeed in developing platform software to enable our licensees’ products to meet wireless carriers’ procedures or that wireless carriers will accept or promote the success of our licensees’ products. If our licensees’ products do not comply with ~~wireless~~ ~~carriers’ qualification, network certification and adoption procedures or if wireless carriers do not promote the success of our licensees’ products, our business will be harmed.~~

wireless carriers’ qualification, network certification and adoption procedures or if wireless carriers do not promote the success of our licensees’ products, our business will be harmed.

We cannot accurately predict when we will recognize revenues from a particular licensee, if at all, or whether a particular licensee will ultimately market products incorporating Palm OS.

Once we enter into a license agreement, it often takes eight to 12twelve months or longer, depending on the specific technical capabilities of the licensee and the complexity of the licensee’s product, for our licensees to develop commercially available products, if at all, on which we can begin to recognize license revenues. The process of persuading licensees to adopt our technology can be lengthy and, even if adopted, we cannot assure you that our technology will be used in a product that is ultimately brought to market, achieves commercial acceptance or results in significant royalties to us. Due to these challenges, predicting when a new licensee will generate product royalty revenues, if at all, is difficult. If we invest management and engineering resources in a licensee but the licensee’s product is ultimately not introduced to market or is not well received by end users, our operating results would suffer. Even if a licensee’s product is introduced to market, the revenue recognition of royalties derived from sales of the product may be deferred to a later period, or may be recognized over an extended period, in accordance with U.S. generally accepted accounting principles.

If we, or our licensees that incorporate Palm OS, fail to develop and introduce new products and services timely and successfully, we will not be able to compete effectively, our operating results may fluctuate and our ability to generate revenues will suffer.

We operate in a highly competitive environment characterized by rapid technological changes, frequent new product and service introductions, evolving industry standards, and changing customer demands. The development of new products, such as our Linux based platform, and services can be very difficult and requires high levels of innovation. The development process is also lengthy and costly. Our future success depends on our ability to develop and introduce in the mobile information device market new products and services that our customers and end users choose to buy. In addition, we rely heavily on the efforts of our licensees and third-party developers for the ~~development~~creation of new products and services based on Palm OS.

We have made, and we intend to continue to make, significant investments in research and development. However, if we or our licensees or third-party developers fail to anticipate our customers’ and end users’ needs and technological trends accurately and are unsuccessful at developing and introducing appealing new products and services on a cost-effective and timely basis with acceptable prices and terms, we will not be able to compete effectively, our ability to generate revenues will suffer and our operating results will be harmed.

If Palm Powered products do not effectively interoperate with software running on desktop, network servers and other computer hardware, the attractiveness and use of Palm OS could be adversely affected.

Palm Powered products depend upon effective interoperability with software running on personal computers and network servers to acquire and backup information. Interoperability with this other software can be affected by the design of the personal or network server operating environments, the device which incorporates Palm OS or Palm OS itself. For example, if Microsoft modified its desktop or server software products to make them incompatible with Palm OS, demand for Palm Powered devices would be significantly reduced, particularly among existing users of Microsoft products. If the desktop or network server interoperability of Palm OS devices is compromised in any way, the attractiveness and use of Palm OS would likely be adversely affected. As a result, our business, results of operations and financial condition would be seriously harmed.

We could be prevented from selling or developing our software if the GNU General Public License and similar licenses under which such products are developed and licensed are not enforceable.

The Linux kernel and the mLinux operating system of our CMS subsidiary have been developed and licensed under the GNU General Public License and similar open source licenses. These licenses state that any

program licensed under them may be liberally copied, modified and distributed. The GNU General Public License is also the subject of litigation in the case of The SCO Group, Inc. v. International Business Machines Corporation, pending in the United States District Court for the District of Utah. It is possible that a court in that litigation would hold these licenses to be unenforceable or that someone could assert a claim for proprietary rights in a program developed and distributed under them. Any ruling by a court that these licenses are not enforceable, or that Linux-based operating systems, or significant portions of them, may not be liberally copied, modified or distributed, would have the effect of preventing us from selling or developing all or a portion of our products based on such technologies.

The Palm OS platform and other software products may contain errors or defects, and may be vulnerable to computer viruses. Any or all of these could result in the rejection of our products and services and damage to our reputation, as well as lost revenues, diverted development resources and increased service costs and warranty claims.

The Palm OS platform is complex and must meet stringent manufacturer and user requirements. We must develop our software products and services quickly to keep pace with the rapidly changing mobile information device market. Products and services as sophisticated, as ours are likely to contain undetected errors or defects, particularly when first introduced or when new models or versions are released. These errors or defects may include vulnerability to computer viruses. For example, the 29A virus-writing group created the Duts and Cabir viruses to infect devices running Pocket PC and Symbian OS, respectively. ~~While~~ ~~these~~Cabir ~~viruses~~was ~~were~~subsequently ~~developed~~incorporated asinto ~~academic~~a ~~exercises rather than as serious attempts to spread~~ malicious ~~code~~worm ~~across~~program ~~handheld~~distributed ~~computers,~~for ~~they~~Symbian ~~demonstrate that the threat is real~~phones. Palm OS may not be free from errors or defects after commercial shipments by our licensees have begun, which could result in the rejection of products and services based on Palm OS, damage to our reputation, lost revenues, diverted development resources and increased customer service and support costs and warranty and indemnity claims, which could harm our business, results of operations and financial condition. The threat of a virus could also discourage wireless carriers from offering smartphones, which will impact the growth of our markets.

~~Third~~In ~~parties~~connection ~~have~~with ~~claimed~~our ~~and~~separation ~~may~~agreements, ~~claim~~palmOne inhas ~~the~~agreed ~~future~~to ~~that~~indemnify ~~our~~us ~~products~~for damages ~~infringe~~incurred ~~their~~due ~~intellectual~~to ~~property~~certain litigation with Xerox Corporation; if ~~these~~palmOne ~~claims~~is ~~are~~not ultimately successful, wein ~~could~~the ~~suffer~~litigation ~~significant~~and ~~litigation~~is unable to or ~~licensing~~does ~~expenses~~not orindemnify us, our business, results of operations, financial condition and cash flows would be ~~prevented~~significantly ~~from~~harmed, ~~licensing~~we ~~Palm~~may OSnot be able to stay in business, and our licensees ~~who~~may ~~sell~~not ~~Palm~~be ~~Powered~~able to ship products with Graffiti handwriting recognition software.

InpalmOne ~~the~~and ~~course~~PalmSource ofare ~~our~~defendants ~~business,~~in wea ~~receive~~civil ~~claims~~action ofbrought ~~infringement~~by orXerox ~~otherwise~~Corporation ~~become~~in ~~aware~~1997 ofrelating ~~potentially~~to ~~relevant~~the ~~patents~~Graffiti handwriting orrecognition ~~other~~software ~~intellectual~~then ~~property~~used ~~rights~~in ~~held~~handheld bycomputers ~~other~~using ~~parties.~~Palm ~~For~~OS, ~~example~~which is more fully described in Note 13, ~~Xerox~~Litigation. ~~has~~As ~~filed~~part ~~suit against~~of our separation agreements with palmOne, ~~and~~palmOne ushas ~~relating~~agreed to ~~the~~indemnify ~~original~~us ~~version~~for ofcertain ~~Graffiti~~damages ~~handwriting~~that ~~recognition~~we may ~~software~~incur ~~used~~due into ~~handheld~~the ~~computers~~Xerox ~~using~~litigation. ~~Palm~~In OS2002, ~~which~~we islicensed ~~discussed~~certain intechnology, ~~more~~that ~~detail~~we ~~above~~used ~~and~~to increate ~~the~~an ~~section~~alternative ~~titled~~handwriting ~~“Business—Legal Proceedings.”~~recognition Wesystem ~~may~~for beuse ~~added~~in Palm OS, referred to ~~the~~as ~~complaint~~Graffiti by2, ~~Xerox.~~and Ifwhich anwe ~~injunction~~now isoffer ~~obtained~~to byall ~~Xerox,~~of itour ~~could~~licensees. ~~have~~At the aend ~~significant~~of ~~adverse~~2002, ~~impact~~we onbegan offering this alternative software to our ~~operations~~existing licensees, and ~~financial~~disclaimed ~~condition~~responsibility iffor ~~licensees~~any ~~have~~damages ~~not~~resulting ~~transitioned~~from toany ashipments ~~handwriting~~after ~~recognition system~~that ~~outside~~time of the ~~scope~~original versions of ~~Xerox’s~~Graffiti ~~asserted~~handwriting ~~claims~~recognition software by our licensees. As part of our separation agreements, palmOne ~~has~~is ~~agreed~~required to indemnify us for certain damages that we may incur due to the Xerox litigation,. ~~but~~If palmOne is not ~~required~~successful in the Xerox litigation and is unable to or does not indemnify us, ~~for~~we ~~any profits~~might webe ~~lose~~required asto apay ~~result~~Xerox ofsignificant ~~the~~damages ~~litigation.~~or Iflicense wefees ~~are~~or ~~not~~pay ~~successful~~our inlicensees ~~the~~significant ~~Xerox~~amounts ~~litigation~~to ~~and~~indemnify them for their losses. In particular, pursuant to our separation agreements, if palmOne is ~~unable~~required to orpay Xerox, ~~does~~as ~~not~~a ~~indemnify~~result ~~us,~~of a judgment or ifin ~~any~~connection ~~liability~~with wea ~~are~~settlement, ~~ruled~~and fails to ~~have~~do toso ~~Xerox~~within is60 ~~outside~~days after the ~~scope~~entry of ~~palmOne’s indemnification~~such ~~obligations~~judgment toor usthe due date under such settlement, we ~~might~~will be required to pay ~~Xerox~~any ~~significant~~shortfall ~~damages~~amounts. orAny ~~license~~such ~~fees~~payment by us does not, however, relieve palmOne of its obligation either to make the payment or ~~pay~~to ~~our~~reimburse ~~licensees~~us. ~~significant~~Damages ~~amounts~~in patent litigation of this nature can be calculated in a variety of ways, and are subject to ~~indemnify~~factual ~~them~~determinations. ~~for~~We ~~their~~cannot ~~losses~~easily predict the amount of these damages, and while palmOne has prevailed at the current stage of the litigation on those claims made by Xerox, if it is not ultimately successful in the litigation, damages could be substantial. While we believe that there are adequate defenses to

We38 evaluate the validity and applicability of third-party 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, Palm OS licensees or end users of Palm Powered products are infringing or contributing to the infringement of their intellectual property rights, and we may be found to

~~infringe or contribute to~~ the ~~infringement~~claims ofmade ~~those~~by ~~intellectual~~Xerox, ~~property~~we ~~rights~~cannot ~~and~~assure ~~require~~you athat ~~license~~palmOne towill ~~use those rights. We may~~ be ~~unaware~~successful ofor ~~intellectual property rights of others~~ that ~~may~~an ~~cover~~adverse ~~some~~outcome ofwill ~~our~~not ~~technology,~~significantly ~~products and services. In addition~~harm, our ~~licensees~~business, ~~may be entitled to seek indemnification from us for any claims~~ results of ~~infringement~~operations ~~brought~~and ~~against~~financial ~~them~~condition ~~that~~would ~~arise~~be ~~out~~significantly ofharmed, ~~the~~and ~~intellectual property~~we ~~they~~may ~~have~~be ~~licensed~~rendered ~~from us~~insolvent.

In addition, if palmOne is required to pay damages to Xerox, they may no longer be able to pay us the minimum annual commitments due under our license agreement with palmOne. Accordingly, if Xerox is successful in its claims against palmOne, and palmOne does not or is unable to indemnify us for these claims, our business, results of operations, financial condition and cash flows could be significantly harmed, and we may be rendered insolvent.

Third parties have claimed and may claim in the future that our products infringe their intellectual property; if these claims are successful, we could suffer significant litigation or licensing expenses or be prevented from licensing Palm OS and other software products to our licensees who sell Palm Powered products.

In the course of our business, we receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. For example, the SCO Group, Inc., or SCO, has publicly alleged that certain Linux kernels, similar to those used in the mLinux operating system developed by CMS, contain unauthorized UNIX code or derivative works of that UNIX code, and in which SCO claims copyright ownership. While SCO, to date, has not asserted a claim of infringement against CMS uncertainty concerning SCO’s allegations, regardless of their merit, could adversely affect sales of CMS’ products. If SCO were to prevail in this or other actions related to its claims regarding Linux, our business could be materially and adversely affected.

We evaluate the validity and applicability of third-party 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, Palm OS licensees or end users of Palm Powered products 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. In addition, our licensees may be entitled to seek indemnification from us for any claims of infringement brought against them that arise out of the intellectual property they have licensed from us.

Any litigation regarding patents or other intellectual property is likely to be costly and time consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements or indemnify our customers. However, we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all, and the obligations under such agreements could result in substantial expenses. If we are unable to enter into royalty or license agreements, our business may be harmed. In addition, a licensee’s or developer’s development, marketing or sales of our products could be severely disrupted or shut down as a result of litigation or claims of infringement, which could adversely affect our business, results of operations and financial condition. We also may be subject to significant monetary damages or court-ordered injunctions that restrict or prevent the development and sale of our products. Any or all of these factors could have a material adverse effect on our business, results of operations and financial condition.

We make use of intellectual property that was developed prior to our separation from Palm. In connection with the separation, we executed agreements that allocated ownership of and granted cross-licenses to intellectual property of PalmSource and Palm. In the future, palmOne or a successor to palmOne may seek to use these agreements to restrict our use of intellectual property that was allocated or licensed to us by these agreements. For example, palmOne may interpret field-of-use restrictions differently from us, so as to restrict us from using licensed intellectual property in the fulfillment of our business plans or to allow palmOne to use intellectual property in a way that adversely impacts our business. In addition, palmOne may seek to interpret the allocation of rights under the separation agreements so as to obtain ownership of intellectual property currently owned by us. Furthermore, if palmOne does not hold clear and complete title to the intellectual property retained by it under these agreements, or holds this intellectual property subject to prior grants of licenses or other rights, our license to use this intellectual property may be invalidated or impaired by a third party possessing ownership, license, or other rights.

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 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 business and results of operations.~~

~~Our~~39 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 our patent or trademark applications or registrations. Even if 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. Policing 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. Regardless of the merits of any claim, intellectual property litigation is expensive and time-consuming and could divert our management’s attention from operating our business. Despite our efforts, we may not be successful in any litigation or other enforcement action we may bring, may not be able to detect infringement and, as a result, may lose competitive position in the market. In

~~addition,~~may ~~competitors~~not ~~may~~provide ~~design~~us ~~around~~a ~~our~~significant ~~technology~~competitive oradvantage. ~~develop~~If ~~competing~~we ~~technologies.~~fail ~~Intellectual~~to ~~property~~protect ~~rights~~or ~~may~~to ~~also~~enforce beour ~~unavailable~~intellectual orproperty ~~limited~~rights insuccessfully, our competitive ~~some~~position ~~foreign~~could ~~countries~~suffer, which could ~~make~~harm itour ~~easier~~business ~~for~~and ~~competitors~~results toof ~~capture market share~~operations.

Our pending patent and trademark applications for registration may not be allowed, or others may challenge the validity or scope of our patents or trademarks, including our patent or trademark applications or registrations.

Even if 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.

In the past, there have been thefts and attempted thefts of computer equipment from us and our employees. This computer equipment has contained proprietary information and intellectual property. We have formulated a security plan to reduce the risk of any future thefts and have cooperated with law enforcement officials in an investigation of past incidents. We also generally enter into confidentiality agreements with our employees and with our licensees and our developers. We may not be successful in preventing future thefts, or in preventing those responsible for past thefts from using our technology to produce competing products. The unauthorized use of our technology by competitors could have a material adverse effect on our ability to sell our products.

In addition, certain products or technologies acquired or developed by us, including for example the Linux-based products of our CMS subsidiary, may ~~include~~incorporate so-called “open source” software. Open source software is typically licensed for use at no initial charge, but certain open source software licenses impose on the ~~user~~licensee of the applicable open source software certain requirements to license or make available to others both the open source software as well as the software that relates to, or interacts with, the open source software. Our ability to commercialize products or technologies incorporating open source software or otherwise fully realize the anticipated benefits of any such acquisition may be restricted as a result of using such open source software because, among other reasons:

•

open source license terms may be ambiguous and may result in being subject to unanticipated obligations regarding our products and technologies;

•

competitors may have improved access to information that may help them develop competitive products;

•

open source software cannot be protected under trade secret law;

•

it may be difficult for us to accurately determine the origin of the open source code and whether the acquired open source software in fact infringes third party intellectual property rights; and

•

open source software potentially increases customer support costs because (i) such software typically does not contain warranties as to functionality or is not accompanied by any support offerings from the provider of such open source software and (ii) licensees can modify the software and potentially introduce errors.

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 the ~~complexity of the technical issues involved, among other things, and we cannot assure you that we will be successful in enforcement of, or defending ourselves against, intellectual~~ property claims. Moreover, patent litigation has increased due to the current uncertainty of the law and the increasing competition and overlap of product functionality in the field. Attempts may be made to copy or reverse engineer aspects of our product or to obtain and use information that we regard as proprietary. Accordingly, we cannot assure you that we will be able to protect our proprietary rights against unauthorized third-party copying or use. Unauthorized use by others of our proprietary rights could materially harm our business.

We40 currently intend to expand our international presence in countries that may not protect our intellectual property rights to the same extent as the laws of the United States, which may increase the risk of infringement of our intellectual property.

As part of our business strategy, we intend to expand our international presence by targeting countries with large populations and propensities for adopting new technologies including China, India and Brazil. However, many of the countries we are targeting do not prevent misappropriation of intellectual property or deter others from developing similar, competing technologies or intellectual property that infringe our rights. Effective copyright, trademark and trade secret protections may be unenforceable, unavailable or limited in some foreign

~~countries.~~complexity Inof ~~particular,~~ the ~~laws~~technical ofissues ~~some~~involved, ~~foreign~~among ~~countries~~other inthings, ~~which~~and ~~our~~we ~~technology~~cannot isassure ~~licensed,~~you orthat ~~may~~we inwill ~~the~~be ~~near~~successful ~~future~~in beenforcement ~~licensed~~of, ~~may~~or ~~not~~defending ourselves ~~protect~~against, ~~our~~ intellectual property ~~rights~~claims. Moreover, patent litigation has increased due to the ~~same~~current ~~extent~~uncertainty asof the ~~laws~~law ofand the ~~United~~increasing ~~States.~~competition Asand aoverlap ~~result,~~of weproduct ~~may~~functionality ~~not~~in the field. Attempts may be ~~able~~made to ~~effectively~~copy ~~prevent~~or reverse ~~competitors~~engineer inaspects ~~these~~of ~~regions~~our ~~from~~product ~~infringing~~or onto ~~our~~obtain ~~intellectual~~and ~~property~~use ~~rights~~information that we regard as proprietary. Accordingly, ~~which~~we ~~would~~cannot ~~reduce~~assure ~~our competitive~~you ~~advantage~~that ~~and~~we ~~ability~~will be able to ~~compete~~protect inour ~~these~~proprietary ~~regions~~rights ~~and~~against ~~negatively~~unauthorized ~~impact~~third-party copying or use. Unauthorized use by others of our proprietary rights could materially harm our business.

We ~~currently~~have ~~intend~~recently toexpanded ~~establish~~our ~~engineering~~operations ~~resources~~into orthe toPeople’s ~~outsource~~Republic ~~engineering~~of ~~services~~China, or ~~both~~China, ~~outside~~and ofcurrently ~~the~~intend ~~United~~to ~~States~~expand our international presence in other countries that may not protect our intellectual ~~property and confidential~~ ~~information or the intellectual~~ property orrights ~~confidential information of our licensees or partners~~ to the same extent as the laws of the United States., ~~This~~which may increase the risk of ~~misappropriation or~~ infringement of our intellectual property ~~or confidential information, or the intellectual property or confidential information of our licensees or partners~~.

As part of our business strategy, we have recently expanded our operations into China and currently intend to ~~establish~~expand ~~engineering~~our ~~resources~~international orpresence toby targeting ~~outsource~~other ~~engineering~~countries ~~services~~with orlarge ~~both~~populations inand ~~China~~propensities ~~and~~for adopting new technologies, such as India and Brazil. However, China and other countries we are targeting may not prevent misappropriation of intellectual property or deter others ~~Effective~~from ~~patent~~developing similar, competing technologies or intellectual property that infringe our rights. Effective copyright, trademark and trade secret protections may be unenforceable, unavailable or limited in ~~these~~some foreign countries. In particular, the laws of ~~China~~some orforeign ~~India~~countries ~~may~~in ~~not~~which ~~protect~~ our ~~intellectual~~technology ~~property~~is ~~rights~~licensed, ~~and~~or ~~our~~may ~~confidential~~in ~~information~~the ornear ~~that of~~future be licensed, may not protect our ~~licensees~~intellectual ~~and~~property ~~partners~~rights to the same extent as the laws of the United States. As a result, we may not be able to effectively prevent ~~people~~competitors ~~or entities~~ in these regions, ~~including our employees and consultants or our competitors,~~ from ~~misappropriating~~ or infringing on our intellectual property rights ~~and confidential information or that of our licensees or partners~~, which ~~could~~would reduce our competitive advantage and ability to compete in ~~our~~these ~~markets,~~regions ~~cause us to incur substantial legal fees, expose us to liability to third parties, including our licensees~~ and ~~partners, result in strained relationships with or licensees and partners and otherwise~~ negatively impact our business.

Through our recent acquisition of CMS, we have established engineering resources in China. As part of our business strategy, we continue to evaluate locations to establish engineering resources or to outsource engineering services. Effective patent, copyright, trademark and trade secret protections may be unavailable or limited in these countries. In particular, certain jurisdictions may not protect our intellectual property rights and our confidential information or that of our licensees and partners to the same extent as the laws of the United States. As a result, we may not be able to effectively prevent people or entities in these regions, including our employees and consultants or our competitors, from misappropriating or infringing on our intellectual property rights and confidential information or that of our licensees or partners, which could reduce our competitive advantage and ability to compete in our markets, cause us to incur substantial legal fees, expose us to liabilities to third parties, including our licensees and partners, result in strained relationships with our licensees and partners and otherwise negatively impact our business.

If we do not continue to support our third-party developer community or provide attractive incentives to encourage application development, these developers may cease development of new Palm OS applications, which could affect our competitive advantage, lower the value of our products to end users and affect our licensees’ ability to market their products incorporating our products and services.

The proliferation of applications that run on Palm Powered products has largely been attributable to our extensive third-party developer community, which we continue to rely on for future application development. There are ~~approximately 300~~more than 400,000 registrants in our Palm OS developer program which offers Palm OS developer tools, ~~program~~programs, and support to enable the creation of software applications for our platform. According to PalmGear.com, a leading online provider of handheld applications, more than 2026,~~000~~500 software titles are available for Palm Powered products in English with additional applications and content available in other languages worldwide. There is no guarantee that third parties who have registered as developers have actually developed applications or will do so in the future. We must continue to provide support for developers and provide attractive incentives to encourage future Palm OS application development. For example, we do not have the resources to provide cash incentives to our developers, as some of our competitors do. If we are unable to retain our existing developer community and attract additional third-party developers, the availability of new software applications for Palm OS may be adversely affected, which could affect our ability to compete, lower the value of Palm Powered products to end users and affect our licensees’ ability to market our products and services, cause our operating results to fluctuate and adversely affect our business, results of operations and financial condition.

If41 we are unable to obtain key technology from third parties on a timely basis that is free from errors or defects or we are required to develop such technology ourselves, we may have to cancel or delay the release of certain features in the Palm OS platform and product shipments or incur increased costs.

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

~~licensee~~our ~~will~~existing ~~develop~~developer acommunity ~~specific feature for the Palm OS platform that we will then own~~ and ~~may~~attract ~~later~~additional ~~incorporate into new releases of the Palm OS platform. 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 and we are unable to obtain alternative technology to use in our products. As a result~~developers, ~~our~~the ~~product shipments~~availability ~~could~~of benew ~~delayed~~software orapplications ~~our~~for ~~offering~~Palm ofOS ~~features~~may ~~could~~ be ~~reduced~~adversely affected, which could ~~adversely~~ affect our ~~business~~ability orto ~~results~~compete, oflower ~~operations.~~the Invalue ~~addition,~~of ~~our~~Palm ~~reputation~~Powered ~~and~~products ~~business~~to ~~could~~end beusers ~~harmed~~ and weaffect ~~could~~our ~~incur~~licensees’ ~~damages~~ability ~~if third-party licensed software contains errors or defects that are not discovered and fixed prior~~ to ~~release~~market of our products. ~~Furthermore~~and services, acause ~~third-party~~our ~~developer~~operating orresults ~~joint~~to ~~developer~~fluctuate ~~may~~and ~~improperly use or disclose the software, which could~~ adversely affect our ~~competitive~~ ~~position. Because we license some of our development tools from third parties, our~~ business would suffer if we could no longer obtain those tools from those third parties or if the tools developers wanted to use were not available. If we are unable to offer technology that our licensees need to build successful Palm Powered products, ~~which~~results weof ~~obtain~~operations byand ~~licensing~~financial ~~the technology from third parties or developing it internally, then our business would suffer~~condition.

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

We license third-party software for our software as well as provide software development tools to enable applications to be written for the Palm OS platform. In addition to third-party licensed software, we may enter into development agreements with certain licensees of the Palm OS platform whereby a licensee will develop a specific feature for the Palm OS platform that we will then own and may later incorporate into new releases of the Palm OS platform. 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 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 or results of operations. In addition, our reputation and business could be harmed and we could incur damages if third-party licensed software contains errors or defects that are not discovered and fixed prior to release of our products. Further, a third-party developer may improperly use or disclose the developed software, which could adversely affect our competitive position. Because we license some of our development tools from third parties, our business would suffer if we could no longer obtain those tools from those third parties or if the tools developers wanted to use were not available. If we were unable to offer technology that our licensees need to build successful Palm Powered products, which we obtain by licensing the technology from third parties or developing it internally, then our business would suffer.

For example, Graffiti 2 includes a subcomponent of the Jot technology we license from Communication Intelligence Corporation, or CIC. If the technology components we license from CIC contain errors or defects or cannot be seamlessly integrated into the products of our licensees, our licensees’ ability to market their products may be delayed or canceled. Further, should we be required to license the Jot technology after expiration or termination of the Jot license or if the Jot technology were no longer available for any other reason, such as the termination or sale of the Jot product line by CIC or the acquisition or bankruptcy of CIC, we may be unable to renegotiate the license on favorable terms or obtain alternative technology from another third party, which may require us to license other third-party solutions, develop aspects of the functionality ourselves or cease offering certain applications or features of Palm OS. Any of these events may result in lost sales, higher licensing costs to us and delayed shipment of products based on Palm OS, which could adversely affect our business, results of operations and financial condition.

Products incorporating ~~the~~our ~~Palm~~software ~~OS technology~~ that are marketed by our licensees or other strategic partners may contain errors or defects, which could result in the rejection of our products and services and damage to our brand, as well as lost revenues, diverted development resources and increased service costs and warranty claims.

We cannot fully control the business and quality control standards of our licensees, many of whom are device manufacturers, and we are unable to completely monitor the distribution to end users of products containing our technology. We cannot assure you that the products and services provided by our licensees are free from errors or defects. If Palm Powered products contain errors or defects, it could result in the rejection of these products and services by users, damage to our reputation, lost revenues and diverted development resources, which could adversely affect our business and results of operations. The presence of errors or defects in Palm Powered products could also result in increased customer service and support costs and warranty claims and could subject us and our licensees to product liability claims, any of which could harm our business, results of operations and financial condition.

We42 ~~may periodically restructure our operations or change our pricing model, which could harm our operating results in the short term before we receive any benefits from these changes, if at all.~~

~~connection~~We ~~with~~may ~~such~~periodically arestructure ~~restructuring that could harm~~ our ~~business~~operations ~~before~~or wechange ~~were to receive any benefit, if at all, from the restructuring. In addition, we may introduce changes to~~ our pricing model, ~~and~~which ~~these~~could ~~changes~~harm ~~may~~our ~~not~~operating ~~result~~results in ~~increased or even~~ the ~~same~~short ~~level~~term ofbefore ~~revenues~~we inreceive ~~the~~any ~~timeframes~~benefits ~~that~~from wethese ~~anticipate~~changes, orif at all.

We continually evaluate the strengths and weaknesses of our operations. In connection with this evaluation, we may decide to reduce or realign our available resources and, as a result, shut down or sell business lines that do not fit into our long-term business plan. For example, in June 2005, August 2004 and February 2003, we reduced our worldwide headcount by approximately 40, 16 and 60 regular employees, respectively, and in August 2003, we sold our Palm Digital Media product line to PalmGear. If we reduce headcount in the future, we will incur significant severance and termination costs and other related expenses that could harm our business before we were to receive any benefit, if at all, from the reduced headcount expenses. If we shut down any of our business lines in the future, we may incur costs or charges, receive less in the sale than such assets are worth, disrupt customer goodwill or lose revenue streams in connection with such a restructuring that could harm our business before we were to receive any benefit, if at all, from the restructuring. In addition, we may introduce changes to our pricing model, and these changes may not result in increased or even the same level of revenues in the timeframes that we anticipate, or at all.

Our operating results may suffer if we do not grow our services business as anticipated.

We believe that our future business prospects depend in part on our ability to generate service revenues from our licensees. We currently do not generate significant service revenues and may not be able to in the future. Our service offerings will have to achieve market acceptance and meet an expanding range of customer requirements to be successful. If we are not able to meet these requirements and grow our service revenues, our operating results may be harmed.

Our sales cycle is lengthy and complicated.

The development of a business relationship with a potential licensee can be a lengthy process, spanning 12 twelve months or longer. The sales cycle often involves multiple divisions within a potential licensee’s organization and multiple layers of management, thus making our sales process relatively complicated and long. Additionally, negotiating the terms of a new license agreement can be a protracted process with no set timetable for completion. Due to the length and complicated nature of our sales cycle, predicting the fiscal period in which a new license agreement will be entered into, if at all, and the financial terms of such an agreement is difficult. In addition, once a prospect becomes a licensee, the licensee must then develop a product and, providing the product development efforts are successful, commence commercial shipment of the product. This product development and commercial shipment process by our licensees is often eight to 12twelve months or longer, depending upon the complexity of the product, the licensee’s experience with Palm OS, and other factors. Because of the length of time our licensees must spend to first develop, and then commence shipment of the product, the period before we receive revenue, if any, from a new licensee can be lengthy.

The loss of key personnel could negatively impact our business.

We rely upon the continued service and performance of a relatively small number of key technical and senior management personnel. ~~Our~~As ~~future~~a ~~success depends~~result onof our ~~retention~~recent restructuring, a number of ~~these~~operating functions have been consolidated under a few key employees,. ~~such~~Our asfuture ~~David~~success ~~Nagel,~~depends on our ~~president~~retention ~~and~~of ~~chief~~these key ~~executive officer~~employees, ~~and~~such as our key executives and technical personnel. None of our key technical or senior management personnel is bound by employment or non-competition agreements, and, as a result, any of these employees could leave with little or no prior notice and compete against us. We are not the beneficiary of any life insurance policies on any of our personnel. We may not be able to provide our key technical and senior management personnel with adequate incentives to remain employed by us. The loss of any of them could ~~negatively~~have ~~impact~~a material adverse affect on our business, results of operations and financial condition.

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

Our future success depends on our ability to attract and retain highly skilled executive, technical, sales, marketing, and administrative personnel. If we fail to retain and hire an adequate number of these employees, we ~~will not be able to maintain and expand our business. Our~~ success also depends on our ability to expand, integrate and retain our management team. Recruiting and retaining skilled personnel, including software engineers, is highly competitive, particularly in the San Francisco Bay Area where we are headquartered. Volatility or lack of positive performance in our stock price may also affect our ability to retain key employees.

In43 recent quarters, we have initiated reductions in our workforce of both employees and contractors to balance the size of our employee base with our current and anticipated revenue base. These reductions have resulted in reallocations of employee duties, which could result in employee and contractor uncertainty. These and any future reductions in our workforce could make it difficult to motivate and retain the remaining employees and contractors, which would affect our ability to deliver our products and services in a timely fashion and negatively affect our business. We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business objectives. We have initiated outsourcing of certain

~~engineering~~will ~~projects~~not be able to maintain and weexpand ~~expect~~our tobusiness. ~~increase~~Our success also depends on our ~~level~~ability ofto ~~outsourcing~~expand, inintegrate ~~the~~and ~~future~~retain our management team. ~~The~~Recruiting and ~~outsourcing~~retaining ~~may~~skilled ~~make~~personnel, itincluding ~~difficult~~software toengineers, ~~motivate~~is ~~and~~highly ~~retain~~competitive, particularly in the ~~remaining~~ ~~employees~~San Francisco Bay Area where we are headquartered and ~~contractors~~our development center in Nanjing, ~~which~~China ~~would~~through ~~affect~~the ~~our~~acquisition ~~ability~~of toChina ~~deliver~~MobileSoft. Volatility ~~our~~or ~~products~~lack ~~and~~of ~~services~~positive performance in aour ~~timely~~stock ~~fashion~~price ~~and~~may ~~negatively~~also affect our ~~business~~ability to retain key employees.

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 current and anticipated revenue base. These reductions have resulted in reallocations of employee duties, which could result in employee and contractor uncertainty. These and any future reductions in our workforce could make it difficult to motivate and retain the remaining employees and contractors, which would affect our ability to deliver our products and services in a timely fashion and negatively affect our business. We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business objectives. We have outsourced or relocated offshore certain engineering projects to reduce development costs, and we expect to continue this practice in the future. This may make it difficult to motivate and retain the experienced employees and contractors in our higher cost development centers, which would affect our ability to deliver products and services in a timely fashion and could have a material adverse affect on our business.

We may not be able to successfully manage the growth and expansion of our business, which could have a material adverse effect on our business, results of operations and financial condition.

We plan to increase our scope of operations domestically and internationally, an example of which is our recent acquisition of CMS. The recent addition of our operations in China will increase our exposure to certain risks including attracting and retaining qualified personnel, transition of certain engineering activities, realignment of our resources for cost savings, realization of any anticipated cost savings, business practices which may be different from our other business locations, and increased controls for monitoring and reviewing activities. We may not be equipped to successfully manage any future periods of rapid growth or expansion, which could be expected to place a significant strain on our limited managerial, financial, engineering and other resources. Any delays or difficulties in our research and development process caused by these factors or others could make it difficult for us to develop future generations of our technology and to remain competitive. In addition, the rapid rate of hiring new employees, including several key employees, could be disruptive and could adversely affect the efficiency of our research and development process. The rate of our future expansion, if any, in combination with the complexity of the technology involved in our licensing business model, may demand an unusually high level of managerial effectiveness in anticipating, planning, coordinating and meeting our operational needs as well as the needs of our licensees. Additionally, we may be required to reorganize our managerial structure to more effectively respond to the needs of customers and other potential strategic partners. Given the small pool of potential licensees, the adverse effect resulting from a lack of effective management in any of these areas could be magnified. Inability to manage the expansion of our business could have a material adverse effect on our business, results of operations and financial condition. We historically used Palm’s operational and administrative infrastructure and may not be able to independently create an appropriate infrastructure to accommodate an expansion of the size of our operations. In addition, if we do not achieve the expected benefits from any expansion, our business, results of operations and financial condition will be harmed.

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

WeAlthough we may not be successful in expanding into particular international markets, including China, or generating revenues from foreign operations, we currently anticipate that revenues from international operations will represent an increasing portion of our total revenues over time. Expansion into international markets, such as our recent entry into China with the acquisition of CMS, requires management attention and resources. We may not be successful in expanding into particular international markets or in generating revenues from foreign operations. Accordingly, our future results could be harmed by a variety of factors related to our international operations, including:

•

changes in foreign currency exchange rates;

•

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

• natural disasters or outbreaks of infectious diseases affecting the regions in which we or our licensees sell products;

•

tariffs, trade protection measures and import or export licensing requirements;

•

potentially negative consequences from changes in foreign government regulation, tax laws and regulatory requirements;

•

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

•

disproportionate management attention or company resources;

•

changes in diplomatic and trade relationships; and

•

less effective protection of intellectual property.

We are subject to changes in demand for our products and services resulting from exchange rate fluctuations that make our products and services relatively more or less expensive in international markets. If exchange rate fluctuations occur, our business could be harmed by decreases in demand for our products and services or reductions in gross margins. Historically, we have not used derivative instruments to hedge foreign exchange rate risk. However, we may use derivative, or similar, instruments to hedge foreign exchange rate risk in the future. Our licensees are subject to many of the risks described above with respect to companies that are located in different countries, particularly manufacturers located in Asia Pacific and elsewhere. We cannot assure you that one or more of the risks associated with international licenses of our technology will not have a direct or indirect material adverse effect on our business, results of operations and financial condition.

54Our investment in CMS is subject to risks and uncertainties relating to the laws and regulations of China.

~~Table~~In January 2005, we acquired CMS, which is a company organized under the laws of ~~Contents~~The Peoples’ Republic of China, or PRC, and whose assets are located in China. As such, CMS is subject to many of the risks of doing business internationally described above under “Our future results could be harmed by economic, political, regulatory and other risks associated with international sales and operations.” Under its current leadership, the Chinese government has been pursuing economic reform policies, including the encouragement of foreign trade and investment and greater economic decentralization. No assurance can be given, however, that the government of China will continue to pursue such policies, that such policies will be successful if pursued, or that such policies will not be significantly altered from time to time. Despite progress in developing its legal system, the PRC does not have a comprehensive and highly developed system of laws, particularly with respect to foreign investment activities and foreign trade. Enforcement of existing and future laws and contracts is uncertain, and implementation and interpretation thereof may be inconsistent. As the Chinese legal system develops, the promulgation of new laws, changes to existing laws and the preemption of local regulations by national laws may adversely affect foreign investors. Further, any litigation in the PRC may be protracted and result in substantial costs and diversion of resources and management attention. In addition, some government policies and rules are not timely published, if they are published at all. As a result, we may operate our business in violation of new rules and policies without having any knowledge of their existence. These uncertainties could limit the legal protections available to us.

different countries, particularly manufacturers located in Asia Pacific and elsewhere. We cannot assure you that one or more of the risks associated with international licenses of our technology will not have a direct or indirect material adverse effect on our business, results of operations and financial condition.

If we increase our revenues from international license fees, our exposure to withholding taxes may increase.

The laws of certain countries in which we currently, or may in the future, license our technology require significant withholding taxes on payments for intellectual property, which we may not be able to offset fully against our U.S. tax obligations. Our exposure to withholding taxes may increase given our strategy to aggressively pursue opportunities in foreign countries. We are subject to the further risk that tax authorities in those countries may re-characterize certain engineering fees as license fees, which could also result in increased tax withholdings ~~and penalties.~~

aggressively pursue opportunities in foreign countries. We are subject to the further risk that tax authorities in those countries may re-characterize certain engineering fees as license fees, which could also result in increased tax withholdings and penalties.

If we are not able to successfully enter into new enterprise strategic alliances with partners, our enterprise market penetration may not proceed as rapidly or as lucratively as we anticipate, which could negatively impact our results.

Our strategy to broaden the ~~usage~~use of Palm Powered devices in the enterprise includes forming strategic alliances with leading enterprise solutions and service providers to provide additional resources to further enable penetration of the enterprise market. However, certain competitors may have longer and closer relationships with the senior management of potential strategic partners who deploy mobile information device products in the enterprise. 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. If we are unable to successfully enter into strategic alliances, or if they are not as productive as we anticipate, our enterprise market penetration may not proceed as rapidly or as lucratively as we anticipate and our results of operations could be negatively impacted.

We may pursue strategic acquisitions and investments, which could have an adverse impact on our business, results of operations, financial condition and cash flows.

Within the last five years, Palm acquired and assigned to us assets of Be Incorporated, peanutpress.com, Inc., Actual Software, WeSync.com, Inc. and Smartcode Technologies SARL. We recently acquired CMS, and we will evaluate other acquisition opportunities that could advance our objectives to penetrate the smart mobile device business or provide us with additional product or service offerings or additional industry expertise or geographic presence, as such opportunities arise. Acquisitions ~~and~~involve ~~the~~numerous ~~integration of acquired companies may result in problems related to integration of technology and management teams. We may not successfully integrate operations~~risks, ~~personnel~~including ~~or products that we have acquired or may acquire in~~ the ~~future.~~following: 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. In addition, if we issue stock as consideration in an acquisition, the ownership interests of our stockholders will be diluted. Acquisitions typically include a significant amount of goodwill and other intangible assets. If the value of this goodwill is impaired over time we may have to record significant charges against earnings. In addition, we have made and may make strategic venture investments in other companies. If these investments are unsuccessful, this could have an adverse impact on our results of operations and financial position. For example, in fiscal years 2003 and 2004, we recorded an impairment charge of $3.2 million and $0.5 million, respectively, related to a private equity investment.

If• wedifficulties ~~have any impairment~~ in integrating the ~~value~~operations, ~~of our goodwill~~technologies, weproducts ~~will have~~and topersonnel ~~take~~of anthe ~~accounting~~acquired ~~charge against our earnings that might negatively impact our stock price.~~ companies;

In• ~~accordance~~diversion ~~with U.S. generally accepted accounting principles, we conduct an impairment analysis~~ of ~~our~~management’s ~~goodwill~~attention ~~annually~~from ornormal ~~whenever~~daily anoperations ~~event or change in circumstances occurs which would indicate potential impairment. If we discover significant impairment as a result~~ of ~~any~~the ~~of these tests, we would be required to record a corresponding non-cash impairment charge against our earnings that could negatively affect our stock price.~~ business;

55• potential difficulties in completing projects associated with in-process research and development;

•

insufficient revenue to offset increased expenses associated with acquisitions; and

•

potential loss of key employees of the acquired companies.

Acquisitions may also cause us to:

•

issue common stock that would dilute our current stockholders’ percentage ownership;

•

assume liabilities;

•

record goodwill and nonamortizable intangible assets that will be subject to impairment testing on a regular basis and potential periodic impairment charges;

•

incur large and immediate write-offs and restructuring and other related expenses; and

•

become subject to intellectual property or other litigation.

Mergers and acquisitions and investments in high-technology companies are inherently risky, and no assurance can be given that our previous or future acquisitions or investments will be successful and will not materially adversely affect our business, operating results, or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results. Even when an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that preacquisition due diligence will have identified all

possible issues that might arise with respect to products or the acquiree’s business. If we ~~engage~~are inunable ~~certain~~to ~~equity~~complete ~~transactions~~an acquisition or an acquisition is delayed, our ~~ability~~business tocould ~~use~~be ~~our~~adversely ~~U.S.~~affected ~~net~~due ~~operating~~to ~~loss~~diversion ~~and~~of ~~tax~~management ~~credit carryforwards~~attention ~~may~~and becompany ~~substantially~~resources ~~limited~~from alternative approaches, which ~~could~~may ~~harm~~prevent ~~our~~us ~~financial~~from ~~condition~~achieving strategic goals.

WeIn ~~are currently generating U.S. net operating losses and tax credits~~addition, ~~which~~from wetime ~~are not able~~ to ~~utilize at this~~ time. ~~Substantial~~we ~~restrictions~~have ~~are~~made ~~imposed~~acquisitions ~~on the utilization~~ of ~~net~~in-process research ~~operating losses~~ and ~~tax~~development ~~credit carryforwards~~that ifhave ~~the~~been ~~equity~~charged ~~ownership~~to ofan aindividual ~~company~~quarter. ~~changes~~These ~~such~~charges ~~that~~may ~~more~~occur ~~than~~in ~~50%~~any ofparticular ~~its stock~~quarter, ~~measured~~resulting ~~over~~in avariability ~~three-year~~in ~~period,~~our isquarterly ~~transferred to one or more “5% shareholders” during the period~~earnings. ~~Therefore~~Further, ~~our~~we ~~recent~~have ~~public~~made ~~offering~~ and ~~future~~may ~~equity~~make ~~transactions~~strategic byventure ~~us,~~investments ~~including~~in other ~~issuance~~companies. ofIf ~~our~~these ~~stock~~mergers inand aacquisitions ~~merger~~ or ~~acquisition,~~investments ~~may~~are ~~significantly~~unsuccessful, ~~limit~~this ~~our~~could ~~ability~~have toan ~~use~~adverse inimpact ~~the~~on ~~future~~our ~~net~~results ~~operating~~of ~~loss~~operations and ~~tax~~financial ~~credit carryforwards existing at the time of any ownership change~~position. ~~Since~~ ~~the~~For ~~limitation~~example, isin ~~based~~fiscal onyears a2003 ~~number~~and ~~of factors~~2004, we ~~cannot~~recorded ~~determine~~an ~~the~~impairment ~~impact~~ charge of ~~such~~$3.2 amillion ~~limitation~~and at$0.5 ~~this~~million, ~~time~~respectively, ~~but~~related ~~if our ability~~ to ~~use~~a ~~net~~private ~~operating~~equity ~~loss and tax credit carryforwards were substantially limited, it could harm our financial condition~~investment.

~~Recent~~We may also incur third party costs in the evaluation, negotiation and ~~proposed~~completion ~~regulations~~of ~~related~~acquisitions. toThese ~~equity~~costs ~~compensation~~are deferred and treated as part of the acquisition cost upon completion of the acquisition. If an ~~could~~acquisition ~~adversely~~is ~~affect~~not ~~our~~completed, ~~ability~~the deferred costs are charged to ~~attract~~earnings ~~and~~in ~~retain~~the ~~key~~period ~~personnel~~in which the acquisition is certain not to be completed, which can impact our results of operations.

~~Since~~New ~~the~~regulations ~~distribution,~~related weto ~~have used stock options and other long-term~~ equity ~~incentives as a fundamental component of our employee~~ compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with our company. Several regulatory agencies and entities are considering regulatory changes that could ~~make~~adversely itaffect more difficult or expensive for us to grant stock options to employees. For example, the Financial Accounting Standards Board has announced that it will propose changes to the U.S. generally accepted accounting principles that, if implemented, would require us to record a charge to earnings for employee stock option grants. In addition, new regulations implemented by the Nasdaq National Market generally requiring stockholder approval for all stock option plans could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant stock options to employees, we may incur increased compensation costs, change our ~~equity~~ability ~~compensation strategy or find it difficult~~ to attract, ~~retain~~ and ~~motivate~~retain ~~employees,~~key ~~each of which could materially and adversely affect our business~~personnel.

Since the distribution, we have used stock options and other long-term equity incentives as a fundamental component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with our company. Recent regulatory changes could make it more difficult or expensive for us to grant stock options to employees. For example, in December 2004 the Financial Accounting Standards Board issued Statement No. 123(R), “Share-Based Payment” (revised 2004). Statement 123(R) will require us to measure all stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, the adoption of Statement 123(R) will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. Statement 123(R) is effective beginning of fiscal 2007. In addition, new regulations implemented by the Nasdaq National Market generally requiring stockholder approval for all stock option plans could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant stock options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.

Business interruptions could adversely affect our business.

Our operations and those of our licensees, developers and customers are vulnerable to interruption by fire, flood, earthquake, power loss, telecommunications failure, terrorist attacks, wars and other events beyond our control. Our corporate headquarters are located in California, near major earthquake faults~~, and adjacent to a privately operated, natural gas-fueled cogeneration plant~~. In addition, we have a significant research and development operation in France, which could be impacted by nationwide service interruptions from time to time. A catastrophic event that results in the destruction of any of our critical business or information technology systems could severely affect our ability to conduct normal business operations and as a result, our future operating results could be adversely affected. Our operations could also be negatively impacted by events such as outbreaks of infectious disease, for example the recent outbreak of Severe Acute Respiratory Syndrome and its negative effect on the Asian economy. The business interruption insurance under which we are covered may not be sufficient to compensate us fully for losses or damages that may occur as a result of these events, if at all. Any such losses or damages incurred by us could have a material adverse effect on our business.

AsCompliance ~~part~~with ofnew ~~our~~rules ~~separation from Palm, we have certain rights, restrictions~~ and ~~obligations~~regulations toconcerning acorporate ~~customer~~governance ~~database~~may ~~jointly~~be ~~created~~costly, bywhich ~~Palm and us. Our loss of use of this customer database~~ could ~~delay~~harm our ~~anticipated revenue from our online store or cause such revenue not to materialize~~business.

AsThe ~~part~~Sarbanes-Oxley Act of ~~our~~2002, ~~separation~~or ~~from~~Sarbanes-Oxley, ~~Palm~~requires, weamong ~~received certain rights to use a customer database we jointly created with Palm. With these rights came certain~~other ~~obligations~~things, ~~for~~that ~~and~~companies ~~restrictions~~adopt onnew ~~our~~corporate ~~use~~governance ofmeasures ~~the customer database. Should we be found not to be in compliance with the restrictions~~ and ~~obligations~~imposes ~~associated~~comprehensive ~~with~~reporting ~~the database,~~ and asdisclosure ~~a result lose our right to use the database~~requirements, ~~our~~sets ~~anticipated~~ ~~revenue may be delayed or not materialize at all.~~

5647

~~Compliance~~ stricter ~~with~~independence ~~new~~and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers for securities law violations. In addition, the Nasdaq National Market, on which our common stock is traded, has adopted additional comprehensive rules and regulations ~~concerning~~relating ~~corporate~~to corporate governance. ~~may~~These belaws, ~~costly~~rules and regulations have increased the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. These new rules and regulations may also make it more difficult and more expensive for us to obtain director and officer liability insurance and make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee.

The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, requires, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers for securities law violations. In ~~addition,~~ the ~~Nasdaq~~event ~~National Market, on which our common stock is traded, has adopted~~we ~~additional~~are ~~comprehensive~~unable ~~rules~~to ~~and~~satisfy ~~regulations~~regulatory requirements relating to ~~corporate~~internal ~~governance. These laws~~control, ~~rules~~or ~~and~~if ~~regulations~~these ~~will~~internal ~~increase~~control ~~the~~over ~~scope,~~financial ~~complexity and cost of our corporate governance,~~ reporting ~~and~~are ~~disclosure~~not ~~practices~~effective, ~~which could harm~~ our ~~results~~ ~~of operations and divert management’s attention from~~ business ~~operations. These new rules~~ and ~~regulations may also make it more difficult and more expensive for us to obtain director and officer liability insurance and make it more difficult for us to attract and retain qualified members of~~ our ~~board~~stock ofprice ~~directors,~~could ~~particularly to serve on our audit committee~~suffer.

InSection ~~the~~404 ~~event~~of weSarbanes-Oxley ~~are~~requires ~~unable~~companies to ~~satisfy~~do ~~regulatory~~a ~~requirements~~comprehensive ~~relating~~and costly evaluation of their internal control over financial reporting. We have recently completed our evaluation of our internal control over financial reporting and our independent registered public accounting firm will publicly attest to such evaluation. While our evaluation resulted in our conclusion that as of June 3, 2005 our internal ~~controls~~control over financial reporting was effective, orwe ifcannot ~~these~~predict the outcome of our testing in the future periods. If we are unable to assert that our internal ~~controls~~control over financial reporting are ~~not~~ effective in any future period (or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal control), we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls, which could have an adverse effect on our business and our stock price ~~could suffer~~.

Section 404 of Sarbanes-Oxley requires companies to do a comprehensive and costly evaluation of their internal controls. As a result, during our fiscal year ending May 27, 2005, we will be required to perform an evaluation of our internal controls over financial reporting and have our auditor publicly attest to such evaluation. We have prepared an internal plan of action for compliance, which includes a timeline and scheduled activities with respect to preparation of such evaluation. Our efforts to comply with Section 404 and related regulations regarding our management’s required assessment of internal control over financial reporting and our independent auditors’ attestation of that assessment has required, and continues to require, the commitment of significant financial and managerial resources. If we fail to timely complete this evaluation, or if our auditors cannot timely attest to our evaluation, we could be subject to regulatory scrutiny and a loss of public confidence in our internal controls, which could have an adverse effect on our business and our stock price.

Changes in applicable law could affect the way we and our licensees and developers promote and sell products incorporating the Palm OS technology and limit our ability to use personal information.

We and many of our licensees and developers use electronic mail to promote products incorporating the Palm OS technology, and many Palm Powered products are available for sale through Internet sites. In addition, we and our licensees and developers collect e-mail addresses and other personal information from end users and potential end users of Palm Powered products, and use that personal information for various purposes, including marketing and customer support. The law regarding these activities is changing rapidly. For example, Congress recently enacted legislation limiting the use of unsolicited commercial e-mail, and laws regarding privacy and electronic commerce have been proposed or enacted in several states. We cannot guarantee that our activities and those of our licensees and developers will be unaffected by changes in federal, state or other applicable law, and if we violate these laws, we could be subject to substantial fines or other penalties. Applicable laws could significantly restrict our ability, or that of our licensees and developers, to promote and sell Palm Powered products, and could materially limit our use of the personal information we have gathered, which could result in lost revenues and harm our business, results of operations and financial condition.

We may repatriate cash from our foreign subsidiaries, which could result in additional income taxes that could negatively impact our results of operations and financial position. In addition, if foreign countries’ currency policies limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

One or more of our foreign subsidiaries may hold a portion of our cash and cash equivalents. If we need additional cash to acquire assets or technology, or to support our operations in the United States, and if the currency policies of these foreign countries allow us, we may repatriate some of our cash from these foreign subsidiaries to the United States. Depending on our financial results and the financial results of our subsidiaries at the time that the cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. In addition, if the currency policies of these foreign countries prohibit or limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

5748

subsidiaries to the United States. Depending on our financial results and the financial results of our subsidiaries at the time that the cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. In addition, if the currency policies of these foreign countries prohibit or limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

Risks Relating to Our Separation from Palm

~~Our~~We ~~historical financial~~may ~~information~~be required to indemnify palmOne for tax liabilities it may ~~not~~incur bein ~~representative~~connection ofwith ~~our~~its ~~results~~distribution asof aour ~~stand-alone~~common ~~company~~stock and, ~~therefore,~~each of us may ~~not~~ be ~~reliable~~required asto anindemnify ~~indicator~~the ofother ~~future~~for ~~results~~certain taxes.

~~Our~~In ~~combined~~connection ~~and~~with ~~consolidated~~the ~~financial~~distribution, ~~statements~~Palm ~~prior~~received toa ~~December~~private 3letter ruling from the Internal Revenue Service, ~~2001~~or ~~have~~IRS, ~~been~~to ~~carved~~the ~~out~~effect ~~from~~that the ~~consolidated financial~~distribution ~~statements~~of our shares of common stock by Palm ~~using~~to ~~the~~its ~~historical~~stockholders ~~results~~in ofOctober ~~operations~~2003 ~~and~~would ~~historical~~not ~~bases~~be taxable ofto ~~the~~Palm ~~assets~~or ~~and~~its ~~liabilities~~stockholders. ofThis ~~the~~ruling ~~PalmSource~~is ~~business~~generally ~~that~~binding weon ~~comprise.~~the ~~Accordingly~~IRS, subject to the ~~historical~~continuing ~~financial~~accuracy ~~information~~of ~~that~~certain wefactual ~~have~~representations ~~included~~and inwarranties. ~~this report~~Although ~~for~~some ~~periods~~facts ~~prior~~changed toafter the issuance of the ruling and before the distribution, ~~does~~in the opinion of palmOne’s tax counsel, these changes did not ~~necessarily~~adversely ~~reflect~~affect ~~what~~the ~~our~~validity ~~financial~~of ~~position,~~the ~~results~~private ruling. Notwithstanding the receipt of ~~operations~~the ruling and ~~cash~~the ~~flows~~opinion ~~would~~of ~~have~~counsel ~~been~~described ~~had~~above, wethe ~~been~~PalmSource astock distribution ~~separate,~~may ~~stand-alone~~nonetheless ~~entity~~result ~~during~~in ~~the~~significant ~~periods~~taxable ~~presented.~~gain ~~Palm~~to ~~did~~palmOne ~~not~~under ~~account for~~Section ~~us,~~355(e) ~~and~~of wethe ~~were~~Internal ~~not~~Revenue ~~operated~~Code, asor athe ~~separate~~Code, ~~stand-alone~~if ~~entity~~50% ~~for~~or ~~most~~more of the ~~periods~~stock ~~presented.~~of ~~Revenues~~palmOne ~~from~~or ~~Palm~~our ~~were~~stock ~~not~~is ~~recorded~~acquired ~~until~~as ~~December~~part 3,of ~~2001,~~a ~~the~~plan ~~effective~~or ~~date~~series of ~~our~~related transactions ~~software~~that ~~license~~include ~~agreement~~the ~~with~~PalmSource ~~Palm~~stock distribution.

WeUnder ~~have~~the ~~not~~tax ~~made~~sharing ~~adjustments~~agreement between Palm and us, we would be required to indemnify palmOne if the sale or transfer of our ~~historical~~stock ~~financial~~(pursuant ~~information~~to a public offering or otherwise during periods before and/or after the distribution) causes the distribution of our stock in October 2003 to be taxable to palmOne. In such event, the amount of taxable gain would be based on the fair market value of our stock at the time it was distributed to the Palm stockholders. Our public offering completed ~~reflect~~in ~~many~~April ~~significant~~2004 ~~changes~~did ~~that~~not trigger any tax liabilities to palmOne pursuant to Section 355(e) for which we would have any indemnity obligations. However, in order to avoid triggering this tax indemnity obligation in the future, we will ~~occur~~be limited in our ability ~~cost~~to ~~structure~~issue our stock in other public offerings, ~~funding~~and possibly in certain other circumstances. The rules under Section 355(e) are quite complex and ~~operations~~subject asto asignificant ~~result~~uncertainty. ofAlthough we will monitor our ~~separation~~subsequent ~~from~~stock ~~Palm~~offerings in an effort to avoid triggering this potential tax liability, ~~including~~there ~~increased~~can ~~costs~~be ~~associated~~no assurance that the IRS will not take the position that this offering, in combination with ~~reduced~~certain ~~economies~~other ofstock ~~scale~~offerings or transfers that have been made, ~~increased~~or ~~marketing~~may ~~expenses~~in ~~related~~the tofuture ~~building~~be amade, ~~company~~is ~~brand~~sufficient ~~identity~~to ~~separate~~trigger ~~from~~taxable ~~palmOne~~gain ~~and~~to ~~increased~~palmOne ~~costs~~under ~~associated~~Section 355(e) with ~~being~~respect to the October 2003 distribution of our stock. If such a ~~publicly~~claim ~~traded~~were successfully pursued by the IRS, ~~stand-alone~~our ~~company~~indemnity obligation to palmOne under the tax sharing agreement could be quite substantial, and we may not have sufficient cash or other assets to satisfy our contractual obligation.

palmOne is subject to general commercial and other litigation claims as part of its operations, which could implicate the Palm OS technology or products incorporating Palm OS and result in claims against us in the future.

In the course of palmOne’s business, it occasionally receives claims related to consumer protection, general commercial claims related to the conduct of its business, intellectual property infringement and the performance of its products and services and other litigation claims, such as stockholder derivative class action lawsuits. palmOne is currently subject to a number of these claims. Though the claims currently do not name us as defendants, the substance of the claims may implicate us, preclude us from selling certain products or features, result in claims against us in the future or require us to indemnify palmOne.

We can no longer rely on palmOne to fund our future capital requirements as we have in the past, and financing from other sources may not be available on favorable terms or at all.

In the past, most of our capital needs were satisfied by Palm. Since the separation of the Palm and PalmSource businesses, Palm has made net capital contributions and transfers to us of $47.9 million, consisting of capital contributions and transfers of $38.1 million in fiscal year 2002 reduced by a capital distribution and transfers of $1.4 million during fiscal year 2003 and net capital contributions and transfers of $11.2 million from the beginning of fiscal year 2004 through the distribution date, October 28, 2003. However, since the distribution, palmOne is no longer providing funds to finance our working capital or other cash requirements.

We believe that our capital requirements will vary greatly from quarter to quarter, depending on, among other things, fluctuations in our operating results, financing activities, acquisitions and investments. In addition, we expect that general and administrative expenses will increase in the future due in part to operating as a public company. In particular, as a result of the distribution, we have a large stockholder base and expect to incur significant costs associated with routine stockholder communications, in addition to the potentially significant

legal and regulatory compliance cost associated with being a public company. We may require, or choose to obtain, additional debt or equity financing to finance acquisitions or other investments in our business. We may also require additional financing if our operating and working capital requirements vary materially from those currently planned. Future equity financings would be dilutive to the ownership interests of existing holders of our common stock. Future debt financings could involve unfavorable interest rates and/or restrictive covenants and would require us to use our future cash to make principal and interest payments. If we require additional financing and are unable to obtain it under reasonable terms or at all, we may be required to sell assets or significantly reduce costs, which could reduce our ability to develop new products, respond to new market opportunities or compete in the marketplace. If we cannot sufficiently reduce costs, we may not be able to finance future operations or service our debt obligations.

If we fail to successfully promote a company brand identity separate from palmOne and to achieve strong brand recognition in our target markets, our product licensing and sales could be adversely affected and demand for our products and services could decrease.

In connection with our separation from Palm, we have adopted a new brand identity separate from the palmOne device business and are modifying some of the trademarks and trade names under which we conduct our business. Subject to certain restrictions, we have an exclusive license to use certain “Palm” marks in connection with our business, but are repositioning the brand to be identified with an independent operating system company rather than a device manufacturer. We believe that recognition of our Palm Powered ingredient brand, which is a brand identifying Palm OS as a key component of mobile information devices, will be important to our success, particularly in Europe and Asia Pacific, where we are expanding our operations and sales efforts. We currently have a limited marketing budget for positioning our brand and it is anticipated that we will continue to have a limited budget for the foreseeable future. If we fail to promote our Palm Powered ingredient brand successfully, or if our brand fails to achieve widespread recognition, the value of our brand may decrease. As a result, the demand for our products and services may decline and our business may be harmed.

Establishing our new Palm Powered ingredient brand has required the creation or modification of currently existing “Palm” or “palmOne” brand trademarks and trade names; protection and maintenance of these trademarks and trade names may be difficult and costly in the future, which may harm our business, results of operations and financial position.

The adoption of a new brand identity separate from the palmOne device business required creating new trademarks and trade names or modifying some of the trademarks and trade names under which we conduct our business. To protect our rights to the various trademark and trade name combinations that we wish to identify with our products, we may be required to defend the use of our trademarks and trade names, which may result in costly litigation or other actions against third parties. The difficulty and costs of protecting and maintaining our Palm Powered ingredient brand and related trademarks and trade names will also require us to expend significant company resources to enforce our rights or establish an alternative brand identity, which may harm our business, results of operations and financial position.

We may be required to indemnify palmOne for tax liabilities it may incur in connection with its distribution of our common stock and each of palmOne and us may be required to indemnify the other for certain taxes.

In connection with the distribution, Palm received a private letter ruling from the Internal Revenue Service, or IRS, to the effect that the distribution of our shares of common stock by Palm to its stockholders in October 2003 would not be taxable to Palm or its stockholders. This ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. Although some facts changed after the issuance of the ruling and before the distribution, in the opinion of palmOne’s tax counsel, these changes did not adversely affect the validity of the private ruling. Notwithstanding the receipt of the ruling and the opinion of counsel described above, the PalmSource stock distribution may nonetheless result in significant taxable gain to

palmOne under Section 355(e) of the Internal Revenue Code, or the Code, if 50% or more of the stock of palmOne or our stock is acquired as part of a plan or series of related transactions that include the PalmSource stock distribution.

Under the tax sharing agreement between Palm and us, we would be required to indemnify palmOne if the sale or transfer of our stock (pursuant to a public offering or otherwise during periods before and/or after the distribution) causes the distribution of our stock in October 2003 to be taxable to palmOne. In such event, the amount of taxable gain would be based on the fair market value of our stock at the time it was distributed to the Palm stockholders. Our recent public offering completed in April 2004 did not trigger any tax liabilities to palmOne pursuant to Section 355(e) for which we would have any indemnity obligations. However, in order to avoid triggering this tax indemnity obligation in the future, we will be limited in our ability to issue our stock in other public offerings, and possibly in certain other circumstances. The rules under Section 355(e) are quite complex and subject to significant uncertainty. Although we will monitor our subsequent stock offerings in an effort to avoid triggering this potential tax liability, there can be no assurance that the IRS will not take the position that this offering, in combination with certain other stock offerings or transfers that have been made, or may in the future be made, is sufficient to trigger taxable gain to palmOne under Section 355(e) with respect to the October 2003 distribution of our stock. If such a claim were successfully pursued by the IRS, our indemnity obligation to palmOne under the tax sharing agreement could be quite substantial, and we may not have sufficient cash or other assets to satisfy our contractual obligation.

Notwithstanding the foregoing, we believe the current temporary regulations promulgated under Section 355(e) will not materially adversely affect our ability to use our stock as consideration to acquire the assets or stock of other business entities or operations, or to raise equity capital in other than the public offering context.

In addition, under the tax sharing agreement, palmOne and we have agreed to indemnify each other for certain taxes and similar obligations that the other party could incur under certain circumstances. Although palmOne is required to indemnify us for its own taxes, we may be held liable by the applicable taxing authority for any income taxes imposed on other members of the palmOne consolidated group for those tax periods during which we were a member if such taxes are not paid by palmOne or some other member.

We may be limited in the amount of stock we issue in subsequent public equity offerings.

To avoid triggering taxable gain for palmOne pursuant to Section 355(e) of the Code for which we would be liable, we may be limited in the amount of stock we issue in ~~subsequent~~future public offerings. This could seriously restrict our ability to access the public markets to raise additional equity capital in the future at a time when such access would be beneficial to us. These same concerns would also limit our ability to use our stock as consideration to effect any acquisition or business combination, or to engage in a private offering of our stock, in circumstances where substantial negotiations regarding such transaction, or a similar transaction, commenced prior to the October 2003 distribution of our stock. Because no such negotiations occurred prior to the October 2003 distribution of our stock, however, we do not believe these particular tax provisions will materially adversely affect our ability to use our stock to effect acquisitions or business combinations, or to engage in a private ~~offering of our stock, in the future. However, we cannot~~ ~~assure you that the Internal Revenue Service will not take a contrary position.~~

We49 ~~may have potential business conflicts of interest with palmOne with respect to our past and ongoing relationships, which may not be resolved on terms favorable to us.~~

Conflicts of interest may arise between palmOne and us in a number of areas relating to our past and ongoing relationships, including:

• indemnification obligations to each other;

• labor, tax, employee benefit and other matters arising from our separation from Palm;

• offering ~~intellectual~~of ~~property~~our ~~matters~~stock, ~~including~~in ~~management~~the offuture. ~~our~~However, ~~brand;~~we ~~and~~cannot assure you that the Internal Revenue Service will not take a contrary position.

• business opportunities that may be attractive to both palmOne and us.

In addition, either party may make strategic choices that are not in the best interest of the other party. For example, other than restrictions on the use of certain trademarks and domain names, nothing prohibits palmOne from competing with us or offering products based on a competing operating system. We may not be able to resolve any potential conflicts that may arise between palmOne and us, and even if we are able to do so, the resolution may be less favorable than if we were dealing with a third party.

Our directors and executive officers may have conflicts of interest.

Some of our directors and officers own shares of palmOne common stock and options to purchase shares of palmOne common stock. In addition some directors and officers of palmOne own shares of our common stock as a result of the distribution. Ownership of shares of palmOne common stock by our directors and officers, ownership of shares of our common stock by palmOne’s directors and officers and/or having directors serve as directors of both companies now that we have been separated from palmOne could create, or appear to create, potential conflicts of interest when directors and officers are faced with decisions that could have different implications for palmOne and us. Currently, one of our directors, Eric Benhamou, is the chairman of our board of directors and is also a director and the chairman of palmOne’s board of directors. In addition, one of our directors, Satjiv Chahil, has entered into a consulting agreement with us, and was recently employed by, and is a consultant to, palmOne. Mr. Benhamou has announced his intention to resign from our Board after our annual stockholder meeting in October 2004 and Mr. Chahil will not stand for re-election at that meeting. Another of our directors, Robert Finocchio, has a sister who was until recently an executive officer of Palm.

Under the rules and regulations of Nasdaq and the Securities and Exchange Commission relating to the composition of audit committees of boards of directors, our audit committee must consist entirely of independent members of our Board of Directors. However, the Board of Directors may, under exceptional and limited circumstances, appoint one member of the audit committee who is not independent if the Board of Directors determines such appointment is in our best interest and in the best interest of our stockholders; provided that the member is not a current officer, employee or family member of any officer or employee of ours. Our audit committee members are Robert Finocchio (Chairperson), John Shoven and Betsy Rafael. Robert Finocchio is not an independent director because his sister was until recently an executive officer of Palm. Our Board of Directors has determined that it is in our best interest and in the best interest of our stockholders to have Mr. Finocchio serve on the audit committee. Ms. Rafael will be appointed to serve as Chairperson after the annual stockholder meeting.

Creditors of Palm at the time of the PalmSource distribution may attempt to challenge the distribution as a fraudulent conveyance, which could result in either our stockholders being required to turn over some or all of their shares of our common stock or palmOne or us to fund the liabilities of creditors of Palm, which could adversely impact our business.

A court, in a lawsuit by an unpaid creditor or representative of creditors of Palm, such as a trustee in bankruptcy, may be asked to void the PalmSource distribution, in whole or in part, as a fraudulent conveyance if the court were to find that, among other things, at the time of the distribution, Palm or we:

• were insolvent;

• were rendered insolvent by reason of the distribution;

• were engaged in a business or transaction for which Palm’s or our remaining assets constituted unreasonably small capital; or

• intended to incur, or believed it would incur, debts beyond its ability to pay such debts as they matured.

The court could then require that our stockholders return some or all of the shares of our common stock, or require palmOne or us, as the case may be, to fund liabilities of the other company for the benefit of creditors, which could adversely affect our business. The measure of insolvency for purposes of the foregoing will vary depending upon the jurisdiction whose law is being applied. Generally, however, each of palmOne and us, as the case may be, would be considered insolvent if the fair value of its assets were less than the amount of its liabilities or if it incurred debt beyond its ability to repay such debt as it matures.

Risks Relating to the Stock Market

Our stock price may continue to be volatile.

Our common stock has experienced substantial price volatility, including as a result of announcements by our competitors, our licensees and us. Furthermore, speculation in the press or investment community about our strategic position, financial condition, results of operations, business or significant transactions can cause changes in our stock price. In addition, the stock market has experienced extreme price and volume fluctuations that have affected the market price of many technology companies, in particular, and that have often been unrelated to the operating performance of these companies. These factors, as well as general economic and political conditions, may materially adversely affect the market price of our common stock in the future. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom are compensated in part based on the performance of our stock price.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Foreign Exchange Risk

We are exposed to changes in foreign exchange rates. These exposures may change over time and could have a material adverse impact on our financial results. Currently, we do not utilize foreign currency forward contracts to manage the risk of exchange rate fluctuations. Our recent acquisition in China increases our exposure to foreign exchange risk in China’s currency, Yuan. We do not anticipate any material effect on our consolidated financial position due to our current exchange risk management strategy.

Interest Rate Risk

We currently maintain an investment portfolio of cash equivalents, short-term and long-term investments primarily in government obligations and money market funds. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase substantially. The primary objective of our investment activities is to maintain the safety of principal and preserve liquidity while maximizing yields without significantly increasing risk. This is accomplished by investing in marketable investment grade securities and by limiting exposure to any one issue or issuer. We do not use derivative financial instruments in our investment portfolio, and due to the nature of our investments, primarily debt securities with maturities of less than 90 days, an immediate and uniform increase in market interest rates by 10% from levels at May 31, ~~2004~~2005 would cause an immaterial decline in the fair value of our investment portfolio. We would not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

Equity Price Risk

We have a $4.0 million investment in a private company, which we valued at approximately $0.31 million as of May 31, ~~2004~~2005, due to decline in the value of the entity that we determined to be other than temporary. 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 further declines in the value of our investment or even lose the entire value of the investment.

6250

Item 8. Financial Statements and Supplementary Data

Index to ~~Combined and~~ Consolidated Financial Statements and Financial Statement Schedule

		Page
Combined and Consolidated Financial Statements:
Consolidated Financial Statements:
Report of Independent Registered Public Accounting Firm		6452
Combined and Consolidated Statements of Operations		65
Management’s Report on Internal Control over Financial Reporting		54
Combined and Consolidated Balance Sheets		66
Consolidated Statements of Operations		55
Combined and Consolidated Statements of Stockholders’ Equity		67
Consolidated Balance Sheets		56
Combined and Consolidated Statements of Cash Flows		68
Consolidated Statements of Stockholders’ Equity		57
Notes to Combined and Consolidated Financial Statements		69
Consolidated Statements of Cash Flows		58
Quarterly Results of Operations (Unaudited)		103
Notes to Consolidated Financial Statements		59
Quarterly Results of Operations (Unaudited)		94
Financial Statement Schedule:
Schedule II—Valuation and Qualifying Accounts		~~109~~101

6351

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of PalmSource, Inc.:

InWe ~~our~~have ~~opinion,~~completed ~~the~~an ~~combined~~integrated ~~and~~audit ~~consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position~~ of PalmSource, Inc.’s ~~and~~2005 ~~its~~consolidated ~~subsidiaries~~financial atstatements ~~May 31, 2004~~ and ~~2003 and the results~~ of ~~their~~its operations and their cash flows for each of the three years in the period ended May 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in ourinternal ~~opinion,~~control ~~the~~over financial ~~statement~~reporting ~~schedules~~as ~~listed~~of inJune ~~the accompanying index present fairly~~3, in2005 ~~all material respects, the information set forth therein when read in conjunction with the related combined~~ and ~~consolidated~~audits ~~financial~~of ~~statements.~~its ~~These financial~~2004 ~~statements~~ and ~~financial~~2003 ~~statement~~consolidated ~~schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these~~ financial statements ~~and financial statement schedules based on our audits. We conducted our audits of these statements~~ in accordance with the standards of the Public Company Accounting Oversight Board (United States). ~~Those~~Our ~~standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining~~opinions, based on ~~a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates~~our ~~made by management~~audits, ~~and~~are ~~evaluating~~presented ~~the overall financial statement presentation~~below. ~~We believe that our audits provide a reasonable basis for our opinion.~~

~~The Company was historically integrated with the businesses of Palm, Inc. through December 3, 2001 and, consequently, as indicated in Note 1, the combined~~Consolidated ~~and consolidated~~ financial statements ~~for that period have been derived from the consolidated financial statements~~ and ~~accounting records of Palm Inc. and reflect significant assumptions and allocations. Accordingly, the combined and consolidated~~ financial ~~statements~~statement doschedule ~~not necessarily reflect the financial position, results of operations, and cash flows of the Company had it been a stand-alone Company.~~

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of PalmSource, Inc. and its subsidiaries at June 3, 2005 and May 28, 2004, and the results of their operations and their cash flows for each of the three years in the period ended June 3, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying indexpresents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of June 3, 2005 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 3, 2005, based on criteria established in Internal Control—Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable

assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded CMS from its assessment of internal control over financial reporting as of June 3, 2005 because it was acquired by the Company in a purchase business combination during 2005. We have also excluded CMS from our audit of internal control over financial reporting. CMS is a wholly owned subsidiary whose total assets and total revenues represent 13% and less than 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended June 3, 2005.

/s/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

August 1917, ~~2004~~2005

6453

Management’s Report on Internal Control over Financial Reporting

Management of PalmSource, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting has been designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

The Company’s internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures are being made only in accordance with authorization of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.

Management assessed the effectiveness of the Company’s internal control over financial reporting at June 3, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework. Based on that assessment under those criteria, management has determined that, at June 3, 2005, the Company’s internal control over financial reporting was effective.

Management has excluded CMS from its assessment of internal control over financial reporting as of June 3, 2005 because it was acquired by the Company in a purchase business combination in January 2005. CMS is a wholly-owned subsidiary of the Company whose total assets and total revenues represent 12.7% and less than 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended June 3, 2005.

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting at June 3, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

The evaluation by the Chief Financial Officer and the interim Chief Executive Officer did not identify any change over our internal control over financial reporting that occurred during the quarter ended June 3, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


By:		/s/ PATRICK MCVEIGH
Name: Title:		Patrick McVeigh Interim Chief Executive Officer

By:		/s/ JEANNE SEELEY
Name: Title:		Jeanne Seeley Chief Financial Officer and Treasurer

PALMSOURCE, INC.

~~COMBINED AND~~ CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

	Year Ended May 31,
	2002			2003			2004
	2003			2004			2005
Revenues:
Related party license and royalty	$	2249,~~685~~066		$	4924,~~066~~927		$	242,~~927~~025
Third-party license and royalty		1918,~~485~~379			1842,~~379~~563			4265,~~563~~461
Total license and royalty		4267,~~170~~445			67,~~445~~490			67,~~490~~486
Related party support and service		~~997~~1,473			~~1,473~~605			~~605~~345
Third-party support and service		14,~~783~~496			45,~~496~~022			54,~~022~~080
Total support and service		25,~~780~~969			5,~~969~~627			54,~~627~~425
Total revenues		4473,~~950~~414			73,~~414~~117			7371,~~117~~911
Cost of revenues:
License and royalty		87,~~482~~539			74,~~539~~038			43,~~038~~052
Support and service		2,~~121~~682			2,~~682~~136			21,~~136~~867
Total cost of revenues		10,~~603~~221			106,~~221~~174			64,~~174~~919
Gross margin		3463,~~347~~193			6366,~~193~~943			66,~~943~~992
Operating expenses:
Research and development		4939,~~587~~795			3933,~~795~~885			3331,~~885~~700
Sales and marketing		1917,~~309~~187			1719,~~187~~381			19,~~381~~646
General and administrative		12,~~779~~794			1219,~~794~~446			19,~~446~~978
Amortization of intangibles		~~310~~411			~~411~~163			~~163~~131
Restructuring charges		1,992			2,188			—
Restructuring charges and employee termination benefits		2,188			—			3,233
Separation costs		519			5,024			6,867
Executive severance		—			—			2,527
Total operating expenses		84,496			77,399			79,742
Separation costs		5,024			6,867			18
Loss from operations		(50,149	)		(14,206	)		(12,799	)
Total operating expenses		77,399			79,742			77,233
Interest expense		(256	)		(507	)		(654	)
Loss from operations		(14,206	)		(12,799	)		(10,241	)
Interest and other income (expense), net		(421	)		(4,627	)		(264	)
Interest expense		(507	)		(654	)		(31	)
Loss before income taxes		(50,826	)		(19,340	)		(13,717	)
Interest and other income (expense), net		(4,627	)		(264	)		1,187
Income tax provision		421			2,420			1,530
Gain on sale of an asset		—			—			26,693
Net loss	$	(51,247	)	$	(21,760	)	$	(15,247	)
Gain on early extinguishment of debt		—			—			1,875
Basic and diluted net loss per share	$	(5.12	)	$	(2.18	)	$	(1.40	)
Income (loss) before income taxes		(19,340	)		(13,717	)		19,483
Shares used in computing basic and diluted net loss per share		10,000			10,000			10,878
Income tax provision		2,420			1,530			1
Net income (loss)	$	(21,760	)	$	(15,247	)	$	19,482
Basic net earnings (loss) per share	$	(2.18	)	$	(1.40	)	$	1.30
Shares used in computing basic net earnings (loss) per share		10,000			10,878			14,980
Diluted net earnings (loss) per share	$	(2.18	)	$	(1.40	)	$	1.27
Shares used in computing diluted net earnings (loss) per share		10,000			10,878			15,323

The accompanying notes are an integral part of these ~~combined and~~ consolidated financial statements.

6555

PALMSOURCE, INC.

~~COMBINED AND~~ CONSOLIDATED BALANCE SHEETS

(In thousands, except par value amounts)

	May 31,2003			May 31,2004
	May 31, 2004			May 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	3727,~~465~~144		$	4522,~~144~~228
Short-term investments		—43,057			2535,~~057~~088
Receivables from related parties		5,132			—
Accounts receivable, net of allowance of $100 and $100, respectively		6,038			11,583
Accounts receivable, net of allowance of $0 and $100, respectively		583			6,038
Receivable from palmOne		—			6,186
Prepaids and other		12,~~305~~124			2,~~214~~099
Total current assets		4478,~~485~~363			7877,~~363~~184
Restricted investments		1,~~671~~680			~~1,680~~121
Property and equipment, net		32,~~419~~281			26,~~281~~950
Goodwill		52,845			5272,~~845~~759
Intangible assets, net		~~976~~111			~~111~~2,359
Long-term investments		—16,733			1614,~~733~~418
Other assets		1,211			779
Long-term receivable from palmOne		—			13,453
Total assets	$	104,607		$	152,792
Other assets		779			620
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
Total assets	$	152,792		$	187,864
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,~~868~~494		$	2,~~494~~866
Payable to Palm, Inc.		1,911			—
Deferred revenue		8,296			6,854
Deferred revenue		9,392			8,296
Accrued employee termination benefits		—			2,718
Accrued restructuring		349			—
Other accrued liabilities		7,625			9,175
Other accrued liabilities		9,215			7,625
Total current liabilities		18,415			21,613
Total current liabilities		23,735			18,415
Non-current liabilities:
Note payable to Palm Inc., including accrued interest		20,744			—
Deferred revenue and other		10,386			11,586
Deferred revenue and other		13,848			10,386
Long-term convertible subordinated note		15,000			—
Long-term convertible subordinated note		—			15,000
Commitments and contingencies (Notes 7 and 13)
Series A redeemable convertible preferred stock 10,000 shares authorized; outstanding: 3,333 and none, respectively		20,000			—
Stockholders’ equity:
Preferred stock, $.001 par value, authorized: 40,000 shares; none outstanding		—			—
Common stock, $.001 par value, authorized: 950,000 shares; outstanding: 15,103 and 16,807 shares, respectively		15			17
Common stock, $.001 par value, authorized: 950,000 shares; outstanding: 10,000 and 15,103 shares, respectively		10			15
Additional paid-in capital		165,835			189,619
Additional paid-in capital		61,939			165,835
Accumulated other comprehensive loss		259			287
Accumulated other comprehensive income		448			259
Unearned stock-based compensation		(5,754	)		(3,376	)
Unearned stock-based compensation		—			(5,754	)
Accumulated deficit		(51,364	)		(31,882	)
Accumulated deficit		(36,117	)		(51,364	)
Total stockholders’ equity		108,991			154,665
Total stockholders’ equity		26,280			108,991
Total liabilities and stockholders’ equity	$	152,792		$	187,864
Total liabilities, redeemable convertible preferred stock and stockholders’ equity	$	104,607		$	152,792

The accompanying notes are an integral part of these ~~combined and~~ consolidated financial statements.

6656

PALMSOURCE, INC.

~~COMBINED AND~~ CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

	Common Stock			AdditionalPaid-InCapital			~~Palm, Inc.NetInvestment(Deficit)~~AccumulatedDeficit			~~AccumulatedDeficit~~Accumulated OtherComprehensiveIncome (Loss)			~~AccumulatedOtherComprehensiveIncome (Loss)~~UnearnedStock-BasedCompensation			~~UnearnedStock-BasedCompensation~~Total			~~Total~~
	Shares	Amount
Balances, May 31, 2001	—	$	—	$	—		$	29,994		$	—		$	(383	)	$	—		$	29,611
Balances, May 31, 2002	10,000		10		62,831			(14,357	)		(185	)		—			48,299
Components of comprehensive loss:
Net loss	—		—		—			(3621,~~890~~760	)		~~(14,357~~—	)		—			—(21,760	)		~~(51,247~~	)
Net unrealized gain (loss) on available for sale investment	—		—		—			—			—			(38	)		—			(38	)
Net unrecognized gain (loss) on available for sale investment	—		—		—			—			29			—			29
Recognized loss included in earnings	—		—		—			—			—			64			—			64
Cumulative translation adjustments	—		—		—			—			604			—			604
Cumulative translation adjustments	—		—		—			—			—			172			—			172
Total comprehensive loss	—		—		—			—			—			—			(21,127	)
Total comprehensive loss	—		—		—			—			—			—			—			(51,049	)
Transfer of stock-based compensation from Palm, Inc.	—		—		546			—			—			—			546
Transfer of net assets from Palm, Inc. related to business acquisition	—		—		—			11,000			—			—			—			11,000
Net transfers from Palm, Inc.	—		—		1,484			—			—						1,484
Transfer of stock-based compensation from Palm, Inc.	—		—		321			322			—			—			—			643
Distribution to Palm, Inc.	—		—		(2,922	)		—			—			—			(2,922	)
Net transfers from Palm, Inc.	—		—		7,024			19,952			—			—			—			26,976
Balances, May 31, 2003	10,000		10		61,939			(36,117	)		448			—			26,280
Recapitalization and issuance of Class C common stock, net	10,000		10		24,368			(24,378	)		—			—			—			—
Components of comprehensive loss:
Capital contribution by Palm, Inc.	—		—		31,118			—			—			—			—			31,118
Net loss	—		—		—			(15,247	)		—			—			(15,247	)
Balances, May 31, 2002	10,000		10		62,831			—			(14,357	)		(185	)		—			48,299
Net unrealized gain (loss) on available-for-sale investment	—		—		—			—			(247	)		—			(247	)
Components of comprehensive loss:
Cumulative translation adjustments	—		—		—			—			58			—			58
Net loss	—		—		—			—			(21,760	)		—			—			(21,760	)
Total comprehensive loss	—		—		—			—			—			—			(15,436	)
Net unrecognized gain (loss) on available for sale investment	—		—		—			—			—			29			—			29
Restricted stock grants	958		1		14,886			—			—			(14,887	)		—
Cumulative translation adjustments	—		—		—			—			—			604			—			604
Amortization of unearned stock-based compensation	—		—		—			—			—			9,133			9,133
Total comprehensive loss	—		—		—			—			—			—			—			(21,127	)
Transfer of stock-based compensation from Palm, Inc.	—		—		(14	)		—			—			—			(14	)
Transfer of stock-based compensation from Palm, Inc.	—		—		546			—			—			—			—			546
Conversion of Series A redeemable convertible preferred stock	667		1		19,999			—			—			—			20,000
Net transfers from Palm, Inc.	—		—		1,484			—			—			—						1,484
Issuance of long-term convertible subordinated note	—		—		(15,000	)		—			—			—			(15,000	)
Distribution to Palm, Inc.	—		—		(2,922	)		—			—			—			—			(2,922	)
Capital contribution by Palm, Inc.	—		—		26,000			—			—			—			26,000
Balances, May 31, 2003	10,000		10		61,939			—			(36,117	)		448			—			26,280
Stock issued under employee stock purchase plan	28		—		438			—			—			—			438
Components of comprehensive loss:
Net proceeds from public offering of common stock	3,450		3		57,433			—			—			—			57,436
Net loss	—		—		—			—			(15,247	)		—			—			(15,247	)
Net transfers from Palm, Inc.	—		—		154			—			—			—			154
Net unrealized gain (loss) on available-for-sale investment	—		—		—			—			—			(247	)		—			(247	)
Balances, May 31, 2004	15,103	$	15	$	165,835		$	(51,364	)	$	259		$	(5,754	)	$	108,991
Cumulative translation adjustments	—		—		—			—			—			58			—			58
Components of comprehensive income:
Total comprehensive loss	—		—		—			—			—			—			—			(15,436	)
Net income	—		—		—			19,482			—			—			19,482
Restricted stock grants	958		1		14,886			—			—			—			(14,887	)		—
Net unrealized gain on available-for-sale investment	—		—		—			—			20			—			20
Amortization of unearned stock-based compensation	—		—		—			—			—			—			9,133			9,133
Cumulative translation adjustments	—		—		—			—			8			—			8
Transfer of stock-based compensation from Palm, Inc.	—		—		(14	)		—			—			—			—			(14	)
Total comprehensive income	—		—		—			—			—			—			19,510
Conversion of Series A redeemable convertible preferred stock	667		1		19,999			—			—			—			—			20,000
Restricted stock grants	45		—		710			—			—			(710	)		—
Issuance of long-term convertible subordinated note	—		—		(15,000	)		—			—			—			—			(15,000	)
Accelerated vesting of restricted stock	—		—		25			—			—			—			25
Capital contribution by Palm, Inc.	—		—		26,000			—			—			—			—			26,000
Amortization of unearned stock-based compensation	—		—		—			—			—			7,069			7,069
Stock issued under employee stock purchase plan	28		—		438			—			—			—			—			438
Issuance of stock for acquisition of CMS, Ltd.	1,508		2		21,445			—			—			(3,579	)		17,868
Net proceeds from public offering of common stock	3,450		3		57,433			—			—			—			—			57,436
Inducement restricted stock grants	40		—		402			—			—			(402	)		—
Net transfers from Palm, Inc.	—		—		154			—			—			—			—			154
Restricted stock issued and vested	10		—		100			—			—			—			100
Balances, May 31, 2004	15,103	$	15	$	165,835			—		$	(51,364	)	$	259		$	(5,754	)	$	108,991
Stock option exercise	5		—		104			—			—			—			104
Stock issued under employee stock purchase plan.	96		—		1,039			—			—			—			1,039
Offering expense from public offering of common stock	—		—		(41	)		—			—			—			(41	)
Balances, May 31, 2005	16,807	$	17	$	189,619		$	(31,882	)	$	287		$	(3,376	)	$	154,665

The accompanying notes are an integral part of these ~~combined and~~ consolidated financial statements.

6757

PALMSOURCE, INC.

~~COMBINED AND~~ CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

	Year Ended May 31,
	2002			2003			2004
	2003			2004			2005
Cash flows from operating activities:
Net loss	$	(51,247	)	$	(21,760	)	$	(15,247	)
Net income (loss)	$	(21,760	)	$	(15,247	)	$	19,482
Adjustments to reconcile net loss to net cash used in operating activities:
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		7,~~626~~122			72,~~122~~409			21,~~409~~990
Stock-based compensation transferred from Palm, Inc.		643			546			(14	)
Gain on sale of an asset		—			—			(26,693	)
Stock-based compensation expense		—			—			9,133
Stock-based compensation transferred from Palm, Inc.		546			(14	)		—
Deferred income taxes		412			350			1,216
Stock-based compensation expense		—			9,133			7,196
Loss on disposal of equipment		301			148			—
Deferred income taxes		350			1,216			357
Impairment of equity investment recorded at cost		—			3,206			483
Loss on disposal of equipment		148			—			—
Changes in assets and liabilities, net of effect of acquisitions:
Gain on early extinguishment of debt		—			—			(1,875	)
Receivable from related parties		(6,645	)		1,513			5,132
Impairment of equity investment recorded at cost		3,206			483			162
Accounts receivable		(457	)		545			(5,455	)
Changes in assets and liabilities, net of effect of acquisition:
Prepaids and other		(1,820	)		457			(894	)
Receivable from related parties		1,513			5,132			—
Accounts payable		(2,388	)		101			(519	)
Accounts receivable		545			(5,455	)		(5,072	)
Payable to Palm, Inc.		5,751			(3,840	)		(1,911	)
Prepaids and other		457			(894	)		(250	)
Deferred revenue		4,545			(634	)		(5,532	)
Accounts payable		101			(519	)		186
Accrued restructuring		303			(1,446	)		(349	)
Payable to Palm, Inc.		(3,840	)		(1,911	)		—
Other accrued liabilities		(2,392	)		4,779			(2,991	)
Deferred revenue		(634	)		(5,532	)		(2,731	)
Net cash used in operating activities		(45,368	)		(8,913	)		(14,539	)
Accrued restructuring		(1,446	)		(349	)		2,718
Other accrued liabilities		4,779			(2,991	)		735
Net cash used in operating activities		(8,913	)		(14,539	)		(3,795	)
Cash flows from investing activities:
Purchase of property and equipment		(13,~~042~~275	)		(~~3,275~~786	)		(~~786~~3,431	)
Proceeds from sale of assets		—			—			386
Business combinations, net of cash acquired		—			—			(4,417	)
Purchase of investments		—			—			(42,037	)
Proceeds from sale of assets		—			386			7,500
Purchases of restricted investments		(1,551	)		(120	)		—
Unrealized gain/loss on available-for-sale securities		—			—
Net cash used in investing activities		(2,593	)		(3,395	)		(42,437	)
Purchase of investments		(211,000	)		(282,037)			(202,975	)
Sale of investments		187,000			246,000			213,400
Purchases of restricted investments		(120	)		—			1,578
Net cash provided by (used in) investing activities		(27,395	)		(36,437	)		11,655
Cash flows from financing activities:
Net cash transfers from Palm, Inc.		261,~~976~~484			16,~~484~~000			~~6,000~~—
Capital contributions from (distribution to) Palm, Inc.		31(2,~~118~~922	)		~~(2,922~~—	)		—
Net proceeds from public offering		—			—58,684			~~58,684~~—
Public offering expenses		—			—(538	)		(~~538~~751	)
Stock issuance under employee stock purchase plan		—			—			438
Payment of convertible subordinated note		—			—			(13,125	)
Sale of Series A redeemable convertible preferred stock		—			20,000			—
Stock issuance under employee stock purchase plan		—			438			1,039
Note payable to Palm, Inc.		20,000			—			—
Option Exercise		—			—			104
Other, net		204			499			—
Sale of Series A redeemable convertible preferred stock		20,000			—			—
Net cash provided by financing activities		78,298			19,061			64,584
Note payable to Palm, Inc.		—			—			—
Effect of exchange rate changes on cash		(32	)		24			71
Other, net		499			—			—
Change in cash and cash equivalents		30,305			6,777			7,679
Net cash provided by (used in) financing activities		19,061			64,584			(12,733	)
Cash and cash equivalents, beginning of period		383			30,688			37,465
Effect of exchange rate changes on cash		24			71			(43	)
Cash and cash equivalents, end of period	$	30,688		$	37,465		$	45,144
Change in cash and cash equivalents		(17,223	)		13,679			(4,916	)
Cash and cash equivalents, beginning of period		30,688			13,465			27,144
Cash and cash equivalents, end of period	$	13,465		$	27,144		$	22,228
Other cash flow information:
Cash paid for income taxes	$	231,995		$	~~1,995~~11		$	11337
Supplemental disclosure of non-cash activities:
Transfer of net assets from Palm, Inc. related to business acquisitions	$	11,000		$	—		$	—
Contribution of note payable to Palm, Inc.	$	—		$	20,000		$	—
Contribution of note payable to Palm, Inc.	$	—		$	—		$	20,000
Conversion of Series A redeemable convertible preferred stock to common stocks	$	—		$	(20,000	)	$	—
Conversion of Series A redeemable convertible preferred stock to common stocks	$	—		$	—		$	(20,000	)
Assumption of convertible subordinated note	$	—		$	(15,000	)	$	—
Assumption of convertible subordinated note	$	—		$	—		$	(15,000	)
Issuance of stock for acquisition of CMS	$	—		$	—		$	17,868

The accompanying notes are an integral part of these ~~combined and~~ consolidated financial statements.

6858

PALMSOURCE, INC.

NOTES TO ~~COMBINED AND~~ CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Background and Basis of Presentation

~~On August 27, 2001, Palm, Inc. (“Palm”) announced its plan to form a wholly owned subsidiary to own and operate Palm’s operating system platform and licensing business, subsequently named~~ PalmSource, Inc. (“PalmSource”) oris ~~the~~a ~~“Company”).~~leading ~~PalmSource~~developer ~~develops~~ and ~~licenses~~licensor ~~operating~~of ~~system~~ software, ~~personal information management applications and software development tools~~ for mobile information devices. ~~PalmSource~~Our ~~targets~~software ~~device manufacturers~~platform, asPalm ~~well as developers~~OS, ~~enterprises~~consists ~~and consumers~~of ~~with its Palm~~ operating system, orsoftware ~~Palm~~and ~~OS.~~software ~~PalmSource’s~~development ~~product~~tools ~~offerings~~that ~~include~~operate ~~Palm~~the ~~OS,~~features ~~Palm Digital Media~~ and ~~services~~functions ~~and~~on ~~support. In August 2003~~PDAs, ~~the~~smartphones ~~Palm~~and ~~Digital~~other ~~Media product line was sold to PalmGear, Inc.~~handheld ~~(“PalmGear”).~~devices ~~For~~such ~~additional~~as ~~information~~industrial onand ~~the~~industry-specific ~~PalmGear~~PDAs ~~transaction,~~used ~~see~~in ~~Note 3~~education, ~~Acquisitions~~healthcare and ~~Dispositions~~hospitality industries.

InThe ~~December~~Company ~~2001, PalmSource~~ was incorporated in Delaware ason ~~a wholly owned subsidiary of Palm, and as of~~ December 3, 2001, ~~authorized~~as ~~and~~a ~~issued~~wholly ~~50,000 shares~~owned ofsubsidiary ~~Series A preferred stock to Palm in exchange for the assignment to PalmSource~~ of ~~certain of~~ Palm~~’s assets and liabilities~~, ~~including~~Inc. ~~intellectual property~~(“Palm”). ~~Effective~~On ~~May~~October 928, ~~2002~~2003, ~~PalmSource’s~~Palm distributed ~~board~~on ofa ~~directors~~pro-rata ~~authorized~~basis ~~a re-capitalization~~all of the ~~authorized and~~ outstanding ~~Series A preferred stock into common stock and a simultaneous 1,000-for-1 stock split, resulting in 50,000,000~~ shares of PalmSource common stock ~~issued~~to ~~and outstanding and owned by~~ Palm ~~which was later re-capitalized as 10~~stockholders,~~000,000~~ ~~shares~~an ofevent ~~common~~referred ~~stock~~to ~~via~~in athis ~~one~~document ~~for~~as ~~five reverse stock split. The one for five reverse stock split was approved by~~ the ~~Company’s board of directors on June 30, 2003 and became effective on September 22, 2003~~distribution. ~~Shares~~ ~~outstanding and net loss per share have been adjusted for periods presented prior to the effective date.~~

InPalmSource ~~December~~and ~~2001,~~ Palm ~~and~~have ~~PalmSource~~ entered into avarious ~~Master~~agreements ~~Separation~~detailing ~~and~~the ~~Distribution~~provisions ~~Agreement,~~of ~~as amended June 3, 2003, (~~the ~~“Separation Agreement”)~~distribution ~~under~~of ~~which~~PalmSource from Palm ~~transferred~~and torelated ~~PalmSource at December 3~~tax, ~~2001,~~transition ~~the~~services ~~date~~and ofemployee ~~legal~~matters. ~~separation~~See ~~(the~~Note ~~“Separation~~14 ~~Date”),~~for ~~substantially~~additional ~~all~~discussion. ofTransactions ~~the~~between ~~assets~~PalmSource and ~~liabilities of~~ Palm’s ~~operating~~have ~~system~~been ~~and~~identified ~~software~~in ~~business except for~~ the ~~Palm~~financial ~~brands,~~statements ~~trademarks~~as ~~and~~transactions ~~certain~~between ~~other~~ related ~~intellectual~~parties ~~property~~for ~~which~~the ~~were~~fiscal year ~~transferred~~ending at2003 aand ~~later~~through ~~date.~~the ~~(See~~distribution ~~Note~~in ~~14,~~fiscal ~~Transactions~~year ~~with Palm~~2004.)

OnIn ~~October~~January 72005, ~~2002,~~we ~~Sony~~acquired ~~Corporation~~China ofMobileSoft ~~America~~Ltd. (~~“Sony”~~CMS), ~~invested~~a ~~$20~~Nanjing China-based developer and licensor of software for mobile phones.0 ~~million~~Through inthis ~~PalmSource~~acquisition, ~~purchasing 3,333,333~~we ~~shares~~gained oflocal ~~the~~sales ~~Company’s~~and ~~Series~~marketing Aresources, ~~redeemable~~and ~~convertible~~a ~~preferred~~suite ~~stock.~~of ~~The~~applications ~~shares~~and software ofplatforms ~~the~~that ~~preferred~~address ~~stock~~the ~~were~~mobile ~~automatically~~phone ~~converted~~opportunity ~~into~~in ~~666~~China,~~666~~ ~~shares~~which ofis the ~~Company’s~~largest ~~common~~market ~~stock~~for ~~immediately~~mobile ~~prior~~phones toin the ~~October~~world. 28Additionally, ~~2003~~the acquisition brought us, highly skilled engineering resources in a low cost environment that expand, ~~distribution~~as ofwell ~~PalmSource~~as ~~common~~complement ~~stock~~our byproduct ~~Palm~~development toefforts ~~Palm’s~~in ~~stockholders~~Sunnyvale, California and Montpellier, France.

OnWe ~~October~~currently ~~28,~~have ~~2003~~more ~~(the~~than ~~“distribution~~a ~~date”),~~dozen Palm ~~stockholders~~OS ~~approved~~licensees ~~the~~including ~~PalmSource~~palmOne ~~distribution~~Inc., ~~from~~LG ~~Palm~~Electronics, ~~and~~Garmin ~~Palm~~Ltd., ~~distributed~~Symbol ~~all~~Technologies ofInc. ~~the~~and ~~outstanding~~GSPDA. Additionally, ~~shares~~as of ~~PalmSource’s~~June ~~common~~3, ~~stock~~2005, ~~owned~~we ~~by Palm~~have to24 ~~Palm’s~~licensees ~~stockholders~~shipping onindividual or bundled applications, such as a ~~pro~~multi-~~rata~~media ~~basis.~~messaging Atservice ~~the~~(MMS) ~~same~~client ~~time~~or aswireless application protocol (WAP) browser into the ~~distribution,~~China ~~Palm~~market. ~~acquired~~These ~~Handspring~~licensees include: Haier Group, ~~Inc.~~Konka ~~and~~Group ~~the~~Company ~~combined~~Ltd, ~~entity~~China ~~changed~~TechFaith ~~its~~and ~~name~~Wireless toCommunication ~~palmOne,~~Technology ~~Inc~~Ltd.

Palm sells devices that incorporate PalmSource software to its customers under the terms of a Software License Agreement, as amended, (the “Software License Agreement”). Under the terms of this agreement, PalmSource has granted Palm certain rights to use, produce, grant end user sublicenses and distribute certain software for the period December 3, 2001 to December 3, 2006, and may be renewed by mutual written consent. PalmSource receives license and royalty fees based upon the shipment of Palm’s products, which incorporate PalmSource software or on distribution by Palm of PalmSource software, subject to minimum annual commitments of $40.0 million, $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring December 3, 2006. PalmSource also receives fees for support and services. For periods

PALMSOURCE, INC.

NOTES TO COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

prior to December 3, 2001, there is no revenue recorded from Palm, as the Software License Agreement was not effective until December 3, 2001. However, costs were incurred during these periods as the Company was supporting Palm. (See Note 14, Transactions with Palm.)

The combined and consolidated financial statements of PalmSource reflect the results of operations, financial position, changes in stockholders’ equity and cash flows applicable to the Company and its subsidiaries, after elimination of intercompany transactions. The combined financial statements of PalmSource are derived from the historic books and records of Palm through the separate date, December 3, 2001, using Palm’s historical bases in the assets and liabilities and the historical results of operations of the Palm OS platform and licensing business. Changes in stockholders’ equity represent Palm’s transfer of its net investment in PalmSource, after giving effect to the net loss of PalmSource plus net cash transfers and other transfers to and from Palm. Subsequent to the Separation Date, the Company has relied on Palm for administrative, management and other services and is billed by Palm for these services. PalmSource’s reliance on Palm (a licensee of PalmSource) for such services has gradually declined as PalmSource has established its own independent systems and infrastructure for administration, management and other services. The financial information included herein may not reflect the combined and consolidated financial position, results of operations, changes in stockholders’ equity and cash flows of PalmSource in the future or what they would have been had PalmSource been a separate stand-alone entity during the periods presented.

The combined and consolidated financial statements include allocations of certain Palm expenses, including centralized legal, accounting, treasury, real estate, information technology and other Palm corporate services and infrastructure costs. The expense allocations have been determined on the bases that Palm and PalmSource considered to be reasonable reflections of the utilization of services provided or the benefit received by PalmSource.

Prior to the distribution, related party revenues in the combined and consolidated financial statements included revenues from Palm and Sony, a PalmSource stockholder. Subsequent to the distribution, related party revenues, cost of revenues and accounts receivable in the combined and consolidated financial statements only included those from Sony. The majority of the Company’s cost of revenues is of a fixed nature, either amortization of intangibles or term license fees paid to technology vendors recognized ratably, and are not directly related or allocable to either third party or related party revenues. The Company incurred separately identifiable costs directly associated with related party professional services revenue of $0.2 million, $0.3 million and $23,000 for the years ended May 31, 2002, 2003 and 2004, respectively.

Note 2. Significant Accounting Policies

Fiscal Year

PalmSource’s 52-53 week fiscal year ends on the Friday nearest to May 31. Fiscal years ~~2002,~~ 2003 and 2004 each contained 52 weeks. Fiscal year 2005 contained 53 weeks. PalmSource’s fiscal quarters end on a Friday and are ~~generally~~ thirteen weeks in length except the fourth fiscal quarter of 2005 was 14 weeks in length. For presentation purposes, the periods have been presented as ending on May 31.

Use of Estimates in the Preparation of ~~Combined and~~ Consolidated Financial Statements

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 PalmSource’s ~~combined and~~ consolidated financial statements and the accompanying notes. The Company bases its estimates and ~~judgments~~ judgments on historical experience and on various other assumptions that it believes 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 the Company’s balance sheets and the amounts of revenues and expenses reported for each of its fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, allocations from Palm, goodwill impairments, loss contingencies, restructuring and income taxes. Actual results could differ from these estimates.

7059

PALMSOURCE, INC.

NOTES TO ~~COMBINED AND~~ CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

~~other~~Reclassifications assumptions that it believes 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 the Company’s balance sheets and the amounts of revenues and expenses reported for each of its fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, allocations from Palm, goodwill impairments, loss contingencies, restructuring and income taxes. Actual results could differ from these estimates.

~~Principles~~In the third quarter fiscal 2005, the Company had determined that it was appropriate to classify its investment in auction-rate securities as short-term investments. These investments were included in cash and cash equivalents in previous Form 10-K filing and registration statement on Form S-1 for periods ending May 31, 2003 and 2004 ($24 million and $18 million at May 31, 2003 and 2004, respectively), and such amounts have been reclassified to conform to the current period classification. This change in classification had no effect on the amounts of ~~Combination~~previously reported under the headings of, “total current assets”, “total assets”, “net income” or “cash flow from operations” of the Company. The following table summarizes the balance sheet amounts as previously reported and ~~Consolidation~~as reclassified (dollars in thousands):

The combined financial statements of the Company have been prepared using Palm’s historical bases in the assets and liabilities and the historical results of operations of Palm’s OS platform and licensing business, except for the accounting for income taxes on a separate return basis. No revenues from Palm have been recorded prior to December 3, 2001, the effective date of the software license agreement between PalmSource and Palm. The consolidated financial statements include the accounts of PalmSource and its subsidiaries from the Separation Date. All significant intercompany balances and transactions have been eliminated in consolidation.


Year ended May 31,	As Reported						As Reclassified:
Year ended May 31,	Cash & Cash Equivalents		Short-Term Investments		Total		Cash & Cash Equivalents		Short-Term Investments		Total
2004	$	45,144	$	25,057	$	70,201	$	27,144	$	43,057	$	70,201
2003	$	37,465		0	$	37,465	$	13,465	$	24,000	$	37,465

The following table summarizes the amounts in Cash Flow Statements as previously reported and as reclassified (dollars in thousands):


	As Reported							As Reclassified:
Year ended May 31,	Purchase of Available for Sale Securities			Sales / Maturities of Available for Sale Securities	Total			Purchase of Available for Sale Securities			Sales / Maturities of Available for Sale Securities		Total
2004	$	(42,037	)	—	$	(42,037	)	$	(282,037	)	$	246,000	$	(36,037	)
2003		—		—		—		$	(211,000	)	$	187,000	$	(24,000	)

Principles of Consolidation

The consolidated financial statements include the accounts of PalmSource and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

Cash equivalents comprise money market accounts and highly liquid debt investments acquired with remaining maturities of three months or less at the time of purchase. ~~Prior~~The tocarrying ~~the~~value ~~Separation~~of ~~Date,~~ cash receipts associated with PalmSource’s business were collected by Palm, and Palm funded PalmSource’s disbursements with net transfers being recorded as contributions or distributions in the Palm net investment account. Subsequent to the Separation Date, PalmSource maintains its own cash and cash equivalents. ~~(See~~approximates ~~Note~~their ~~14,~~current ~~Transactions~~fair ~~with~~market ~~Palm~~value.)

Short-~~term~~Term and Long-Term Investments

Investments with maturities greater than three months and less than one year are classified as short-term investments. Investments with maturities greater than one year are classified as long-term investments. PalmSource ~~accounts~~short-term ~~for its~~ investments, ~~including~~consist of money market funds, U.S. government and agency obligations and other debt securities,. inAuction ~~accordance~~rate debt securities with ~~Statement~~interest ofrates ~~Financial~~that ~~Accounting~~reset ~~Standards~~in less ~~(“SFAS”)~~than ~~No.~~three ~~115~~months ~~“Accounting~~but ~~for Certain~~with ~~Investments~~maturity indates ~~Debt~~longer ~~and~~than ~~Equity~~three ~~Securities.”~~months, ~~PalmSource~~are ~~determines~~classified ~~the~~as ~~appropriate~~short-term ~~classification~~investments. ofAll ~~its~~such investments have been classified as “available-for-sale” and are carried at ~~the~~fair ~~time~~value. ~~all~~Unrealized gains and losses, net of ~~purchase~~taxes ~~and~~reported, ~~re-evaluates~~are ~~such~~recorded ~~classification~~as ata ~~each~~component ~~balance~~of ~~sheet~~accumulated ~~date.~~other ~~PalmSource~~comprehensive ~~has~~income ~~classified all~~(loss). The cost of ~~its~~debt ~~investments~~security asis ~~available-~~adjusted for~~-sale~~ amortization of premiums and ~~carries~~accretion ~~such~~of ~~investments~~discounts atto ~~fair~~maturity. ~~value~~Such amortization, ~~with~~interest income, ~~unrealized~~realized gains and losses ~~reported~~and declines in ~~the~~value ~~accumulated~~that are considered to be other ~~comprehensive~~than temporary, are included in interest and other income (~~loss~~expense), ~~component~~net, ofin ~~stockholders’~~the ~~equity~~Consolidated ~~until~~Statements ~~disposition~~of Operations. ~~The cost~~There ofhave ~~securities~~been ~~sold~~no isdeclines ~~based~~in onvalue ~~the~~that are ~~specific~~considered ~~identification~~to ~~method.~~be ~~These~~other ~~investments~~than ~~are~~temporary ~~maintained~~for ~~with~~the ~~several~~years ~~financial~~ended ~~institutions~~May 31, 2004 and 2005.

~~Concentration~~

Filing Compare · PALMSOURCE INC