PALM INC, 10-Q, 2000-10-12

PALM INC
10-Q, 2000-10-12
COMPUTER TERMINALS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 1, 2000 COMMISSION FILE NO. 0-29597

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

FOR THE TRANSITION PERIOD FROM TO

____________

PALM, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

5470 GREAT AMERICA PARKWAY 95052
SANTA CLARA, CALIFORNIA -----
----------------------- (Zip Code)
(Address of principal executive offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 326-9000

FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT: N/A

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.

YES X NO
--- ---

AS OF OCTOBER 2, 2000, 565,890,034 SHARES OF THE REGISTRANT'S COMMON STOCK WERE
OUTSTANDING.

THIS REPORT CONTAINS A TOTAL OF 38 PAGES OF WHICH THIS PAGE IS NUMBER 1.

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PALM, INC.

TABLE OF CONTENTS

Page
----
<S> <C>
PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

Condensed Consolidated Statements of Operations
THREE MONTHS ENDED SEPTEMBER 1, 2000 AND AUGUST 27, 1999 3

Condensed Consolidated Balance Sheets
SEPTEMBER 1, 2000 AND JUNE 2, 2000 4

Condensed Consolidated Statements of Cash Flows
THREE MONTHS ENDED SEPTEMBER 1, 2000 AND AUGUST 27, 1999 5

Notes to Condensed Consolidated Financial Statements 6

ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 34

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings 35

ITEM 6. Exhibits and Reports on Form 8-K 36

Signatures 38

</TABLE>

Palm OS and Palm.Net are registered trademarks and Palm, Palm VII and Palm VIIx
are trademarks of Palm, Inc. or its subsidiaries.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PALM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>

Three Months Ended
-------------------------------
September 1, August 27,
2000 1999
------------- ------------
<S> <C> <C>

Revenues $ 400,976 $ 176,505

Cost of revenues 247,513 98,324
------------- -------------

Gross profit 153,463 78,181
------------- -------------

Operating expenses:
Sales and marketing 76,001 42,514
Research and development 30,320 12,134
General and administrative 20,491 7,160
Amortization of goodwill
and intangible assets 5,235 507
Purchased in-process
technology 853 -
Separation costs 1,815 -
------------- -------------
Total operating expenses 134,715 62,315
------------- -------------

Operating income 18,748 15,866
Interest and other income
(expense), net 13,244 (63)
------------- -------------

Income before income taxes 31,992 15,803
Income tax provision 14,717 6,145
------------- -------------

Net income $ 17,275 $ 9,658
============= =============

Net income per share:
Basic $ 0.03 $ 0.02
Diluted $ 0.03 $ 0.02

Shares used in computing
per share amounts:
Basic 565,149 532,000
Diluted 568,095 532,000

</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

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PALM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)

September 1, June 2,
2000 2000
------------ -------
(Unaudited)

ASSETS
<S> <C> <C>

Current assets:
Cash and cash equivalents $ 703,173 $1,062,128
Short-term investments 224,417 -
Accounts receivable, net of allowance for doubtful
accounts of $9,165 and $6,810, respectively 221,357 122,276
Inventories 31,666 24,057
Deferred income taxes 47,704 34,907
Prepaids and other 29,666 9,590
---------- ------------

Total current assets 1,257,983 1,252,958

Property and equipment, net 25,026 13,013
Goodwill, intangibles and other assets 97,981 14,330
Deferred income taxes - 2,375
---------- ------------
Total assets $1,380,990 $1,282,676
========== ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 170,461 $ 123,106
Other accrued liabilities 135,687 117,376
---------- ------------
Total current liabilities 306,148 240,482

Non-current liabilities:
Deferred income taxes 4,985 -
Deferred revenue and other 12,176 13,006

Stockholders' equity:
Preferred stock, $.001 par value, 125,000 shares
authorized; none outstanding - -
Common stock, $.001 par value, 2,000,000 shares
authorized; outstanding: September 1, 2000,
565,345; June 2, 2000, 564,963 565 565
Additional paid-in capital 1,045,172 1,032,449
Unamortized restricted stock grants (17,683) (16,053)
Retained earnings 29,712 12,437
Accumulated other comprehensive income (loss) (85) (210)
---------- ------------
Total stockholders' equity 1,057,681 1,029,188
---------- ------------
Total liabilities and stockholders' equity $1,380,990 $1,282,676
========== ============

</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

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PALM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

Three Months Ended
---------------------------------
September 1, August 27,
2000 1999
------------- -----------
<S> <C> <C>

Cash flows from operating activities:
Net income $ 17,275 $ 9,658
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 7,893 2,085
Amortization of restricted stock 1,548 -
Loss on disposal of property and equipment 8 -
Deferred income taxes (8,526) (2,723)
Purchased in-process technology 853 -
Changes in assets and liabilities:
Accounts receivable (98,817) 9,623
Inventories (7,609) (19,044)
Prepaids and other (21,532) (91)
Accounts payable 45,718 15,518
Other accrued liabilities 8,052 (4,955)
------------- ------------
Net cash provided by (used in) operating activities (55,137) 10,071
------------- ------------

Cash flows from investing activities:
Purchases of property and equipment (12,084) (2,289)
Acquisition of businesses, net of cash acquired (67,023) -
Purchases of short-term investments (224,417) -
Other, net (2,180) -
------------- ------------
Net cash used in investing activities (305,704) (2,289)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,178 -
Net transfers from 3Com Corporation - 29,095
Repayments of debt (1,295) -
Other, net 3 (217)
------------- ------------
Net cash provided by financing activities 1,886 28,878
------------- ------------
Change in cash and cash equivalents (358,955) 36,660
Cash and cash equivalents, beginning of period 1,062,128 478
------------- ------------
Cash and cash equivalents, end of period $ 703,173 $ 37,138
============= ============
Other cash flow information:
Cash paid for interest $ 17 $ 9
============= ============
Tax benefit from employee stock options $ 1,695 $ -
============= ============
Unrealized gain/loss on investments $ 122 $ -
============= ============
</TABLE>

SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

5
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PALM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. Basis of Presentation

The condensed consolidated financial statements have been prepared by Palm,
Inc. ("Palm," "us," "we," or "our"), without audit, pursuant to the rules
of the Securities and Exchange Commission ("SEC"). In the opinion of
management, these unaudited condensed consolidated financial statements
include all adjustments necessary for a fair presentation of Palm's
financial position as of September 1, 2000 and Palm's results of operations
and cash flows for the three months ended September 1, 2000 and August 27,
1999. Certain prior year balances have been reclassified to conform to the
current year presentation.

Palm has a 52-53 week fiscal year ending on the Friday nearest to May 31.
Accordingly, fiscal 2001 will end on June 1, 2001, resulting in a 52-week
fiscal 2001, compared to 53 weeks as reported in fiscal 2000. The results
of operations for the three months ended September 1, 2000 may not be
indicative of the results to be expected for the fiscal year ending June 1,
2001. These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes
thereto included in Palm's Annual Report on Form 10-K for the fiscal year
ended June 2, 2000.

Through February 25, 2000, Palm was wholly-owned by 3Com Corporation
("3Com"). Through this date, Palm's condensed consolidated financial
statements reflect the historical results of operations and cash flows of
the handheld computing business of 3Com during each respective period. The
condensed consolidated financial statements have been prepared using 3Com's
historical bases in the assets and liabilities and the historical results
of operations of Palm. The financial information included herein may not
reflect the consolidated financial statements, operating results and cash
flows of Palm in the future or what they would have been had Palm been a
separate stand-alone entity during the periods presented.

Through February 25, 2000, the condensed consolidated financial statements
include allocations of certain 3Com expenses, including centralized legal,
accounting, treasury, real estate, information technology, distribution,
customer service, sales, marketing, engineering, and other 3Com corporate
services and infrastructure costs. The expense allocations have been
determined on the bases that 3Com and Palm considered to be reasonable
reflections of the utilization of services provided or the benefit received
by Palm. The allocation methods include relative revenues, headcount or
square footage. Management believes that the expenses allocated to Palm are
representative of the operating expenses it would have incurred had Palm
been operated on a stand-alone basis.

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The allocated amounts from 3Com included in Palm's condensed consolidated
statement of operations for the three months ended August 27, 1999 were as
follows (in thousands):

<S> <C>

Cost of revenues $ 2,920
Sales and marketing 5,446
Research and development 1,647
General and administrative 3,952
Other (income) and expense, net 63

</TABLE>

2. Separation from 3Com and Initial Public Offering

On September 13, 1999, 3Com announced its plan to create an independent
publicly-traded company, Palm, Inc., comprised of 3Com's handheld computing
business. Following the completion of Palm's initial public offering in
March 2000, 3Com owned 532,000,000 shares of Palm, representing
approximately 94% of Palm's outstanding common stock. On July 27, 2000,
3Com distributed the shares of Palm common stock it owned to the
stockholders of 3Com, and options to purchase shares of 3Com common stock
held by Palm employees were converted into options to purchase shares of
Palm common stock.

3Com and Palm entered into a Master Separation and Distribution Agreement
in December 1999. In accordance with the separation agreement, 3Com
transferred to Palm the 3Com-owned assets and liabilities which related to
Palm prior to the date of separation from 3Com, except for most of Palm's
accounts receivable and accounts payable, which were retained by 3Com for
administrative convenience. Palm began incurring separation costs in the
second quarter of fiscal 2000, which are costs associated with the process
of becoming a stand-alone, publicly-held company, including consulting and
professional fees.

Palm's legal separation from 3Com occurred on February 26, 2000 ("the
separation date"), at which time Palm began to operate independently from
3Com. Beginning in the fourth quarter of fiscal 2000, Palm's consolidated
financial statements no longer include an allocated portion of 3Com's
corporate services and infrastructure costs. However, Palm continues to
incur amounts payable to 3Com under transitional service agreements, under
which 3Com provides services such as information systems, real estate and
transaction processing in accounting and human resources. Expenses incurred
to 3Com under transitional service agreements and facilities lease
agreements during the three months ended September 1, 2000 totaled $9.3
million.

Palm completed its initial public offering in March 2000, receiving net
proceeds of $947.5 million, after deducting underwriting commissions and
offering expenses, from the sale of 26,450,000 shares of common stock. Palm
also received net proceeds of $225.0 million from the sale of a total of
5,921,052 shares of common stock to America Online, Motorola and Nokia in
private placements. Using a portion of the proceeds from the offering, Palm
paid a dividend of $150.0 million to 3Com in March 2000.

In May 2000, Palm entered into an agreement with 3Com permitting the
purchase and sale of approximately 39 acres of land located in San Jose,
California. Palm was required to place a deposit pending the assignment of
its obligations under the agreement to a third party. Such assignment
occurred in conjunction with an operating lease agreement which Palm
entered into September 2000 (see Note 9 to the condensed consolidated
financial statements).

7
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3. Comprehensive Income

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

Three Months Ended
-----------------------------
September 1, August 27,
2000 1999
----------- -----------
<S> <C> <C>

Net income $ 17,275 $ 9,658

Other comprehensive income:
Unrealized gain on investments 122 -
Change in accumulated translation adjustments 3 15
--------- -----------
Total comprehensive income $ 17,400 $ 9,673
========= ===========
</TABLE>

4. Net Income Per Share

Basic net income per share is calculated based on the weighted average
shares of common stock outstanding during the period. Diluted net income
per share is calculated based on the weighted average shares of common
stock outstanding, plus the dilutive effect of stock options, calculated
using the treasury stock method. The dilutive effect of stock options was
approximately 2,946,000 shares for the first quarter of fiscal 2001. For
the first quarter of fiscal 2000, there was no dilutive effect from stock
options, as there were no Palm stock options outstanding.

5. Inventories

Inventories consist of (in thousands):
<TABLE>
<CAPTION>

September 1, June 2,
2000 2000
------------ ---------
<S> <C> <C>

Finished goods $ 27,204 $ 22,557
Work-in-process 4,462 1,500
Purchased components - -
---------- ----------
$ 31,666 $ 24,057
========== ==========
</TABLE>

6. Acquisition of AnyDay.com

During the first quarter of fiscal 2001, Palm completed the acquisition of
AnyDay.com. The total purchase price of $85.7 million consisted of $71.4
million of cash, $4.7 million of stock options assumed, contractual
commitments of $9.2 million and direct transaction costs of $0.4 million.
Total liabilities assumed in the transaction of $13.7 million included
accounts payable, accrued liabilities, contractual commitments and
long-term debt.

The purchase price was allocated as follows: identifiable intangible assets
- $20.3 million, net tangible assets - $2.3 million, purchased in-process
technology - $0.9 million, and goodwill - $65.3 million. Goodwill and other
intangible assets from the AnyDay.com acquisition are being amortized over
periods ranging from two to four years. The purchased in-process technology
of $0.9 million had not reached technological feasibility, had no
alternative future use and was

8
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charged to operations in the first quarter of fiscal 2001.

7. Litigation

Palm is a party to lawsuits in the normal course of its business.
Litigation in general, and intellectual property litigation in particular,
can be expensive and disruptive to normal business operations. Moreover,
the results of complex legal proceedings are difficult to predict. Palm
believes that it has defenses to the cases set forth below and is
vigorously contesting these matters. Palm is not currently able to estimate
the possible loss, or range of loss, if any, from the cases listed below
and an unfavorable resolution of these lawsuits could adversely affect
Palm's business, results of operations or financial condition.

On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District
Court for the Western District of New York. The case is now captioned:
XEROX CORPORATION v. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP.,
PALM COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T.
The complaint alleged willful infringement of U.S. patent 5,596,656
entitled "Unistrokes for Computerized Interpretation of Handwriting." The
complaint sought unspecified damages and to permanently enjoin the
defendants from infringing the patent in the future. In an Order entered by
the District Court on June 6, 2000, the District Court granted the
defendants' motion for summary judgment of non-infringement and dismissed
the case in its entirety. On July 5, 2000, Xerox filed a Notice of Appeal
of the dismissal with the U.S. Court of Appeals for the Federal Circuit.

On July 22, 1999, Palm filed a copyright infringement action against
Olivetti and CompanionLink in the United States District Court for the
Northern District of California and obtained a preliminary injunction
against further distribution, sale, import or export of Olivetti Office
USA's "Royal daVinci" handheld device and the daVinci OS Software
Development Kit (distributed by CompanionLink Software, Inc.), which
contained source code copied from the Palm OS operating system. The
injunction is to remain in effect pending the outcome of the lawsuit. Palm
also initiated a copyright infringement action in Hong Kong on July 21,
1999, against EchoLink Design Ltd., the company responsible for developing
the operating system software contained in the daVinci products. The High
Court of the Hong Kong Special Administrative Region issued an order the
same day restraining EchoLink from further copying, distribution, sale,
import or export of Palm OS operating system source code or EchoLink's
"NEXUS OS" source code, which Palm maintains infringes its copyrights. On
October 7, 1999, 3Com notified certain third-party retailers about the
preliminary injunction order cited above. Olivetti has filed a motion
seeking leave to assert counterclaims against Palm and 3Com for unfair
competition, intentional interference with potential economic advantage,
libel and trade libel, based upon certain statements that were allegedly
made, or that 3Com allegedly omitted to make, in the October 7, 1999
letter.

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411331. The complaint alleges breach of contract, constructive fraud,
fraud and deceit, negligent misrepresentation, misappropriation of assets
and trade secrets, unfair competition, unjust enrichment and intentional
interference with economic advantage in connection with our and 3Com's
discussions with WaveWare concerning WaveWare's potential acquisition by
3Com. The complaint seeks unspecified monetary damages and injunctive
relief. Discovery is ongoing and the case is set for trial in January 2001.

On December 27, 1999, Telxon Corporation and Penright! Corporation filed a
complaint in the U.S. District Court for the Northern District of Ohio,
Eastern Division (Case No. 1:99CV3157) against 3Com and Palm alleging
copyright infringement, unfair competition and theft of trade secrets. In
an Order dated July 31, 2000, the Federal Judge assigned to the action
transferred the case to the U.S. District Court for the Northern District
of California. The case is now captioned TELXON CORPORATION V. 3COM INC.
(CASE NO. C00-02885 CRB). The plaintiffs allege that the Palm OS operating
system contains graphical user interface software copied from the
plaintiffs' software. The complaint seeks unspecified compensatory and
treble damages and to enjoin, among other things, distribution and sales of
the Palm OS operating system. No trial date has been set. The case is still
in the early stages of discovery.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against "3Com,
Inc." in the United States District Court for the Southern District of New
York and later filed on March 6, 2000 an Amended Complaint against Palm and
3Com. In an Order dated June 9, 2000, the Federal Judge assigned to the
action transferred the case to the U.S. District Court for the Northern
District of California. The case is now captioned E-PASS TECHNOLOGIES, INC.
V. 3COM CORPORATION, A/K/A 3COM, INC. AND PALM, INC. (Case No. C00 2255-DLH
ADR). The Amended Complaint alleges willful infringement of U.S. patent
5,276,311 entitled "Method and Device for Simplifying the Use of Credit
Cards, or the Like." The complaint seeks unspecified compensatory and
treble damages and to permanently enjoin the defendants from infringing the
patent in the future. Palm is in the preliminary stages of investigating
the allegations contained in the suit. No trial date has been set. The case
is still in the early stages of discovery.

On May 2, 2000, Rotis Technologies Corporation filed suit against Palm and
two other defendants in the U.S. District Court for the Northern District
of Texas. The case is now captioned ROTIS TECHNOLOGIES CORPORATION V. TRACK
DATA CORPORATION, PALM, INC. AND SPRINT SPECTRUM L.P. (Case No.
300CV-931-L). The complaint alleges infringement of U.S. patent 4,473,824
entitled "Price Quotation System." The complaint seeks unspecified
compensatory and treble damages and to permanently enjoin the defendants
from infringing the patent in the future. Palm is in the preliminary stages
of investigating the allegations contained in the suit. No trial date has
been set. The case is still in the early stages of discovery.

8. Recent Accounting Pronouncements

In June 1998 and June 1999, the Financial Accounting Standards Board
("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities and SFAS No. 137,

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Accounting for Derivative Instruments and Hedging Activities-Deferral of
the Effective Date of FASB Statement No. 133. These statements require
companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes
in the values of those derivatives would be accounted for depending on the
use of the derivative and whether it qualifies for hedge accounting. SFAS
133 will be effective for Palm's fiscal year ending May 31, 2002.
Management is currently in the process of assessing the impact of SFAS 133
and believes that the adoption of these statements is unlikely to have a
significant impact on Palm's financial position or results of operations.

In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in
Financial Statements. SAB 101 will be effective for Palm's fiscal year
ending June 1, 2001. Due to the potential impact of certain provisions of
SAB 101 for which registrants have requested interpretative guidance, Palm
has not yet determined the impact, if any, that SAB 101 may have on its
financial position or results of operations.

In March 2000, the FASB issued Interpretation No. 44 ("FIN 44"), Accounting
for Certain Transactions involving Stock Compensation, an interpretation of
APB Opinion No. 25. FIN 44 clarifies the application of APB 25 for certain
issues, including the definition of an employee, the treatment of the
acceleration of stock options and the accounting treatment for options
assumed in business combinations. FIN 44 became effective on July 1, 2000,
but is applicable for certain transactions dating back to December 1998.
The adoption of FIN 44 is not expected to have a significant impact on
Palm's historical financial position or results of operations.

9. Subsequent Events

Subsequent to quarter-end, we entered into an operating lease agreement
related to our new corporate campus, for which occupancy is planned
beginning in mid-2002. In conjunction with this agreement, we are required
to guarantee a minimum residual value for the property and to maintain
certain levels of cash collateral over the term of the agreement. Such cash
collateral will be classified as non-current restricted cash in our
consolidated balance sheet and totaled approximately $225 million at the
inception of the lease agreement. As the leased facilities are constructed
the amount of cash collateral required to be maintained is expected to
increase to at least $400 million. Palm will continue to receive the
interest income earned on the cash collateral.

<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This quarterly report contains forward-looking statements within the meaning of
the federal securities laws. These statements include those concerning the
following: the intention to continue pursuing licensing opportunities for the
Palm platform; the intention to expand Internet services and solutions; the
intention to continue to expand Palm's international business; the intention to
make strategic investments to enhance, develop and introduce products and
Internet solutions; the intention to introduce new products, designs and
Internet solutions; the intention to make strategic acquisitions; the intention
to continue Palm's strategic alliances and relationships with other companies;
Palm's expectation that an increasing portion of its revenues will come from
Palm platform licensing and Internet services and solutions; Palm's expectation
that international revenues will continue to increase as a percentage of total
revenues; Palm's belief that it will continue to experience strong growth in
unit shipments of Palm handheld devices; Palm's expectation of future gross
margins; Palm's expectation that it will make significant strategic investments
throughout fiscal year 2001; Palm's anticipation of future operating margins and
interest income; and Palm's belief that its cash and cash equivalents will be
sufficient to satisfy its anticipated cash requirements for at least the next 12
months. These statements are subject to risks and uncertainties that could cause
actual results and events to differ materially. These risks and uncertainties
include, among others: possible development or marketing delays with the
products and solutions to be offered; potential defects in the products and
solutions to be developed; the acceptance by the market of these products and
solutions; possible fluctuations in demand for Palm's products and services;
Palm's ability to anticipate demand for its products and services in order to
secure sufficient quantities or cost-effective production and avoid costly
excess production or inventories; Palm's dependence on suppliers and
distributors; Palm's ability to compete effectively with existing or new
competitors; possible future price cutting or other actions by competitors; and
Palm's ability to successfully work with other companies and secure resources to
realize the benefits of Palm's alliances.

For a detailed discussion of these risks and uncertainties, see the "Business
Environment and Risk Factors" section of this report. Palm undertakes no
obligation to update forward-looking statements to reflect events or
circumstances occurring after the date of this report.

OVERVIEW

We were founded in 1992 and introduced our first handheld device in 1996.
Immediately prior to our initial public offering on March 2, 2000, we were a
wholly-owned subsidiary of 3Com. Through 1999, our business was focused
primarily on developing and selling our Palm-branded handheld devices, and as of
September 1, 2000, we had sold over 8.7 million Palm devices worldwide. In 1999,
we expanded our strategy of licensing our Palm platform and developed our
wireless Internet access service to support Internet-enabled handheld devices.
Our revenues have increased from approximately $1 million in fiscal 1995 to
approximately $1.06 billion in fiscal 2000. Through our initial public offering
and concurrent private placements to America Online, Motorola, and Nokia, we
raised net proceeds of $1.17 billion, out of which a dividend of $150 million
was paid to 3Com. On July 27, 2000, 3Com completed the distribution of the
remaining shares of Palm it owned to the stockholders of 3Com. Immediately prior
to the distribution, 3Com owned approximately 94% of the Palm shares
outstanding.

Substantially all of our revenues to date have been generated from sales of our
handheld devices and related peripherals and accessories. A small percentage of
our revenues have been derived from licensing our Palm platform or from
subscriptions to our wireless Internet access service. With our

<PAGE>

expanded focus on Palm platform licensing and Internet services and solutions,
we expect that an increasing portion of our revenues in future periods will come
from these sources, although they will still represent a relatively small
portion of our total revenues in fiscal 2001. International revenues represented
31% of total revenues in both the first quarter of fiscal 2001 and the first
quarter of fiscal 2000. International revenues have generally been increasing as
a percentage of total revenues, and this trend is expected to continue, although
there may be quarters in which international revenues decline as a percentage of
total revenue. We believe that we will continue to experience strong growth in
unit shipments of our Palm handheld devices, although the year over year growth
rates may decline on a percentage basis compared to recent levels.

Gross margins as a percentage of revenues remained relatively constant through
the third quarter of fiscal 2000, but have declined over the past two quarters.
Gross margin levels declined significantly from the first quarter of fiscal 2000
to the first quarter of fiscal 2001, and we anticipate that gross margins in
fiscal 2001 will remain lower than gross margins in fiscal 2000. Factors which
we believe may contribute to lower gross margins in fiscal 2001 relative to
fiscal 2000 include increased competition, introduction of new entry level price
point devices, supply constraints for certain components, and an increased
percentage of our revenue being derived from wireless Internet services and
solutions.

In line with our strategy to expand our business, we expect to continue to make
significant strategic investments throughout fiscal year 2001. These investments
will focus on development and introduction of new products and Internet
solutions, continued expansion into new customer segments and geographic
regions, as well as other marketing investments. We also expect to continue to
incur some duplication of costs during fiscal 2001 as we continue to build the
infrastructure necessary for a stand-alone public company, while also paying
3Com to perform certain of these services under transition service agreements.
In addition, we expect to incur costs related to our separation from 3Com
throughout fiscal 2001.

Due primarily to the impact of these factors, our operating margins declined in
the first quarter of fiscal 2001 as compared to the same period in the previous
year. We anticipate our operating margins will continue to be lower in fiscal
2001 than they were in fiscal 2000, and there may be quarters in which we report
operating losses as we invest to expand our business, take advantage of market
opportunities and execute our strategic plan as an independent stand-alone
company. Furthermore, we intend to make strategic acquisitions, which will
likely result in amortization costs that could adversely effect our operating
results.

<PAGE>

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage of
total revenues represented by the line items reflected in Palm's condensed
consolidated statements of operations:

Three Months Ended
------------------
September 1, August 27,
2000 1999
------------ ----------
<S> <C> <C>
Revenues 100.0% 100.0%
Cost of revenues 61.7 55.7
------ ------
Gross profit 38.3 44.3
Operating expenses:
Sales and marketing 19.0 24.1
Research and development 7.6 6.9
General and administrative 5.1 4.0
Amortization of goodwill and
intangible assets 1.3 0.3
Purchased in-process
technology 0.2 -
Separation costs 0.4 -
------ ------
Total operating expenses 33.6 35.3
------ ------
Operating income 4.7 9.0
Interest and other income (expense), net 3.3 -
------ ------
Income before income taxes 8.0 9.0
Income tax provision 3.7 3.5
------ ------
Net income 4.3% 5.5%
====== ======
Effective tax rate (percentage of income
before income taxes) 46.0% 38.9%

Excluding amortization of goodwill and
intangible assets, purchased in-process
technology and separation costs:
Total operating expenses 31.7% 35.0%
Operating income 6.6% 9.3%
Effective tax rate 40.0% 38.9%
</TABLE>

REVENUES

Revenues for the first quarter of fiscal 2001 were $401.0 million, an increase
of $224.5 million or 127% over revenues for the same quarter of the previous
year. This increase was primarily due to higher unit shipments, offset by a
moderate decline in the average selling price. The decline in average selling
price was due in part to the new product launch of the m100, an entry-level
device with the lowest suggested retail price of any Palm handheld to date.
Revenues increased in all geographic areas, with Europe experiencing the highest
growth rate. International revenues represented 31% of total revenues in both
the first quarter of fiscal 2001 and the first quarter of fiscal 2000.

GROSS PROFIT

Gross profit was $153.5 million for the first quarter of fiscal 2001, increasing
by 96% over the same period in fiscal 2000. Gross profit as a percentage of
revenues was 38.3% for the first quarter of fiscal 2001, declining by 6.0
percentage points compared to the first quarter of fiscal 2000. This decline was

<PAGE>

primarily attributable to a shift in revenue mix towards products with lower
average selling prices and lower gross profit margins. In addition, gross profit
was impacted by the effect of purchasing certain supply-constrained components
at premiums.

SALES AND MARKETING

Sales and marketing expenses were $76.0 million for the first quarter of fiscal
2001, increasing by 79% compared to the same period in fiscal 2000. Sales and
marketing expenses decreased as a percentage of revenues from 24.1% in the first
quarter of fiscal 2000 to 19.0% for the same period of fiscal 2001, as expenses
were spread over a higher revenue base. The increase in absolute dollars
compared to the prior year was due to increased spending on demand generation
advertising and marketing programs, headcount and related expenses, and expenses
related to the worldwide branding campaign which began in the fourth quarter of
fiscal 2000 and continued into the first quarter of fiscal 2001.

RESEARCH AND DEVELOPMENT

Research and development expenses were $30.3 million for the first quarter of
fiscal 2001, increasing by 150% compared to the same period in fiscal 2000.
Research and development expenses increased as a percentage of revenue from 6.9%
in the first quarter of fiscal 2000 to 7.6% in the first quarter of fiscal 2001.
The increases in absolute dollars and as a percentage of revenues compared to
the prior year were primarily due to increased spending on headcount and related
expenses. These increases were required to support an increasing number of new
product introductions, and to expand Palm's development efforts into new product
areas such as wireless Internet solutions, platform licensing and web based
calendaring.

GENERAL AND ADMINISTRATIVE

General and administrative expenses were $20.5 million for the first quarter of
fiscal 2001, increasing by 186% compared to the same period in fiscal 2000.
General and administrative expenses increased as a percentage of revenues from
4.0% in the first quarter of fiscal 2000 to 5.1% in the first quarter of fiscal
2001. The increases in absolute dollars and as a percentage of revenues were
primarily due to increased spending for headcount and related expenses, in order
to build the infrastructure necessary for a stand-alone public company,
particularly in areas such as finance, human resources and legal, while at the
same time continuing to pay 3Com for transitional services.

AMORTIZATION OF GOODWILL AND INTANGIBLE ASSETS

Amortization of goodwill and intangible assets was $5.2 million for the first
quarter of fiscal 2001, compared to $0.5 million for the same period in fiscal
2000. The increase relates to the amortization of goodwill and other intangible
assets resulting from the acquisitions of AnyDay.com and Actual Software which
closed in June 2000 and May 2000, respectively.

PURCHASED IN-PROCESS TECHNOLOGY

Purchased in-process technology for the first quarter of fiscal 2001 relates to
the acquisition of AnyDay.com in June 2000. Approximately $0.9 million of the
purchase price represented purchased in-process technology that had not yet
reached technological feasibility, had no alternative future use and
accordingly, was charged to operations.

<PAGE>

SEPARATION COSTS

Separation costs of $1.8 million for the first quarter of fiscal 2001 consist of
costs associated with the process of becoming a stand-alone, publicly held
company, including consulting and professional fees. We expect to continue to
incur separation costs over the remainder of fiscal 2001.

INTEREST AND OTHER INCOME (EXPENSE), NET

Interest and other income (expense), on a net basis was $13.2 million for the
first quarter of fiscal 2001, compared to a nominal amount for the same period
in fiscal 2000. Substantially all of the interest income relates to the interest
earned on the proceeds of the initial public offering and private placements. We
anticipate that interest income is likely to decline from quarter to quarter
over the remainder of fiscal 2001, as we make investments in order to execute
our strategic plan as an independent public company.

INCOME TAX PROVISION

The effective tax rate for the first quarter of fiscal 2001 was 46.0%, up from
38.9% for the first quarter of fiscal 2000. Excluding the effect of
non-deductible goodwill amortization and purchased in-process technology, the
effective tax rate for the first quarter of fiscal 2001 was 40.0%, which
represents a slight decrease from the 41.0% effective rate for the full year of
fiscal 2000.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents at September 1, 2000 were $703.2 million, compared to
$1,062.1 million at June 2, 2000. The decrease of $358.9 million was
attributable to cash used in operating activities of $55.1 million and cash used
in investing activities of $305.7 million, offset by cash provided by financing
activities of $1.9 million.

Cash used in operating activities consisted of net income, adjusted for non-cash
charges and changes in non-cash working capital assets and liabilities. The most
significant changes in non-cash working capital assets and liabilities were
increases in accounts receivable and prepaid and other current assets, offset
partially by increases in accounts payable and other accrued liabilities. Cash
used in investing activities of $305.7 million consisted primarily of purchases
of short-term investments of $224.4 million, the net impact of the acquisition
of AnyDay.com of $67.0 million and purchases of property and equipment of $12.1
million. Cash provided by financing activities of $1.9 million consisted
primarily of the proceeds from the issuance of common stock resulting from stock
option exercises, offset by the repayment of debt assumed through the
acquisition of AnyDay.com.

Based on current plans and business conditions, we believe that our existing
cash and cash equivalents and short-term investments will be sufficient to
satisfy our anticipated cash requirements for at least the next twelve months.
Subsequent to quarter-end, we entered into an operating lease agreement related
to our new corporate campus, for which occupancy is planned beginning in
mid-2002. In conjunction with this agreement, we are required to guarantee a
minimum residual value for the property and to maintain certain levels of cash
collateral over the term of the agreement. Such cash collateral will be
classified as non-current restricted cash in our consolidated balance sheet and
totaled approximately $225 million at the inception of the lease agreement. As
the leased facilities are constructed the amount of cash collateral required to
be maintained is expected to increase to at least $400 million. Palm will
continue

16
<PAGE>

to receive the interest income earned on the cash collateral.

BUSINESS ENVIRONMENT AND RISK FACTORS

COMPANY-SPECIFIC TRENDS AND RISKS:

RISKS RELATED TO OUR BUSINESS

IF WE FAIL TO DEVELOP AND INTRODUCE NEW PRODUCTS AND SERVICES TIMELY AND
SUCCESSFULLY, WE WILL NOT BE ABLE TO COMPETE EFFECTIVELY AND OUR ABILITY TO
GENERATE REVENUES WILL SUFFER.

We operate in a highly competitive, quickly changing environment, and our future
success depends on our ability to develop and introduce new products and
services that our customers and end users choose to buy. If we are unsuccessful
at developing and introducing new products and services that are appealing to
end users, our business and operating results would be negatively impacted
because we would not be able to compete effectively and our ability to generate
revenues would suffer.

The development of new products and services can be very difficult and requires
high levels of innovation. The development process is also lengthy and costly.
If we fail to anticipate our end users' needs and technological trends
accurately or are otherwise unable to complete the development of products and
services quickly, we will be unable to introduce new products and services into
the market on a timely basis, if at all. For example, we are currently
developing Internet services and content such as web-based calendaring and have
also announced new handheld device products which will contain wireless
communications and expansion capabilities. We cannot assure you that we will be
able to introduce these services and products on a timely basis, or that
customer demand for these services and products will meet our expectations.

Because the sales and marketing life cycle of our handheld solutions is
generally 12 to 18 months or less, we must:

- continue to develop updates to our Palm platform, new handheld devices and
new Internet services, or our existing products and services will quickly
become obsolete;

- manage the timing of new product introductions so that we minimize the
impact of customers delaying purchases of existing products in anticipation
of new product releases;

- manage the timing of new product introductions to meet seasonal market
demands, including the holiday shopping season;

- manage the levels of existing and older product and component inventories
to minimize inventory write-offs; and

- adjust the prices of our existing products and services in order to
increase or maintain customer demand for these products and services.

<PAGE>

IF WE DO NOT CORRECTLY ANTICIPATE DEMAND FOR OUR PRODUCTS, WE MAY NOT BE ABLE TO
SECURE SUFFICIENT QUANTITIES OR COST-EFFECTIVE PRODUCTION OF OUR HANDHELD
DEVICES OR WE COULD HAVE COSTLY EXCESS PRODUCTION OR INVENTORIES.

Historically, we have seen steady increases in demand for our products and have
generally been able to increase production to meet that demand. However, the
demand for our products depends on many factors and is difficult to forecast, in
part due to the market for our products being relatively new and currently
experiencing high growth rates. As we introduce and support multiple handheld
device products and as competition in the market for our products intensifies,
we expect that it will become more difficult to forecast demand. Significant
unanticipated fluctuations in demand could adversely impact our financial
results and cause the following problems in our operations:

- If demand increases beyond what we forecast, we would have to rapidly
increase production at our third party manufacturers. We depend on our
suppliers to provide additional volumes of components and those suppliers
might not be able to increase production rapidly enough to meet unexpected
demand. There is the risk that even if we are able to procure enough
components, our third party manufacturers might not be able to produce
enough of our devices to meet the market demand for our products. The
inability of either our manufacturers or our suppliers to increase
production rapidly enough could cause us to fail to meet customer demand.

- Rapid increases in production levels to meet unanticipated demand could
result in higher costs for manufacturing and supply of components and other
expenses. These higher costs could lower our profits. Furthermore, if
production is increased rapidly, manufacturing yields could decline, which
may also lower our profits.

- If forecasted demand does not develop, we could have excess production
resulting in higher inventories of finished products and components, which
would use cash and could lead to write-offs of some or all of the excess
inventories. Lower than forecasted demand could also result in excess
manufacturing capacity at our third party manufacturers and failure to meet
some minimum purchase commitments, each of which could result in lower
margins.

OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND SEASONALITY, AND
IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR
SHARE PRICE MAY DECREASE SIGNIFICANTLY.

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

- Seasonality. Historically, our revenues have usually been weaker in the
first and third quarters of each fiscal year and have, from time to time,
been lower than the preceding quarter. This seasonality is due to the fact
that our devices are highly consumer-oriented, and consumer buying is
traditionally lower in these quarters. In addition, we attempt to time our
new product releases to coincide with

18
<PAGE>

relatively higher consumer spending in the second and fourth fiscal
quarters, which contributes to these seasonal variations.

- Increases in Operating Expenses. As we expand our operations, we expect
that our operating expenses, particularly our sales, marketing and research
and development costs, will continue to increase. We also expect to make
significant expenditures to expand our Internet solutions and services. If
revenues decrease and we are unable to reduce our costs rapidly enough, our
operating results would be negatively affected. In addition, we are adding
costs to continue building an independent business and administration
infrastructure following our separation from 3Com.

- Revenue Mix. Our profit margins differ among the handheld device, Palm
platform licensing and Internet services parts of our business. In
addition, the product mix and sales prices of our device products affects
profit margins in any particular quarter. As our business evolves and the
mix of revenues from devices, licenses and services varies from quarter to
quarter, our operating results will likely fluctuate. For example,
increased demand for our licensees' products could negatively impact sales
of our handheld devices, which could adversely impact our operating
results.

- New Product Introductions. As we introduce new products and services, the
timing of these introductions will affect our quarterly operating results.
We may have difficulty predicting the timing of new product and service
introductions and the user acceptance of these new products and services.
If products and services are introduced earlier or later than anticipated,
or if user acceptance is unexpectedly high or low, our quarterly operating
results may fluctuate unexpectedly. In addition, we typically increase
sales and marketing expenses to support new product introductions.

- Quarterly Linearity of Revenues. In the last quarter, we recorded
approximately 50% of our revenues in the last five weeks of the quarter due
to the timing of new product introductions and the availability of
components. Shipping a high percentage of our quarterly revenue near the
end of the quarter subjects us to risks such as unexpected disruptions in
component availability, manufacturing, order management, information
systems and shipping. If a significant disruption occurs, our results of
operations or financial condition could be adversely affected.

- Use of Purchase Orders with Customers. We rely on one-time purchase orders
rather than long-term contracts with our customers. Because we cannot
predict with certainty incoming purchase orders, decreases in orders or
failure to fulfill orders may cause our operating results to fluctuate.

WE RELY ON THIRD PARTY MANUFACTURERS TO PRODUCE OUR HANDHELD DEVICES, AND OUR
REPUTATION AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED BY OUR
INABILITY TO CONTROL THEIR OPERATIONS.

We outsource all of our manufacturing to Manufacturers' Services Limited and
Flextronics. We depend on these third party manufacturers to produce sufficient
volume of our products in a timely fashion and at satisfactory quality levels.
If our third party manufacturers fail to produce quality products on time and in
sufficient quantities, our reputation and results of operations would suffer. We
depend on Flextronics to manufacture some of our device products at its
facilities in Mexico, California, Malaysia and Hungary, and the rest of our
device products are manufactured by Manufacturers' Services Limited at its Utah
facility. The cost, quality and availability of third party manufacturing
operations are essential to the successful production and sale of our handheld
devices. Our reliance on third parties exposes us to the following risks outside
our control:

19
<PAGE>

- unexpected increases in manufacturing costs;

- interruptions in shipments if one of our manufacturers is unable to
complete production;

- inability to control quality of finished device products;

- inability to control delivery schedules;

- unpredictability of manufacturing yield;

- potential lack of adequate capacity; and

- potential inability to secure adequate volumes of components.

We believe that both Manufacturers' Service Limited and Flextronics are
currently experiencing significant growth due in part to acquisitions of
additional manufacturing facilities. This may present challenges to effectively
integrate these new facilities. Operational challenges at Manufacturers' Service
Limited or Flextronics could impact their ability to meet our manufacturing
requirements, which could have a material adverse effect on our results of
operations.

We do not have a manufacturing agreement with Flextronics, upon whom we rely to
manufacture a significant number of our device products. We presently order our
products on a purchase order basis from Flextronics. The absence of a
manufacturing agreement means that, with little or no notice, Flextronics could
refuse to continue to manufacture all or some of the units of our devices that
we require or change the terms under which it manufactures our device products.
If Flextronics were to stop manufacturing our devices, we may be unable to
replace the lost manufacturing capacity on a timely basis and our results of
operations could be harmed. In addition, if Flextronics were to change the terms
under which they manufacture for us, our manufacturing costs could increase and
our profitability could suffer.

WE DEPEND ON OUR SUPPLIERS, MANY OF WHICH ARE THE SOLE SOURCE FOR OUR
COMPONENTS, AND OUR PRODUCTION WOULD BE SERIOUSLY HARMED IF THESE SUPPLIERS ARE
NOT ABLE TO MEET OUR DEMAND AND ALTERNATIVE SOURCES ARE NOT AVAILABLE.

Our products contain components, including liquid crystal displays, touch
panels, memory chips and microprocessors, that are procured from a variety of
suppliers. The cost, quality and availability of components are essential to the
successful production and sale of our device products. Recently, including
during the fourth quarter of fiscal 2000 and the first quarter of fiscal 2001,
we have experienced shortages of certain key components, including liquid
crystal displays and related components, flash memory chips and dynamic random
access memory (DRAM) chips. A number of our suppliers are capacity constrained,
due to high industry demand for their components and relatively long lead times
required to expand factory capacity. In addition, recently our ability to obtain
certain radio frequency integrated circuits has been adversely impacted, due in
part to a fire which occurred at one of the manufacturing facilities used by one
of our suppliers. Shortages of these radio frequency integrated circuits will
impact our ability to produce Palm VIIx devices. In addition, reduced sales of
these Palm VIIx devices is likely to limit the growth rate of our Palm.Net
service revenues.

<PAGE>

Some components, such as displays, power supply integrated circuits, digital
signal processors, microprocessors, crystals and several radio frequency and
discrete components, come from sole or single source suppliers. Alternative
sources are not currently available for these sole and single source components.
If suppliers are unable or unwilling to meet our demand for sole source
components and if we are unable to obtain an alternative source or if the price
for an alternative source is prohibitive, our ability to maintain timely and
cost-effective production of our handheld computing device products would be
seriously harmed. In addition, because we rely primarily on one-time purchase
orders with our suppliers, including our sole and single source suppliers, we
cannot predict with certainty our ability to procure components if the demand
for our products exceeds our forecast. If the shortages of liquid crystal
displays and related components and flash memory chips or any other key
component persists or worsens, we will likely not be able to deliver sufficient
quantities of our products to satisfy demand. This could result in quarterly
fluctuations in operating results and could result in market share loss to
competitors who are able to supply sufficient quantities of their products to
meet demand. In addition our costs to purchase these components would increase,
which would lower our profits.

WE USE THIRD PARTIES TO PROVIDE SIGNIFICANT OPERATIONAL AND ADMINISTRATIVE
SERVICES, AND OUR ABILITY TO SATISFY OUR CUSTOMERS AND OPERATE OUR BUSINESS WILL
SUFFER IF THE LEVEL OF SERVICES DOES NOT MEET OUR REQUIREMENTS.

We use third parties to provide services such as customer service, product
distribution, data center operations and desktop support, and facilities
services. Should any of these third parties fail to deliver an adequate level of
service, our business could suffer.

WE DO NOT KNOW IF THE PALM PLATFORM LICENSING AND INTERNET SERVICES PARTS OF OUR
BUSINESS WILL BE ABLE TO GENERATE SIGNIFICANT REVENUE IN THE FUTURE, AND WE WILL
CONTINUE TO RELY ON OUR HANDHELD DEVICE PRODUCTS AS THE PRIMARY SOURCE OF OUR
REVENUE FOR THE FORESEEABLE FUTURE.

Our future growth and a significant portion of our future revenue depend on the
commercial success of our Palm handheld devices, which comprise the primary
product line that we currently offer. We expanded our Palm platform licensing
and Internet services parts of our business only recently, and these parts of
our business have generated a small percentage of our revenues. If revenues from
our device business do not grow, our other business activities may not be able
to compensate for this shortfall.

A SIGNIFICANT PORTION OF OUR REVENUES CURRENTLY COMES FROM A SMALL NUMBER OF
DISTRIBUTORS, AND ANY DECREASE IN REVENUES FROM THESE DISTRIBUTORS COULD HARM
OUR RESULTS OF OPERATIONS.

A significant portion of our revenues comes from only a small number of
distributors. For example, Ingram Micro and Tech Data represented approximately
22% and 8%, respectively, of our revenues in the quarter ended September 1,
2000. We expect that the majority of our revenues will continue to depend on
sales of our handheld devices to a small number of distributors. Any downturn in
the business of these customers could seriously harm our revenues and results of
operations.

<PAGE>

WE RELY ON DISTRIBUTORS, RETAILERS AND RESELLERS TO SELL OUR PRODUCTS, AND
DISRUPTIONS TO THESE CHANNELS WOULD ADVERSELY AFFECT OUR ABILITY TO GENERATE
REVENUES FROM THE SALE OF OUR HANDHELD DEVICES.

Because we sell a significant portion of our products to distributors, retailers
and traditional and Internet based resellers, we are subject to many risks,
including risks related to their inventory levels and support for our products.
Historically, our distributors, retailers and resellers have maintained
significant levels of our products in their inventories. However, in both the
fourth quarter of fiscal 2000 and the first quarter of fiscal 2001, we were
generally unable to fully meet the demand for our products from our
distributors, retailers and resellers. If we are unable to supply our
distributors, retailers and resellers with sufficient levels of inventory to
meet customer demand, our sales could be negatively impacted.

Our distributors, retailers and resellers also sell products offered by our
competitors. As previously discussed, for the past two quarters we have
generally been unable to fully meet the demand for our products based on orders
placed by our distributors, retailers and resellers. If our competitors offer
our distributors, retailers and resellers more favorable terms or have more
products available to meet their needs, those distributors, retailers and
resellers may de-emphasize or decline to carry our products or carry our
competitors' products instead. In the future, we may not be able to retain or
attract a sufficient number of qualified distributors, retailers and resellers.
Further, distributors, retailers and resellers may not recommend, or continue to
recommend, our products. If we are unable to maintain successful relationships
with distributors, retailers and resellers or to expand our distribution
channels, our business will suffer.

If we reduce the prices of our products to our distributors, retailers and
resellers, we may have to compensate them for the difference between the higher
price they paid to buy their inventory and the new lower prices. In addition,
like other manufacturers, we are exposed to the risk of product returns from
distributors, either through their exercise of contractual return rights or as a
result of our strategic interest in assisting distributors in balancing
inventories.

We believe our distributors, retailers and traditional resellers are
experiencing intense competition from Internet-based suppliers that distribute
directly to end-user customers, and that competition among Internet-based
suppliers is also intense. We also sell our products directly to end-user
customers from our Palm.com web site. These actions could cause conflict among
our channels of distribution, which could seriously harm our revenues and
results of operations.

IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR
RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS, FEWER
CUSTOMER ORDERS, REDUCED MARGINS AND LOSS OF MARKET SHARE.

We compete in the handheld device, operating system software and Internet
services markets. The markets for these products and services are highly
competitive and we expect competition to increase in the future. Some of our
competitors or potential competitors have significantly greater financial,

22
<PAGE>

technical and marketing resources than we do. These competitors may be able to
respond more rapidly than Palm to new or emerging technologies or changes in
customer requirements. They may also devote greater resources to the
development, promotion and sale of their products than we do.

- Our handheld computing device products compete with a variety of smart
handheld devices, including keyboard-based devices, sub-notebook computers,
smart phones and two-way pagers. Our principal competitors include Casio,
Compaq, Hewlett-Packard, Psion, Research in Motion Limited (RIM), Sharp and
Palm platform licensees such as Handspring, Sony and TRG.

- Our Palm platform competes primarily with operating systems such as
Microsoft's Windows CE for palm-sized personal computers (Pocket PC) and
Symbian's EPOC for wireless devices. Licensees of our Palm platform are
under no obligation to introduce new products based on our operating
system, and may elect to use an alternative operating system, in which case
we may not be able to increase our revenue from licensing the Palm
platform, or expand the proliferation of the Palm economy.

- Our Internet services compete with a variety of alternative technologies
and services, such as those based on different industry standards for
wireless Internet access, information appliances that provide Internet
connectivity and other traditional and developing methods. Competitors to
our wireless Internet services include RIM and Omnisky. Our
subscription-model access business also competes indirectly with other
providers of Internet access, ranging from dedicated Internet service
providers such as America Online and Earthlink to local phone companies.

We expect our competitors to continue to improve the performance of their
current products and services and to introduce new products, services and
technologies. For example, in the first half of calendar 2000, Microsoft
introduced a new version of its Windows CE operating system. We believe that
Microsoft is investing aggressively to assist its licensees in marketing the
Pocket PC line of handheld computers based on this new version of the Windows CE
operating system. Successful new product introductions or enhancements by our
competitors, or increased market acceptance of competing products, such as the
Pocket PC and RIM devices or devices offered by our licensees, such as
Handspring and Sony, could reduce the sales and market acceptance of our
products and services, cause intense price competition or make our products
obsolete. To be competitive, we must continue to invest significant resources in
research and development, sales and marketing and customer support. We cannot be
sure that we will have sufficient resources to make these investments or that we
will be able to make the technological advances necessary to be competitive.
Increased competition could result in price reductions, fewer customer orders,
reduced margins and loss of market share. Our failure to compete successfully
against current or future competitors could seriously harm our business,
financial condition and results of operations.

IF WE FAIL TO EFFECTIVELY RESPOND TO COMPETITION FROM PRODUCTS INTRODUCED BY
LICENSEES OF OUR PALM PLATFORM OR IF OUR LICENSEES FAIL TO SELL PRODUCTS BASED
ON THE PALM PLATFORM, OUR RESULTS OF OPERATIONS MAY SUFFER AS THE REVENUES WE
RECEIVE FROM LICENSE FEES MAY NOT COMPENSATE FOR THE LOSS OF REVENUES FROM OUR
DEVICE PRODUCTS.

The success of our business depends on both the sale of handheld device products
and the licensing of

<PAGE>

our Palm platform. However, licensees of our Palm platform offer products that
compete directly or indirectly with our handheld computing devices. For example,
licensees such as Handspring and Sony use our Palm platform in products that can
compete with our handheld devices. In addition, our Palm platform has been
licensed by other manufacturers such as Nokia and Kyocera for use in devices
such as mobile phones or other similar products that can compete indirectly with
our handheld devices. If revenues from our handheld devices suffer because of
competition from licensees of our Palm platform, our results of operations would
suffer and our ability to implement our business model would be seriously
challenged. In addition, our licensees may not be successful in selling products
based on the Palm platform, which could harm our business and results of
operations.

DEMAND FOR OUR PRODUCTS IS PARTIALLY DEPENDENT UPON SUPPORT FROM THIRD PARTY
SOFTWARE AND HARDWARE DEVELOPERS.

Decisions by customers to purchase our handheld device products, as opposed to
competitive product offerings, are sometimes based on the availability of third
party software, hardware and other expansion capabilties. In the future, we
believe that the level of support from third party developers in developing
products which provide expansion capabilities to handheld devices will become
increasingly important. For example, Handspring's line of Visor products feature
a hardware expansion slot. While we believe that our products compete favorably
with respect to expansion capabilities, our operating results could be adversely
impacted if third party developers focus their efforts on developing products
that provide expansion capabilities to competitive product offerings.

OUR PALM PLATFORM AND HANDHELD DEVICES MAY CONTAIN ERRORS OR DEFECTS, WHICH
COULD RESULT IN THE REJECTION OF OUR PRODUCTS AND DAMAGE TO OUR REPUTATION, AS
WELL AS LOST REVENUES, DIVERTED DEVELOPMENT RESOURCES AND INCREASED SERVICE
COSTS AND WARRANTY CLAIMS.

Our Palm platform and our devices are complex and must meet stringent user
requirements. We must develop our software and hardware products quickly to keep
pace with the rapidly changing handheld device market. Products and services as
sophisticated as ours are likely to contain undetected errors or defects,
especially when first introduced or when new models or versions are released. We
have in the past experienced delays in releasing some models and versions of our
products until problems were corrected. Our products may not be free from errors
or defects after commercial shipments have begun, which could result in the
rejection of our products, damage to our reputation, lost revenues, diverted
development resources and increased customer service and support costs and
warranty claims. Any of these results could harm our business. For instance, we
recently experienced increased support costs related to a faulty memory
component used in a limited number of our handheld devices, which required us to
develop a software patch to address the problem.

Recently, there have been reports of computer viruses impacting handheld device
operating systems. Viruses and publicity about them may adversely impact sales
of our products. In particular, if anti-virus protection which users deem to be
adequate is not developed to combat these viruses, this could have a material
adverse effect on our business, both in our device business as well as the
Internet services and solutions part of our business.

<PAGE>

IF WE FAIL TO MANAGE OUR GROWTH EFFECTIVELY, WE MAY NOT BE ABLE TO SUCCESSFULLY
MANAGE OUR BUSINESS, WHICH COULD CAUSE US TO FAIL TO MEET OUR CUSTOMER DEMAND OR
TO ATTRACT NEW CUSTOMERS.

Our ability to successfully offer our products and implement our business plan
in a rapidly evolving market requires an effective planning and management
process. We continue to increase the scope of our operations domestically and
internationally and have grown our shipments and headcount substantially. At
December 31, 1999, we had a total of approximately 652 employees. At September
1, 2000 we had a total of approximately 1,188 employees. In addition, we plan to
continue to hire a significant number of employees this year. This growth has
placed, and our anticipated growth in future operations will continue to place,
a significant strain on our management systems and resources and increase our
expenses.

We expect that we will need to continue to improve our financial and managerial
controls, reporting systems and procedures. While we have implemented
stand-alone versions of most of the transaction processing systems historically
used by 3Com, we intend to implement new systems over the next 3-12 months that
more closely match our business needs and to incur significant additional
expenses in connection with those systems. In addition, we will need to continue
to expand, train and manage our work force worldwide.

We recently acquired two companies, and may make additional strategic
acquisitions in the future. Acquisitions will make it more difficult to
effectively manage our growth, due to a number of factors including the addition
of new employees, the expansion of our operations into new geographic areas and
the increased geographic dispersion of our personnel, and the expansion of our
product and service offerings. If we are not able to successfully integrate
acquired companies into our business, our results of operations could be
adversely impacted.

THE MARKET FOR THE DELIVERY OF INTERNET SERVICES THROUGH HANDHELD DEVICES IS NEW
AND RAPIDLY EVOLVING, AND OUR BUSINESS AND OUR ABILITY TO GENERATE REVENUES FROM
OUR HANDHELD DEVICES, PALM PLATFORM OR INTERNET SERVICES COULD SUFFER IF THIS
MARKET DOES NOT DEVELOP OR WE FAIL TO ADDRESS THIS MARKET EFFECTIVELY.

The market for the delivery of Internet services through handheld devices is new
and rapidly evolving. In addition, our Internet services strategy has been
developed only recently, and we must continue to adapt it to compete in the
rapidly evolving Internet services market. We currently offer our Palm.Net
service, a subscription-based wireless access service that enables users of the
Palm VII family of handhelds to access web-clipped content on the Internet. We
are currently developing additional functionality for our Internet services and
solutions. Other competitors have introduced or developed, or are in the process
of introducing or developing competing Internet services accessible through a
variety of handheld devices and other information appliances. We cannot assure
you that there will be demand for the Internet services provided by us or that
individuals will widely adopt our handheld devices as a means of accessing
Internet services. Accordingly, it is extremely difficult to predict which
products and services will be successful in this market or the future size and
growth of this market. In addition, given the limited history and rapidly
evolving nature of this market, we cannot predict the price that

<PAGE>

wireless subscribers will be willing to pay for these products and services. If
acceptance of our Internet services and solutions is less than anticipated, our
ability to expand our business could be impacted. In addition, our ability to
produce Palm VIIx devices is currently constrained, thereby limiting the growth
of new subscribers to our Palm.Net services.

WE MAY NOT BE ABLE TO DELIVER INTERNET ACCESS IF OUR WIRELESS CARRIER RAISES ITS
RATES, DISCONTINUES DOING BUSINESS WITH US OR DOES NOT DELIVER ACCEPTABLE
SERVICE.

The future success of our Internet services business substantially depends on
the capacity, affordability, reliability and security of our wireless networks.
Only a small number of wireless providers offer the network services we require.
We currently rely on BellSouth Wireless Data to provide all of our Palm VII and
Palm VIIx handheld wireless network services pursuant to an agreement. Our
agreement with BellSouth permits each party to terminate the agreement on an
annual basis. If BellSouth failed to provide us with service at rates acceptable
to us or at all, we may not be able to provide Internet access to our users. In
addition, our Palm VII series of products are configured around the frequency
standard used by BellSouth. If we needed to switch to another wireless carrier,
we would have to redesign significant portions of our software and hardware to
permit transmission on a different frequency. Users of Palm VII series products
existing before the redesign would not be able to access the service provided by
the new wireless carrier. If we were required to redesign these elements, our
business could be adversely affected. If BellSouth delivers unacceptable
service, the quality of our Internet services would suffer and we would likely
lose users who are dissatisfied with our service. For example, we are aware that
BellSouth, like other wireless carriers, has experienced service outages from
time to time in their wireless data network.

WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR WIRELESS INTERNET SERVICES INTO
INTERNATIONAL MARKETS.

BellSouth provides wireless data services only in the United States. We intend
to expand our network services to support Internet services internationally, but
doing so will require us to enter into new relationships with wireless providers
abroad. We may not be able to enter into relationships with international
wireless carriers which are on favorable terms to us. In addition, because many
international wireless carriers use different standards and transmit data on
different frequencies than BellSouth, we are likely to incur incremental
expenses related to the redesign of significant portions of our software and
hardware. Furthermore, our products may be subject to a lengthy certification
process with each wireless carrier with whom we seek to enter into a
relationship. These certification requirements could delay or otherwise
negatively impact our strategy of expanding our wireless Internet services into
international markets.

OUR REPUTATION AND ABILITY TO GENERATE REVENUES WILL BE HARMED IF DEMAND FOR OUR
INTERNET SERVICES EXCEEDS OUR TELECOMMUNICATIONS AND NETWORK CAPACITY.

We may from time to time experience increases in our Internet services usage
which exceed our

<PAGE>

available telecommunications capacity and the capacity of our third party
network servers. As a result, users may be unable to register or log on to our
service, may experience a general slow-down in their Internet access or may be
disconnected from their sessions. Excessive user demand could also result in
system failures of our third party network servers' networks.

Inaccessibility, interruptions or other limitations on the ability to access our
service due to excessive user demand, or any failure of our third party network
servers to handle user traffic, would have a material adverse effect on our
reputation and our revenues.

WE PLAN TO EXPAND OUR DIRECT E-COMMERCE OPERATION, AND OUR ABILITY TO GENERATE
REVENUES FROM OUR INTERNET SERVICES COULD BE HARMED IF THIS OPERATION IS NOT
SUCCESSFUL.

We may not be able to achieve any or all of the necessary components of a
successful e-commerce operation. We intend to expand our Palm.com and Palm.net
websites. This expansion will require additional expenditures. We have little
experience in implementing or operating a direct e-commerce business, and if we
are not successful in operating it or in successfully managing our current sales
channels alongside our direct e-commerce channel, our operating results could be
adversely affected.

IF THE SECURITY OF OUR WEBSITES IS COMPROMISED, OUR REPUTATION COULD SUFFER AND
CUSTOMERS MAY NOT BE WILLING TO USE OUR INTERNET SERVICES, WHICH COULD CAUSE OUR
REVENUES TO DECLINE.

A significant barrier to widespread use of electronic commerce sites, such as
our Palm.com site, and network services sites, such as our Palm.net site, is
concern for the security of confidential information transmitted over public
networks. Despite our efforts to protect the integrity of our Palm.com and
Palm.net sites, a party may be able to circumvent our security measures and
could misappropriate proprietary information or cause interruptions in our
operations and damage our reputation. Any such action could negatively affect
our customers' willingness to engage in online commerce with us. We may be
required to expend significant capital and other resources to protect against
these security breaches or to alleviate problems caused by these breaches.

WE MAY NOT BE ABLE TO MAINTAIN AND EXPAND OUR BUSINESS IF WE ARE NOT ABLE TO
HIRE, RETAIN AND INTEGRATE SUFFICIENT QUALIFIED PERSONNEL.

Our future success depends to a significant extent on the continued contribution
of our key executive, technical, sales, marketing, supply chain and
administrative personnel. It also depends on our ability to expand, integrate
and retain our management team. The loss of services of key employees could
adversely affect our business, operating results or financial condition. Many
members of our senior management have been with the business only a short time.
In addition, recruiting and retaining skilled personnel, including software and
hardware engineers, is highly competitive, particularly in the San Francisco Bay
Area where we are headquartered. If we fail to retain, hire and integrate
qualified employees and contractors, we will not be able to maintain and expand
our business. In addition, we must carefully balance the growth of our employees
commensurate with our anticipated revenue growth.

<PAGE>

If our revenue growth or attrition levels vary significantly, our results of
operations or financial condition could be adversely affected. Further, our
common stock price has been, and may continue to be extremely volatile. When our
common stock price is less than the exercise price of stock options granted to
employees, turnover is likely to increase, which could adversely affect our
results of operations or financial condition.

THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE WE ARE INFRINGING THEIR
INTELLECTUAL PROPERTY, AND WE COULD SUFFER SIGNIFICANT LITIGATION OR LICENSING
EXPENSES OR BE PREVENTED FROM SELLING PRODUCTS IF THESE CLAIMS ARE SUCCESSFUL.

In the course of our business, we frequently receive claims of infringement
or otherwise become aware of potentially relevant patents or other
intellectual property rights held by other parties. We evaluate the validity
and applicability of these intellectual property rights, and determine in
each case whether we must negotiate licenses or cross-licenses to incorporate
or use the proprietary technologies in our products. Third parties may claim
that we or our customers or Palm platform licensees are infringing their
intellectual property rights, and we may be found to infringe those
intellectual property rights and require a license to use those rights. We
may be unaware of intellectual property rights of others that may cover some
of our technology, products and services. For a description of pending
lawsuits involving claims that we are infringing a third party's intellectual
property, refer to Part II--Item 1--Legal Proceedings of this Report on Form
10-Q.

Any litigation regarding patents or other intellectual property could be costly
and time-consuming, and divert our management and key personnel from our
business operations. The complexity of the technology involved and the
uncertainty of intellectual property litigation increase these risks. Claims of
intellectual property infringement might also require us to enter into costly
royalty or license agreements or indemnify our Palm platform licensees. However,
we may not be able to obtain royalty or license agreements on terms acceptable
to us, or at all. We also may be subject to significant damages or injunctions
against development and sale of our products.

We often rely on licenses of intellectual property for use in our business. We
cannot assure you that these licenses will be available in the future on
favorable terms or at all.

IF THIRD PARTIES INFRINGE OUR INTELLECTUAL PROPERTY, WE MAY EXPEND SIGNIFICANT
RESOURCES ENFORCING OUR RIGHTS OR SUFFER COMPETITIVE INJURY.

Our success depends in large part on our proprietary technology. We rely on a
combination of patents, copyrights, trademarks and trade secrets,
confidentiality provisions and licensing arrangements to establish and protect
our proprietary rights. If we fail to protect or to enforce our intellectual
property rights successfully, our competitive position could suffer, which could
harm our operating results.

Our pending patent and trademark registration applications may not be allowed or
competitors may

<PAGE>

challenge the validity or scope of these patent applications or trademark
registrations. In addition, our patents may not provide us a significant
competitive advantage.

We may be required to spend significant resources to monitor and police our
intellectual property rights. We may not be able to detect infringement and may
lose competitive position in the market before we do so. In addition,
competitors may design around our technology or develop competing technologies.
Intellectual property rights may also be unavailable or limited in some foreign
countries, which could make it easier for competitors to capture market share.

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

OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS.

Since we sell our products worldwide, our business is subject to risks
associated with doing business internationally. We anticipate that revenue from
international operations will represent an increasing portion of our total
revenue. In addition, several of the facilities where our devices are
manufactured are located outside the United States. Accordingly, our future
results could be harmed by a variety of factors, including:

- changes in foreign currency exchange rates;

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

- trade protection measures and import or export licensing requirements;

- potentially negative consequences from changes in tax laws;

- difficulty in managing widespread sales and manufacturing operations; and

- less effective protection of intellectual property.

For example, several companies have recently reported decreased demand from
European customers, which they have attributed to unfavorable exchange rate
fluctuations and higher oil prices. Although substantially all of our revenues
are denominated in U.S. dollars, we are subject to changes in demand for our
products resulting from exchange rate fluctuations that make our products
relatively more or less expensive in international markets. If exchange rate
fluctuations occur, such as the recent decline of the

<PAGE>

Euro relative to the US dollar, our business could be negatively impacted by
decreases in demand for our products or reductions in gross margins.
Notwithstanding the recent exchange rate fluctuations, in the first quarter of
fiscal 2001 our European customers requested more products than we supplied.

WE INTEND TO PURSUE STRATEGIC ACQUISITIONS AND INVESTMENTS WHICH COULD HAVE AN
ADVERSE IMPACT ON OUR BUSINESS IF UNSUCCESSFUL.

We recently acquired Actual Software and Anyday.com. We often evaluate other
acquisition opportunities that could provide us with additional product or
services offerings or additional industry expertise. Acquisitions could result
in difficulties assimilating acquired operations and products, and result in the
diversion of capital and management's attention away from other business issues
and opportunities. Integration of acquired companies may result in problems
related to integration of technology and inexperienced management teams. Our
management has had limited experience in assimilating acquired organizations and
products into our operations. We may not successfully integrate any operations,
personnel or products that we have acquired or may acquire in the future. If we
fail to successfully integrate acquisitions, our business could be materially
harmed.

In addition, we have recently designated up to $50 million for strategic
investments in other companies which provide products and services which are
complementary to ours. If these investments are unsuccessful, this could have a
material adverse impact on our results of operations and financial position.

OUR ABILITY TO PURSUE MERGERS AND ACQUISITIONS MAY BE LIMITED.

3Com has obtained a ruling from the Internal Revenue Service that the
distribution of 3Com's shares of Palm common stock to 3Com's stockholders will
be not be taxable. Such ruling requires 3Com and Palm, through July 27, 2002,
not to engage in certain transactions that would constitute a change of more
than 50% of the equity interest in either company. Consequently, our ability to
engage in mergers and acquisitions will be limited by this requirement. If
either 3Com or Palm fail to conform to requirements set forth in the ruling,
there would be material adverse consequences, potentially including making the
distribution taxable, and causing the company which was responsible for such
non-conformance to indemnify the other company for any resulting damages.

WE CANNOT PREDICT THE IMPACT OF RECENT ACTIONS AND COMMENTS BY THE SEC AND FASB

Recent actions and comments from the SEC have focused on the integrity of
financial reporting. In addition, the FASB and other regulatory accounting
agencies have recently introduced several new or proposed accounting standards,
some of which represent a significant change from current industry practices.
For example, In December 1999, the SEC issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements." SAB 101 provides guidance on the
recognition, presentation, and disclosure of revenue in financial statements of
all public registrants. In response to numerous requests for interpretive
guidance of SAB 101, the effective date of the standard has been delayed twice.
We currently expect SAB 101 to become effective during fiscal 2001. Depending on
the

<PAGE>

final interpretation of the standard, the adoption of SAB 101 may have a
material effect on our reported revenues and results of operations for any
particular quarter. However, we believe that the impact of SAB 101 will not have
a material effect on the underlying strength or weakness of our business
operations as measured by the dollar value of our product shipments and cash
flows.

RISKS RELATED TO OUR SEPARATION FROM 3COM

BECAUSE WE CURRENTLY USE PORTIONS OF 3COM'S NETWORK INFRASTRUCTURE, REAL ESTATE
FACILITIES, AND RELATED SITE SERVICES, OUR ABILITY TO OPERATE OUR BUSINESS COULD
BE IMPACTED BY DISRUPTIONS IN SERVICE LEVELS FROM 3COM.

We continue to rely upon the network infrastructure and certain other systems
provided and maintained by 3Com. We are in the process of migrating to our own
network infrastructure which we intend to outsource to a third party. We may
experience network interruptions related to either the current 3Com network
infrastructure or the migration to our new network infrastructure maintained by
a third party.

Any failure or significant downtime in 3Com's or our own network or information
systems could prevent us from taking customer orders, shipping products or
billing customers and could harm our business. In addition, our network and
information systems require the services of employees with extensive knowledge
of these information systems and the business environment in which we operate.
In order to successfully implement and operate our systems, we must be able to
attract and retain a significant number of highly skilled employees. If we fail
to attract and retain the highly skilled personnel required to implement,
maintain, and operate our information systems, our business could suffer.

In addition, we currently lease office space from 3Com in Santa Clara and other
locations. We have entered into arrangements with 3Com to lease our Santa Clara
facilities under a lease that is terminable with six months notice beginning in
July 2001 and expires in February 2003. After this transition period, we will
need to secure alternative facilities. We recently announced our intention to
build a new campus which we intend to be available in mid 2002. We are currently
in the process of locating additional space and negotiating the lease terms to
meet our expected facilities requirements until the new campus is available. If
we fail to successfully conclude this negotiation process, or fail to find other
replacement facilities in a timely fashion, our business will be harmed.

The agreements with 3Com for these services and leases were made in the context
of a parent-subsidiary relationship and were negotiated in the overall context
of our separation from 3Com. The prices charged to us under these agreements may
be lower than the prices that we may be required to pay third parties for
similar services or the costs of similar services if we undertake them
ourselves.

OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR RESULTS AS
A SEPARATE COMPANY.

Through February 25, 2000, our consolidated financial statements were carved out
from the consolidated

<PAGE>

financial statements of 3Com using the historical results of operations and
historical bases of the assets and liabilities of the 3Com handheld computing
business that we comprised. Accordingly, the historical financial information
does not necessarily reflect what our financial position, results of operations
and cash flows would have been had we been a separate, stand-alone entity during
the periods presented. 3Com did not account for us, and we were not operated, as
a separate, stand-alone entity for the periods presented.

Our historical costs and expenses include allocations from 3Com for centralized
corporate services and infrastructure costs, including legal, accounting,
treasury, real estate, information technology, distribution, customer service,
sales, marketing and engineering.

These allocations were determined on bases that 3Com and Palm considered to be
reasonable reflections of the utilization of services provided to or the benefit
received by Palm. The historical financial information is not necessarily
indicative of what our results of operations, financial position and cash flows
will be in the future. We have not made adjustments to our historical financial
information to reflect the many significant changes that have occurred and will
occur in our cost structure, funding and operations as a result of our
separation from 3Com, including increased costs associated with reduced
economies of scale, increased marketing expenses related to building a company
brand identity separate from 3Com and increased costs associated with being a
publicly traded, stand-alone company.

WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH 3COM WITH RESPECT TO
OUR PAST AND ONGOING RELATIONSHIPS AND MAY NOT RESOLVE THESE CONFLICTS ON THE
MOST FAVORABLE TERMS TO US.

Conflicts of interest may arise between 3Com and us in a number of areas
relating to our past and ongoing relationships, including:

- labor, tax, employee benefit, indemnification and other matters arising
from our separation from 3Com;

- intellectual property matters;

- employee retention and recruiting;

- the nature, quality and pricing of transitional services 3Com has agreed to
provide us; and

- business opportunities that may be attractive to both 3Com and us.

Nothing restricts 3Com from competing with us.

We may not be able to resolve any potential conflicts, and even if we do, the
resolution may be less favorable than if we were dealing with an unaffiliated
party. The agreements we have entered into with 3Com may be amended upon
agreement between the parties.

<PAGE>

RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK

OUR SECURITIES HAVE NOT BEEN PUBLICLY TRADED VERY LONG AND OUR STOCK PRICE MAY
BE SUBJECT TO SIGNIFICANT FLUCTUATIONS AND VOLATILITY.

Our common stock has been publicly traded only since March 2, 2000. The market
price of our common stock has been subject to significant fluctuations since the
date of our initial public offering. These fluctuations could continue. Among
the factors that could affect our stock price are:

- quarterly variations in our operating results;

- changes in revenue or earnings estimates or publication of research reports
by analysts;

- speculation in the press or investment community;

- strategic actions by us or our competitors, such as new product
announcements, acquisitions or restructuring;

- actions by institutional stockholders;

- general market conditions; and

- domestic and international economic factors unrelated to our performance.

The stock markets in general, and the markets for high technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. These broad market
fluctuations may adversely affect the trading price of our common stock.

PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW AND OUR ADOPTION OF A
STOCKHOLDER RIGHTS PLAN MAY DELAY OR PREVENT ACQUISITION OF US, WHICH COULD
DECREASE THE VALUE OF YOUR SHARES.

Our certificate of incorporation and bylaws and Delaware law contain provisions
that could make it harder for a third party to acquire us without the consent of
our board of directors. These provisions include a classified board of directors
and limitations on actions by our stockholders by written consent. Delaware law
also imposes some restrictions on mergers and other business combinations
between us and any holder of 15% or more of our outstanding common stock. In
addition, our board of directors has the right to issue preferred stock without
stockholder approval, which could be used to dilute the stock ownership of a
potential hostile acquirer. Although we believe these provisions provide for an
opportunity to receive a higher bid by requiring potential acquirers to
negotiate with our board of directors, these provisions apply even if the offer
may be considered beneficial by some stockholders.

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

33
<PAGE>

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE SENSITIVITY

Palm's exposure to market risk for changes in interest rates relates primarily
to our investment portfolio, which consists of cash, cash equivalents and
short-term investments as of September 1, 2000. The primary objective of our
investment activities is to maintain the safety of principal and preserve
liquidity while maximizing yields without significantly increasing risk. This is
accomplished by investing in marketable investment grade securities and by
limiting exposure to any one issuer. We do not use derivative financial
instruments in our investment portfolio and due to the nature of our
investments, we do not expect our operating results or cash flows to be affected
to any significant degree by the effect of a sudden change in market interest
rates on our investment portfolio. As of September 1, 2000, all investments
mature within one year and are carried at amortized cost, which approximates
fair market value.

Subsequent to quarter-end, we entered into an operating lease agreement related
to our new corporate campus, for which occupancy is planned beginning in
mid-2002. In conjunction with this agreement, we are required to guarantee a
minimum residual value for the property and to maintain certain levels of cash
collateral over the term of the agreement. Such cash collateral will be
classified as non-current restricted cash in our consolidated balance sheet and
totaled approximately $225 million at the inception of the lease agreement. As
the leased facilities are constructed the amount of cash collateral required to
be maintained is expected to increase to at least $400 million. Palm will
continue to receive the interest income earned on the cash collateral.

FOREIGN CURRENCY EXCHANGE RATE RISK

Prior to our separation from 3Com, our exposure to foreign currency exchange
rate risk was managed on an enterprise-wide basis as part of 3Com's risk
management strategy. This strategy utilized foreign exchange forward and option
contracts to hedge certain balance sheet exposures and intercompany balances
against future movements in foreign exchange rates. Having now separated from
3Com, we will manage our exchange rate risk on an independent basis. Currently,
substantially all of our revenues are denominated in US dollars. We do not
currently and do not intend in the future to utilize derivative financial
instruments for trading purposes.

<PAGE>

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Palm is a party to lawsuits in the normal course of its business. Litigation in
general, and intellectual property litigation in particular, can be expensive
and disruptive to normal business operations. Moreover, the results of complex
legal proceedings are difficult to predict. Palm believes that it has defenses
to the cases set forth below and is vigorously contesting these matters. Palm is
not currently able to estimate the possible loss, or range of loss, if any, from
the cases listed below and an unfavorable resolution of these lawsuits could
adversely affect Palm's business, results of operations or financial condition.

On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District Court
for the Western District of New York. The case is now captioned: XEROX
CORPORATION v. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP., PALM
COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T. The
complaint alleged willful infringement of U.S. patent 5,596,656 entitled
"Unistrokes for Computerized Interpretation of Handwriting." The complaint
sought unspecified damages and to permanently enjoin the defendants from
infringing the patent in the future. In an Order entered by the District Court
on June 6, 2000, the District Court granted the defendants' motion for summary
judgment of non-infringement and dismissed the case in its entirety. On July 5,
2000, Xerox filed a Notice of Appeal of the dismissal with the U.S. Court of
Appeals for the Federal Circuit.

On July 22, 1999, Palm filed a copyright infringement action against Olivetti
and CompanionLink in the United States District Court for the Northern District
of California and obtained a preliminary injunction against further
distribution, sale, import or export of Olivetti Office USA's "Royal daVinci"
handheld device and the daVinci OS Software Development Kit (distributed by
CompanionLink Software, Inc.), which contained source code copied from the Palm
OS operating system. The injunction is to remain in effect pending the outcome
of the lawsuit. Palm also initiated a copyright infringement action in Hong Kong
on July 21, 1999, against EchoLink Design Ltd., the company responsible for
developing the operating system software contained in the daVinci products. The
High Court of the Hong Kong Special Administrative Region issued an order the
same day restraining EchoLink from further copying, distribution, sale, import
or export of Palm OS operating system source code or EchoLink's "NEXUS OS"
source code, which Palm maintains infringes its copyrights. On October 7, 1999,
3Com notified certain third-party retailers about the preliminary injunction
order cited above. Olivetti has filed a motion seeking leave to assert
counterclaims against Palm and 3Com for unfair competition, intentional
interference with potential economic advantage, libel and trade libel, based
upon certain statements that were allegedly made, or that 3Com allegedly omitted
to make, in the October 7, 1999 letter.

On December 13, 1999, WaveWare Communications, Inc. filed suit against 3Com,
Palm and others in the Superior Court of California, San Mateo County. The case
is captioned WAVEWARE COMMUNICATIONS, INC. v. 3COM CORPORATION, PALM COMPUTING,
INC., AND MARK BERCOW, No. 411331. The complaint alleges breach of contract,
constructive fraud, fraud and deceit, negligent misrepresentation,
misappropriation of assets and trade secrets, unfair competition, unjust
enrichment and intentional interference with economic advantage in connection
with our and 3Com's discussions with WaveWare concerning WaveWare's potential
acquisition by 3Com. The complaint seeks unspecified monetary damages and
injunctive relief. Discovery is ongoing and the case is set for trial in January
2001.

On December 27, 1999, Telxon Corporation and Penright! Corporation filed a
complaint in the U.S. District Court for the Northern District of Ohio, Eastern
Division (Case No. 1:99CV3157) against 3Com

<PAGE>

and Palm alleging copyright infringement, unfair competition and theft of trade
secrets. In an Order dated July 31, 2000, the Federal Judge assigned to the
action transferred the case to the U.S. District Court for the Northern District
of California. The case is now captioned TELXON CORPORATION V. 3COM INC. (CASE
NO. C00-02885 CRB). The plaintiffs allege that the Palm OS operating system
contains graphical user interface software copied from the plaintiffs' software.
The complaint seeks unspecified compensatory and treble damages and to enjoin,
among other things, distribution and sales of the Palm OS operating system. No
trial date has been set. The case is still in the early stages of discovery.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against "3Com, Inc."
in the United States District Court for the Southern District of New York and
later filed on March 6, 2000 an Amended Complaint against Palm and 3Com. In an
Order dated June 9, 2000, the Federal Judge assigned to the action transferred
the case to the U.S. District Court for the Northern District of California. The
case is now captioned E-PASS TECHNOLOGIES, INC. V. 3COM CORPORATION, A/K/A 3COM,
INC. AND PALM, INC. (Case No. C00 2255-DLH ADR). The Amended Complaint alleges
willful infringement of U.S. patent 5,276,311 entitled "Method and Device for
Simplifying the Use of Credit Cards, or the Like." The complaint seeks
unspecified compensatory and treble damages and to permanently enjoin the
defendants from infringing the patent in the future. Palm is in the preliminary
stages of investigating the allegations contained in the suit. No trial date has
been set. The case is still in the early stages of discovery.

On May 2, 2000, Rotis Technologies Corporation filed suit against Palm and two
other defendants in the U.S. District Court for the Northern District of Texas.
The case is now captioned ROTIS TECHNOLOGIES CORPORATION V. TRACK DATA
CORPORATION, PALM, INC. AND SPRINT SPECTRUM L.P. (Case No. 300CV-931-L). The
complaint alleges infringement of U.S. patent 4,473,824 entitled "Price
Quotation System." The complaint seeks unspecified compensatory and treble
damages and to permanently enjoin the defendants from infringing the patent in
the future. Palm is in the preliminary stages of investigating the allegations
contained in the suit. No trial date has been set. The case is still in the
early stages of discovery.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

Exhibit
Number Description
------- -----------
<S> <C>

2.1(1) Master Separation and Distribution Agreement between
3Com and the registrant effective as of December 13,
1999, as amended.
2.2(2) General Assignment and Assumption Agreement between
3Com and the registrant, as amended.
2.3(2) Master Technology Ownership and License Agreement
between 3Com and the registrant.
2.4(2) Master Patent Ownership and License Agreement between
3Com and the registrant.
2.5(2) Master Trademark Ownership and License Agreement between 3Com
and the registrant.
2.6(2) Employee Matters Agreement between 3Com and the registrant.
2.7(2) Tax Sharing Agreement between 3Com and the registrant.

36
<PAGE>

2.8(2) Master Transitional Services Agreement between 3Com and the registrant.
2.9(2) Real Estate Matters Agreement between 3Com and the registrant.
2.10(2) Master Confidential Disclosure Agreement between 3Com and the registrant.
2.11(2) Indemnification and Insurance Matters Agreement between 3Com
and the registrant.
2.12(1) Form of Non-U.S. Plan.
3.1 (1) Amended and Restated Certificate of Incorporation.
3.2 (1) Bylaws.
4.1 (1) Reference is made to Exhibits 3.1 and 3.2 hereof.
4.2 (1) Specimen Stock Certificate.
10.1(1)* 1999 Stock Plan.
10.2(1)* Form of 1999 Stock Plan Agreements.
10.3(1)* 1999 Employee Stock Purchase Plan.
10.4(1)* Form of 1999 Employee Stock Purchase Plan Agreements.
10.5(3)* Amended and Restated 1999 Director Option Plan
10.6(1)* Form of 1999 Director Option Plan Agreements.
10.7(1)* Management Retention Agreement dated as of December 1, 1999 by and
between Carl J. Yankowski and the registrant.
10.8(1)* Form of Indemnification Agreement entered into by the
registrant with each of its directors and executive
officers.
10.9(1)** RAM Mobile Data USA Limited Partnership Value Added
Reseller Agreement between RAM Mobile Data USA
Limited Partnership (now BellSouth Wireless Data,
L.P.) and the registrant.
10.10(1)** Supply Agreement between Manufacturers' Services Salt Lake City
Operations, Inc. and the registrant.
10.11(1) Common Stock Purchase Agreement between America Online and the
registrant.
10.12(1) Common Stock Purchase Agreement between Motorola and the registrant.
10.13(1) Common Stock Purchase Agreement Between Nokia and the registrant.
10.14(1) Form of Management Retention Agreement.
10.15 Agreement for Purchase and Sale of Land between 3Com Corporation
and the Registrant.
27.1 Financial Data Schedule.
</TABLE>

(1) - Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (No. 333-92657) filed with the Commission on December 13, 1999, as
amended.

(2) - Incorporated by reference from the Registrant's Report on Form 10-Q filed
with the Commission on April 10, 2000.

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

* - Denotes an executive or director compensation plan or arrangement.
** - Confidential treatment granted on portions of this exhibit.

(b) Reports on Form 8-K

None.

<PAGE>

SIGNATURES

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

Palm, Inc.
(Registrant)

Dated: October 10, 2000 By: /s/ Judy Bruner
--------------------- -------------------------------
Judy Bruner
Senior Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)