Prepared by R.R. Donnelley Financial -- Amended Registration Statement on Form S-4

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE PUBLIC: As soon as practicable following the effectiveness of this registration statement and upon consummation of the transaction described in the merger agreement.

If the securities being registered on this Form are to be offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

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The information in this joint proxy statement/prospectus is not complete and may be changed. Palm may not sell these securities until the registration statement filed with the United States Securities and Exchange Commission is effective. This joint proxy statement/prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

On behalf of the boards of directors of Palm, Inc. and Handspring, Inc., we are pleased to deliver our joint proxy statement/prospectus for the transaction involving the distribution of PalmSource common stock held by Palm to Palm’s stockholders and Palm’s subsequent acquisition of Handspring. We are seeking the approval of both Palm and Handspring stockholders with respect to this transaction. YOUR VOTE IS VERY IMPORTANT.

In the transaction, Palm will distribute approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock, $0.001 par value, held by Palm’s existing stockholders at the time of the closing and, following the distribution, will acquire Handspring. Handspring stockholders will be entitled to receive 0.09 of a share of Palm common stock for each share of Handspring common stock held at that time. Based on the number of shares of Handspring common stock outstanding on the record date, Palm would issue shares of its common stock in exchange for Handspring common stock as a result of the Handspring merger. Handspring stockholders will not receive shares of PalmSource common stock.

Palm common stock is listed on the Nasdaq National Market under the trading symbol “PALM.” On September 18, 2003, the closing sale price of Palm common stock was $ per share. Immediately following the completion of the transaction, Palm expects to change its corporate name to palmOne, Inc. and Nasdaq National Market trading symbol to “PLMO.” There is no current public market for PalmSource’s common stock. Following the distribution of PalmSource common stock to Palm’s stockholders, we expect that PalmSource’s common stock will trade on the Nasdaq National Market under the symbol “PSRC.”

After careful consideration, the boards of directors of both Palm and Handspring have unanimously determined the transaction to be fair to you and in your best interests. The boards of directors of both Palm and Handspring have approved the transaction and recommend that you vote in favor of the transaction.

Stockholders of Palm and Handspring are cordially invited to attend the meeting of stockholders of their company to vote on the transaction. The Palm 2003 annual meeting of stockholders will be held on , 2003 at 8:00 a.m. local time at 580 N. McCarthy Blvd., Building 10, Milpitas, California. The Handspring special meeting of stockholders will be held on , 2003 at a.m. local time at .

At the Palm 2003 annual meeting of stockholders, in addition to approval of the transaction, Palm stockholders are also being asked to elect members of Palm’s board of directors, to ratify the appointment of Deloitte & Touche LLP as Palm’s independent auditors and to approve the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors. Palm’s board of directors is currently composed of eight members, three of whom are standing for election at the 2003 annual meeting. Following the transaction, the board of directors of the combined company will be composed of ten members: seven will be from the current Palm board of directors and three will be from the current Handspring board of directors. The executive leadership of the combined company following the transaction will include officers from both companies, with R. Todd Bradley, the current Chief Executive Officer of the Palm Solutions Group business, serving as the Chief Executive Officer of the combined company.

This joint proxy statement/prospectus provides you with detailed information concerning Palm, PalmSource, Handspring and the transaction. Please pay careful attention to all of the information in this joint proxy statement/prospectus. In particular, you should carefully consider the discussion in “ Risk Factors” beginning on page 25 of this joint proxy statement/prospectus and the risk factors relating to PalmSource beginning on page of Annex A.

Your vote is very important, regardless of the number of shares you own. Whether or not you plan to attend the Palm annual meeting of stockholders or the Handspring special meeting of stockholders, please take the time to vote by completing and mailing the enclosed proxy card or voting instruction card and returning it in the pre-addressed envelope provided or, if available, following the telephone or internet voting instructions set forth on the enclosed proxy card or voting instruction card.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be issued in connection with this joint proxy statement/prospectus or determined if this joint proxy statement/prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

This joint proxy statement/prospectus is dated , 2003, and is first being mailed to stockholders of Palm and Handspring on or about , 2003.

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This joint proxy statement/prospectus incorporates important business and financial information about Palm and Handspring from documents that each company has filed with the Securities and Exchange Commission but that have not been included in or delivered with this joint proxy statement/prospectus. For a listing of documents incorporated by reference into this joint proxy statement/prospectus, please see “Incorporation of Certain Documents by Reference” beginning on page 216 of this joint proxy statement/prospectus.

Palm will provide you with copies of the information relating to Palm, without charge, upon written or oral request to:

In addition, you may obtain copies of this information by making a request through Palm’s investor relations website, http://ir.palm.com.

Handspring will provide you with copies of the information relating to Handspring, without charge, upon written or oral request to:

In addition, you may obtain copies of this information by making a request through Handspring’s investor relations website, http://www.handspring.com/company/investor_ relations.jhtml.

In addition, PalmSource has filed a registration statement with the Securities and Exchange Commission. The prospectus contained in the registration statement is included as Annex A to this joint proxy statement/prospectus. You may obtain the exhibits filed with the registration statement, without charge, upon written or oral request to:

If you would like to request any documents from Palm, Handspring or PalmSource, please do so by , 2003, which is five business days before the date of the Palm and Handspring meetings of stockholders, in order to receive them before the Palm annual meeting or Handspring special meeting.

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NOTICE IS HEREBY GIVEN that the annual meeting of stockholders of Palm, Inc., a Delaware corporation, will be held on , 2003 at , local time, at 580 N. McCarthy Blvd., Building 10, Milpitas, California 95035, for the following purposes:

1. To consider and vote upon a proposal to approve and adopt the Agreement and Plan of Reorganization, dated June 4, 2003, by and among Palm, Inc., Peace Separation Corporation, a wholly owned subsidiary of Palm, Inc., Harmony Acquisition Corporation, a wholly owned subsidiary of Palm, Inc., and Handspring, Inc., and the issuance of shares of Palm common stock to Handspring stockholders;

2. To elect three Class I directors to Palm’s board of directors to hold office for a three-year term;

3. To ratify the appointment of Deloitte & Touche LLP as Palm’s independent public auditors for the fiscal year ending May 28, 2004;

4. To approve the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors; and

5. To transact such other business as may properly come before the annual meeting or any adjournment or postponement of the annual meeting.

These items are described more fully in the joint proxy statement/prospectus attached to this notice. Please give your careful attention to all of the information in the joint proxy statement/prospectus.

The board of directors of Palm has fixed the close of business on September 18, 2003 as the record date for determining which Palm stockholders of record are entitled to receive notice of, and to vote at, the annual meeting and any adjournment or postponement of the annual meeting. Only holders of record of shares of Palm common stock on the record date are entitled to receive notice of and to vote at the annual meeting or any adjournment or postponement of the annual meeting.

Your vote is important. Even if you plan to attend the annual meeting in person, we request that you complete, sign, date and return the enclosed proxy or voting instruction card or, if available, follow the instructions for telephone or Internet voting to ensure that your shares will be represented at the annual meeting if you are unable to attend. If you do attend the annual meeting and wish to vote in person, you may withdraw your proxy and vote in person.

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NOTICE IS HEREBY GIVEN that a special meeting of the stockholders of Handspring, Inc., a Delaware corporation, will be held at a.m., local time, on , 2003 at for the following purpose:

To consider and vote on a proposal to approve and adopt the Agreement and Plan of Reorganization, dated June 4, 2003, by and among Palm, Inc., Peace Separation Corporation, a wholly owned subsidiary of Palm, Inc., Harmony Acquisition Corporation, a wholly owned subsidiary of Palm, Inc., and Handspring, Inc., pursuant to which Handspring will become a wholly owned subsidiary of Palm.

This item is described more fully in the joint proxy statement/prospectus attached to this notice. Please give your careful attention to all of the information in the joint proxy statement/prospectus.

Only stockholders of record at the close of business on September 18, 2003, the record date, are entitled to notice of and to vote at the special meeting or any adjournment or postponement of the special meeting. The merger will require the affirmative vote of the holders of a majority of the shares of Handspring’s common stock outstanding on the record date.

Your vote is important. To ensure that your shares are represented at the special meeting, we encourage you to complete, date, sign and promptly return your proxy card in the enclosed postage-paid envelope or, if available, follow the instructions for telephone or Internet voting whether or not you plan to attend the special meeting in person. You may revoke your proxy in the manner described in the joint proxy statement/prospectus at any time before it has been voted at the special meeting. Any stockholders attending the special meeting may vote in person even if the stockholder has returned a proxy.

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In this joint proxy statement/prospectus, when we refer to the transaction, we refer to the PalmSource distribution and the Handspring merger as component parts of the merger agreement. Following the transaction, there will be two independent publicly-traded companies:

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This joint proxy statement/prospectus contains important information about the transaction and Palm’s and Handspring’s stockholder meetings, as well as about Palm, PalmSource and Handspring. This joint proxy statement/prospectus also contains important information about the other proposals to be presented at Palm’s 2003 annual meeting of stockholders. In addition, stockholders should carefully review the information related to PalmSource included in Annex A in determining whether to approve and adopt the merger agreement. You should read this joint proxy statement/prospectus carefully.

After the transaction, the executive officers of Palm will consist of: R. Todd Bradley, as President and Chief Executive Officer; Judy Bruner, as Senior Vice President and Chief Financial Officer; Mary E. Doyle, as

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Senior Vice President, General Counsel and Secretary; Patricia A. Tomlinson, currently the Vice President, Human Resources of Handspring, as Senior Vice President and Chief Human Resources Officer; Edward T. Colligan, currently the President and Chief Operating Officer of Handspring, as Senior Vice President, General Manager, Wireless Business Unit; Ken Wirt as Senior Vice President, General Manager, Handheld Business Unit; Angel Mendez, as Senior Vice President, Global Operations and Accessory Solutions; and Jeffrey C. Hawkins, currently the Chairman of Handspring and its Chief Product Officer, will serve as Chief Technology Officer of the combined company on a part-time basis as he did in his capacity as Chief Product Officer at Handspring.

Handspring’s proposal to approve and adopt the merger agreement requires the affirmative vote of holders of a majority of the outstanding shares of Handspring common stock entitled to vote at the Handspring special meeting of stockholders.

For Palm stockholders, failure to return your proxy card or to vote by Internet or telephone, in the case of a record holder, or the delivery of a broker non-vote, in the case of holders in street name, will not have any effect on the outcome of the voting on Palm’s proposal to elect three Class I directors, its proposal to ratify Deloitte & Touche LLP as Palm’s independent public auditors for its fiscal year ending May 28, 2004, or its proposal to approve the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors though it will affect whether there is a quorum at the Palm 2003 annual meeting.

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In addition, stockholders may be asked to vote upon such other business as may properly come before the Palm 2003 annual meeting or any adjournment or postponement of the Palm 2003 annual meeting.

The executive officers of PalmSource following the transaction will consist of: David C. Nagel as President and Chief Executive Officer, Albert J. Wood as Chief Financial Officer and Treasurer, Doreen S. Yochum as Chief Administrative Officer and Secretary, Gabriele R. Schindler as Senior Vice President of Worldwide Marketing, Lamar Potts as Vice President of Worldwide Licensing and Sales, Larry Slotnick as Chief Products Officer and David A. Limp as Senior Vice President of Corporate and Business Development and Chief Strategy Officer.

When the PalmSource distribution is completed, outstanding rights to purchase shares of Palm common stock under the Palm 1999 Employee Stock Purchase Plan of Palm employees will continue in effect. Outstanding rights to purchase shares of Palm common stock under the Palm 1999 Employee Stock Purchase Plan of PalmSource employees will be terminated at the distribution date and any amounts withheld will be refunded without interest.

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No adjustment will be made to the exercise price per share or the number of shares issuable upon the exercise of Palm’s outstanding warrant, but upon exercise the warrant holder will be entitled to receive from Palm the number of shares of PalmSource stock which the warrant holder would have been entitled to receive if the warrant holder had exercised the warrant prior to the transaction. If the warrant is exercised following the PalmSource distribution, Palm would likely acquire shares of PalmSource common stock through market purchases.

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This summary highlights selected information from this joint proxy statement/prospectus and may not contain all of the information that is important to you. To understand the transaction fully and for a more complete description of the legal terms of the transaction, you should read carefully the entire joint proxy statement/prospectus, including the annexes, and the documents we refer to in this joint proxy statement/prospectus. See “Where You Can Find More Information” in this joint proxy statement/prospectus.

This joint proxy statement/prospectus, any accompanying prospectus supplement and the documents incorporated by reference into this joint proxy statement/prospectus contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements that are not statements of historical fact are forward looking statements. Forward-looking statements generally are identified by the words “expects,” “anticipates,” “believes,” “intends,” “estimates,” “should,” “would,” “strategy,” “plan” and similar expressions. For example, in this joint proxy statement/prospectus these forward-looking statements, include, among others, statements regarding: the combined company’s ability to compete in the handheld computing and smartphone market; the timing of the consummation of the transaction; the management and board composition of Palm following the merger; the ability of the transaction to increase shareholder value; the attraction of additional PalmSource licensees as a result of the PalmSource distribution; Palm’s future technologies and growth and trends relating to such technologies; employees and employee response to the PalmSource distribution; Palm’s and PalmSource’s increased access to capital markets; growth and growth opportunities available to PalmSource and the combined company; the expectation of greater revenue opportunities, operating efficiencies, cost savings and other synergies as a result of the merger; the relocation of Handspring employees to Palm’s Milpitas headquarters; the strength of distribution channels and the product portfolio of the combined company; the integration of the Handspring management team and employees with the Palm management team and employees; future financial results of PalmSource, Palm, Handspring and the combined company; current and future litigation; the ability of the Palm Solutions Group to realize its objectives of growing the market, maintaining industry leadership and achieving consistent profitability; and Palm’s existing and future products.

These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from such forward-looking statements. For a detailed discussion of these risks and uncertainties, see “Risk Factors” in this joint proxy statement/prospectus. You should consider carefully the statements set forth in “Risk Factors” and other sections of this joint proxy statement/prospectus, and any accompanying prospectus supplement, and in other documents that are incorporated by reference into this joint proxy statement/prospectus. All subsequent written and oral forward-looking statements attributable to Palm or Handspring, or to persons acting on Palm’s or Handspring’s behalf, are expressly qualified in their entirety by the applicable cautionary statements. Neither Palm nor Handspring undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this joint proxy statement/prospectus.

Palm, Peace Separation Corporation, Harmony Acquisition Corporation and Handspring have entered into the merger agreement to conduct the transaction described in this joint proxy statement/prospectus. A copy of the merger agreement is attached to this joint proxy statement/prospectus as Annex B and is incorporated by reference into this joint proxy statement/prospectus. The merger agreement provides for a transaction with two components, the PalmSource distribution and the Handspring merger.

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PalmSource Distribution. PalmSource currently is a majority-owned subsidiary of Palm, with Palm owning approximately 86% of PalmSource’s outstanding shares of common stock on an as-converted basis as of August 29, 2003. Pursuant to the merger agreement, Palm will first distribute all of the shares of PalmSource common stock held by Palm to Palm’s existing stockholders. The distribution will be effected by means of a merger. Pursuant to the merger agreement, Peace Separation Corporation, a wholly owned subsidiary of Palm, will merge with and into Palm. Palm will be the surviving corporation in this merger. In this merger, each share of Palm common stock outstanding as of the effective time of this merger will remain outstanding and will also be entitled to receive a number of shares of PalmSource common stock such that Palm will have distributed to Palm stockholders all of the PalmSource common stock Palm owns. No fractional shares of PalmSource common stock will be issued in the distribution. Instead, all fractional shares of PalmSource common stock will be aggregated for all Palm stockholders and be sold in the public market. Accordingly, stockholders who would otherwise be entitled to receive a fractional share of PalmSource common stock will receive cash for their fractional interest. Cash amounts received for such fractional share may be taxable to stockholders. Based on shares of Palm common stock outstanding on August 29, 2003, Palm stockholders will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held. This ratio is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution. Handspring stockholders will not receive PalmSource common stock in the transaction.

Handspring Merger. Following the PalmSource distribution, Palm, which will consist of its Solutions Group business, will acquire Handspring through a merger transaction. Palm’s wholly owned subsidiary, Harmony Acquisition Corporation, will merge with and into Handspring. Handspring will be the surviving corporation in this merger and will thereafter be a wholly owned subsidiary of Palm. In this merger, each share of Handspring common stock, together with its associated preferred stock purchase right, will be converted into the right to receive 0.09 of a share of Palm common stock. Palm shares will be issued to Handspring stockholders with their associated preferred stock purchase rights. No fractional shares of Palm common stock will be issued in the Handspring merger. In lieu of receiving a fractional share of Palm common stock, each holder will receive an amount of cash equal to the product obtained by multiplying such fractional share by the average closing price of Palm common stock for the ten consecutive trading days ending on, and including, the trading day immediately prior to the Handspring merger.

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The diagram below depicts the ownership structure of the parties affected by the transaction as of the date of this joint proxy statement/prospectus and the structure of the companies immediately following the transaction, based on equity ownership as of the date of this joint proxy statement/prospectus.

Founded in 1992 and reincorporated under the laws of Delaware in December 1999, Palm is the leading global provider of handheld computing devices and operating systems for handheld devices. Palm currently consists of two operating segments: PalmSource, Inc., a majority owned subsidiary of Palm, and the Solutions Group. PalmSource is a leading developer and licensor of enabling software for mobile information devices. PalmSource’s software solution consists of operating system software, personal information management software and software development tools. Palm’s Solutions Group develops, markets and sells handheld computing devices, add-ons and accessories as well as related services and software, targeting consumer, enterprise, education and government users. Since Palm introduced its first handheld computer in 1996, it has shipped over 22 million handheld devices worldwide as of May 31, 2003. Following the transaction, Palm will consist of its Solutions Group business and the Handspring business.

Palm’s website address is www.palm.com. The information on Palm’s website is not a part of this joint proxy statement/prospectus.

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Founded in July 1998 and reincorporated under the laws of Delaware in May 2000, Handspring is a leading provider of handheld computing and communications devices, also called smartphones and communicators. Shipments of Handspring’s first Visor handheld organizers began in October 1999. In its fourth quarter of fiscal 2001, Handspring began to shift its strategic focus to the potentially high growth market for integrated devices offering voice, data, email and personal information management capabilities in a single device.

Handspring’s website address is www.handspring.com. The information on Handspring’s website is not part of this joint proxy statement/prospectus.

Incorporated under the laws of Delaware in December 2001, PalmSource develops, markets and supports a leading software platform for mobile information devices. PalmSource licenses the Palm operating system, or Palm OS, and software development tools that mobile information device manufacturers use to develop products from PalmSource’s platform as well as personal information management, web-browser and e-mail applications. PalmSource enables manufacturers to rapidly and efficiently create powerful, innovative and easy-to-use mobile information devices. PalmSource licenses its products to leading device manufacturers, including Garmin, Handspring, Kyocera, Lenovo (formerly known as Legend), Palm, Samsung and Sony.

PalmSource’s website address is www.palmsource.com. The information on PalmSource’s website is not a part of this joint proxy statement/prospectus.

Incorporated under the laws of Delaware in May 2003, Peace Separation Corporation is a direct wholly owned subsidiary of Palm and was incorporated for the sole purpose of merging with and into Palm to effect the distribution of the PalmSource common stock held by Palm to Palm’s stockholders. Peace Separation Corporation does not have any operations.

Incorporated under the laws of Delaware in May 2003, Harmony Acquisition Corporation is a direct wholly owned subsidiary of Palm and was incorporated for the sole purpose of merging with and into Handspring to effect the Handspring merger. Harmony Acquisition Corporation does not have any operations.

The “Risk Factors” beginning on page 26, in addition to the risk factors relating to PalmSource beginning on page in Annex A, should be considered carefully by Palm stockholders and Handspring stockholders in evaluating whether to approve and adopt the merger agreement. These risk factors should be considered along with any additional risk factors in the periodic reports of Palm and Handspring filed with the Securities and Exchange Commission and any other information included in this joint proxy statement/prospectus.

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Following the transaction, Palm believes that its stock price will likely be adversely affected as a result of the PalmSource distribution. This adverse effect may be equal to, greater than or less than the value of the PalmSource stock distributed, and may also be impacted by the subsequent combination with Handspring immediately following the distribution. Although Palm is pursuing the distribution with the goal of increasing the combined value of the PalmSource business and the combined Solutions Group and Handspring business, we cannot predict the trading price of PalmSource or palmOne following the completion of the transaction.

Palm and PalmSource believe that Palm stockholders will realize benefits from the complete separation of the two companies as a result of the distribution of the shares of PalmSource held by Palm to Palm’s stockholders, including the following:

Palm and Handspring believe that the combination of Palm and Handspring will form a stronger market leader in mobile computing and communications. Palm and Handspring believe the potential benefits of the Handspring merger include the ability to:

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After careful consideration, Palm’s board of directors has unanimously determined that the transaction is advisable and that it is fair to, and in the best interests of, Palm and its stockholders, and has unanimously approved the merger agreement. Palm’s board of directors unanimously recommends that Palm’s stockholders vote FOR approval and adoption of the merger agreement. Approval of the merger agreement by Palm’s stockholders will also constitute approval of a merger of Peace Separation Corporation and Palm effecting the PalmSource distribution and approval of the issuance of Palm common stock to Handspring’s stockholders in the transaction.

Among other things considered by Palm’s board of directors in making this recommendation, Palm’s board of directors requested and considered the written opinion of Morgan Stanley described below that addresses the fairness to Palm, from a financial point of view, of the exchange ratio of 0.09 pursuant to the merger agreement.

Palm’s board of directors also unanimously recommends that you vote FOR the election of R. Todd Bradley, Michael Homer and Gareth C.C. Chang to serve as Class I directors of Palm, the ratification of Deloitte & Touche LLP as independent public auditors for the fiscal year ending May 28, 2004 and approval of the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors.

Opinion of Palm Financial Advisor Regarding the Handspring Merger (see page 71)

On June 3, 2003, Morgan Stanley delivered its oral opinion, subsequently confirmed in writing, to Palm’s board of directors, to the effect that, as of that date and subject to and based upon the assumptions and other considerations set forth in its written opinion, the exchange ratio of 0.09 pursuant to the merger agreement was fair to Palm, from a financial point of view. Morgan Stanley provided its opinion for the information and assistance of Palm’s board of directors in connection with the board’s consideration of the Handspring merger. The Morgan Stanley opinion does not constitute a recommendation as to how any Palm stockholder should vote with respect to the proposal to approve and adopt the merger agreement or any matter.

The full text of the written opinion of Morgan Stanley, which sets forth assumptions made, matters considered and limitations on the review undertaken in connection with its opinion is attached to this joint proxy statement/prospectus as Annex C. Palm recommends that Palm stockholders read the opinion carefully and in its entirety. Palm stockholders should carefully consider the summary of Morgan Stanley’s analysis in this joint proxy statement/prospectus.

After careful consideration, Handspring’s board of directors has unanimously determined that the Handspring merger is advisable and that it is fair to, and in the best interests of, Handspring and its stockholders, and has unanimously approved the merger agreement. Handspring’s board of directors unanimously recommends that Handspring’s stockholders vote FOR approval and adoption of the merger agreement.

Among other things considered by Handspring’s board of directors in making this recommendation, Handspring’s board of directors requested and considered the written opinion of Credit Suisse First Boston LLC described below regarding the fairness, from a financial point of view and as of the date of such opinion, of the exchange ratio in the Handspring merger to holders of Handspring common stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders.

Opinion of Handspring Financial Advisor Regarding the Handspring Merger (see page 80)

On June 3, 2003, Credit Suisse First Boston LLC delivered its oral opinion to Handspring’s board of directors, subsequently confirmed in writing as of June 4, 2003, that, as of that date and subject to the assumptions, considerations and limitations set forth in its opinion, the exchange ratio for Handspring shares

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provided for in the merger agreement is fair, from a financial point of view, to holders of Handspring common stock other than such holders who are both directors and officers of Handspring or affiliates of such holders. Credit Suisse First Boston provided its opinion for the information and assistance of Handspring’s board of directors in connection with the board of directors’ consideration of the Handspring merger. The Credit Suisse First Boston opinion is not a recommendation as to how any Handspring stockholder should vote with respect to the proposal to approve and adopt the merger agreement.

The full text of the written opinion of Credit Suisse First Boston, which sets forth assumptions made, matters considered and limitations on the review undertaken in connection with its opinion, is attached to this joint proxy statement/prospectus as Annex D. Handspring stockholders are urged to read the opinion carefully and in its entirety. Handspring stockholders should carefully consider the discussion of Credit Suisse First Boston’s analysis in this joint proxy statement/prospectus.

Some of the directors and executive officers of Palm and Handspring have personal interests in the Handspring merger that are different from the interests of other Palm and Handspring stockholders.

Interests of Directors and Executive Officers of Palm in the Handspring Merger

In considering Palm’s board of directors’ recommendation that you, as a Palm stockholder, vote to approve and adopt the merger agreement, you should be aware that some of Palm’s executive officers and directors have interests in the transaction that are different from, or in addition to, your interests as a Palm stockholder. These interests include, among other things, the following:

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As a result, certain executive officers and directors of Palm may be more likely to vote to approve and adopt the merger agreement than Palm’s stockholders generally.

Interests of Directors and Executive Officers of Handspring in the Handspring Merger

In considering Handspring’s board of directors’ recommendation that you, as a Handspring stockholder, vote to approve and adopt the merger agreement and to approve the Handspring merger, you should be aware that some of Handspring’s executive officers and directors have interests in the Handspring merger that are different from, or in addition to, your interests as a Handspring stockholder. These interests include, among other things, the following:

As a result, certain executive officers and directors of Handspring may be more likely to vote to approve and adopt the merger agreement and to approve the Handspring merger than Handspring’s stockholders generally.

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Security Ownership of Certain Beneficial Owners, Directors and Management of Palm and Handspring (see pages 49 and 53)

At the close of business on the record date for the Palm annual meeting, directors and executive officers of Palm and their affiliates beneficially owned and were entitled to vote approximately % of the shares of Palm common stock outstanding on that date. The directors and certain executive officers of Palm have agreed to vote all of their Palm shares, representing less than 1% of the outstanding Palm common stock on May 28, 2003, in favor of approving and adopting the merger agreement. Approval of the proposal to approve and adopt the merger agreement requires the affirmative vote of holders of at least a majority of the outstanding shares of Palm common stock.

At the close of business on the record date for the Handspring special meeting, directors and executive officers of Handspring and their affiliates beneficially owned and were entitled to vote approximately % of the shares of Handspring common stock outstanding on that date. Certain directors and executive officers of Handspring have agreed to vote Handspring shares representing approximately 37.5% of the outstanding Handspring common stock on May 28, 2003 in favor of approving and adopting the merger agreement. Approval of the proposal to approve and adopt the merger agreement requires the affirmative vote of holders of at least a majority of the outstanding shares of Handspring common stock.

Several conditions must be satisfied or waived before we complete the transaction, including those summarized below:

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The merger agreement contains detailed provisions that prohibit each of Palm and Handspring, and their respective subsidiaries, officers and directors from taking any action to solicit or engage in discussions or negotiations with, to furnish any nonpublic information to, or to enter into any agreement or commitment with any third party with respect to an acquisition proposal as defined in the merger agreement. Notwithstanding the prohibitions contained in the merger agreement, if either of Palm or Handspring receives an unsolicited written acquisition proposal that its board of directors concludes in good faith, following the receipt of the advice of its outside legal counsel and its financial advisor, satisfies, or is reasonably likely to satisfy, certain criteria specified in the merger agreement, then the party receiving such offer may furnish nonpublic information to, and engage in negotiations with, the third party making the acquisition proposal, if its board of directors concludes in good faith, following the receipt of advice of its outside legal counsel, that failure to do so would result in a breach of its fiduciary obligations under applicable law.

Termination of the Merger Agreement by Palm and Handspring under Specified Circumstances (see page 117)

Under certain circumstances specified in the merger agreement, either Palm or Handspring may terminate the merger agreement at any time prior to the completion of the Handspring merger. These circumstances include:

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Each of Palm and Handspring have agreed to pay to the other a termination fee of up to $4,500,000 if the merger agreement is terminated under certain specified circumstances.

Treatment of Awards Outstanding under Stock Plans and Outstanding Warrants (see page 112)

When the PalmSource distribution is completed, each outstanding option to purchase shares of Palm common stock will continue in effect. Each option will be subject to all of the terms and conditions set forth in the applicable documents evidencing such Palm option immediately prior to the PalmSource distribution, including any repurchase rights or vesting provisions, except that each such option will be adjusted to maintain the same option value immediately before and immediately after the transaction. This adjustment will be accomplished by multiplying the number of shares for which the option is exercisable by a ratio, the numerator of which will be the closing sales price of Palm common stock on the last full day of trading prior to the PalmSource distribution and the denominator of which will be the opening sales price of Palm common stock on the first full day of trading after the PalmSource distribution, and multiplying the exercise price at which such option will be exercisable by the inverse of that ratio. Palm’s board of directors and its compensation committee believe that this adjustment is required by or advisable under the terms of Palm’s stock option plans. Accordingly, on July 1, 2003, Palm’s board of directors amended Palm’s 1999 Stock Plan and 1999 Director Option Plan to reserve additional shares of Palm’s common stock for the sole purpose of effecting such an adjustment. For those employees who are employees of PalmSource, their options will be adjusted as provided above, except that any unvested Palm options will terminate on the distribution date and such PalmSource employees shall be deemed terminated under their option agreements, giving them a limited number of days to exercise vested options before they expire.

When the PalmSource distribution is completed, outstanding rights to purchase shares of Palm common stock under the Palm 1999 Employee Stock Purchase Plan will continue in effect. Outstanding rights to purchase shares of Palm common stock under the Palm 1999 Employee Stock Purchase Plan of PalmSource employees will be terminated at the distribution date and any amounts withheld will be refunded. Each purchase right will be subject to all of the terms and conditions set forth in the Palm 1999 Employee Stock Purchase Plan and the documents governing such purchase right, except that the purchase price of the shares of Palm common stock for each respective purchase date for each purchase right will be the lower of (a) the product determined by multiplying eighty-five percent (85%) of the fair market value of Palm common stock on the offering date of each offering period outstanding at the time of the PalmSource distribution by a ratio, the numerator of which will be the opening sales price of Palm common stock on the first full day of trading after the PalmSource distribution and the denominator of which will be closing sales price of Palm common stock on the last full day of trading prior to the PalmSource distribution or (b) eighty-five percent (85%) of the fair market value of Palm common stock on each purchase date of each such offering period occurring after the PalmSource distribution.

Handspring’s outstanding options and warrants will be assumed by Palm in the Handspring merger. Each option and warrant so assumed will thereafter represent an option or warrant to purchase up to a number of shares of Palm common stock equal to 0.09 multiplied by the number of Handspring shares such optionee or warrant holder would be entitled to acquire under the applicable option or warrant agreement, rounded down to the nearest whole share. The exercise price per share of the assumed option or warrant will also be adjusted to an amount determined by dividing the exercise price per share of the Handspring option or warrant by 0.09, rounded

Index to Financial Statements

up to the nearest cent. The Handspring options and warrants will otherwise continue to have the same terms and conditions (including vesting schedules and option periods) as they had prior to their assumption.

No adjustment will be made to the exercise price per share on the number of shares issuable upon the exercise of Palm’s outstanding warrant, but upon exercise the warrant holder will be entitled to receive the number of shares of PalmSource stock which the warrant holder would have been entitled to receive if the warrant holder had exercised the warrant prior to the transaction.

Palm and Handspring have entered into a loan agreement pursuant to which Palm will provide up to an aggregate of $20 million in term loans to Handspring. The term loans will be secured by a first priority security interest against substantially all of the assets and property of Handspring. Interest will accrue on the term loans at an annual interest rate equal to the prime rate plus 3% and be payable at the end of each calendar quarter. The term loans will mature upon the earliest of:

Handspring may prepay the term loans at any time without penalty or premium. Handspring is required to prepay the term loans under certain circumstances. Handspring must meet certain conditions in order to borrow under the term loans.

The loan agreement contains customary events of default for a credit facility of this type, including, among others, failure to make payments when due, breaches of covenants, breaches of representations and warranties, cross-default to other indebtedness, bankruptcy and insolvency defaults, unsatisfied judgment defaults, and ERISA defaults.

Palm and PalmSource entered into certain agreements effective as of December 2001 to generally provide for the assignment by Palm of assets, and the assumption by PalmSource of liabilities, related to the Palm OS business. In June 2003, Palm and PalmSource entered into additional agreements, some of which amended or amended and restated separation agreements previously entered into by the parties and others further allocated assets and liabilities between Palm and PalmSource in light of circumstances existing at that time.

Relationship between Palm and PalmSource Following the Transaction (see page 124)

Palm and PalmSource will be independent publicly-traded companies following the transaction. However, Palm and PalmSource have entered into a number of agreements that provide for a continuing business relationship between them, including a software license agreement between them under which Palm will continue to be a licensee of the Palm OS and agreements with Palm Trademark Holding Company, LLC under which Palm and PalmSource will both continue to use certain Palm-related trademarks and domain names.

Index to Financial Statements

Material U.S. Federal Income Tax Consequences of the PalmSource distribution and Handspring merger (see page 97)

In general, Palm stockholders will not recognize gain or loss for United States federal income tax purposes, except with respect to cash received instead of fractional shares, as a result of the receipt of PalmSource shares in the distribution. Palm has received a private letter ruling from the Internal Revenue Service, or IRS, to the effect that the PalmSource distribution will qualify as a tax-free transaction under Section 355 of the Internal Revenue Code. This ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. Although some facts have changed since the issuance of the ruling, neither Palm nor PalmSource is aware of any material change in the facts and circumstances of the PalmSource distribution, upon which the ruling was based, that would call into question the validity of the ruling and in the opinion of Palm’s counsel, the factual developments that have occurred since the receipt of the ruling will not adversely affect the validity of the ruling.

In general, Handspring stockholders will not recognize gain or loss for United States federal income tax purposes, except with respect to cash received instead of fractional shares as a result of the receipt of Palm shares in the combination of Palm and Handspring in a merger transaction. It is a condition to the Handspring merger that Palm and Handspring receive legal opinions from their respective tax counsel to the effect that the merger will constitute a reorganization within the meaning of Section 368(a) of the Internal Revenue Code.

Following the PalmSource distribution, the operations of PalmSource will be accounted for by Palm as a discontinued operation. The Handspring merger will be accounted for by Palm as a “purchase” for financial accounting purposes.

Palm and Handspring have made the required filings under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 with the United States Department of Justice and the United States Federal Trade Commission and the applicable waiting period under the Hart-Scott-Rodino Act has terminated. Palm and Handspring have also made foreign antitrust filings in Germany and have received clearance from the German antitrust authorities for the Handspring merger. The parties are not aware of any other governmental approvals required in order to complete the merger. The reviewing agencies or governments, states or private persons may challenge the Handspring merger at any time before or after its completion.

It is a condition to the transaction that the Palm common stock issued to Handspring stockholders and the PalmSource common stock distributed to Palm stockholders be approved for listing on the Nasdaq National Market. Palm has agreed to use all reasonable efforts to authorize for listing these shares on the Nasdaq National Market. PalmSource’s shares of common stock have been approved for listing on the Nasdaq National Market subject to meeting the $5.00 per share minimum price requirement on the first day of trading.

The Delaware General Corporation Law does not provide appraisal rights to holders of Palm common stock or Handspring common stock in connection with the transaction.

Index to Financial Statements

The tables below present summary selected historical condensed consolidated financial data of Palm. The information set forth below should be read in conjunction with the consolidated financial statements (including the notes thereto) and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Palm’s annual report on Form 10-K for the fiscal year ended May 31, 2003, which is incorporated by reference into this joint proxy statement/prospectus.

The consolidated statements of operations data for each of the three years in the period ended May 31, 2003 and the consolidated balance sheet data as of May 31, 2002 and 2003 have been derived from Palm’s audited consolidated financial statements which are incorporated by reference into this joint proxy statement/prospectus, and have been audited by Deloitte & Touche LLP, independent auditors, whose report is also incorporated by reference into this joint proxy statement/prospectus. The condensed consolidated statements of operations data for each of the two years in the period ended May 31, 2000 and the condensed consolidated balance sheet data as of May 31, 1999, 2000 and 2001 have been derived from Palm’s audited consolidated financial statements not included or incorporated by reference into this joint proxy statement/prospectus. On February 26, 2000, Palm legally separated from 3Com Corporation. Through the date of its separation from 3Com, Palm’s costs and expenses included allocations of certain 3Com corporate services and infrastructure costs. After its separation from 3Com, Palm’s costs and expenses included amounts paid to 3Com for certain leased facilities and transitional services. On October 15, 2002, Palm effected a one-for-twenty reverse stock split of its common stock. All per share amounts reflect the retroactive effects of this reverse stock split. Certain reclassifications have been made to prior periods to conform to the current period presentation. Such reclassifications had no effect on net income (loss) or net income (loss) per share.

The historical financial information may not be indicative of Palm’s future performance.

Index to Financial Statements

The tables below present summary selected historical condensed consolidated financial data of Handspring. The information set forth below should be read in conjunction with the consolidated financial statements (including the notes thereto) and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Handspring’s annual report on Form 10-K for the fiscal year ended June 30, 2003, which is incorporated by reference into this joint proxy statement/prospectus.

The condensed consolidated statement of operations data for each of the three years in the period ended June 30, 2003 and the condensed consolidated balance sheet data as of June 30, 2002 and 2003 have been derived from Handspring’s audited consolidated financial statements, incorporated by reference into this joint proxy statement/prospectus, and have been audited by PricewaterhouseCoopers LLP, independent accountants, whose report is also incorporated by reference into this joint proxy statement/prospectus. The condensed consolidated statement of operations data for the period from July 29, 1998 (the date of inception) to June 30, 1999 and the year ended June 30, 2000 and the condensed consolidated balance sheet data as of June 30, 1999, 2000 and 2001 have been derived from Handspring’s audited consolidated financial statements not included or incorporated by reference into this joint proxy statement/prospectus. Certain reclassifications have been made to prior periods to conform to the current period presentation. Such reclassifications had no effect on net loss or net loss per share.

The historical financial information may not be indicative of Handspring’s future performance.

Index to Financial Statements

The following selected combined and consolidated financial data of PalmSource reflect its historical results of operations and balance sheet data. PalmSource’s combined and consolidated statement of operations data set forth below for the years ended May 31, 2001, 2002 and 2003 and the combined and consolidated balance sheet data as of May 31, 2002 and 2003 are derived from its audited combined and consolidated financial statements included in Annex A to this joint proxy statement/prospectus.

The combined and consolidated statement of operations data for the year ended May 31, 1999 and the combined and consolidated balance sheet data as of May 31, 1999 and May 31, 2000 are derived from PalmSource’s unaudited combined and consolidated financial statements that are not included elsewhere in this joint proxy statement/prospectus. The combined and consolidated statement of operations data for the year ended May 31, 2000 and the combined and consolidated balance sheet data as of May 31, 2001 are derived from PalmSource’s audited combined and consolidated financial statements that are not included elsewhere in this joint proxy statement/prospectus.

The unaudited pro forma data is presented giving effect to a one for five reverse stock split on September 22, 2003 and assuming the conversion of outstanding Series A redeemable convertible preferred stock to common stock, and the re-capitalization of the issued and outstanding shares of common stock of PalmSource prior to the distribution. The unaudited pro forma balance sheet also gives effect to the intended issuance by PalmSource of a $15.0 million 5% convertible subordinated note due December 2006, payable to Texas Instruments following the distribution and the recapitalization of the $20.0 million note payable to Palm as additional paid in capital, immediately prior to the distribution in accordance with the terms of the amended and restated intercompany loan agreement. In addition, the unaudited pro forma balance sheet also gives effect to the contribution by Palm, in accordance with the terms of the letter agreement regarding cash contributions, of an additional $6.0 million in cash upon the distribution date. The unaudited pro forma basic and diluted net loss per share does not include the impact of interest expense related to the issuance of a $15.0 million 5% convertible subordinated note which will occur following the distribution. Interest on this note is payable semi-annually and the note is due and payable on December 6, 2006.

The financial information presented below may not be indicative of PalmSource’s future performance and does not necessarily reflect what its financial position and results of operations would have been had it operated as a separate, stand-alone entity during the periods presented. See “Annex A—Risk Factors—Risks Relating to Our Separation from Palm—Our historical financial information may not be representative of our results as a stand-alone company and therefore, may not be reliable as an indicator of future results.” In addition, due to the acquisitions that PalmSource has made, and the change in its method of accounting for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets effective June 1, 2001, PalmSource’s results of operations are not necessarily comparable between the periods presented. In addition, PalmSource’s historical combined and consolidated balance sheet data set forth below is not comparable to the pro forma balance sheet data set forth below due to the transactions anticipated to occur as of the distribution date discussed above. You should also read the section titled “Annex A—Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which describes a number of factors that have affected PalmSource’s financial results.

Index to Financial Statements

The following summary unaudited pro forma combined condensed selected financial data should be read in conjunction with Palm’s unaudited pro forma combined condensed financial statements and related notes thereto included elsewhere in this joint proxy statement/prospectus. The summary unaudited pro forma combined condensed financial data for the year ended May 31, 2003, gives effect to the PalmSource distribution and Handspring merger. Effective as of the distribution date, PalmSource will be recapitalized, resulting in 10 million shares of common stock outstanding and held by Palm. As a result, each Palm stockholder will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held as of the distribution date. For purposes of the following summary unaudited pro forma combined condensed selected financial data, the distribution ratio is calculated based on Palm’s outstanding shares of common stock as of August 29, 2003 and is subject to change based on the issuance of additional shares of Palm common stock between August 29, 2003 and the distribution date. Upon the PalmSource distribution, the PalmSource Series A redeemable convertible preferred stock will convert to approximately 667,000 shares of PalmSource common stock. The operations of PalmSource following the PalmSource distribution will be accounted for by Palm as a discontinued operation as defined under Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Following the PalmSource distribution, Palm will combine its remaining business with Handspring in a merger transaction. The stockholders of Handspring will receive 0.09 of a share of Palm common stock for each share of Handspring common stock held at the time of the Handspring merger. The proposed Handspring merger will be accounted for using the purchase method of accounting.

The summary unaudited pro forma combined condensed statement of operations data for the year ended May 31, 2003 gives effect to the above transactions as if they had occurred on June 1, 2002. The summary unaudited pro forma combined condensed statement of operations data for the year ended May 31, 2003 has been derived from the audited historical consolidated statement of operations of Palm for the year ended May 31, 2003, after giving effect to the PalmSource distribution and from the audited historical consolidated statement of operations of Handspring for the year ended June 30, 2003.

The summary unaudited pro forma combined condensed statement of operations data for the year ended May 31, 2003 has been derived by eliminating the PalmSource business from the historical Palm financial results and recording cost of revenues for royalties due to PalmSource under the software license agreement, as amended, between PalmSource and Palm. The results are further combined with the Handspring historical statements of operations and include estimated adjustments to reflect the purchase method of accounting. The adjustments for purchase accounting were estimated based on significant assumptions including the timing of the close of the transaction. Upon the Handspring merger, the combined company will operate under a single software license agreement with PalmSource. The summary pro forma combined condensed statement of operations data reflects the historical software license agreements with PalmSource which were in effect at that time for each respective company. All per share data amounts reflect the retroactive effects of the Palm one-for-twenty reverse stock split effective October 15, 2002.

The summary unaudited pro forma combined condensed consolidated balance sheet data as of May 31, 2003 gives effect to the above transactions as if they occurred on May 31, 2003, with the exception that the purchase accounting adjustments were estimated based on the anticipated closing of the transaction.

The total estimated purchase price of the acquisition of Handspring has been allocated on a preliminary basis to assets acquired and liabilities assumed based upon management’s best estimates of their expected fair value at the time of the anticipated closing of the transaction, with the excess cost over the net tangible and

Index to Financial Statements

estimated intangible assets acquired being allocated to goodwill. This allocation is subject to change pending a final analysis of the total purchase cost and the fair value of the assets acquired and liabilities assumed. The impact of these changes could be material.

The unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have been achieved if the PalmSource distribution and Handspring merger had occurred at the beginning of the earliest period presented, nor is it necessarily indicative of future operating results or financial position. Actual results could differ. The pro forma adjustments are based upon information and assumptions available as of the date of this joint proxy statement/prospectus. The pro forma information should be read in conjunction with the accompanying notes thereto, with Palm and Handspring’s historical financial statements and related notes thereto incorporated by reference into this joint proxy statement/prospectus, and with PalmSource’s historical financial statements and related notes thereto included in Annex A of this joint proxy statement/prospectus.

Index to Financial Statements

The following table sets forth certain historical per share data of Palm, PalmSource and Handspring and the per share data of Palm, PalmSource and Handspring on an unaudited pro forma basis after giving effect to the PalmSource distribution and the Handspring merger. Effective as of the date of the PalmSource distribution, PalmSource will be recapitalized, resulting in 10 million shares of common stock outstanding and held by Palm. As a result, each Palm stockholder will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held as of the distribution date. For purposes of this unaudited pro forma per share data, the distribution ratio is calculated based on Palm’s outstanding shares as of August 29, 2003 and is subject to change based on the issuance of additional shares of Palm common stock between August 29, 2003 and the distribution date. Upon the PalmSource distribution, the Series A redeemable convertible preferred stock will convert to approximately 667,000 shares of common stock. Subsequent to the distribution, each Handspring stockholder will receive 0.09 of a share of Palm common stock for each share of Handspring common stock held at the time of the merger. All Palm per share data amounts reflect the retroactive effect of the Palm one-for-twenty reverse stock split effective October 15, 2002. PalmSource historical per share data amounts give effect retroactively to the one-for-five reverse stock split, the recapitalization of PalmSource common stock and the conversion of the PalmSource Series A redeemable convertible preferred stock.

The following data should be read in conjunction with the separate historical consolidated financial statements of Palm and Handspring and related notes thereto incorporated by reference into this joint proxy statement/prospectus, and with PalmSource’s combined and consolidated financial statements included elsewhere within this joint proxy statement/prospectus.

The unaudited pro forma per share data is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the PalmSource distribution and Handspring merger had taken place at the beginning of the earliest period presented, nor is it necessarily indicative of future operating results or financial position. Actual results could differ.

The earnings per share information of Palm, PalmSource and Handspring are computed in accordance with SFAS No. 128, Earnings Per Share, for all periods presented.

Other than the $150 million cash dividend paid to 3Com Corporation, Palm’s former parent company, out of the proceeds from Palm’s initial public offering, Palm has not declared or paid cash dividends on its common stock since inception. PalmSource and Handspring have not declared or paid cash dividends on their common stock since inception.

Index to Financial Statements

Palm common stock trades on the Nasdaq National Market under the symbol “PALM.” Handspring common stock trades on the Nasdaq National Market under the symbol “HAND.”

The table below sets forth the high and low sales price per share of Palm common stock and Handspring common stock, each as reported on the Nasdaq National Market on June 3, 2003, the last completed trading day prior to the signing and announcement of the Handspring merger, and on , 2003, the last full trading day for which high and low sales prices were available as of the date of this joint proxy statement/prospectus. The table below also includes the equivalent high and low sales prices per share of Handspring common stock on those dates. These equivalent high and low sales prices per share of Handspring reflect the fluctuating value of Palm common stock that Handspring stockholders would receive in exchange for each share of Handspring common stock if the Handspring merger was completed on either of those dates, applying the exchange ratio of 0.09 of a share of Palm common stock for each share of Handspring common stock.

Because the high and low sales prices of Palm common stock presented in the table below do not reflect the PalmSource distribution, the Palm stock prices and the Handspring equivalent per share prices may not necessarily be meaningful to Handspring stockholders in determining whether to approve and adopt the merger agreement.

The above table shows only historical comparisons. These comparisons may not provide meaningful information to Palm or Handspring stockholders in determining whether to approve and adopt the merger agreement. Palm and Handspring stockholders are urged to obtain current market quotations for Palm and Handspring common stock and to review carefully the other information contained in this joint proxy statement/prospectus and incorporated by reference into this joint proxy statement/prospectus in considering whether to approve and adopt the merger agreement. See “Where You Can Find More Information” beginning on page 215 of this joint proxy statement/prospectus.

Index to Financial Statements

You should carefully consider the risks described below and the other information in this joint proxy statement/prospectus. You should also carefully consider the risks related to PalmSource contained in Annex A of this joint proxy statement/prospectus. The business, results of operations or financial condition of Palm, Handspring and/or PalmSource could be seriously harmed if any of these risks materialize. The trading price of shares of Palm, Handspring and/or PalmSource common stock may also decline due to any of these risks.

Throughout this section “Risk Factors,” we sometimes refer to the surviving company of the Handspring merger as the combined company, which will consist of the Solutions Group business and the Handspring business.

Although we expect that the transaction will result in benefits to the combined company, the combined company may not realize those benefits because of integration and other challenges.

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

Index to Financial Statements

The combined company may not successfully integrate the operations of the Solutions Group and Handspring in a timely manner, or at all, and the combined company may not realize the anticipated benefits and synergies of the transaction which are based on projections and assumptions, not actual experience, and assume a successful integration. In addition to the integration risks discussed above, the combined company’s ability to realize these benefits and synergies could be adversely impacted by practical or legal constraints on its ability to combine operations.

Handspring stockholders will receive a fixed ratio of 0.09 of a share of Palm common stock for each share of Handspring common stock, and consequently, if Palm’s stock price decreases for any reason, including as a result of the PalmSource distribution, Handspring stockholders will receive less in value for their Handspring common stock.

Upon the closing of the Handspring merger, each holder of shares of Handspring common stock will be entitled to receive 0.09 of a share of Palm common stock for each share of Handspring common stock held by such holder at the closing of the Handspring merger. The market values of Palm common stock and Handspring common stock have varied since Palm and Handspring entered into the merger agreement and will continue to vary in the future due to changes in the business, operations or prospects of Palm and Handspring, market assessments of the value of the PalmSource common stock to be distributed by Palm, market assessments of the Handspring merger, regulatory considerations, market and economic considerations and other factors. The dollar value of Palm common stock that Handspring stockholders will receive upon the closing of the Handspring merger will depend on the market value of Palm common stock at the time of the closing of the Handspring merger, which may be different from, and lower than, the closing price of Palm common stock on the last full trading day preceding the public announcement of the transaction, the last full trading day prior to the date of this joint proxy statement/prospectus or the date of the Palm annual meeting and Handspring special meeting. Handspring stockholders will not receive any shares of PalmSource common stock in the transaction, and it is uncertain the effect that the PalmSource distribution will have on Palm’s stock price following the transaction. Moreover, the closing of the Handspring merger may occur some time after stockholder approval has been obtained. There will be no adjustment to the exchange ratio (except for adjustments to reflect the effect of any stock split, reverse stock split, stock dividend, reorganization, recapitalization, reclassification or other like change with respect to Palm common stock or Handspring common stock, other than with respect to the PalmSource distribution), and the parties do not have a right to terminate the merger agreement based upon changes in the market price of either Palm common stock or Handspring common stock. Accordingly, if Palm’s stock price decreases, Handspring’s stockholders will receive less in value for their shares of Handspring common stock.

The combined post-distribution value of the shares of Palm common stock and PalmSource common stock may not equal or exceed the pre-distribution value of shares of Palm common stock.

After the PalmSource distribution, we anticipate that shares of Palm common stock will continue to be traded on the Nasdaq National Market and we expect the shares of PalmSource common stock will also be traded on the Nasdaq National Market. We cannot assure you that the combined trading prices of shares of Palm common stock and PalmSource common stock after the PalmSource distribution will be equal to or greater than the trading price of shares of Palm common stock prior to the distribution. Until the market has fully evaluated the business of Palm without the business of PalmSource and combined with the business of Handspring, the price at which shares of Palm common stock trade may fluctuate significantly. Similarly, until the market has fully evaluated the PalmSource business on a stand-alone basis, the price at which shares of PalmSource common stock trade may fluctuate significantly.

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

Handspring is currently attempting to obtain third-party consents for some agreements providing for a consent right upon a change of control, but if it is unable to do so, the combined company may be forced to

Index to Financial Statements

renegotiate these agreements or enter into new agreements with various third parties as a separate, stand-alone entity. The Handspring agreements requiring consent include certain agreements with carriers, such as Orange SA and T-Mobile and other agreements with developers, strategic partners, distributors and suppliers. The receipt of consents to assignment from Orange SA and T-Mobile are conditions to the obligation of Palm to consummate the Handspring merger. We cannot assure you that the combined company will be able to negotiate new agreements on terms as favorable to it as those that Handspring had, or at all.

Some of the directors and executive officers of Palm and Handspring have interests and arrangements that could have affected their decisions to support or approve the transaction.

The interests of some of the directors and officers of Palm and Handspring in the transaction and their participation in arrangements that are different from, or are in addition to, those of Palm and Handspring stockholders generally could have affected their decision to support or approve the transaction. See “The Transaction—Interests of Certain Persons in the Merger.”

Immediately following the transaction, we will be primarily a device solutions company and will not have the diversification that we currently have as a result of PalmSource’s operating system and software business.

Following the transaction, we will develop, market and sell handheld computing devices, smartphones, add-ons and accessories as well as related services and software. The business of developing and licensing operating system software, personal information management software and software development tools will exist in PalmSource, which will be an independent public company outside of our control. While we are not precluded from re-entering the operating system and software licensing markets, we currently have no plans or intentions of doing so. As a result, we will lack the diversification that PalmSource currently provides and will be more dependent on the hardware side of the mobile device industry and its fluctuations, and our stock price will be subject to greater volatility.

The stock prices and businesses of Palm and Handspring may be adversely affected if the transaction is not completed.

If the transaction is not completed, the trading prices of Palm common stock and Handspring common stock may decline. In addition, Palm’s and Handspring’s businesses and operations may be harmed to the extent that customers, suppliers and others believe that the companies cannot effectively compete in the marketplace without the transaction, or there is customer or employee uncertainty surrounding the future direction of the product and service offerings and strategy of Palm or Handspring on a stand-alone basis. Completion of the transaction is subject to several closing conditions, including obtaining requisite regulatory and stockholder approvals, and Palm and Handspring may be unable to obtain such approvals on a timely basis or at all. If the transaction is not completed, Palm would not derive the strategic benefits expected to result from the transaction. Palm and Handspring will also be required to pay significant costs incurred in connection with the transaction, including legal, accounting and a portion of financial advisory fees, whether or not the transaction is completed. Moreover, under specified circumstances described in this joint proxy statement/prospectus, Palm may be required to pay Handspring a termination fee of up to $4.5 million plus any applicable costs, expenses and interest pursuant to the merger agreement, or Handspring may be required to pay Palm a termination fee of up to $4.5 million plus any applicable costs, expenses and interest pursuant to the merger agreement, in connection with the termination of the merger agreement.

Charges to earnings resulting from the application of the purchase method of accounting may adversely affect the market value of Palm’s common stock following the transaction.

In accordance with United States generally accepted accounting principles, the combined company will account for the Handspring merger using the purchase method of accounting, which will result in charges to earnings that could have a material adverse effect on the market value of Palm common stock following the

Index to Financial Statements

closing of the Handspring merger. Under the purchase method of accounting, the combined company will allocate the total estimated purchase price to Handspring’s net tangible assets, amortizable intangible assets, intangible assets with indefinite lives and in-process research and development based on their fair values as of the date of the closing of the Handspring merger, and record the excess of the purchase price over those fair values as goodwill. The portion of the estimated purchase price allocated to purchased in-process technology will be expensed by the combined company in the quarter in which the Handspring merger is completed. The combined company will incur additional depreciation and amortization expense over the useful lives of certain of the net tangible and intangible assets acquired in connection with the merger. In addition, to the extent the value of goodwill or intangible assets with indefinite lives becomes impaired, the combined company may be required to incur material charges relating to the impairment of those assets. These depreciation, amortization, purchased in-process technology and potential impairment charges could have a material impact on the combined company’s results of operations.

The terms of the separation and distribution of PalmSource have been and will continue to be negotiated in the context of a parent-subsidiary relationship.

Until the PalmSource distribution, Palm will own a majority of PalmSource’s common stock. All of the agreements relating to the separation entered into between Palm and PalmSource were entered into in the context of a parent-subsidiary relationship and were, and any amendments to the agreements prior to the PalmSource distribution will be, negotiated in the overall context of the separation of PalmSource from Palm. As a result, the terms of such agreements may be more or less favorable to Palm or PalmSource than if they had been negotiated with unaffiliated third parties. Moreover, material changes to such agreements made after June 4, 2003 are required to be approved by Handspring under the terms of the merger agreement with Handspring.

The Solutions Group’s and PalmSource’s historical financial information may not be representative of their respective results as separate companies and, therefore, may not be reliable as an indicator of future results.

The historical financial information for the Solutions Group included in this joint proxy statement/ prospectus does not necessarily reflect what the Solutions Group’s financial position, results of operations and cash flows would have been had the PalmSource business not been a part of Palm during the periods presented.

PalmSource’s combined and consolidated financial statements have been carved out from the consolidated financial statements of Palm using the historical results of operations and historical bases of the assets and liabilities of the PalmSource business that PalmSource comprises. Accordingly, the historical financial information for PalmSource included in this joint proxy statement/prospectus does not necessarily reflect what PalmSource’s financial position, results of operations and cash flows would have been had PalmSource been a separate, stand-alone entity during the periods presented. Palm did not account for PalmSource, and PalmSource was not operated, as a separate, stand-alone entity for most of the periods presented. PalmSource’s revenues from the Solutions Group have been presented on the basis of applying the terms of the software license agreement, as amended, between the Solutions Group and PalmSource effective December 3, 2001. PalmSource’s costs and expenses include allocations from Palm for centralized corporate services and infrastructure costs, including:

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

The Solutions Group and PalmSource may have potential business conflicts of interest with each other with respect to their respective past and ongoing relationships and they may not resolve these respective conflicts on terms favorable to both the Solutions Group and PalmSource.

Conflicts of interest may arise between the Solutions Group and PalmSource in a number of areas relating to their respective past and ongoing relationships, including:

Other than restrictions on use of certain trademarks and domain names, nothing prohibits the combined company from competing with PalmSource or offering products based on a competing operating system, and, other than the restrictions on use of certain trademarks and domain names, nothing prohibits PalmSource from competing with the combined company or offering PalmSource’s operating system to competitors of the combined company. The combined company and PalmSource may not be able to resolve any potential conflicts that may arise between the combined company and PalmSource, and even if they are able to do so, the resolution may be less favorable than if they were each dealing with an unaffiliated party.

Directors and executive officers of Palm and PalmSource, respectively, may have conflicts of interest.

Two of Palm’s current directors, Eric Benhamou and David Nagel, are also directors of PalmSource. Mr. Benhamou is the Chairman of both Palm and PalmSource and is currently employed by Palm as its Chief Executive Officer. Mr. Nagel is currently employed by PalmSource as its President and Chief Executive Officer. However, following the completion of the transaction, Mr. Nagel will resign from Palm’s board of directors, and R. Todd Bradley will replace Mr. Benhamou as the Chief Executive Officer of the combined company and Mr. Benhamou will be the Chairman of the Board of Directors of the combined company and PalmSource. Another of PalmSource’s directors was previously employed by Palm and was a consultant to Palm. In addition, one of the Solutions Group’s executive officers is a sibling of a director of PalmSource.

Index to Financial Statements

Some directors and officers of PalmSource own shares of Palm common stock and options to purchase shares of Palm common stock. In addition some directors and officers of Palm will own shares of PalmSource common stock as a result of the PalmSource distribution. Ownership of shares of Palm common stock by PalmSource’s directors and officers, ownership of shares of PalmSource common stock by Palm’s directors and officers and/or having directors serve as directors of both the combined company and PalmSource after the separation of PalmSource from Palm could create, or appear to create, potential conflicts of interest when directors and officers are faced with decisions that could have different implications for the combined company and PalmSource. In November 2002, Mr. Benhamou was granted an option to acquire 60,000 shares of Palm’s common stock. Upon the PalmSource distribution, the vesting schedule under the option accelerates so that after the PalmSource distribution, all shares under the option will be vested and exercisable. In addition, following the PalmSource distribution, Mr. Benhamou has been promised an option to acquire 5,000 shares of Palm common stock with an exercise price equal to fair market value on the date of grant and an option to purchase 30,000 shares of PalmSource common stock.

Creditors of Palm at the time of the PalmSource distribution may attempt to challenge the PalmSource distribution as a fraudulent conveyance, which could result in PalmSource stockholders being required to turn over some or all of their shares of PalmSource common stock.

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

The court could then require that the PalmSource stockholders return some or all of the shares of PalmSource common stock, or require PalmSource to fund liabilities of Palm for the benefit of creditors. The measure of insolvency for purposes of the foregoing will vary depending upon the jurisdiction whose law is being applied. Generally, however, each of the combined company and PalmSource, as the case may be, would be considered insolvent if the fair value of its assets was less than the amount of its liabilities or if it incurred debt beyond its ability to repay such debt as it matures. Palm believes that each company, PalmSource and the combined company, will be solvent after the distribution, with sufficient capital to operate their respective businesses as proposed, but creditors and courts may not concur.

As separate companies, the combined company and PalmSource may have difficulty funding their respective future capital requirements.

In the past, most of PalmSource’s capital needs have been satisfied by Palm. Through the closing of the transaction, Palm will have made net capital contributions to PalmSource totaling $54.2 million. However, following the distribution, the combined company will no longer provide funds to finance PalmSource’s working capital or other cash requirements. While PalmSource currently believes that its existing cash, cash equivalents and short-term investments will be sufficient to satisfy its anticipated cash requirements for the next 12 months, PalmSource will not likely be able to obtain financing with interest rates as favorable as those that it has historically incurred under its intercompany loan agreement with Palm and may not be able to obtain financing from other sources at all, which could have a negative effect on PalmSource’s business and financial condition. In addition, even if expectations are met, PalmSource may find it advisable to seek additional funding.

The Solutions Group currently believes that its existing cash, cash equivalents and short-term investments will be sufficient to satisfy anticipated cash requirements for it and for the combined company for the next

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12 months. The Solutions Group could be required to seek additional funding if the expectations for the Solutions Group are not met. Following the transaction, the combined company could be required to seek additional funding if Solutions Group’s expectations of the combined company are not met. For example, if Solutions Group’s or the combined company’s operating results do not meet its expectations or if inventory, accounts receivable or other assets require greater use of cash than currently anticipated, the Solutions Group or the combined company may be required to seek additional funding through financings or other arrangements. Even if expectations for the Solutions Group or for the combined company are met, the Solutions Group or the combined company may find it advisable to seek additional funding. If the Solutions Group or the combined company seeks additional funding, adequate funds may not be available when needed on favorable terms or at all, which could have a negative effect on the Solutions Group’s or the combined company’s business and financial condition. It is not possible at this time to determine whether such funding will be more or less available than if Palm did not distribute its shares of PalmSource common stock and combine with Handspring. In addition, it is not possible at this time to determine whether, over the long term, such funding will be more or less than the funding that would have been available from the earnings of PalmSource had the separation and distribution not occurred.

We believe that the combined company’s and PalmSource’s capital requirements will vary greatly from quarter to quarter, depending on, among other things, fluctuations in their respective operating results, financing activities, acquisitions and investments and, with respect to the combined company, costs relating to the integration of Handspring and the Solutions Group following the transaction. The combined company and PalmSource may require or choose to obtain additional debt or equity financing in order to finance acquisitions or other investments in their respective businesses. The combined company and PalmSource may also require additional financing if their respective operating and working capital requirements vary materially from those currently planned. Future equity financings would be dilutive to the existing holders of each company’s common stock. Future debt financings could involve restrictive covenants which could impair their ability to engage in certain business transactions. We cannot assure you that financing and funding for the combined company’s and PalmSource’s respective capital requirements, if needed, will be available to the combined company and PalmSource on favorable terms or at all.

PalmSource may be required to indemnify Palm for tax liabilities Palm may incur in connection with its distribution of PalmSource’s common stock, and each of Palm and PalmSource may be required to indemnify the other for certain taxes.

Palm has received a private letter ruling from the Internal Revenue Service to the effect that the distribution of the shares of PalmSource common stock held by Palm to Palm’s stockholders will not be taxable to Palm or its U.S. stockholders. This ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. Although some facts have changed since the issuance of the ruling, in the opinion of Palm’s tax counsel, these changes will not adversely affect neither Palm nor PalmSource is aware of any material change in the facts and circumstances of the distribution that would call into question the validity of the ruling. For a more complete discussion of the ruling and the U.S. federal income tax consequences of the distribution, please see “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource distribution and Handspring merger.”

Notwithstanding the receipt of the ruling described above, the distribution may nonetheless be taxable to Palm under Section 355(e) of the Code if 50% or more of the stock of Palm or PalmSource stock is acquired as part of a plan or series of related transactions that include the PalmSource distribution. For a more complete discussion of the U.S. federal income tax consequences in the event that the distribution were taxable, please see “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource distribution and the Handspring merger.”

Under the tax sharing agreement between Palm and PalmSource, PalmSource would be required to indemnify Palm if the sale of PalmSource’s common stock caused the distribution of PalmSource’s common

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stock to be taxable to Palm. PalmSource may not be able to adequately satisfy its indemnification obligation under the tax sharing agreement. In addition, under the tax sharing agreement, Palm and PalmSource have agreed to indemnify each other for certain taxes and similar obligations that the other party could incur under certain circumstances. For a more complete description of the tax sharing agreement, please see “The PalmSource Separation—Amended and Restated Tax Sharing Agreement.” Finally, although under the tax sharing agreement PalmSource is required to indemnify us for taxes of PalmSource, we may be held jointly and severally liable for taxes determined on a consolidated basis.

The combined company’s ability to utilize its net operating losses may be limited if the combined company engages in transactions which bring cumulative change in ownership for Palm to 50% or more.

As a result of the Handspring merger, Palm will experience a change in ownership of approximately 30%. Over a three-year period, if the cumulative change in ownership of Palm exceeds 50% (including the change in ownership resulting from the Handspring merger), the combined company’s ability to utilize its net operating losses to offset future taxable income may be limited. This would limit the net operating loss available to offset taxable income each year following the change in ownership over 50%. In the event the usage of these net operating losses is subject to limitation and the combined company is profitable, the combined company’s cash flows could be adversely impacted due to the combined company’s increased tax liability.

Following the PalmSource distribution, the combined company and PalmSource will not benefit from any previous synergies or shared resources, which may harm the businesses of the combined company and PalmSource.

Prior to the PalmSource separation and distribution, the Solutions Group and PalmSource were able to benefit from certain synergistic alliances and shared resources. Although the Solutions Group and PalmSource believe that the external separation of the businesses will provide benefits to the respective businesses, there can be no assurance that the two businesses will not be adversely affected by the external separation.

The combined company will have limited use and control of the Palm brand and the combined company brands following the distribution, which could impact its revenues and results of operations.

We believe that the Palm brand is a valuable asset. Prior to the transaction, certain Palm and PalmSource trade names, trademarks, service marks and domain names containing the word or letter string “palm” will be assigned to the Palm Trademark Holding Company, LLC, a holding company owned by Palm and PalmSource for the purpose of receiving, holding, maintaining, registering, enforcing and defending such intellectual property. Following the transaction, the combined company will be changing its branding strategy, corporate name to palmOne and Nasdaq ticker symbol to “PLMO”. While we will continue to use elements of the Palm brand pursuant to a trademark license from the holding company, we cannot assure you that these changes will not have an adverse impact on the business of the combined company. In addition, if the combined company is unable in the future to license the Palm-related trademarks, service marks, domain names and trade names from the Palm Trademark Holding Company, LLC, or if the holding company fails to enforce its intellectual property rights in them successfully, the competitive position could suffer, which could harm its business.

PalmSource stockholders could experience substantial dilution of their interest in PalmSource as a result of the assumption by PalmSource of a portion of Palm’s note with Texas Instruments.

In connection with the PalmSource separation, Palm’s existing $50 million note payable to Texas Instruments will be divided into and replaced by two notes: one issued by Palm, or the new Palm note, and one issued by PalmSource, or the PalmSource note. Palm and Texas Instruments have agreed that the new Palm note will be issued in the principal amount of $35 million and the PalmSource note will be issued in the principal amount of $15 million. The new Palm note will be convertible into only Palm common stock and the PalmSource note will be convertible into only PalmSource common stock.

Index to Financial Statements

The conversion price of the PalmSource note will be set according to a formula based upon the decrease in the average trading price of Palm’s common stock for the five days before the PalmSource distribution, versus the average trading price of Palm’s common stock for the five days after the PalmSource distribution. However, the minimum conversion price will be 115% of the volume weighted average PalmSource common stock price on its first trading day and the maximum conversion price will be 400% of such price on its first trading day. Because the adjustment is based on the decrease in Palm’s trading price, subject to the minimum and maximum conversion prices, if Palm’s stock price does not decline significantly following the PalmSource distribution, PalmSource stockholders may incur substantial dilution. In addition, in the event the minimum conversion price becomes applicable, the lower PalmSource’s average trading price is on its first trading day, the greater the potential dilution. In addition, PalmSource would be required to record non-cash interest expense to the extent the conversion price of the PalmSource note is less than the trading price of PalmSource common stock on the date of issuance of the PalmSource note. We cannot predict the prices at which Palm and PalmSource may trade. See “The Solutions Group Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note” for a more complete description of the conversion mechanism of the PalmSource note.

If the merger does not close, Palm may have an outstanding note from Handspring that may be subject to risk of default.

As part of the merger agreement, Palm may be required to loan up to $20.0 million to Handspring to fund its operations. As of June 28, 2003, Handspring’s accumulated deficit was $417.3 million and its net worth was only $6.6 million. In addition, losses are likely to continue in the short-term. If the merger does not close, the note may be subject to a risk of default and while it is collateralized by all of the assets of Handspring, such assets may not be sufficient to allow Palm to fully recover the loaned funds. Furthermore, the loaned funds could help Handspring in competing against Palm in various segments of the mobile computing market.

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

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

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

Carriers significantly affect the ability of smartphone providers such as us to develop and launch products for use on their wireless networks. If we fail to address the needs of carriers, identify new product and service opportunities or modify or improve our smartphone products in response to changes in technology, industry standards or carrier requirements, our products could rapidly become less competitive or obsolete. In addition, we are required to certify our wireless products with the wireless carriers for use on their networks. The certification process can be time consuming and affect our ability to timely deliver products to customers.

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

If Palm is unsuccessful in its litigation with Xerox, the combined company’s business, results of operations and financial condition would be significantly harmed.

Palm is engaged in a civil action brought by Xerox Corporation in 1997 in New York federal district court alleging willful infringement of a Xerox patent by the Graffiti handwriting recognition system employed in handheld computers operating the Palm OS. While the district court dismissed the case in 2000, ruling that the Xerox patent is not infringed by the Graffiti handwriting recognition system, Xerox appealed the dismissal. The appellate court reversed and remanded the case to the district court for further proceedings. The district court subsequently found the patent valid, enforceable and infringed. Palm appealed the judgment in December 2001.

In February 2002, the district court rejected an injunction sought by Xerox to prohibit the manufacture or sale of products using the Graffiti handwriting recognition system. The court also rejected a request by Xerox for a trial date to determine damages, but required Palm to post a $50 million bond, a decision from which Palm appealed; Xerox filed a cross-appeal. The federal appeals court decided in February 2003 that the Xerox patent is infringed by the Graffiti handwriting recognition system, but remanded the case to the district court to determine whether the patent is valid, thereby lifting the requirement that Palm post a bond. In its opinion, however, the appellate court directed that, in the event the patent is held valid, Xerox would be entitled to an injunction. Proceedings on the issue of the validity of the patent are now pending in the district court. In connection with the PalmSource separation, we entered into an agreement pursuant to which we agreed to defend and indemnify PalmSource from liabilities incurred in connection with the Xerox litigation. In the event we are found liable for damages in this litigation, we would not be entitled to contribution from PalmSource.

We cannot assure you that Palm will be successful in the litigation. If Palm is not successful, we may be required to pay Xerox significant damages or license fees or pay significant amounts with respect to Palm OS licenses for their losses pursuant to our indemnity to PalmSource. It may also result in other indirect costs and expenses, such as significant diversion of management resources, loss of reputation and goodwill, damage to our customer relationships and declines in our stock price. Accordingly, if Xerox is successful, our business, results of operations and financial condition could be significantly harmed and we may be rendered insolvent. In addition, Xerox might again seek an injunction preventing us or Palm OS licensees from offering products with Palm OS with Grafitti handwriting recognition software. Palm has largely transitioned its products to a handwriting recognition software that does not use Grafitti.

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

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

Index to Financial Statements

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

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

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

The downturn in general economic conditions and the substantial decline in the stock market have led to reduced demand for a variety of goods and services, including many technology products. If conditions continue to decline, or fail to improve, we could see a significant additional decrease in the overall demand for our products that could harm our operating results. This is particularly true with respect to a number of our premium products as they typically carry a list price in excess of $300 and therefore are expensive purchases for many consumers.

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

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

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

Index to Financial Statements

Our device products are manufactured by our third party manufacturers at their international facilities, which are currently located in China and Mexico. The cost, quality and availability of third party manufacturing operations are essential to the successful production and sale of our handheld devices. Our reliance on third party manufacturers exposes us to risks, which are not in our control and our revenues or cost of revenues could be negatively impacted. For example, the Severe Acute Respiratory Syndrome (SARS) outbreak in China could result in quarantines or closures of our third party manufacturers or their suppliers. In the event of such a quarantine or closure, our revenues, or cost of revenues and results of operations, could be negatively impacted.

We do not have manufacturing contracts with all of the third party manufacturers upon which we rely to manufacture our device products. The absence of a manufacturing contract means that, with little or no notice, these manufacturers could refuse to continue to manufacture all or some of the units of our devices that we require or change the terms under which they manufacture our device products. If these manufacturers were to stop manufacturing our devices, we may be unable to replace the lost manufacturing capacity on a timely basis and our results of operations could be harmed. In addition, if these manufacturers were to change the terms under which they manufacture for us, our manufacturing costs could increase and our cost of revenues could increase.

After the transaction, we may choose to rationalize third party manufacturers. If we transition the manufacturing of any product to a new manufacturer, there is a risk of disruption in manufacturing and, revenues and results of operations could be adversely impacted.

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

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

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

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

Some components, such as displays and certain integrated circuits, digital signal processors, microprocessors, radio frequency components and other discrete components, come from sole source suppliers, one of which is also a competitor of ours in certain markets. Alternative sources are not always available or may be financially prohibitive. If suppliers were unable or unwilling to meet our demand for sole source components and if we are unable to obtain an alternative source or if the price for an alternative source is prohibitive, our ability to maintain timely and cost-effective production of our handheld computing device products will be seriously harmed.

We enter into agreements for the development and licensing of third party technology to be incorporated into some of our products. Our ability to release and sell our products could be seriously harmed if the third party technology is not delivered to us in a timely manner or contains errors or defects which are not discovered and

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fixed prior to release of our products. Our inability to obtain alternative technology could result in damage to our reputation as well as lost revenues and divert our development resources from other business objectives.

Our product strategy is substantially dependent on the Palm OS, and after this transaction PalmSource will be an independent public company outside of our control.

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

As part of this transaction, PalmSource is becoming an independent company. Our business would be harmed if PalmSource is not able to successfully implement its business strategy or is otherwise unsuccessful as a stand-alone company. In addition, we cannot assure you that PalmSource will remain an independent public company following the transaction. While our software license agreement with PalmSource includes certain protections for us if PalmSource is acquired, this protection may not be adequate to fully protect our interests, which may reduce our ability to compete in the marketplace and cause us to incur significant costs.

Palm is a defendant in several intellectual property lawsuits involving the Palm OS. Although PalmSource generally indemnifies us for damages arising from such lawsuits, we could still be adversely affected by a determination adverse to PalmSource as a result of market uncertainty, product changes that could arise from such a determination, or failure of PalmSource to adequately indemnify us.

We rely on carriers, distributors, retailers and resellers to sell our products, and disruptions to these channels would adversely affect our ability to generate revenues from the sale of our handheld devices.

Our carriers, distributors, retailers and resellers sell products offered by our competitors. If our competitors offer our carriers, distributors, retailers and resellers more favorable terms or have more products available to meet their needs, those carriers, distributors, retailers and resellers may de-emphasize or decline to carry our products. If we are unable to maintain successful relationships with carriers, distributors, retailers and resellers or to expand our distribution channels, our business will suffer.

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

Distributors, retailers and traditional resellers experience competition from Internet-based resellers that distribute directly to end-user customers, and there is also competition among Internet-based resellers. We also

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sell our products directly to end-user customers from our Palm.com website. These varied sales channels could cause conflict among our channels of distribution, which could harm our revenues and results of operations.

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

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

For example, flat data rate pricing plans offered by some carriers may expose us to risk. While flat data pricing helps customer adoption of the data services offered by carriers and therefore highlights the advantages of the data applications of our smartphones, such plans may not allow our smartphones to contribute as much average revenue per user (ARPU) to carriers as when they were pricing incrementally, and therefore reduces our differentiation from other products.

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

Because of their large sales channels, strategic carriers may purchase large quantities of our products prior to launch so that the products are widely available. Reorders of products may fluctuate quarter to quarter, depending upon customer demand and inventory levels required by the carriers. As we develop new strategic relationships and launch new products with new and existing strategic partners, our smartphone revenue will be subject to fluctuation based upon the timing of carrier product launches as well as customer demand and carrier inventory requirements.

The amount of future carrier subsidies is uncertain and carriers are free to lower or reduce their subsidies with little or no notice to us.

When we sell our wireless products on our own website, we sometimes have the opportunity to earn subsidies from carriers if the customer also purchases a voice or data plan from the carrier. Today the wireless

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industry is generally decreasing subsidies on voice services. Moreover, carriers that currently provide the Solutions Group and Handspring with subsidies may reduce or discontinue such subsidies with little or no notice. While we believe carriers will continue to offer subsidies to the combined company, if these subsidies were reduced or eliminated the gross margins for the affected products would decline and we would be more limited in our ability to sell at prices that are attractive to cost sensitive consumers.

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

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

We compete in the handheld and smartphone device markets. The market for these products and services are highly competitive, and we expect increased competition in the future, particularly as companies from various established industry segments, such as mobile handset, personal computer and consumer electronics, increasingly develop and market products that compete with us. Some of our competitors or potential competitors possess capabilities developed over years of serving customers in their respective markets. In addition, many of our competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products. Finally, these competitors bring with them customer loyalties, and such loyalties may limit our ability to attract new users despite superior product offerings.

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

As an independent company, PalmSource may license the Palm OS to companies who compete directly or indirectly with our business. For example, PalmSource has recently signed Palm OS license agreements with HuneTech, Legend and Group Sense (International) Limited, located in the Asia Pacific region. Our revenues and gross margins could suffer because of competition from licensees of the Palm OS platform.

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

Certain competitors may have longer and closer relationships with the senior management of enterprise customers who decide which products and technologies will be deployed in their enterprises. Moreover, these

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competitors may have larger and more established sales forces calling upon potential enterprise customers and therefore could contact a greater number of potential customers with more frequency. Consequently, these competitors could have a better competitive position than we do, which could result in potential enterprise customers deciding not to choose our products and services, which would adversely impact our business, revenues, sales and marketing expenses and financial condition.

Certain competitors may have longer and closer relationships with wireless carrier customers. Moreover, these competitors may have existing business relationships, more products to offer, and larger and more established sales forces calling upon potential wireless carrier customers and therefore could have a better competitive position than we do. This could result in potential wireless carrier customers deciding not to choose our products and services, which would adversely impact our business, revenues, sales and marketing expenses and financial condition.

Successful new product introductions or enhancements by our competitors, or increased market acceptance of competing products could reduce the sales and market acceptance of our products, cause intense price competition or could make our products obsolete. To be competitive, we must continue to invest significant resources in research and development, sales and marketing and customer support. We cannot be sure that we will have sufficient resources to make these investments or that we will be able to make the technological advances necessary to be competitive. Increased competition could result in price reductions, fewer customer orders, reduced margins and loss of market share. Our failure to compete successfully against current or future competitors could seriously harm our business, financial condition and results of operations.

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

Our devices are complex and must meet stringent user requirements. We must develop hardware and software application 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. Our products may not be free from errors or defects after commercial shipments have begun, which could result in the rejection of our products, damage to our reputation, lost revenues, diverted development resources and increased customer service and support costs and warranty claims, which could harm our business, revenues, cost of revenues and financial condition.

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

Our future success depends on our ability to attract and retain highly skilled personnel, including personnel from Handspring that are expected to be a part of the combined company following the proposed Handspring merger. We compensate our employees through a combination of salary, bonuses, benefits and equity compensation. If we fail to provide competitive compensation to our employees, we may be unable to retain them. Volatility or lack of positive performance in our stock price may also affect our ability to retain key employees, all of whom have been granted stock options.

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

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

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In recent quarters, we have initiated reductions in our workforce of both employees and contractors to balance the size of our employee base with our anticipated revenue base. In addition, following the proposed Handspring merger, there will be employee reductions related to the integration of the Solutions Group and Handspring. These reductions have and will result in reallocations of employee duties, which could result in employee and contractor uncertainty. Reductions in our workforce could make it difficult to motivate and retain the remaining employees and contractors, which could affect our ability to deliver our products in a timely fashion and negatively affect our business.

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

In the course of our business, we frequently receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. For example, as our focus has shifted to wireless communicators, we have received, and expect to continue to receive, communications from holders of patents related to GSM, GPRS, CDMA and other mobile communication standards. We evaluate the validity and applicability of these intellectual property rights, and determine in each case whether we must negotiate licenses or cross-licenses to incorporate or use the proprietary technologies in our products. Third parties may claim that we or our customers are infringing or contributing to the infringement of their intellectual property rights, and we may be found to infringe or contribute to the infringement of those intellectual property rights and require a license to use those rights. We may be unaware of intellectual property rights of others that may cover some of our technology, products and services.

Any litigation regarding patents or other intellectual property could be costly and time consuming and could divert our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of litigation generally increase the risks associated with intellectual property litigation. Moreover, patent litigation has increased due to the current uncertainty of the law and the increasing competition and overlap of product functionality in our markets. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements or indemnify our customers. However, we may not be able to obtain royalty or license agreements on terms acceptable to us or at all. We also may be subject to significant damages or injunctions against development and sale of our products. In addition, following the transaction, we will become liable for lawsuits filed against Handspring, which lawsuits could also have a material adverse effect on our business, financial condition or operating results.

If third parties infringe our intellectual property or if we are unable to secure and protect our intellectual property, we may expend significant resources enforcing our rights or suffer competitive injury.

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

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

We may be required to spend significant resources to monitor and police our intellectual property rights. Effective policing of the unauthorized use of our products or intellectual property is difficult and litigation may be necessary in the future to enforce our intellectual property rights. Intellectual property litigation is not only expensive, but time-consuming, regardless of the merits of any claim, and could divert attention of our

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management from operating the business. Despite our efforts, we may not be able to detect infringement and may lose competitive position in the market before we do so. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign countries, which could make it easier for competitors to capture market share.

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

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

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

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

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

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

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

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

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

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

We have made acquisitions in the past and we will continue to evaluate other acquisition opportunities that could provide us with additional product or service offerings or additional industry expertise as they arise. Acquisitions could result in difficulties assimilating acquired operations and products, and result in the diversion of capital and management’s attention away from other business issues and opportunities. Integration of acquired companies may result in problems related to integration of technology and management teams. We may not successfully integrate operations, personnel or products that we have acquired or may acquire in the future, including the proposed Handspring merger. If we fail to successfully integrate acquisitions, our business could be materially harmed. In addition, our acquisitions may not be successful in achieving our desired strategic objectives, which would also cause our business to suffer. These transactions may result in the diversion of capital and management’s attention away from other business issues and opportunities. In addition, we have made strategic venture investments in other companies that provide products and services that are complementary to ours. If these investments are unsuccessful, this could have an adverse impact on our results of operations and financial position.

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

We own approximately 39 acres of land in San Jose, California which we do not plan to develop. In the third quarter of fiscal year 2003, we reported an impairment charge to adjust the carrying cost of the land to its then current fair market value. While we currently have no immediate plans to sell this property, a future sale or other disposition of the land at less than its carrying value, or a further deterioration in market values that impacts our expected recoverable value, would result in a non-cash charge which would negatively impact our results of operations.

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

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

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

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

The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering. These fluctuations could continue. Among the factors that could affect our stock price are:

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

Provisions in our charter documents and Delaware law and our adoption of a stockholder rights plan may delay or prevent acquisition of us, which could decrease the value of shares of our common stock.

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

Our board of directors adopted a stockholder rights plan, pursuant to which we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of November 6, 2000. Unless

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redeemed by us prior to the time the rights are exercised, upon the occurrence of certain events, the rights will entitle the holders to receive upon exercise thereof shares of our preferred stock, or shares of an acquiring entity, having a value equal to twice the then-current exercise price of the right. The issuance of the rights could have the effect of delaying or preventing a change in control of us.

On August 22, 2003, Palm sold 1.2 million shares of its common stock under its universal shelf registration statement to an institutional investor at a price of $15 per share, with proceeds to Palm of $18 million. The net proceeds of the offering will be allocated to the Solutions Group and will be used for general corporate purposes, including capital expenditures and to meet working capital needs. Pending their application, the net proceeds will be invested in interest bearing securities.

On August 28, 2003, Palm entered into a two-year, $30 million revolving credit line from a financial institution. The credit line is secured by its assets, including but not limited to cash and cash equivalents, accounts receivable, inventory and property and equipment. The interest rate may vary based on fluctuations in market rates. Palm is subject to certain financial covenant requirements under the agreement.

On August 29, 2003, Palm entered into agreements to sell 1.2 million shares of its common stock under its universal shelf registration statement to a group of private investors at a price of $15.90 per share, with proceeds to Palm of approximately $19.1 million. The net proceeds of the offering will be allocated to the Solutions Group and will be used for general corporate purposes, including capital expenditures and to meet working capital needs. Pending their application, the net proceeds will be invested in interest bearing securities.

In September 2003, Palm reported results for the first fiscal quarter of its 2004 fiscal year, ended August 29, 2003. Palm reported consolidated revenues of $177.4 million, consolidated net loss of $21.7 million and a consolidated net loss per share of $0.74. The Solutions Group reported revenues of $168.6 million and a segment loss before income taxes of $16.5 million.

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The proposals set forth in this joint proxy statement/prospectus are being solicited by the board of directors of Palm for use at the annual meeting of stockholders to be held on , 2003, at 8:00 a.m. local time or any adjournment or postponement thereof, for the purposes set forth in the accompanying Notice of Annual Meeting of Stockholders. The meeting will be held at 580 N. McCarthy Blvd., Building 10, Milpitas, California. Palm’s telephone number is (408) 503-7000.

Certain Financial Information. Please take note that Palm’s financial statements and related information are included with its 2003 annual report on Form 10-K filed with the Securities and Exchange Commission, which is enclosed with this joint proxy statement/prospectus.

Matters to be Voted On. Palm stockholders are being asked to vote on four matters:

Voting Securities. Only stockholders of record as of the close of business on September 18, 2003, the record date, will be entitled to vote at the meeting and any adjournment or postponement thereof. As of the record date, there were shares of Palm’s common stock issued and outstanding. Stockholders may vote in person or by proxy. Each holder of shares of common stock is entitled to one vote on the proposals presented in this joint proxy statement/prospectus for each share of common stock held. There is no cumulative voting in the election of directors.

Solicitation of Proxies. The cost of soliciting proxies will be borne by Palm. In addition to soliciting stockholders by mail and through its regular employees, Palm will request banks and brokers, and other custodians, nominees and fiduciaries to solicit their customers who have stock of Palm registered in the names of such persons and will reimburse them for their reasonable, out-of-pocket costs. Palm may use the services of its officers, directors and others to solicit proxies, personally or by telephone, facsimile or electronic mail, without additional compensation. Palm has retained Georgeson Shareholder Communications, Inc., a professional solicitation firm, to assist in the solicitation of proxies at a cost of approximately $15,000, $4.00 per completed telephone call with registered stockholders and non-objecting beneficial owners and $3.50 per televote received, plus reasonable expenses.

Voting of Proxies. All valid proxies received prior to the meeting will be voted. All shares represented by a proxy will be voted, and where a stockholder specifies by means of the proxy a choice with respect to any matter to be acted upon, the shares will be voted in accordance with the specification so made. If no choice is indicated on the proxy, the shares will be voted “FOR” all nominees, “FOR” all other proposals described herein and as the proxy holders may determine in their discretion with respect to any other matters that properly come before the meeting. A stockholder giving a proxy has the power to revoke his or her proxy, at any time prior to

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the time it is voted, by delivering to the Secretary of Palm a written instrument revoking the proxy or a validly executed proxy with a later date, or by attending the meeting and voting in person. If you have instructed a broker or bank to vote your shares by executing a voting instruction card, you must follow the directions received from your broker or bank to change your voting instructions.

Quorum. The required quorum for the transaction of business at the annual meeting is a majority of the votes eligible to be cast by holders of shares of common stock issued and outstanding on the record date. Shares that are voted “FOR,” “AGAINST,” “WITHHELD FROM” or “ABSTAIN” on a matter, or votes cast, are treated as being present at the meeting for purposes of establishing a quorum and are also treated as shares entitled to vote at the annual meeting with respect to such matter.

Adjournments. If sufficient votes to constitute a quorum or to approve and adopt the merger agreement are not received by the date of the annual meeting of stockholders, the persons named as proxies may propose one or more adjournments of the meeting to permit further solicitation of proxies. Adjournment would require the affirmative vote of the holders of a majority of the outstanding shares of Palm common stock present in person or represented by proxy at the annual meeting. The persons named as proxies would generally exercise their authority to vote in favor of adjournment.

Abstentions. Abstentions will be counted for purposes of determining both (i) the presence or absence of a quorum for the transaction of business and (ii) the total number of votes cast with respect to a proposal (other than the election of directors). In the absence of controlling precedent to the contrary, Palm intends to treat abstentions in this manner. Accordingly, abstentions will have the same effect as a vote against a proposal.

Broker Non-Votes. Under the applicable rules of the New York Stock Exchange, brokers and nominees are prohibited from giving a proxy to vote their customers’ shares with respect to approval and adoption of the merger agreement and approval of the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors. These broker non-votes will be counted for purposes of determining the presence or absence of a quorum for the transaction of business but will not be counted for purposes of determining the number of votes cast with respect to the particular proposal on which the broker has expressly not voted. Accordingly, broker non-votes will not affect the outcome of the voting on a proposal that requires a majority of the votes cast. However, because Delaware law requires Proposal No. 1 (the approval and adoption of the merger agreement) to be approved by the holders of a majority of Palm’s outstanding shares, and not merely the approval of a majority of the votes cast, broker non-votes will have the same effect as a vote against Proposal No. 1.

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Security Ownership of Certain Beneficial Owners and Management. The following table sets forth certain information, as of September 23, 2003, with respect to the beneficial ownership of Palm’s common stock by (i) each person who is known to Palm to own beneficially more than 5% of Palm’s common stock; (ii) each director and director-nominee of Palm; (iii) the Chief Executive Officer and each other person included in the Summary Compensation Table beginning on page 201 of this joint proxy statement/prospectus, referred to in this joint proxy statement/prospectus collectively as the named executive officers; and (iv) all current executive officers and directors of Palm as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to the securities. Shares of Palm’s common stock subject to options or warrants that are currently exercisable or exercisable within 60 days of September 23, 2003 are deemed to be outstanding and beneficially owned for the purpose of computing the percentage ownership of that person but are not treated as outstanding for the purpose of computing the percentage ownership of any other person.

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This joint proxy statement/prospectus is being sent to you as a Handspring stockholder in order to provide you with important information regarding the Handspring merger in connection with the solicitation of proxies by Handspring’s board of directors for use at the special meeting of its stockholders and at any adjournment or postponement of the special meeting.

Handspring will hold a special meeting of its stockholders on , 2003, at a.m., local time, at .

At the Handspring special meeting, Handspring stockholders will be asked to consider and vote upon a proposal to approve and adopt the merger agreement. Handspring stockholders will also consider and vote upon any other matters that may properly come before the special meeting or any adjournment or postponement of the special meeting. Handspring is not currently aware of any other matter that will come before the special meeting.

After careful consideration, the Handspring board of directors has unanimously approved the merger agreement and the Handspring merger. The Handspring board of directors believes that the terms of the merger agreement and the Handspring merger are advisable, fair to, and in the best interests of, Handspring and its stockholders. The Handspring board of directors unanimously recommends that the Handspring stockholders vote FOR the proposal to approve and adopt the merger agreement and to approve the Handspring merger.

The record date for determining the Handspring stockholders entitled to vote at the special meeting is September 18, 2003. Only holders of record of Handspring common stock as of the close of business on that date are entitled to vote at the special meeting. As of the record date, there were shares of Handspring common stock issued and outstanding, held by approximately stockholders of record. As of the record date, the directors and executive officers of Handspring and their affiliates held outstanding shares of Handspring common stock. Each share of Handspring common stock issued and outstanding as of the record date entitles its holder to cast one vote at the special meeting.

In order to conduct business at the special meeting, a quorum must be present. Handspring’s bylaws provide that a quorum at the special meeting will be the holders of a majority of the stock outstanding on the record date for the meeting. Handspring will treat shares of common stock represented by a properly signed and returned proxy, including abstentions and broker non-votes, as present at the meeting for purposes of determining the existence of a quorum. If sufficient votes to constitute a quorum or to approve and adopt the merger agreement and to approve the Handspring merger are not received by the date of the special meeting, the persons named as proxies may propose one or more adjournments of the meeting to permit further solicitation of proxies. Adjournment would require the affirmative vote of the holders of a majority of the outstanding Handspring common stock present in person or represented by proxy at the special meeting. The persons named as proxies would generally exercise their authority to vote in favor of adjournment.

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A majority of the shares of Handspring’s common stock outstanding on the record date must be voted for the proposal to approve and adopt the merger agreement and to approve the Handspring merger in order for the proposal to pass. The inspector of elections appointed for the special meeting will tabulate the votes.

The Handspring proxy accompanying this joint proxy statement/prospectus is solicited on behalf of the Handspring board of directors for use at the Handspring special meeting.

General. Shares represented by a properly signed and dated proxy will be voted at the special meeting in accordance with the instructions indicated on the proxy. Proxies that are properly signed and dated but which do not contain voting instructions will be voted FOR the proposal to approve and adopt the merger agreement and to approve the Handspring merger. The proxy holder may vote the proxy in its discretion as to any other matter that may properly come before the Handspring special meeting.

Abstentions. Handspring will count a properly executed proxy marked “ABSTAIN” as present for purposes of determining whether a quorum is present, but the shares represented by that proxy will not be voted at the special meeting. Because the affirmative vote of a majority of the outstanding shares of Handspring common stock is required to approve and adopt the merger agreement and to approve the Handspring merger, if you mark your proxy “ABSTAIN,” it will have the effect of a vote against the proposal to approve and adopt the merger agreement and to approve the Handspring merger.

Broker Non-Votes. If your shares are held by your broker, your broker will vote your shares for you only if you provide instructions to your broker on how to vote your shares. You should follow the directions provided by your broker regarding how to instruct your broker to vote your shares. Your broker cannot vote your shares of Handspring common stock without specific instructions from you. Because the affirmative vote of a majority of the outstanding shares of Handspring common stock is required to approve and adopt the merger agreement and to approve the Handspring merger, if you do not instruct your broker how to vote, it will have the effect of a vote against the proposal to approve and adopt the merger agreement and to approve the Handspring merger.

Voting Shares In Person That Are Held Through Brokers. If your shares are held by your broker or another nominee and you wish to vote those shares in person at the special meeting, you must obtain from the nominee holding your Handspring common stock a properly executed legal proxy identifying you as an Handspring stockholder, authorizing you to act on behalf of the nominee at the special meeting and identifying the number of shares with respect to which the authorization is granted.

Notices to the Secretary of Handspring should be addressed to Secretary, Handspring, Inc., 189 Bernardo Avenue Mountain View, California 94043.

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Handspring will pay its own costs of soliciting proxies for the special meeting. Certain directors, officers and employees of Handspring may solicit proxies, without additional remuneration, by telephone, facsimile, electronic mail, telegraph and in person. Handspring expects that the expenses of this special solicitation will be nominal. Following the mailing of this joint proxy statement/prospectus, Handspring will request brokers, custodians, nominees and other record holders to forward copies of this joint proxy statement/prospectus to persons for whom they hold shares of common stock and to request authority for the exercise of proxies. In such cases, Handspring, upon the request of the record holder, will reimburse such holder for their reasonable expenses. Handspring has retained Georgeson Shareholder Communications, Inc., a professional solicitation firm, to assist in the solicitation of proxies at a cost of approximately $7,500, $4.00 per completed telephone call with registered stockholders and non-objecting beneficial owners and $3.75 per televote received, plus reasonable expenses.

If your shares are registered in the name of a bank or brokerage firm, you may be eligible to vote your shares by telephone or Internet. A large number of banks and brokerage firms are participating in the ADP Investor Communication Services telephone or Internet voting program. This program provides eligible stockholders the opportunity to vote by telephone or Internet. If your bank or brokerage firm is participating in ADP’s program, your voting form will provide instructions. If your voting form does not reference telephone or Internet information, please complete and return the paper proxy card in the self-addressed, postage-paid envelope provided.

Three Handspring stockholders have agreed to vote a total of 37.5% of the outstanding voting power of the Handspring common stock entitled to vote on the merger agreement and the Handspring merger in favor of the proposal to approve and adopt the merger agreement and to approve the Handspring merger and have executed proxies with respect to their shares in favor of Palm.

If the Handspring merger is not completed, Handspring will convene a 2003 annual meeting of stockholders. Stockholder proposals intended to be presented at Handspring’s 2003 annual meeting of stockholders must have been received by Handspring at its principal executive offices no later than May 26, 2003 in order to be included in Handspring’s proxy statement and form of proxy relating to that meeting. Stockholders wishing to bring a proposal before the 2003 annual meeting of stockholders (but not include it in Handspring’s proxy materials) must have provided written notice of such proposal to Handspring’s Secretary at Handspring’s principal executive offices no later than August 9, 2003.

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Security Ownership of Certain Beneficial Owners and Management of Handspring

The following table sets forth certain information, as of July 26, 2003, with respect to the beneficial ownership of Handspring’s common stock by (i) each stockholder known by Handspring to be the beneficial owner of more than 5% of Handspring’s common stock, (ii) each director, (iii) Handspring’s chief executive officer and each of Handspring’s five other most highly compensated executive officers for fiscal year 2003, or the named executive officers, and (iv) all directors and named executive officers as a group. There were 148,642,451 shares of Handspring’s common stock outstanding on July 26, 2003.

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This section of the joint proxy statement/prospectus describes the transaction, including the proposed PalmSource distribution and Handspring merger. While we believe that the description in this section addresses the material terms of the transaction, this summary may not contain all of the information that is important to you. You should carefully read this entire document and the other documents we have referred you to in this joint proxy statement/prospectus for a more complete understanding of the transaction. You should carefully review the information related to PalmSource included in Annex A in determining whether to approve and adopt the merger agreement.

Palm and Handspring have entered into a merger agreement that provides for a transaction with two components.

First, the common stock of PalmSource held by Palm will be distributed to the existing stockholders of Palm by means of the merger of Peace Separation Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Palm, which we refer to as the PalmSource distribution. Upon effectiveness of the PalmSource distribution, each outstanding share of Palm common stock (including the associated preferred stock purchase right) will be automatically converted into the right to receive (A) one validly issued, fully paid and nonassessable share of Palm common stock (together with the associated right), such that each share of Palm common stock will remain outstanding after the completion of the PalmSource distribution and (B) the right to receive approximately 0.32 of a share of PalmSource common stock and cash in lieu of any fractional share. This ratio is based on the number of shares of Palm common stock outstanding on August 29, 2003, and is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution.

Following the PalmSource distribution, Palm, which will consist of its Solution Group business, will acquire Handspring by means of the merger of Harmony Acquisition Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Handspring, which we refer to as the Handspring merger. Upon completion of the Handspring merger, each share of Handspring common stock (including the associated preferred stock purchase right) outstanding immediately prior to the effective time of the Handspring merger will be canceled and extinguished and automatically converted into the right to receive 0.09 of a share of Palm common stock upon surrender of the certificate representing such share of Handspring common stock and cash in lieu of any fractional share. Palm shares will be issued with associated preferred stock purchase rights.

In structuring the combination of Palm and Handspring, the parties sought to achieve the following objectives:

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The parties considered various transaction structures to achieve these objectives and agreed on the structure outlined in the merger agreement.

The merger agreement is described in more detail in “The Merger Agreement” beginning on page 101 of this joint proxy statement/prospectus. The merger agreement is attached to this joint proxy statement/prospectus as Annex B and is incorporated by reference into this joint proxy statement/prospectus. We encourage you to read it carefully in its entirety for a more complete understanding of the merger agreement.

Palm, Inc. was founded in 1992 and launched the first commercially successful mass-market handheld computer, or personal digital assistant (PDA), the Palm Pilot, in 1996. The Palm Pilot contained a proprietary operating system, the Palm OS, which was developed by Palm. At that time, Palm saw the opportunity to license the Palm OS and generated its first licensing revenues in 1997. Palm’s initial licensing strategy was to target companies in adjacent market segments, to avoid competition with Palm’s principal products. Over time, and as the market grew, Palm shifted its licensing strategy to target a greater number of additional licensees, including companies that would produce directly competitive products.

In the summer of 2001, after several years of licensing the Palm OS to directly competitive customers, and after an extensive evaluation of its business, Palm recognized the need to separate its operating system business from its hardware solutions business. Palm determined that a separation of the two business units was needed in order for its operating system business to be able to work effectively with licensees and in order to allow its hardware business to respond to rapid technology change. In July 2001, Palm announced its intent to form a wholly owned subsidiary to contain the Palm OS group, then called the Platform Solutions Group and now PalmSource, and to operate it as a separate business within Palm. Palm also announced the formation of a separation committee of its board of directors to oversee the separation of the operating systems business. During the late summer and fall of 2001, the separation committee formed teams of Palm management to identify and separate the assets and liabilities of the operating systems and hardware solutions businesses and to define how the two businesses would operate separately within Palm. On August 27, 2001, Palm announced that David C. Nagel, Ph. D. had been hired as President of the Platform Solutions Group.

On December 18, 2001, Palm’s board of directors approved a series of separation agreements that addressed the allocation of assets and liabilities between the operating systems business and the hardware solutions business, the licensing of Palm OS to the hardware solutions business, the provision of infrastructure services to the operating systems business and other separation matters. In December 2001, Palm incorporated the Palm OS subsidiary in Delaware, and Palm announced the formation of this subsidiary on January 21, 2002. On February 5, 2002, Palm announced that it had named the subsidiary PalmSource, Inc. In March 2002, Palm began providing segment reporting for the results of its two businesses, PalmSource and the hardware solutions business, referred to as the Solutions Group. Throughout 2002, the Palm board of directors received frequent updates regarding the separation planning and the operation of the existing agreements.

In April 2002, Palm met with nine nationally recognized investment banks to explore alternative strategies for the external separation of PalmSource. A variety of alternatives were discussed at these meetings for achieving forms of external separation of PalmSource, including a distribution of PalmSource stock to Palm’s stockholders, either with or without an initial public offering of PalmSource common stock, a split-off (a transaction in which Palm’s stockholders would surrender shares of Palm common stock to receive shares of PalmSource common stock), a private investment in PalmSource stock by a strategic partner with whom Palm

Index to Financial Statements

would share control, a majority carveout (a public offering of greater than 50% of PalmSource stock), and a sale of PalmSource.

On April 26, 2002, the Palm board of directors held a meeting to discuss, among other topics, the PalmSource separation. The board was given an update on activities related to both the internal separation of PalmSource from the Solutions Group, as well as the external separation of PalmSource. At this meeting, the board of directors authorized management to take initial steps towards a distribution of PalmSource stock preceded by an initial public offering. At the same time, Palm continued to explore alternative forms of external separation as well as alternatives for raising capital required by PalmSource.

In spring 2002 through the remainder of the year, Palm held meetings with several financial and strategic investors to discuss an investment in, or sale of, PalmSource, or a joint venture involving PalmSource.

On June 6, 2002, Palm applied for a ruling with the IRS that the distribution of PalmSource stock to Palm stockholders would be a tax-free distribution under Section 355 of the Internal Revenue Code; the IRS granted that ruling in December 2002. On June 24, 2002, Palm announced the addition of independent board members to the PalmSource board of directors. These actions were taken with a view to the possibility of making PalmSource an independent publicly-traded company.

On July 26, 2002, Palm’s board of directors held a meeting to discuss, among other topics, an update on PalmSource external separation activities and financing alternatives. At this meeting, Morgan Stanley advised the board that market conditions were not conducive for consummating an initial public offering of PalmSource, and Palm management provided an update on discussions with strategic and financial investors. The board of directors authorized management to continue to pursue third party investment in PalmSource. In addition, during a private session of the board of directors, there was further discussion of other possible forms of accomplishing external separation, including a sale of PalmSource or a joint venture involving PalmSource.

During 2002, at the same time Palm was pursuing the separation of the Palm OS business, Palm’s Solutions Group, as part of its ongoing strategic planning, evaluated its wireless strategy in light of current industry trends. In the spring of 2002, Palm recognized the importance of wireless handheld and smartphone products which incorporate phone capabilities and began to investigate a number of different paths to expand its offerings in these areas, including in-house development, partnership or acquisition. In the summer of 2002, Palm began to consider potential strategic relationships with Handspring as one method to achieve this strategy.

Palm and Handspring share common history, as the founders of Handspring also founded and played a key role in the early success of Palm. In July 1998, Donna L. Dubinsky, then President and General Manager of Palm and Jeffrey C. Hawkins, then Chief Product Officer of Palm left Palm and in September 1998, Edward T. Colligan, then Vice President, Marketing of Palm joined them to form Handspring. Handspring entered into a five-year licensing agreement for the Palm OS with Palm in September 1998. In April 2001, Palm’s license to Handspring was extended through 2009. Through 2001, Handspring principally sold handheld computers and accessories, but in the summer of 2001, Handspring began to focus its business strategy on developing wireless handheld computers with voice communications capabilities, or smartphones and in October 2001 publicly announced its Treo line of communicator products.

In summer of 2001, as Handspring began to transition its business away from traditional handheld computers to smartphones, Handspring contacted Palm about the possibility of Palm acquiring Handspring’s Visor line of handheld computers. Palm ultimately declined Handspring’s proposal. Handspring eventually discontinued its Visor line of handheld computers.

In the summer of 2002, R. Todd Bradley, then Executive Vice President and Chief Operating Officer of Palm’s Solutions Group, contacted Ms. Dubinsky, Chief Executive Officer of Handspring, to gauge Handspring’s interest in exploring ways that the two companies could work more closely together, including the possibility of a

Index to Financial Statements

merger. Ms. Dubinsky agreed to consider possible business relationships and discuss them informally with Handspring’s senior management and directors. Mr. Bradley and Ms. Dubinsky agreed to talk again once Ms. Dubinsky was able to consult with Handspring management and directors. Periodically, throughout the summer, Mr. Bradley and Ms. Dubinsky met to discuss topics such as the market environment, developments in their businesses and strategic rationale for a business combination. Mr. Bradley also met with Mr. Hawkins, Chairman and Chief Product Officer of Handspring, and Mr. Colligan, President and Chief Operating Officer of Handspring, during the summer of 2002 to discuss their thoughts relating to a possible business combination.

Around the time that Mr. Bradley first spoke with Ms. Dubinsky, in July 2002, Palm asked Morgan Stanley & Co. Incorporated to assist it in exploring a possible business combination involving Handspring. Also in July 2002, Palm engaged Morgan Stanley to provide it with advice and assistance in connection with a possible separation transaction of PalmSource.

On July 26, 2002, the Palm board of directors held a meeting to discuss, among other topics, management’s view of the future of the handheld computing industry and the strategy for the Solutions Group after the separation of PalmSource. At this meeting, Mr. Bradley presented Palm management’s view that the converged device category—handheld devices that incorporate multiple functions such as a voice and data transmittal capability—would become increasingly important for Palm and that the handheld industry was likely to experience significant consolidation over the coming years. Mr. Bradley also presented a number of strategic opportunities for Palm to consider to address these industry trends, one of which was to acquire Handspring.

In August 2002, Palm engaged Needham & Company, Inc. to provide it with advice and assistance in connection with a possible separation transaction of PalmSource. The fees payable to Needham in connection with this engagement are $0.4 million, $0.3 million of which are payable upon completion of the PalmSource distribution.

On September 1, 2002, Mr. Bradley became a director of Palm and President and Chief Executive Officer of the Palm Solutions Group.

From September 2002 through early April 2003, Ms. Dubinsky had discussions with five companies that Handspring believed may have had an interest in acquiring Handspring. Ms. Dubinsky initiated the discussion with all five companies after management determined, with board concurrence, that these companies could provide a strategic fit for Handspring based on scale, product portfolio and strategic rationale. None of the discussions successfully reached the point of valuation negotiations. Ms. Dubinsky updated the board on these efforts at various board meetings. After April 7, 2003, no other entities contacted Handspring to discuss a possible acquisition, and Ms. Dubinsky held no further discussions with any entities other than Palm regarding an acquisition of Handspring.

On September 11, 2002, Mr. Bradley, Philippe Morali, Vice President Corporate Development and Treasurer of Palm, and Ken Wirt, then Senior Vice President, Marketing of Palm, met with Mr. Colligan, Ms. Dubinsky and Dan McCammon, Handspring’s then interim Chief Financial Officer, to share financial information and product roadmaps, and to explore a possible combination of the two companies. At this meeting, the companies signed a mutual non-disclosure agreement covering the strategic discussions between the two companies. Following that meeting, Mr. Bradley and Ms. Dubinsky agreed to reconvene in early 2003, to allow Palm to make further progress towards the PalmSource separation and to allow Handspring to complete negotiations which were underway to restructure its lease obligations for its Sunnyvale, California facility.

On September 18, 2002, Handspring held a regularly scheduled board meeting. At the meeting, management and the board discussed, among other topics, an update on discussions with Palm regarding a potential acquisition of Handspring by Palm. Management also discussed the possibility of a financing from financial and strategic investors or an acquisition by a company other than Palm.

Index to Financial Statements

On October 8, 2002, PalmSource announced it had received a $20 million minority equity investment from Sony Corporation.

On November 6, 2002, Handspring held a regularly scheduled board meeting. At the meeting, management and the board discussed, among other topics, an update on discussions with Palm regarding a potential acquisition of Handspring by Palm. Management also discussed the possibility of a financing from financial and strategic investors.

On December 17, 2002, the Palm board of directors held a meeting and discussed, among other topics, remaining asset and liability allocation issues between Palm and PalmSource. The Palm board of directors appointed a new separation committee to address these remaining issues.

On January 16, 2003, Handspring announced that it completed the restructuring of its Sunnyvale lease obligations.

On January 20, 2003, Palm’s board of directors held a meeting where the separation committee of the board of directors updated the board of directors on the principles and processes by which the separation committee was operating and discussed various issues regarding the separation of PalmSource.

In early January 2003, Mr. Bradley contacted Ms. Dubinsky to resume preliminary discussions about a combination. On January 23, 2003, Messrs. Bradley and Morali met with Ms. Dubinsky to formalize a process to advance the combination discussions between the two companies. Ms. Dubinsky also discussed the lease restructuring.

On January 31, 2003, Angel Mendez, Senior Vice President, Global Operations of Palm, Mr. Morali, Dave Vadasz, Senior Director, Corporate Development of Palm, and Jason Zajac, Vice President, Product Planning and Strategy of Palm, met with Mr. Colligan, Ms. Dubinsky, John Hartnett, Vice President, Worldwide Operations of Handspring, and William R. Slakey, Vice President and Chief Financial Officer of Handspring, to discuss Handspring’s business strategy, product roadmap, carrier relationships and financial plan, and exchange views on the strategic rationale for a combination.

On February 5, 2003, the Handspring board of directors held a regularly scheduled board meeting. At the meeting, the board discussed, among other topics, potential financing opportunities with financial and strategic investors. The board then discussed the status of management’s discussions with Palm regarding a potential merger. Management also updated the board on its discussions with various other potential acquirors. The board determined that management should continue to pursue the potential transaction with Palm, and, as an alternative, a financing with outside investors or an acquisition by a company other than Palm.

On February 7, 2003, Messrs. Morali, Vadasz and Zajac met with Messrs. Colligan and Hawkins and Ms. Dubinsky to discuss Palm’s business strategy, product roadmap, financial plan, and to further exchange views on the strategic rationale for a combination.

On February 10, 2003, Eric Benhamou, Chairman of Palm’s board of directors and interim Chief Executive Officer of Palm spoke with L. John Doerr, director of Handspring, to discuss the potential transaction. The two agreed to proceed and meet to discuss the transaction further.

On February 10, 2003, the Handspring board of directors held a meeting to discuss the potential transaction with Palm and financing opportunities with investors. Management also updated the board on its discussions with various other potential acquirors. The board determined that management should continue to pursue the transaction with Palm, the financing opportunities and an acquisition by a company other than Palm.

On February 12, 2003, Messrs. Bradley and Morali met with Mr. Colligan and Ms. Dubinsky to discuss the potential management structure and board composition of the combined company.

Index to Financial Statements

On February 13, 2003, Mr. Benhamou met with Mr. Doerr to discuss their views regarding strategies for, and the potential of, the combined company and corporate governance matters.

On February 18, 2003, Judy Bruner, Senior Vice President and Chief Financial Officer of Palm, and Mr. Vadasz met with Mr. Slakey to review Handspring’s financial plan.

On February 28, 2003, Mr. Benhamou again met with Mr. Doerr. They discussed Palm’s outstanding litigation and the proposed structure order and timing of the transaction, which would include the PalmSource distribution and then the acquisition of Handspring.

On March 3, 2003, Messrs. Morali and Vadasz, along with representatives from Wilson Sonsini Goodrich & Rosati, Professional Corporation, and Hale & Dorr LLP, counsel to Palm, met with Ms. Dubinsky, David G. Pine, Vice President and General Counsel of Handspring, and representatives from Fenwick & West LLP, counsel to Handspring, to discuss the status of outstanding litigation matters for both companies.

On March 3, 2003, Messrs. Morali and Vadasz, along with representatives from Morgan Stanley and Wilson Sonsini Goodrich & Rosati, met with Ms. Dubinsky, and Messrs. Slakey and Pine, along with representatives from Fenwick & West, to discuss a possible transaction structure, timing to complete a transaction and a valuation framework. Palm presented a proposed transaction structure which comprised the distribution of the PalmSource stock held by Palm to Palm’s existing stockholders followed by the combination of the remaining Palm Solutions Group business with Handspring. Very early in the negotiations, the parties agreed that the appropriate business structure was to combine the two hardware companies, the Solutions Group and Handspring, after the PalmSource distribution. The parties agreed that, based on the businesses of Palm and Handspring being combined, Palm stockholders would have a continuing interest in both companies, while the Handspring stockholders should only have an ownership interest in the combined device company. The parties did not discuss a transaction in which Handspring stockholders would receive stock in PalmSource. Negotiations relating to the consideration to be received by Handspring stockholders in the transaction focused on two main areas: (i) the merger exchange ratio without PalmSource (i.e. the equity that Handspring stockholders would receive in the combined device company), and (ii) the allocation between the new, combined company and PalmSource following the closing of the transaction of assets, liabilities and similar items. To ensure that the negotiated consideration would not change during the pendency of the transaction, Handspring required that the transaction documents provide it a veto right over any material modification to the allocation described in item (ii) during the period between signing the merger agreement and closing of the transaction. The parties agreed to negotiate the acquisition price first as a function of the percentage ownership of the combined hardware company, with Handspring stockholders receiving shares in the new, combined company, but not PalmSource. This percentage ownership of the combined company was subsequently translated into an exchange ratio.

On March 4, 2003, Steve Manser, Senior Vice President, Product Development of Palm, and Messrs. Vadasz and Zajac met with Celeste Baranski, Vice President of Engineering of Handspring, and Mr. Colligan to discuss Handspring’s engineering organization and product development schedule for their next generation product.

On March 4, 2003, Handspring engaged Credit Suisse First Boston to act as Handspring’s financial advisor.

On March 7, 2003, the Palm board of directors held a meeting where management and its advisors provided an update regarding the discussions with Handspring. At this meeting, Mr. Morali led a discussion regarding the strategic rationale of the transaction, a proposed transaction structure, timing and key legal and financial terms of the transaction, including the pro forma impact of the transaction. The board of directors approved management’s recommendation to present proposed key terms to and conduct further due diligence on Handspring. The Palm board discussed issues relating to the separation of PalmSource, the guiding principles of the separation committee and recommendations of the separation committee. In addition, a representative of Richards, Layton & Finger, counsel to Palm, and representatives of Wilson Sonsini Goodrich & Rosati discussed with the Palm board fiduciary duty issues related to the transaction.

Index to Financial Statements

Commencing in late February and continuing through March 2003, management of Palm’s Solutions Group and PalmSource met frequently to discuss the status of various outstanding issues relating to the separation and to negotiate the remaining agreements to complete the separation of the two businesses.

On March 10, 2003, Messrs. Morali and Vadasz and representatives from Morgan Stanley met with Messrs. Colligan and Slakey, Ms. Dubinsky and representatives from Credit Suisse First Boston to discuss proposed board composition, management structure and Palm’s valuation. The parties also discussed Handspring’s stand-alone financial model and synergy assumptions.

On March 11, 2003, the Handspring board of directors met with its financial advisor to discuss the potential transaction with Palm, including timing, the strategic rationale, risks, key terms, and Palm’s preliminary views of a proposed transaction valuation. Management and the board reviewed in detail the preliminary terms proposed by Palm and approved counter-proposals to be made to Palm by management and Mr. Doerr and director Bruce W. Dunlevie.

On March 12, 2003, Michael Homer and Susan Swenson, directors of Palm, met with Messrs. Dunlevie and Doerr to discuss board composition of the combined company.

On March 17, 2003, Ms. Bruner, Messrs. Morali and Vadasz and representatives from Morgan Stanley met with Ms. Dubinsky, Mr. Slakey and representatives from Credit Suisse First Boston to discuss business model assumptions and potential synergies for the combined company.

On March 20, 2003, Mr. Bradley met with Ms. Dubinsky to further discuss the board composition of the combined company.

On March 21, 2003, Mr. Benhamou and Mr. Doerr met again for a mutual update on the progress of the negotiations and governance of the combined company. Also on the same day, Mr. Benhamou spoke with Mr. Dunlevie regarding governance of the combined company.

On March 21, 2003, Messrs. Bradley and Morali met with Mses. Dubinsky and Baranski and Messrs. Colligan, Hartnett, Hawkins, Pine and Slakey, Joseph K. Sipher, Vice President, Worldwide Marketing of Handspring, Patricia A. Tomlinson, Vice President, Human Resources of Handspring, and Gregory S. Woock, Vice President, Worldwide Sales of Handspring, to address Palm’s strategy and corporate culture, as well as exchange views on the future of the mobile computing and communications industry.

On March 23, 2003, Mr. Benhamou and Ms. Dubinsky met to discuss board composition of the combined company. Mr. Benhamou and Ms. Dubinsky communicated from time to time during the remainder of the negotiation process in April and May.

On March 24, 2003, the Handspring board of directors held a meeting where management and its financial advisors provided an update regarding the discussions with Palm concerning the potential transaction. Messrs. Dunlevie and Doerr updated the board on their discussions with Palm regarding certain key terms. The board discussed the possibility of receiving financing from Palm in connection with a potential transaction. The board also discussed stand-alone financing alternatives and determined that management should continue to pursue both options.

On March 25, 2003, Palm executed an engagement letter dated as of March 18, 2003 with Morgan Stanley under which Palm engaged Morgan Stanley to act as Palm’s financial advisor in connection with a proposed business combination involving Handspring.

On March 28, 2003, Messrs. Morali and Vadasz and representatives from Morgan Stanley and Wilson Sonsini Goodrich & Rosati, met with Ms. Dubinsky, Messrs. Pine and Slakey and representatives from Credit

Index to Financial Statements

Suisse First Boston and Fenwick & West to discuss key terms of a transaction and to organize the due diligence process. At this meeting, Palm also requested that Handspring agree to negotiate exclusively with Palm. Also at the meeting, representatives of Handspring discussed Handspring’s need for financing and requested that Palm provide interim financing to Handspring during the pendency of a business combination and extend credit in the event that the transaction was not completed.

On March 30, 2003, the Handspring board of directors held a meeting with its financial and legal advisors to discuss the potential transaction with Palm, including a potential interim financing by Palm during the pendency of the transaction and other strategic alternatives. Management and Handspring’s legal counsel updated the board regarding its discussions of the terms proposed by Palm. The board also discussed strategic alternatives to a transaction with Palm, including a potential financing from investors. The board determined that management should continue to pursue both the potential transaction with Palm and a financing from investors.

On March 31, 2003, the Handspring board of directors met again with its financial and legal advisors to further discuss the potential transaction with Palm and other strategic alternatives, including potential financing from financial and strategic investors. The board reviewed in detail the terms proposed by Palm and the request by Palm to enter into an exclusivity agreement. The board approved counter-proposals to be made to Palm by management and Handspring’s advisors. The board also discussed the status of Handspring’s recent contacts with potential financial and strategic investors, and agreed that management should continue to pursue both the transaction with Palm and a financing.

On March 31, 2003, Palm and PalmSource held an internal organizational meeting to begin the resolution of the remaining PalmSource separation issues and complete the remaining documentation relating to the separation. Separate groups were formed to address the various topics that remain unresolved with respect to the separation, and these groups met frequently in April and May 2003 to negotiate the unresolved issues under the guidance and supervision of the separation committee of the Palm board of directors.

On April 2, 2003, Ms. Swenson met with Ms. Dubinsky and Messrs. Colligan and Hawkins to discuss Handspring’s business strategy and Palm’s governance philosophy.

On April 3, 2003, Messrs. Bradley, Morali, Vadasz and Zajac, Ms. Bruner and Neil Scott, Vice President and Corporate Controller of Palm, and representatives from Morgan Stanley and Wilson Sonsini Goodrich & Rosati met with Mses. Dubinsky, Baranski and Tomlinson, John Gilmore, Director, Carrier Services and Support of Handspring, and Messrs. Hartnett, Pine, Sipher, Slakey and Woock and representatives from Credit Suisse First Boston and Fenwick & West. Each team gave an overview presentation regarding its business. In addition, Palm gave a presentation outlining the proposed terms of the separation of PalmSource.

On April 4 and 7, 2003, executives from both companies met for the purpose of Palm conducting due diligence on Handspring. In addition, beginning April 4, 2003 Handspring made confidential legal and financial due diligence materials available to Palm and its advisors, and Palm and its advisors continued their legal and financial due diligence investigation of Handspring’s business.

On April 7, 2003, based on the preliminary transaction terms discussed between the parties, Palm and Handspring executed an exclusivity agreement in which Handspring agreed to negotiate exclusively with Palm for 30 days regarding an acquisition transaction, other than with respect to certain permitted financing transactions.

Beginning on April 9, 2003, Palm made confidential legal and financial due diligence materials available to Handspring and its advisors, and Handspring and Fenwick & West continued their legal and financial due diligence investigation of Palm’s business.

On April 10, 2003, Mr. Morali, Mr. Nagel and representatives from Morgan Stanley met with representatives from Credit Suisse First Boston to discuss the PalmSource business.

Index to Financial Statements

Also on April 10, 2003, the Handspring board of directors met with its financial and legal advisors to discuss, among other things, the preliminary results for Handspring’s third fiscal quarter, the potential transaction with Palm and a potential financing from financial and strategic investors. Handspring’s financial advisors provided an update on negotiations with Palm. Handspring’s legal advisors presented preliminary due diligence findings which included a discussion of the separation of PalmSource from Palm and a review of Palm’s outstanding and potential liabilities. The board also discussed the status of Handspring’s recent contacts with potential financial and strategic investors, and agreed that management should continue to pursue both the transaction with Palm, as well as an alternative financing with outside investors.

On April 11 and 16, 2003, executives from both companies met for the purpose of Handspring conducting due diligence on Palm.

On April 16, 2003, the Palm board of directors held a meeting at which management and its advisors provided an update regarding the discussions with, and due diligence on, Handspring. Mr. Bradley provided an overview to the board of directors regarding the results of Palm’s preliminary due diligence investigation of Handspring. Mr. Colligan and Ms. Dubinsky attended a portion of the meeting and presented on their business strategy and next generation product, as well as thoughts related to the prospects of the combined company. At the conclusion of the meeting, the Palm board instructed management to conduct further due diligence related to Handspring’s carrier contracts and channel inventory.

On April 18, 2003, Messrs. Morali and Vadasz and representatives from Morgan Stanley met with Messrs. Pine and Slakey and representatives from Credit Suisse First Boston and Fenwick & West to present a non-binding term sheet to Handspring.

On April 18, 2003, the Handspring board of directors met with its financial and legal advisors to discuss the status of Handspring’s business, the potential transaction with Palm and a potential financing from investors. Management discussed the strategic rationale for the transaction. Management and Handspring’s legal advisors presented results of their business and legal due diligence to date. In addition, Handspring’s legal advisors gave a detailed presentation related to Palm’s outstanding litigation. The board reviewed in detail the terms proposed by Palm and approved counter-proposals to be made to Palm by management and Handspring’s advisors. The board concluded that management should continue to pursue both the transaction with Palm and the financing.

On April 22, 2003, representatives of Fenwick & West delivered comments to the term sheet prepared by Palm.

On April 23, 2003, Messrs. Morali and Vadasz and representatives from Morgan Stanley and Wilson Sonsini Goodrich & Rosati met with Mr. Slakey and representatives from Credit Suisse First Boston and Fenwick & West to negotiate the term sheet and the key terms of the transaction. Mr. Slakey reiterated Handspring’s request for financing from Palm.

On April 25, 2003, the Palm board of directors held a meeting at which management and its advisors provided an update related to the discussions with Handspring. At this meeting, Mr. Morali presented findings from the additional due diligence requested by Palm’s board of directors. The board of directors also discussed Handspring’s request for funding and authorized Palm’s management to explore arrangements to provide financing to Handspring.

On April 25, 2003, the Handspring board of directors met with its financial and legal advisors to discuss the potential transaction with Palm and a potential financing from investors. Handspring’s legal advisors discussed with the board its fiduciary duty obligations in the context of the potential transaction. Handspring’s legal advisors then summarized the terms of the transaction with Palm that were currently under negotiation. Handspring’s financial advisors made a detailed presentation comparing the potential economic terms of a merger with Palm against various financing scenarios. The board then approved counter-proposals to be made to

Index to Financial Statements

Palm. The board also discussed the status of Handspring’s recent contacts with potential financial and strategic investors, and agreed that management should continue to pursue both the transaction with Palm and a financing.

On May 6, 2003, Messrs. Morali and Vadasz and representatives of Morgan Stanley and Wilson Sonsini Goodrich & Rosati met with Messrs. Pine and Slakey and representatives of Credit Suisse First Boston and Fenwick & West to negotiate key terms of the transaction, including the exchange ratio for the transaction, merger agreement terms and a proposed term sheet for Palm to extend financing to Handspring in connection with a merger agreement.

From May 7 to May 14, the representatives of Palm and Handspring spoke frequently regarding the proposed terms of the business combination, including the valuation of the transaction and the terms of the financing proposed to be provided by Palm.

On May 7, 2003, the Handspring board of directors held a regularly scheduled board meeting. Handspring’s financial and legal advisors were present to discuss the potential transaction with Palm and a potential financing from investors. Handspring’s legal advisors updated the board on the status of the negotiations with Palm and management reported on the status of a potential financing. The board agreed that management should continue to pursue both the transaction with Palm and the financing alternative.

On May 9, 2003, Messrs. Benhamou and Homer and Ms. Swenson met with management and Palm’s advisors and received an update related to the discussions with Handspring, including a summary of the proposed terms of the transaction and an update on the legal and financial aspects of the transaction. Messrs. Benhamou and Homer and Ms. Swenson provided feedback on the current terms and suggestions for counter-proposals to be made to Handspring.

On May 9, 2003, Mr. Bradley met with Mr. Colligan and Ms. Dubinsky to discuss the proposed management structure of the combined company.

On May 12, 2003, a subset of the Handspring board of directors met with Mr. Bradley to discuss questions related to Palm’s strategy and plans for the combined company.

On May 14, 2003, the Palm board of directors held a meeting at which management and its advisors provided an update related to the discussions with Handspring and the separation. At this meeting, Mr. Morali led a discussion with the board regarding the key terms of the definitive merger agreement, the proposed financing arrangements and other key legal and financial matters. Mr. Morali completed the discussion on Handspring by presenting a timeline to complete the merger and key risks and contingencies related to the transaction. In addition, at the May 14 board meeting, Palm’s board of directors received updates regarding the agreements relating to the separation of PalmSource and a report on the work of the separation committee.

On May 15, 2003, the Handspring board of directors met with its financial and legal advisors to discuss the status of Handspring’s business, the potential transaction with Palm and a potential financing from investors. Management explained in detail the issues under negotiation related to the potential merger with Palm. Management and Handspring’s legal advisors also updated the board on due diligence of Palm, including pending and threatened litigation against Palm. The board discussed the terms proposed by Palm and the due diligence in detail and approved counter-proposals to be made to Palm. The board also discussed the history and status of Handspring’s recent contacts with potential investors, and agreed that management should continue to pursue both the transaction with Palm and a financing.

On May 16, 2003, Messrs. Bradley and Morali and Ms. Bruner met with Ms. Dubinsky and Mr. Slakey. At this meeting the two parties reached agreement on key terms and agreed to a process to negotiate the definitive merger agreement. Also on May 16, Messrs. Morali and Vadasz and representatives of Wilson Sonsini Goodrich & Rosati and Morgan Stanley held a telephone conference call with Messrs. Slakey and Pine and

Index to Financial Statements

representatives of Fenwick & West and Credit Suisse First Boston to discuss the process for completion of definitive agreements for the transaction.

On May 17, 2003, Palm delivered a draft definitive agreement and related documents for the transaction and draft definitive agreements for a credit line for Handspring.

On May 20 and May 21, 2003, representatives of Handspring delivered comments to the draft definitive agreements delivered by Palm.

On May 22, 2003, Messrs. Bradley and Morali met with Mr. Colligan and Ms. Dubinsky to discuss management structure, employee severance and retention strategy, post-merger integration planning and communications plans.

On May 22, 2003, the Handspring board of directors met with its legal advisors to discuss the potential transaction with Palm and a potential financing from investors. Handspring’s legal advisors reviewed in detail the terms proposed by Palm and summarized the terms still under negotiation. Management and the board also discussed the history and status of Handspring’s recent contacts with potential financial and strategic investors. The board determined that management should continue to pursue both the transaction with Palm and a financing.

On May 26, 2003, representatives of Wilson Sonsini Goodrich & Rosati and Fenwick & West met to further discuss the definitive agreements relating to the transaction.

On May 27, 2003, Mr. Vadasz and representatives of Wilson Sonsini Goodrich & Rosati and Mr. Slakey and representatives of Fenwick & West met to continue to discuss the definitive agreements relating to the transaction.

On May 28, 2003, Mr. Vadasz and Al Wood, Chief Financial Officer of PalmSource, and representatives from Morgan Stanley spoke with representatives from Credit Suisse First Boston to discuss the PalmSource business model and financial plan.

On May 28, 2003, Marianne Jackson, Senior Vice President and Chief Human Resources Officer of Palm and Mr. Morali met with Mr. Colligan and Ms. Tomlinson to discuss employment offers for members of the Handspring executive team.

On May 29, 2003, the Palm board of directors held a meeting at which management and its advisors provided an update related to the separation and the discussions with Handspring. Representatives of Wilson Sonsini Goodrich & Rosati reviewed with the board of directors their fiduciary obligations with respect to the transaction, including the separation of PalmSource, and provided the board with a detailed summary of the terms of the separation agreements approved in December 2001 and the proposed amendments to those agreements and new separation agreements. The representatives of Wilson Sonsini Goodrich & Rosati also reviewed the remaining open issues with respect to the separation agreements. The Palm board of directors reviewed the plans to distribute the PalmSource shares to Palm stockholders as part of the transaction and thereby fully separate Palm and PalmSource, including a review of the viability of each of the two companies on a stand-alone basis. Mr. Morali also reviewed with the board of directors the status of the discussions with Handspring, including due diligence items that remain unresolved, management’s communications plan and the post-merger integration planning process.

On May 29, 2003, executives and advisors from both companies held a series of telephonic meetings for the purpose of updating each other on their respective performances for the current fiscal quarter.

From May 29 through June 3, 2003, the parties met frequently to complete the definitive documentation for the transaction. During that time, Palm also presented employment offers to members of the Handspring executive team.

Index to Financial Statements

On May 30, 2003, the Handspring board of directors held a meeting with its financial and legal advisors to review the status of the merger negotiations with Palm and its pursuit of a financing from investors and to discuss adopting a stockholder rights plan. Management updated the board on its discussions with various potential investors. Then management gave a presentation on the strategic benefits and risks of the proposed combination with Palm. Management and Handspring’s legal advisors provided a detailed summary of the proposed transaction terms as well as a summary of due diligence of the business of Palm, the separation of PalmSource and risks related to Palm. Following presentations regarding the terms and operation of a stockholders rights plan, the board discussed the desirability of Handspring adopting such a plan. Following discussion, the Handspring board authorized the company’s management to continue to pursue both the transaction with Palm and a potential financing.

On June 2, 2003, the Handspring board of directors met with its financial and legal advisors to discuss the potential transaction with Palm and a potential financing from investors. Management updated the board on the status of negotiations with potential investors and noted that potential investors were reluctant to significantly improve the proposed terms of a potential financing. Management then updated the board on the status of the definitive transaction agreements related to the proposed merger with Palm and summarized the terms that still required agreement. Management also discussed the benefits of a merger, the timing of the transaction and updated the board on due diligence matters. Following discussion, the Handspring board authorized the company’s management to pursue the transaction with Palm and attempt to improve the terms of a potential financing.

From June 2 to June 4, 2003, representatives from Palm and Handspring worked to finalize the definitive agreements and employment arrangements for Handspring executives. The representatives also worked to complete communications materials, including a joint press release announcing the transaction. In addition, during late May and early June, Palm and PalmSource completed the remaining definitive agreements relating to the separation.

On June 3, 2003, the Palm board of directors held a meeting to approve the transaction. Mr. Morali led a discussion summarizing the strategic rationale of the transaction and key risks and contingencies. At this meeting, a representative of Wilson Sonsini Goodrich & Rosati and Mary E. Doyle, Palm’s Senior Vice President and General Counsel, presented an update regarding the final separation agreements and summarized the remaining open items relating to the separation. The board approved the separation agreements subject to resolution by Palm and PalmSource management of the remaining items, with resolution of any disputes delegated to Palm’s separation committee; the remaining issues were resolved by Palm and PalmSource management early the next morning. A representative of Wilson Sonsini Goodrich & Rosati provided an overview of the board of directors’ fiduciary duties and the final terms related to the transaction and the merger agreement. Representatives of Morgan Stanley reviewed their financial analyses with respect to the proposed Handspring merger, and Morgan Stanley rendered its oral opinion, subsequently confirmed in writing, to the effect that, as of June 3, 2003 and subject to and based on the assumptions and other considerations set forth in its written opinion, the exchange ratio of 0.09 pursuant to the merger agreement was fair to Palm from a financial point of view. After consideration of these presentations, the Palm board of directors discussed the reasons for the transaction. The Palm board of directors unanimously approved the transaction and the merger agreement, unanimously concluding that the transaction was in the best interests of Palm stockholders.

On June 3, 2003, the Handspring board of directors held a meeting to consider the approval of the proposed merger. During this meeting, representatives of Fenwick & West gave a detailed report on due diligence related to Palm, including certain of Palm’s pending litigation matters, and reviewed the terms of the transaction. Then representatives of Credit Suisse First Boston provided the board with a detailed financial analysis of the proposed transaction, and delivered to the board the oral opinion of Credit Suisse First Boston, subsequently confirmed in writing on June 4, 2003, that, as of that date and subject to the assumptions, considerations and limitations set forth in its opinion, the exchange ratio for shares of Palm common stock to be received by Handspring stockholders in the transaction was fair to such stockholders, other than such stockholders who were both directors and officers of Handspring or affiliates of such stockholders, from a financial point of view. Then representatives of Credit Suisse First Boston presented to the board their financial analyses for purposes of having the board set an exercise price of the rights to be issued in connection with a stockholder rights plan.

Index to Financial Statements

Following additional discussion, the board of directors of Handspring unanimously determined that the merger transaction with Palm was advisable and in the best interests of Handspring’s stockholders and approved the merger and related matters, and the adoption of a stockholder rights plan.

On June 4, 2003, Palm and Handspring entered into the merger agreement and a joint press release announcing the transaction was issued prior to the opening of the Nasdaq National Market.

As the transaction with Handspring was negotiated on the basis of a combination of Handspring with the Palm Solutions Group business, but not PalmSource, and due to timing and execution complexities of launching the two new companies, Palm and Handspring determined to effect the business combination, with the agreed ownership percentages and allocation of other economics, at a single point in time. In order to optimize the tax, accounting and economics of the transaction, and to minimize the complexity and execution risk, the legal structure agreed to effect the business combination is comprised of two component parts—a merger of a subsidiary of Palm and Handspring (in which Handspring shares are converted into Palm shares), immediately preceded by a merger of Palm with another subsidiary (which is the mechanism to insulate from Handspring stockholders any equity interest in PalmSource).

The board of directors of Palm has determined that the separation of PalmSource from Palm’s Solutions Group and the PalmSource distribution is advisable and in the best interests of Palm and its stockholders. In making its determination to approve the PalmSource distribution, the board of directors of Palm identified several reasons for, and potential benefits to Palm stockholders of, the separation of Palm’s device business from its Palm OS business, and the creation of two independent public companies. Palm believes these potential benefits include:

Palm and PalmSource believe that, despite PalmSource’s success in licensing Palm OS to multiple device manufacturers, a market perception that Palm’s device business competes with PalmSource’s current or prospective Palm OS licensees has limited PalmSource’s ability to attract new licensees. Each company believes that the separation will address the perceived conflict of interest between Palm and PalmSource and expand the licensing opportunities available to PalmSource.

As an independent publicly traded company, we believe PalmSource will be more focused on advancing the Palm OS in order to attract and maintain licensees. We believe this will lead to a more competitive Palm OS, which will allow both Palm and PalmSource to be more successful in the marketplace.

Palm and PalmSource believe that they will be able to make decisions more quickly and assign resources more rapidly and efficiently than they could as a part of a more complex organization with many different strategic initiatives. As a result, each company believes that they will be better positioned as a stand-alone company to accelerate the development of their respective businesses than they would be as part of a combined organization.

The separation will allow Palm and PalmSource to have their own board of directors, management team, sales force and other employees focused specifically on their respective businesses and strategic

Index to Financial Statements

opportunities. Each company will have greater ability to modify its business processes and organization to better fit the needs of its business, customers and employees. Each company will also be able to implement a marketing strategy that focuses on its business. Finally, competition for management time, group resources and capital that may currently exist between PalmSource’s operating system business and Palm’s device business will be eliminated.

Palm and PalmSource expect the motivation of their employees and the focus of their management teams will be strengthened by incentive compensation programs tied to the market performance of Palm’s and PalmSource’s common stock and linked to the performance of their respective businesses. Each company also expects that their ability to attract and retain qualified personnel will be enhanced.

As separate companies, Palm and PalmSource will have direct access to the capital markets to fund operations and acquire businesses, key products and technologies. Each company believes that, as separate companies, their respective businesses will be better positioned to be more easily understood and valued by investors and securities analysts.

In addition, the Palm board of directors viewed the opportunity to complete the PalmSource distribution together at the same time with the Handspring merger as a means of creating two leadership companies each with a strong focus on its core business and opportunities for growth.

We believe the complementary strengths of Palm’s Solutions Group business and Handspring will combine to create the broadest portfolio and the most experienced leadership team in the handheld computing and communications solutions industry. The decision of the boards of directors of Palm and Handspring to combine was based on this combined leadership and several additional potential benefits of the Handspring merger that they believe will contribute to the future success of the combined company and to the value received by its customers, partners and stockholders. These potential benefits include:

We expect that the combined company will have greater revenue opportunities. With our combined assets and resources, we believe that we can better pursue the emerging growth opportunity associated with the smartphone segment. We also expect to obtain improved operating efficiencies of approximately $25 million of cost savings annually. The cost savings assume combined employee reductions of approximately 125 people, elimination of overlapping programs and unnecessary real estate, and the advantages of increased volume in manufacturing and distribution.

With the addition of Handspring’s line of Treo smartphones the products of the combined company will span core handhelds to wireless data and voice-centric solutions. This will allow the combined company to address the major segments of the handheld computing and communications solutions industry.

Palm’s strength in the traditional personal digital assistant, or PDA, space has enabled it to develop a strong brand and retail distribution presence. The combined company will take advantage of these assets to the benefit of the emerging wireless handheld and smartphone segments.

Index to Financial Statements

The Handspring merger will add three members to the board of directors of Palm from the current Handspring board of directors: L. John Doerr, Bruce W. Dunlevie and Donna L. Dubinsky. In addition, Edward T. Colligan, currently President and Chief Operating Officer of Handspring, will become Senior Vice President, General Manager, Wireless Business Unit of the combined company, Jeffrey C. Hawkins, Handspring’s current Chairman and Chief Product Officer, will become the Chief Technology Officer of the combined company and will serve in this capacity on a part-time basis as he did in his capacity as Chief Product Officer of Handspring, and Patricia A. Tomlinson, Handspring’s Vice President, Human Resources, will become Senior Vice President, Chief Human Resources Officer of the combined company. Ms. Dubinsky and Messrs. Hawkins and Colligan each played a critical role in the early success of Palm and, as a result, the creation and development of the handheld industry. Messrs. Doerr and Dunlevie are each successful venture investors with extensive experience in the handheld industry and corporate governance.

The boards of directors and management teams of Palm and Handspring have each considered a number of alternatives for enhancing their competitive position and stockholder value and believe the combination of Palm and Handspring offers the best alternative to form a stronger market leader in mobile computing and communications.

We believe our competitive position, financial strength and innovative product offerings are all improved by this transaction. For these reasons, we believe the transaction will allow us to grow, to meet competitive challenges ahead and to deliver value to our stockholders, customers and employees.

Consideration of the Transaction by, and Recommendation of, the Board of Directors of Palm

The board of directors of Palm has determined that the transaction is advisable, and is fair to and in the best interests of Palm and its stockholders. In making its determination to approve the PalmSource distribution and Handspring merger, the board of directors of Palm consulted with Palm’s management, Palm’s legal counsel regarding the legal terms of the PalmSource distribution and Handspring merger, and Palm’s financial advisors regarding the financial aspects of the PalmSource distribution and the Handspring merger and fairness, from a financial point of view, of the Handspring merger exchange ratio to Palm. The factors that the board of directors of Palm considered in reaching its determination include, but were not limited to, the following:

Index to Financial Statements

In addition, the board of directors of Palm also identified and considered a variety of potentially negative factors in its deliberations concerning the transaction, including, but not limited to:

Index to Financial Statements

The board of directors of Palm concluded, however, that these negative factors could be managed or mitigated by Palm or by the combined company or were unlikely to have a material impact on the transaction or the combined company, and that, overall, the potentially negative factors associated with the transaction were outweighed by the potential benefits of the transaction.

The above discussion of the material factors considered by the board of directors of Palm is not intended to be exhaustive, but does set forth the principal factors considered by the board of directors of Palm. The board of directors collectively reached the unanimous conclusion to approve the merger agreement and the transaction in light of the various factors described above and other factors that each member of the board of directors felt were appropriate. In view of the wide variety of factors considered by the board of directors in connection with its evaluation of the transaction and the complexity of these matters, the board of directors did not consider it practical, and did not attempt, to quantify, rank or otherwise assign relative weights to the specific factors it considered in reaching its decision. Rather, the board of directors made its recommendation based on the totality of information presented to and the investigation conducted by it. In considering the factors discussed above, individual directors may have given different weights to different factors.

The Palm board of directors unanimously recommends that Palm stockholders vote “FOR” approval and adoption of the merger agreement.

Under an engagement letter dated as of March 18, 2003, Palm retained Morgan Stanley to provide it with financial advisory services and a financial opinion letter in connection with the Handspring merger. At the meeting of Palm’s board of directors on June 3, 2003, Morgan Stanley rendered its oral opinion, subsequently confirmed in writing, to the effect that, as of June 3, 2003 and subject to and based upon the assumptions and other considerations set forth in its written opinion, the exchange ratio of 0.09 pursuant to the merger agreement was fair to Palm from a financial point of view.

The full text of the written opinion of Morgan Stanley, dated as of June 3, 2003, is attached as Annex C to this joint proxy statement/prospectus. The opinion sets forth, among other things, the assumptions made, procedures followed, matters considered and limitations on the scope of the review undertaken by Morgan Stanley in rendering its opinion. Palm recommends that you read the entire opinion carefully. Morgan Stanley’s opinion is directed to Palm’s board of directors and addresses only the fairness, from a financial point of view, of the exchange ratio pursuant to the merger agreement to Palm as of the date of the opinion. It does not address any other aspects of the Handspring merger and does not constitute a recommendation to any holder of Palm common stock as to how such stockholder should vote with respect to the Handspring merger or any matter. The summary of the opinion of Morgan Stanley set forth in this document is qualified in its entirety by reference to the full text of the opinion.

Index to Financial Statements

Morgan Stanley assumed and relied upon, without independent verification, the accuracy and completeness of the information reviewed by it for the purposes of its opinion. With respect to the internal financial statements, other financial and operating data, and financial projections, including certain projections and information relating to the strategic, financial and operational costs and benefits anticipated from the Handspring merger, Morgan Stanley assumed that they were reasonably prepared on bases reflecting the best currently available estimates and judgments of the future financial performance of Palm and Handspring, respectively. In addition, Morgan Stanley assumed that the Handspring merger and the merger of Palm and Palm Separation Corporation which implements the PalmSource distribution, will be consummated in accordance with the terms set forth in the merger agreement without material modification or waiver, including among other things, that the Handspring merger and the PalmSource distribution will be treated as a tax-free reorganization and distribution, each pursuant to the Internal Revenue Code.

Morgan Stanley relied upon the assessment by the managements of Palm and Handspring of their ability to retain key employees of Palm and Handspring, respectively. Morgan Stanley also relied upon, without independent verification, the assessment by the managements of Palm and Handspring of: (i) the strategic, financial and other costs and benefits expected to result from the Handspring merger; (ii) the timing and risks associated with the integration of Palm and Handspring; and (iii) the validity of, and risks associated with, Palm’s and Handspring’s existing and future technologies, services or business models. Morgan Stanley has not made any independent valuation or appraisal of the assets or liabilities or technology of Palm and Handspring, nor has it been furnished with any such appraisals.

Morgan Stanley’s opinion was necessarily based on financial, economic, market and other conditions as in effect on, and the information made available to Morgan Stanley as of, June 3, 2003.

Morgan Stanley was not asked to consider, and Morgan Stanley’s opinion does not address, the relative merits of the Handspring merger as compared to any alternative strategies or transactions that might exist for Palm or the effect of such strategies or transactions, whether or not such strategies or transactions may be available.

Index to Financial Statements

Morgan Stanley’s opinion did not in any manner address the prices at which the Palm common stock or the PalmSource common stock will actually trade following the consummation of the Handspring merger or the PalmSource distribution. Morgan Stanley expressed no opinion or recommendation as to how the stockholders of Palm should vote at the stockholders’ meeting to be held in connection with the Handspring merger. In addition, Morgan Stanley expressed no opinion as to the terms of the loan agreement.

The following is a brief summary of the material analyses performed by Morgan Stanley in connection with its oral opinion and the preparation of its written opinion, which represent all of the material analyses considered by Morgan Stanley in arriving at its opinion. Some of these summaries of financial analyses include information presented in tabular format. In order to fully understand the financial analyses used by Morgan Stanley, the tables must be read together with the text of each summary. The tables alone do not constitute a complete description of the financial analyses.

Trading Range Analysis. Morgan Stanley reviewed the range of closing prices of Handspring common stock for various periods ending on June 2, 2003, the last full trading day prior to the meeting of Palm’s board of directors to consider and approve the Handspring merger and two days prior to the public announcement of the Handspring merger. Morgan Stanley observed the following:

Morgan Stanley noted that the closing price of Handspring common stock price increased from $0.88 to $1.22 from May 29, 2003 through June 2, 2003.

Based on Palm’s market capitalization as of June 2, 2003 of $349 million, illustrative values of PalmSource of $50 million and $100 million, and the exchange ratio of 0.09 pursuant to the merger agreement, Morgan Stanley noted that the per share values of Handspring common stock implied by the Handspring merger ranged from $0.77 to $0.93.

Comparable Company Trading Analysis. Morgan Stanley compared certain publicly available financial information of Handspring with publicly available information for Palm and the following companies:

Morgan Stanley then analyzed the ratio of aggregate value, defined as market capitalization plus total debt less cash and cash equivalents, for each of these companies to estimated calendar year 2004 revenues (based on publicly available equity research analyst estimates). This analysis showed the following:

Index to Financial Statements

Based on Handspring’s market capitalization as of June 2, 2003 of $191 million, Palm management’s view of Handspring’s estimated calendar year 2004 revenues of $189 million and $53 million of cash and cash equivalents (as of March 31, 2003), Morgan Stanley noted that Handspring common stock was trading at 0.7 times estimated calendar year 2004 revenues. Based upon this analysis and estimated calendar year 2004 revenues noted above, and a reference range of aggregate value to estimated 2004 revenue of 0.2x to 1.0x, the implied per share value of Handspring common stock ranged from $0.59 to $1.50. Based on Palm’s market capitalization as of June 2, 2003 of $349 million, illustrative values of PalmSource of $50 million and $100 million, and the exchange ratio of 0.09 pursuant to the merger agreement, Morgan Stanley noted that the per share values of Handspring common stock implied by the Handspring merger ranged from $0.77 to $0.93.

No company utilized in the comparable company analysis is identical to Handspring. In evaluating the comparable companies, Morgan Stanley made judgments and assumptions with regard to industry performance, general business, economic, market and financial conditions and other matters, many of which are beyond the control of Handspring. Mathematical analysis, such as determining the average or median, is not in itself a meaningful method of using comparable company data.

Discounted Cash Flow Analysis. Morgan Stanley calculated a range of equity values per share for Handspring based on a discounted cash flow analysis. Morgan Stanley relied on projections provided by Palm management for fiscal years 2004 through 2006 and extrapolations of those projections for fiscal years 2007 and 2008 reviewed by Palm management. In arriving at the estimated equity values per share of Handspring common stock, Morgan Stanley calculated a terminal value as of May 31, 2008 by applying a range of perpetual growth rates ranging from 4% to 6%. The unlevered free cash flows from fiscal year 2004 through 2008 and the terminal value were then discounted to present values using a range of discount rates of 12% to 18%. Using this methodology, including estimated net cash as of September 30, 2003, the estimated equity value and equity value per share of Handspring common stock ranged from $95 million to $283 million or $0.62 to $1.74 per share. Based on Palm’s market capitalization as of June 2, 2003 of $349 million, illustrative values of PalmSource of $50 million and $100 million, and the exchange ratio of 0.09 pursuant to the merger agreement, Morgan Stanley noted that the per share values of Handspring common stock implied by the Handspring merger ranged from $0.77 to $0.93.

Historical Relative Trading Analysis. Morgan Stanley reviewed the ratios of the closing prices of Handspring common stock divided by the corresponding closing prices of Palm common shares over various periods ending June 2, 2003, which are referred to as the average exchange ratios. For purposes of this analysis, the closing prices of Palm common stock were adjusted by subtracting illustrative values of PalmSource of $50 million and $100 million.

Index to Financial Statements

Morgan Stanley examined the premiums/discounts represented by the exchange ratio of 0.09 pursuant to the merger agreement over the averages of these period average exchange ratios, and found them to be as follows:

Morgan Stanley noted that the exchange ratio pursuant to the merger agreement of 0.09 represented an implied premium or discount to the average exchange ratio based upon the time period examined and the illustrative value of PalmSource considered in this analysis.

Relative Contribution Analysis. Morgan Stanley compared Palm (excluding PalmSource) and Handspring stockholders’ respective percentage ownership of the combined company to Palm’s and Handspring’s respective percentage contribution (and the implied ownership based on such contribution) to the combined company using revenues, gross profit and net cash, based on estimates provided by Palm management for both Palm and Handspring. This analysis showed the following:

Index to Financial Statements

upon relative revenue, gross profit and net cash contributed to the combined company by Handspring for the years considered in this analysis.

Morgan Stanley also compared Palm on a stand-alone basis (excluding PalmSource) to the incremental contribution, including synergies, that were projected to accrue to the combined company as a result of the Handspring merger. This analysis attributed to Handspring stockholders implied ownership based on the incremental contribution, including synergies, to the combined company based upon revenues, gross profit and operating profit. This analysis used estimates for fiscal years 2004 through 2006 provided by Palm management and extrapolations of those estimates for fiscal years 2007 and 2008 reviewed by Palm management for Palm, Handspring and the combined company, including anticipated synergies expected to result from the Handspring merger. This analysis showed the following:

Morgan Stanley noted that the implied pro forma ownership of the combined company by Handspring stockholders was approximately 32.2% based on the exchange ratio pursuant to the merger agreement of 0.09, which percentage ownership was greater than the implied pro forma ownership of the combined company based upon relative revenue and gross profit, and less than the implied pro forma ownership of the combined company based upon relative operating income, in each case contributed to the combined company by Handspring for the years considered in this analysis.

Analysis of Stock Price Premiums Paid. Morgan Stanley compared publicly available statistics for 52 selected transactions announced between January 1, 2002 and June 2, 2003 involving public companies in the technology industry where the acquiror and/or target was domiciled in the United States and in which transaction values were greater than or equal to $100 million. Of these transactions, there were 27 in which the consideration paid consisted solely of stock.

For each of these stock transactions, Morgan Stanley analyzed the premiums to the one-day historical exchange ratio and the 30-day average historical exchange ratio prior to the announcement of each of the transactions. Morgan Stanley then applied the results from this analysis to the relevant financial statistic for Handspring. For purposes of this analysis, the closing prices of Palm common stock were adjusted by subtracting illustrative values of PalmSource of $50 million and $100 million.

Index to Financial Statements

Morgan Stanley noted that the exchange ratio pursuant to the merger agreement of 0.09 represented a discount to the implied exchange ratios based upon the precedent statistics considered in this analysis.

No company or transaction utilized in the analysis of stock price premiums paid is identical to Palm or Handspring or the Handspring merger. In evaluating the precedent acquisition transactions, Morgan Stanley made judgments and assumptions with regard to general business, market and financial conditions and other matters, which are beyond the control of Palm and Handspring which could affect the public trading value of the companies and the aggregate value of the transactions to which they are being compared.

Relative Discounted Cash Flow Analysis. Morgan Stanley calculated a range of equity values per share for Palm (excluding PalmSource) based on a discounted cash flow, or DCF, analysis. Morgan Stanley relied on projections provided by Palm management for fiscal years 2004 through 2006 and extrapolations of those projections for fiscal years 2007 and 2008 reviewed by Palm management. In arriving at the estimated values per share of Palm common stock, Morgan Stanley calculated a terminal value as of May 31, 2008 by applying a range of perpetual growth rates ranging from 2% to 4%. The unlevered free cash flows from fiscal year 2004 through 2008 and the terminal value were then discounted to present values using a range of discount rates of 11% to 15%. Using this methodology, and including estimated net cash as of September 30, 2003, the estimated equity value of Palm common stock ranged from $338 million to $517 million.

Morgan Stanley then calculated a range of relative DCF exchange ratios by dividing the range of Handspring equity values by the Palm equity values (excluding PalmSource), in each case as summarized above. This analysis implied a range of exchange ratios of 0.034 to 0.155, compared to the exchange ratio pursuant to the merger agreement of 0.09.

Morgan Stanley also calculated a range of equity values for the combined company based on a DCF analysis taking into account assumptions for the combined company made by Palm management as noted above. Morgan Stanley then compared these equity values for the combined company to the Palm equity values summarized above to calculate the incremental equity value resulting from the Handspring merger.

Morgan Stanley then calculated a range of relative DCF exchange ratios by dividing these incremental equity values, by the Palm equity values (excluding PalmSource) plus the incremental equity values, estimated in each case as described above. This analysis resulted in a range of exchange ratios of 0.079 to 0.243, compared to the exchange ratio pursuant to the merger agreement of 0.09.

In connection with the review of the Handspring merger by Palm’s board of directors, Morgan Stanley performed a variety of financial and comparative analyses for purposes of rendering its opinion. The preparation of a fairness opinion is a complex process and is not necessarily susceptible to a partial analysis or summary description. In arriving at its opinion, Morgan Stanley considered the results of all of its analyses as a whole and did not attribute any particular weight to any analysis or factor it considered. Morgan Stanley believes that selecting any portion of its analyses, without considering all analyses as a whole, would create an incomplete view of the process underlying its analyses and opinion. Morgan Stanley did not reach any particular conclusion as to whether or not any particular analysis supported its fairness determination. In addition, Morgan Stanley may have given various analyses and factors more or less weight than other analyses and factors, and may have deemed various assumptions more or less probable than other assumptions. As a result, the ranges of valuations resulting from any particular analysis described above should not be taken to be Morgan Stanley’s view of the actual value of Palm or Handspring. In performing its analyses, Morgan Stanley made numerous assumptions

Index to Financial Statements

with respect to industry performance, general business and economic conditions and other matters. Many of these assumptions are beyond the control of Palm or Handspring. Any estimates contained in Morgan Stanley’s analyses are not necessarily indicative of future results or actual values, which may be significantly more or less favorable than those suggested by such estimates.

Morgan Stanley conducted the analyses described above solely as part of its analysis of the fairness of the exchange ratio pursuant to the merger agreement from a financial point of view to Palm and in connection with the delivery of its opinion to Palm’s board of directors. These analyses do not purport to be appraisals or to reflect the prices at which shares of common stock of Palm or Handspring might actually trade.

The exchange ratio pursuant to the merger agreement was determined through arm’s-length negotiations between Palm and Handspring and was approved by Palm’s board of directors. Morgan Stanley provided advice to Palm during these negotiations. Morgan Stanley did not however, recommend any specific exchange ratio to Palm or that any specific exchange ratio constituted the only appropriate exchange ratio for the Handspring merger.

In addition, as described elsewhere in this document, Morgan Stanley’s opinion and its presentation to Palm’s board of directors was one of many factors taken into consideration by Palm’s board of directors in deciding to approve the Handspring merger. Consequently, the analyses as described above should not be viewed as determinative of the opinion of Palm’s board of directors.

Palm’s board of directors retained Morgan Stanley based upon Morgan Stanley’s qualifications, experience and expertise. Morgan Stanley is an internationally recognized investment banking and advisory firm. Morgan Stanley, as part of its investment banking and financial advisory business, is continuously engaged in the valuation of businesses and securities in connection with mergers and acquisitions, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and valuations for corporate, estate and other purposes. In the ordinary course of Morgan Stanley’s trading and brokerage activities, Morgan Stanley or its affiliates may at any time hold long or short positions, may trade or otherwise effect transactions, for its own account or for the account of customers in the equity and other securities of Palm and Handspring. In addition, in the past Morgan Stanley has provided financial advice and financing services to Palm and has received fees in connection with such services, including financial advisory services in connection with Palm’s separation of PalmSource.

Under the engagement letter, Morgan Stanley provided financial advisory services in connection with the Handspring merger, and Palm agreed to pay Morgan Stanley a fee for its services based on the transaction value of the Handspring merger. The fee for the Handspring merger will be $2.5 million, of which $1 million was paid upon announcement of the Handspring merger and $1.5 million will become payable upon consummation of the Handspring merger. Palm has also agreed to reimburse Morgan Stanley for its expenses incurred in performing its services. In addition, Palm has agreed to indemnify Morgan Stanley and its affiliates, their respective directors, officers, agents and employees and each person, if any, controlling Morgan Stanley or any of its affiliates against certain liabilities and expenses, including certain liabilities under the federal securities laws, related to or arising out of Morgan Stanley’s engagement. Palm has also agreed to pay Morgan Stanley a separate fee for its services in connection with Palm’s separation of PalmSource. The fee for Palm’s separation of PalmSource will be $2.5 million, of which $250,000 has been paid and $2.25 million will become payable upon consummation of the PalmSource distribution. Palm will also pay Morgan Stanley an additional fee of 0.4% of PalmSource’s market value post-distribution (based upon a five-day average).

Consideration of the Handspring Merger by, and Recommendation of, the Handspring Board of Directors

The Handspring board of directors has determined that the terms of the merger agreement and the Handspring merger are advisable, fair to, and in the best interests of, Handspring and its stockholders. In reaching its unanimous decision to approve the merger agreement and the Handspring merger, the Handspring board of directors consulted Handspring’s management, financial advisors and legal counsel, and identified and

Index to Financial Statements

considered many factors which, when taken as a whole, supported its decision. The Handspring board of directors considered the following material information and factors in reaching its determination to approve the merger agreement and the Handspring merger:

Index to Financial Statements

In reaching its decision to approve the merger agreement and the Handspring merger and to recommend approval and adoption of the merger agreement and approval of the Handspring merger to Handspring’s stockholders, Handspring’s board of directors also considered a number of potentially negative factors concerning the Handspring merger. These factors included the following:

In addition, Handspring’s board of directors considered the interests that its officers and directors may have with respect to the Handspring merger in addition to their interests as Handspring stockholders. See “—Interests of Certain Persons in the Merger” on page 91 for a more complete discussion of these interests.

After due consideration, the Handspring board of directors concluded that the potential benefits of the proposed Handspring merger outweighed the risks associated with the Handspring merger.

The foregoing information and factors considered by Handspring’s board of directors are not intended to be exhaustive but are believed to include all of the material factors considered by Handspring’s board. In view of the variety of factors and the amount of information considered, Handspring’s board of directors did not find it practicable to, and did not, quantify, rank or otherwise assign relative weights to the specific factors it considered in approving the merger agreement and the Handspring merger. In addition, individual members of Handspring’s board of directors may have given different weights to different factors. The Handspring board considered all of these factors as a whole, and overall considered them to be favorable to and to support its determination.

The Handspring board of directors unanimously recommends that Handspring stockholders vote “For” approval and adoption of the merger agreement.

Index to Financial Statements

Handspring retained Credit Suisse First Boston to act as its exclusive financial advisor in connection with the Handspring merger. In connection with Credit Suisse First Boston’s engagement, Handspring requested that Credit Suisse First Boston evaluate the fairness, from a financial point of view, of the exchange ratio to holders of Handspring common stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders. On June 3, 2003, the Handspring board of directors met to review the proposed Handspring merger and the terms of the merger agreement. During this meeting, Credit Suisse First Boston reviewed with the Handspring board of directors certain financial analyses, as described below, and rendered its oral opinion to the Handspring board of directors, subsequently confirmed in writing as of June 4, 2003, that, as of such date and based upon and subject to the various considerations set forth in the Credit Suisse First Boston opinion, the exchange ratio was fair, from a financial point of view, to holders of Handspring common stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders.

The full text of the Credit Suisse First Boston opinion, which sets forth, among other things, assumptions made, procedures followed, matters considered and limitations on the scope of the review undertaken by Credit Suisse First Boston in rendering its opinion, is attached as Annex D to this joint proxy statement/prospectus and is incorporated by reference in its entirety. Handspring stockholders are urged to, and should, read the Credit Suisse First Boston opinion carefully and in its entirety. The Credit Suisse First Boston opinion addresses only the fairness, from a financial point of view, of the exchange ratio to holders of Handspring common stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders, as of the date of the Credit Suisse First Boston opinion, and does not constitute a recommendation to any stockholder as to how such stockholder should vote or act on any matter relating to the Handspring merger. The summary of the Credit Suisse First Boston opinion in this joint proxy statement/prospectus is qualified in its entirety by reference to the full text of the Credit Suisse First Boston opinion.

In connection with its review, Credit Suisse First Boston did not assume any responsibility for independent verification of any of the foregoing information and relied on such information being complete and accurate in all material respects. With respect to the financial forecasts for Handspring that Credit Suisse First Boston reviewed, Credit Suisse First Boston was advised, and it assumed, that such forecasts were reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Handspring as to the future financial performance of Handspring. With respect to the financial forecasts for Palm and PalmSource (each after taking into account the PalmSource distribution) that Credit Suisse First Boston reviewed, Credit

Index to Financial Statements

Suisse First Boston was advised, and it assumed, that such forecasts were reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Palm as to the future financial performance of Palm and PalmSource, respectively. In addition, Credit Suisse First Boston relied upon, without independent verification, the assessment of the managements of Handspring and Palm as to:

Handspring also informed Credit Suisse First Boston, and Credit Suisse First Boston assumed, that the Handspring merger and the PalmSource distribution will be treated as a tax-free reorganization and tax-free spin-off, respectively, for federal income tax purposes. Credit Suisse First Boston also assumed, with Handspring’s consent, that in the course of obtaining necessary regulatory and third party approvals and consents for the Handspring merger and the PalmSource distribution, no modification, delay, limitation, restriction or condition will be imposed that will have a material adverse effect on Handspring or Palm or the contemplated benefits of the Handspring merger and the PalmSource distribution, that the Handspring merger and the PalmSource distribution will be consummated in accordance with the terms of the merger agreement without waiver, modification or amendment of any material terms, conditions or agreements contained in the merger agreement and that the PalmSource distribution and the separation of Palm and PalmSource will occur in the manner described to Credit Suisse First Boston by the management of Palm. Credit Suisse First Boston was not requested to make, and did not make, an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of Handspring, Palm or PalmSource, nor was Credit Suisse First Boston furnished with any such evaluations or appraisals. The Credit Suisse First Boston opinion is necessarily based upon information available to it as of the date of its opinion, and upon financial, economic, market and other conditions as they existed and could be evaluated on the date of the Credit Suisse First Boston opinion. Credit Suisse First Boston did not express any opinion as to what the value of Palm common stock actually will be when issued to holders of Handspring common stock pursuant to the Handspring merger or the prices at which shares of Palm common stock will trade at any time. The Credit Suisse First Boston opinion does not address the relative merits of the Handspring merger as compared to other business strategies that might be available to Handspring, nor does it address the underlying business decision of Handspring to proceed with the Handspring merger. Credit Suisse First Boston was not requested to, and did not, solicit third party indications of interest in acquiring all or any part of Handspring.

Credit Suisse First Boston did not express any opinion as to any legal matters involving Palm, as to which Credit Suisse First Boston understands that Handspring conducted such investigations, and obtained such advice from qualified professionals, as Handspring deemed necessary. With respect to outstanding litigation involving Palm in which significant damages are alleged, the board of directors of Handspring, after consultation with management of Handspring and its outside counsel, instructed Credit Suisse First Boston to assume, and Credit Suisse First Boston did assume, without independent verification and based solely upon the assessment and judgment of management of Handspring after taking into account the advice of Handspring’s outside counsel, (i) that the aggregate amount of damages, if any, that could be assessed against or agreed to by Palm in any pending litigation will not exceed the amount estimated by management of Handspring, and (ii) that no such pending litigation involving Palm will otherwise have an adverse impact on the current or future results of operations of Palm.

In preparing its opinion, Credit Suisse First Boston performed a variety of financial and comparative analyses. The preparation of a fairness opinion is a complex process and is not necessarily susceptible to partial

Index to Financial Statements

analysis or summary description. Credit Suisse First Boston’s opinion was based on all of the analysis performed by it and all of the factors that it considered, taken as a whole. Therefore, Credit Suisse First Boston believes that its analyses must be considered as a whole and that selecting portions of its analyses and of the factors considered by it, without considering all analyses and factors, could create a misleading view of the processes underlying the Credit Suisse First Boston opinion. Credit Suisse First Boston did not reach any particular conclusion as to whether or not any particular analysis supported Credit Suisse First Boston’s fairness determination. No company or transaction used in the analysis performed by Credit Suisse First Boston as a comparison is identical to Handspring, Palm or the contemplated Handspring merger. In addition, Credit Suisse First Boston may have given various analyses more or less weight than other analyses, and may have deemed various assumptions more or less probable than other assumptions, so that the range of valuation resulting from any particular analysis described below should not be taken to be Credit Suisse First Boston’s view of the actual value of Handspring or Palm. The analyses performed by Credit Suisse First Boston are not necessarily indicative of actual values or actual future results, which may be significantly more or less favorable than suggested by such analyses. In addition, analyses relating to the value of businesses or assets do not purport to be appraisals or to necessarily reflect the prices at which businesses or assets may actually be sold. The analyses performed were prepared solely as part of Credit Suisse First Boston’s analysis of the fairness, from a financial point of view, of the exchange ratio to holders of Handspring common stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders, and were provided to the board of directors of Handspring in connection with the delivery of the Credit Suisse First Boston opinion.

The following is a summary of material financial analyses performed by Credit Suisse First Boston in connection with the preparation of its opinion, and reviewed with the Handspring board of directors at a meeting of the Handspring board of directors held on June 3, 2003. Certain of the following summaries of financial analyses that were performed by Credit Suisse First Boston include information presented in tabular format. In order to understand fully the material financial analyses that were performed by Credit Suisse First Boston, the tables should be read together with the text of each summary. The tables alone do not constitute a complete description of the material financial analyses.

Where relevant, the analyses performed by Credit Suisse First Boston assumed that the aggregate amount of damages that would be assessed against or agreed to by Palm in any pending litigation involving Palm would be $60 million. The Handspring board instructed Credit Suisse First Boston to assume, for purposes of its analyses, that the potential damages that could be assessed against or agreed to by Palm in any pending litigation involving Palm could range from $0 to $60 million and Credit Suisse First Boston, without expressing any view on the litigation, assumed $60 million as the most conservative case within this range. The analyses also assumed that no such pending litigation involving Palm would otherwise have an adverse impact on the current or future results of operations of Palm. In addition, where relevant, the analyses performed by Credit Suisse First Boston assumed (i) that the value of land held by Palm is $60 million and (ii) except where otherwise indicated, that the hypothetical value of Palm after the PalmSource distribution would be $50 million lower than prior to the PalmSource distribution.

Illustrative Transaction Economics. Based on assumptions that the hypothetical value of Palm after the PalmSource distribution would be lower than prior to the PalmSource distribution by $25 million, $50 million and $75 million, Credit Suisse First Boston calculated several values implied by the merger exchange ratio of 0.09, including the premium/(discount) of the merger exchange ratio to several historical average ratios of Handspring’s closing share price to Palm’s hypothetical closing share price (after giving effect to the PalmSource distribution) for periods prior to June 2, 2003, which are referred to as the average exchange ratios, the implied price per Handspring share, the implied Handspring fully-diluted equity value (using the treasury method) and aggregate value (defined as the equity value plus total debt less cash and cash equivalents), the implied ratios of the Handspring aggregate value to estimated Handspring revenues for calendar years 2003 and 2004 (based on Handspring management estimates and publicly available estimates of securities research analysts), and the implied pro forma fully-diluted ownership (using the treasury method) of Handspring stockholders in Palm. The treasury method takes into account all shares underlying vested or unvested in-the-money options and warrants in defining the number of fully-diluted shares outstanding and assumes that the proceeds from the exercise of such

Index to Financial Statements

options and warrants are used to repurchase shares outstanding and assumes that the proceeds from the exercise of such options and warrants are used to repurchase shares of stock with such repurchased shares treated as treasury shares. The following table summarizes the results of this analysis:

Valuation Analyses—Palm and Palm after giving effect to the PalmSource Distribution

Palm Historical Stock Trading Performance. Credit Suisse First Boston analyzed the prices at which Palm common stock traded from June 3, 2002 through June 2, 2003. Credit Suisse First Boston noted that the high closing price of Palm common stock during this period was $35.20 on June 28, 2002, and that the low closing price of Palm common stock was $9.08 on April 11, 2003. Credit Suisse First Boston also noted the average closing price of Palm common stock over various periods ended June 2, 2003, as summarized below:

Comparable Company Analysis. Credit Suisse First Boston compared selected financial and trading data of Palm with similar data for selected publicly traded companies engaged in businesses that Credit Suisse First Boston judged to be reasonably comparable to those of Palm. These companies were:

Index to Financial Statements

Credit Suisse First Boston compared the fully-diluted aggregate value (defined as equity value plus total debt less cash and cash equivalents) of Palm of $351 million as of June 2, 2003 as a multiple of estimated revenues of Palm for calendar years 2003 and 2004, and the multiple of the Palm equity price per share of $12.01 as of June 2, 2003, to estimated earnings per share for Palm for calendar years 2003 and 2004 (in each case based on Palm management estimates and publicly available estimates of securities research analysts), to similar values for the comparable companies, using publicly available estimates of securities research analysts for the comparable companies, and closing share prices on June 2, 2003. This analysis allowed Credit Suisse First Boston to compare whether the fully-diluted aggregate value and price per share of Palm were greater or lesser than those of the selected publicly traded companies, when calculated as a multiple of future revenues and earnings per share, respectively. The following table summarizes the results of this analysis:

Credit Suisse First Boston also calculated the Palm aggregate value (after giving effect to the PalmSource distribution) implied by applying a range of multiples of aggregate value to revenues derived from the comparable companies to the estimated revenues of Palm (after giving effect to the PalmSource distribution) for calendar years 2003 and 2004 (based on Palm management estimates). Credit Suisse First Boston then calculated the implied Palm equity value by incorporating cash and cash equivalents (including the assumed value of the land held by Palm of $60 million) and total debt (including the assumed aggregate amount of damages from any pending litigation involving Palm of $60 million from the aggregate value, and the price per Palm share implied by such equity values (in each case after giving effect to the PalmSource distribution). The following table summarizes the results of this analysis:

Index to Financial Statements

No company used in this analysis is identical to Palm. In evaluating companies identified by Credit Suisse First Boston as comparable companies to Palm, Credit Suisse First Boston made judgments and assumptions with regard to industry performance, general business, economic, market and financial conditions and other matters. A complete analysis involves complex considerations and judgments concerning differences in financial and operating characteristics of the comparable companies and other factors that could affect the public trading values of such comparable companies; mathematical analysis, such as determining the mean or the median, is not in itself a meaningful method of using comparable market trading data.

Discounted Cash Flow Analysis. Using a discounted cash flow analysis, Credit Suisse First Boston calculated certain implied equity values for Palm on a stand-alone basis and the price per Palm share implied by such equity values (in each case after giving effect to the PalmSource distribution). The discounted cash flow analysis was based on estimates for the future performance of Palm (after giving effect to the PalmSource distribution) provided by Palm management. In arriving at the equity values and price per Palm share (in each case after giving effect to the PalmSource distribution), Credit Suisse First Boston calculated a terminal value as of May 31, 2008 by applying a forward exit price/earnings multiple ranging from 12.5x to 17.5x. The unlevered free cash flows from fiscal years 2004 through 2008 and the terminal value were then discounted to present values using discount rates ranging from 15% to 20%. Using this methodology, and incorporating cash and cash equivalents (including the assumed value of the land held by Palm) and total debt (including the assumed aggregate amount of damages from any pending litigation involving Palm), this analysis yielded the following results, summarized below.

Handspring Historical Stock Trading Performance. Credit Suisse First Boston analyzed the prices at which Handspring common stock traded from June 3, 2002 through June 2, 2003. Credit Suisse First Boston noted that the high closing price of Handspring common stock during this period was $2.14 on July 1, 2002, and that the low closing price of Handspring common stock was $0.58 on October 22, 2002. Credit Suisse First Boston also noted the average closing price of Handspring common stock over various periods ended June 2, 2003, as summarized below:

Index to Financial Statements

Comparable Company Analysis. Credit Suisse First Boston compared selected financial and trading data of Handspring with similar data for selected publicly traded companies engaged in businesses that Credit Suisse First Boston judged to be reasonably comparable to those of Handspring. These companies were:

Credit Suisse First Boston compared the fully-diluted aggregate value (defined as equity value plus total debt less cash and cash equivalents) of Handspring of $192 million as of June 2, 2003 as a multiple of estimated revenues of Handspring for calendar years 2003 and 2004, and the multiple of the Handspring price per share of $1.22 to estimated earnings per share for Handspring for calendar years 2003 and 2004 (in each case based on Handspring management estimates and publicly available estimates of securities research analysts), to similar values for the comparable companies, using publicly available estimates of securities research analysts for the comparable companies, and closing share prices on June 2, 2003. This analysis allowed Credit Suisse First Boston to compare whether the fully-diluted aggregate value and price per share of Handspring were greater or lesser than those of the selected publicly traded companies, when calculated as a multiple of future revenues and earnings per share, respectively. The following table summarizes the results of this analysis:

Index to Financial Statements

No company used in this analysis is identical to Handspring. In evaluating companies identified by Credit Suisse First Boston as comparable companies to Handspring, Credit Suisse First Boston made judgments and assumptions with regard to industry performance, general business, economic, market and financial conditions and other matters. A complete analysis involves complex considerations and judgments concerning differences in financial and operating characteristics of the comparable companies and other factors that could affect the public trading values of such comparable companies; mathematical analysis, such as determining the mean or the median, is not in itself a meaningful method of using comparable market trading data.

Discounted Cash Flow Analyses. Using a discounted cash flow analysis, Credit Suisse First Boston calculated certain implied equity values for Handspring on a stand-alone basis, the price per Handspring share implied by such equity values and the premium/(discount) of such implied prices per Handspring share to the market price per Handspring share on June 2, 2003 of $1.22, and the 10-day and 30-day average prices per Handspring share prior to June 2, 2003 of $0.92 and $0.81, respectively. The discounted cash flow analysis was based on estimates for the future performance of Handspring provided by Handspring management. In arriving at the equity values and the implied price per Handspring share, Credit Suisse First Boston calculated a terminal value as of June 30, 2008 by applying a forward exit price/earnings multiple ranging from 12.5x to 17.5x. The unlevered free cash flows from fiscal years 2004 through 2008 and the terminal values were then discounted to present values using discount rates ranging from 17.5% to 22.5%. Using this methodology and incorporating cash and cash equivalents and total debt, this analysis yielded the following results, summarized below.

Credit Suisse First Boston noted that the implied premium (discount) to market price per Handspring share and the 10-day average price per Handspring share on June 2, 2003 was (28)%-8% and (4)%-43%, respectively.

Historical Indexed Trading Performance. Credit Suisse First Boston compared the recent price performance of Handspring common stock with the recent price performance of Palm common stock, a composite index of 16 comparable companies and the Nasdaq index over the period from June 3, 2002 through June 2, 2003 and over the period from March 3, 2003 to June 2, 2003. The following table summarizes the results of this analysis:

Index to Financial Statements

Historical Exchange Ratio Analysis. Credit Suisse First Boston calculated the average ratio of Handspring’s closing share price to Palm’s hypothetical closing share price (after giving effect to the PalmSource distribution and assuming that the hypothetical value of Palm after the PalmSource distribution would be $50 million lower than prior to the PalmSource distribution) for each trading day for various periods ended June 2, 2003, and the premium/(discount) of the merger exchange ratio of 0.09 to such average exchange ratios. The following table summarizes the results of this analysis:

Credit Suisse First Boston noted that the premium/(discount) of the merger exchange ratio to such average exchange ratios ranged from (24.0% to 4.2%).

Contribution Analysis. Credit Suisse First Boston analyzed the relative contributions of Handspring and Palm (after giving effect to the PalmSource distribution) to the estimated pro forma total revenues and gross profit of the combined company, based on estimates for calendar years 2003 and 2004, and fiscal years 2003, 2004 and 2005, prepared by the managements of Handspring and Palm, respectively. Credit Suisse First Boston calculated certain values implied by such relative contributions, including the implied pro forma fully-diluted ownership of Handspring stockholders in Palm and the implied exchange ratio (each after giving effect to the PalmSource distribution and assuring that the hypothetical value of Palm, after the PalmSource distribution could be $50 million less than prior to the PalmSource distribution) and the premium represented by the merger exchange ratio of 0.09 to the implied exchange ratio. The following table summarizes the results of this analysis:

Credit Suisse First Boston noted that the premium represented by the merger exchange ratio of 0.09 to the implied exchange ratios ranged from 49% to 147%.

Index to Financial Statements

Relative and Pro Forma Combined DCF Analyses. Using the stand-alone discounted cash flow analyses summarized above for each of Palm (after giving effect to the PalmSource distribution) and Handspring, Credit Suisse First Boston calculated the exchange ratio implied by dividing the implied discounted cash flow equity value per share of Handspring common stock by the implied discounted cash flow equity value per share of Palm common stock (after giving effect to the PalmSource distribution), and the premium of the merger exchange ratio of 0.09 to such implied exchange ratio. The following table summarizes the results of this analysis:

Credit Suisse First Boston noted that the merger exchange ratio of 0.09 represented premiums ranging from 55% to 66% to the implied exchange ratios.

Credit Suisse First Boston also performed a discounted cash flow analysis of Palm (after giving effect to the PalmSource distribution) on a pro forma combined basis after giving effect to the Handspring merger. Credit Suisse First Boston calculated certain implied equity values are the price per share for Palm (after giving effect to the PalmSource distribution and the Handspring merger), and the price per Handspring share implied by such analysis based on the merger exchange ratio of 0.09 , and the premium/(discount) of such implied prices per Handspring share to the market price per Handspring share on June 2, 2003 of $1.22, and the 10-day and 30-day average prices per Handspring share prior to June 2, 2003 of $0.92 and $0.81, respectively. The discounted cash flow analysis was based on estimates for the future performance of Palm (after giving effect to the PalmSource distribution and the Handspring merger) provided by Palm management, and includes synergies anticipated by the management of Handspring and Palm to result from the Handspring merger.

In arriving at the equity value and the implied price per Palm share (in each case after giving effect to the PalmSource distribution and the Handspring merger), Credit Suisse First Boston calculated a terminal value as of May 31, 2008 by applying a forward exit price/earnings multiple ranging from 12.5x to 17.5x. The unlevered free cash flows from fiscal years 2004 through 2008 and the terminal value were then discounted to present values using discount rates ranging from 15% to 20%. Using this methodology, and incorporating cash and cash equivalent (including the assumed value of the land held by Palm) and total debt (including the assumed aggregate amount of damages from any pending litigation involving Palm), this analysis yielded the following results, summarized below.

Precedent Transactions Analysis. Using publicly available securities research analyst estimates and other information, Credit Suisse First Boston examined the following transactions that it deemed to be relevant to determine (i) the multiple of the implied aggregate value (defined as equity value plus total debt less cash and cash equivalents) of the target companies in such transactions at the time of announcement to the last twelve month revenues and estimates at the time of announcement of the next twelve month revenues for the target companies, and (ii) the multiple of the implied price per share of the target companies in such transactions at the time of announcement to the last twelve month earnings per share and estimates at the time of announcement of

Index to Financial Statements

the next twelve month earnings per share for the target companies. The precedent transactions that Credit Suisse First Boston considered are:

All calculations of multiples paid in the selected transactions were based on public information available at the time of public announcement. Credit Suisse First Boston’s analysis did not take into account different market and other conditions during the period in which the selected transactions occurred. Based on the multiples paid in the related transactions and publicly available estimates of securities research analysts for Handspring, Credit Suisse First Boston calculated the implied price per Handspring share, the implied exchange ratio (assuming that the hypothetical value of Palm after the PalmSource distribution would be $50 million less than prior to the PalmSource distribution) and the premium/(discount) of the merger exchange ratio of 0.09 to such implied exchange ratio. The following table summarizes the results of this analysis:

Credit Suisse First Boston noted that the premium/(discount) of represented by the merger exchange ratio of 0.09 to the implied exchange ratios ranged from (16%) to 63%.

No transaction utilized as a comparison in the precedent transactions analysis is identical to the Handspring merger. Mathematical analysis, such as determining the average or the median, is not in itself a meaningful method of using comparable transaction data.

Pro Forma Impact Analyses. Credit Suisse First Boston analyzed certain pro forma effects expected to result from the Handspring merger, including the expected effect of the Handspring merger on the estimated earnings per share for Handspring for fiscal years 2004 through 2006, based on estimates prepared by the managements of Palm and Handspring. The following table summarizes the results of this analysis:

Index to Financial Statements

The actual results achieved by the combined company after the Handspring merger may vary from such estimated results and the variations may be material.

Credit Suisse First Boston’s opinion and presentation to the Handspring board of directors was one of many factors taken into consideration by the Handspring board of directors in making its determination to engage in the Handspring merger. Consequently, the analyses described above should not be viewed as determinative of the opinion of the Handspring board of directors or the management of Handspring with respect to the value of Handspring or whether the Handspring board of directors would have been willing to agree to a different exchange ratio.

The Handspring board of directors retained Credit Suisse First Boston to act as its exclusive financial advisor in connection with the Handspring merger. Credit Suisse First Boston was selected by the Handspring board of directors based on Credit Suisse First Boston’s qualifications, expertise and reputation. Credit Suisse First Boston is an internationally recognized investment banking and advisory firm. Credit Suisse First Boston, as part of its investment banking business, is continuously engaged in the valuation of businesses and securities in connection with mergers and acquisitions, leveraged buyouts, negotiated underwritings, competitive biddings, secondary distributions of listed and unlisted securities, private placements and valuations for corporate and other purposes. In the past, Credit Suisse First Boston and its affiliates have provided financial and investment banking services to Handspring unrelated to the Handspring merger for which it received compensation and it may in the future provide such services to Palm for which it would expect to receive compensation. In the ordinary course of its business, Credit Suisse First Boston and its affiliates may actively trade the debt and equity securities of Handspring and Palm for their own accounts and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities.

Pursuant to an engagement letter dated as of March 4, 2003, Handspring engaged Credit Suisse First Boston to provide financial advisory services to the Handspring board of directors in connection with the Handspring merger, including, among other things, rendering its opinion. Pursuant to the terms of the engagement letter, Handspring has agreed to pay Credit Suisse First Boston a transaction fee equal to $2,250,000 payable upon the consummation of the Handspring merger. Handspring also has paid Credit Suisse First Boston a fee of $400,000 upon delivery by Credit Suisse First Boston of its opinion, which amount will be credited against the transaction fee payable to Credit Suisse First Boston. In addition, Handspring has agreed to reimburse Credit Suisse First Boston for its out-of-pocket expenses, including attorney’s fees, incurred in connection with its engagement and to indemnify Credit Suisse First Boston and certain related persons against certain liabilities and expenses arising out of or in conjunction with its rendering of services under its engagement, including liabilities arising under the federal securities laws.

Palm. Approval of the proposal to approve and adopt the merger agreement requires the affirmative vote of holders of at least a majority of the outstanding shares of Palm common stock. Approval and adoption of the merger agreement will also constitute approval of the PalmSource distribution by means of the merger of Peace Separation Corporation with and into Palm and the approval of the issuance of Palm common stock to Handspring stockholders in connection with the Handspring merger. In addition, under the listing rules of the Nasdaq Stock Market, approval of the issuance of Palm stock to the stockholders of Handspring under the merger agreement requires the affirmative vote of a least a majority of the total votes cast on the proposal in person or by proxy. However, because approval and adoption of the merger agreement already requires the affirmative vote of holders of at least a majority of the outstanding shares of Palm common stock, approval of the merger agreement will fulfill the Nasdaq listing requirement. For a description of the treatment and effect of abstentions and broker non-votes, see “The Palm Annual Meeting of Stockholders—Abstentions” and “—Broker Non-Votes” in this joint proxy statement/prospectus.

Index to Financial Statements

Handspring. Approval of the proposal to approve and adopt the merger agreement requires the affirmative vote of holders of at least a majority of the outstanding shares of Handspring common stock. Approval and adoption of the merger agreement will also constitute approval of the Handspring Merger. For a description of the treatment and effect of abstentions and broker non-votes, see “The Handspring Special Meeting of Stockholders—Quorum and Vote Required” and “—Voting of Proxies” in this joint proxy statement/prospectus.

Interests of Directors and Executive Officers of Palm in the Handspring merger

In considering the Palm board of directors’ recommendation that you, as a Palm stockholder, vote to approve and adopt the merger agreement, you should be aware that some of Palm’s executive officers and directors have interests in the transaction that are different from, or in addition to, your interests as a Palm stockholder. These interests include, among other things, the following:

As a result, certain executive officers and directors of Palm may be more likely to vote to approve and adopt the merger agreement than Palm’s stockholders generally.

Interests of Directors and Executive Officers of Handspring in the Handspring merger

In considering the recommendation of the Handspring board of directors regarding the merger agreement and the Handspring merger, Handspring stockholders should be aware that some of Handspring’s stockholders, directors and executive officers have interests in the Handspring merger that are different from, or in addition to, their interests as Handspring stockholders. These interests may create potential conflicts of interest. The Handspring board of directors was aware of these interests and took these interests into account in approving the merger agreement and the Handspring merger.

Voting Agreements. The following Handspring stockholders have entered into voting agreements and granted irrevocable proxies to Palm pursuant to which they have agreed to vote approximately 37.5% of the

Index to Financial Statements

outstanding stock of Handspring in favor of the proposal to approve and adopt the merger agreement and to approve the Handspring merger:

Acceleration of Handspring Stock Options Held by Handspring Directors. The Handspring stock options held by each of Handspring’s directors and executive officers will be assumed in the Handspring merger and become exercisable, in accordance with their terms, for shares of Palm common stock. Upon the Handspring merger, the vesting of stock options held by L. John Doerr, Bruce W. Dunlevie, William Kennard and Mitchell Kertzman, all of whom are non-employee directors of Handspring, will accelerate and become fully vested.

Acceleration of Handspring Stock Options Held by Handspring’s Chief Financial Officer. Pursuant to the terms of Handspring’s offer letter to William R. Slakey, Handspring’s Chief Financial Officer, upon the Handspring merger, his option to purchase 725,000 shares will accelerate as to 25% of the unvested shares subject to such option. Mr. Slakey may receive further benefits, including additional option acceleration, pursuant to the Handspring Retention and Severance Plan as described on page 95.

Acceleration of Handspring Stock Options Held by Handspring Employees. Options granted under Handspring’s 2000 Equity Incentive Plan to any Handspring employees who do not become employees of Palm or who are terminated without cause within one year from the date of the Handspring merger will accelerate as to 25% of the unvested shares subject to such options. Mses. Dubinsky and Tomlinson and Messrs. Pine, Hartnett and Slakey may receive additional acceleration of options pursuant to the Handspring Retention and Severance Plan, as described on page 95.

Certain executive officers of Handspring have agreed to employment arrangements with Palm that will become effective upon the completion of the merger. In particular, Edward T. Colligan, Handspring’s President and Chief Operating Officer, will become Palm’s Senior Vice President, General Manager, Wireless Business Unit; Jeffrey C. Hawkins, Handspring’s Chief Product Officer and Chairman of Handspring’s board of directors, will become Palm’s Chief Technology Officer and will serve in this capacity on a part-time basis as he did in his capacity as Chief Product Officer of Handspring; Patricia A. Tomlinson, Handspring’s Vice President, Human Resources, will become a Palm Senior Vice President and Chief Human Resources Officer; Celeste S. Baranski, Handspring’s Vice President, Engineering, will become Palm’s Vice President, Engineering; John Hartnett, Handspring’s Vice President, Worldwide Operations, will become a Palm Vice President; Joseph K. Sipher, Handspring’s Vice President, Marketing, will become Palm’s Vice President, Product Management; and Gregory S. Woock, Handspring’s Vice President, Worldwide Sales, will become Palm’s Vice President, Carrier Sales. Other executive officers may also be employed by Palm following the merger.

The agreements that these Handspring employees have entered into with Palm are contingent upon and will take effect on the day the merger is completed. Each offer letter sets forth the employee’s position, reporting structure and compensation, including annual salary and target bonus and incentive compensation opportunity, with Palm. The offer letters provide that employment with Palm will be “at will” in nature, meaning that the employee or Palm may terminate the employment relationship with or without cause or notice, at any time. In addition, Ms. Baranski, Mr. Hartnett, Mr. Sipher and Mr. Woock will be granted Palm options and Mr. Colligan will be granted restricted shares of Palm that will be governed by the applicable equity plan.

Under the offer letters, each employee is required to sign, in addition to the offer letter, Palm’s Code of Business Conduct and Ethics, the Palm U.S. Employee Handbook and the standard Palm Employee Agreement. Further, each of Messrs. Colligan and Hawkins have entered into a Non-Competition and Non-Solicitation

Index to Financial Statements

Agreement with Palm, prohibiting him, for a period of two years after closing of the merger, from competing with Palm, soliciting employees, clients, customers or licensees of Palm, or from consenting to the use of his name in connection with any business that competes with Palm.

Each of Messrs. Colligan and Hawkins are entitled to receive a Management Retention Agreement and a Severance Agreement with Palm, the terms of which are described under “Palm Management Retention Agreements” and “Palm Severance Agreements” below.

Palm Management Retention Agreements. Under new employment arrangements, each of Messrs. Colligan and Hawkins will receive a management retention agreement with Palm pursuant to which he will receive payments and benefits upon termination of employment occurring within twelve months following a change of control of Palm. In exchange for such payments and benefits, Mr. Colligan and Mr. Hawkins must agree for one year following his termination to not directly or indirectly solicit any individuals to leave the employ of Palm or otherwise interfere with existing employment relations between Palm and its current and prospective employees.

If the employment of Mr. Colligan or Mr. Hawkins is terminated other than for cause, death or disability or if the employee voluntarily terminates employment for good reason (as defined) within twelve months following a change of control, each will be entitled to:

A “change of control” includes a change in beneficial ownership of more than 50% of Palm, the sale or disposition of all or substantially all of Palm’s assets, a merger resulting in Palm shareholders owning less than 50% of the surviving entity, and certain changes in the composition of Palm’s board of directors, but excluding the transaction between Handspring and Palm. Voluntary termination by the employee for “good reason” includes any of the following being effected without the employee’s consent: a material reduction in the employee’s duties, title, authority or responsibilities, a material reduction in the facilities and perquisites made available to the employee, a reduction in the employee’s base salary, a material reduction in benefits provided to the employee, certain relocations, failure of Palm to have the Management Retention Agreement assumed by any successor to Palm or any act or set of acts which would constitute a “constructive termination” under California case law.

The spin-off of a subsidiary of Palm while the employee is employed by such subsidiary will not entitle employee to the payments and benefits under the Management Retention Agreement.

Palm Severance Agreements. Under new employment arrangements, each of Messrs. Colligan and Hawkins will receive a Severance Agreement with Palm pursuant to which he will receive payments and benefits upon termination of his employment, provided he signs and delivers to Palm a release of claims.

Index to Financial Statements

Voluntary termination by the employee for “good reason” includes any of the following being effected without the employee’s consent: employee being assigned duties inconsistent with his background, certain relocations of the employee’s principal place of work, reduction of the employee’s base salary and bonus or Palm’s failure to provide substantially comparable benefits as are provided to other similarly situated employees, provided that changes to the employee’s duties, work location and other employment terms resulting from the transaction between Palm and Handspring whereby the employee became an employee of Palm shall not constitute good reason.

The spin-off of a subsidiary of Palm while the employee is employed by such subsidiary will not entitle employee to the payments and benefits under the Severance Agreement.

If the employee’s termination would entitle Mr. Colligan or Mr. Hawkins to payments and benefits under a Management Retention Agreement described above, such employee will not receive any payments or benefits under the Severance Agreement, but instead shall receive the payments and benefits due under the Management Retention Agreement.

Summary of Cash and Equity Compensation Packages for Officers and Directors of Handspring who will Become Directors and Executive Officers of Palm

The table below summarizes for each of the executive officers and directors of Handspring who will become executive officers and directors of Palm following the transaction, the annualized salary, target bonus and equity compensation.

Index to Financial Statements

Handspring Retention and Severance Plan. Handspring has adopted a retention and severance plan to induce full-time employees of Handspring to remain employed by Handspring through the merger and, in some instances, for transition periods following the merger. Under the retention and severance plan, participants who do not receive a written offer of employment with Palm as of the Effective Time of the merger will receive certain severance payments and benefits, the amount of which depends on the designation of a participant as an “Executive”, a “Director” or “Any Other Participant” for purposes of the retention and severance plan and, if applicable, whether and to what extent such participant is requested to and provides transitional services following the merger. For purposes of the severance and retention plan, “Executives” include Messrs. Slakey, Pine and Hartnett and Mses. Dubinsky and Tomlinson; “Directors” include those employees with the title of director or higher who are not designated as “Executives”; and “All Other Participants” are participants not designated as Executives or Directors. In each case, to receive the severance payments and benefits the participant must be a full time employee of Handspring providing services to Handspring as of June 4, 2003 and continuing through the Effective Time of the merger.

Generally, a participant who does not receive an offer of employment (at least half-time at or above such participant’s current base salary) by Palm or a Palm subsidiary and who is not requested to and/or does not provide transitional services following the merger will receive severance payments and benefits under the retention and severance plan as follows: Executives will receive a lump sum payment equal to 12 months of base salary (such base salary, for purposes of the retention and severance plan, being equal to 111% of the Executive’s current base salary), 100% acceleration of vesting of all outstanding unvested equity awards and payment of any costs incurred in connection with continuation of health coverage under COBRA for a 12 month period; Directors will receive a lump sum payment equal to 6 months of base salary, acceleration of vesting of 25% of all then unvested equity awards (provided that such acceleration shall not increase any accelerated vesting otherwise provided under Handspring’s 2000 Equity Incentive Plan), and payment of any COBRA costs incurred for a 6 month period; and All Other Participants will receive a lump sum payment equal to 3 months of base salary, acceleration of vesting of 25% of all then unvested equity awards (provided that such acceleration shall not increase any accelerated vesting otherwise provided under Handspring’s 2000 Equity Incentive Plan), and payment of any COBRA costs incurred for a 3 month period.

Participants who do not receive an offer of employment (at least half-time at or above such participant’s current base salary) by Palm or a Palm subsidiary but who are requested to provide and do provide transitional services following the merger will receive the severance payments and benefits they would have received had they not been requested to provide such transitional services (as described in the immediately preceding paragraph) and will receive the following additional payments: Executives will receive an amount equal to 4 weeks of base salary (such base salary, for purposes of the retention and severance plan, being equal to 111%

Index to Financial Statements

of the Executive’s current base salary (which represents 100% of the Executive’s base salary prior to a 10% reduction to management salaries), reduced to reflect part-time employment with Palm or a Palm subsidiary) for each full month of full-time service provided to Palm (up to a maximum of 16 weeks); Directors will receive an amount equal to 3 weeks of base salary (reduced to reflect part-time employment with Palm or a Palm subsidiary) for each full month of full-time service provided to Palm (up to a maximum of 12 weeks); and All Other Participants will receive an amount equal to 2 weeks of base salary (reduced to reflect part-time employment with Palm or a Palm subsidiary) for each full month of full-time service provided to Palm (up to a maximum of 8 weeks). With respect to participants providing transitional services, these additional severance payments and benefits, as well as the severance payments and benefits described in the immediately preceding paragraph, will be payable only if Handspring terminates the participant without cause or if the participant’s employment is terminated for any reason, including a voluntary termination, more than four months after the Effective Time of the merger. Such amounts also will not be payable if the Participant terminates service voluntarily within four (4) months after the effective time of the merger.

Payments and benefits made under the retention and severance plan are conditioned upon the delivery by each participant of a signed release of claims and the acknowledgement of such participant’s continuing obligations under the confidentiality and/or proprietary rights agreement between the participant and Handspring and, if applicable, between the participant and Palm. If any amounts payable to a participant under the retention and severance plan are characterized as “excess parachute payments” under Section 4999 of the Code and would be subject to excise tax, the participant may in his or her sole discretion reduce the amounts payable to such participant under the retention and severance plan or have any portion of stock options or restricted stock held by such participant not accelerate in vesting to avoid any “excess parachute payment”. The retention and severance plan is intended to be subject to, and shall be construed in accordance with, the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and, to the extent not preempted by ERISA, with the laws of the state of California.

Palm Board Seats. Ms. Dubinsky, Handspring’s Chief Executive Officer and a member of Handspring’s board of directors, and Messrs. Doerr and Dunlevie, both of whom are currently members of Handspring’s board of directors, will become members of Palm’s board of directors upon the consummation of the Handspring merger. Ms. Dubinsky and Messrs. Doerr and Dunlevie will receive the standard compensation received by Palm’s non-employee directors.

Indemnification. The merger agreement provides that, from and after the consummation of the Handspring merger, Palm will cause the surviving corporation to fulfill and honor the obligations of Handspring pursuant to any indemnification agreements between Handspring and its directors and officers in effect prior to the Handspring merger, subject to applicable law. Palm will cause the certificate of incorporation and bylaws of the surviving corporation to contain provisions with respect to exculpation and indemnification that are at least as favorable as those contained in the certificate of incorporation and bylaws of Handspring in effect immediately prior to the Handspring merger. For at least six years following the Handspring merger, these provisions will not be amended, repealed or otherwise modified in any manner that would adversely affect the rights of Handspring’s directors or officers immediately prior to the Handspring merger, unless such modification is required by law.

The merger agreement also provides that, for at least six years following the Handspring merger, Palm will maintain directors’ and officers’ liability insurance comparable to Handspring’s existing policy, provided that Palm will not be required to pay any premium in excess of 200% of the annual premium currently paid by Handspring. To the extent the annual premium would exceed 200% of Handspring’s current annual premium, Palm shall maintain the maximum amount of coverage, if any, as is available for 200% of such annual premium. Directors of Handspring who become directors of Palm will be provided with the same directors’ and officers’ liability insurance given to any other Palm director and will enter into indemnification agreements on the same terms, if any, entered into with other directors of Palm generally.

Index to Financial Statements

As a result of interests described above, these executive officers and directors could be more likely to vote for, and to recommend the vote for, the proposal to approve and adopt the merger agreement and to approve the Handspring merger, than if they did not hold these interests.

Palm and Handspring have made the required filings with the Antitrust Division of the Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Act and the applicable waiting period has terminated. Palm and Handspring have made foreign antitrust filings in Germany and have received clearance from the German antitrust authorities for the Handspring merger. The parties are not aware of any other governmental approvals required in order to complete the merger.

The Antitrust Division of the Department of Justice or the Federal Trade Commission may still challenge the Handspring merger on antitrust grounds after expiration of the waiting period or consummation of the transaction. Accordingly, at any time before or after the completion of the Handspring merger, either of these entities could take action under the antitrust laws as it deems necessary or desirable in the public interest. Other persons also could take action under the antitrust laws, including seeking to enjoin the Handspring merger. Additionally, at any time before or after the completion of the Handspring merger, any state could take action under the antitrust laws as it deems necessary or desirable in the public interest. There can be no assurance that a challenge to the Handspring merger will not be made or that, if a challenge is made, we will prevail.

As a result of the PalmSource distribution, the operations of PalmSource will be accounted for by Palm as a discontinued operation as defined under SFAS No. 144. The Handspring merger will be accounted for using the purchase method of accounting. The purchase price will be allocated to the assets and liabilities of Handspring and those assets and liabilities will be recorded on Palm’s books at their respective fair values upon completion of the Handspring merger. A portion of the purchase price may be identified as in-process research and development. This amount, if any, will be charged to Palm’s operations in the quarter the merger is completed and the purchase accounting valuation amounts are finalized. Furthermore, a portion of the purchase price equal to the intrinsic value of the unvested options assumed in the merger will be allocated to deferred stock-based compensation, which will be amortized over the remaining vesting period of those options. The remaining purchase price will be recorded as goodwill and other intangible assets and will be amortized over the useful lives of such assets.

Material U.S. Federal Income Tax Consequences of the PalmSource distribution and Handspring merger

This section summarizes material U.S. federal income tax considerations relating to Palm’s distribution of PalmSource stock to Palm stockholders and to the merger combination involving Palm and Handspring. This summary does not provide a complete analysis of all potential tax considerations, including tax considerations that may apply because of a stockholder’s particular circumstances, including status as a non-United States person, or because a stockholder is subject to special rules. The information provided below is based on existing authorities. These authorities may change, or the Internal Revenue Service, or IRS, might interpret the existing authorities differently. In either case, the tax consequences of purchasing, owning or disposing of common stock could differ from those described below. Finally, the summary does not describe the effect of the United States federal estate and gift tax laws or the effects of any applicable foreign, state or local laws.

STOCKHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR SITUATIONS AND THE CONSEQUENCES OF FEDERAL ESTATE OR GIFT TAX LAWS, FOREIGN, STATE OR LOCAL LAWS AND TAX TREATIES.

Index to Financial Statements

Palm has received a private letter ruling from the IRS in December 2002 to the effect that the PalmSource distribution will qualify as a tax-free transaction under Section 355 of the Internal Revenue Code, or the Code. The ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. A copy of the ruling, which includes the factual representations upon which the ruling is based, is attached as an exhibit to the registration statement of which this joint proxy statement/prospectus is a part. Although some facts have changed since the issuance of the ruling (for example, the execution of the Handspring merger agreement), in the opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation, tax counsel to Palm, these changes will not adversely affect the validity of the ruling.

Stockholders of Palm who receive cash from the distribution agent in respect of fractional shares will recognize gain or loss equal to the difference between the cash received and the holder’s basis in such fractional share interest. Such gain or loss should be capital gain or loss to such holder, provided the fractional share interest is a capital asset in the hands of such holder.

If the distribution did not qualify as a tax-free transaction, Palm would recognize taxable gain equal to the excess of the fair market value of PalmSource common stock distributed to Palm stockholders over Palm’s tax basis in PalmSource common stock. In addition, each stockholder who receives PalmSource common stock in the distribution would generally be treated as receiving a taxable distribution in an amount equal to the fair market value of PalmSource common stock received.

Even if the distribution otherwise qualifies for tax-free treatment under Sections 355 and 368 of the Code, it may be taxable to Palm under Section 355(e) of the Code if 50% or more of the stock of Palm or of PalmSource is acquired as part of a plan or series of related transactions that include the PalmSource distribution. If such an acquisition of PalmSource stock or Palm’s stock triggers the application of Section 355(e), Palm would recognize taxable gain as described above but the distribution should generally be tax-free to each Palm stockholder. Under the tax sharing agreement between Palm and PalmSource, PalmSource would be required to indemnify Palm against that taxable gain if it were triggered by an acquisition of PalmSource stock. Please see “The PalmSource Separation—Amended and Restated Tax Sharing Agreement” for a more detailed discussion of the tax sharing agreement between Palm and PalmSource.

U.S. Treasury regulations require each Palm stockholder that receives shares of PalmSource stock in the distribution to attach to the stockholder’s U.S. federal income tax return for the year in which such stock is received a detailed statement setting forth such data as may be appropriate to show the applicability of Section 355 of the Code to the distribution. Within a reasonable period of time after the distribution, Palm will provide its stockholders who receive PalmSource common stock pursuant to the distribution with the information necessary to comply with such requirement.

Index to Financial Statements

Each Palm stockholder should consult his or her tax adviser about the particular consequences of the PalmSource distribution to such stockholder, including the application of state, local and foreign tax laws, and possible changes in tax law that may affect the tax consequences described above.

The following discussion provides the opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation, tax counsel to Palm, and Fenwick & West LLP, tax counsel to Handspring, as to the material federal income tax consequences of the Handspring merger. Completion of the Handspring merger is conditioned upon the receipt by Palm and Handspring of legal opinions from their respective tax counsel to the effect that the Handspring merger will constitute a reorganization within the meaning of Section 368(a) of the Internal Revenue Code.

The opinions set forth herein and the closing tax opinions are or will be, respectively, rendered on the basis of facts, representations and assumptions set forth or referred to in such opinions, including representations contained in certificates of officers of Palm and Handspring. These tax opinions will also be based upon the Internal Revenue Code, existing treasury regulations, and current administrative rulings and court decisions, all of which are subject to change, possibly with retroactive effect.

Subject to the foregoing, the merger will qualify as a reorganization within the meaning of Section 368 of the Internal Revenue Code, resulting in the following federal income tax consequences:

Stockholders of Handspring who receive cash in the merger in respect of fractional shares will recognize gain or loss equal to the difference between the cash received and the holder’s basis in such fractional share interest. Such gain or loss should be capital gain or loss to such holder, provided the fractional share interest is a capital asset in the hands of such holder.

Neither Palm nor Handspring will request a ruling from the Internal Revenue Service in connection with the Handspring merger. The tax opinions do not bind the Internal Revenue Service and do not prevent the Internal Revenue Service from successfully asserting a contrary opinion.

It is a condition to the completion of the transaction that the Palm common stock to be issued in connection with the Handspring merger be approved for listing on the Nasdaq National Market, subject to official notice of issuance. Palm has agreed use all reasonable efforts to cause the shares of Palm common stock to be issued in connection with the transaction to be authorized for listing on the Nasdaq National Market before the completion of the transaction, subject to official notice of issuance.

The shares of PalmSource common stock to be delivered to Palm stockholders in connection with the PalmSource distribution has been accepted for listing on the Nasdaq National Market, subject to official notice of

Index to Financial Statements

issuance and the condition that PalmSource common stock trade at or above $5.00 per share on the first trading day on the Nasdaq National Market. If PalmSource common stock does not trade at or above $5.00 per share on the first trading day on the Nasdaq National Market, PalmSource’s common stock may trade on the Nasdaq SmallCap Market, if it meets certain requirements, or be eligible for quotation on the OTC Bulletin Board, or a successor of the OTC Bulletin Board.

Delisting and Deregistration of Handspring Common Stock After the Transaction

After the Handspring merger is completed, Handspring common stock will be delisted from the Nasdaq National Market and deregistered under the Securities Exchange Act of 1934.

On or about June 17 and 19, 2003, respectively, two putative class action lawsuits were filed in the Court of Chancery in the State of Delaware in and for the County of New Castle against Palm, Handspring and various officers and directors of Handspring. The cases are captioned Goldhirsch v. Handspring, Inc., et al., Civil Action No. 20376-NC and Majarian v. Handspring, Inc., et al., Civil Action No. 20381-NC. The Majarian complaint was amended on or about June 23, 2003 to, among other things, delete certain previously named officer defendants. Both complaints allege that the officers and directors of Handspring breached their fiduciary duties to Handspring stockholders by, among other things, failing to undertake an appropriate evaluation of Handspring’s net worth as a merger or acquisition candidate and failing to maximize Handspring stockholder value by not engaging in a meaningful auction of Handspring. The Majarian complaint also alleges, among other things, that the officers and directors of Handspring breached their fiduciary duties by failing to act independently so that the interests of Handspring’s public stockholders would be protected and enhanced. Both complaints allege that Palm aided and abetted the alleged breaches of fiduciary duty of Handspring’s officers and directors. Both complaints seek, among other things, a preliminary and permanent injunction against the transaction, a rescission of the transaction if it is consummated and unspecified damages. The Goldhirsch complaint also requests, among other things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or an unspecified market check. Palm and Handspring believe that the lawsuits are without merit and intend to vigorously defend the cases. A copy of each of the complaints filed by the plaintiffs in the lawsuits are filed as exhibits to the registration statement filed by Palm with the SEC of which this joint proxy statement/prospectus forms a part.

The Delaware General Corporation Law does not provide appraisal rights to holders of Palm common stock or Handspring common stock in connection with the PalmSource distribution or the Handspring merger.

Index to Financial Statements

The following summary describes certain material provisions of the merger agreement. The provisions of the merger agreement are complicated and not easily summarized. This summary may not contain all of the information about the merger agreement that is important to you. The merger agreement is attached to this joint proxy statement/prospectus as Annex B and is incorporated by reference into this joint proxy statement/prospectus. We encourage you to read it carefully in its entirety for a more complete understanding of the merger agreement.

The merger agreement provides for a transaction with two components. First, in the PalmSource distribution the common stock of PalmSource held by Palm will be distributed to the existing stockholders of Palm by means of the merger of Peace Separation Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Palm, which we sometimes refer to as the Parent merger or the PalmSource distribution. Palm will continue as the surviving corporation in the Parent merger. Following such distribution, the remaining business of Palm and Handspring will be combined by means of the merger of Harmony Acquisition Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Handspring, which we refer to as the Handspring merger. Handspring will survive the Handspring merger as a wholly-owned subsidiary of Palm.

We will complete the transaction when all of the conditions to completion of the transaction contained in the merger agreement are satisfied or waived, including approval and adoption of the merger agreement by the stockholders of Palm and Handspring. The PalmSource distribution will become effective upon the filing of a certificate of merger in connection with the Parent merger with the Delaware Secretary of State. Immediately after such filing, a certificate of merger in connection with the Handspring merger will be filed with the Delaware Secretary of State. We expect to file both certificates and complete both the PalmSource distribution and the Handspring merger on the same date. Trading in PalmSource common stock is expected to commence on the first trading day following the completion of the Parent merger.

We are working to complete the transaction as quickly as possible. We currently plan to complete the transaction by fall 2003. Because completion of the transaction is subject to customary closing conditions, however, we cannot predict the exact timing.

Upon completion of the PalmSource distribution, each share of Palm common stock (including any associated preferred stock purchase rights) outstanding immediately prior to the effective time of the PalmSource distribution will be automatically converted into the right to receive (A) one validly issued, fully paid and nonassessable share of Palm common stock (together with the associated preferred stock right), such that each share of Palm common stock will remain outstanding after the completion of the PalmSource distribution, and (B) the right to receive a number of shares of the common stock of PalmSource currently outstanding and held by Palm such that all the shares of PalmSource common stock outstanding and held by Palm immediately prior to the effective time of the PalmSource distribution are distributed to all existing holders of Palm common stock on a pro rata basis, based on the number of shares of Palm common stock held by each such Palm stockholder. Upon completion of the PalmSource distribution, all options to purchase Palm common stock shall continue in effect. Rights outstanding under Palm’s employee stock purchase plan will remain outstanding and exercisable for Palm common stock without alteration.

A total of approximately 10,000,000 shares of PalmSource common stock will be distributed in connection with the PalmSource distribution to existing holders of Palm common stock. As a result, based on the number of shares of common stock of Palm currently outstanding as of August 29, 2003, each holder of an outstanding

Index to Financial Statements

share of Palm common stock immediately prior to the PalmSource distribution will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held. This ratio is based on the number of Palm common stock outstanding on August 29, 2003, and is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution. Handspring stockholders will not receive any PalmSource shares.

Upon completion of the Handspring merger, each share of Handspring common stock (including the associated preferred stock purchase right) outstanding immediately prior to the effective time of the Handspring merger will be canceled and extinguished and automatically converted into the right to receive 0.09 of a validly issued, fully-paid and nonassessable share of Palm common stock upon surrender of the certificate representing such share of Handspring common stock in the manner provided in the merger agreement. Palm shares will be issued with their associated preferred stock purchase rights under Palm’s Stockholder Rights Plan. Upon completion of the Handspring merger, Palm also will assume outstanding options and warrants to purchase Handspring common stock.

The exchange ratio in the Handspring merger (i.e., 0.09 of a share of Palm common stock for each share of Handspring common stock surrendered) will be adjusted to reflect the effect of any stock split, reverse stock split, stock dividend (including any dividend or distribution of securities convertible into Palm common stock or Handspring common stock), reorganization, recapitalization, reclassification or other like change with respect to Palm common stock or Handspring common stock having a record date on or after the date of the merger agreement and prior to completion of the Handspring merger. However, no adjustment will be made to the exchange ratio as a result of the PalmSource distribution.

Each share of Handspring common stock held by Handspring or owned by Palm or any of their direct or indirect wholly-owned subsidiaries immediately prior to the completion of the Handspring merger will be automatically canceled and extinguished, and none of Handspring, Palm or any of their direct or indirect subsidiaries will receive any securities of Palm or other consideration in exchange for those shares.

Based on the exchange ratio and the number of shares of Handspring common stock and options and warrants to purchase Handspring common stock outstanding as of the Handspring record date, a total of approximately shares of Palm common stock will be issued in connection with the Handspring merger to holders of Handspring common stock and a total of approximately shares of Palm common stock will be reserved for issuance upon the exercise of options and warrants to purchase Handspring common stock assumed by Palm in connection with the Handspring merger.

PalmSource Distribution. Palm will not issue any fractional shares of common stock of PalmSource in connection with the PalmSource distribution. Instead, EquiServe will sell the aggregate of the fractional shares of PalmSource common stock in one or more transactions, and will distribute a cash payment to each holder of Palm common stock who would otherwise be entitled to receive a fraction of a share of common stock of PalmSource, which cash payment would represent such holder’s proportionate interest in the net proceeds from such sale. The amount of such payment will depend on the prices at which the PalmSource shares are sold by the exchange agent in the open market shortly after the effective date of the PalmSource distribution.

Handspring Merger. Palm will not issue any fractional shares of common stock of Palm in connection with the Handspring merger. Instead, each holder of Handspring common stock who would otherwise be entitled to receive a fraction of a share of Palm common stock will receive cash, without interest, in an amount equal to such fraction multiplied by the average closing price of one share of Palm common stock for the ten most recent trading days that Palm common stock has traded ending on the trading day one day prior to the date on which the Handspring merger is completed, as reported by the Nasdaq National Market.

Index to Financial Statements

The cash distributions described above that are paid to Palm and Handspring stockholders in lieu of fractional shares may be taxable. See “Material U.S. Federal Income Tax Consequences of the Transaction” beginning on page 97 of this joint proxy statement/prospectus. In addition, after the PalmSource distribution, some stockholders may hold odd lots, or blocks of less than 100 shares, of PalmSource or Palm common stock. Any investor selling an odd lot may be required to pay a higher commission rate than an investor selling round lots, or blocks of 100 shares.

PalmSource Distribution. Holders of Palm common stock will not need to complete a letter of transmittal and should not send in their Palm stock certificates, as there will be no exchange of Palm stock certificates. Following the completion of the PalmSource distribution, each certificate previously representing shares of Palm common stock will continue to represent the same number of shares of Palm common stock. EquiServe will deliver to each holder of shares of Palm common stock such number of shares of PalmSource common stock to which such holder is entitled as a result of the PalmSource distribution registered in uncertificated book-entry form (unless a holder of Palm common stock requests a certificate representing such holder’s whole shares of PalmSource common stock). As a result, instead of receiving stock certificates, holders of Palm common stock will receive account statements reflecting their ownership interest in whole shares of PalmSource common stock. Such book-entry shares will be held with EquiServe, who will serve as the record keeper for all shares of PalmSource common stock being distributed in connection with the PalmSource distribution. Any stockholder who wishes to receive a physical certificate evidencing shares of PalmSource common stock will be able to obtain a certificate at no charge by contacting EquiServe.

Handspring Merger. Holders of Handspring common stock should not send in their Handspring stock certificates until they receive a letter of transmittal from EquiServe Trust Company, N.A., the exchange agent for the Handspring merger, following the completion of the transaction with instructions for the surrender of Handspring stock certificates.

Promptly following completion of the Handspring merger, EquiServe Trust Company, N.A., the exchange agent for the Handspring merger, will mail to each record holder of Handspring common stock a letter of transmittal and instructions for surrendering the record holder’s stock certificates in exchange for a certificate representing Palm common stock registered in uncertificated book-entry form (unless a holder of Handspring common stock requests a certificate representing such holder’s whole shares of Palm common stock). Only those holders of Handspring common stock who properly surrender their Handspring stock certificates in accordance with the exchange agent’s instructions will receive (1) a certificate representing Palm common stock, (2) cash in lieu of any fractional share of Palm common stock, and (3) any dividends or other distributions, if any, to which they are entitled under the terms of the merger agreement. The surrendered certificates representing Handspring common stock will be canceled. After the completion of the Handspring merger, each certificate representing shares of Handspring common stock that has not been surrendered will represent only the right to receive each of the items enumerated in the second sentence of this paragraph. Following the completion of the Handspring merger, Handspring will not register any transfers of Handspring common stock on its stock transfer books.

Distributions with Respect to Unexchanged Shares. Holders of Handspring common stock are not entitled to receive any dividends or other distributions on Palm common stock until the Handspring merger is completed. After the Handspring merger is completed, holders of Handspring common stock certificates will be entitled to dividends and other distributions declared or made after completion of the Handspring merger with respect to the number of whole shares of Palm common stock which they are entitled to receive upon exchange of their Handspring stock certificates, but they will not be paid any dividends or other distributions on the Palm common stock until they surrender their Handspring stock certificates to the exchange agent in accordance with the exchange agent’s instructions and will not receive any shares of PalmSource common stock distributed by Palm.

Transfer of Ownership and Lost Stock Certificates. Palm will issue a Palm stock certificate, pay cash in lieu of a fractional share and deliver any dividends or distributions that may be applicable, in a name other than

Index to Financial Statements

the name in which a surrendered Handspring stock certificate is registered only if the person requesting such exchange presents to the exchange agent all documents required to show and effect the unrecorded transfer of ownership and to show that such person paid any applicable stock transfer taxes. If a Handspring stock certificate is lost, stolen or destroyed, the holder of such certificate may need to deliver an affidavit or bond prior to receiving any Palm stock certificate.

The merger agreement generally contains reciprocal representations and warranties made by each of Palm, on the one hand, and Handspring, on the other, regarding aspects of their respective businesses, financial condition and structure, as well as other facts pertinent to the transaction. These representations and warranties relate to the following subject matters with respect to each party:

Index to Financial Statements

The representations and warranties of Palm and Handspring contained in the merger agreement expire upon completion of the Handspring merger.

Under the merger agreement, Handspring has agreed that, until the earlier of the completion of the Handspring merger or termination of the merger agreement, or unless Palm consents in writing, it will:

Under the merger agreement, Handspring also agreed that, until the earlier of the completion of the Handspring merger or termination of the merger agreement, or unless Palm consents in writing, it will conduct its business in compliance with some specific restrictions relating to the following:

Index to Financial Statements

Under the merger agreement, Palm has agreed that, until the earlier of the completion of the Handspring merger or termination of the merger agreement, or unless Handspring consents in writing, it will not:

Under the terms of the merger agreement, subject to certain exceptions described below, each of Palm and Handspring has agreed that it will not, and each of its subsidiaries, officers and directors and the officers and directors of its subsidiaries will not, directly or indirectly:

In addition, each of Palm and Handspring agreed to use all reasonable efforts to cause its and its subsidiaries’ employees, agents and representatives (including any retained investment banker, attorney or accountant) not to do any of the foregoing.

An acquisition proposal is any offer or proposal, including a tender or exchange offer, by a third party or group with respect to Palm or Handspring that would result in any of the following:

Index to Financial Statements

Under the merger agreement, each of Palm and Handspring agreed to cease, as of June 4, 2003, all existing activities, discussions or negotiations with any parties conducted prior to that date with respect to any acquisition proposal.

Each of Palm and Handspring is obligated to promptly notify the other orally and in writing upon receipt of any type of acquisition proposal described above or any request for nonpublic information or inquiry it reasonably believes would lead to an acquisition proposal. The notice must include the material terms and conditions of the acquisition proposal, request or inquiry, the identity of the person or group making the acquisition proposal, request or inquiry and all related written materials provided in connection with the acquisition proposal, request or inquiry. Following delivery of the initial notice to the other party, the party receiving an acquisition proposal, request or inquiry of the type described above also must provide the other party with all information as is reasonably necessary to keep the other party informed in all material respects of the status and details of the acquisition proposal, request or inquiry and all written materials subsequently provided in connection with the acquisition proposal, request or inquiry. Each of Palm and Handspring further agreed to generally provide the other party with 48 hours notice of any meeting of its board of directors at which its board of directors is reasonably expected to consider any acquisition proposal.

Notwithstanding the prohibitions contained in the merger agreement with respect to the type of acquisition proposals described above, if either of Palm or Handspring receives an unsolicited written acquisition proposal that its board of directors concludes in good faith, following the receipt of the advice of its outside legal counsel and its financial advisor, satisfies, or is reasonably likely to satisfy, each of following criteria that constitute a “Superior Offer”:

then the party receiving the Superior Offer may furnish nonpublic information to, and engage in negotiations with, the third party making the acquisition proposal, if its board of directors concludes in good faith, following the receipt of advice of its outside legal counsel, that failure to do so would result in a breach of its fiduciary obligations under applicable law.

In the event that either of Palm or Handspring furnishes nonpublic information to a third party making an acquisition proposal, it is required to give the other party written notice of such action and a copy of the

Index to Financial Statements

information furnished concurrently with its delivery of such information to the potential third party acquirer. It also must enter into a confidentiality agreement with the third party on terms which are at least as restrictive as the terms contained in the confidentiality agreement entered into between Palm and Handspring. The confidentiality agreement may not contain any provision calling for an exclusive right to negotiate with such third party. In addition, in the event that a party enters into negotiations with a third party making an acquisition proposal, it is required to concurrently give the other party written notice of its intention to do so.

Obligations of the Palm Board of Directors and Handspring Board of Directors with Respect to their Recommendations and Holding a Meeting of their Stockholders

The Palm board of directors agreed to call, hold and convene a meeting of its stockholders promptly after the registration statement of which this joint proxy statement/prospectus forms a part is declared effective by the Securities and Exchange Commission and the registration statement filed by PalmSource with respect to the PalmSource distribution of its common stock is declared effective by the Securities and Exchange Commission, to vote on the merger agreement, the Parent merger and the issuance of the shares of Palm common stock in connection with the Handspring merger. The Palm board of directors also agreed to recommend the approval and adoption of the merger agreement and approval of the Parent merger and approval of the issuance of shares of Palm common stock in connection with the Handspring merger to its stockholders and to use all reasonable efforts to obtain the required stockholder approval. The Handspring board of directors agreed to call, hold and convene a meeting of its stockholders promptly after the registration statement of which this joint proxy statement/prospectus forms a part is declared effective by the Securities and Exchange Commission and the registration statement filed by PalmSource with respect to the PalmSource distribution of its common stock is declared effective by the Securities and Exchange Commission, to vote on the merger agreement an the Handspring merger. The Handspring board of directors also agreed to recommend the approval and adoption of the merger agreement and approval of the Handspring merger to its stockholders and to use all reasonable efforts to obtain the required stockholder approvals and adoption. Notwithstanding each of the Palm board of directors’ and the Handspring board of directors’ obligations described in this paragraph, in response to a third party acquisition proposal deemed by the board of directors to be a Superior Offer, the board of directors of Palm or Handspring, as the case may be, may withhold, withdraw, amend or modify its recommendation to its stockholders as described in this paragraph and, in the case of a Superior Offer that is a tender or exchange offer made directly to its stockholders, may recommend that its stockholders accept the tender or exchange offer if the following conditions are met:

If a Superior Offer has been made to Handspring, prior to effecting a change in its recommendation to its stockholders as described above, Handspring must provide Palm with a reasonable opportunity to make

Index to Financial Statements

adjustments to the terms and conditions of the merger agreement in a manner that would allow Handspring to proceed with its recommendation in favor of the Handspring merger without effecting a change of recommendation, but such opportunity does not extend the three business day period after which the Handspring board may change its recommendation.

Regardless of whether the board of directors of either of Palm or Handspring has received an acquisition proposal or has withheld, withdrawn, amended or modified its recommendation to its stockholders, each of Palm and Handspring is obligated under the terms of the merger agreement to call, give notice of, convene and hold a meeting of its stockholders to consider and vote upon its respective proposal. Prior to the termination of the merger agreement by its terms, neither Palm nor Handspring is permitted under the merger agreement to submit to the vote of its respective stockholders any acquisition proposal, or propose to do so except for the transaction contemplated by the merger agreement.

Treatment of Awards Outstanding under Palm Stock Plans and Outstanding Warrants

When the PalmSource distribution is completed, each outstanding option to purchase shares of Palm common stock will continue in effect. Each option will be subject to all of the terms and conditions set forth in the applicable documents evidencing such Palm option immediately prior to the PalmSource distribution, including any repurchase rights or vesting provisions, except that each such option will be adjusted so that it will be exercisable for an additional number of shares of Palm common stock equal in fair market value to the consideration to be received by holders of Palm common stock in connections with the PalmSource distribution. This adjustment will be accomplished by multiplying the number of shares for which the option is exercisable by a ratio, the numerator of which will be the closing sales price of Palm common stock on the last full day of trading prior to the PalmSource distribution and the denominator of which will be the opening sales price of Palm common stock on the first full day of trading after the PalmSource distribution, and multiplying the exercise price at which such option will be exercisable by the inverse of that ratio. Palm’s board of directors and its compensation committee believe that this adjustment is required by or advisable under the terms of Palm’s stock option plans. Accordingly, on July 1, 2003, Palm’s board of directors amended Palm’s 1999 Stock Plan and Amended and Restated 1999 Director Option Plan to reserve additional shares of Palm’s common stock for the sole purpose of effecting such an adjustment. For those employees who are employees of PalmSource, their Palm options will be adjusted as provided above, except that any unvested Palm options will terminate on the distribution date, and such PalmSource employees shall be deemed terminated under their Palm option agreements, giving them a limited number of days to exercise vested Palm options before they expire.

When the PalmSource distribution is completed, outstanding rights to purchase shares of Palm common stock under the Palm 1999 Employee Stock Purchase Plan will continue in effect. Each purchase right will be subject to all of the terms and conditions set forth in the Palm 1999 Employee Stock Purchase Plan and the documents governing such purchase right, except that the purchase price of the shares of Palm common stock for each respective purchase date for each purchase right will be the lower of (a) the product determined by multiplying eighty-five percent (85%) of the fair market value of Palm common stock on the offering date of each offering period outstanding at the time of the PalmSource distribution by a ratio, the numerator of which will be the opening sales price of Palm common stock on the first full day of trading after the PalmSource distribution and the denominator of which will be closing sales price of Palm common stock on the last full day of trading prior to the PalmSource distribution or (b) eighty-five percent (85%) of the fair market value of Palm common stock on each purchase date of each such offering period occurring after the PalmSource distribution.

Index to Financial Statements

Palm the number of shares of PalmSource common stock which the warrant holder would have been entitled to receive if the warrant holder had exercised the warrant prior to the transaction. If the warrant is exercised following the PalmSource distribution, Palm would likely acquire shares of PalmSource common stock through market purchases.

When the Handspring merger is completed, Palm will assume outstanding options to purchase shares of Handspring common stock and convert them into options to purchase shares of Palm common stock. Palm will convert each assumed Handspring option into an option to purchase that number of shares of Palm common stock equal to the number of shares of Handspring common stock purchasable pursuant to the Handspring option immediately prior to the effective time of the Handspring merger, multiplied by the exchange ratio, rounded down to the nearest whole number of shares of Palm common stock. The exercise price per share will be equal to the exercise price per share of Handspring common stock divided by the exchange ratio, rounded up to the nearest whole cent. Each assumed option will continue to have and be subject to all other terms and conditions set forth in the applicable documents evidencing such Handspring option immediately prior to the effective time of the Handspring merger, including any repurchase rights or vesting provisions. As of May 31, 2003, options for approximately 21,388,695 shares of Handspring common stock were outstanding in the aggregate under various Handspring stock option plans.

Palm will also assume outstanding Handspring warrants and convert them into warrants to purchase Palm common stock. The number of shares into which each Handspring Warrant will be converted and the exercise price of each such warrant will be adjusted in the same manner as Handspring options. As of August 22, 2003, warrants for 9,150,000 shares of Handspring common stock were outstanding.

Shortly after the Handspring merger is completed, Palm will file a registration statement on Form S-8 with the Securities and Exchange Commission, to the extent available, for the shares of Palm common stock issuable with respect to Handspring options assumed by Palm in connection with the Handspring merger.

Handspring’s employee stock purchase plan permits eligible Handspring employees to purchase Handspring common stock at a discount to its market price. Prior to the effective time of the Handspring merger, the Handspring employee stock purchase plan will be terminated. The last business day prior to (or, alternatively, if more practicable, the last payroll date prior to) the effective time of the Handspring merger shall become the last day of the offering period in connection with the Handspring employee stock purchase plan, and pro rata adjustments to the rights of employees in the Handspring employee stock purchase plan will be made to reflect the shortened offering period. Each shortened offering period will otherwise be treated as a fully effective and completed offering period for all purposes under the Handspring employee stock purchase plan.

In the merger agreement, Palm and Handspring have stated their intent to confer and work together to agree upon mutually acceptable employee benefit and compensation arrangements for employees of Handspring following completion of the Handspring merger. Handspring employees will generally be granted credit for service with Handspring, except to the extent such service credit will result in the duplication of benefits and subject to certain restrictions. Palm has agreed to use commercially reasonable efforts to (A) waive certain limitations under applicable medical, dental or health plans, and (B) credit deductibles or out of pocket expenses incurred by Handspring employees. Palm will also use all reasonable efforts to provide Handspring employees who continue to be employed by Palm after the completion of the Handspring merger an opportunity to enroll in a special offering period under Palm’s employee stock purchase plan.

Index to Financial Statements

Under the merger agreement, the statement in the preceding paragraph regarding employee benefit matters are statements of intent only, and no Handspring employee or other person or entity, including Handspring, has any rights of enforcement relating to those statements and no Handspring employee or other person or entity, including Handspring, is intended to be a contractual beneficiary of the statements.

The Palm board of directors agreed to take all actions necessary such that, immediately following completion of the Handspring merger, the Palm board of directors will be comprised of ten directors, and will include three Handspring directors, who will be Donna L. Dubinsky, Bruce W. Dunlevie and L. John Doerr. However, if one or more of those persons is not able or available to serve as a director of Palm following completion of the Handspring merger, then Handspring may designate another person on the Handspring board of directors that is acceptable to Palm to serve instead, as long as at least two of the newly appointed directors are “independent directors” under the rules of Nasdaq with respect to Handspring and Palm.

Regulatory Filings; Antitrust Matters; Reasonable Efforts to Obtain Regulatory Approvals

Each of Palm, Harmony Acquisition Corporation and Handspring agreed to coordinate and cooperate with one another and use all reasonable efforts to comply with, and refrain from actions that would impede compliance with, applicable laws, regulations and any other requirements of any governmental entity. Each of Palm and Handspring also agreed to make all filings and submissions required by any governmental entity in connection with the transaction and the other transactions contemplated by the merger agreement, including the following:

Except as prohibited or restricted by applicable law, each of Palm and Handspring generally agreed to do the following:

Subject to the provisions described in “—Palm and Handspring Prohibited from Soliciting Other Offers” beginning on page 108 of this joint proxy statement/prospectus, “—Obligations of the Palm Board of Directors and Handspring Board of Directors with Respect to their Recommendations and Holding a Meeting of their Stockholders” beginning on page 110 of this joint proxy statement/prospectus and “—Limitation on Reasonable Efforts to Obtain Regulatory Approvals” immediately following this paragraph, each of Palm and Handspring

Index to Financial Statements

agreed to use all reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, all things necessary, proper or advisable to complete the transactions contemplated by the merger agreement in the most expeditious manner practicable.

Neither Palm nor any of its subsidiaries or affiliates is required to, and Handspring may not, without the prior written consent of Palm, make proposals, execute or carry out agreements or submit to any applicable laws, regulations and any other requirements of any governmental entity providing for:

The respective obligations of each party to the merger agreement to complete the transactions contemplated by the merger agreement are subject to the satisfaction or waiver of each of the following conditions:

Index to Financial Statements

In addition, the obligation of Handspring to complete the transaction and the other transactions contemplated by the merger agreement are subject to the satisfaction or waiver by Handspring of the following additional conditions:

In addition, the obligation of Palm, Peace Separation Corporation and Harmony Acquisition Corporation to complete the transaction is subject to the satisfaction or waiver by Palm of the following additional conditions:

Index to Financial Statements

In addition, the completion of the PalmSource distribution is a condition to the obligations of each party to effect the Handspring merger, and the satisfaction or waiver of all conditions by both parties to the Handspring merger listed above is a condition to Palm’s obligation to effect the PalmSource distribution.

Under the terms of the merger agreement, a “Material Adverse Effect” on either Palm or Handspring is defined to mean any change, event, violation, inaccuracy, circumstance or effect, individually or when taken together, that is or is reasonably likely to: (A) be materially adverse to the business, assets (including intangible assets), capitalization, financial condition or results of operations of the company taken as a whole with its subsidiaries, or in the case of Handspring, Handspring taken as a whole with its subsidiaries, or in the case of Palm, Palm taken as a whole with its subsidiaries or (B) materially impede the authority of the company to complete the transactions contemplated by the merger agreement. However, under the terms of the merger agreement, none of the following will be deemed to constitute a Material Adverse Effect on Palm or Handspring, as the case may be:

For purposes of determining whether a Material Adverse Effect with respect to Palm has occurred, only changes, events, violations, inaccuracies, circumstances or effects that relate to the Solutions Group business of Palm will be taken into account, and effects relating to PalmSource or its subsidiaries, including the

Index to Financial Statements

development, licensing or provision of the Palm operating system, will not be taken into account, except to the extent that such effects would or would be reasonably likely to adversely affect Palm following the transaction (taking into account the terms of the separation agreements).

The merger agreement may be terminated at any time prior to completion of the Handspring merger by action of the board of directors of Palm or Handspring, as the case may be, either before or after the requisite approvals of the stockholders of Palm or Handspring have been obtained:

Index to Financial Statements

Each of Palm and Handspring has agreed to pay to the other a termination fee of $4,500,000 if all of the following conditions are met:

The termination fee is payable within two business days following the earlier to occur of: (i) the entering into of an agreement by Palm or Handspring, as the case may be, within 12 months following termination of the merger agreement providing for an acquisition of the type described below; or (ii) the completion of an acquisition of Palm or Handspring, as the case may be, as described below, by the party entering into such transaction.

Index to Financial Statements

Each of Palm and Handspring have agreed to pay to the other a termination fee of $1,500,000 within two business days of the termination of the merger agreement if the merger agreement is terminated by the other party (prior to such party obtaining its requisite stockholder approval) because of the occurrence of a Triggering Event with respect to such party.

In addition, each of Palm and Handspring have agreed to pay an additional termination fee of $3,000,000 to the other in the event that either of the following has occurred after termination of the merger agreement for the reasons indicated immediately above:

Under the terms of the merger agreement, an acquisition of either Palm or Handspring, as applicable, for the purposes of these termination provisions, is any of the following:

Payment of the termination fee is not in lieu of damages incurred in the event of breach of the merger agreement. If the party entitled to payment of the termination fee has to make a claim against the other party and such claim results in a judgment against the other party, the party required to pay the termination fee will also have to pay the other party’s reasonable costs and expenses in connection with the suit together with interest on the unpaid termination fee.

The merger agreement may be amended by mutual written consent of Palm, Handspring, Peace Separation Corporation and Harmony Acquisition Corporation, subject to all applicable laws. Any amendment proposed after obtaining the required approvals of the stockholders of Palm and Handspring may not be made without the further approval of such stockholders, if required by applicable laws or the rules of any relevant stock exchange or the Nasdaq National Market.

At any time prior to completion of the Handspring merger, either Palm or Handspring may extend the other’s time for the performance of any of the obligations or other acts under the merger agreement, waive any inaccuracies in the other’s representations and warranties and waive compliance by the other with any of the agreements or conditions contained in the merger agreement.

Index to Financial Statements

Agreement to Vote. Each of Edward T. Colligan, Donna L. Dubinsky and Jeffrey C. Hawkins has entered into a voting agreement with Palm. Each of these Handspring directors and officers has agreed to vote all of (or in the case of Jeffrey C. Hawkins, a portion of) his or her shares of Handspring common stock, including shares of Handspring common stock acquired after the date of the voting agreements, in favor of approval of the Handspring merger, adoption and approval of the merger agreement, and in favor of any matter that could reasonably be expected to facilitate the Handspring merger, against any proposal made in opposition to, or in competition with, the Handspring merger, against any other matter that could reasonably be expected to facilitate any acquisition or purchase of the Handspring’s assets or capital stock by any person other than Palm and against any other action that would delay or adversely affect the Handspring merger. These stockholders have the right, as of the Handspring record date, to vote a total of shares of Handspring common stock or approximately % of the outstanding shares of Handspring common stock as of the Handspring record date.

Each of Edward T. Colligan, Donna L. Dubinsky and Jeffrey C. Hawkins has also granted to Palm an irrevocable proxy to vote the shares of Handspring common stock subject to the voting agreement in accordance with its terms.

Transfer Restrictions. The voting agreements restrict the ability of each stockholder that is a party to the agreement to sell, pledge, encumber, grant an option with respect to, transfer or otherwise dispose of the shares of Handspring common stock subject to the agreement, either directly or indirectly, or agree to do any of the foregoing, without the prior written consent of Palm unless to a family member of such stockholder if the family member agrees to be bound by the terms and provisions of the agreement and delivers a proxy to Palm. The voting agreement also prohibits the ability of each stockholder to deposit, or permit the deposit of, any such shares in a voting trust, grant any proxy in respect of the shares or enter into any voting agreement or similar arrangement with respect to any of the shares, other than pursuant to the agreement.

Termination. The obligations under the voting agreements and the irrevocable proxies will terminate upon the earlier to occur of the termination of the merger agreement and the completion of the Handspring merger. The voting agreements provide that voting agreements will not, and it is the intent of the parties that the voting agreements will not, preclude the board of directors of Handspring or any member thereof from exercising their fiduciary duties as required by applicable law.

Agreement to Vote. Each of Eric Benhamou, Todd Bradley, Judy Bruner, Gordon A. Campbell, Gareth C.C. Chang, Jean-Jacques Damlamian, Michael Homer, David Nagel and Susan G. Swenson has entered into a voting agreement with Handspring. Each of these Palm directors and officers has agreed to vote all of his or her shares of Palm common stock, including shares of Palm common stock acquired after the date of the voting agreements, in favor of the adoption and approval of the merger agreement and approval of the issuance of Palm common stock in connection with the Handspring merger, in favor of any matter that could reasonably be expected to facilitate the transaction, against any proposal made in opposition to, or in competition with, the transaction and against any other action that would delay or adversely affect the transaction. These stockholders have the right, as of the Palm record date, to vote a total of shares of Palm common stock or approximately % of the outstanding shares of Palm common stock as of the Palm record date.

Each of Eric Benhamou, Todd Bradley, Judy Bruner, Gordon A. Campbell, Gareth C.C. Chang, Jean-Jacques Damlamian, Michael Homer, David Nagel and Susan G. Swenson has also granted to Palm an irrevocable proxy to vote his or her shares of Palm common stock in accordance with the terms of the voting agreement.

Index to Financial Statements

Transfer Restrictions. The voting agreements restrict the ability of each stockholder that is a party to the agreement to sell, pledge, encumber, grant an option with respect to, transfer or otherwise dispose of the shares of Palm common stock subject to the agreement, either directly or indirectly, or agree to do any of the foregoing, without the prior written consent of Handspring unless to a family member of such stockholder if the family member agrees to be bound by the terms and provisions of the agreement and delivers a proxy to Handspring. The voting agreement also prohibits the ability of each stockholder to deposit, or permit the deposit of, any such shares in a voting trust, grant any proxy in respect of the shares or enter into any voting agreement or similar arrangement with respect to any of the shares, other than pursuant to the agreement.

Termination. The obligations under the voting agreements and the irrevocable proxies will terminate upon the earlier to occur of the termination of the merger agreement and the completion of the Handspring merger. The voting agreements provide that voting agreements will not, and it is the intent of the parties that the voting agreements will not, preclude the board of directors of Palm or any member thereof from exercising their fiduciary duties as required by applicable law.

Transfer Restrictions. The transfer restriction agreements restrict the ability of each stockholder that is a party to the agreement to sell, pledge, encumber, grant an option with respect to, transfer or otherwise dispose of the shares of Handspring common stock subject to the agreement, either directly or indirectly, or to agree to do any of the foregoing, without the prior written consent of Palm. The transfer restriction agreements provide for limited exceptions to transfer shares to a family member of such stockholder or to a trust for the benefit of such stockholder or member of such stockholder’s family if the family member or trust agrees to be bound by the terms and provisions of the agreement, or if the stockholder is a venture capital limited liability corporation or partnership, for a distribution without consideration of all or any portion of the shares to its constituents in proportion to their ownership interests, or with respect to Jeffrey C. Hawkins only, in accordance with the terms of his Rule 10b5-1 trading plan.

The transfer restriction agreements also require each stockholder that is a party to the agreement to revoke any proxy previously given with respect to any of the shares and restricts the ability of each stockholder to deposit, or permit the deposit of, any of their shares in a voting trust, grant any proxy in respect of the shares other than to Palm, or enter into any voting agreement or similar arrangement with respect to any of the shares.

Termination. The obligations imposed in the transfer restriction agreements will terminate upon the earlier to occur of the termination of the merger agreement and the completion of the Handspring merger.

No Solicitation. Commencing at the effective time of the Handspring merger and continuing for a period of two years, each of Edward T. Colligan, Donna L. Dubinsky and Jeffrey C. Hawkins agrees not to solicit, encourage, or take any other action which is intended to induce or encourage, any employee of Palm to terminate his or her employment with Palm, or to solicit business in any territory where Palm is engaged in business, or otherwise distributes, licenses or sells its products or renders services, relating to a competitive business activity, as defined in the agreement.

No Competition. Commencing on the effective time of the Handspring merger and continuing for a period of two years, each of Edward T. Colligan, Donna L. Dubinsky and Jeffrey C. Hawkins agrees not to engage in a competitive business activity, as defined in the agreement, in any territory where Palm is engaged in business, or otherwise distributes, licenses or sells its products or renders services, without the prior written consent of Palm.

Index to Financial Statements

Secured Term Loan Facility. In connection with the merger agreement, Palm and Handspring have entered into a loan agreement pursuant to which Palm will provide up to $20 million in term loans to Handspring. The term loans will be secured by a first priority security interest against substantially all of the assets and property of Handspring.

Interest and Repayment Terms. Interest will accrue on the term loans at an annual interest rate equal to the prime rate plus 3% and be payable at the end of each calendar quarter. The term loans will mature upon the earliest of:

A maturity event of extension will occur pursuant to the terms of the loan agreement if each of the following occurs:

Handspring will have the right to prepay the terms loans at any time without penalty or premium. Handspring shall be required to prepay the term loans:

Index to Financial Statements

Conditions to Lending. Up to $10 million of term loans will be available for Handspring to borrow from June 26, 2003 until September 26, 2003, or, if earlier, the date on which the merger agreement is terminated, provided that the following conditions are satisfied:

Up to $20 million, inclusive of the initial $10 million referenced in the previous paragraph, of term loans will be available for Handspring to borrow from September 26, 2003, or, if earlier, the date on which a funding event of extension occurs pursuant to the terms of the loan agreement, until the date of maturity of the term loans, provided that:

A funding event of extension will occur pursuant to the terms of the loan agreement at any time that a maturity event of extension occurs, other than a maturity event of extension with respect to a termination of the merger agreement pursuant to clauses (8) and (11) of “The Merger Agreement—Termination of the Merger Agreement” beginning on page 117 of this joint proxy statement/prospectus, provided that a funding event of extension will be deemed to have occurred in the case of Palm’s willful breach of any representation, warranty, covenant or agreement contained in the merger agreement.

Covenants. Prior to the termination of the Merger Agreement, Handspring shall be subject to the covenants relating to its business as described in “The Merger Agreement—Conduct of Business Before Completion of the Transaction” beginning on page 105 of this joint proxy statement/prospectus. After the termination of the merger agreement, Handspring shall be subject to covenants customary for a credit facility of this type, including, among others, restrictions on the ability of Handspring and its subsidiaries to incur indebtedness or liens, dispose of assets, enter into mergers and acquisitions, make investments or loans, pay dividends and distributions, make capital expenditures, make changes in their business, make payments on indebtedness, or enter into transactions with affiliates.

Events of Default. The loan agreement contains customary events of default for a credit facility of this type, including, among others, failure to make payments when due, breaches of covenants, breaches of representations and warranties, cross-default to other indebtedness, bankruptcy and insolvency defaults, unsatisfied judgment defaults, defaults with respect to loan documents and ERISA defaults.

Index to Financial Statements

Effective December 3, 2001, which we refer to as the separation date in this joint proxy statement/prospectus, Palm and PalmSource entered into certain agreements to generally provide for the assignment by Palm of assets, and the assumption by PalmSource of liabilities, related to the business of licensing the Palm OS. We refer to the business of licensing the Palm OS as the PalmSource business. The purpose of the separation was to establish PalmSource as an independent company. In June 2003, Palm and PalmSource entered into additional agreements, some of which amended or amended and restated separation agreements previously entered into by the parties, and others further allocated assets and liabilities between Palm and PalmSource in light of circumstances existing at that time.

A summary description of the principal separation agreements between the parties is set forth below. The following summary describes certain provisions of the principal separation agreements, but the provisions of the separation agreements are complicated and not easily summarized. This summary may not contain all of the information about the separation agreements that is important to you. Each separation agreement has been filed as an exhibit to the registration statement of which this joint proxy statement/prospectus is a part, and is available to you upon request.

The amended and restated master separation agreement, or master separation agreement, outlines the general terms and conditions of the separation of PalmSource from Palm and the general intent of the parties as to how these matters have and will be undertaken and completed.

The Separation. The separation was effected as of December 3, 2001. As of the effective date of the separation, Palm and PalmSource entered into additional ancillary agreements with each other that govern the transfer of assets and liabilities from Palm to PalmSource and the various relationships between Palm and PalmSource following the separation.

Covenants. In addition to transferring control and ownership of various assets and liabilities from Palm to PalmSource, Palm and PalmSource agree to exchange certain information, limit the solicitation of each party’s employees and resolve disputes in particular ways.

Accounting Practices. So long as Palm is required to consolidate PalmSource’s results of operations and financial position, PalmSource agrees to:

Palm agrees to provide PalmSource with all relevant information to enable PalmSource to prepare its financial statements and to grant its internal auditors access to Palm’s records.

Expenses. PalmSource and Palm agree to bear their respective costs and expenses incurred in connection with the separation, except that certain separation costs and expenses are allocated between PalmSource and Palm.

Index to Financial Statements

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

All of the agreements between Palm and PalmSource relating to the separation contain similar dispute resolution provisions.

No Representations and Warranties. Palm does not make any representations or warranties to PalmSource regarding:

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

The general assignment and assumption agreement, as amended, or assignment agreement, identifies the assets and liabilities relating to the PalmSource business that Palm transferred to PalmSource and PalmSource accepted from Palm as part of the separation. This agreement also describes when and how the transfers occurred.

Asset Transfer. Pursuant to the assignment agreement, Palm transferred the following assets to PalmSource:

Index to Financial Statements

Assumption of Liabilities. The assignment agreement provides for the assumption of the following liabilities by PalmSource:

Assets and Liabilities Not Transferred. If PalmSource and Palm discover that specific assets or liabilities that are primarily related to the PalmSource business were not transferred or assumed pursuant to the assignment agreement, PalmSource and Palm agree to cooperate in good faith to effect the transfer, or re-transfer, or assumption or re-assumption of those assets or liabilities.

Delayed Transfers. If the transfer of any assets and liabilities is not consummated prior to or on the separation date, the assignment agreement provides that these assets and liabilities will be transferred after the separation date.

Terms of Other Ancillary Agreements Govern. To the extent that another ancillary agreement expressly provides for the transfer of an asset or an assumption of a liability, the terms of such other ancillary agreement will determine the manner of the transfer and assumption.

Obtaining Approvals and Consents. PalmSource and Palm both agree that if the transfer of an asset or an assumption of a liability would be a violation of applicable laws or require any consent or governmental approval, then the transfer or assignment shall be automatically deemed deferred until such time as all legal impediments are removed and/or such consents or governmental approvals have been obtained and PalmSource and Palm both agree to use commercially reasonable efforts to accomplish such transfer or assignment.

Nonrecurring Costs and Expenses. Any nonrecurring costs and expenses that are not allocated in the master separation agreement, the assignment agreement or any other ancillary agreement shall be the responsibility of the party that incurs such costs and expenses.

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

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

Index to Financial Statements

Source Code Licenses. The software license agreement provides for three mechanisms by which PalmSource provides Palm with access and license rights to certain source code, subject to confidentiality obligations. PalmSource provides to Palm (1) a copy of the source code for alpha, beta and gold master releases of the operating system software, which may be modified for error corrections and certain types of optimizations, (2) limited sets of modules of source code specified in source code attachments, which may be modified for the specific purpose identified in the attachment, and (3) after the strategic collaboration agreement between the parties becomes effective, the parties may enter into certain co-development agreements whereby Palm receives controlled live access to certain source code under development for new versions of the operating system software.

Compatibility Testing Requirement and Changes to Test Criteria. Palm may not distribute Palm hardware products that use the licensed software unless the products have satisfied compatibility testing requirements. PalmSource will use reasonable discretion in determining the test criteria for new functionality and will follow a procedure to provide Palm with the test criteria, and to limit changes to the test criteria, in connection with alpha, beta and gold master releases of the operating system software. PalmSource retains broad discretion under the agreement to determine whether source code modifications made by Palm may be released and the test criteria that will apply to those modifications.

Source Code Escrow. For applications licensed under the software license agreement where source code is not otherwise provided, PalmSource will deposit into escrow the source code for those applications. The escrow material will be released to Palm if: (a) PalmSource rejects the software license agreement in bankruptcy; (b) Microsoft Corporation acquires more than 50% of the voting equity of PalmSource; or (c) PalmSource or its successor breaches its support or maintenance obligations and (i) fails to cure 30 days after notice or (ii) has materially breached the software license agreement at least three times in the preceding 12 months. Palm receives a license to use the released escrow material to make error corrections.

Acquisition of PalmSource. If Microsoft Corporation acquires more than 50% of the voting equity of PalmSource: (a) the minimum annual payment obligations of Palm under the software license agreement will cease to apply; (b) the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension; (c) the escrow material will be released to Palm as described above; and (d) Palm will have a license to modify (for any purpose without restriction) the escrow material and the source code for releases of the operating system software licensed to Palm under the software license agreement. If a hardware competitor of Palm (as defined in the software license agreement) acquires more than 50% of the voting equity of PalmSource, the minimum annual payment obligations of Palm under the software license agreement will cease to apply and the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension. If an entity, other than those described above, acquires more than 50% of the voting equity of PalmSource, Palm will have the option of extending the software license agreement for two years, with the royalty rate and minimum annual payment obligations for Palm during the extension being the same as during the final contract year.

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

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

Palm may request the right to sublicense certain rights to third party contractors for developing, manufacturing, testing and supporting Palm hardware products that use the operating system software as its

Index to Financial Statements

primary operating system. PalmSource will not unreasonably withhold approval of contractors, provided that no sublicensing shall be permitted unless and until expressly approved in writing by PalmSource. Palm may not permit a contractor to exercise these sublicense rights and also act as a distributor (other than a single contract manufacturer/distributor in Brazil that is permitted due to local tax regulations).

Royalties. The software license agreement also sets forth fees for bundled sales and stand-alone sales of products with respect to the operating system software and additional applications, which fees are calculated based on percentages of net revenue and/or a per unit basis. In addition, Palm pays PalmSource a non-refundable royalty of $6.0 million for the source code licenses for the period of June 4, 2003 to December 3, 2006, payable in three annual installments.

Maintenance and Support Fees. The software license agreement provides for annual maintenance and support fees with respect to the operating system software and certain additional applications, subject to increase after the first contract year by up to 10% per year. The annual maintenance and support fees relating to the operating system software will increase upon the close of the Handspring merger.

Minimum Annual Payment. Palm is obligated to make a minimum annual payment of certain royalties and support and maintenance fees. If Palm does not reach the minimum annual payments set forth in the software license agreement in any contract year, Palm must make a payment equal to the amount of the shortfall. The minimum annual payment for contract year 2003 is $37.5 million, contract year 2004 is $39.0 million, contract year 2005 is $41.0 million and contract year 2006 is $42.5 million, with each contract year ending on December 3.

Updates, Upgrades and New Versions. PalmSource will deliver to Palm all updates, upgrades and new versions to the operating system software and certain additional applications, provided Palm has paid PalmSource the applicable maintenance and support fees.

Most Favored Licensee. The following preference provisions are conditioned upon Palm’s continued obligation to pay the minimum annual payments under the software license agreement.

Proprietary Rights. PalmSource owns the operating system software and additional applications licensed under the software license agreement, and all derivative works and discrete modifications to such software and additional applications made by or for Palm, including modifications and extensions to the application program interface, or APIs, and applications that operate with operating system software through unpublished system APIs. PalmSource grants a license back to Palm under inventions and patents assigned by Palm to PalmSource in

Index to Financial Statements

connection with those modifications. Subject to PalmSource’s ownership of these items, Palm owns the Palm hardware products that use the operating system software as its primary operating system and Palm software. Palm also retains ownership of certain replacement fragments and independently developed applications that interact with the operating system software solely through published system APIs. Palm also grants covenants not to assert intellectual property rights retained by Palm that are embodied in whole or in part in its modifications, or certain replacement fragments and modules used with the operating system software.

Indemnification by PalmSource. Except for the Xerox litigation described more fully in this joint proxy statement/prospectus and subject to the limitation on liability in the software license agreement, PalmSource agrees to defend Palm, and pay any settlements or damages awarded, for claims alleging that an unmodified production release of the licensed operating system software, additional applications (other than a specified e-mail product), end-user documentation or compatibility trademarks, as delivered, infringe (a) patents in the U.S. and other specified countries, (b) world-wide copyrights or trade-secrets, or (c) registered trademark rights in the U.S. and other specified countries. If an injunction requires Palm to recall products from its own inventory or its own distribution channels (which products have not been sold to end-users), then PalmSource will indemnify Palm for its out of pocket costs for retrieving and re-working such products, up to the per unit royalty actually paid by Palm for such specific units recalled. If an injunction causes a shortfall against a minimum annual payment, that minimum annual payment will be reasonably reduced on a pro rata basis as reasonably adjusted for seasonality, if no other versions of the licensed operating system software or additional applications are available that would permit Palm to continue shipping products.

Indemnification by Palm. Subject to the limitation on liability in the software license agreement, Palm agrees to defend PalmSource, and pay any settlements or damages awarded, for claims alleging that: (a) the Palm hardware products that use the operating system software as its primary operating system, Palm software, or Palm trademarks infringe (i) patents in the U.S. and other specified countries, (ii) world-wide copyrights or trade-secrets, or (iii) registered trademark rights in the U.S. and other specified countries, or (b) certain developments to the operating system software made by Palm, or any Palm pre-existing material incorporated into those developments or PalmSource’s source code tree, infringe the copyrights or misappropriate the trade secrets of a third party. In addition, subject to the limitation on liability in the software license agreement, Palm will indemnify and defend PalmSource for claims for bodily injury, death and damage to tangible property as a result of the Palm hardware products that use the operating system software as its primary operating system.

Limitation on Liability. Except for each party’s indemnity obligations and breach of the confidentiality provisions, neither party is liable for any incidental, consequential, indirect, special or punitive damages, loss of revenue, or loss of business. Except for express payment obligations and breach by Palm of the scope or confidentiality obligations of the source code license, each party’s total cumulative liability under the software license agreement is limited to $50,000,000.

Assignability. Each party may assign the software license agreement to a successor of all or substantially all of its stock or assets, except that the source code licenses will terminate upon an assignment by Palm. Any other assignment requires consent from the other party. If a competitor of PalmSource (as defined in the software license agreement) acquires more than a 50% interest in Palm, then the source code access and license provisions, provisions providing for customer technology briefings and the most favored licensee provisions terminate. If a competitor of Palm (as defined in software license agreement) acquires more than a 50% interest in PalmSource, then provisions providing for customer technology briefings and sharing of customer data terminate. Upon close of the merger agreement with Handspring, (a) Handspring products will be included under the software license agreement as Palm hardware products that use the operating system software as its primary operating system, and no further payments will accrue under PalmSource’s operating system license agreement with Handspring, (b) maintenance and support fees for the operating system software will be increased to $600,000 annually, (c) the existing Handspring source code attachments will survive, and (d) PalmSource’s operating system license agreement with Handspring will otherwise terminate.

Index to Financial Statements

Palm Digital Media. Palm will use good faith efforts to include a certain application related to PalmSource’s Palm Digital Media subsidiary in a Palm hardware product, and provide certain marketing services for that application. PalmSource agreed to supply upgrades and new versions of that application that are generally released by PalmSource to licensees free of charge. In connection with the sale of the Palm Digital Media product line to PalmGear on August 29, 2003, PalmSource assigned these obligations to PalmGear.

Term and Termination. The term of the software license agreement is five years, from December 3, 2001 until December 2, 2006. Each party has the right to terminate (a) for certain bankruptcy-related events or (b) for material breach by the other party which remains uncured 30 days after notice, and which the parties are unable to resolve after 30 days of good faith discussions. A breach by a contractor, private label partner or subsidiary of Palm may be treated as a material breach by Palm if Palm fails to take specified remedial actions. The software license agreement includes a wind-down period that varies depending on which party causes the termination. Except in the case of partial termination by PalmSource, Palm shall pay a pro rata portion of the minimum annual payment for the then current contract year, based on the percentage of the contract year for which the software license agreement was in effect prior to the effective date of termination. No further minimum annual payments will be due. In the event of a material breach that would entitle PalmSource to terminate the software license agreement, PalmSource may elect to terminate only a subset of the provisions under the software license agreement (including source code access, right to sublicense to private label partners or subsidiaries, and the most favored licensee clauses). In such case, Palm shall remain obligated to continue making all minimum annual payments remaining under the software license agreement and may continue to distribute the Palm hardware products that use the operating system software as its primary operating system.

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

Under the SDIO license agreement, Palm grants PalmSource a license to use and distribute the SDIO software drivers in object code form for use with certain PalmSource products. SDIO is an acronym for secure digital input output. Palm also grants PalmSource a license to create certain modifications of the SDIO software drivers in source code form, and to distribute such modifications in object code form.

If Palm makes modifications to the SDIO software drivers it must include such modifications in an update, upgrade or new version of the SDIO software drivers. Palm owns all rights in the SDIO software drivers. PalmSource or its sublicensees will own all rights in modifications made by or for PalmSource or its sublicensees, and PalmSource grants Palm a license to those modifications.

Except for breach of the license or confidentiality obligations, both parties disclaim consequential damages and each party’s liability is limited to $1,000,000 under the SDIO license agreement. The SDIO license agreement is effective until November 26, 2007, and certain licenses survive the termination of the SDIO license agreement. PalmSource will pay, indemnify and hold Palm harmless from any tax liability arising from the SDIO License Agreement. Either party may assign the SDIO license agreement without restrictions to a purchaser of all or substantially all of the stock or assets of such party, provided that the assignee agrees to be bound by its terms.

Under the development agreement, PalmSource grants to Palm a non-exclusive, royalty-free, nontransferable license to use the source code for the most recent versions of NetLib software, plug-ins for NetLib, and related network preference panels solely for the purpose of specified development services. Palm grants PalmSource a non-exclusive, royalty-free, nontransferable license to use, modify, sublicense and sell any

Index to Financial Statements

of the specified pre-existing materials of Palm that are delivered under the development agreement or which are necessary for utilization of the work product by PalmSource.

PalmSource and its licensors will own all work product delivered under the development agreement. Palm will own the specified pre-existing materials of Palm that are delivered under the development agreement or which are necessary for utilization of the work product by PalmSource and any modifications thereof made by PalmSource. Except for liability arising from confidentiality obligations, neither party is liable to the other for consequential or punitive damages.

The amended and restated tax sharing agreement, or the tax sharing agreement, sets forth the principal arrangements between Palm and PalmSource regarding the filing of tax returns, the payment of taxes and the conduct of tax audits or other disputes. The tax sharing agreement provides for the calculation of PalmSource’s tax liability as if PalmSource were a stand-alone corporation (i.e., to the extent that PalmSource would have been liable for taxes on a stand-alone basis, it will pay Palm for such tax liability). Conversely, to the extent that any PalmSource operating losses reduce PalmSource’s tax liability as a stand-alone corporation in a future period, any required payment to Palm under the tax sharing agreement will be reduced.

Under the tax sharing agreement, Palm is required to prepare and file all Palm and PalmSource consolidated tax returns through the date of the distribution of the shares of PalmSource stock held by Palm to Palm’s stockholders, including the final consolidated Palm and PalmSource federal income tax return. PalmSource has the right to review and consent to any Palm and PalmSource consolidated returns filed after the date of such distribution, provided that it does not withhold such consent unreasonably. In addition, Palm has sole and complete authority to control and resolve all tax audits and other disputes relating to any Palm and PalmSource consolidated returns filed before and after the date of such distribution. After the date of such distribution, however, Palm may not enter into any dispute settlement that would materially increase PalmSource’s liability under the tax sharing agreement without PalmSource’s consent, which consent PalmSource cannot withhold unreasonably.

The tax sharing agreement also contains provisions requiring PalmSource to indemnify Palm for, among other things, (a) any increases in PalmSource’s stand-alone income tax liability or other consolidated tax liabilities arising as a result of any amended return, audit or other dispute and attributable to periods after December 3, 2001, (b) any increases in certain non-income taxes (including payroll and employee withholding taxes) attributable to PalmSource’s business, (c) any transfer taxes incurred on the transfer of assets by Palm to PalmSource, and (d) any tax liability incurred by Palm on account of the sale of PalmSource’s common stock in connection with the distribution of the shares of PalmSource stock held by Palm to Palm’s stockholders.

The amended and restated intercompany loan agreement, or the intercompany loan agreement, governs the outstanding $20 million intercompany loan from Palm to PalmSource Holding Company, a wholly owned subsidiary of PalmSource. PalmSource assumed all of PalmSource Holding Company’s rights and obligations under the intercompany loan agreement.

All amounts due under the intercompany loan by PalmSource will be forgiven if the PalmSource distribution occurs prior to December 3, 2004 and PalmSource issues a $15 million 5% convertible subordinated note due December 2006, the PalmSource note. To the extent that PalmSource assumes less than $15 million of the principal amount of such promissory note, PalmSource will make a new note in favor of Palm with a principal amount equal to the difference between $15 million and the principal amount assumed.

Index to Financial Statements

The maturity date of the PalmSource note will be December 6, 2006 and interest under the new note will be payable semi-annually on June 15 and December 15 each year at a per annum rate of 5%. The PalmSource note will be subordinated to all senior indebtedness of PalmSource (including borrowed money, capitalized lease obligations and secured indebtedness). PalmSource may be required to repurchase the PalmSource note within 30 trading days of a change of control at a repurchase price equal to (a) the amount of principal to be repurchased plus (b) all accrued and unpaid interest to the date of repurchase. Under the PalmSource note, PalmSource may not consolidate with, merge with or sell all or substantially all of its assets to another entity, unless such entity is organized under the laws of the United States and such entity expressly agrees to assume PalmSource’s obligations under the PalmSource note. The PalmSource note will include events of default upon the occurrence of which the holder will have the right to accelerate all outstanding obligations, including all principal and accrued and unpaid interest. The events of default in the PalmSource note will include the following (with certain cure periods): failure to make payments when due, breaches of covenants, breaches of representations and warranties, cross acceleration of indebtedness for money borrowed in excess of $10.0 million, voluntary and involuntary bankruptcy or insolvency proceedings and judgments in excess of $10.0 million.

Under the intercompany loan agreement, interest will accrue on the outstanding principal amount at a rate of 2.48% per annum. After a default under the intercompany loan agreement, interest will accrue at a rate of 7.48% per annum.

Events of default under the intercompany loan agreement include (with certain cure periods): failure to make payments when due, breaches of covenants, breaches of representations and warranties, and voluntary and involuntary bankruptcy or insolvency proceedings. Upon an event of default, the holder has the right to accelerate all outstanding obligations, including all principal and accrued and unpaid interest.

General Release of Pre-Distribution Claims. Under the amended and restated indemnification and insurance matters agreement or the indemnification and insurance agreement, on the distribution date, Palm and PalmSource will release each other from and agree not to pursue any claim based on any liabilities arising from events occurring on or before the date of such distribution, including events occurring in connection with the activities to implement the separation of PalmSource from Palm and such distribution.

Indemnification. In general, PalmSource agrees to indemnify Palm from all liabilities arising from:

In general, Palm agrees to indemnify PalmSource from all liabilities arising from:

Insurance Matters. In general, Palm agrees to maintain insurance coverage for the benefit of PalmSource during the period beginning on the separation date and ending on the date of the distribution of the shares of PalmSource stock held by Palm to Palm’s stockholders, and PalmSource agrees to reimburse Palm for premiums paid in connection with such insurance coverage. After the date of such distribution, PalmSource will be responsible for obtaining and maintaining its own insurance coverage.

Index to Financial Statements

Environmental Matters. Palm agrees to indemnify PalmSource from, among other things, all liabilities arising from environmental conditions existing prior to the separation date at facilities transferred to PalmSource, or which arise out of operations occurring on or before the separation date at such facilities. Further, Palm agrees to indemnify PalmSource from all liabilities arising from environmental conditions existing, or caused by operations occurring at any time, whether before or after the separation date, at any Palm facility (unless caused by operations of PalmSource on or after the separation date).

PalmSource agrees to indemnify Palm from all liabilities arising (a) from environmental conditions caused by operations on and after the separation date at any of the facilities transferred to PalmSource, (b) from environmental conditions at PalmSource’s facilities arising from any contamination event that occurs on or after the separation date, and (c) on certain new PalmSource facilities.

The Xerox litigation agreement governs Palm’s and PalmSource’s obligations with respect to the current patent litigation with Xerox. The agreement returns the responsibility for the defense and indemnity of the Xerox litigation from PalmSource back to Palm. This responsibility was originally allocated to PalmSource as of December 3, 2001, and PalmSource paid Palm’s defense costs from that time through May 31, 2003.

Under the Xerox litigation agreement, Palm assumes responsibility for managing the Xerox litigation, determining strategy and making most settlement decisions. Palm has management control over the Xerox litigation, but the agreement prohibits Palm from consenting to any judgment or settlement that would: (a) allow injunctive or declaratory relief to be ordered against PalmSource, (b) require PalmSource to pay any future royalties or otherwise require PalmSource to make any payment that is not fully indemnified, (c) require PalmSource to license its intellectual property, or (d) otherwise affect the business, financial condition or operations of PalmSource or its licensees in a material way.

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

The Xerox litigation agreement obligates Palm to bear the costs of the Xerox litigation that are incurred after June 1, 2003, not including the imputed costs of PalmSource’s personnel or of any independent advice PalmSource may choose to seek. Palm also must pay the amount of any damages awarded in, or agreed to in settlement of, the Xerox litigation. In the event that any damages are not paid by Palm within sixty days after the date of entry of a judgment or due date under a settlement agreement, PalmSource is obligated to pay any shortfall amounts. Any such payment by PalmSource does not, however, relieve Palm of its obligation either to make the payment or to reimburse PalmSource.

The master technology ownership and license agreement, as amended (or master technology agreement), allocates rights in non-patented intellectual property and data and provides for certain cross-licenses between Palm and PalmSource of certain such technology and data related to the Palm and PalmSource businesses. This agreement does not cover the licensing of the PalmSource operating system and certain other technology that are covered in the software license agreement and the Elaine software license and services agreement.

Index to Financial Statements

In the master technology agreement, Palm assigns to PalmSource all right, title and interest in and to specific technology and data related to the PalmSource business, and a joint interest in certain data to be jointly owned by Palm and PalmSource.

PalmSource grants back to Palm, under PalmSource’s right to certain technology and data assigned to PalmSource, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except with PalmSource’s written consent) license, with right of sublicense, to use specified technology to, among other things, create and distribute Palm products and extract and re-utilize specified data, subject to certain obligations and restrictions. Palm grants to PalmSource, under Palm’s rights under certain technology and data allocated to Palm, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except with Palm’s written consent) license, with right of sublicense, to use specified Palm technology to, among other things, create and distribute PalmSource products and extract and re-utilize specified data, subject to certain obligations and restrictions.

The master technology agreement does not obligate either Palm or PalmSource to disclose or provide to the other party licenses to improvements that it makes, whether to its own technology or to the other party’s technology licensed or assigned to it under this agreement.

Neither party may assign or transfer the master technology agreement without the other party’s prior written consent. However, in the event of an acquisition of all or substantially all of either party’s business or assets, such party may assign the master technology agreement without the other party’s written consent, except that the licenses to certain technology and data granted by each party are assignable only with the other party’s written consent.

The master confidential disclosure agreement provides that Palm and PalmSource agree not to disclose confidential information of the other (except in certain circumstances) that is known prior to the separation or disclosed pursuant to the master separation agreement and related agreements (but not the software license agreement or the Elaine software license and services agreement, which contains separate confidentiality requirements) for the later of one year after the separation date or for as long as services are provided under the business services agreement. The confidentiality period is five years, except that, with respect to highly confidential information (such as source code), the confidentiality period is perpetual.

Palm and PalmSource each agree (a) to protect each other’s confidential information, (b) not to use such confidential information in violation of any use restriction in the master separation agreement and related agreements (but not the software license agreement or the Elaine software license and services agreement, which contain separate confidentiality requirements), and (c) not to disclose without the other party’s prior written consent such confidential information except as may be expressly permitted in the master separation agreement, related agreements and any other agreements Palm and PalmSource enter into with each other. The non-disclosing party is able to use, but not disclose, residual information retained in the unaided memories of individuals who have had access to confidential information of the disclosing party.

Neither party may assign or transfer the master confidential disclosure agreement without the other party’s prior written consent. However, in the event of an acquisition of all or substantially all of either party’s business or assets, such party may assign the master confidential disclosure agreement without the other party’s written consent.

The master patent ownership and license agreement, or master patent agreement, allocates rights relating to patents, patent applications and invention disclosures and provides for certain limited cross-licenses between

Index to Financial Statements

Palm and PalmSource. Under the master patent agreement, Palm assigns to PalmSource all right, title and interest in and to specific patents, patent applications and invention disclosures related to the PalmSource business.

PalmSource grants Palm, under PalmSource’s rights to the patents, patent applications and invention disclosures assigned to PalmSource, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except in a permitted assignment of the master patent agreement) license, with limited right to grant sublicenses, to make, have made, use, lease, sell, offer for sale and import (a) Palm computer hardware devices that incorporate the PalmSource operating system as the primary operating system in all fields of use and (b) all other Palm products in all fields of use except for the field of operating systems. Palm grants to PalmSource, under Palm’s rights to the patents, patent applications and invention disclosures retained by Palm, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except in a permitted assignment of the master patent agreement) license, with limited right of sublicense, to make, have made, use, lease, sell, offer for sale and import PalmSource products in all fields except the field of computer hardware.

Palm’s right to sublicense is limited to its subsidiaries and third parties to make, have made, use, lease, sell, offer for sale and import Palm computer hardware devices that incorporate the PalmSource operating system as the primary operating system and other Palm products other than operating system software. PalmSource’s right to sublicense is limited to its subsidiaries and licensees of the PalmSource operating system to make, have made, use, lease, sell, offer for sale and import their mobile and handheld device products that incorporate the PalmSource operating system as the primary operating system. PalmSource’s right to sublicense such Palm patents to allow third parties to make, have made, use, lease, sell, offer for sale and import such products extends only to hardware features that are necessary to use the PalmSource operating system, and not to hardware features that are not necessary to use the PalmSource operating system.

Neither party may assign or transfer the master patent agreement without the other party’s prior written consent. However, in the event of an acquisition of all or substantially all of either party’s business or assets, such party may assign the master patent agreement without the other party’s written consent.

The business services agreement governs corporate support services that Palm agrees to provide to PalmSource following the separation date. The term during which Palm provides such services is generally one year after December 3, 2001, but the agreement allows the parties to extend the term in writing with respect to any service. The parties continue to discuss an extension of the agreement and continue to operate under it during these discussions. Separate service level agreements under the business services agreement set forth details and additional terms of Palm’s provision of services, and each such service level agreement is deemed to extend the business services agreement with respect to the specific service to which the service level agreement relates if it specifies a completion date beyond the aforementioned one-year term.

The services provided under the business services agreement and service level agreements include functional areas such as corporate development, corporate strategy, finance, global corporate procurement, human resources, information technology, insurance and risk management, legal, real estate and site services, security/environmental health and safety, stock administration, tax and trade, travel and meeting services, and treasury. Such services are specified and provided on the terms set forth in the service level agreements and in the schedules to the service level agreements. The business services agreement also provides for the provision of additional services identified from time to time that PalmSource reasonably believes were inadvertently or unintentionally omitted from the specified services or that are essential to effectuate an orderly transition under the master separation agreement.

The charges that PalmSource must pay Palm under the business services agreement for any service are contained in the applicable service level agreement. Generally, Palm will charge PalmSource for services based

Index to Financial Statements

on internal cost allocation. After the distribution date, however, the charges for services will change so that PalmSource will pay Palm the direct and indirect costs of providing the services plus five percent (5%), and the parties will maintain arm’s length pricing.

As of the date of this joint proxy statement/prospectus, many of the services covered under the service level agreements have been completed.

The strategic collaboration agreement does not become effective until after October 2003. The strategic collaboration agreement provides for certain mutual exchanges of information and establishes a framework for conducting mutually agreed co-development projects.

Beginning on the effective date, Palm and PalmSource agree to exchange information in their respective relevant business areas on a regular basis, subject to confidentiality and other obligations to third parties.

After the effective date, Palm will be one of the two additional development partners permitted under PalmSource’s existing agreement with Sony. After the effective date, PalmSource must notify Palm, and provide Palm with a limited opportunity for good faith discussion, before engaging an additional licensee of the PalmSource operating system (other than Sony) in a joint development agreement for new versions of Palm OS where the development partner (i) develops material portions of the source code for a new version of the Palm OS, and (ii) has the right to access and modify all or substantially all of Palm OS source code to execute the joint development project.

Until October 7, 2005, the parties intend to meet at the beginning of each contract year and draft a mutually agreed plan outlining potential areas of collaboration, with the objective of having at least one active collaboration project at any given time during the year. All co-development will be performed pursuant to a definitive written co-development agreement to be mutually agreed by the parties prior to the commencement of a given project.

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

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

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

Index to Financial Statements

Neither party may assign the strategic collaboration agreement without the other party’s prior written consent, provided that either party may assign to the successor to all or substantially all of its business or assets relating to the Palm OS or Palm devices incorporating the Palm OS as its primary operating system, as applicable. In the event of such a transfer, the non-assigning party will hold good faith discussions with the assignee whether to continue or terminate the strategic collaboration agreement, and if they do not agree to continue within 30 days, the strategic collaboration agreement will terminate.

The employee matters agreement sets forth the principal arrangements between Palm and PalmSource with regard to their respective employees, employee compensation, employee benefit plans, programs and arrangements and other employment matters.

Assumption of Liabilities. Effective as of the separation date, PalmSource generally assumes all liabilities relating to PalmSource employees to the extent such liabilities arise out of their employment with PalmSource and are based on facts occurring after the separation date. In addition, assets in the Palm employee benefit plans related to contributions made by PalmSource will be transferred to PalmSource employee benefit plans.

Equity Compensation. PalmSource will not assume options to purchase Palm common stock held by PalmSource employees on the distribution date, and Palm restricted stock held by PalmSource employees on the distribution date will not be assumed, but rather substituted for PalmSource restricted Stock.

Retirement Plans, Welfare Plans and Other Benefits. PalmSource assumes sole responsibility for the administration of PalmSource employee benefit plans and for the employer-related costs required to establish and maintain such employee benefit plans.

Miscellaneous. The employee matters agreement also contains administrative provisions designed to ensure an efficient post-separation date transition, whereby, among other things, Palm will provide PalmSource with certain transitional staffing services and the parties will share participant information and assist each other in complying with all of the reporting, testing and disclosure requirements of ERISA. The employee matters agreement also provides for delivery of the personnel records of PalmSource employees to PalmSource by Palm prior to the date of the distribution of the shares of PalmSource stock held by Palm to Palm’s stockholders.

After the distribution date, the use of trade names, trademarks, service marks and domain names that contain the word or letter string “palm” or “palmOne” will be administered by Palm Trademark Holding Company, LLC, or Holding Company, a holding company established and owned by Palm and PalmSource for the purpose of receiving, holding, maintaining, registering, enforcing and defending such intellectual property. Holding Company’s administration of the intellectual property will be governed by its operating agreement and by a trademark license agreement between Holding Company and each of Palm and PalmSource.

The more important facets of the operating structure of the Holding Company are described below. Based on its operating structure, the Holding Company arrangement is essentially a cost sharing mechanism between Palm and PalmSource to administer the intellectual property rights attributed to the “Palm” trademark. All material revenues (such as recoveries from litigation), costs, assets and liabilities are expected to be specifically identified with either Palm or PalmSource and consolidated into the respective financial statements of those companies.

Administration of Trademarks Through Holding Company. Under Holding Company’s operating agreement, Palm and PalmSource contributed and assigned all Palm marks and palmOne marks respectively owned, registered claimed or used by each of them to Holding Company. Holding Company will, among other

Index to Financial Statements

things, administer such contributed marks and enhance and maintain the integrity of, and promote the expansion of the value of and goodwill associated with such marks for the benefit of Palm and PalmSource. Holding Company will operate independently of Palm and PalmSource but Palm will own 45% and PalmSource will own 55% of Holding Company’s equity. Additionally, each of them will be responsible for contributing funds to cover (i) costs associated with certain of the marks, such as litigation and trademark prosecution expenses, and (ii) its share of Holding Company’s operating expenses, which shall be divided based on Palm’s and PalmSource’s ownership interest in the Holding Company.

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

Trademark License Agreements. Holding Company licenses the marks contributed by Palm and PalmSource by entering into a trademark license agreement with each of them. Under the trademark license agreement with PalmSource, Holding Company grants to PalmSource an exclusive license to use the Palm marks (other than palmOne) on or in connection with PalmSource’s business and all products and services associated with its business, as an element in domain names and in connection with its corporate identity. This license, however, is subject to several restrictions. For example, PalmSource cannot use any Palm mark other than the Palm Powered mark or its successor mark on products that compete with Palm’s, and PalmSource cannot use any corporate name comprising only “Palm” and a designation of entity status, that is an entity name historically used by Palm, that uses Palm and any number, or that has a space between the elements “palm” and “source.”

Under the trademark license agreement with Palm, subject to certain restrictions, Holding Company grants to Palm:

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

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

Palm.com Website; Links. Holding Company will own the Palm.com site, and Palm will host, manage and pay costs associated with the site until February 2004. After February 2004, the Palm.com site will be modified to reflect an equally split page providing descriptions of each company’s business and links to each company’s primary website, and general costs associated with the site will be shared, with PalmSource paying 55% and Palm paying 45%.

Trademark Prosecution. Even though Holding Company owns all Palm marks, under the trademark license agreements, Palm and PalmSource, subject to Holding Company’s responsibility to maintain the integrity value and goodwill of the Palm marks, each effectively directs prosecution of applications and maintenance of registrations for the marks it is licensed by requesting that the Brand Manager implement Palm’s or PalmSource’s instructions concerning such prosecution and maintenance.

Palm and PalmSource are each responsible for all costs related to trademark prosecution and maintenance, and domain name registration, for their licensed marks. Additionally, each must indemnify the other and Holding Company for liabilities resulting from uses of licensed marks by it or its sublicensees in jurisdictions or on or in connection with goods or services beyond the scope of then-existing applications or registrations, or Palm’s or PalmSource’s filing of trademark applications for Palm marks.

Indemnification; Control Over Sublicensees. Palm and PalmSource respectively are obligated to indemnify Holding Company for liability incurred by Holding Company as a result of Palm’s or PalmSource’s (and any respective sublicensee’s) unlicensed use of the Palm marks and actions in breach of their respective trademark license agreements. If a Palm or PalmSource sublicensee does not cure a breach within 30 days, that licensee must terminate the rights granted to the sublicensee.

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

Both Palm and PalmSource have a right of participation in any actions initiated against third parties. When either Palm or PalmSource initiates an action, the other can assert its right to exclusive or limited control,

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depending on which marks the action concerns. If an action concerns only a party’s licensed marks, then that party has the right to exclusive control of the action. In cases of limited control—such as when the action at hand concerns marks licensed to both Palm and PalmSource—the other party’s instructions to the Brand Manager are subject to the consent of the party who has asserted its limited control rights.

With respect to litigation matters initiated by third parties relating to a licensee’s (or its sublicensee’s) use of licensed marks, that licensee controls, pays for defense of, and is entitled to any recoveries from, the claim. In addition, if Holding Company is a party to the claim regarding a licensed mark, that licensee is empowered to make requests to the Brand Manager regarding conduct and settlement of the claim. Both Palm and PalmSource, however, have a right of limited defense in any actions initiated by third parties. If Palm or PalmSource asserts its right of limited defense when an action is initiated against the other, then the other party’s decisions concerning the defense and possible settlement of the claim are subject to Palm or PalmSource’s consent. The party asserting its right of limited defense shall pay 45% of all costs and expenses, and shall be entitled to 45% of all recoveries. The Brand Manager will act as requested unless doing so would compromise the integrity of, value of or goodwill associated with the marks. Subject to the other’s right of limited defense, the party’s whose use is at issue pays all costs and expenses, and is entitled to all recoveries, unless a court or tribunal allocates such costs, expenses and recoveries differently.

All actions existing as of December 2002 and listed on a schedule to the trademark license agreements shall be paid for by Palm and are to remain under the exclusive control of Palm, except that Palm’s right to modify claims, appeal awards or judgments, or settle such existing actions is subject to PalmSource’s reasonable consent.

Term of Licenses; Termination. The terms of the licenses granted under the trademark license agreements are perpetual. Palm and PalmSource can terminate their respective trademark license agreements with 180 days notice. Holding Company cannot terminate any of the trademark agreements other than for cause. Holding Company can terminate Palm’s trademark agreement for cause if Palm fails to cure a material breach within 120 days of final determination of a material breach, if Palm’s Palm OS license terminates, or if Palm abandons the palmOne mark. Holding Company can terminate PalmSource’s trademark agreement for cause if PalmSource fails to cure a material breach within 120 days of final determination of a material breach, if PalmSource no longer develops or supports Palm OS Software, or if PalmSource abandons the Palm marks.

The Elaine software license and services agreement provides a license from PalmSource to Palm to use and reproduce the Elaine server software to provide proxy services for Palm.net customers. The Elaine software license and services agreement provides for a non-exclusive, non-transferable, royalty-free license to Palm for the Elaine software. Palm is permitted to subcontract with a third party to provide the proxy services and is permitted to modify and prepare derivative works of the Elaine software source code and use and reproduce any such modifications and derivative works in object code form only.

Palm is required to use commercially reasonable efforts to provide support and maintain the proxy services to third party devices using the PalmSource operating system without charge to PalmSource. PalmSource provides support for the Elaine software and will deliver to Palm any upgrades or updates to such software.

Palm may cease providing the Palm.net service to customers during the term of the Elaine software license and services agreement, provided that it provides PalmSource with a copy of the then current Elaine software source code if Palm has made changes to such code during the term of the Elaine software license and services agreement. PalmSource may request Palm to install additional server equipment to run the Elaine software to expand third party proxy services for new PalmSource licensees or existing PalmSource licensees who begin to use new PalmSource products, provided that PalmSource pays the incremental out-of-pocket costs of Palm to support the new PalmSource licensees.

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If a competitor of PalmSource acquires more than 50% of the voting equity of Palm, Palm’s license to create and use modifications to the Elaine source code terminates. If a competitor of Palm acquires more than 50% of the voting equity of PalmSource, Palm’s obligations to use commercially reasonable efforts to provide the proxy services to third parties will cease.

PalmSource will indemnify Palm for infringement by the Elaine software of third party intellectual property rights in specified jurisdictions. Palm will indemnify PalmSource for Palm’s willful or negligent failure to provide third party proxy services, and for infringement by Palm’s modifications to the Elaine software of third party intellectual property rights in specified jurisdictions. Neither party will be liable to the other in a cumulative amount exceeding $10.0 million under the Elaine software license and services agreement.

PalmSource consents to the assignment by Palm of the Elaine software license and services agreement in connection with the sale of the assets relating to the Palm.net business, provided Palm pays PalmSource a license fee equal to 10% of the net proceeds of the sale. The agreement shall be effective for three years from its effective date.

In the letter agreement between Palm and PalmSource regarding cash contributions from Palm to PalmSource, the parties acknowledge previous cash contributions from Palm to PalmSource of $20.0 million in January 2002 and approximately $11.1 million in March 2002. In addition, the letter agreement provides for the contribution of an additional $6.0 million from Palm to PalmSource upon the date of a transaction in which Palm distributes its shares of PalmSource’s capital stock to Palm’s stockholders, provided that such distribution transaction is not preceded by an initial public offering of PalmSource’s capital stock.

Index to Financial Statements

Throughout this section “Solutions Group Business,” we sometimes use “we”, “our”, “us” or “the Solutions Group” to refer to the Solutions Group of Palm.

The Solutions Group operating segment of Palm develops, markets and sells handheld computing devices, add-ons and accessories as well as related services and software. We target consumer, enterprise, education and government users. The Solutions Group currently offers the Tungsten and Zire families of handheld devices as well as the m130 and m515 handhelds, each of which runs on the Palm OS. Since Palm introduced its first handheld computer in 1996, it has been the leading handheld device provider in the world, having shipped over 22 million handheld devices worldwide as of May 31, 2003.

The Solutions Group has three key objectives: grow the market, maintain its market leadership position and achieve operational excellence.

A key part of our success is continuing to develop innovative products that address customer needs and desired functionality. We do this by delivering solutions tailored to specific customer segments, including entry-level, media savvy, professional and enterprise users. At the entry-level, we deliver our Zire handheld, our most affordable handheld to date, which sells at a retail price of under $100. The Zire’s mix of price, functionality and performance has expanded our available market to new users, as demonstrated by our user registration data. We believe that by making an entry-level product such as the Zire available, we are driving the early adoption of handheld devices by consumers who would not otherwise own a handheld and increasing the potential for future upgrade purchases as customers become accustomed to handheld technology and demand additional functionality in the future.

We believe wireless communications is another area that presents future growth opportunities for us. We expect that growth in the market for wireless communication devices will come primarily from devices that combine voice and data transmission capabilities, including smartphones and data centric communicators, also known as converged devices. These will include integrated wireless devices as well as two-piece wireless solutions, such as a Bluetooth enabled handheld device that can wirelessly access data through a Bluetooth enabled phone. The Solutions Group through our Tungsten line of handheld computers offers a wide range of solutions covering the various wireless communications technologies, such as Bluetooth for personal area networks (PAN), WiFi for local area networks (LAN) and GSM/GPRS for wide area networks (WAN).

We are also pursuing opportunities to grow the market through international expansion, such as in China and Brazil. International Data Corporation, or IDC, reports that China is expected to generate a 21% compound annual growth rate in handheld unit shipments from 2002 through 2007. In April 2003, we opened a sales and marketing support office in China and launched several products in that market. In June 2003, we entered into a relationship with a third party to manufacture and sell certain Palm branded products in Brazil.

The Solutions Group continues to maintain its market leadership position both in the United States and worldwide. The Solutions Group’s devices held a 57% unit market share in United States Retail for the month of

Index to Financial Statements

May 2003, according to the National Purchase Diary (NPD) Group and a 40% unit market share worldwide for the second calendar quarter of 2003, according to IDC. Our strategy is to maintain our leadership position by delivering innovative, differentiated products which enhance the user experience and incorporate new applications. We will continue to foster strategic relationships with companies such as IBM, with which we are engaged in a strategic relationship to develop and promote mobile solutions jointly leveraging Palm devices and IBM’s enterprise software, along with both companies’ sales, marketing and service resources.

The Solution Group’s business necessitates the development of products that ship in high volumes during rapid product cycles and therefore operational excellence plays a critical role in achieving profitability and building a sustainable competitive advantage. We have broadly focused the Solutions Group on the objective of operational excellence. This encompasses initiatives such as improving productivity, reducing product costs and operating expenses, reducing cycle times within manufacturing and product development, and improving forecast accuracy. Our strategy of operational excellence is aimed at helping us return to consistent annual profitability and minimizing the working capital required to operate the business.

Our products are differentiated in terms of price, functionality and software applications that are delivered with the device. Standard software in all of our products includes an address book, date book, clock, to do list, memo pad, note pad, and calculator. Other features that can be found in certain of our products include:

In Fall 2002, the Solutions Group introduced two new product sub-brands—Zire and Tungsten. The Zire family is designed for the entry-level and media savvy customers and the Tungsten line is designed for business professionals and the enterprise customer. With the introduction of these new product families, we have solutions that span the handheld market and include a wide range of wireless technologies, including Bluetooth, WiFi and GSM/GPRS. We have leading edge products that include the latest Palm OS (Palm OS 5) running on Texas Instruments Open Mobile Application Platform (OMAP) and Intel XScale ARM processors which provide improved power and speed as compared to non-ARM processors used with older versions of the Palm OS.

The Solutions Group currently offers the Tungsten and Zire families of handheld devices as well as the m130 and m515 handhelds.

The m130 is an entry-level product that features removable faceplates in many different colors, a 16-bit color display, a SD/MMC slot for expansion and Palm OS 4.

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The m515 is aimed at the business professional and features Palm’s slimmest form factor, a color display, a SD/MMC slot for expansion and Palm OS 4. It also includes business software applications such as DataViz’s Documents-to-Go that allows users to create, view and edit Microsoft Word and Excel files and view PowerPoint files.

The Zire handheld was introduced in October 2002 and is our first product that had a retail price of under $100 at launch. The Zire is designed for first-time and entry-level users looking for a paper replacement. We designed the Zire to be profitable at the sub-$100 price point, and it has been the fastest growing handheld in our history. The Zire has won numerous awards including PC Magazine’s Best Product of 2002 and was the best selling product in United States Retail in the fourth calendar quarter of 2002, according to NPD Powerview. The Zire runs on Palm OS 4.

The Zire 71 handheld was introduced in April 2003. It includes a new slider design that conceals an integrated camera, the ability to listen to stereo quality MP3 music and watch video clips using the Kinoma player, a joystick for navigation, a SD/MMC slot, and a new 320x320 transflective Thin Film Transistor (TFT) color display which is the sharpest screen we have ever offered. The Zire 71 is based on Palm OS 5.

The Tungsten T handheld was introduced in October 2002 and includes a new compact form factor with a slider design that conceals the Graffiti writing area, five-way navigation, a SD/MMC slot, a 320x320 reflective TFT color display and a voice recorder. The Tungsten T was our first product based on Palm OS 5. In addition, the Tungsten T has integrated wireless capability using Bluetooth technology, which is a short-range radio technology facilitating data transfer between compatible Bluetooth devices such as mobile phones, laptops, printers, access points and other handhelds. Using a compatible Bluetooth enabled mobile phone as a modem, a user can access the Internet or email wirelessly.

The Tungsten C handheld was introduced in April 2003 and includes integrated WiFi capability, an integrated keyboard, five-way navigation, a SD/MMC slot, a new 320x320 transflective TFT color display and a Solutions Group software enhancement that allows 64MB of memory and is based on Palm OS 5. It also includes virtual private network (VPN) software to access behind-the-firewall data and email using Palm’s VersaMail 2.5 email client. This product was designed for the mobile professional in a wireless networked campus, in a home network or using public hotspots, which allow users broadband wireless Internet access.

The Tungsten W handheld was introduced in February 2003 and includes an integrated keyboard, five-way navigation, a SD/MMC slot, a 320x320 reflective TFT color display and integrated tri-band GSM/GPRS radio and is based on Palm OS 4. Tungsten W is a wireless, data-oriented device with messaging, SMS capability and the ability to make voice calls with up to 10 hours of talk time. Wireless service for the Tungsten W is currently offered on several networks around the world, including AT&T Wireless in the United States, Rogers AT&T Wireless in Canada, Vodaphone in Australia, and SingTel in Asia. In addition, we are working with Orange France to provide wireless service in France.

We also sell add-ons and accessories, including portable keyboards, SD/MMC expansion cards for storage and content, modems and carrying cases. In addition, we provide the ability to purchase and download software applications via a link from our Palm.com website.

The Solutions Group sells its products to distributors, retailers, resellers, and directly to end users through its website at www.palm.com. In fiscal years 2003, 2002 and 2001, the Solutions Group’s customers Ingram Micro represented 18%, 20% and 19% and Tech Data represented 9%, 12% and 9% of consolidated revenues, respectively. Ingram Micro and Tech Data are distributors of the Solutions Group’s products.

Index to Financial Statements

Competition in the mobile device market is intense and characterized by rapid change and complex technology. Our devices compete with a variety of mobile devices, including pen- and keyboard-based devices, mobile phones, converged voice/data devices and sub-notebooks and personal computers. Our principal competitors include:

We believe the principal competitive factors affecting the market for our handheld devices are functionality, features, operating system performance, styling, brand, price, availability of third party software applications, customer and developer support, and access to channels of distribution. We believe that we compete more favorably than many of our current competitors with respect to some or all of these factors, which is reflected by our greater number of users, our leading market share and strong brand recognition.

The separation of the Solutions Group and PalmSource businesses into two independent companies may result in more competition for the Solutions Group’s handheld devices as PalmSource may license the Palm OS to companies who compete directly or indirectly with our Solutions Group’s business. For example, PalmSource has a license agreement with Sony and has recently signed Palm OS license agreements with HuneTech, Lenovo (formerly known as Legend) and Group Sense (International) Limited, located in the Asia Pacific region.

We sell to our end-users primarily through distributors, retailers and resellers. We primarily sell products to enterprise customers through corporate and value added resellers. We also sell directly to end-user customers through our Palm.com website.

In the United States, retailers represent our largest sales channel and encompass national and regional office supply stores, computer superstores, consumer electronics retailers and mass merchants. Distributors represent our second largest United States channel and generally sell to both traditional and Internet retailers and resellers, including enterprise and education resellers. In Europe and Asia, we sell our products primarily through distributors. We have over 100 international distributors, located throughout Europe, Latin America, Canada, Asia, the Middle East and South Africa. These distributors sell primarily to retailers and resellers.

We use our Palm.com store as a vehicle to sell our products and third-party products, focusing particularly on the installed base of Palm branded devices. This is accomplished through e-marketing campaigns and product bundles. We also offer a wide array of software titles on the Software Connection website which is accessed from the Palm.com store.

Index to Financial Statements

We build awareness of our products and brands through mass-media advertising, targeted advertising, public relations efforts, in-store promotions and merchandising, retail advertising and our branded Internet properties. We also receive feedback from our end users and our channel customers through market research. We use this feedback to refine our product development efforts and for marketing our products.

We believe that customer service and technical support are essential to the sales process within our industry. Our customer service organization works closely with our entire customer base, including distributors, retailers, resellers, enterprises, and individual customers, to develop service programs that meet specific customer needs.

Individual customers have access to an Internet-based repository for technical information and troubleshooting techniques. They can obtain support through other means such as the Palm website, email, web chat, and telephone support. Our customer support is provided by outsourced service providers as well as internal personnel.

Our product development efforts are focused on both improving the functionality of our existing products and developing new products. We believe the innovation and design of our products has played an important role in our success. We intend to continue to identify and respond to the needs of our existing and potential customers by introducing new products with an emphasis on innovation in the functionality, mobility, style and ease of use of our products. We utilize third parties to design, develop and manufacture certain products, (outsource design and manufacturer, or ODM partners), after we have completed product definition.

To identify and develop technologies for future generations of Palm branded devices, we use parallel development teams to avoid schedule dependencies from one product to the next. These parallel development teams share results to avoid duplication of effort. As a result, we have a rapid product development cycle that targets releasing new versions of products approximately every six months and introducing new generation products approximately every 12 to 18 months, depending on the complexity of the next generation product release.

We currently outsource all of our manufacturing and much of the hardware design of our devices to third party manufacturers. This outsourcing extends from prototyping to volume manufacturing and includes activities such as material procurement, final assembly, test, quality control and shipment to distribution centers. We believe that there is currently an adequate supply of components to manufacture our products. The majority of our products are assembled in China and Mexico. Distribution centers are operated on an outsourced basis in Tennessee, Ireland and Hong Kong.

We order finished products from third party manufacturers based upon our forecast of worldwide customer demand and in advance of receiving orders from our customers. Our customers generally place orders on an as needed basis, and products are shipped as soon as possible after receipt of an order, usually within one to four weeks. Generally, orders may be canceled or rescheduled by the customer without penalty.

Our Solutions Group business is generally affected by the seasonal fluctuations of traditional retail sales. Our Solutions Group revenues are generally sequentially higher in the second quarter of our fiscal year, as

Index to Financial Statements

distributors and retailers purchase product in anticipation of the December holiday selling season. The timing of our new product launches also contributes to seasonal fluctuations in our revenue. We typically introduce new products in the Fall and in the Spring, which contributes to higher revenue in the second fiscal quarter and the fourth fiscal quarter, respectively.

We rely on a combination of patent, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights.

The United States Patent and Trademark Office has issued approximately 80 patents to us. We have over 250 applications pending in the United States Patent and Trademark Office, and numerous foreign counterpart applications on file. We own a number of trademarks, including the ZIRE and TUNGSTEN marks, and we have applications for registration of these marks pending in the United States and in just over 60 other jurisdictions. We are working to increase and protect our rights in our patent and trademark portfolios, which is important to our value, reputation and branding. While our patents are important to our business, our business is not materially dependent on any one patent.

We believe that the public perception of our brand and trademarks is instrumental to our success. In 2003 and in connection with the separation of PalmSource, Palm established a holding company, Palm Trademark Holding Company, LLC, to administer the use of trade names, trademarks, service marks and domain names that contain the word or letter string “palm”. Palm and PalmSource own Palm Trademark Holding Company, LLC for the purpose of receiving, holding, maintaining, registering, enforcing and defending intellectual property. Subject to certain restrictions, the Solutions Group has an exclusive license from Palm Trademark Holding Company, LLC to use the palmOne mark and domain name. In August 2003, Palm announced its intent to change its name to palmOne following the PalmSource distribution. If our new branding efforts are unsuccessful our reputation and business could be harmed. While our trademarks are important to our business, our business is not materially dependent on any one trademark or group of related trademarks, other than the “Palm” and “palmOne” related trademarks.

We also license technologies from third parties for integration into our products. We believe that the licensing of complementary technologies from parties with specific expertise is an effective means of expanding the features and functionality of our products. We are substantially dependent upon PalmSource to provide us the operating system software necessary to operate our handheld devices. Without a license to this technology, we would be required to devote substantial resources to develop our own operating system software or alternatively acquire a license from another provider of operating system software, such as Microsoft. We cannot assure you that we would be able to develop our own operating system software, or if required to obtain a license to such software from a third party, that we could acquire such a license on favorable terms. The software license agreement expires in December 2006.

While we rely on these methods to protect our intellectual property, we also believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements are essential to establishing and maintaining a technology leadership position. We cannot assure you that others will not develop technologies that are similar or superior to our technology.

As of June 30, 2003, we had a total of 674 employees, of which 82 were in supply chain, 204 were in engineering, 258 were in sales and marketing and 130 were in general and administrative activities. None of our employees is subject to a collective bargaining agreement. We consider our relationship with our employees to be good.

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The Solutions Group’s headquarters and most of its operations are located in the United States. The Solutions Group conducts its sales, marketing and customer service activities throughout the world. Geographic revenue information is based on the location of the customer. For fiscal years 2003, 2002 and 2001, no single country outside the United States accounted for 10% or more of total revenues. Total revenues in the United States totaled $492.5 million, $643.9 million and $940.5 million and total revenues in other geographic locations totaled $345.1 million, $360.5 million and $592.7 million in fiscal years 2003, 2002 and 2001, respectively. Land not in use, property and equipment, net in the United States totaled $89.6 million, $204.9 million and $216.9 million in fiscal years 2003, 2002, and 2001, respectively and land not in use, property and equipment net in other geographic locations totaled $1.6 million, $4.6 million and $3.2 million in fiscal years 2003, 2002 and 2001, respectively.

We currently occupy 153,274 square feet of leased space in Milpitas, California in three buildings. We also lease research and development facilities in Washington, Illinois, and Massachusetts and sales and support offices domestically and internationally. We believe that existing facilities are adequate for our current needs and we are attempting to sublease excess space in certain locations. If we require additional space, we believe that we will be able to secure such space on commercially reasonable terms without undue operational disruption.

We also own approximately 39 acres of land not in use, located in San Jose, California that was originally acquired with the intent of building our corporate headquarters. In May 2001, with the downturn in the market and our declining revenues, construction plans were terminated. We have no current plan to develop this land. Given the depressed state of commercial real estate in the San Jose area, we are not actively marketing the land at the present time.

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Our financial condition and results of operations may be affected by risks and uncertainties set forth in “Risk Factors” beginning on page 26 of this joint proxy statement/prospectus. You should consider these risks and uncertainties in conjunction with the following discussion.

Palm is the leading global provider of handheld computing devices and operating systems for handheld devices. For purposes of this joint proxy statement/prospectus, we refer to the devices designed and sold by Palm as Palm Branded devices, and we refer to devices running on the Palm operating system, the Palm OS, as Palm Powered devices. Palm Powered devices include Palm Branded devices as well as devices designed and sold by third parties licensing the Palm OS. The term “we” and “our” when used in this section of the joint proxy statement/prospectus refers to the Solutions Group. Our 52-53 week fiscal year ends on the Friday nearest May 31. Fiscal years 2003, 2002 and 2001 contained 52 weeks. For presentation purposes, the fiscal years have been presented as ending on May 31. Unless otherwise stated, all years and dates refer to our fiscal years and fiscal periods.

Palm was founded in 1992 as Palm Computing Inc. In 1995, Palm was acquired by U.S. Robotics Corporation, and sold its first handheld product in 1996, quickly establishing a leadership role in the handheld device industry. In 1997, 3Com Corporation acquired U.S. Robotics and in 1999, 3Com announced the intent to separate the Palm business into an independent company. In preparation for becoming an independent, publicly traded company, Palm Computing, Inc. changed its name to Palm, Inc. and was reincorporated in Delaware in December 1999. In March 2000, approximately 6% of the shares of Palm common stock were sold in an initial public offering and concurrent private placements and in July 2000, 3Com distributed the remaining shares of Palm common stock it owned, approximately 94% of Palm’s common stock outstanding, to 3Com’s stockholders. In July 2001, Palm announced its intent to establish a subsidiary for its operating system business and to manage that business independently. In December 2001, Palm formed PalmSource, Inc., a stand-alone subsidiary for its operating system business, and subsequently announced its intent to establish PalmSource as an independent, publicly traded company.

Since December 2001, Palm has been organized in two operating segments—PalmSource and the Solutions Group. The following represents Management’s Discussion and Analysis of the Financial Condition and Results of Operations of the Solutions Group as presented in the Unaudited Pro Forma Financial Information contained elsewhere in this joint proxy statement/prospectus. Presentation of the results of operations of the Solutions Group requires the allocation of certain revenues and expenses between PalmSource and the Solutions Group including revenues and expenses that were previously eliminated in consolidation. The allocation of revenues and expenses between the Solutions Group and PalmSource is required because the Solutions Group licenses technology from PalmSource, and certain expenses have been incurred by the Solutions Group on behalf of PalmSource. The expense allocations have been determined on bases that Palm and PalmSource considered to be reasonable reflections of the utilization of services provided or the benefit received by PalmSource. Palm’s management believes that the expenses allocated to each operating segment reflect each operating segment’s proportionate share of such expenses. The pro forma adjustments to the Solutions Group’s financial data are more fully described in the “Palm, Inc., Notes to Unaudited Pro Forma Combined Condensed Financial Statements” included elsewhere in this joint proxy statement/prospectus.

Index to Financial Statements

estimates that affect the amounts reported. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. The amounts of assets and liabilities reported in our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions which are used for, but not limited to, the accounting for rebates, price protection, product returns, allowance for doubtful accounts, warranty and technical service costs, goodwill and intangible asset impairments, restructurings, inventory and income taxes. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of our consolidated financial statements.

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

Revenue from software license agreements with end-users is recognized upon delivery of the software, provided that persuasive evidence of an arrangement exists, collection is determined to be probable and no significant obligations remain. Deferred revenue is recorded for post contract support and any other future deliverables, and is recognized over the support period or as the elements of the agreement are delivered.

Vendor specific objective evidence of the fair value of the elements contained in these software license agreements is based on the price determined by management having the relevant authority when the element is not yet sold separately, but is expected to be sold in the marketplace within six months of the initial determination of the price by management.

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

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

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

We evaluate the recoverability of goodwill annually or more frequently if impairment indicators arise, as required under Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. Goodwill is reviewed for impairment by applying a fair-value-based test at the reporting unit level, which is the same as the business segment level. A goodwill impairment loss is recorded for any goodwill that is determined to be impaired. Under SFAS No. 144, Accounting for the Disposal of Long-Lived Assets, intangible assets are evaluated whenever events or changes in circumstances indicate that the carrying value of the asset

Index to Financial Statements

may be impaired. An impairment loss is recognized for an intangible asset to the extent that the asset’s carrying value exceeds its fair value, which is determined based upon the estimated future cash flows expected to result from the use of the asset, including disposition. Cash flow estimates used in evaluating for impairment represent management’s best estimates using appropriate assumptions and projections at the time.

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

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

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

Our key accounting estimates and policies are reviewed with the audit committee of Palm’s board of directors.

Index to Financial Statements

The following table sets forth our unaudited pro forma consolidated statement of operations data for the Solutions Group which reflects certain adjustments more fully described in the “Palm, Inc. Notes to Unaudited Pro Forma Combined Condensed Financial Statements” included elsewhere in this joint proxy statement/prospectus. The table below includes the expression of our operating results as a percentage of revenues from continuing operations for the fiscal years indicated (in thousands, except percentages):

We derive our revenues primarily from sales of our handheld computing devices, add-ons, and accessories as well as related services and software. Revenues for fiscal year 2003 were $837.6 million, a decrease of $166.8 million or approximately 17% from revenues for fiscal year 2002. The decrease in revenues was primarily driven by a decline in unit shipments reflecting a continued weak economy in both the consumer and enterprise segments and a decline in the average selling price of our handheld devices reflective of a price sensitive and increasingly competitive market. The average selling price of our handheld devices decreased to approximately $171 per unit in fiscal year 2003 from approximately $192 per unit in fiscal year 2002, accounting for more than 50% of the overall decrease in revenues. Net unit shipments of devices were 4.2 million units in fiscal year 2003 compared to 4.4 million units in fiscal year 2002, accounting for just under 30% of the decrease in revenues. Revenues from accessory sales were down by approximately $40.1 million, or 37%, from fiscal year 2002, reflective of a decrease in device sales and an increase in competition in the accessories business. These factors were partially offset by a decrease in the provision for product return reserves from 7.3% of revenue in fiscal year 2002 to 4.5% of revenue in fiscal 2003. This decrease was primarily attributable to lower return rates from our channel partners for product returned to them by their end customers (open box returns) driven by a decrease in product defects and our channel partners developing alternative means for selling open box returns.

Index to Financial Statements

International revenues were approximately 41% of worldwide revenues in fiscal year 2003 compared with approximately 36% in fiscal year 2002. Of the 17% decline in worldwide revenues from fiscal year 2002 to fiscal year 2003, 15% resulted from a reduction in US revenues and 2% resulted from a reduction in international revenues. The relatively smaller decline in international revenues accounts for international revenues providing for a larger share of worldwide revenues in fiscal year 2003 despite a reduction in absolute international revenues. Although average selling prices for our handheld devices declined similarly in both the US and international markets by about 11% from fiscal year 2002 to fiscal year 2003, absolute international revenues declined by only 5% relative to the decline in US revenues of 23%. The lower decline in international revenues came from an increase in handheld units sold internationally, (representing a 10% increase in fiscal year 2003 over fiscal year 2002, versus a 10% reduction in the US), coupled with a lower decline in accessories revenue internationally (a 21% decline internationally in fiscal year 2003 over fiscal year 2002 versus a 44% decline in the US). The international revenues reflected strong year over year performance in Europe with increased unit shipments and sell through to end users reflecting European market share gains.

We believe Palm faced weaker economies and more intense competition both domestically and internationally in fiscal year 2003 over fiscal year 2002.

‘Total cost of revenues’ is comprised of ‘Cost of revenues’, ‘Cost of revenues—charge (benefit) for special excess inventory and related costs’ and the applicable portion of ‘Amortization of goodwill and intangible assets’ as shown in the Solutions Group results of operations table. ‘Total cost of revenues’ was $625.9 million in fiscal year 2003 and $691.5 million in fiscal year 2002. ‘Total cost of revenues’ as a percentage of revenues was 74.7% in fiscal year 2003 compared to 68.9% in fiscal year 2002. ‘Cost of revenues’ primarily consists of costs to produce and deliver our devices, accessories and related services. ‘Cost of revenues’ in fiscal year 2003 was $625.2 million, or 74.6% of revenues, compared to $790.0 million, or 78.7% of revenues, in fiscal year 2002. The decrease in ‘Cost of revenues’ as a percentage of revenues was primarily due to improvement in component and product transformation costs of approximately 2.0 percentage points, reduced excess and obsolete costs of approximately 1.2 percentage points, resulting from improved inventory management, and lower product warranty expenses of approximately 1.2 percentage points as a result of fewer than anticipated claims with respect to electro-static discharge issues as well as lower repair costs per unit resulting from contract renegotiations and changes in third party repair vendors, partially offset by increased scrap and rework and manufacturing spending of approximately 1.6 percentage points. Additionally, prior to December 3, 2001, the effective date of the software license agreement between Palm and PalmSource, we incurred expenses for the development and maintenance of our operating system (Palm OS) which are included in ‘Cost of revenues’. Since December 3, 2001, under the terms of the software license agreement, we have paid royalties to PalmSource to license the Palm OS which are also included in ‘Cost of revenues’. Expenses related to the Palm OS accounted for approximately 0.2 percentage points of the decrease in ‘Cost of revenues’.

Index to Financial Statements

rapid and unexpected decline in demand for handheld device products and in revenues resulted in the Solutions Group recording a charge totaling $268.9 million consisting of $144.3 million of excess inventory and related tooling costs and $124.6 million of non-cancelable inventory purchase commitments in excess of our forecasted needs. This excess inventory charge was calculated in accordance with our policy, which is based on inventory levels determined to be in excess of anticipated 12-month demand based upon our internal sales and marketing forecasts of product demand and inventory levels in the distribution channel. During fiscal year 2002, we experienced continued customer demand for the products that had been previously written off and settled the component purchase commitments for less than the original amount. Accordingly, during fiscal year 2002, we recognized a benefit of $101.8 million, or 10.1% of revenues, because we were able to sell approximately $83.0 million of inventory that had previously been written off and to realize approximately $18.8 million from the favorable settlement of non-cancelable component commitments. There were no similar benefits recognized in fiscal year 2003, as all excess inventory related to the fiscal year 2001 inventory charge had been sold or scrapped by the end of fiscal year 2002.

The ‘Amortization of goodwill and intangible assets’ applicable to the cost of revenues decreased as a percentage of revenue and in absolute dollars in fiscal year 2003 as compared to fiscal year 2002 reflecting the cost of the development and maintenance of the operating system (Palm OS) recorded on an imputed cost basis for the six months prior to December 3, 2001.

Sales and marketing expenses consist principally of advertising and marketing programs, salaries and benefits for sales and marketing personnel, sales commissions, travel expenses and related information technology and facilities costs. Sales and marketing expenses were $160.7 million in fiscal year 2003 compared to $218.1 million in fiscal year 2002, a decrease of $57.4 million or approximately 26%. Sales and marketing expenses as a percentage of revenues were 19.2% in fiscal year 2003 compared to 21.7% in fiscal year 2002. The decrease in sales and marketing expenses as a percentage of revenues and in absolute dollars reflects decreased spending across all marketing areas. Sales and marketing expenses were significantly reduced during fiscal year 2003 as compared to fiscal year 2002 to better align our spending with current revenue levels. Advertising and branding expense reductions accounted for approximately $20.0 million, direct marketing, program and promotion reductions accounted for approximately $15.2 million, international marketing expense reductions accounted for approximately $6.8 million and trade show and other marketing expense reductions accounted for approximately $5.6 million of the decrease in sales and marketing expenses. Additionally, personnel and related expenses decreased by approximately $6.2 million and associated information technology and facilities costs decreased by approximately $3.0 million primarily due to headcount reductions as a result of our restructuring actions and new lower cost facilities leases.

Research and development expenses consist principally of employee related costs, third party development costs, program materials, depreciation and related information technology and facilities costs. Research and development expenses were $70.9 million in fiscal year 2003 compared to $92.3 million in fiscal year 2002, a decrease of $21.4 million or approximately 23%. Research and development expenses decreased as a percentage of revenues to 8.5% in fiscal year 2003 from 9.2% in fiscal year 2002. Approximately $7.9 million of the decrease in research and development expenses was due to decreased third party development costs, as some of these costs are now incurred in cost of revenues consistent with our ODM strategy and reduced program materials expenses. Approximately $6.7 million of the decrease is due to lower personnel related costs and consulting expenses. Personnel and related costs, including salaries and related benefits and travel, decreased primarily as a result of reduced headcount in fiscal year 2003 compared to fiscal year 2002 resulting from restructuring actions initiated to align our cost structure with our business operations.

Index to Financial Statements

General and administrative expenses consist of employee related costs, travel expenses and related information technology and facilities costs for finance, legal, human resources and executive functions, outside legal and accounting fees, provision for doubtful accounts and business insurance costs. General and administrative expenses were $37.7 million in fiscal year 2003 compared to $44.2 million in fiscal year 2002, a decrease of $6.5 million or approximately 15%. General and administrative expenses as a percentage of revenues increased to 4.5% in fiscal year 2003 from 4.4% in fiscal year 2002. The increase as a percentage of revenues in fiscal year 2003 is primarily due to decreased revenues in fiscal year 2003 as compared to fiscal year 2002. The decrease in absolute dollars was due to lower employee related expenses of approximately $5.4 million as a result of reduced headcount and lower legal and professional services expenses of approximately $5.3 million. These decreases in expenses were offset by an increased provision for doubtful accounts, of approximately $5.7 million. The provision for doubtful accounts was a charge of $0.9 million in fiscal year 2003 compared to a credit of $4.8 million in fiscal year 2002; this credit was due to collection of certain specifically reserved fiscal year 2001 receivables and the overall lower balance of gross accounts receivable. Headcount at the end of fiscal year 2003 decreased by approximately 23% compared to fiscal year 2002, resulting from restructuring actions initiated to align our cost structure with current revenue levels.

Amortization of intangible assets was $1.1 million in fiscal year 2003 compared to $9.4 million in fiscal year 2002. The decrease in amortization of goodwill and intangible assets of $8.3 million is a result of certain intangible assets becoming fully amortized and the impairment of certain other intangible assets that would otherwise have been amortized.

Restructuring charges relate to the implementation of a series of actions to better align our expense structure with our revenues. Restructuring charges of $37.3 million recorded during fiscal year 2003 consist of $19.1 million related to the restructuring actions taken during the third quarter of fiscal year 2003 plus $18.2 million of net adjustments related to restructuring actions taken in prior fiscal years.

Index to Financial Statements

Cost reduction actions initiated in the second and fourth quarters of fiscal year 2002 and in the fourth quarter of fiscal year 2001 are substantially complete except for remaining rent payments related to excess facilities. Cost reduction actions initiated in the third quarter of fiscal year 2003 are expected to be substantially complete by the end of the second quarter of fiscal year 2004. We cannot assure you that our current estimates of the costs associated with these restructuring actions will not change during implementation.

In the third quarter of fiscal year 2003, we incurred an impairment charge of $102.5 million, including $100.0 million related to approximately 39 acres of land in San Jose, California owned by us. Market conditions for commercial real estate in the Silicon Valley have deteriorated since the land was acquired in May 2001, and during the third quarter of fiscal year 2003, we determined that we no longer expect to hold the land as long as would be required to realize the $160.0 million carrying value. As a result, we adjusted the carrying value to $60.0 million based upon the estimated fair value at February 2003. Additionally, a $2.5 million impairment charge was recorded in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets, related to the core technology acquired as a result of the December 2001 business combination with ThinAirApps, Inc. The core technology of ThinAirApps is no longer considered useful, and its carrying value is not considered to be recoverable. The fair value of the core technology was determined using the discounted cash flow method.

Separation costs reflect costs related to separating our business from 3Com, such as consulting and professional fees. Separation costs were $0.3 million in fiscal year 2002. We did not incur separation costs in fiscal year 2003.

Interest and other income (expense), on a net basis, was $3.0 million of income in fiscal year 2003 compared to $1.6 million of income in fiscal year 2002. Interest and other income (expense) in fiscal year 2003

Index to Financial Statements

primarily consisted of insurance proceeds of $12.7 million from a partial insurance settlement of a business interruption claim and interest income on our cash balances of $3.8 million offset by interest expense of $2.6 million, bank charges, including amortization of financing activities and credit card fees, of $3.9 million, legal settlements of $4.1 million and impairment of equity investments of $2.7 million. Interest and other income (expense) for fiscal year 2002 primarily consisted of interest income on our cash balances of $9.2 million and insurance proceeds of $5.0 million from a partial insurance settlement of a business interruption claim offset by banking charges of $5.1 million, impairment of our investments in two privately-held companies of $5.1 million and interest expense of $1.8 million. Interest income decreased primarily as the result of lower cash balances and reduced interest rates on our investments. Bank charges decreased due to decreased credit card fees of $1.2 million. Interest expense increased reflective of a full year of interest from the issuance of our subordinated convertible debt in the second quarter of fiscal year 2002.

As of the end of fiscal year 2002, we had recorded a net deferred tax asset of $254.4 million. The realization of the net deferred tax asset was supported by certain identified tax strategies, involving the potential sale or transfer of appreciated assets, which were prudent, feasible and which management would implement, if necessary, to realize the related tax benefits before our net operating loss carryforwards expired. The identified tax strategies included the potential sale or transfer of certain identified business operations, consisting of our PalmSource, Inc. subsidiary and our wireless access service operations, as well as the transfer of certain intellectual property from a foreign subsidiary to the United States, on a taxable basis. During the first quarter of fiscal year 2003, there was a significant decline in the value of these identified business operations and assets. In addition, our business plans had developed such that the potential sale or transfer of PalmSource, Inc. and our wireless access service operations on a taxable basis were no longer feasible tax planning strategies. As a result, we increased our valuation allowance by $219.6 million to reflect these changes and to reduce the net deferred tax assets to $34.8 million, which is the amount supported by the value of our intellectual property transfer strategy which, as of that date and at the end of fiscal year 2003, continues to be prudent, feasible and one that management would implement, if necessary, to realize the related tax benefits before our net operating loss carryforwards expired. The net operating loss carryforwards, which are a significant component of our deferred tax assets and which totaled $562 million at May 31, 2003, remain available for us to utilize against future profits. The income tax benefit for fiscal year 2002 was $25.8 million, or 32% of pretax loss, which included a $22.7 million valuation allowance that related to a portion of net operating loss and tax credit carryforwards. The income tax benefit for fiscal year 2001 was $160.8 million, or 32.0% of pretax loss.

Revenues for fiscal year 2002 were $1,004.4 million, a decrease of $528.8 million or approximately 34% from revenues for fiscal year 2001. The decline in revenues was primarily driven by a decrease in unit shipments. Unit shipments decreased to 4.4 million in fiscal year 2002 from 6.4 million units in fiscal year 2001, accounting for more than 75% of the decrease in revenues, as a result of an economic slowdown and reduced growth in the handheld industry. In addition, our average selling price decreased to $192 per unit in fiscal 2002 from $206 per unit in fiscal 2001 due to increased competition in the handheld market, accounting for approximately 12% of the decrease in revenues. International revenues for fiscal year 2002 were 36% of revenues compared with 39% of revenues for fiscal year 2001.

For fiscal year 2002, ‘Total cost of revenues’ was $691.5 million compared to $1,389.1 million in fiscal year 2001. ‘Total cost of revenues’ is comprised of ‘Cost of revenues’, ‘Cost of revenues—charge (benefit) for special excess inventory and related costs’ and the applicable portion of ‘Amortization of goodwill and intangible

Index to Financial Statements

assets’. ‘Total cost of revenues’ as a percentage of revenues was 68.9% in fiscal year 2002 compared to 90.6% in fiscal year 2001. ‘Cost of revenues’ in fiscal year 2002 was $790.0 million, or 78.7% of revenues, compared to $1,116.1 million, or 72.8% of revenues, in fiscal year 2001. The increase in ‘Cost of revenues’ as a percentage of revenues was primarily due to a decrease in the average selling price of our products, accounting for approximately 3.0 percentage points of the increase in ‘Cost of revenues’. Additionally, prior to December 3, 2001, the effective date of the software license agreement between Palm and PalmSource, we incurred expenses for the development and maintenance of our operating system (Palm OS) which are included in ‘Cost of revenues’. Since December 3, 2001, under the terms of the software license agreement, we have paid royalties to PalmSource, to license the Palm OS which are also included in ‘Cost of revenues’. Expenses related to the Palm OS accounted for approximately 2.1 percentage points of the increase in ‘Cost of revenues’. Furthermore, warehousing and freight expenses increased as we experienced a sudden and significant decline in demand for our products resulting in increased inventories, accounting for approximately 0.8 percentage points. This increase was slightly off-set by lower product warranty expenses of approximately 0.9 percentage points as a result of improved efficiencies reducing repair costs per unit.

In the fourth quarter of fiscal year 2001, we recorded an inventory related charge of $268.9 million, or 17.5% of revenues, captioned ‘Cost of revenues—charge (benefit) for special excess inventory and related costs’ in the Solutions Group results of operations table. During the first three quarters of fiscal year 2001, we were experiencing high growth rates and product supply constraints, including a limited supply of certain key components. As a result, we purchased inventory and made purchase commitments with third party suppliers in anticipation of the continuation of this trend. During the fourth quarter of fiscal year 2001, we experienced a sudden and significant decline in demand for our products. Revenues in the fourth quarter of fiscal year 2001 were $165.3 million compared to revenues of $470.8 million during the third quarter of fiscal year 2001. This rapid and unexpected decline in demand for handheld device products and in revenues resulted in us recording a charge totaling $268.9 million consisting of $144.3 million of excess inventory and related tooling costs and $124.6 million of non-cancelable inventory purchase commitments in excess of our forecasted needs. This excess inventory charge was calculated in accordance with our policy, which is based on inventory levels determined to be in excess of anticipated 12-month demand based upon our internal sales and marketing forecasts of product demand and inventory levels in the distribution channel. During fiscal year 2002, we experienced continued customer demand for the products that had been previously written off and settled the component purchase commitments for less than the original amount. Accordingly, during fiscal year 2002, we recognized a benefit of $101.8 million, or 10.1% of revenues, because we were able to sell approximately $83.0 million of inventory that had previously been written off and to realize approximately $18.8 million from the favorable settlement of non-cancelable component commitments.

The ‘Amortization of goodwill and intangible assets’ applicable to the cost of revenues decreased in absolute dollars in fiscal year 2002 compared to fiscal year 2001, primarily due to amortization of goodwill being discontinued in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.

Sales and marketing expenses were $218.1 million in fiscal year 2002 compared to $311.9 million in fiscal year 2001, a decrease of $93.8 million or approximately 30%. Sales and marketing expenses as a percentage of revenues were 21.7% in fiscal year 2002 compared to 20.4% in fiscal year 2001. The increase in sales and marketing expenses as a percentage of revenues primarily reflects decreased revenues in fiscal year 2002 compared to fiscal year 2001. The decrease in absolute dollars in fiscal year 2002 compared to fiscal year 2001 was primarily the result of decreased advertising and branding expenses of approximately $35.0 million, reduced direct marketing and program and promotion expenses of approximately $27.8 million, decreased trade show and other marketing expenses of approximately $11.3 million and reduced international marketing of $5.1 million. Additionally, personnel and related expenses decreased approximately $11.4 million. These reductions were all intended to better align our spending with lower revenues in fiscal year 2002 compared to fiscal year 2001.

Index to Financial Statements

Research and development expenses were $92.3 million in fiscal year 2002 compared to $104.7 million in fiscal year 2001, a decrease of $12.4 million or approximately 12%. Research and development expenses increased as a percentage of revenues to 9.2% in fiscal year 2002 from 6.8% in fiscal year 2001. The increase in research and development expenses as a percentage of revenues primarily reflects decreased revenues in fiscal year 2002. The decrease in expenses in absolute dollars in fiscal year 2002 compared to fiscal year 2001 was primarily due to decreased consulting and personnel and related expenses of approximately $9.8 million and decreased spending on project materials of approximately $1.5 million. The reduction in personnel and related costs resulted from restructuring actions which reduced headcount in order align our cost structure with our lower revenues in fiscal year 2002 compared to fiscal year 2001.

General and administrative expenses were $44.2 million in fiscal year 2002 compared to $77.0 million in fiscal year 2001, a decrease of $32.8 million or approximately 43%. General and administrative expenses as a percentage of revenues decreased to 4.4% in fiscal year 2002 from 5.0% in fiscal year 2001. The decrease as a percentage of revenues and in absolute dollars was primarily due to a decrease in the provision for doubtful accounts of approximately $13.5 million. The provision for doubtful accounts was a credit of $4.8 million in fiscal year 2002 compared to a charge of $8.7 million in fiscal year 2001; the credit in fiscal year 2002 was due to collection of certain specifically reserved fiscal year 2001 receivables and the overall lower balance of gross accounts receivable, and the charge in fiscal year 2001 reflects provision for specifically identified accounts and the overall higher balance of gross accounts receivable. In addition, personnel and related expenses decreased approximately $7.0 million, reflecting reduced headcount as a result of restructuring actions.

Amortization of goodwill and intangible assets was $9.4 million in fiscal year 2002 compared to $37.3 million in fiscal year 2001, a decrease of $27.9 million. The decrease was primarily the result of the implementation of SFAS No. 142, Goodwill and Other Intangible Assets, at the beginning of fiscal year 2002, which resulted in goodwill no longer being amortized and the impairment of the intangible assets acquired in connection with the June 2000 business combination with AnyDay.com, Inc., or AnyDay. The impairment of the AnyDay intangible assets was recorded in the fourth quarter of fiscal year 2001 and resulted in the termination of related amortization charges. The decrease of goodwill amortization of approximately $20.5 million and AnyDay intangible asset amortization of approximately $1.7 million was partially offset by amortization charges resulting from certain acquisitions made during fiscal year 2002 of $0.6 million. We completed our transitional and annual impairment tests of the goodwill recorded on our balance sheet during fiscal year 2002, and there was no impairment indicated.

During fiscal year 2002, we recorded restructuring charges of $44.6 million. These charges relate to two restructuring programs announced during the second and fourth quarters of fiscal year 2002 and an adjustment to the charges recorded in the fourth quarter of fiscal year 2001.

In the fourth quarter of fiscal year 2002, we recorded restructuring charges of $14.9 million related to decisions and commitments made in that quarter. These restructuring charges consist of workforce reduction costs across all geographic regions, excess facilities charges and discontinued project costs. We recorded approximately $5.2 million related to workforce reductions primarily related to severance, benefits and related costs due to the reduction of approximately 90 regular employees. We recorded a charge of approximately $6.1 million related to facilities and property and equipment that would be disposed of or removed from service in fiscal year 2003. The facilities charges reflected the remaining commitment on existing leases which we would

Index to Financial Statements

not use. We recorded a charge of approximately $3.6 million, of which $2.3 million had been paid in cash as of May 31, 2002, related to projects that had been cancelled.

In the second quarter of fiscal year 2002, we announced actions intended to reduce our cost structure and we recorded charges of $21.7 million in the second quarter for these actions. The second quarter fiscal year 2002 restructuring charges consisted of workforce reduction costs across all geographic regions and excess facilities and related costs for lease commitments for space no longer needed to support ongoing operations. We recorded approximately $13.3 million related to workforce reductions of approximately 210 regular employees and, as of May 31, 2003, headcount reductions were complete. During the remainder of fiscal year 2002, we recorded charges totaling $0.2 million primarily due to changes from the original estimate in the expected sublease income from excess facilities. As of May 31, 2002, cash payments of $13.7 million had been made in connection with the second quarter of fiscal year 2002 restructuring charge.

In the fourth quarter of fiscal year 2001, we recorded restructuring charges which consisted of carrying and development costs related to the land on which we had previously planned to build our future headquarters facility, facilities costs related to lease commitments for space no longer intended for use, workforce reduction costs across all geographic regions and discontinued project costs. These workforce reductions affected approximately 205 regular employees. During fiscal year 2002, we recorded charges totaling $7.8 million due to changes from the original estimate of the cost of the restructuring actions announced in the fourth quarter of fiscal year 2001 primarily as a result of a reduction in estimated sublease income. As of May 31, 2002, the headcount reductions were essentially complete. As of May 31, 2002, cash payments of $19.7 million had been made in connection with the fourth quarter of fiscal year 2001 restructuring charge.

In the fourth quarter of fiscal year 2001, we incurred impairment charges of $106.7 million consisting of a $47.7 million impairment of goodwill and intangible assets related to the AnyDay acquisition, due to the AnyDay acquisition performing below expectations, and a $59.0 million impairment charge related to the land on which we had previously intended to build our new corporate headquarters.

In the fourth quarter of fiscal year 2001, we terminated a seven-year master lease agreement that had been entered into during the second quarter of fiscal year 2001 related to the land and construction of a headquarters facility in San Jose, California. At the initiation of the lease agreement, the lessor acquired the land for our future headquarters. Due to the uncertain economic environment and changes to our business, we decided not to go forward with the lease commitment or construction of the future headquarters facility. Pursuant to the terms of the master lease agreement, upon termination of the agreement, we were required to exercise our option to purchase the related land for the lessor’s full initial purchase price. Recognizing that there had been a decline in the market value of land in the Silicon Valley area due to the downturn in the economy, an impairment charge was recorded for the difference between the fair market value of the land at May 31, 2001 and our purchase price.

Separation costs were $0.3 million in fiscal year 2002 compared to $4.0 million in fiscal year 2001, a decrease of $3.7 million or approximately 93%. The separation costs, in both periods, related to our separation from 3Com.

Purchased in-process technology in fiscal year 2001 was a result of the AnyDay acquisition. Approximately $0.9 million of the purchase price of AnyDay represented purchased in-process technology that had not yet reached technological feasibility, had no alternative future use and was charged to operations.

Index to Financial Statements

Interest and other income (expense), on a net basis, was $1.6 million in fiscal year 2002 compared to $41.9 million in fiscal year 2001. Interest and other income (expense) in fiscal year 2002 primarily consisted of interest income on our cash balances of $9.2 million and insurance proceeds of $5.0 million from a partial insurance settlement of a business interruption claim offset by banking charges of $5.1 million, impairment of our investments in two privately-held companies of $5.1 million and interest expense of $1.8 million. Interest and other income (expense) for fiscal year 2001 primarily consisted of interest income on our cash balances of $48.7 million offset by approximately $5.5 million related to the net settlement of two lawsuits. The decline in interest and other income (expense) is the result of lower cash balances, reduced interest rates on investments, increased interest expenses arising from the issuance of subordinated convertible debt in the second quarter of fiscal year 2002 and the amortization of financing charges incurred related to the $150 million asset-backed, borrowing-base credit facility obtained in the first quarter of fiscal year 2002.

The income tax benefit for fiscal year 2002 was $25.8 million, or 28% of pretax loss, which included a $22.7 million valuation allowance that relates to a portion of the net operating loss and tax credit carryforwards.

The income tax benefit for fiscal year 2001 was $160.8 million, or 32% of pretax loss.

Pro forma cash and cash equivalents for the Solutions Group at May 31, 2003 were $199.0 million.

We lease our facilities and certain equipment under capital and operating lease arrangements which expire at various dates through September 2011. As of May 31, 2003, future minimum lease payments under noncancelable operating leases are $10.7 million in fiscal year 2004, $9.7 million in fiscal year 2005, $6.7 million in fiscal year 2006, $5.4 million in fiscal year 2007, $5.5 million in fiscal year 2008 and an aggregate of $17.5 million thereafter.

In December 2001, Palm issued a $50 million 5% convertible subordinated note due 2006, or the existing Palm note, to Texas Instruments. The existing Palm note has a conversion price of $92.6316 per Palm share or a conversion rate of 10.79545 Palm shares per $1,000 of principal amount (in each case, after giving effect to Palm’s one for twenty reverse stock split, which took place effective October 15, 2002).

In connection with the PalmSource distribution, Palm and Texas Instruments have agreed that the existing Palm note will be divided into and replaced by two notes: one issued by Palm, or the new Palm note, and one issued by PalmSource, or the PalmSource note. The new Palm note will be issued in the principal amount of $35 million and the PalmSource note will be issued in the principal amount of $15 million. The new Palm note will be convertible only into Palm common stock and the PalmSource note will be convertible only into PalmSource common stock. The conversion prices and conversion rates of each of the two notes will be set according to formulas agreed to by Palm and Texas Instruments.

Index to Financial Statements

If after the distribution the trading price of PalmSource stock increases to be higher than the conversion price of the PalmSource note, it is likely that the PalmSource note will be converted, resulting in dilution of PalmSource stockholders’ interest in PalmSource. If the decline in the stock price of Palm is very small and/or the actual market capitalization of PalmSource is much smaller than expected in relation to the PalmSource note, the dilution of the PalmSource stockholders’ interest could be substantial. This description of the formula to determine the conversion prices and conversion rates of the new Palm note and the PalmSource note is a summary only and is qualified in its entirety by the amended terms of the 5% convertible subordinated note due 2006 issued by Palm to Texas Instruments, which is incorporated by reference to Palm’s registration statement on Form S-4 of which this prospectus forms a part.

then the PalmSource note would be convertible into shares of PalmSource common stock at $72.54, representing a conversion premium of 282% to the $19.00 price per share of the PalmSource common stock, which would convert into 206,773 shares of common stock of PalmSource, which shares would represent 1.75% dilution to the PalmSource stockholders. However, the PalmSource note would likely be converted only if the trading price of our common stock were to increase to at least $72.54.

Index to Financial Statements

then the PalmSource note would be convertible into shares of PalmSource common stock at $11.50 (due to the 115% minimum conversion price discussed above), representing a conversion premium of 15% to the $10.00 price per share of the PalmSource common stock, which would convert into 1,304,347 shares of common stock of PalmSource, which shares would represent 10.11% dilution to the PalmSource stockholders. However, the PalmSource note would likely be converted only if the trading price of our common stock were to increase to at least $11.50.

If the decline in value in Palm common stock after the distribution date under the above calculations were less than the above examples, and especially if the PalmSource price per share were lower than the second example, then the conversion price of the PalmSource note would be lower, the conversion premium would be less, the PalmSource note would convert into more shares of PalmSource common stock and the dilution to PalmSource stockholders would be greater. If such variances are substantial, then the changes in the conversion price, the conversion premium, the number of shares that the PalmSource note would convert into and the dilution to PalmSource stockholders would be substantial.

As of May 31, 2003, we had in place an asset-backed borrowing-base credit facility from a group of financial institutions for up to a maximum of $150 million with the actual amount available determined by eligible accounts receivable and inventory as well as a real estate line of credit less the amount of any outstanding cash advances and letters of credit. As of May 31, 2003, we had used our credit facility to support the issuance of letters of credit of $4.6 million. In June 2003, the asset-backed borrowing-base credit facility expired. The 4.6 million of letters of credit issued under the credit facility were replaced by new letters of credit collateralized with restricted cash.

On August 28, 2003, we obtained a two-year, $30.0 million revolving credit line from Silicon Valley Bank (“SVB”). The credit line is secured by our assets, including but not limited to cash and cash equivalents, accounts receivable, inventory and property and equipment. The interest rate is equal to SVB’s prime rate (4% at August 28, 2003) or, at our election subject to certain specific requirements, equal to LIBOR plus 1.75% (2.87% at August 28, 2003). The interest rate may vary based on fluctuations in market rates. We are subject to a financial covenant requirement under the agreement: to maintain unrestricted cash on deposit in the United States of not less than $100.0 million.

We have a patent cross license agreement under which we are committed to pay up to $2.4 million in fiscal year 2004 and $2.7 million in fiscal year 2005.

We have a minimum component purchase commitment with a third party under which we could be liable for payments of up to a maximum of $4.9 million during calendar year 2003.

We have an agreement with PalmSource that grants us certain licenses to develop, manufacture, test, maintain and support our products. Under this agreement, we have agreed to pay PalmSource license and royalty fees based upon net shipment revenue of our products which incorporate PalmSource’s software, a source code license and maintenance and support fees. The agreement includes a minimum annual royalty and license commitment of $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring December 3, 2006.

Index to Financial Statements

The following is a summary of the contractual commitments associated with our debt and lease obligations as well as our purchase commitments as of May 31, 2003 (in thousands):

The Solutions Group utilizes contract manufacturers to build its products. These contract manufacturers acquire components and build product based on demand forecast information supplied by the Solutions Group, which typically covers a rolling 12-month period. Consistent with industry practice, the Solutions Group acquires inventories through a combination of formal purchase orders, supplier contracts, and open orders based on projected demand information. Such formal and informal purchase commitments typically cover the Solutions Group’s forecasted component and manufacturing requirements for periods ranging from 30 to 90 days. As of May 31, 2003, the Solutions Group had outstanding third-party manufacturing commitments and component purchase commitments of approximately $82 million.

In March 2002, we filed a universal shelf registration statement to give us the flexibility to sell up to $200 million of debt securities, common stock, preferred stock, depository shares and warrants in one or more offerings and in any combination thereof. The net proceeds from the sale of securities offered are intended for general corporate purposes, including to meet working capital needs and for capital expenditures. We had not sold any securities under this universal shelf registration statement as of May 31, 2003. On August 22, 2003, we sold 1.2 million shares of common stock under the registration statement to an institutional investor for proceeds of $18.0 million. As of August 29, 2003, we had entered into agreements to sell an additional 1.2 million shares of common stock under the registration statement to institutional investors for additional proceeds of approximately $19.1 million.

We denominate our sales to certain European customers in the Euro and in Pounds Sterling. We also incur expenses in a variety of currencies. We hedge certain balance sheet exposures and intercompany balances against future movements in foreign currency exchange rates by using foreign exchange forward contracts. Gains and losses on the contracts are intended to offset foreign exchange gains or losses from the revaluation of assets and liabilities denominated in currencies other than the functional currency of the reporting entity. All such gains and (losses) of $0.7 million, $(0.9) million and $0.5 million in fiscal years 2003, 2002 and 2001, respectively, are included in interest and other income (expense) in our consolidated statements of operations. Our foreign exchange forward contracts generally mature within 30 days. We do not intend to utilize derivative financial instruments for trading purposes.

Based on current plans and business conditions, we believe that our existing cash and cash equivalents will be sufficient to satisfy our anticipated cash requirements for at least the next 12 months. Net cash used in operating activities during fiscal year 2003 was approximately $55.0 million and we anticipate a similar or lesser amount over the next 12 months, which would be satisfied by our May 31, 2003 cash and cash equivalents balance of $199.0 million. Subsequent to our fiscal year end, we sold 1.2 million shares of common stock to an institutional investor for proceeds of $18.0 million. As of August 29, 2003, we had entered into agreements to sell an additional 1.2 million shares of common stock to institutional investors for additional proceeds of approximately $19.1 million. Based on our current forecast, we do not anticipate any short-term or long-term liquidity deficiencies. We cannot be certain, however, that our underlying assumed levels of revenues and expenses will be accurate. If our operating results do not meet our expectations or if inventory, accounts receivable or other assets require a greater use of cash than is currently anticipated, we could be required to seek

Index to Financial Statements

additional funding through public or private financings or other arrangements. In such event, adequate funds may not be available when needed or may not be available on favorable terms, which could have a negative effect on our business and financial condition.

In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We adopted FIN No. 45 during the quarter ended February 28, 2003, which did not have an impact on our historical financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, an amendment of SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. In addition, it amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. The new interim disclosure provisions are effective for the first interim period beginning after December 15, 2002, which, for the Solutions Group, will be the quarter ended August 31, 2003. The adoption of this statement did not have an impact on our historical financial position or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. FIN No. 46 requires an investor with a majority of the variable interests in a variable interest entity to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A variable interest entity is an entity in which the equity investors do not have a controlling interest or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional subordinated financial support from the other parties. The implementation of this interpretation did not have a significant impact on our historical financial condition or results of operation.

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

In May 2003 the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that falls within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, which for the Solutions Group is the quarter ended November 30, 2003. The adoption of SFAS No. 150 will not have an impact on our historical financial position or results of operations.

Index to Financial Statements

The following unaudited pro forma combined condensed financial statements give effect to the PalmSource distribution and the Handspring merger in accordance with Article 11 of the Securities and Exchange Commission’s Regulation S-X. As a result of the PalmSource distribution, the operations of PalmSource will be accounted for by Palm as a discontinued operation as defined under Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The Handspring merger will be accounted under the purchase method of accounting.

In July 2001, Palm announced its plan to form a wholly owned subsidiary to own and operate Palm’s operating system platform and licensing business, subsequently named PalmSource, Inc. In December 2001, Palm and PalmSource entered into a Master Separation Agreement under which Palm transferred to PalmSource at December 3, 2001, the date of legal separation, or the separation date, substantially all of the assets and liabilities of Palm’s operating system and software business except for the Palm brands, trademarks and certain other related intellectual property which will be transferred to Palm Trademark Holding Company, LLC at a later date. Palm sells devices that incorporate PalmSource software to its customers under the terms of a Software License Agreement, as amended, or the software license agreement. Under the terms of this software license agreement, PalmSource has granted Palm certain rights to use, produce, grant end user sublicenses and distribute certain software for the period December 3, 2001 to December 3, 2006. PalmSource receives license and royalty fees based upon the shipment of Palm’s products which incorporate PalmSource software or on distribution by Palm of PalmSource software, subject to certain minimum annual commitments. PalmSource also receives fees for support and services.

On June 4, 2003, we entered into an agreement for the transaction which includes the PalmSource distribution and the Handspring merger. In the PalmSource distribution, the 10 million shares of PalmSource common stock held by Palm will be distributed to existing Palm stockholders on a pro rata basis. The final exchange ratio for the PalmSource distribution will be determined based on the number of shares of Palm common stock outstanding at the distribution date. For purposes of these unaudited pro forma combined condensed financial statements, our pro forma adjustments were based on a ratio of 0.32 of a share of PalmSource common stock to be distributed for every share of Palm common stock outstanding, based on Palm shares outstanding as of August 29, 2003 and this ratio is subject to change based on the issuance of additional shares of Palm common stock between now and the distribution date. The unaudited combined condensed balance sheet as of May 31, 2003 includes adjustments to reflect the elimination of the PalmSource business from Palm’s consolidated balance sheet. These adjustments reflect the requirements of the various agreements relating to the separation of PalmSource from Palm which result in certain transactions that will occur at the date of the PalmSource distribution and the recognition of intercompany balances which were eliminated in the consolidated balance sheet. The unaudited pro forma statement of operations for the year ended May 31, 2003 has been derived by eliminating the PalmSource business from the historical Palm financial results and recording cost of revenues for royalties due to PalmSource under the software license agreement, as amended, between PalmSource and Palm. The unaudited pro forma statement of operations for the year ended May 31, 2002 has been derived by eliminating the PalmSource business from the historical Palm financial results and recording cost of revenues and amortization of intangible assets for the cost of the development and maintenance of the operating system (Palm OS) on an imputed cost basis for the six months prior to December 3, 2001 and for the six months subsequent to December 3, 2001 recording cost of revenues for royalties due to PalmSource under the software license agreement between PalmSource and Palm. The unaudited pro forma statement of operations for the year ended May 31, 2001 has been derived by eliminating the PalmSource business from the historical Palm financial results and recording cost of revenues and amortization of goodwill and intangible assets for the cost incurred for the development and maintenance of the operating system (Palm OS). The total pro forma Solutions Group information substantially represents the historical results that will be presented in Palm’s statement of operations when PalmSource is reported as discontinued operations in accordance with SFAS No. 144,

Index to Financial Statements

Accounting for the Impairment or Disposal of Long-Lived Assets, following the transaction. All pro forma adjustments resulting from the elimination of the PalmSource business are described in the notes to the unaudited combined condensed pro forma financial statements under “Pro forma Adjustments—Separation of PalmSource.”

In the Handspring merger, the stockholders of Handspring will receive 0.09 of a share of Palm common stock for each share of Handspring common stock held. For purposes of the following unaudited pro forma combined condensed financial statements, the purchase price is preliminarily estimated at $228.0 million. The estimated purchase price is comprised of (a) approximately $185.7 million representing the estimated fair value of Palm stock to be issued to Handspring stockholders, (b) $26.8 million representing the fair value of Handspring options and warrants to be assumed, (c) $7.5 million of estimated direct transaction costs of Palm and (d) $8.0 million of estimated other liabilities directly related to the acquisition. Because the value of the securities to be issued cannot be determined until the transaction is completed, such securities are preliminarily valued in these unaudited pro forma combined condensed financial statements based upon an estimated ex-dividend Palm share price of $13.78 (as more fully described in Note L to Unaudited Pro Forma Combined Condensed Financial Statements). Upon closing of the Handspring merger, the Company will value the transaction using a per share price based on an average over a reasonable period of time beginning with the first trading day that Palm trades without the right to receive the PalmSource distribution, which is a when-issued or the equivalent of an ex-dividend basis. This equivalent of the ex-dividend date is expected to be approximately two weeks before the closing date. The estimated direct transaction costs consist primarily of investment banking, legal and accounting fees and printing costs to be incurred which are directly related to the proposed Handspring merger. The other liabilities directly related to the merger pertain to liabilities defined under Emerging Issues Task Force (EITF) No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. There can be no assurance that Palm and Handspring will not incur additional charges related to the Handspring merger or that management will be successful in its efforts to integrate the operations of the two companies. All pro forma adjustments resulting from the proposed Handspring merger are described in the Notes to Unaudited Pro Forma Combined Condensed Financial Statements under “Pro Forma Adjustments—Handspring Merger.”

As required by the rules of the Securities and Exchange Commission, the unaudited pro forma combined condensed statement of operations for the year ended May 31, 2003 give effect to the proposed PalmSource distribution as if the distribution took place on the the first day of fiscal year 2001 and the proposed Handspring merger as if it occurred on the first day of fiscal year 2003, with the exception that the purchase accounting adjustments were estimated based on the anticipated closing date of the Handspring merger.

The unaudited pro forma combined condensed statement of operations for the year ended May 31, 2003 has been derived from the audited historical consolidated statement of operations of Palm for the year ended May 31, 2003, the audited historical combined and consolidated statement of operations of PalmSource for the year ended May 31, 2003 and the audited historical consolidated statement of operations of Handspring for the year ended June 30, 2003.

The unaudited pro forma combined condensed statements of operations for the years ended May 31, 2001 and 2002 have been derived from the audited historical consolidated statements of operations of Palm for the years ended May 31, 2001 and 2002, respectively, and the audited combined and consolidated statement of operations of PalmSource for the years ended May 31, 2001 and 2002, respectively.

All per share data amounts reflect the retroactive effects of the Palm one-for-twenty reverse stock split effective October 15, 2002.

The unaudited pro forma combined condensed balance sheet as of May 31, 2003 gives effect to the above transactions as if they occurred on May 31, 2003. The unaudited pro forma combined condensed balance sheet as of May 31, 2003, has been derived from the audited historical consolidated balance sheet of Palm, the audited

Index to Financial Statements

historical consolidated balance sheet of PalmSource, both as of May 31, 2003, and the audited historical consolidated balance sheet of Handspring as of June 30, 2003.

Because these unaudited pro forma combined condensed financial statements have been prepared based on preliminary estimates of fair values, the actual amounts recorded as of the completion of the Handspring merger may differ materially from the information presented in these unaudited pro forma combined condensed consolidated financial statements. The total estimated purchase price of the Handspring merger has been allocated on a preliminary basis to assets acquired and liabilities assumed based upon management’s best estimates of their fair value with the excess cost over the net tangible and intangible assets acquired being allocated to goodwill. This allocation is subject to change pending a final analysis of the total purchase cost and the fair value of the assets acquired and liabilities assumed. The final purchase price, as well as the impact of ongoing integration activities, the timing of the completion of the Handspring merger, changes in Handspring’s net tangible assets, estimated other liabilities directly related to the Handspring merger and changes in purchase accounting allocations could all cause material differences from the information presented.

The pro forma information is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have been achieved if the PalmSource distribution and Handspring merger had occurred at the beginning of the earliest period presented, nor is it necessarily indicative of future operating results or financial position. Actual results could differ. The pro forma adjustments are based upon information and assumptions available at the time of the filing of this document. The pro forma information should be read in conjunction with the accompanying notes thereto, with Palm and Handspring’s historical financial statements and related notes thereto, incorporated by reference into this joint proxy statement/prospectus, and with PalmSource’s historical financial statements and related notes thereto included elsewhere within this joint proxy statement/prospectus.

Index to Financial Statements

A. Adjustment required to offset the subtraction of PalmSource revenues for intercompany royalty revenues eliminated in the historical consolidated Palm amounts and to offset the timing difference between the carveout revenue recognized by PalmSource compared to consolidated amounts. Pursuant to the terms of the software license agreement, as amended, between Palm and PalmSource effective December 3, 2001, PalmSource recognized intercompany license, royalty, support and service revenues of $39.1 million and $18.5 million for the years ended May 31, 2003 and 2002, respectively, which are eliminated in Palm, Inc.’s Consolidated Statements of Operations. In accordance with generally accepted accounting principles, Palm defers revenue when collection is not considered probable. There is a timing difference between the revenue recognized in the Palm, Inc. Consolidated Statement of Operations and the carveout revenue recognized by PalmSource, as the PalmSource Consolidated Financial Statements were prepared after collection of the related accounts receivable had occurred.

B. Adjustment required to record PalmSource royalty expense for the Solutions Group which is eliminated in the historical consolidated Palm amounts and the cost of development and maintenance of the Palm OS. Under the software license agreement, as amended, between Palm and PalmSource, Palm recognized intercompany license, royalty, support and service cost of revenues of $39.6 million and $22.0 million for the years ended May 31, 2003 and 2002, respectively, which are eliminated in Palm, Inc.’s Consolidated Statements of Operations. PalmSource recognized these royalty revenues from Palm on a contractually reported basis which was one month in arrears from when the Solutions Group recognized cost of revenues. Prior to December 3, 2001, the effective date of the software license agreement between Palm and PalmSource, the Solutions Group would have incurred costs for the development and maintenance of its operating system (Palm OS). The Solutions Group is recognizing the cost of the development and maintenance of Palm OS based on an imputed cost methodology. Therefore, the Solutions Group is recognizing as cost of revenues, the research and development expenses of PalmSource of $26.0 million for the period prior to the effective date of the software license agreement in fiscal year 2002 and $55.9 million fiscal year 2001 and a proportionate share of the cost of revenues of PalmSource of $1.3 million for the period prior to the effective date of the software license agreement in fiscal year 2002 and $1.8 million in fiscal year 2001.

C. Amounts represent allocations from Palm for centralized accounting, real estate, information technology, and other Palm corporate services and infrastructure costs which were allocated to PalmSource based on headcount and percentage of revenues. If the distribution were to occur at the earliest date presented, these costs would have been incurred by Palm. The amount of allocations reflected in the adjustment to cost of revenues is less than $0.1 million for each of the years ended May 31, 2003, 2002 and 2001, respectively.

D. Amounts represent a presentation adjustment of amortization of intangible assets and charges for amortization expense from PalmSource to the Solutions Group. PalmSource stand-alone financial statements include the applicable portion of amortization of goodwill and intangible assets in cost of revenues. This adjustment reclassifies amounts related to amortization of intangible assets attributed to PalmSource’s business included in cost of revenues of $4.5 million, $5.7 million and $2.9 million for the years ended May 31, 2003, 2002 and 2001, respectively, to the amortization of intangible assets line item. The Solutions Group is recognizing the cost incurred for the development and maintenance of Palm OS. The amortization of intangible assets recorded by PalmSource prior to December 3, 2001, the effective date of the software license agreement between Palm and PalmSource, of $2.9 million and $9.4 million in fiscal years 2002 and 2001, respectively, has been attributed to the Solutions Group.

E. Amount represents the reclassification of separation costs incurred by Palm relating to the PalmSource distribution to loss from discontinued operations.

Index to Financial Statements

F. Amounts represent the PalmSource loss from operations and tax provision and the effect of various transactions between Palm and PalmSource. In accordance with Statement of Accounting Standards (“SFAS”) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” these amounts will be reported as loss from discontinued operations and the related income tax effect to account for the distribution.

G. Amounts represent an adjustment of the tax provision to reflect the stand-alone Solutions Group tax expense.

H. Amounts represent the assumption by PalmSource of $15.0 million of a convertible note due 2006 payable to a third party made by Palm which bears interest at 5.0% per annum and the automatic recapitalization of the $20.0 million PalmSource note payable to Palm, as additional paid-in capital immediately on the distribution date in accordance with the terms of the amended and restated intercompany loan agreement. The related accrued interest on the PalmSource note payable to Palm will be due and payable within seven days after the date of distribution. In addition, Palm will contribute an additional $6.0 million in cash to PalmSource at the date of distribution.

I. Adjustments required to reflect the amounts due from and to PalmSource, previously eliminated in consolidation.

J. Amount represents the goodwill and associated deferred tax impacts related to the WeSync acquisition recorded by Palm which was greater than that carved out as belonging to PalmSource due to the gross up of goodwill for deferred tax liabilities pursuant to SFAS No. 109, “Accounting for Income Taxes”, which would have been accounted for differently if PalmSource had been a stand alone entity.

K. Amounts represent the elimination of PalmSource’s common stock, additional paid-in capital, and accumulated deficit from the Solutions Group results assuming the distribution occurred at the earliest period presented. Additional paid-in capital also reflects the elimination of Palm’s investment in PalmSource upon distribution of PalmSource shares to Palm stockholders.

L. These amounts represent adjustments related to the acquisition of Handspring under the purchase method of accounting. The total estimated purchase price of the merger with Handspring has been allocated on a preliminary basis to assets acquired and liabilities assumed based upon management’s best estimates of their fair value with the excess cost over the net tangible and intangible assets acquired allocated to goodwill. The preliminary estimated purchase price is allocated as follows and is for illustrative purposes only:

The estimated purchase price of $228.0 million is comprised of (a) approximately $185.7 million related to the estimated fair value of Palm stock to be issued to Handspring stockholders, (b) $26.8 million representing the fair value of Handspring options and warrants to be assumed, (c) $7.5 million of estimated direct transaction costs of Palm, and (d) $8.0 million of estimated other liabilities directly related to the acquisition.

Index to Financial Statements

The estimated fair value of Palm stock to be issued to Handspring stockholders and Handspring options and warrants to be assumed was calculated using an estimated ex-dividend Palm share price of $13.78 based upon the average closing market price of Handspring’s common stock for the five business days ending September 19, 2003 of $1.24 per share. Palm has used the market value of Handspring as an estimate of the fair value of the consideration to be issued because the Handspring stockholders will not receive any rights to the shares of PalmSource which are being distributed to Palm common stockholders prior to the consummation of the Handspring acquisition and there does not exist a separate market for either PalmSource common stock or for Palm common stock excluding the right to receive shares of PalmSource.

The fair value of Handspring options and warrants to be assumed were valued using the Black-Scholes option valuation model with the following weighted average assumptions: a risk free interest rate of 1.53%, volatility of 100%, a term of three years and a dividend yield of 0%.

The estimated other liabilities reflects liabilities defined under EITF No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, and includes $6.5 million related to facilities lease commitments in excess of the requirements of the combined company and $1.5 million related to workforce reduction costs. The amount related to facilities leases represents contractual commitments from the planned cease use date until the termination of the lease. Due to the depressed commercial real estate market, no sublease income has been estimated. The workforce reduction costs are primarily related to severance, benefits and related costs for approximately 30 Handspring employees, across all functional and geographic areas. The terms of the arrangement have been communicated to the affected employees and will be completed upon consummation of the merger. The amount of the estimated other liabilities cannot be finalized prior to consummation of the transaction.

The adjustment also reflects the elimination of the equity of Handspring and the issuance of Palm common stock and options to purchase common stock.

This allocation is subject to change pending a final analysis of the total purchase cost and the fair value of the assets acquired and liabilities assumed. The final purchase cost, as well as the impact of ongoing integration activities, the timing of the completion of the merger, changes in Handspring’s net tangible assets, estimated other liabilities directly related to the Handspring merger and changes in purchase accounting allocations, could all cause material differences from the information presented.

The table below is a pro forma analysis that reflects the impact of ex-dividend share prices for Palm common stock of $10.00, $15.00 and $20.00 per share upon the estimated purchase price and related goodwill and the related impact on the pro forma combined loss from continuing operations, net loss, net loss per share, amortization of intangible assets and amortization of deferred stock-based compensation resulting from the estimated value of Handspring stock options and warrants assumed in the transaction (in thousands, except per share amounts):

Index to Financial Statements

M. Amounts represent the adjustments to eliminate Handspring’s deferred revenue balance of $1.3 million and record Handspring’s estimated transaction costs of $3.7 million associated with the merger, at the balance sheet date. Handspring defers subsidy revenue earned from wireless carriers on a new customer service contract because the customers have a specified period of time in which they may cancel the contract. In accordance with EITF No. 01-03, Accounting in a Business Combination for Deferred Revenue of an Acquiree, the deferred revenue does not represent a legal performance obligation assumed by Palm and therefore it has been determined that the fair value is zero and it will not be recorded as a liability by the combined company.

N. Amounts represent the elimination of Handspring’s common stock, additional paid-in capital, unamortized deferred stock based compensation, accumulated deficit and accumulated other comprehensive loss.

O. Amounts represent a reclassification of selling, general and administrative expenses and amortization of intangible assets and deferred stock-based compensation of Handspring to conform to the Palm financial statement presentation.

P. Amounts represent the amortization of approximately $1.8 million related to unvested options assumed in the acquisition of Handspring over their estimated remaining vesting term of approximately 2 years. Annual amortization amounts are: cost of revenues, less than $0.1 million; sales and marketing, $0.3 million; research and development, $0.2 million; and general and administrative, $0.3 million. This estimate is based on certain assumptions about the number of options granted, the intrinsic value of the options granted, and the remaining vesting term of the underlying options. These amounts are subject to change and can be finalized only on the date of completing the acquisition.

Q. Amounts represent the amortization of intangible assets (per the allocation of the estimated purchase price in L. above) that would have been recorded during the year ended May 31, 2003 of $8.2 million had the transaction closed on the first day of fiscal year 2003. The intangible assets in Palm’s acquisition of Handspring will be amortized on a straight-line basis over a period approximating two years. In addition, for purposes of these pro forma statements, the amortization of approximately $5.0 million related to a customer backlog intangible asset is not included, as it is a non-recurring charge that is expected to be included in the combined company’s income statement within twelve months following the transaction. This allocation is an estimate, subject to change pending a final analysis of the total purchase price and the fair value of the intangibles acquired. When completed, certain amounts identified as intangible assets may be amortized over periods other than the period represented in the pro forma statement of operations. Additionally, a portion of the purchase price may be identified as in-process purchased technology. This amount, if any, will be charged to operating results of the combined company in the period the merger is completed and the purchase accounting and valuation amounts are finalized.

R. Reflects the issuance of 0.09 of a share of Palm common stock for each share of Handspring common stock outstanding as of the balance sheet date. The computation of diluted net loss per share excludes securities outstanding that could potentially dilute basic earnings per share in the future, but which were excluded in the computation of diluted net loss per share in the periods presented, as their effect would have been antidilutive.

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The following section of this joint proxy statement/prospectus compares the rights of holders of Palm common stock with the rights of holders of Handspring common stock and describes any material differences between them.

Palm and Handspring are each incorporated under the laws of the State of Delaware and the respective rights of stockholders of each company are governed by the Delaware General Corporation Law. The following summary does not purport to be a complete statement of the rights of holders of Palm common stock under applicable Delaware law, Palm’s certificate of incorporation and bylaws, nor does it purport to be a complete statement of, or a comprehensive comparison with, the rights of holders of Handspring common stock under applicable Delaware law, Handspring’s certificate of incorporation and bylaws. While we believe that the summary below covers the material differences between the rights of holders of Palm common stock and Handspring common stock, the summary may not contain all of the information that is important to you. This summary is qualified in its entirety by reference to the applicable Delaware law and the respective governing corporate documents of Palm and Handspring.

Upon completion of the Handspring merger, the stockholders of Handspring will become stockholders of Palm, and the Palm certificate of incorporation and Palm bylaws will govern the rights of former Handspring stockholders.

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Delaware law provides, in general, that a corporation has the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation), because the person is or was a director or officer of the corporation. Such indemnity may be against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding, if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation and if, with respect to any criminal action or proceeding, the person did not have reasonable cause to believe the person’s conduct was unlawful.

Delaware law also provides, in general, that a corporation has the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor because the person is or was a director or officer of the

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corporation, against any expenses (including attorneys’ fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation.

Additionally, under Delaware law, a corporation generally has the power to purchase and maintain insurance on behalf of any person who is or was a director or officer of the corporation against any liability asserted against the person in any such capacity, or arising out of the person’s status as such, whether or not the corporation would have the power to indemnify the person against such liability under the provisions of the law.

For a description of the indemnification provisions for directors, officers and employees of Palm and Handspring, please refer to the “Comparison of Stockholder Rights” table above. In addition, for a description of Palm’s obligation to (i) fulfill and honor the obligations of Handspring pursuant to any indemnification agreements between Handspring and its directors and officers in effect prior to the Handspring merger and (ii) maintain directors’ and officers’ liability insurance comparable to Handspring’s existing policy, see “Interests of Directors and Executive Officers of Handspring in the Handspring Merger” in this joint proxy statement/prospectus. Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended, may be permitted to directors, officers or persons controlling Palm or Handspring pursuant to the foregoing provisions, Palm has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is therefore unenforceable.

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The number of directors authorized by Palm’s bylaws, as amended, is currently fixed at eight. Palm’s bylaws, as amended, provide that the directors shall be divided into three classes, with the classes of directors serving for staggered three-year terms. Class I currently has three members, whose terms currently expire as of the date of the 2003 annual meeting. A stockholder may not cast votes for more than three nominees. The three Class I directors to be elected at the 2003 annual meeting are to be elected to hold office until the fiscal year 2006 annual meeting or until their successors have been appointed or elected and qualified.

Palm’s nominees for election at the annual meeting to Class I of the board of directors are Michael Homer, Gareth C.C. Chang and R. Todd Bradley. If a nominee declines to serve or becomes unavailable for any reason (although the board of directors knows of no reason to anticipate that this will occur), the proxies may be voted for such substitute nominee as the board of directors may designate.

If a quorum is present and voting at the annual meeting, the three nominees for Class I directors receiving the highest number of affirmative votes will be elected as Class I directors. Votes withheld from any director are counted for purposes of determining the presence or absence of a quorum but have no other legal effect under Delaware law. For a description of the treatment and effect of abstentions and broker non-votes, see “Abstentions” and “Broker Non-Votes” under “The Palm Annual Meeting of Stockholders” in this joint proxy statement/prospectus.

The following table sets forth the name and age of each nominee and each director of Palm whose term of office continues after the annual meeting, the principal occupation of each during the past five years and the period during which each has served as a director of Palm. Each nominee is currently serving as a director of Palm. If the merger agreement is approved and adopted by Palm’s and Handspring’s stockholders, David Nagel will resign from Palm’s board of directors upon the Handspring merger.

Nominees for Election as Class I Directors Serving for a Term Expiring in 2006

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During the fiscal year ended May 30, 2003, the board of directors held ten meetings. The board of directors has an Audit Committee, a Compensation Committee and a Nominating and Governance Committee.

During the fiscal year ended May 30, 2003, Palm’s Audit Committee met seven times. Its current members are Gordon A. Campbell, Michael Homer and Susan G. Swenson. The Audit Committee, among other things, oversees Palm’s auditing, accounting, financial reporting and internal control functions, appoints, compensates, retains, oversees, determines the funding for and evaluates Palm’s independent auditors, and monitors the independence of and the audit and non-audit services provided by such independent auditors. For additional information concerning the Audit Committee, see “Report of the Audit Committee of the Board of Directors.”

During the fiscal year ended May 30, 2003, the Compensation Committee met six times. Its current members are Gordon A. Campbell and Susan G. Swenson. In addition, Eric A. Benhamou serves as a non-voting member of the Compensation Committee. The Compensation Committee determines, approves and reports to the board of directors on all elements of compensation for Palm’s executive officers including salaries, bonuses, stock options, benefits and other compensation arrangements. For additional information concerning the Compensation Committee, see “Executive Compensation and Other Matters—Compensation Committee Interlocks and Insider Participation” and “Report of the Compensation Committee of the Board of Directors on Executive Compensation.”

During the fiscal year ended May 30, 2003, the Nominating and Governance Committee met one time. Its current members are Gareth C.C. Chang and Eric A. Benhamou. The Nominating and Governance Committee focuses on issues relating to the composition and operation of the board of directors and provides assistance to the board of directors in the areas of membership selection, committee selection and rotation practices, evaluation of the overall effectiveness of the board of directors, and review and consideration of developments in corporate governance practices. The Nominating and Governance Committee reviews director nominees submitted by stockholders of Palm. Stockholders submitting such recommendations for director nominees should follow the procedures described in “Stockholder Proposals to be Presented at the Next Palm Annual Meeting” and “Transaction of Other Business at the Palm Annual Meeting” in this joint proxy statement/prospectus.

During the fiscal year ended May 30, 2003, no directors attended fewer than seventy-five percent (75%) of the aggregate of the total number of meetings of the board of directors held during the period they served as directors and the total number of meetings held by the committees of the board of directors during the period that they served on any such committees of the board of directors.

Members of the board of directors who are not employees of Palm or any subsidiary of Palm, or non-employee directors, received payments (which have been paid quarterly since September 1999) during the fiscal year ended May 30, 2003 as follows: members of the board of directors received an annual retainer of $20,000 each and $4,000 for each full day board meeting that they attended, $2,000 for each half day board meeting that they attended and $1,000 for each board meeting of three hours or less that they attended; plus reimbursement of

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travel expenses for travel by members of the board of directors who reside outside of the local area. Additionally, members of the board of directors who serve on the audit committee of the board of directors receive an annual retainer of $15,000 each, members of the board of directors who serve on the compensation committee receive an annual retainer of $10,000 each, and members of the board of directors who serve on the nominating and governance committee receive an annual retainer of $10,000 each. Members of the board of directors who serve on any such standing committees of the board of directors also receive $4,000 for each full day committee meeting that they attend, $2,000 for each half day committee meeting that they attend and $1,000 for each committee meeting of three hours or less that they attend.

In connection with the PalmSource distribution and the Handspring merger, the board formed a special separation committee of the board of directors in fiscal year 2003. Mr. Homer and Ms. Swenson serve as members of the separation committee, and Mr. Benhamou serves as an ex-officio member of the separation committee. The two full members of the separation committee will each receive payments of $40,000 in fiscal year 2004 for their services on the separation committee. The members of the separation committee did not receive any compensation in fiscal year 2003 for their service on the separation committee.

Non-employee directors are eligible to receive stock options under Palm’s 2001 Stock Option Plan for non-employee directors, or the 2001 Director Plan. The numbers of shares described in this section reflect the adjustments to the number of shares subject to options under the 2001 Director Plan to give effect to the 1-for-20 reverse stock split of Palm common stock which was effective as of October 15, 2002. Proposed changes to the 2001 Director Plan, including the annual automatic grants to the non-employee directors, are set forth in Proposal No. 4 on pages 196 to 200 of this joint proxy statement/prospectus.

Under the 2001 Director Plan, each non-employee director who was a non-employee director on October 11, 2001, the effective date of the 2001 Director Plan, received an automatic grant of an option to purchase 3,000 shares of Palm common stock, provided that he or she had served as such for at least the six months immediately preceding that date. Each non-employee director who first becomes a non-employee director after the effective date of the 2001 Director Plan will automatically be granted an option to purchase 3,000 shares of Palm common stock on the date that he or she is first appointed or elected as a non-employee director. Each non-employee director will also automatically be granted an option to purchase 1,500 shares of Palm common stock on the date of each annual meeting after the effective date of the 2001 Director Plan if he or she is a non-employee director on the date of such annual meeting and has served as such for, at least, the immediately preceding six months.

In addition to the initial and/or ongoing grants of options described above, a non-employee director may be eligible to receive automatic grants of options based on his or her service as the chairman of a standing committee of the board of directors (which we will refer to in this joint proxy statement/prospectus as a committee chair), a member (whether voting or non-voting) of a standing committee of the board of directors (which we will refer to in this joint proxy statement/prospectus as a committee member), and/or the chairman of the board of directors. Each non-employee director who was a committee chair on the effective date of the 2001 Director Plan was automatically granted an option to purchase 350 shares of Palm common stock on that date. Each non-employee director who first becomes a committee chair after the effective date of the 2001 Director Plan will automatically be granted an option to purchase 350 shares of Palm common stock on the date that he or she is first appointed as a committee chair. Each non-employee director who has received an option by reason of his or her status as a committee chair will also automatically be granted an option to purchase 350 shares of Palm common stock on the date of each annual meeting after the effective date of the 2001 Director Plan if he or she is a committee chair on the date of such annual meeting and has served in such position for at least the immediately preceding six months. A non-employee director will be entitled to more than one option by reason of his or her status as a committee chair to the extent that, on any grant date, he or she is the chairman of more than one standing committee of the board of directors. In addition, each non-employee director who was a committee member on the effective date of the 2001 Director Plan was automatically granted an option to purchase 250 shares of Palm common stock on that date. Each non-employee director who first becomes a committee

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member after the effective date of the 2001 Director Plan will automatically be granted an option to purchase 250 shares of Palm common stock on the date that he or she is first appointed as a committee member. Each non-employee director who has received an option by reason of his or her status as a committee member will also automatically be granted an option to purchase 250 shares of Palm common stock on the date of each annual meeting after the effective date of the 2001 Director Plan if he or she is a committee member on the date of such annual meeting and has served in such position for at least the immediately preceding six months. A non-employee director will be entitled to more than one option by reason of his or her status as a committee member to the extent that, on any grant date, he or she is a member of more than one standing committee of the board of directors. However, a non-employee director may not receive an option by reason of his or her service on any standing committee with respect to which he or she is entitled to receive an option by reason of his or her status as the chairman of that committee. Finally, each non-employee director who is the chairman of the board of directors on the date of an annual meeting will automatically be granted an option to purchase 500 shares of Palm’s common stock on that date. Each option granted under the 2001 Director Plan has a maximum term of ten years and an exercise price equal to the fair market value of the shares subject to the option on the date of grant. Each option becomes exercisable in three equal annual installments, beginning on the first anniversary of the date of grant, provided that in each case the non-employee director remains a director on those dates. However, if a change of control (as defined in the 2001 Director Plan) occurs and an optionee will cease to be a non-employee director as an immediate and direct consequence of the change of control, his or her outstanding options will become fully vested and exercisable on the date of the change of control. Also, if an optionee terminates his or her service on the board of directors due to his or her death, his or her outstanding options will immediately vest in full.

During the fiscal year ended May 30, 2003, options were granted under the 2001 Director Plan for the following number of shares of Palm common stock and at the exercise prices shown: Gordon A. Campbell: 2,100 shares at a per share exercise price of $13.40; Gareth C.C. Chang: 1,500 shares at a per share exercise price of $13.40; Jean-Jacques Damlamian: 1,500 shares at a per share exercise price of $13.40; Michael Homer: 1,750 shares at a per share exercise price of $13.40; and Susan G. Swenson: 2,100 shares at a per share exercise price of $13.40.

Non-employee directors are also eligible for discretionary awards under Palm’s 1999 Stock Plan, as amended. During the fiscal year ended May 30, 2003, options were granted under the 1999 Stock Plan for the following number of shares of Palm’s common stock and at the exercise prices shown: Gordon A. Campbell: 7,500 shares at a per share exercise price of $13.15; Gareth C.C. Chang: 7,500 shares at a per share exercise price of $13.15; Jean-Jacques Damlamian: 7,500 shares at a per share exercise price of $13.15; Michael Homer: 7,500 shares at a per share exercise price of $13.15; and Susan G. Swenson: 7,500 shares at a per share exercise price of $13.15. The numbers of shares described in this foregoing sentence reflect the adjustments to the number of shares subject to such options to give effect to the 1-for-20 reverse stock split of Palm common stock effective as of October 15, 2002.

During the fiscal year ended May 30, 2003, Gordon A. Campbell and Susan G. Swenson served as members of the Compensation Committee of Palm’s board of directors, none of whom is or has been an officer or employee of Palm. In addition, during the fiscal year ended May 30, 2003, Eric A. Benhamou served as a non-voting member of the Compensation Committee. Mr. Benhamou currently serves as Palm’s Chief Executive Officer. No interlocking relationship existed during the fiscal year ended May 30, 2003 between Palm’s board of directors or Compensation Committee and the board of directors or compensation committee of any other company.

Section 16(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, requires Palm’s executive officers, directors and persons who beneficially own more than 10% of Palm’s common stock to file

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initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission. Such persons are required by Securities and Exchange Commission regulations to furnish Palm with copies of all Section 16(a) forms filed by such persons.

Based solely on Palm’s review of such forms furnished to Palm and written representations from certain reporting persons, Palm believes that all filing requirements applicable to Palm’s executive officers, directors and persons who beneficially own more than 10% of Palm’s common stock were complied with during the fiscal year ended May 30, 2003.

The board of directors unanimously recommends that the stockholders vote “FOR” the election of Michael Homer, Gareth C.C. Chang and R. Todd Bradley to Class I of the board of directors of Palm.

Index to Financial Statements

The board of directors of Palm has selected Deloitte & Touche LLP as the independent public auditors of Palm for the fiscal year ending May 28, 2004. Deloitte & Touche LLP served in such capacity for the fiscal year ended May 30, 2003. A representative of Deloitte & Touche LLP will be present at the annual meeting, will be given the opportunity to make a statement, if he or she so desires, and will be available to respond to appropriate questions.

In the event ratification by the stockholders of the appointment of Deloitte & Touche LLP as Palm’s independent public auditors is not obtained, the board of directors of Palm will reconsider such appointment.

The affirmative vote of a majority of the votes cast is required for approval of this proposal. For a description of the treatment and effect of abstentions and broker non-votes, see “Abstentions” and “Broker Non-Votes” under “The Palm Annual Meeting of Stockholders” in this joint proxy statement/prospectus.

The board of directors unanimously recommends a vote “FOR” ratification of the appointment of Deloitte & Touche LLP as Palm’s independent public auditors for the fiscal year ending May 28, 2004.

Index to Financial Statements

We are asking stockholders to approve the amendment and restatement of Palm’s 2001 Stock Option Plan for Non-Employee Directors, as amended, or the Director Plan, so that Palm can continue to attract and retain outstanding and highly skilled individuals to serve on its board of directors. The amendments include:

Prior to Palm’s one-for-20 reverse stock split approved at the 2002 annual meeting of stockholders, there were 6,000,000 shares reserved for issuance under the Director Plan and the guidelines provided for an initial grant of 60,000 shares, an ongoing annual grant for board participation of 30,000 shares, an ongoing annual grant for each committee membership of 5,000 shares, an ongoing annual grant for each committee chair of 7,000 shares and an ongoing annual grant for the Chairman of the board of directors of 10,000 shares.

The board of directors has approved the amendment and restatement of the Director Plan. Although Palm’s non-employee directors have an interest in obtaining approval of the amendment and restatement of the Director Plan because they will be the beneficiaries of the approval, the board of directors believes that the offer of the amended equity incentives to Palm’s non-employee directors will be a key factor in Palm’s overall financial performance.

Stock options such as those provided under the Director Plan are vital to our ability to attract and retain the best available individuals for service as non-employee directors, especially in the extremely competitive markets in which we must compete. To remain competitive in our industry, we believe strongly that we must increase the stock options offered to our non-employee directors and that the approval of the amendment and restatement of the Director Plan is essential. In accordance with the rules of the Nasdaq Stock Market, stockholders must approve certain changes to stock option plans, such as the Director Plan, pursuant to which stock may be acquired by directors.

The amended and restated 2001 Director Plan is attached as Appendix C to this joint proxy statement/prospectus. The following summary of the Director Plan does not contain all of the terms and conditions of the

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Director Plan, and is qualified in its entirety by reference to the Director Plan. You should refer to Appendix C for a complete set of terms and conditions of the Director Plan.

Purpose. The purpose of the Director Plan is to attract and retain the best available individuals for service as non-employee directors. The Director Plan is also intended to closely align the interests of the non-employee directors with those of Palm’s stockholders by making a significant portion of their compensation directly related to the total return performance of Palm common stock. The Director Plan is further intended to encourage stock ownership on the part of non-employee directors.

Shares Reserved for Issuance. Palm’s board of directors has reserved a total of 950,000 shares of Palm common stock for issuance under the Director Plan. If an option granted under the Director Plan expires or is cancelled for any reason without having been fully exercised or vested, the unvested or cancelled shares will be returned to the available pool of shares reserved for issuance under the Director Plan.

In addition, Palm’s board of directors has directed that the number of shares of Palm common stock which have been reserved for issuance under the Director Plan shall be increased from time to time for any increase in the number of issued shares of Palm common stock resulting from any adjustment pursuant to Section 4.3.1 of the Director Plan (adjustments in options and authorized shares for changes in capitalization, including spin-offs) in connection with the PalmSource distribution.

Administration of the Director Plan. The Director Plan is administered by the compensation committee of Palm’s board of directors. Subject to the terms of the Director Plan, the committee has the sole discretion to interpret the provisions of the Director Plan and outstanding options. All decisions of the committee are final and binding on all persons, and will be given the maximum deference permitted by law.

Eligibility. Options under the Director Plan may be granted only to non-employee directors. Non-employee directors will receive annual, automatic, nondiscretionary grants of stock options, as described below.

Initial Grants. Each individual who first becomes a non-employee director of Palm after that date of Palm’s 2003 Annual Meeting will automatically receive an option to purchase 28,000 shares on the date that he or she is first appointed or elected as a non-employee director.

Ongoing Grants. Each non-employee director will also automatically receive an option to purchase 14,000 shares on the date of each subsequent annual meeting if he or she is a non-employee director on that date and has served as such for at least the immediately preceding six months.

Additional Grants. In addition to the initial and/or ongoing grants of options described above, a non-employee director may be eligible to receive the following grants based on his or her service as the Chairperson of a standing committee of Palm’s board of directors, a member (whether voting or non-voting) of a standing committee of Palm’s board of directors, and/or the Chairman of Palm’s board of directors:

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Terms and Conditions of Options. Each option granted under the Director Plan is evidenced by a written stock option agreement between Palm and the optionee, and is subject to the following additional terms and conditions:

Adjustments Upon Changes in Capitalization, Dissolution, Merger or Sale of Assets. Subject to any required action by stockholders, the number and class of shares of Palm common stock available for issuance under the Director Plan and the number, class and exercise price of shares subject to outstanding options and future grants of options under the Director Plan will be proportionately adjusted by the compensation committee for any increase or decrease in the number of issued shares of Palm common stock resulting from a stock split, reverse stock split, stock dividend, spin-off, combination or reclassification of shares of Palm common stock, or any other increase or decrease in the number of shares of Palm common stock issued effected without receipt of consideration (with certain restrictions).

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In the event of a proposed liquidation or dissolution of Palm, any unexercised options will terminate immediately prior to the consummation of the liquidation or dissolution.

In the event of Palm’s merger with or into another corporation or the sale of substantially all of Palm’s assets, each outstanding option may be assumed or an equivalent option substituted by the successor corporation. If the successor corporation does not assume an outstanding option or substitute for it an equivalent option, the option will become fully vested and exercisable, including as to shares for which it would not otherwise be exercisable. If an option becomes fully vested and exercisable in lieu of such assumption or substitution, the committee will notify the optionee that the option is fully exercisable for 30 days from the date of such notice and that the option terminates upon expiration of such period.

Options to be Granted to Certain Individuals and Groups. The following table sets forth the total number of shares of Palm common stock subject to options expected to be granted to certain individuals and groups under the Director Plan for fiscal year 2004 if the Director Plan is approved by stockholders. Because these options have not yet been granted, the average per share exercise price of the options cannot be determined. Under the formula for granting options under the Director Plan, the total number of shares subject to options granted during any fiscal year will depend on a number of factors, including the total number of members of Palm’s board of directors, the number of committees of Palm’s board of directors and the number of directors who serve on each committee.

Market Value of Securities Underlying Options. On , 2003, the closing sale price of Palm’s common stock was per share and there were shares underlying outstanding options under the Director Plan.

Federal Income Tax Consequences. The following discussion summarizes certain federal income tax considerations for U.S. taxpayers receiving options under the Director Plan and certain tax effects on Palm, based upon the provisions of the Code, as in effect on the date of this joint proxy statement/prospectus, current regulations and existing administrative rulings of the IRS. However, it does not purport to be complete and does not discuss the provisions of the income tax laws of any municipality, state or foreign country in which the optionee may reside. Tax consequences for any particular individual may be different.

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Options granted pursuant to the Director Plan are “nonstatutory stock options” (that is, options that are not “incentive stock options” as defined in Section 422 of the Code) and will not qualify for any special tax benefits to the optionee. An optionee does not recognize any taxable income at the time he or she is granted an option under the Director Plan. Upon exercise, the optionee recognizes taxable income generally measured by the excess of the then fair market value of the shares over the exercise price of the option. Palm is generally entitled to a deduction for federal income tax purposes in the same amount as the ordinary income recognized by the optionee. Upon a disposition of such shares by the optionee, any difference between the sale price and the optionee’s exercise price, to the extent not recognized as ordinary income as provided above, is treated as long-term or short-term capital gain or loss, depending on the holding period. Net capital gains on shares held more than 12 months may be taxed at a maximum federal rate of 20%. Capital losses are allowed in full against capital gains and up to $3,000 against other income.

Amendment and Termination of the Director Plan. The Board of Directors, in its sole discretion, may amend or terminate the Director Plan, or any part thereof, at any time and for any reason. However, no such amendment or termination may, without the consent of the optionee, alter or impair any rights under any outstanding option.

The affirmative vote of a majority of the votes cast is required for approval of this proposal. For a description of the treatment and effect of abstentions and broker non-votes, see “The Palm Annual Meeting of Stockholders—General Information—Abstentions” and “The Palm Annual Meeting of Stockholders—General Information—Broker Non-Votes” in this joint proxy statement/prospectus.

The board of directors unanimously recommends a vote “FOR” the amendment and restatement of the 2001 Stock Option Plan for Non-Employee Directors.

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The following table sets forth information concerning the compensation paid by Palm to (i) the Chief Executive Officer of Palm and (ii) the four other most highly compensated individuals (based on salary and bonus during the fiscal year ended May 30, 2003) who were serving as executive officers of Palm at the end of the fiscal year ended May 30, 2003. We shall refer to such individuals collectively as the named executive officers in this joint proxy statement/prospectus.

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The following table provides information concerning grants of options to purchase Palm’s common stock made during the fiscal year ended May 30, 2003 to the named executive officers:

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The following table provides information concerning option exercises during the fiscal year ended May 30, 2003 and the exercisable and unexercisable options held by the named executive officers as of May 30, 2003:

Aggregated Option Exercises in Fiscal Year 2003 and Fiscal Year-End Option Values

Pursuant to an Employment Offer Letter dated September 13, 2001, Mr. Nagel accepted the position of Chief Executive Officer and President of PalmSource, Inc. The terms of the offer letter include, among other things, a starting salary of $620,000 per year, participation in a discretionary cash bonus plan, a grant of stock options to purchase shares of PalmSource (when possible), a grant of shares of Palm restricted stock, a sign-on/retention bonus of $200,000 paid over 18 months, and standard benefits. Pursuant to the offer letter, Mr. Nagel is entitled to severance benefits if his employment is terminated involuntarily by Palm or PalmSource, other than for cause (as defined in the offer letter) or voluntarily by him for good reason (as defined in the offer letter). These severance benefits include a severance payment equal to two times Mr. Nagel’s annual salary and 100% of his target bonus, continued employee benefits for two years, a pro-rated bonus payment, acceleration of vesting of his stock options and his Palm restricted stock grant as if he continues as an employee of PalmSource for two additional years following his termination, payment of the difference between the total value of Mr. Nagel’s Palm restricted stock grant on the date of termination and $2,000,000 (if such termination occurs prior to September 15, 2003), and a waiver of any obligation on his part to return any of the sign-on/retention bonus.

Palm has entered into management retention agreements with the following named executive officers: R. Todd Bradley, Judy Bruner and Marianne Jackson. The management retention agreements with Mr. Bradley and Ms. Bruner entitle each such officer to full acceleration of the vesting of his or her outstanding stock options and full vesting of any shares of restricted stock upon a change of control (as defined in the management retention agreements). Under Ms. Jackson’s management retention agreement, Ms. Jackson’s outstanding stock options and restricted stock become fully vested if, within 12 months following a change of control (as defined in the management retention agreement), her employment is terminated involuntarily by Palm other than for cause (as defined in the management retention agreement), death or disability or voluntarily by Ms. Jackson for good reason (as defined in the management retention agreement). Further, the management retention agreements with all of the named executive officers listed above provide that each such officer is entitled to additional severance benefits if, within 12 months following a change of control (as defined in the management retention agreements), the employee’s employment is terminated involuntarily by Palm other than for cause (as defined in the management retention agreements), death or disability or voluntarily by the employee for good reason (as defined in the management retention agreements) and the employee enters into a mutual release of claims with Palm. These severance benefits include a severance payment of one times annual salary and target bonus (except that with respect to Mr. Bradley, this severance payment is two times annual salary and target bonus), continued company-paid coverage of certain employee benefits for a minimum of two years following his or her termination, pro-rated bonus payment and a tax equalization payment to eliminate the effects of any applicable “golden parachute” excise tax.

Index to Financial Statements

In addition, Palm has entered into severance agreements with R. Todd Bradley and Judy Bruner. Pursuant to the severance agreements, each of these employees is entitled to severance benefits if the employee’s employment is terminated involuntarily by Palm other than for cause (as defined in the severance agreements), death or disability (as defined in the severance agreements) or voluntarily by the employee for good reason (as defined in the severance agreements) and the employee enters into a mutual release with Palm, complies with all of the terms of the severance agreement, including the non-solicitation of employees, and does not qualify for payments and benefits under his or her management retention agreement. With respect to Ms. Bruner, the severance benefits include a lump-sum payment equal to 100% of annual base salary, one year of accelerated vesting of stock options (excluding any shares that would vest solely or have their vesting accelerate upon the achievement of performance objectives), vesting of one-half of any shares of restricted stock (excluding any shares that vest solely or have their vesting accelerate upon the achievement of performance objectives) and certain employer paid health benefits for one year if the employee elects continuation coverage. With respect to Mr. Bradley, the severance benefits include a lump-sum payment equal to 200% of annual base salary, two years of accelerated vesting of stock options (excluding any shares that would vest solely or have their vesting accelerate upon the achievement of performance objectives), vesting of one-half of any shares of restricted stock (excluding any shares that vest solely or have their vesting accelerate upon the achievement of performance objectives) and certain employer paid health benefits for two years if the employee elects continuation coverage. Under the terms of the severance agreements, a termination event will not be deemed to have occurred where an individual is employed by a subsidiary of Palm and Palm distributes the securities of such subsidiary to Palm’s stockholders.

Palm has also entered into executive retention agreements with the following named executive officers pursuant to the Solution Group’s executive retention program: R. Todd Bradley, Judy Bruner and Marianne Jackson. Pursuant to these agreements, each of these officers is entitled to a guaranteed bonus based on target percentages of his or her eligible base salary for the period from the first quarter of fiscal year 2003 through the second quarter of fiscal year 2004. The bonuses are contingent on the achievement of minimum performance ratings exceeding expectations and are scheduled to be paid after the end of Palm’s quarter ending November 28, 2003, provided the officer has remained at Palm through that date. In addition, these agreements provide for grants of restricted stock to these officers, subject to a three year vesting schedule in equal annual installments, in the following amounts (such amounts are adjusted to give effect to the one-for-20 reverse stock split of Palm common stock effective as of October 15, 2002): 5,000 shares for Mr. Bradley, 2,500 shares for Ms. Bruner and 2,500 shares for Ms. Jackson.

In May 2001, Palm entered into an offer letter agreement with R. Todd Bradley, which provides for: a base annual salary of $525,000, bonus eligibility, and a grant of an option to acquire 37,500 shares of Palm common stock (such number of shares is adjusted to give effect to the one-for-twenty reverse stock split of Palm common stock effective as of October 15, 2002) subject to four year vesting with 25% vesting after the first year and monthly vesting thereafter. In May 2002, Mr. Bradley was promoted to President, Solutions Group, and his compensation was adjusted to provide for an enhanced bonus potential and a grant of an additional option to acquire 37,500 shares of Palm common stock (such number of shares is adjusted to give effect to the one-for-twenty reverse stock split of Palm common stock effective as of October 15, 2002), subject to four year vesting with 25% vesting after the first year and the remaining option vesting monthly thereafter. In September 2002, Mr. Bradley’s title was changed to President and Chief Executive Officer, Solutions Group, and his base annual salary was increased to $620,000. In August 2003, Mr. Bradley’s annual base salary was increased to $660,000, and in July 2003, he was granted an option to purchase 150,000 shares of Palm common stock, subject to monthly vesting over three years.

In January 2002, Palm entered into an offer letter agreement with Marianne F. Jackson, which provides for: a base annual salary of $275,000, bonus eligibility, and a grant of an option to acquire 22,500 shares of Palm common stock (such number of shares is adjusted to give effect to the one-for-twenty reverse stock split of Palm common stock effective as of October 15, 2002), subject to four year vesting with 25% vesting after the first year and monthly vesting thereafter. In September 2003, Palm entered into a severance agreement with Ms. Jackson, which, pursuant to her existing severance agreement, provides for a lump sum payment on approximately

Index to Financial Statements

November 1, 2003 in the amount of $275,000, payment of accrued but unused paid time off, up to $10,000 of executive outplacement services, coverage of COBRA premiums through October 2004, one year of accelerated vesting of stock options as of approximately November 1, 2003 (excluding any shares that would vest solely or have their vesting accelerate upon the achievement of performance objectives) and accelerated vesting of one-half of any shares of restricted stock that remain unvested as of approximately November 1, 2003 (excluding any shares that vest solely or have their vesting accelerate upon the achievement of performance objectives). In addition, the severance agreement provides an additional lump sum payment in the amount of $187,000, which Ms. Jackson would have earned pursuant to the executive retention program had she remained with Palm through November 28, 2003.

In November 2002, Palm entered into a letter arrangement with Eric Benhamou, which provides for: an annual base salary of $525,000; bonus eligibility; a grant of an option exercisable for 60,000 shares of Palm common stock (such amount gives effect to the one-for-twenty reverse stock split of Palm common stock effective as of October 15, 2002), which vests in equal annual installments over three years and accelerated vesting in full at the time of the PalmSource distribution; and an additional grant of an option exercisable for 5,000 shares of Palm common stock to be made at the time of the consummation of the PalmSource distribution.

Palm’s 1999 Stock Plan, as amended (the “Stock Plan”), provides that in the event of Palm’s merger with or into another corporation or the sale of substantially all of Palm’s assets, the successor corporation may assume or substitute an equivalent award for each outstanding option or stock purchase right. If following such an assumption or substitution, the holder of an option or stock purchase right is terminated without cause within 12 months following a change of control (as defined in the Stock Plan), then the vesting and exercisability of 50% of the then unvested shares of common stock of Palm subject to his or her option or stock purchase right will accelerate. If the outstanding options or stock purchase rights are not assumed or substituted for in connection with a merger or sale of assets, the administrator of the Stock Plan will provide notice to the optionee that he or she has the right to exercise the option or stock purchase right as to all of the shares subject to the option or stock purchase right, including shares which would not otherwise be exercisable, for a period of 15 days from the date of the notice. The option or stock purchase right will terminate upon the expiration of the 15-day period.

Under Palm’s 1999 Employee Stock Purchase Plan, as amended, in the event of Palm’s merger with or into another corporation or the sale of all or substantially all of Palm’s assets, the successor corporation may assume or substitute an equivalent option for each outstanding option. If the successor corporation does not assume or substitute for the outstanding options, the purchase periods and offering periods then in progress will be shortened by setting a new exercise date, which will be before the merger or sale of assets.

Palm’s Amended and Restated 1999 Director Option Plan, as amended, or the 1999 Director Plan, provides that in the event of Palm’s merger with or into another corporation or the sale of substantially all of Palm’s assets, each outstanding option may be assumed or an equivalent option substituted by the successor corporation. If the successor corporation does not assume or substitute for an outstanding option, the option will become fully vested and exercisable. If an option becomes fully vested and exercisable in lieu of such assumption or substitution, the administrator of the 1999 Director Plan will notify the optionee that the option is fully exercisable for 30 days from the date of such notice and that the option will terminate upon the expiration of such 30-day period. In addition, in the event of a change of control (as defined in the 1999 Director Plan), the exercisability of each outstanding option will accelerate and become fully vested and exercisable immediately prior to the change of control as to all of the shares then subject to the option. The option will terminate immediately following the change of control.

Palm’s 2001 Stock Option Plan for non-employee directors, or the 2001 Director Plan, provides that in the event of Palm’s merger with or into another corporation or the sale of substantially all of Palm’s assets, each outstanding option may be assumed or an equivalent option substituted by the successor corporation. If the successor corporation does not assume or substitute for an outstanding option, the option will become fully vested and exercisable. If an option becomes fully vested and exercisable in lieu of such assumption or

Index to Financial Statements

substitution, the administrator of the 2001 Director Plan will notify the optionee that the option is fully exercisable for 30 days from the date of such notice and that the option will terminate upon the expiration of such 30-day period. In addition, if a change of control (as defined in the 2001 Director Plan) occurs and a non-employee director will cease to be such as an immediate and direct consequence of the change of control, his or her outstanding options (if not yet expired) will become fully exercisable on the date of the change of control.

Index to Financial Statements

After the legal separation from 3Com in February 2000, Palm has paid 3Com for certain leased facilities and for transitional services required while Palm established its independent infrastructure. Amounts paid to 3Com under these agreements since the separation date were approximately $12.9 million, $25.2 million and $31.9 million for fiscal years 2003, 2002 and 2001, respectively.

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

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

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

Under the terms of a software license agreement between PalmSource and 3Com, PalmSource recorded $0.4 million and $0.2 million of support revenues for fiscal years 2003 and 2002, respectively.

See “The PalmSource Separation” in this joint proxy statement/prospectus for a description of the principal agreements relating to the separation of PalmSource from Palm.

At the date of the PalmSource distribution, PalmSource will assume $15.0 million of a note payable to Texas Instruments by Palm, which bears interest at 5.0% per annum and is due December 6, 2006.

In December 2001, Palm entered into the software license agreement with PalmSource, which was amended and restated in June 2003. David C. Nagel, one of our directors, is the President and Chief Executive Officer of PalmSource. Under the software license agreement, we recorded aggregate payments of $21.1 million to PalmSource in fiscal year 2002 and $38.9 million in fiscal year 2003 respectively. The agreement establishes minimum annual license and royalty commitments which are $37.5 million for the contract year ending December 3, 2003 and $39.0 million for the contract year ending December 3, 2004.

Palm entered into a business consulting agreement effective as of June 2002 with Satjiv Chahil, who was formerly Palm’s Chief Marketing Officer. Under this consulting agreement, Palm paid Mr. Chahil approximately $0.4 million in consulting fees during fiscal year 2003. This consulting agreement expired on May 31, 2003. Mr. Chahil served as a Palm spokesperson, delivering keynote addresses at industry forums and assisting with industry and analyst relations activities, assisted with the separation of PalmSource from Palm, and solicited advice and feedback from key influencers and opinion leaders on Palm’s strategy and products.

In fiscal year 2003, Palm made a $1.0 million equity investment in and entered into a product procurement agreement with Mobile Digital Media, Inc., a company founded by Barry Cottle, the former Senior Vice

Index to Financial Statements

President and Chief Internet Officer of Palm until his employment with Palm terminated in February 2002. Palm paid $4.6 million for products purchased under the product procurement agreement during fiscal year 2003. These products were purchased by Palm for resale.

In fiscal year 2003, Palm purchased $0.3 million of software licenses and services from Kontiki, Inc. Michael Homer, a current member of Palm’s board of directors, is the Chairman and Chief Executive Officer of Kontiki, Inc.

In fiscal year 2003, Palm purchased $0.1 million of products from SanDisk Corporation through a series of purchase orders and without further obligations on the part of Palm. Judy Bruner, Palm’s current chief financial officer, serves as a member of the board of directors of SanDisk Corporation.

Eric Benhamou is the Chairman of the board of directors of both Palm and PalmSource and is currently employed by Palm as its Chief Executive Officer.

David Nagel is currently a member of the board of directors of both Palm and PalmSource and is currently employed by PalmSource as its President and Chief Executive Officer.

Marianne Jackson, Senior Vice President and Chief Human Resources Officer of Palm, is the sister of Robert J. Finnochio, a director of PalmSource.

Index to Financial Statements

Set forth below is a report submitted by Palm’s Audit Committee describing Palm’s financial and accounting management policies and practices. The Audit Committee is composed of three directors who are independent as determined in accordance with Nasdaq’s listing standards. The Audit Committee operated throughout fiscal year 2003 under a written charter adopted by Palm’s board of directors, a copy of which was attached as Appendix A to the proxy statement for Palm’s 2001 Annual Meeting of Stockholders. The Audit Committee has reviewed the relevant requirements of the Sarbanes-Oxley Act, the proposed rules of the U.S. Securities and Exchange Commission and the proposed new listing standards of Nasdaq regarding audit committee policies. Although some of these rules and standards had not yet been finalized, the board of directors adopted an amendment and restatement of the Audit Committee charter on July 1, 2003, to proactively implement certain of these proposed rules and standards. A copy of this amended and restated charter has been attached to this joint proxy statement/prospectus as Annex E.

Index to Financial Statements

Based on such review and discussions, the Audit Committee recommended to the board of directors that the audited financial statements be included in Palm’s Annual Report on Form 10-K for the fiscal year ended May 31, 2003.

Index to Financial Statements

In September 2002, the Audit Committee of Palm’s board of directors adopted policies and procedures for pre-approving all audit and permissible non-audit services performed by Deloitte & Touche LLP. Under these policies, the Audit Committee pre-approves the use of audit and specific permissible audit-related and non-audit services up to an aggregate dollar limit. All such audit, audit-related, tax and non-audit services provided to Palm by Deloitte & Touche, LLP since September 2002 have been pre-approved by the Audit Committee in accordance with its policies and procedures.

The following table sets forth the audit and related fees for services provided to Palm by Deloitte & Touche LLP for fiscal years 2002 and 2003, respectively.

Audit fees include fees billed to Palm by Deloitte & Touche LLP for the audit of Palm’s annual financial statements, for the review of the financial statements included in Palm’s quarterly reports on Form 10-Q, statutory audits of Palm’s foreign subsidiaries and assistance with the review of various Securities and Exchange Commission filings.

Audit-related fees billed to Palm by Deloitte & Touche LLP include fees for accounting consultations concerning financial accounting and reporting standards and consultations in connection with acquisitions.

Tax fees include fees billed to Palm by Deloitte & Touche LLP for tax planning and advice and tax return preparation services.

For fiscal year 2003, other fees billed to Palm by Deloitte & Touche LLP related to expatriate administrative service. In fiscal year 2002, other fees billed to Palm by Deloitte & Touche LLP related to certain non-recurring consulting services to assist Palm in completing the implementation of certain key financial and non-financial information systems. Palm engaged in a significant number of systems implementations beginning in the fourth quarter of fiscal year 2000 as it separated from 3Com Corporation. Those systems implementations were completed in the first half of fiscal year 2002.

Index to Financial Statements

Palm designs its compensation program to enable it to attract, retain, motivate and reward highly qualified executive officers who are likely to contribute to the long-term success of Palm. Palm’s compensation program for all employees includes both cash- and equity-based elements. The Compensation Committee believes that it is important to align compensation with Palm’s business objectives and performance and to align incentives for both employees and executive officers with the interests of stockholders in maximizing stockholder value. As a result, Palm emphasizes performance-based equity compensation in the design of its compensation programs.

Palm strives to make its compensation programs competitive with the marketplace. Palm’s executive compensation policies reflect the competition for executive talent and the unique challenges and opportunities facing Palm in the handheld computing and wireless markets. The Compensation Committee conducts annual reviews of Palm’s compensation practices by comparing them to those of peer companies in the high technology community. The Compensation Committee sets objective compensation standards based on these reviews.

Salary. The Compensation Committee offers salaries to its executive officers that are competitive with salaries offered by companies of similar size, complexity and market valuation or capitalization in the high technology community, particularly in the Silicon Valley. Palm sets a base salary range for each executive officer, including the Chief Executive Officer, by reviewing the base salary for comparable positions of a broad peer group that compete with Palm in the recruitment and retention of senior personnel. With respect to determining salary and other aspects of executive compensation for fiscal year 2003, Palm used the Radford Executive Compensation survey, including information from more than one hundred public companies in various high technology industries with revenue in a range comparable to Palm’s revenue.

Cash Bonus. In July 2002, the Compensation Committee established an executive bonus program for the retention of the Solutions Group’s executive officers. This bonus program provided for guaranteed bonuses based on target percentages of an executive officer’s eligible base salary for the period from the first quarter of fiscal year 2003 through the second quarter of fiscal year 2004. Targets for the bonus awards ranged from 50% to 100% of eligible base salary. The bonuses are contingent on the achievement of minimum performance ratings exceeding expectations, and are scheduled to be paid after the end of Palm’s quarter ending November 28, 2003, provided that the officer has remained at Palm through that date. The executive bonus program superseded and replaced previous executive bonus programs. Following the second quarter of fiscal year 2004, executive officers will again be eligible to participate in any Palm bonus plan or program. At the end of the second quarter of fiscal year 2003, based on Palm’s financial performance, a discretionary bonus equal to approximately 14% of the executive officer’s executive bonus program annual bonus target was paid to the executive officers.

On June 20, 2003, the Compensation Committee approved the fiscal year 2004 annual incentive plan. This plan provides that bonuses will be paid to employees upon the achievement of certain profitability and performance objectives. Executive officers will not participate in this plan until the third quarter of the fiscal year ending May 28, 2004.

Palm grants initial or “new-hire” options to executive officers when they first join the company. In addition, Palm may grant restricted stock to some of its executive officers when they first join Palm. Thereafter, Palm may grant options and restricted stock to each executive officer, including the Chief Executive Officer, based on

Index to Financial Statements

performance. To enhance retention, options and restricted stock granted to executive officers are subject to vesting restrictions that generally lapse over one to four years. The number of options and shares of restricted stock that the company grants to a particular executive officer upon hire and throughout employment depends on the officer’s level of responsibility and a review of stock option and restricted stock grants for comparable positions in a broad peer group of companies. Options granted by Palm at the then-current fair market value become valuable and exercisable only if the executive officer continues to serve Palm, and the price of Palm’s stock subsequently increases. As part of the executive bonus program, the Compensation Committee granted shares of restricted stock to the executive officers of the Solutions Group in fiscal year 2003.

In designing executive compensation for the fiscal year ended May 31, 2003, Palm retained outside consultants to provide data necessary to perform a comprehensive assessment of compensation for its Chief Executive Officer and other executive officers. The consultant rendered a report that surveyed competitors’ practices, assessed the mix of pay relative to competitive practices and evaluated the linkage between pay and performance. The Compensation Committee considered this information when making compensation changes for the executive officers.

The Compensation Committee has considered the potential impact of Section 162(m) of the Internal Revenue Code adopted under the Federal Revenue Reconciliation Act of 1993. Section 162(m) disallows a tax deduction for any publicly held corporation for individual compensation exceeding $1 million in any taxable year for any of the named executive officers, other than compensation that is “performance-based.” Palm’s performance-based bonus plan permits Palm to pay compensation that is performance-based and thus generally fully deductible by Palm. Since the targeted cash compensation of the majority of the named executive officers is below the $1 million threshold and Palm believes that any options granted under the 1999 Stock Plan, as amended, will meet the requirement of being performance-based under Section 162(m), the Compensation Committee concluded that Section 162(m) should not materially reduce the tax deductions available to Palm and that no changes to Palm’s compensation program were needed in this regard. However, the Compensation Committee may from time to time approve compensation that is not deductible under Section 162(m).

During the fiscal year ended May 31, 2003, Mr. Benhamou served as interim Chief Executive Officer of Palm. Mr. Benhamou’s salary for the fiscal year ended May 31, 2003 of $525,000 reflected his position, duties and responsibilities. Palm awarded Mr. Benhamou a bonus at the end of the second quarter of fiscal year 2003 of $36,750 as part of the performance-based bonuses paid by Palm. This bonus was based on Mr. Benhamou’s base annual salary, his split of time between Palm and PalmSource and his pro rata percentage of the quarterly bonus pool created by the Compensation Committee based on Palm’s profitable second quarter of fiscal year 2003. Mr. Benhamou’s stock option grant of the right to purchase 60,000 shares during the fiscal year ended May 31, 2003 reflected his position, duties and responsibilities.

Index to Financial Statements

Set forth below is a line graph comparing the cumulative total return on Palm’s common stock (as adjusted for the 1-for-20 reverse stock split of Palm’s common stock effective as of October 15, 2002) with the cumulative total return of the S&P 500 Index and the S&P 500 Information Technology Index for the period commencing on March 2, 2000, the date of the initial public offering of Palm’s common stock, and ending on May 30, 2003, Palm’s fiscal year end.

*ASSUMES $100 INVESTED ON MARCH 2, 2000 IN PALM COMMON STOCK AND $100 INVESTED ON FEBRUARY 29, 2000 IN THE S&P 500 INDEX AND THE S&P 500 INFORMATION TECHNOLOGY INDEX—INCLUDING REINVESTMENT OF ANY DIVIDENDS

Index to Financial Statements

Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California will pass upon the validity of the shares of Palm common stock offered in connection with this joint proxy statement/prospectus and certain federal income tax consequences of the Handspring merger.

Fenwick & West LLP, Mountain View, California, will pass upon certain federal income tax consequences of the Handspring merger for Handspring.

The consolidated financial statements and the related financial statement schedule incorporated in this joint proxy statement/prospectus by reference from Palm’s Annual Report on Form 10-K/A for the year ended May 31, 2003, have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report, which is incorporated herein by reference, and have been so incorporated in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.

The combined and consolidated financial statements of PalmSource, Inc. (a majority owned subsidiary of Palm, Inc.) and its subsidiaries as of May 31, 2003 and 2002 and for each of the three years in the period ended May 31, 2003 included in this prospectus have been so included in reliance on the report (which contains an explanatory paragraph relating to the basis of presentation of the PalmSource, Inc. combined and consolidated financial statements as described in Note 1 to such financial statements) of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

The consolidated financial statements of Be Incorporated as of December 31, 2000 and 1999 and for each of the two years in the period ended December 31, 2000 included in this prospectus have been so included in reliance on the report (which contains an explanatory paragraph relating to Be Incorporated’s ability to continue as a going concern as described in Note 2 to the consolidated financial statements) of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

The consolidated financial statements of Handspring, Inc. incorporated in this joint proxy statement/prospectus by reference to the Annual Report on Form 10-K for the year ended June 28, 2003, have been so incorporated in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

Index to Financial Statements

The documents incorporated by reference into this joint proxy statement/prospectus are available from us upon request. We will provide a copy of any and all of the information that is incorporated by reference into this joint proxy statement/prospectus (not including exhibits to the information unless those exhibits are specifically incorporated by reference into this joint proxy statement/prospectus) to any person, without charge, upon written or oral request. In order for Palm stockholders to receive timely delivery of the documents in advance of the Palm annual meeting, Palm should receive your request no later than , 2003. In order for Handspring stockholders to receive timely delivery of the documents in advance of the Handspring special meeting, Handspring should receive your request no later than , 2003.

Palm stockholders should contact Palm at the telephone number provided above with any questions about the transaction. Additionally, general corporate information about Palm is available at http://ir.palm.com/.

Handspring stockholders should contact Handspring at the telephone number provided above with any questions about the Handspring merger. Additionally, general corporate information about Handspring is available at http://www.handspring.com/company/investor_relations.jhtml.

Palm and Handspring file reports, proxy statements and other information with the Securities and Exchange Commission. Copies of such reports, proxy statements and other information may be inspected and copied at the Public Reference Room maintained by the Securities and Exchange Commission at:

You may obtain information on the operation of the Public Reference Room by calling the Securities and Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission maintains an Internet site that contains reports, proxy statements and other information relating to Palm. The address of the Securities and Exchange Commission Internet site is http://www.sec.gov.

Reports, proxy statements and other information concerning Palm and Handspring may also be inspected at:

Palm has filed a registration statement on Form S-4 under the Securities Act of 1933, as amended, with the Securities and Exchange Commission with respect to the transaction. This joint proxy statement/prospectus constitutes the prospectus of Palm filed as part of that registration statement. This joint proxy statement/prospectus does not contain all of the information set forth in the registration statement because certain parts of the registration statement have been omitted in accordance with the rules and regulations of the Securities and Exchange Commission. The registration statement and its exhibits are available for inspection and copying as set forth above.

Index to Financial Statements

This joint proxy statement/prospectus incorporates documents by reference that are not presented in or delivered herewith. To obtain these additional documents, see “Where You Can Find More Information” above.

The Securities and Exchange Commission allows us to “incorporate by reference” into this joint proxy statement/prospectus information that we have previously filed with the Securities and Exchange Commission. This means that we can disclose important information by referring you to another document filed separately with the Securities and Exchange Commission. The information incorporated by reference is deemed to be part of this document, except for any information superseded by information in this document. All documents filed by Palm and Handspring pursuant to Section 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended, after the date of this joint proxy statement/prospectus and before the date of the Palm annual meeting and Handspring special meeting, respectively, are incorporated by reference into and are to be a part of this joint proxy statement/prospectus from the date of filing of such documents.

Palm’s Securities and Exchange Commission filings incorporated by reference into this joint proxy statement/prospectus are:

Handspring’s Securities and Exchange Commission filings incorporated by reference into this joint proxy statement/prospectus are:

You should rely only on the information contained in or incorporated by reference into this joint proxy statement/prospectus. Neither Palm nor Handspring has authorized anyone else to provide you with information that is different.

Any statement contained herein or in a document incorporated or deemed to be incorporated by reference into this joint proxy statement/prospectus will be deemed to be modified or superceded for purposes of this joint proxy statement/prospectus to the extent that a statement contained in this joint proxy statement/prospectus or any other subsequently filed document that is deemed to be incorporated by reference into this joint proxy statement/prospectus modifies or supercedes such statement. Any statement so modified or superceded will not be deemed, except as so modified or superceded, to constitute a part of this joint proxy statement/prospectus.

Index to Financial Statements

This joint proxy statement/prospectus does not constitute an offer to sell, or a solicitation of an offer to purchase, the securities offered by this joint proxy statement/prospectus, or the solicitation of a proxy, in any jurisdiction to or from any person to whom or from whom it is unlawful to make such offer, solicitation of an offer or proxy solicitation in such jurisdiction. Neither the delivery of this joint proxy statement/prospectus nor any distribution of securities pursuant to this joint proxy statement/prospectus shall, under any circumstances, create any implication that there has been no change in the information set forth or incorporated by reference into this joint proxy statement/prospectus or in our affairs since the date of this joint proxy statement/prospectus.

Certain Palm stockholders who share an address are being delivered only one copy of this joint proxy statement/prospectus and Palm’s 2003 Annual Report on Form 10-K unless Palm or one of its mailing agents has received contrary instructions.

Upon the written or oral request of a Palm stockholder at a shared address to which a single copy of this joint proxy statement/prospectus and 2003 Annual Report on Form 10-K were delivered, Palm will promptly deliver a separate copy of such documents to such Palm stockholder. Written requests should be made to Palm, Inc., Attention: Investor Relations, 400 N. McCarthy Blvd., M/S 9204 Milpitas, California 95035 and oral requests may be made by calling Investor Relations of Palm at (408) 503-7200. In addition, Palm stockholders who wish to receive a separate copy of Palm’s proxy statements and annual reports in the future should notify Palm either in writing addressed to the foregoing address or by calling the foregoing telephone number.

Palm stockholders sharing an address who are receiving multiple copies of Palm’s proxy statements and annual reports may request delivery of a single copy of such documents by writing Palm at the address above or calling Palm at the telephone number above.

Proposals of Palm stockholders that are intended for inclusion in Palm’s proxy statement relating to the 2004 annual meeting of the stockholders of Palm must be received by Palm at its offices at 400 N. McCarthy Blvd., Milpitas, California 95035 not later than , 2004 and must satisfy the conditions established by the Securities and Exchange Commission for stockholder proposals in order to be included in Palm’s proxy statement for that meeting. Stockholder proposals that are not intended to be included in Palm’s proxy materials for such meeting but that are intended to be presented by the stockholder from the floor are subject to the advance notice procedures described below under “Transaction of Other Business at the Palm Annual Meeting.”

At the date of this joint proxy statement/prospectus, the only business that the board of directors of Palm intends to present or knows that others will present at the annual meeting is as set forth above. If any other matter or matters are properly brought before the annual meeting, or any adjournment thereof, it is the intention of the persons named in the accompanying form of proxy to vote the proxy on such matters in accordance with their best judgment.

Any stockholder may present a matter from the floor for consideration at a meeting so long as certain procedures are followed. Under Palm’s bylaws, as amended, in order for a matter to be deemed properly presented by a stockholder, timely notice must be delivered to, or mailed and received by, Palm not later than 90 days prior to the next annual meeting of stockholders (under the assumption that the next annual meeting of stockholders will occur no more than 30 days before or after the anniversary date of the most recent annual

Index to Financial Statements

meeting of stockholders). Any notice of a stockholder proposal received by Palm after such date will be considered untimely. The stockholder’s notice must set forth, as to each proposed matter, the following: (a) a brief description of the business desired to be brought before the meeting; (b) the name and address, as they appear on Palm’s books, of the stockholder proposing such business; (c) the class and number of shares of Palm that are beneficially owned by the stockholder; (d) any material interest of the stockholder in such business; and (e) any other information that is required to be provided by such stockholder pursuant to Regulation 14A under the Securities Exchange Act of 1934. The presiding officer of the meeting may refuse to acknowledge any matter not made in compliance with the foregoing procedure.

At the date of this joint proxy statement/prospectus, the only business that the board of directors of Handspring intends to present at the special meeting is as set forth above. According to Handspring’s bylaws, the only business that may be conducted at the special meeting is such business as is contained in the notice of the special meeting (other than nominations of persons for election to the board of directors for special meetings at which directors are to be elected). As a result, stockholders will not be able to present any matters from the floor for consideration and the business to be transacted at the special meeting will be limited to the Handspring merger proposal set forth above.

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Palm Stockholders. For shares of common stock that are registered in the name of the stockholder directly with EquiServe Trust Company, N.A., you may vote in person, by returning the enclosed proxy card or by Internet or telephone. Specific instructions to be followed by any registered stockholder interested in voting by Internet or telephone are set forth on the enclosed proxy card. The Internet and telephone voting procedures are designed to authenticate the stockholder’s identity and to allow stockholders to vote their shares and confirm that stockholders’ instructions have been properly recorded.

For shares of common stock that are beneficially owned by a stockholder and held in “street name” through a bank or brokerage (if such stockholder’s shares are registered in the name of a bank or brokerage), you may be eligible to vote your shares electronically by Internet or telephone. A large number of banks and brokerage firms are participating in the ADP Investor Communication Services online program, which provides eligible stockholders who receive a paper copy of Palm’s joint proxy statement/prospectus and annual report on Form 10-K the opportunity to vote by Internet or telephone. If your bank or brokerage firm is participating in ADP’s program, your voting form from the bank or brokerage will provide instructions. If your voting form does not reference Internet or telephone information, please complete and return the paper proxy card in the self-addressed, postage paid envelope provided.

Handspring Stockholders. For shares of common stock that are beneficially owned by a stockholder and held in “street name” through a bank or brokerage (if such stockholder’s shares are registered in the name of a bank or brokerage), you may be eligible to vote your shares electronically by Internet or telephone. A large number of banks and brokerage firms are participating in the ADP Investor Communication Services online program, which provides eligible stockholders who receive a paper copy of the joint proxy statement/prospectus the opportunity to vote by Internet or telephone. If your bank or brokerage firm is participating in ADP’s program, your voting form from the bank or brokerage will provide instructions. If your voting form does not reference Internet or telephone information, please complete and return the paper proxy card in the self-addressed, postage paid envelope provided.

Palm and Handspring stockholders voting via the Internet should understand that there may be costs associated with Internet access, such as usage charges from Internet access providers and telephone companies, that must be borne by the stockholder.

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Prior to the distribution there has been no public market for our common stock. We have applied to list our common stock on the Nasdaq National Market under the symbol “PSRC.”

Please pay careful attention to all of the information in this prospectus. In particular, you should carefully consider the discussion in the section titled “ Risk Factors” beginning on page 11 of this prospectus.

Neither the Securities and Exchange Commission nor any state securities regulator has approved or disapproved of the securities to be distributed under this prospectus or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

This prospectus is dated , 2003, and is first being mailed to stockholders of Palm, Inc. on or about , 2003.

The information in this prospectus is not complete and may be changed. Palm may not distribute these securities until the registration statement filed with the United States Securities and Exchange Commission is effective. The prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

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This prospectus incorporates important business and financial information about PalmSource that is not included in or delivered with the prospectus. PalmSource will provide you with copies of this prospectus, as well as exhibits filed with the registration statement, without charge, upon written or oral request to:

If you would like to request any documents from PalmSource, please do so by October 21, 2003.

Through and including the 25th day after the date of the distribution of the shares covered by this prospectus, all dealers effecting transactions in these securities, whether or not participating in this distribution, may be required to deliver a prospectus.

Graffiti and Hotsync are registered trademarks of PalmSource. Palm, Palm OS and PalmSource are registered trademarks of, and Palm Powered is a trademark of, Palm Trademark Holding Company, LLC. Each trademark, trade name or service mark of any other company appearing in the prospectus belongs to its holder.

Index to Financial Statements

In this prospectus, when we refer to the transaction, we refer to the PalmSource distribution and the Handspring merger as component parts of the merger agreement. Following the transaction, there will be two independent publicly-traded companies:

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The executive officers of PalmSource following the transaction will be: David C. Nagel, President and Chief Executive Officer; Albert J. Wood, Chief Financial Officer and Treasurer; Doreen S. Yochum, Chief Administrative Officer and Secretary; Gabriele R. Schindler, Senior Vice President of Worldwide Marketing; Lamar Potts, Vice President of Worldwide Licensing and Sales; Lawrence Slotnick, Chief Products Officer; and David A. Limp, Senior Vice President of Corporate and Business Development.

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If you would like additional copies of this prospectus without charge, or if you have questions about the business of PalmSource, you should contact:

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This summary highlights selected information from this prospectus and may not contain all of the information that is important to you. To understand the transaction fully and for a more complete description of the legal terms of the transaction, you should read carefully the entire prospectus and the documents we refer to in this prospectus. See the section titled “Where You Can Find More Information” in this prospectus.

This prospectus and any accompanying prospectus supplement contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements that are not statements of historical fact are forward-looking statements. Forward-looking statements generally are identified by the words “expects,” “anticipates,” “believes,” “intends,” “estimates,” “should,” “would,” “strategy,” “plan” and similar expressions. For example, in this prospectus these forward-looking statements, include, among others, statements regarding our business strategy, future operating performance, the size of the market for our products and services and the products that incorporate our operating system and our prospects.

These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from such forward-looking statements. For a detailed discussion of these risks and uncertainties, see the section titled “Risk Factors” in this prospectus. You should consider carefully the statements set forth in the section titled “Risk Factors” and other sections of this prospectus, and any accompanying prospectus supplement. All subsequent written and oral forward-looking statements attributable to PalmSource, or to persons acting on PalmSource’s behalf, are expressly qualified in their entirety by the applicable cautionary statements. PalmSource does not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this prospectus.

Palm, Peace Separation Corporation, Harmony Acquisition Corporation and Handspring have entered into a merger agreement to conduct the transaction described in this prospectus. The merger agreement provides for a transaction with two components, the PalmSource distribution and the Handspring merger.

PalmSource Distribution. PalmSource currently is a majority-owned subsidiary of Palm, with Palm owning approximately 86% of PalmSource’s outstanding shares of common stock on an as-converted basis as of August 29, 2003. Pursuant to the merger agreement, Palm will first distribute all of the shares of PalmSource common stock held by Palm to Palm’s existing stockholders. The distribution will be effected by means of a merger. Pursuant to the merger agreement, Peace Separation Corporation, a wholly-owned subsidiary of Palm, will merge with and into Palm. Palm will be the surviving corporation in this merger. In this merger, each share of Palm common stock outstanding as of the effective time of this merger will remain outstanding and will also be entitled to receive a number of shares of PalmSource common stock such that Palm will have distributed to Palm stockholders all of the PalmSource common stock Palm owns. No fractional shares of PalmSource common stock will be issued in the distribution. Instead, all fractional shares of PalmSource common stock will be aggregated for all Palm stockholders and sold in the public market. Accordingly, stockholders who would otherwise be entitled to receive a fractional share of PalmSource common stock will receive cash for their fractional interest. Cash amounts received for such fractional share may be taxable to stockholders. Based on shares of Palm common stock outstanding on August 29, 2003, Palm stockholders will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held. This ratio is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution. Handspring stockholders will not receive PalmSource common stock in the transaction.

Index to Financial Statements

Handspring Merger. Following the PalmSource distribution, Palm, which will consist of its Solutions Group business, will acquire Handspring though a merger transaction. Palm’s wholly-owned subsidiary, Harmony Acquisition Corporation, will merge with and into Handspring. Handspring will be the surviving corporation in this merger and will thereafter be a wholly-owned subsidiary of Palm. In this merger, each share of Handspring common stock, together with its associated preferred stock purchase right, will be converted into the right to receive 0.09 of a share of Palm common stock. Palm shares will be issued to Handspring stockholders with their associated preferred stock purchase rights. No fractional shares of Palm common stock will be issued in the Handspring merger. In lieu of receiving a fractional share of Palm common stock, each holder will receive an amount of cash equal to the product obtained by multiplying such fractional share by the average closing price of Palm common stock for the ten consecutive trading days ending on, and including, the trading day immediately prior to the Handspring merger.

Founded in 1992 and reincorporated under the laws of Delaware in December 1999, Palm is the leading global provider of handheld computing devices and operating systems for handheld devices. Palm currently consists of two operating segments: PalmSource, a majority owned subsidiary of Palm, and the Solutions Group. PalmSource is a leading developer and licensor of enabling software for mobile information devices. PalmSource’s software platform consists of operating system software, personal information management software and software development tools. Palm’s Solutions Group develops, markets and sells handheld computing devices, add-ons and accessories as well as related services and software, targeting consumer, enterprise, education and government users. Since Palm introduced its first handheld computer in 1996, it has shipped over 22 million handheld devices worldwide as of May 31, 2003. Following the transaction, Palm will consist of its Solutions Group business and the Handspring business.

Palm’s web site address is www.palm.com. The information on Palm’s web site is not a part of this prospectus.

Incorporated under the laws of Delaware in December 2001, we develop, market and support a leading software platform for mobile information devices. Our platform consists of the Palm operating system, or Palm OS, and software development tools that mobile information device manufacturers use to develop products from our platform as well as personal information management, web-browser and e-mail applications. Our platform enables manufacturers to rapidly and efficiently create powerful, innovative and easy-to-use mobile information devices. We license our products to leading device manufacturers, including Garmin, Handspring, Kyocera, Lenovo (formerly known as Legend), Palm, Samsung and Sony.

PalmSource’s web site address is www.palmsource.com. The information on our web site is not a part of this prospectus.

Index to Financial Statements

Incorporated under the laws of Delaware in May 2003, Peace Separation Corporation is a direct wholly-owned subsidiary of Palm and was incorporated for the sole purpose of merging with and into Palm to effect the distribution of the PalmSource common stock held by Palm to Palm’s stockholders. Peace Separation Corporation does not have any operations.

Unless otherwise indicated, all references in this prospectus to “we,” “our,” “us,” and “PalmSource” are to PalmSource, Inc. All references to Palm and “parent” are to Palm, Inc.

The “Risk Factors” beginning on page 11 should be considered carefully by Palm stockholders and holders of PalmSource common stock. These risk factors should be considered along with any additional risk factors in the periodic reports of Palm and PalmSource filed with the Securities and Exchange Commission and any other information included in this prospectus or the joint proxy statement/prospectus of Palm and Handspring.

Palm believes that the combination of Palm and Handspring will form a stronger market leader in mobile computing and communications.

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Palm and PalmSource will be independent publicly-traded companies following the transaction. However, Palm and PalmSource have entered into a number of agreements that provide for a continuing business relationship between them, including a software license agreement between them under which Palm will continue to be a licensee of Palm OS and agreements with Palm Trademark Holding Company, LLC, under which Palm and PalmSource will both continue to use Palm-related trademarks and domain names other than the palmOne trademark, which will be used by Palm.

There are potential disadvantages of the PalmSource distribution to the Palm stockholders. In addition to the risks discussed in detail in the “Risk Factors” section of this prospectus, potential disadvantages of the PalmSource distribution include:

Material U.S. Federal Income Tax Consequences of the PalmSource Distribution (see page 34)

PalmSource was historically integrated with the businesses of Palm and, consequently, our combined and consolidated financial statements have been derived from the consolidated financial statements and accounting records of Palm and reflect significant assumptions and allocations (as described in Note 1 to our combined and consolidated financial statements). Accordingly, the combined and consolidated financial statements do not necessarily reflect our financial position, results of operations and cash flows had we been a stand-alone entity for the periods presented. In addition, our combined and consolidated financial statements may not be indicative of our financial position, results of operations and cash flows subsequent to the PalmSource distribution due to transactions anticipated to occur as of the distribution date.

Index to Financial Statements

made foreign antitrust filings in Germany and have received clearance from the German antitrust authorities for the Handspring merger. The parties are not aware of any other governmental approvals required in order to complete the merger. The reviewing agencies or governments, states or private persons may challenge the Handspring merger at any time before or after its completion.

It is a condition to the transaction that the PalmSource common stock distributed to Palm stockholders be approved for listing on the Nasdaq National Market. PalmSource’s shares of common stock have been approved for listing on the Nasdaq National Market subject to meeting the $5.00 per share minimum price requirement on the first day of trading.

In connection with the separation of the Palm and PalmSource businesses, Palm issued to us an inter-company loan of $20.0 million, which will be contributed to us as a capital contribution immediately prior to the distribution. For a description of the intercompany loan agreement, see the section titled, “The PalmSource Separation—Amended and Restated Intercompany Loan Agreement.” Since our incorporation Palm has made additional net capital contributions to us in cash of $28.2 million, consisting of capital contributions of $31.1 million in fiscal year 2002 reduced by a capital distribution of $2.9 million during fiscal year 2003. An additional $6.0 million will be contributed to us as a capital contribution by Palm upon the distribution and we intend to assume $15.0 million of Palm’s $50 million 5% convertible subordinated note payable to Texas Instruments, due December 2006, following the distribution. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.”

Unless we indicate otherwise, all information in this prospectus: (i) assumes the conversion into common stock of each outstanding share of our preferred stock, which will occur automatically upon the distribution; (ii) assumes the re-capitalization of our Class A, Class B and Class C common stock into one class of common stock, which will occur automatically upon the distribution; (iii) gives effect to a one for five reverse stock split on September 22, 2003; (iv) is based upon 11,599,631 shares of PalmSource common stock outstanding as of August 31, 2003; and (v) excludes:

For the quarter ended August 31, 2003, we reported related party revenues of $10.5 million, representing an increase of 1.0% over the quarter ended August 31, 2002 and third-party revenues of $6.6 million, representing an increase of 41% over the quarter ended August 31, 2002. Our net loss for the quarter ended August 31, 2003 was $3.8 million versus $10.8 million for the quarter ended August 31, 2002, representing a decrease in the net loss of 65%.

Index to Financial Statements

On August 29, 2003, PalmSource and PalmGear, Inc. consummated certain transactions related to a stock purchase agreement, strategic alliance and service provider agreement and a brand license agreement between the parties. In connection with the closing of the transactions, PalmSource sold the Palm Digital Media product line to PalmGear. In addition, as part of the strategic alliance, PalmGear agreed to support an online store, at PalmSource’s U.S. web site, for Palm OS applications. The initial term of the strategic alliance is three years. The total initial payments from the above described transactions equaled $4.0 million, however, this amount is subject to a maximum $0.3 million contingent holdback by PalmGear unless Palm Digital Media meets certain financial metrics for the five month period ending January 31, 2004, thereby, resulting in current total proceeds to PalmSource of $3.7 million. The net proceeds of $3.4 million are to be recognized ratably over the three-year term of the arrangement. In addition, PalmSource is guaranteed additional future minimum fees from the strategic alliance and service provider agreement of $1.4 million over the three-year term of the arrangement. Revenues from the Palm Digital Media product line were $0.3 million, $2.0 million and $2.5 million for the years ended May 31, 2001, 2002, and 2003, respectively.

Index to Financial Statements

The following selected combined and consolidated financial data of PalmSource reflect our historical results of operations and balance sheet data. Our combined and consolidated statement of operations data set forth below for the years ended May 31, 2001, 2002 and 2003 and the combined and consolidated balance sheet data as of May 31, 2002 and 2003 are derived from our audited combined and consolidated financial statements included elsewhere in this prospectus.

The combined and consolidated statement of operations data for the year ended May 31, 1999 and the combined and consolidated balance sheet data as of May 31, 1999 and May 31, 2000 are derived from our unaudited combined and consolidated financial statements that are not included in this prospectus. The combined and consolidated statement of operations data for the year ended May 31, 2000 and the combined and consolidated balance sheet data as of May 31, 2001 are derived from our audited combined and consolidated financial statements that are not included in this prospectus.

The unaudited pro forma data is presented giving effect to a one for five reverse stock split on September 22, 2003 and assuming the conversion of outstanding Series A redeemable convertible preferred stock to common stock, and the re-capitalization of the issued and outstanding shares of common stock of PalmSource prior to the distribution. The unaudited pro forma balance sheet also gives effect to the intended issuance by PalmSource of a $15.0 million 5% convertible subordinated note due December 2006, payable to Texas Instruments following the distribution, and the contribution of the $20.0 million note payable to Palm as additional paid in capital, immediately prior to the distribution in accordance with the terms of the amended and restated intercompany loan agreement. The related accrued interest on the contributed Palm note will be due and payable to Palm within seven days of the distribution date. In addition, the unaudited pro forma balance sheet also gives effect to the contribution by Palm, in accordance with the terms of the letter agreement regarding cash contributions, of an additional $6.0 million in cash upon the distribution date. The unaudited pro forma basic and diluted net loss per share does not include the impact of interest expense related to the intended issuance of a $15.0 million 5% convertible subordinated note which will occur following the distribution. Interest on this note is payable semi-annually and the note is due and payable on December 6, 2006. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.”

The financial information presented below may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods presented. See the section titled “Risk Factors—Risks Relating to Our Separation from Palm—Our historical financial information may not be representative of our results as a stand-alone company and, therefore, may not be reliable as an indicator of future results.” In addition, due to the acquisitions that we have made, and the change in our method of accounting for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets effective June 1, 2001, our results of operations are not necessarily comparable between the periods presented. In addition, our historical combined and consolidated balance sheet data is not comparable to the pro forma balance sheet data set forth below due to the transactions anticipated to occur as of the distribution date discussed above. You should also read the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which describes a number of factors that have affected our financial results.

Index to Financial Statements

The following table sets forth certain historical per share data of PalmSource and per share data of PalmSource on an unaudited pro forma basis after giving effect to a one for five reverse stock split on September 22, 2003 and giving effect to the conversion of the outstanding Series A convertible preferred stock to common stock and the re-capitalization of the issued and outstanding shares of common stock of PalmSource prior to the distribution. The unaudited pro forma book value per share also gives effect to the intended issuance by PalmSource of a $15.0 million 5% convertible subordinated note, due December 2006, payable to Texas Instruments following the distribution and the contribution of the $20.0 million note payable to Palm as additional paid in capital, immediately prior to the distribution in accordance with the terms of the amended and restated intercompany loan agreement. The related accrued interest on the $20.0 million note payable to Palm will be due and payable within seven days following the distribution date. In addition, the unaudited pro forma book value per share also gives effect to the contribution by Palm, in accordance with the terms of the letter agreement regarding cash contributions, of an additional $6.0 million in cash upon the distribution date. The unaudited pro forma basic and diluted net loss per share does not include the impact of interest expense related to the intended issuance of a $15.0 million 5% convertible subordinated note which will occur following the distribution. Interest will be payable semi-annually and the note is due and payable on December 6, 2006. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.” The following data should be read in conjunction with our combined and consolidated financial statements included elsewhere within this prospectus.

The unaudited pro forma per share data is presented for illustrative purposes only and is not necessarily indicative of the operating results or financial position that would have occurred if the PalmSource distribution had taken place at the beginning of the earliest period presented, nor is it necessarily indicative of future operating results or financial position. Actual results could differ.

We have not declared or paid cash dividends on our common stock since inception.

Index to Financial Statements

Palm common stock trades on the Nasdaq National Market under the symbol “PALM.” PalmSource common stock has not been publicly traded.

The table below sets forth the high and low sales price per share of Palm common stock, as reported on the Nasdaq National Market on June 3, 2003, the last completed trading day prior to the signing and announcement of the merger, and on September , 2003, the last full trading day for which high and low sales prices were available as of the date of this prospectus.

These prices do not reflect any effect that the PalmSource distribution may have upon the future price of Palm common stock.

The above table shows only historical comparisons. These comparisons may not provide meaningful information to Palm stockholders. Palm stockholders are urged to obtain current market quotations for Palm common stock and to review carefully the other information contained in this prospectus or incorporated by reference into this prospectus.

Index to Financial Statements

You should carefully consider the risks described below and the other information in this prospectus. Our business, results of operations or financial condition could be seriously harmed if any of these risks materialize. The trading price of our common stock may also decline due to any of these risks.

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

We have not been profitable during any of the periods for which we have prepared historical financial statements. During the fiscal years ended May 31, 2003, May 31, 2002 and May 31, 2001, we had net losses of approximately $21.8 million, $51.2 million and $84.0 million, respectively, on revenue of $73.4 million, $45.0 million and $26.3 million, respectively. Cash used for operations for fiscal year 2003 was $8.9 million and cash used for operations for fiscal year 2002 was $45.4 million. In addition, if we continue to incur negative cash flow from operations, our tangible assets may be less than our total liabilities, resulting in a negative tangible net worth. We have historically received upfront, initial license fees, which have partially funded our net losses. We have historically used cash for operations and may not achieve positive cash flow in the future.

We may incur losses and negative cash flows for the foreseeable future, particularly if revenue does not increase substantially, expenses increase faster than our revenues, we are unable to continue to obtain significant upfront license fees or we make unanticipated capital expenditures. Our ability to increase revenue and achieve and sustain profitability will also be affected by other risks and uncertainties described in this prospectus. If we do not increase revenue substantially or cannot raise additional capital, which may not be available on reasonable terms, if at all, we may not be able to fund operations in the future. Furthermore, because we may have a negative tangible net worth, we may not be able to liquidate sufficient assets to pay our liabilities if we are unable to fund operations in the future.

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

Palm is engaged in a civil action brought by Xerox Corporation in 1997 relating to the Graffiti handwriting recognition system used in handheld computers using Palm OS. The complaint by Xerox alleged willful infringement of U.S. Patent No. 5,596,656, titled “Unistrokes for Computerized Interpretation of Handwriting.” The complaint sought unspecified damages and to permanently enjoin the defendants from infringing the patent in the future. As part of our separation agreements with Palm, Palm has agreed to indemnify us for damages that we may incur due to the Xerox litigation. We believe that there are adequate defenses to the claims made by Xerox and Palm intends to continue to defend itself vigorously. However, we cannot assure you that Palm will be successful. If Palm is not successful in the litigation, Xerox might seek an injunction from the court preventing us from licensing Palm OS with Graffiti handwriting recognition software or preventing our licensees from offering products with Graffiti handwriting recognition software. As a result and if Palm is unable to or does not indemnify us, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. The pending litigation may also result in other indirect costs and expenses, such as significant diversion of management resources, loss of reputation and goodwill, damage to our customer and licensee relationships and substantial declines in our stock price. Accordingly, if Xerox is successful in its claims against Palm and Palm does not or is unable to indemnify us for these claims, our business, results of operations and financial condition could be significantly harmed and we may be rendered insolvent. For further discussion, including detail regarding the nature of the claim and the procedural history of the case, see the section titled “PalmSource Business—Legal Proceedings.”

Index to Financial Statements

Our operating results are difficult to predict. We do not have a long history of operations and our operating results have fluctuated significantly. Factors that may cause fluctuations in our operating results, in addition to those disclosed elsewhere in this section titled “Risk Factors,” include the following:

Because our revenue fluctuates and is difficult to predict, and our expenses are largely independent of revenues in any particular period, it is difficult for us to accurately forecast revenues and profitability. Any of these factors, or any of the factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition.

We currently derive our revenue from a small number of licensees of Palm OS, and the failure of one or more of them to sustain sales of Palm Powered products from which we derive revenue could significantly harm our future business prospects.

We currently derive our revenue from a small number of licensees of Palm OS. Revenue from Palm was $18.4 million, or 41.0% of total revenues, in fiscal year 2002 and $39.3 million, or 53.5% of total revenues, in fiscal year 2003. The percentage of our revenues from Palm in fiscal year 2002 would be higher if our software license agreement with Palm had been in effect for periods prior to December 3, 2001 when we were an integrated business unit within Palm. Revenue from Sony was $5.3 million, or 7.5% of total revenues, in fiscal year 2002 and $11.2 million, or 15.3% of total revenues, in fiscal year 2003. Revenue from Handspring was $10.0 million, or 14.3% of total revenues, in fiscal year 2002 and $6.4 million, or 8.8% of total revenues, in fiscal year 2003. Although we have recently expanded our number of licensees, many of these new licensees have yet to introduce products on the market or sell significant numbers of units based on Palm OS. Additionally, the combination of Palm and Handspring will increase the concentration of our customers. We expect that Palm and Sony will continue to account for a substantial portion of our revenue for the foreseeable future. If revenues from either Palm or Sony do not grow as we anticipate, if either of them decide to not incorporate Palm OS into their future products, or if Palm experiences financial difficulties and is not able to satisfy its annual minimum royalty commitments, we will have to significantly reduce our expenses or increase our revenue from other sources in order to stay in business. The term of our license agreement with Palm will expire in December 2006, our license arrangement with Sony will expire in October 2012 and our license agreement with Handspring will be terminated following the Handspring merger. Nothing restricts these licensees from competing with us or offering products based on competing operating systems and these licensees may stop incorporating Palm OS in their products during the term of their agreements with limited notice to us. Once these license arrangements expire, we may not be able to renegotiate them on favorable terms, if at all. If we do not continue to generate significant revenue from Palm or Sony or if we are unable to generate an increased percentage of our revenues from other licensees, our business, results of operations and financial condition will be significantly harmed.

We will not be able to rely on Palm to fund our future capital requirements as we have in the past, and financing from other sources may not be available on favorable terms or at all.

In the past, most of our capital needs have been satisfied by Palm. In connection with the separation of the Palm and PalmSource businesses, Palm issued to us an intercompany loan of $20.0 million, which will be contributed to

Index to Financial Statements

us as a capital contribution immediately prior to the distribution, and since our incorporation has made additional net capital contributions to us in cash of $28.2 million, consisting of capital contributions of $31.1 million in fiscal year 2002 reduced by a capital distribution of $2.9 million during fiscal year 2003. An additional $6.0 million will be contributed to us as a capital contribution by Palm upon the distribution. However, following the distribution, Palm will no longer provide funds to finance our working capital or other cash requirements.

We believe that our capital requirements will vary greatly from quarter to quarter, depending on, among other things, fluctuations in our operating results, financing activities, acquisitions and investments. We may require, or choose to obtain, additional debt or equity financing in order to finance acquisitions or other investments in our business. We may also require additional financing if our operating and working capital requirements vary materially from those currently planned. Future equity financings would be dilutive to the ownership interests of existing holders of our common stock. Future debt financings could involve restrictive covenants. We will likely not be able to obtain financing with interest rates as favorable as those that we have historically incurred under our note payable to Palm or that Palm could obtain or we may not be able to obtain financing at all. If we require additional financing and are not able to obtain it under reasonable terms or at all, we may be required to significantly reduce costs, which could reduce our ability to develop new products, respond to new opportunities or compete in the marketplace. If we cannot sufficiently reduce costs, we may not be able to finance future operations or service our debt obligations, which could, among other things, cause our auditors to modify or qualify their audit opinion and, ultimately, cause us to cease operations.

The success of Palm Powered products on which we depend for revenue is dependent on the development, sales and marketing efforts of our licensees which are largely beyond our ability to control.

Our ability to increase revenue is largely dependent on the development, sales and marketing efforts of our licensees. If one or more of our licensees fails to develop or sustain sales of Palm Powered products, we could lose a significant portion of our revenue. We are subject to many risks beyond our control that influence the success or failure of a particular licensee, including, but not limited to:

If our licensees do not successfully develop, market and sell Palm Powered products our revenue and profitability will suffer and our operating results may fluctuate.

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

We believe the market for PDAs, our traditional strength, is maturing. As a result, we anticipate that our future revenue growth will come from other mobile information devices, in particular smartphones that incorporate Palm OS. The smartphone operating system market, in particular, is highly competitive, with Microsoft and Symbian devoting significant resources to compete with us. If we are unsuccessful in penetrating the markets for these other devices or these markets do not develop as anticipated, our business will not grow as expected and our revenues will suffer. To compete in the smartphone and other new markets and as we continue to expand our product offering to penetrate new markets and industries, we expect to enhance Palm OS by licensing additional technologies from third-party vendors. However, we cannot assure you that we will be able

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to negotiate favorable terms on these third-party royalty contracts or that we will be able to generate sufficient royalty revenue to offset added costs associated with these contracts. If we are unable to do so, our cost of license revenue and gross margins could be materially impacted, which would adversely affect our business, results of operations and financial condition.

We depend on wireless carriers for the success of our platform software intended for smartphones.

The acceptance of smartphones by the market is highly dependent upon the qualification and adoption procedures of wireless carriers. Wireless carriers are relatively few in number and their qualification and adoption procedures are stringent. We have limited experience in developing platform software intended for use in smartphones that comply with such procedures. We cannot assure you that we will be successful in developing platform software to enable our licensees’ products to meet such qualification and adoption procedures or that wireless carriers will accept or promote the success of our licensees’ products. If our licensees’ products do not comply with wireless carriers’ qualification and adoption procedures or if wireless carriers do not promote the success of our licensees’ products, our business will not grow as expected and our revenues will suffer.

Our sales cycle is lengthy and we cannot accurately predict when we will recognize revenue from a particular licensee, if at all, or whether a particular licensee will ultimately market products incorporating Palm OS.

Accurate prediction of revenues from new licensees is difficult because the development of a business relationship with a potential licensee can be a lengthy process, spanning three to 12 months. The fiscal period in which a new license agreement will be entered into, if at all, and the financial terms of such an agreement are difficult to predict. In addition, the process of persuading licensees to adopt our technology can be lengthy and, even if adopted, we cannot assure you that our technology will be used in a product that is ultimately brought to market, achieves commercial acceptance or results in significant royalties to us. Once we enter into a license agreement, it often takes four to 18 months for our licensees to develop commercially available products, if at all, on which we can begin to recognize license revenue. If we invest management and engineering resources in a licensee but the licensee’s product is ultimately not introduced to market or is not well received, we may not be able to offset the lost revenue opportunity in a given quarter, if at all, and our operating results may fluctuate.

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

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

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

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

We compete in the operating system software and services markets. The markets for these products and services are highly competitive, and we expect competition to increase in the future. We compete primarily with

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Microsoft and Symbian. Microsoft has substantially more resources than we do and Symbian, which is supported by companies such as Nokia and Sony Ericsson, has a significant portion of the worldwide smartphone market that we believe is important to our future success. Additionally, there are proprietary operating systems; open source operating systems, such as Linux; and other software technologies, such as Java or Research In Motion’s licensed technology, which could be integrated into devices that compete with Palm Powered devices. Some of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. These competitors may be able to respond more rapidly than we can to new or emerging technologies or changes in customer requirements. They may also devote greater resources to the development, promotion and sale of their products and services and the third-party developer community.

Successful new product introductions or enhancements by our competitors, or increased market acceptance of competing platforms, could reduce the sales and market acceptance of our products and services, cause intense price competition or make our products and services obsolete. To remain competitive, we must continue to invest significant resources in research and development, sales and marketing and customer support. We cannot be sure that we will have sufficient resources to make these investments or that we will be able to make the technological advances necessary to remain competitive. Increased competition could result in price reductions, decreased license and royalty revenues, decreased customer demand, reduced margins and loss of market share. Our failure to compete successfully against current or future competitors could seriously harm our business, results of operations and financial condition and cause our operating results to fluctuate.

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

Palm Powered devices depend upon effective interoperability with software running on personal computers and network servers in order to acquire and back-up information. Interoperability with this information can be affected by the design of the personal or network server operating environments, the device which incorporates Palm OS or Palm OS itself. If the desktop or network server interoperability of Palm OS devices is compromised in any way, the attractiveness and use of Palm OS could be adversely affected. As a result, our business, results of operations and financial condition would be seriously harmed.

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

Our Palm OS platform is complex and must meet stringent manufacturer and user requirements. We must develop our software products and services quickly to keep pace with the rapidly changing mobile information device market. Products and services as sophisticated as ours are likely to contain undetected errors or defects, particularly when first introduced or when new models or versions are released. Palm OS may not be free from errors or defects after commercial shipments by our licensees have begun, which could result in the rejection of products and services based on Palm OS, damage to our reputation, lost revenues, diverted development resources and increased customer service and support costs and warranty claims, which could harm our business, results of operations and financial condition.

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

In the course of our business, we receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. For example, Xerox and Palm are in litigation relating to the Graffiti handwriting recognition system used in handheld computers using Palm OS, which is discussed in more detail above and in the section titled “PalmSource Business—Legal Proceedings.” We may be added to the complaint by Xerox following the PalmSource distribution. We evaluate the validity and applicability of third party intellectual property rights, and determine in each case whether we must negotiate

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licenses or cross-licenses to incorporate or use the proprietary technologies in our products. Third parties may claim that we, Palm OS licensees or end users of Palm Powered products are infringing or contributing to the infringement of their intellectual property rights, and we may be found to infringe or contribute to the infringement of those intellectual property rights and require a license to use those rights. We may be unaware of intellectual property rights of others that may cover some of our technology, products and services.

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

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

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

We may be required to spend significant resources to monitor and police our intellectual property rights. Policing the unauthorized use of our products or intellectual property is difficult and expensive litigation may be necessary in the future to enforce our intellectual property rights. Intellectual property litigation is not only expensive, but time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. Despite our efforts, we may not be able to detect infringement and may lose competitive position in the market before we detect the infringement. 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 and intellectual property. We have formulated a security plan to reduce the risk of any future thefts and have cooperated with law enforcement officials in an investigation of past incidents. We also generally enter into confidentiality agreements with our employees and with our licensees and our developers. We may not be successful in preventing future thefts, or in preventing those responsible for past thefts from using our technology to produce competing products. The unauthorized use of our technology by competitors could have a material adverse effect on our ability to sell our products.

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

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

As part of our business strategy, we intend to expand our international presence by targeting countries with large populations and propensities for adopting new technologies. However, many of these targeted countries do not prevent misappropriation of intellectual property or deter others from developing similar, competing technologies or intellectual property that infringe. Effective copyright, trademark and trade secret protections may be unavailable or limited in some foreign countries. In particular, the laws of some foreign countries in which our technology is licensed, or may in the near future be licensed, may not protect our intellectual property rights to the same extent as the laws of the United States. As a result, we may not be able to effectively prevent competitors in these regions from infringing on our intellectual property rights, which would reduce our competitive advantage and ability to compete in these regions and negatively impact our business.

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

We license third-party software for use in the Palm OS platform as well as to provide software development tools to enable applications to be written for our Palm OS platform. In addition to third-party licensed software, we may enter into joint development agreements with certain licensees of the Palm OS platform whereby a licensee will develop a specific feature for our Palm OS platform that we will then own and may later incorporate into new releases of the Palm OS platform. Our ability to release and sell our products could be seriously harmed if the third-party technology is not delivered to us in a timely manner or contains errors or defects that are not discovered and fixed prior to release of our products and we are unable to obtain alternative technology to use in our products. As a result, our product shipments could be delayed or our offering of features could be reduced, which could adversely affect our business or results of operations. Furthermore, a third-party developer or joint developer may improperly use or disclose the software, which could adversely affect our competitive position. In addition, because we license some of our development tools from third parties, our business would suffer if we could no longer obtain those tools from those third parties or if the tools developers wanted to use were not available. If we are unable to offer technology that our licensees need to build successful Palm Powered products, which we obtain by licensing the technology from third parties or developing it internally, then our business may suffer.

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

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

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

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

The proliferation of applications that run on Palm Powered devices has largely been attributable to our extensive third-party developer community, which we continue to rely on for future application development. More than 275,000 developers have registered to use Palm OS developer tools to create software applications for our platform. According to PalmGear.com, an on-line provider of handheld applications, there are currently more than 19,000 applications available for Palm Powered devices. We must continue to provide support for these developers and provide attractive incentives to encourage future Palm OS application development. We do not have the resources to provide cash incentives to our developers, as some of our competitors do. If we are unable to retain our existing developer community and attract additional third-party developers, the availability of new software applications may be adversely affected, which could affect our competitive advantage, lower the value of our Palm Powered products to end users and affect our licensees’ ability to market our products and services, cause our operating results to fluctuate and adversely affect our business, results of operations and financial condition.

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

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

The loss of some of our key personnel could negatively impact our business.

We rely upon the continued service and performance of a relatively small number of key technical and senior management personnel. Our future success depends on our retention of one or more of these key employees, such as David Nagel, our President and Chief Executive Officer, or one or more of our key executives. None of our key technical or senior management personnel are bound by employment or non-competition agreements, and, as a result, any of these employees could leave with little or no prior notice. We may not be able to provide our key technical and senior management personnel with adequate incentives to remain employed by us. The loss of any of them could negatively impact our business, results of operations and financial condition.

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

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

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

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

We plan to increase our scope of operations domestically and internationally. We may not be equipped to successfully manage any future periods of rapid growth or expansion, which could be expected to place a significant strain on our limited managerial, financial, engineering and other resources. Any delays or difficulties in our research and development process caused by these factors or others could make it difficult for us to develop future generations of our technology and to remain competitive. In addition, the rapid rate of hiring new employees, including several key employees, could be disruptive and could adversely affect the efficiency of our research and development process. The rate of our future expansion, if any, in combination with the complexity of the technology involved in our licensing business model, may demand an unusually high level of managerial effectiveness in anticipating, planning, coordinating and meeting our operational needs as well as the needs of our licensees. Additionally, we may be required to reorganize our managerial structure in order to more effectively respond to the needs of customers and other potential strategic partners. Given the small pool of potential licensees, the adverse effect resulting from a lack of effective management in any of these areas could be magnified. Inability to manage the expansion of our business could have a material adverse effect on our business, results of operations and financial condition.

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

We anticipate that revenues from international operations will represent an increasing portion of our total revenues over time. Accordingly, our future results could be harmed by a variety of factors related to our international operations, including:

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

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

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

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

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

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

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

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

We may pursue strategic acquisitions and investments, which could have an adverse impact on our business.

Within the last five years, we have acquired certain assets of Be Incorporated, peanutpress.com, Inc., Actual Software, WeSync.com, Inc. and Smartcode Technologies SARL. We will evaluate other acquisition opportunities that could provide us with additional product or service offerings or additional industry expertise as they arise. Acquisitions and the integration of acquired companies may result in problems related to integration of technology and management teams. We may not successfully integrate operations, personnel or products that we have acquired or may acquire in the future. If we fail to successfully integrate acquisitions, our business could be materially harmed. In addition, our acquisitions may not be successful in achieving our desired strategic objectives, which would also cause our business to suffer. In addition, if we issue stock as consideration in an acquisition, the ownership interests of our stockholders will be diluted. In addition, we have made and may make strategic venture investments in other companies that provide products and services that are complementary to ours. If these investments are unsuccessful, this could have an adverse impact on our results of operations and financial position. For example, acquisitions typically include a significant amount of goodwill and other intangible assets. If the value of this goodwill is impaired over time we may have to record significant charges against earnings. In fiscal year 2003, we recorded an impairment charge of $3.2 million related to a private equity investment.

If we have any impairment in the value of our goodwill, we will have to take an accounting charge against our earnings that might negatively impact our stock price.

In accordance with generally accepted accounting principles, we conduct an impairment analysis of our goodwill annually or whenever an event or change in circumstances occurs which would indicate potential impairment. If we discover significant impairment as a result of any of these tests, we would be required to record a corresponding non-cash impairment charge against our earnings that could negatively affect our stock price.

We may periodically restructure our business model, which could harm our operating results in the short term before we receive any benefits from the restructuring, if at all.

We continually evaluate the strengths and weaknesses of our business model. In connection with this evaluation, we may decide to realign our available resources and, as a result, shut down or sell business lines that do not fit into our long-term business plan. For example, in August 2003, we sold the Palm Digital Media product line to PalmGear. If we shut down any of our business lines in the future, we may incur costs or charges, disrupt customer goodwill or lose short-term revenue streams in connection with such a restructuring that could harm our business before we were to receive any benefit, if at all, from the restructuring.

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Our historical financial information may not be representative of our results as a stand-alone company and, therefore, may not be reliable as an indicator of future results.

Our combined and consolidated financial statements have been carved out from the consolidated financial statements of Palm using the historical results of operations and historical bases of the assets and liabilities of the PalmSource business that we comprise. Accordingly, the historical financial information we have included in this prospectus 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. Palm did not account for us, and we were not operated, as a separate, stand-alone entity for most of the periods presented. Revenues from Palm were not recorded until December 3, 2001, the effective date of our software license agreement with Palm. Our costs and expenses include allocations from Palm for centralized corporate services and infrastructure costs, including:

These allocations have been determined on bases that we and Palm considered to be reasonable reflections of the utilization of services provided to, or the benefit received by us. 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 many significant changes that will occur in our cost structure, funding and operations as a result of our separation from Palm, including increased costs associated with reduced economies of scale, increased marketing expenses related to building a company brand identity separate from Palm and increased costs associated with being a publicly traded, stand-alone company.

The terms of the separation and distribution of PalmSource have been and will continue to be negotiated in the context of a parent-subsidiary relationship.

Until the PalmSource distribution, Palm will own a majority of our common stock. All of the agreements relating to the separation entered into between Palm and us were entered into in the context of a parent-subsidiary relationship and were, and any amendments to the agreements prior to the PalmSource distribution were or will be, negotiated in the overall context of our separation from Palm. As a result, the terms of such agreements may be more or less favorable to us than if they had been negotiated with unaffiliated third parties. In addition, until the distribution, Palm will be our majority stockholder and the terms of the merger and distribution will be negotiated and determined in the context of this parent-subsidiary relationship. Accordingly, we cannot assure you that the terms of the merger and distribution will be negotiated more or less favorably to us than if they had been negotiated with unaffiliated third parties. Moreover, material changes to such agreements made after June 4, 2003 are required to be approved by Handspring under the terms of the merger agreement with Handspring.

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

In connection with our separation from Palm, we are adopting a new brand identity separate from the Palm device business and modifying some of the trademarks and trade names under which we conduct our business. Subject to certain restrictions, we have an exclusive license to use certain “Palm” marks in connection with our business, but must reposition the brand to be identified with an independent operating system company rather than a device manufacturer. We believe that recognition of our Palm Powered ingredient brand, which is a brand identifying a key component of mobile information devices, will be important to our success, particularly in Europe and Asia Pacific, where we are expanding our operations and sales efforts. We currently have a limited marketing budget for positioning our brand and it is anticipated that we will continue to have a limited budget for the foreseeable future. If we fail to promote our Palm Powered ingredient brand successfully, or if our brand fails to achieve widespread recognition, the value of our brand may decrease. As a result, the demand for our products and services may decline and our business may not grow as we anticipate.

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

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

Palm is subject to general commercial and other litigation claims as part of its operations, which could implicate our Palm OS technology or products incorporating Palm OS and result in claims against us in the future or prevent Palm from distributing our common stock to its stockholders.

In the course of Palm’s business, it occasionally receives claims related to consumer protection, general commercial claims related to the conduct of its business and the performance of its products and services and other litigation claims, such as stockholder derivative class action lawsuits. Palm is currently subject to a number of these claims. Though the claims currently do not name us as defendants, the substance of their claims may implicate us, result in claims against us in the future or require us to indemnify Palm. Please see the section titled “PalmSource Business—Legal Proceedings” for a further discussion of the litigation matters to which Palm is subject that could result in liability to us.

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

Palm has received a private letter ruling from the Internal Revenue Service to the effect that the distribution of our shares of common stock held by Palm to Palm’s stockholders will not be taxable to Palm or its U.S. stockholders. This ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. Although some facts have changed since the issuance of the ruling, in the opinion of Palm’s tax counsel, these changes will not adversely affect the validity of the ruling. For a more complete discussion of the ruling and the U.S. federal income tax consequences of the distribution, please see the section titled “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource Distribution.”

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Notwithstanding the receipt of the ruling and the opinion of counsel described above, the PalmSource distribution may nonetheless be taxable to Palm under Section 355(e) of the Code if 50% or more of the stock of Palm or our stock is acquired as part of a plan or series of related transactions that include the PalmSource distribution. For a more complete discussion of the U.S. federal income tax consequences in the event that the distribution were taxable, please see the section titled “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource Distribution.”

Under the tax sharing agreement between Palm and us, we would be required to indemnify Palm if the sale of our stock caused the distribution of our stock to be taxable to Palm. We may not be able to adequately satisfy our indemnification obligations under the tax sharing agreement. In addition, under the tax sharing agreement, we and Palm have agreed to indemnify each other for certain taxes and similar obligations that the other party could incur under certain circumstances. For a more complete description of the tax sharing agreement, please see the section titled “The PalmSource Separation—Amended and Restated Tax Sharing Agreement.” Finally, although under the tax sharing agreement Palm is required to indemnify us for taxes of Palm, we may be held jointly and severally liable for taxes determined on a consolidated basis.

PalmSource stockholders could experience substantial dilution of their interest in PalmSource as a result of the assumption by PalmSource of a portion of Palm’s note with Texas Instruments.

The conversion price of the PalmSource note will be set according to a formula based upon the decrease in the average trading price of Palm’s common stock for the five days before the PalmSource distribution, versus the average trading price of Palm’s common stock for the five days after the PalmSource distribution. However, the minimum conversion price will be 115% of the volume weighted average PalmSource common stock price on its first trading day and the maximum conversion price will be 400% of such price on its first trading day. Because the adjustment is based on the decrease in Palm’s trading price, subject to the minimum and maximum conversion prices, if Palm’s stock price does not decline significantly following the PalmSource distribution, PalmSource stockholders may incur substantial dilution. In addition, in the event the minimum conversion price becomes applicable, the lower PalmSource’s average trading price is on its first trading day, the greater the potential dilution. In addition, PalmSource would be required to record non-cash interest expense to the extent the conversion price of the PalmSource note is less than the trading price of PalmSource common stock on the date of issuance of the PalmSource note. We cannot predict the prices at which Palm and PalmSource may trade and their effect on the calculation of the conversion price of the PalmSource note. See the section titled “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note” for a more complete description of the conversion mechanism for the PalmSource Note.

We have historically used Palm’s operational and administrative infrastructure and continue to rely on Palm to provide certain business services. Our ability to satisfy our customers and operate our business will suffer if we do not develop our own infrastructure quickly and effectively.

We historically used Palm’s systems, processes and personnel to support many of our operations, including systems to manage our accounting operations and tax filings, and the provision of back-up support for these operations. Since separating from Palm, we have been challenged by the need to create an appropriate infrastructure for the size of our operations and our limited financial resources. We also continue to be reliant on Palm for access to certain historical data related to our business. If their ability to provide access to this data is impaired, our only source of historical data may be lost, which could seriously harm our business and operations.

Index to Financial Statements

We have updated our own systems and processes to replace Palm’s systems and processes, which included the implementation of a separate Enterprise Resource Planning system in December 2002. Any failure or significant downtime in our systems and processes could harm our business. Specifically, our information systems and processes require the services of employees with extensive knowledge of these information systems and processes and the business environment in which we operate. In order to successfully implement and operate our systems and processes, we must be able to attract and retain a significant number of highly skilled employees.

If we are unable to develop our own operational and administrative infrastructure to effectively replace those systems and processes that we historically relied on Palm for, or we fail to attract and retain the highly skilled personnel required to implement, maintain, and operate our information systems and processes, our business, results of operations and financial condition could suffer.

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

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

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

Many of our directors and some of our executive officers own shares of Palm common stock and options to purchase shares of Palm common stock. Currently, two of our directors, Eric Benhamou and David Nagel, are also directors of Palm. Eric Benhamou is the Chairman of our board of directors and is also the Chairman of Palm’s board of directors. Mr. Benhamou is also currently employed by Palm as its Chief Executive Officer and has half of his Palm salary paid for by us. David Nagel, our President and Chief Executive Officer, intends to resign from the Palm board upon completion of the PalmSource distribution. In addition, one of our directors, Satjiv Chahil has entered into a consulting agreement with us, and, was recently employed by, and then was a consultant to, Palm, and another of our directors, Robert Finocchio, has a sister who is currently an executive officer of Palm.

Index to Financial Statements

and PalmSource. In November 2002, Mr. Benhamou was granted an option to acquire 60,000 shares of Palm’s common stock. Upon the PalmSource distribution, the vesting schedule under the option accelerates so that after the PalmSource distribution, all shares under the Palm option will be vested and exercisable. In addition, following the PalmSource distribution, Mr. Benhamou has been promised an option to acquire 5,000 shares of Palm common stock with an exercise price equal to fair market value on the date of grant and an option to purchase 30,000 shares of PalmSource common stock.

We will need to obtain third-party consents for Palm’s assignment to us of certain agreements to complete our separation from Palm and if we cannot obtain these consents, we may not be able to maintain these relationships on favorable terms or at all.

Prior to our separation from Palm in December 2001, several of our agreements with customers, developers, strategic partners, suppliers and others and all of our agreements for the license of technology were agreements between third parties and Palm. Many of these agreements were assigned to us upon our separation from Palm, some of which required that the third party consent to this assignment. We are currently attempting to obtain all of these third-party consents, but if we are unable to do so, we may be forced to renegotiate these agreements or enter into new agreements with various third parties as a separate, stand-alone entity. We cannot assure you that we will be able to negotiate new agreements on terms as favorable to us as those that we had as part of Palm, or at all.

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

The court could then require that our stockholders return some or all of the shares of our common stock, or require Palm or us, as the case may be, to fund liabilities of the other company for the benefit of creditors, which could adversely affect our business. The measure of insolvency for purposes of the foregoing will vary depending upon the jurisdiction whose law is being applied. Generally, however, each of Palm and us, as the case may be, would be considered insolvent if the fair value of its assets were less than the amount of its liabilities or if it incurred debt beyond its ability to repay such debt as it matures. Palm and we believe that each company will be solvent after the distribution with sufficient capital to operate their respective businesses as proposed, but creditors and courts may not concur.

The combined post-distribution and post-merger value of the shares of Palm common stock and PalmSource common stock may not equal or exceed the pre-distribution value of shares of Palm common stock and Handspring common stock.

After the distribution of shares of PalmSource common stock by Palm to Palm’s stockholders, we anticipate that shares of Palm common stock will continue to be traded on the Nasdaq National Market and we expect the shares of PalmSource common stock will also be traded on the Nasdaq National Market. We cannot assure you that the combined trading prices of shares of Palm common stock and PalmSource common stock after the

Index to Financial Statements

distribution will be equal to the trading price of shares of Palm common stock prior to the distribution. Until the market has fully evaluated the business of Palm without the business of PalmSource and combined with the business of Handspring, the price at which shares of Palm common stock trade may fluctuate significantly. Similarly, until the market has fully evaluated the PalmSource business on a stand-alone basis, the price at which shares of PalmSource common stock trade may fluctuate significantly.

Following the distribution of our shares of common stock held by Palm to Palm’s stockholders, we will not benefit from any previous synergies or shared resources with Palm, which may harm our business.

Prior to the separation and distribution of our shares of common stock held by Palm to Palm’s stockholders, Palm’s device business and Palm OS business were able to benefit from certain synergistic alliances and shared resources, such as, among other things, shared development of and access to technology. Although we believe that the external separation of the businesses will provide benefits to the respective businesses, there can be no assurance that the two businesses will not be adversely affected by the external separation.

We will need to obtain insurance as a stand-alone entity separate from Palm, which could be costly and difficult to acquire.

In the past, we have benefited from various economies of scale as an operating segment of Palm. Our current costs and expenses include allocations from Palm for centralized corporate services and infrastructure costs, including costs for insurance. However, following the PalmSource distribution, we will be required to obtain insurance, such as director and officer insurance, as a stand-alone entity separate from Palm. Negotiating favorable terms for future insurance policies may be difficult given our short operating history and absence of Palm’s economies of scale. The costs of obtaining sufficient insurance coverage may differ from amounts that we experienced while operating under Palm.

Substantial sales of our common stock may occur in connection with the distribution, which could cause our stock price to decline.

Palm currently intends to distribute all of the 10 million shares of our common stock it owns to Palm stockholders. Substantially all of these shares will be eligible for immediate resale in the public market. In addition, the shares of our common stock owned by Sony will be eligible for re-sale, subject to certain volume and other limitations, beginning 90 days after the distribution. We are unable to predict whether significant amounts of common stock will be sold in the open market in anticipation of, or following, this distribution. We are also unable to predict whether a sufficient number of buyers will be in the market at that time. Any sales of substantial amounts of common stock in the public market, or the perception that such sales might occur, whether as a result of this distribution or otherwise, could cause the market price of our common stock to decline.

Prior to the PalmSource distribution, there has been no public market for our securities, and we cannot assure you that our common stock will continue to be listed for trading on the Nasdaq National Market or that our stock price will not decline after the distribution.

Before this distribution, there has not been a public market for our common stock, and an active public market for our common stock may not develop or be sustained after this distribution.

Our common stock has been accepted for listing on the Nasdaq National Market. Our common stock may not continue to be listed for trading on the Nasdaq National Market if we fail to establish a minimum bid price of at least $5 per share on the first day of trading. If the trading price of our common stock is less than $1 per share for thirty consecutive trading days, our common stock may not continue to be listed on the Nasdaq National Market.

Index to Financial Statements

If our common stock fails to remain listed on the Nasdaq National Market, we may be listed on the Nasdaq SmallCap Market if we meet certain requirements, or market makers may quote our shares on the OTC Bulletin Board. If shares of our common stock do not trade on the Nasdaq National Market, we may not receive analyst coverage for our business, certain institutional investors will be prohibited from investing in our common stock, investors’ interest in our common stock will likely be more limited, and an active trading market for our common stock may not develop.

We cannot assure you as to the prices at which our common will trade before, on or after the distribution date. Until our common stock is fully distributed and an orderly market develops, the prices at which our stock trades may fluctuate significantly. In addition, the market price of our common stock could be subject to significant fluctuations after this offering. Among the factors that could affect our stock price are:

The stock markets in general, and the equity markets for technology stocks in particular, have experienced high volatility that has often been unrelated or disproportionate to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. You may be unable to resell your shares at any particular price, or at all.

If we fail to meet the expectations of securities analysts or investors, our share price may decrease significantly.

The trading price of our common stock could also be subject to wide fluctuations in response to the publication of reports and changes in financial estimates by securities analysts, and it is possible that our actual results in one or more future periods will fall short of those estimates. If we fail to meet the expectations of securities analysts or investors, our share price may decrease significantly.

Provisions in our separation agreements, charter documents, Delaware law and our ability to adopt a stockholder rights plan without stockholder approval may delay or prevent an acquisition of us, which could decrease the value of your shares.

Our certificate of incorporation, bylaws, certain of our separation agreements and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors. Provisions in our certificate of incorporation and bylaws include a classified board of directors and limitations on actions by our stockholders by written consent. Our tax sharing agreement with Palm requires us to indemnify Palm against Palm’s recognition of taxable gain if it were triggered by an acquisition of our stock. This indemnity obligation, which is further described in the section titled “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource Distribution,” could discourage, delay or prevent a third party from acquiring us. In addition, the provisions of our software license agreement with Palm include certain penalties if we are acquired by Microsoft, or other manufacturers of mobile information devices, that may discourage such companies from acquiring us. See the section titled “The PalmSource Separation—Amended and Restated Software License Agreement.” 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 acquiror. Were our board of directors to adopt a stockholder rights plan, it would be more difficult for a third party to acquire us without the approval of our board of directors.

Although we believe that some of the above provisions and the adoption of a rights plan provide for an opportunity for us to receive a higher bid by requiring potential acquirors to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders. In addition, because these provisions may discourage a change of control, they could decrease the value of our common stock.

Index to Financial Statements

This section of the prospectus describes the proposed PalmSource distribution and only contains a general discussion of the merger of Palm and Handspring which will follow the PalmSource distribution. While we believe that the description in this section addresses the material terms of the PalmSource distribution, this summary may not contain all of the information that is important to you. Important information regarding the Palm and Handspring merger can be found in the joint proxy statement/prospectus which Palm is sending to you. You should carefully read this entire document and the other documents we have referred you to in this prospectus for a more complete understanding of the distribution.

Palm and Handspring have entered into a merger agreement that provides for a transaction with two components.

First, the common stock of PalmSource held by Palm will be distributed to the existing stockholders of Palm by means of the merger of Peace Separation Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Palm, which we refer to as the PalmSource distribution. Upon effectiveness of the PalmSource distribution, each outstanding share of Palm common stock (including the associated preferred stock purchase rights) will be automatically converted into the right to receive: (i) one share of Palm common stock (together with the associated right), such that each share of Palm common stock will remain outstanding after the completion of the PalmSource distribution; and (ii) the right to receive approximately 0.32 of a share of PalmSource common stock and cash in lieu of any fractional share. This ratio is based on the number of shares of Palm common stock outstanding on August 29, 2003, and is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution.

Following the PalmSource distribution, Palm, which will consist of its Solutions Group business, will acquire Handspring by means of the merger of Harmony Acquisition Corporation, a newly formed, wholly-owned subsidiary of Palm, with and into Handspring, which we refer to as the Handspring merger. Upon completion of the Handspring merger, each share of Handspring common stock (including the associated preferred stock purchase right) outstanding immediately prior to the effective time of the Handspring merger will be canceled and extinguished and automatically converted into the right to receive 0.09 of a share of Palm common stock upon surrender of the certificate representing such share of Handspring common stock and cash in lieu of any fractional share. Palm shares will be issued with associated preferred stock purchase rights.

In structuring the combination of Palm and Handspring, the parties sought to achieve the following objectives:

Index to Financial Statements

The parties considered various transaction structures to achieve these objectives and agreed on the structure outlined in the merger agreement. As part of their efforts to effect this structure, Palm and PalmSource accelerated their efforts to finalize the separation of the businesses.

The merger agreement is described in more detail in the section titled “The Merger Agreement” beginning on page 46 of this prospectus.

In the summer of 2001, after several years of licensing the Palm OS to directly competitive customers, and after an extensive evaluation of its business, Palm recognized the need to separate its operating system business from its hardware solutions business. Palm determined that a separation of the two business units was needed in order for its operating system business to be able to work effectively with licensees and in order to allow its hardware business to respond to rapid technology change. In July 2001, Palm announced its intent to form a wholly-owned subsidiary to contain the Palm OS group, then called the Platform Solutions Group and now PalmSource, and to operate it as a separate business within Palm. Palm also announced the formation of a separation committee of its board of directors to oversee the separation of the operating systems business. During the late summer and fall of 2001, the separation committee formed teams of Palm management to identify and separate the assets and liabilities of the operating systems and hardware solutions businesses and to define how the two businesses would operate separately within Palm. On August 27, 2001, Palm announced that David C. Nagel had been hired as President of PalmSource.

On December 18, 2001, Palm’s board of directors approved a series of separation agreements that addressed the allocation of assets and liabilities between the operating systems business and the hardware solutions business, the licensing of Palm OS to the hardware solutions business, the provision of infrastructure services to the operating systems business and other separation matters. In March 2002, Palm began providing segment reporting for the results of its two businesses, PalmSource and the hardware solutions business, referred to as the Solutions Group. Throughout 2002, the Palm board of directors received frequent updates regarding the separation planning and the operation of the existing agreements.

Index to Financial Statements

the PalmSource board of directors. These actions were taken with a view to the possibility of making PalmSource an independent publicly-traded company.

In July 2002, Palm engaged Morgan Stanley to provide it with advice and assistance in connection with a possible separation transaction of PalmSource. The fees payable to Morgan Stanley in connection with this engagement are approximately $3.4 million, $3.1 million of which are payable upon completion of the PalmSource distribution, subject to adjustment based on the market value of PalmSource at the time of the separation.

On July 26, 2002, Palm’s board of directors held a meeting to discuss, among other topics, an update on PalmSource external separation activities and financing alternatives. At this meeting, Morgan Stanley advised the Palm board that market conditions were not conducive for consummating an initial public offering of PalmSource, and Palm management provided an update on discussions with strategic and financial investors. Palm’s board of directors authorized management to continue to pursue third party investment in PalmSource. In addition, during a private session of the board of directors, there was further discussion of other possible forms of accomplishing external separation, including a sale of PalmSource or a joint venture involving PalmSource.

From September 2002 through mid-February 2003, the PalmSource board of directors and senior management began to prepare PalmSource to be a public company, including the preparation of carve-out financials for public filings, conducting executive searches, building out management systems and processes and preparing PalmSource’s initial public filings.

The board of directors of Palm has determined that the separation of PalmSource from Palm’s Solutions Group and the PalmSource distribution is advisable and in the best interests of Palm and its stockholders. In making its determination to approve the PalmSource distribution, the board of directors of Palm identified several reasons for, and potential benefits to Palm stockholders of, the separation of Palm’s device business from Palm’s operating system business, and the creation of two independent public companies. These potential benefits include:

Index to Financial Statements

or prospective Palm OS licensees has limited PalmSource’s ability to attract new licensees. Each company believes that the separation will address the perceived conflict of interest between Palm and PalmSource and expand the licensing opportunities available to PalmSource.

As an independent publicly traded company, we believe we will be better able to focus on advancing Palm OS and attract and maintain licensees. We believe this will lead to a more competitive Palm OS, which will allow both Palm and PalmSource to be more successful in the marketplace.

The separation will allow Palm and PalmSource to have their own board of directors, management team, sales force and other employees focused specifically on their respective businesses and strategic opportunities. Each company will have greater ability to modify its business processes and organization to better fit the needs of its business, customers and employees. Each company will also be able to implement a marketing strategy that focuses on its business. Finally, competition for management time, group resources and capital that may currently exist between PalmSource’s operating system business and Palm’s device business will be eliminated.

The PalmSource distribution will be completed following the adoption and approval of the merger agreement and approval of the merger by the stockholders of Palm and Handspring, and upon the filing of a certificate of merger with the Secretary of State of the State of Delaware. If the stockholders of Palm and Handspring approve the proposal to adopt and approve the merger agreement and approve the merger, we expect Palm to file the certificate of merger with the Secretary of State of the State of Delaware and complete the merger as soon as practicable thereafter. We expect that trading in PalmSource common stock will commence on the next business day.

Following the completion of the merger, each share of Palm common stock that was issued and outstanding as of the effective date of the merger will be converted into (i) one share of Palm common stock (such that each

Index to Financial Statements

share of Palm common stock effectively will remain outstanding after the completion of the merger) and (ii) the right to receive approximately 0.32 of a share of PalmSource common stock based upon the shares of Palm common stock outstanding on August 29, 2003. Accordingly, each stock certificate previously representing shares of Palm common stock will continue to represent the same number of shares of Palm common stock. In addition, holders of Palm common stock will not need to complete a letter of transmittal or surrender their stock certificates to receive the whole shares of PalmSource common stock to which they are entitled. Shares of PalmSource common stock will be issued as uncertificated shares registered in book-entry form (unless a holder of Palm common stock requests a certificate representing such holder’s whole shares of PalmSource common stock). As a result, instead of receiving stock certificates, holders of Palm common stock will receive account statements reflecting their ownership interest in whole shares of PalmSource common stock. Such book-entry shares will be held with Equiserve Trust Company, N.A., or Equiserve, who will serve as the record keeper for all shares of PalmSource common stock being distributed in connection with the PalmSource distribution. Any stockholder who wants to receive a physical certificate evidencing shares of PalmSource common stock will be able to obtain a certificate at no charge by contacting Equiserve.

Holders of shares of Palm common stock will not receive any fractional shares of PalmSource common stock as a result of the merger. In lieu of receiving a fractional share, as soon as practicable after the distribution date, Equiserve will aggregate fractional shares of PalmSource common stock into whole shares of PalmSource common stock and sell them in the open market at prevailing market prices and distribute the aggregate cash proceeds, net of brokerage fees, ratably to holders of Palm common stock otherwise entitled to fractional interests in PalmSource common stock, which may be taxable to such holder. For an explanation of the tax consequences of the merger and distribution of shares of PalmSource common stock, please see the section titled “The Transaction—Material U.S. Federal Income Tax Consequences of the PalmSource Distribution.” The amount of such payment will depend on the prices at which the aggregated fractional shares of PalmSource common stock are sold by Equiserve in the open market shortly after the consummation of the transaction.

Palm and Handspring have made the required filings with the Antitrust Division of the Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Act, and the applicable waiting period has terminated. In addition, Palm and Handspring have made foreign antitrust filings in Germany and have received clearance from the German authorities for the Handspring merger.

Index to Financial Statements

Transactions that are anticipated to occur in connection with the PalmSource distribution include the conversion of outstanding Series A redeemable convertible preferred stock to common stock, the re-capitalization, the intended issuance by PalmSource of a $15.0 million 5% convertible subordinated note, payable to Texas Instruments, the contribution of the $20.0 million note payable to Palm as additional paid in capital, and the contribution by Palm of an additional $6.0 million in cash. As a result of these transactions, our historical combined and consolidated financial statements may not be indicative of our financial position, results of operations and cash flows subsequent to the distribution.

Material U.S. Federal Income Tax Consequences of the PalmSource Distribution

This section summarizes material U.S. federal income tax considerations relating to Palm’s distribution of PalmSource stock to Palm stockholders. This summary does not provide a complete analysis of all potential tax considerations, including tax considerations that may apply because of a stockholder’s particular circumstances, including status as a non-United States person, or because a stockholder is subject to special rules. The information provided below is based on existing authorities. These authorities may change, or the IRS might interpret the existing authorities differently. In either case, the tax consequences of purchasing, owning or disposing of common stock could differ from those described below. Finally, the summary does not describe the effect of the United States federal estate and gift tax laws or the effects of any applicable foreign, state or local laws.

Palm received a private letter ruling from the IRS in December 2002 to the effect that the PalmSource distribution will qualify as a tax-free transaction under Section 355 of the Internal Revenue Code, or the Code. The ruling is generally binding on the IRS, subject to the continuing accuracy of certain factual representations and warranties. A copy of the ruling, which includes the factual representations upon which the ruling is based, is attached as an exhibit to the registration statement of which this prospectus is a part. Although some facts have changed since the issuance of the ruling (for example, the execution of the Handspring merger agreement), in the opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation, tax counsel to Palm, these changes will not adversely affect the validity of the ruling.

Index to Financial Statements

Even if the distribution otherwise qualifies for tax-free treatment under Sections 355 and 368 of the Code, it may be taxable to Palm under Section 355(e) of the Code if 50% or more of the stock of Palm or of PalmSource is acquired as part of a plan or series of related transactions that include the PalmSource distribution. If such an acquisition of PalmSource stock or Palm stock triggers the application of Section 355(e), Palm would recognize taxable gain as described above but the distribution should generally be tax-free to each Palm stockholder. Under the tax sharing agreement between Palm and PalmSource, we would be required to indemnify Palm against that taxable gain if it were triggered by an acquisition of PalmSource stock. Please see the section titled “The PalmSource Separation—Amended and Restated Tax Sharing Agreement” for a more detailed discussion of the tax sharing agreement between Palm and PalmSource.

Our common stock to be delivered to Palm stockholders in connection with the PalmSource distribution has been accepted for listing on the Nasdaq National Market, subject to official notice of issuance and the condition that PalmSource common stock trade at or above $5.00 per share on the first trading day on the Nasdaq National Market. If PalmSource’s common stock does not meet the Nasdaq National Market’s criteria for initial listing, PalmSource’s common stock may trade on the Nasdaq SmallCap Market, if it meets certain requirements, or be eligible for quotation on the OTC Bulletin Board, or a successor of the OTC Bulletin Board.

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

Index to Financial Statements

things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or an unspecified market check. Palm and Handspring believe that the lawsuits are without merit and intend to vigorously defend the cases. A copy of each of the complaints filed by the plaintiffs in the lawsuits are filed as exhibits to the registration statement filed by Palm with the SEC of which this prospectus forms a part.

The following section of this prospectus compares the rights of holders of Palm common stock with the rights of holders of PalmSource common stock and describes any material differences among them.

Palm and PalmSource are each incorporated under the laws of the State of Delaware and the respective rights of stockholders of each company are governed by the Delaware General Corporation Law. The following summary does not purport to be a complete statement of the rights of holders of Palm common stock under applicable Delaware law, Palm’s certificate of incorporation and bylaws, nor does it purport to be a complete statement of, or a comprehensive comparison with, the rights of holders of PalmSource common stock under applicable Delaware law, PalmSource’s certificate of incorporation and bylaws. While we believe that the summary below covers the material differences between the rights of holders of Palm common stock and PalmSource common stock, the summary may not contain all of the information that is important to you. This summary is qualified in its entirety by reference to the applicable Delaware law and the respective governing corporate documents of Palm and PalmSource.

Upon the distribution, current stockholders of Palm will retain their shares of Palm common stock and also become stockholders of PalmSource by virtue of receiving approximately 0.32 of a share of PalmSource common stock (based upon the shares of Palm common stock outstanding as of August 29, 2003) for each share of Palm common stock held. The rights of Palm’s stockholders are governed by Palm’s certificate of incorporation and bylaws, each as currently in effect, and will continue to be so governed after the distribution. The rights of PalmSource’s stockholders are governed by PalmSource’s certificate of incorporation and bylaws, each as will be in effect as of the distribution date, and will continue to be so governed after the PalmSource distribution.

Index to Financial Statements

The following summary describes certain material provisions of the merger agreement. The provisions of the merger agreement are complicated and not easily summarized. This summary may not contain all of the information about the merger agreement that is important to you. In particular, this summary contains only a general discussion of the provisions of the merger agreement that relate to the merger of Palm and Handspring that will follow the PalmSource distribution. Important information regarding the Palm and Handspring merger can be found in the joint proxy statement/prospectus which Palm is sending to you. We encourage you to read it carefully in its entirety for a more complete description of the merger agreement.

Palm will complete the transaction when all of the conditions to completion of the transaction contained in the merger agreement are satisfied or waived, including approval and adoption of the merger agreement by the stockholders of Palm and Handspring. The PalmSource distribution will become effective upon the filing of a certificate of merger in connection with the Parent merger with the Delaware Secretary of State. Immediately after such filing, a certificate of merger in connection with the Handspring merger will be filed with the Delaware Secretary of State. Palm expects to file both certificates and complete both the PalmSource distribution and the Handspring merger on the same date. Trading in PalmSource common stock is expected to commence on the first trading day following the completion of the Parent merger.

Palm is working to complete the transaction as quickly as possible. Palm currently plans to complete the transaction by fall 2003. Because completion of the transaction is subject to customary closing conditions, however, Palm cannot predict the exact timing.

Upon completion of the PalmSource distribution, each share of Palm common stock (including any associated preferred stock purchase rights) outstanding immediately prior to the effective time of the PalmSource distribution will be automatically converted into the right to receive: (i) one share of Palm common stock (together with the associated preferred stock right), such that each share of Palm common stock will remain outstanding after the completion of the PalmSource distribution, and (ii) the right to receive a number of shares of the common stock of PalmSource currently outstanding and held by Palm such that all the shares of PalmSource common stock outstanding and held by Palm immediately prior to the effective time of the PalmSource distribution are distributed to all existing holders of Palm common stock on a pro rata basis, based on the number of shares of Palm common stock held by each such Palm stockholder. Upon completion of the PalmSource distribution, all options to purchase Palm common stock shall continue in effect. Rights outstanding under Palm’s employee stock purchase plan will remain outstanding and exercisable for Palm common stock without alteration.

A total of 10.0 million shares of PalmSource common stock will be distributed in connection with the PalmSource distribution to existing holders of Palm common stock. As a result, based on the number of shares of

Index to Financial Statements

common stock of Palm currently outstanding as of August 29, 2003, each holder of an outstanding share of Palm common stock immediately prior to the PalmSource distribution will receive approximately 0.32 of a share of PalmSource common stock for each share of Palm common stock held. This ratio is subject to reduction in the event that Palm issues additional shares of common stock following August 29, 2003 and prior to the PalmSource distribution. Handspring stockholders will not receive any PalmSource shares.

Palm will not issue any fractional shares of common stock of PalmSource in connection with the PalmSource distribution. Instead, Equiserve will sell the aggregate of the fractional shares of PalmSource common stock in one or more transactions, and will distribute a cash payment to each holder of Palm common stock who would otherwise be entitled to receive a fraction of a share of common stock of PalmSource, which cash payment would represent such holder’s proportionate interest in the net proceeds from such sale. The amount of such payment will depend on the prices at which the PalmSource shares are sold by the exchange agent in the open market shortly after the effective date of the PalmSource distribution.

Holders of Palm common stock will not need to complete a letter of transmittal and should not send in their Palm stock certificates, as there will be no exchange of Palm stock certificates. Following the completion of the PalmSource distribution, each certificate previously representing shares of Palm common stock will continue to represent the same number of shares of Palm common stock. Equiserve will deliver to each holder of shares of Palm common stock such number of shares of PalmSource common stock to which such holder is entitled as a result of the PalmSource distribution registered in uncertificated book-entry form (unless a holder of Palm common stock requests a certificate representing such holder’s whole shares of PalmSource common stock). As a result, instead of receiving stock certificates, holders of Palm common stock will receive account statements reflecting their ownership interest in whole shares of PalmSource common stock. Such book-entry shares will be held with Equiserve, who will serve as the record keeper for all shares of PalmSource common stock being distributed in connection with the PalmSource distribution. Any stockholder who wishes to receive a physical certificate evidencing shares of PalmSource common stock will be able to obtain a certificate at no charge by contacting Equiserve.

Treatment of Awards Outstanding under Palm Stock Plans and Outstanding Warrants

When the PalmSource distribution is completed, each outstanding option to purchase shares of Palm common stock will continue in effect. Each option will be subject to all of the terms and conditions set forth in the applicable documents evidencing such Palm option immediately prior to the PalmSource distribution, including any repurchase rights or vesting provisions, except that each such option will be adjusted so that it will be exercisable for an additional number of shares of Palm common stock equal in fair market value to the consideration to be received by holders of Palm common stock in connection with the PalmSource distribution. This adjustment will be accomplished by multiplying the number of shares for which the option is exercisable by a ratio, the numerator of which will be the closing sales price of Palm common stock on the last full day of trading prior to the PalmSource distribution and the denominator of which will be the opening sales price of Palm common stock on the first full day of trading after the PalmSource distribution, and multiplying the exercise price at which such option will be exercisable by the inverse of that ratio. Palm’s board of directors and its compensation committee believe that this adjustment is required by or advisable under the terms of Palm’s stock option plans. Accordingly, on July 1, 2003, Palm’s board of directors amended Palm’s 1999 Stock Plan and Amended and Restated 1999 Director Option Plan to reserve additional shares of Palm’s common stock for the sole purpose of effecting such an adjustment. For those employees who are employees of PalmSource, their Palm options will be adjusted as provided above, except that any unvested Palm options will terminate on the distribution date, and such PalmSource employees shall be deemed terminated under their Palm option agreements, giving them a limited number of days to exercise vested Palm options before they expire.

Index to Financial Statements

No adjustment will be made to the exercise price per share or the number of shares issuable upon the exercise of Palm’s outstanding warrant, but upon exercise the warrant holder will be entitled to receive from Palm the number of shares of PalmSource common stock which the warrant holder would have been entitled to receive if the warrant holder had exercised the warrant prior to the transaction. If the warrant is exercised following the PalmSource distribution, Palm would likely acquire shares of PalmSource common stock through market purchases.

The merger agreement contains other customary provisions regarding the Handspring merger including reciprocal representations and warranties made by each of Palm and Handspring, provisions related to conditions to completion of the transaction, covenants made by Palm and Handspring, termination of the merger agreement by Palm or Handspring and the payment of termination fees. You should refer to the joint proxy statement/prospectus being sent to you by Palm for a more complete description and the complete text of the merger agreement.

Index to Financial Statements

Effective December 3, 2001, which we refer to as the separation date in this prospectus, Palm and PalmSource entered into certain agreements to generally provide for the assignment by Palm of assets, and the assumption by PalmSource of liabilities, related to the business of licensing Palm OS. We refer to the business of licensing Palm OS as the PalmSource business. The purpose of the separation was to establish PalmSource as an independent company. In June 2003, Palm and PalmSource entered into additional agreements, some of which amended or amended and restated separation agreements previously entered into by the parties, and others further allocated assets and liabilities between Palm and PalmSource in light of circumstances existing at that time.

A summary description of the principal separation agreements between the parties is set forth below. The following summary describes certain provisions of the principal separation agreements, but the provisions of the separation agreements are complicated and not easily summarized. This summary may not contain all of the information about the separation agreements that is important to you. Each separation agreement has been filed as an exhibit to the registration statement of which this prospectus is a part, and is available to you upon request.

Accounting Practices. So long as Palm is required to consolidate PalmSource’s results of operations and financial position, PalmSource agrees to:

Palm agrees to provide PalmSource with all relevant information to enable PalmSource to prepare its financial statements and to grant its internal auditors access to Palm’s records.

Index to Financial Statements

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

All of the agreements between Palm and PalmSource relating to the separation contain similar dispute resolution provisions.

No Representations and Warranties. Palm does not make any representations or warranties to PalmSource regarding:

Asset Transfer. Pursuant to the assignment agreement, Palm transferred the following assets to PalmSource:

Index to Financial Statements

Assumption of Liabilities. The assignment agreement provides for the assumption of the following liabilities by PalmSource:

Index to Financial Statements

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

Source Code Escrow. For applications licensed under the software license agreement where source code is not otherwise provided, PalmSource will deposit into escrow the source code for those applications. The escrow material will be released to Palm if: (i) PalmSource rejects the software license agreement in bankruptcy; (ii) Microsoft Corporation acquires more than 50% of the voting equity of PalmSource; or (iii) PalmSource or its successor breaches its support or maintenance obligations; and (i) fails to cure 30 days after notice; or (ii) has materially breached the software license agreement at least three times in the preceding 12 months. Palm receives a license to use the released escrow material to make error corrections.

Acquisition of PalmSource. If Microsoft Corporation acquires more than 50% of the voting equity of PalmSource: (i) the minimum annual payment obligations of Palm under the software license agreement will cease to apply; (ii) the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension; (iii) the escrow material will be released to Palm as described above; and (iv) Palm will have a license to modify (for any purpose without restriction) the escrow material and the source code for releases of the operating system software licensed to Palm under the software license agreement. If a hardware competitor of Palm (as defined in the software license agreement) acquires more than 50% of the voting equity of PalmSource, the minimum annual payment obligations of Palm under the software license agreement will cease to apply and the term of the software license agreement will be extended two years, with the royalty rate for the final contract year applying during the extension. If an entity, other than those described above, acquires more than 50% of the voting equity of PalmSource, Palm will have the option of extending the software license agreement for two years, with the royalty rate and minimum annual payment obligations for Palm during the extension being the same as during the final contract year.

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

Index to Financial Statements

Most Favored Licensee. The following preference provisions are conditioned upon Palm’s continued obligation to pay the minimum annual payments under the software license agreement.

Index to Financial Statements

Indemnification by PalmSource. Except for the Xerox litigation described more fully in this prospectus and subject to the limitation on liability in the software license agreement, PalmSource agrees to defend Palm, and pay any settlements or damages awarded, for claims alleging that an unmodified production release of the licensed operating system software, additional applications (other than a specified e-mail product), end-user documentation or compatibility trademarks, as delivered, infringe: (i) patents in the U.S. and other specified countries; (ii) world-wide copyrights or trade-secrets; or (iii) registered trademark rights in the U.S. and other specified countries. If an injunction requires Palm to recall products from its own inventory or its own distribution channels (which products have not been sold to end-users), then PalmSource will indemnify Palm for its out of pocket costs for retrieving and re-working such products, up to the per unit royalty actually paid by Palm for such specific units recalled. If an injunction causes a shortfall against a minimum annual payment, that minimum annual payment will be reasonably reduced on a pro rata basis as reasonably adjusted for seasonality, if no other versions of the licensed operating system software or additional applications are available that would permit Palm to continue shipping products.

Indemnification by Palm. Subject to the limitation on liability in the software license agreement, Palm agrees to defend PalmSource, and pay any settlements or damages awarded, for claims alleging that: (a) the Palm hardware products that use the operating system software as its primary operating system, Palm software, or Palm trademarks infringe: (i) patents in the U.S. and other specified countries; (ii) world-wide copyrights or trade-secrets; or (iii) registered trademark rights in the U.S. and other specified countries; or (b) certain developments to the operating system software made by Palm, or any Palm pre-existing material incorporated into those developments or PalmSource’s source code tree, infringe the copyrights or misappropriate the trade secrets of a third party. In addition, subject to the limitation on liability in the software license agreement, Palm will indemnify and defend PalmSource for claims for bodily injury, death and damage to tangible property as a result of the Palm hardware products that use the operating system software as its primary operating system.

Assignability. Each party may assign the software license agreement to a successor of all or substantially all of its stock or assets, except that the source code licenses will terminate upon an assignment by Palm. Any other assignment requires consent from the other party. If a competitor of PalmSource (as defined in the software license agreement) acquires more than a 50% interest in Palm, then the source code access and license provisions, provisions providing for customer technology briefings and the most favored licensee provisions terminate. If a competitor of Palm (as defined in software license agreement) acquires more than a 50% interest in PalmSource, then provisions providing for customer technology briefings and sharing of customer data terminate. Upon close of the merger agreement with Handspring: (i) Handspring products will be included under the software license agreement as Palm hardware products that use the operating system software as its primary operating system, and no further payments will accrue under PalmSource’s operating system license agreement with Handspring; (ii) maintenance and support fees for the operating system software will be increased to $600,000 annually; (iii) the existing Handspring source code attachments will survive; and (iv) PalmSource’s operating system license agreement with Handspring will otherwise terminate.

Index to Financial Statements

Term and Termination. The term of the software license agreement is five years, from December 3, 2001 until December 3, 2006. Each party has the right to terminate: (i) for certain bankruptcy-related events; or (ii) for material breach by the other party which remains uncured 30 days after notice, and which the parties are unable to resolve after 30 days of good faith discussions. A breach by a contractor, private label partner or subsidiary of Palm may be treated as a material breach by Palm if Palm fails to take specified remedial actions. The software license agreement includes a wind-down period that varies depending on which party causes the termination. Except in the case of partial termination by PalmSource, Palm shall pay a pro rata portion of the minimum annual payment for the then current contract year, based on the percentage of the contract year for which the software license agreement was in effect prior to the effective date of termination. No further minimum annual payments will be due. In the event of a material breach that would entitle PalmSource to terminate the software license agreement, PalmSource may elect to terminate only a subset of the provisions under the software license agreement (including source code access, right to sublicense to private label partners or subsidiaries, and the most favored licensee clauses). In such case, Palm shall remain obligated to continue making all minimum annual payments remaining under the software license agreement and may continue to distribute the Palm hardware products that use the operating system software as its primary operating system.

Index to Financial Statements

of the specified pre-existing materials of Palm that are delivered under the development agreement or which are necessary for utilization of the work product by PalmSource.

The tax sharing agreement also contains provisions requiring PalmSource to indemnify Palm for, among other things: (i) any increases in PalmSource’s stand-alone income tax liability or other consolidated tax liabilities arising as a result of any amended return, audit or other dispute and attributable to periods after December 3, 2001; (ii) any increases in certain non-income taxes (including payroll and employee withholding taxes) attributable to PalmSource’s business; (iii) any transfer taxes incurred on the transfer of assets by Palm to PalmSource; and (iv) any tax liability incurred by Palm on account of the sale of PalmSource’s common stock in connection with the distribution of the shares of PalmSource stock held by Palm to Palm’s stockholders.

The amended and restated intercompany loan agreement, or the intercompany loan agreement, governs the outstanding $20 million intercompany loan from Palm to PalmSource Holding Company, a wholly-owned subsidiary of PalmSource. PalmSource assumed all of PalmSource Holding Company’s rights and obligations under the intercompany loan agreement.

All principal due under the intercompany loan by PalmSource will be forgiven if the PalmSource distribution occurs prior to December 3, 2004 and PalmSource issues a $15 million 5% convertible subordinated note due December 2006, the PalmSource note. To the extent that PalmSource assumes less than $15 million of the principal amount of such promissory note, PalmSource will make a new note in favor of Palm with a principal amount equal to the difference between $15 million and the principal amount assumed. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.”

Index to Financial Statements

The maturity date of the PalmSource note will be December 6, 2006 and interest under the new note will be payable semi-annually on June 15 and December 15 each year at a per annum rate of 5%. The PalmSource note will be subordinated to all senior indebtedness of PalmSource (including borrowed money, capitalized lease obligations and secured indebtedness). PalmSource may be required to repurchase the PalmSource note within 30 trading days of a change of control at a repurchase price equal to: (i) the amount of principal to be repurchased plus (ii) all accrued and unpaid interest to the date of repurchase. Under the PalmSource note, we may not consolidate with, merge with or sell all or substantially all of our assets to another entity, unless such entity is organized under the laws of the United States and such entity expressly agrees to assume our obligations under the PalmSource note. The PalmSource note will include events of default upon the occurrence of which the holder will have the right to accelerate all outstanding obligations, including all principal and accrued and unpaid interest. The events of default in the PalmSource note will include the following (with certain cure periods): failure to make payments when due, breaches of covenants, breaches of representations and warranties, cross acceleration of indebtedness for money borrowed in excess of $10.0 million, voluntary and involuntary bankruptcy or insolvency proceedings and judgments in excess of $10.0 million.

Indemnification. In general, PalmSource agrees to indemnify Palm from all liabilities arising from:

In general, Palm agrees to indemnify PalmSource from all liabilities arising from:

Index to Financial Statements

PalmSource agrees to indemnify Palm from all liabilities arising: (i) from environmental conditions caused by operations on and after the separation date at any of the facilities transferred to PalmSource; (ii) from environmental conditions at PalmSource’s facilities arising from any contamination event that occurs on or after the separation date; and (iii) on certain new PalmSource facilities.

Under the Xerox litigation agreement, Palm assumes responsibility for managing the Xerox litigation, determining strategy and making most settlement decisions. Palm has management control over the Xerox litigation, but the agreement prohibits Palm from consenting to any judgment or settlement that would: (i) allow injunctive or declaratory relief to be ordered against PalmSource; (ii) require PalmSource to pay any future royalties or otherwise require PalmSource to make any payment that is not fully indemnified; (iii) require PalmSource to license its intellectual property; or (iv) otherwise affect the business, financial condition or operations of PalmSource or its licensees in a material way.

The Xerox litigation agreement obligates Palm to bear the costs of the Xerox litigation that are incurred after June 1, 2003, not including the imputed costs of PalmSource’s personnel or of any independent advice PalmSource may choose to seek. Palm also must pay the amount of any damages awarded in, or agreed to in settlement of, the Xerox litigation. In the event that any damages are not paid by Palm within 60 days after the date of entry of a judgment or due date under a settlement agreement, PalmSource is obligated to pay any shortfall amounts. Any such payment by PalmSource does not, however, relieve Palm of its obligation either to make the payment or to reimburse PalmSource.

The master technology ownership and license agreement, as amended, or master technology agreement, allocates rights in non-patented intellectual property and data and provides for certain cross-licenses between Palm and PalmSource of certain such technology and data related to the Palm and PalmSource businesses. This agreement does not cover the licensing of the PalmSource operating system and certain other technology that are covered in the software license agreement and the Elaine software license and services agreement.

Index to Financial Statements

Palm and PalmSource each agree: (i) to protect each other’s confidential information; (ii) not to use such confidential information in violation of any use restriction in the master separation agreement and related agreements (but not the software license agreement or the Elaine software license and services agreement, which contain separate confidentiality requirements); and (iii) not to disclose without the other party’s prior written consent such confidential information except as may be expressly permitted in the master separation agreement, related agreements and any other agreements Palm and PalmSource enter into with each other. The non-disclosing party is able to use, but not disclose, residual information retained in the unaided memories of individuals who have had access to confidential information of the disclosing party.

Index to Financial Statements

PalmSource grants Palm, under PalmSource’s rights to the patents, patent applications and invention disclosures assigned to PalmSource, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except in a permitted assignment of the master patent agreement) license, with limited right to grant sublicenses, to make, have made, use, lease, sell, offer for sale and import: (i) Palm computer hardware devices that incorporate the PalmSource operating system as the primary operating system in all fields of use; and (ii) all other Palm products in all fields of use except for the field of operating systems. Palm grants to PalmSource, under Palm’s rights to the patents, patent applications and invention disclosures retained by Palm, a personal, irrevocable, nonexclusive, worldwide, fully-paid, royalty-free and non-transferable (except in a permitted assignment of the master patent agreement) license, with limited right of sublicense, to make, have made, use, lease, sell, offer for sale and import PalmSource products in all fields except the field of computer hardware.

Index to Financial Statements

As of the date of this prospectus, many of the services covered under the service level agreements have been completed.

After the effective date, Palm will be one of the two additional development partners permitted under PalmSource’s existing agreement with Sony. After the effective date, PalmSource must notify Palm, and provide Palm with a limited opportunity for good faith discussion, before engaging an additional licensee of the PalmSource operating system (other than Sony) in a joint development agreement for new versions of Palm OS where the development partner: (i) develops material portions of the source code for a new version of Palm OS; and (ii) has the right to access and modify all or substantially all of the Palm OS source code to execute the joint development project.

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

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

Index to Financial Statements

Neither party may assign the strategic collaboration agreement without the other party’s prior written consent, provided that either party may assign to the successor to all or substantially all of its business or assets relating to the Palm OS or Palm devices incorporating Palm OS as its primary operating system, as applicable. In the event of such a transfer, the non-assigning party will hold good faith discussions with the assignee whether to continue or terminate the strategic collaboration agreement, and if they do not agree to continue within 30 days, the strategic collaboration agreement will terminate.

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

Administration of Trademarks Through Holding Company. Under Holding Company’s operating agreement, Palm and PalmSource contributed and assigned all Palm marks and palmOne marks respectively

Index to Financial Statements

owned, registered, claimed or used by each of them to Holding Company. Holding Company will, among other things, administer such contributed marks and enhance and maintain the integrity of, and promote the expansion of the value of and goodwill associated with such marks for the benefit of Palm and PalmSource. Holding Company will operate independently of Palm and PalmSource but Palm will own 45% and PalmSource will own 55% of Holding Company’s equity. Additionally, each of them will be responsible for contributing funds to cover: (i) costs associated with certain of the marks, such as litigation and trademark prosecution expenses; and (ii) its share of Holding Company’s operating expenses, which shall be divided based on Palm’s and PalmSource’s ownership interest in the Holding Company.

Under the trademark license agreement with Palm, subject to certain restrictions, Holding Company grants to Palm:

Index to Financial Statements

We are a leading developer and licensor of platform software that enables mobile information devices. Our software platform consists of operating system software and software development tools. We have also extended our platform with applications such as personal information management software, web browsers and e-mail. We license these products to leading mobile information device manufacturers, including Garmin, Handspring, Kyocera, Lenovo (formerly known as Legend), Palm, Samsung and Sony. Historically, the majority of our licensees developed personal digital assistants, or PDAs. Palm Powered devices have held the number one PDA market share position as measured in units sold in each of the past six annual reports prepared by IDC.

A wide range of mobile information devices incorporate our solutions, including PDAs; mobile phones; location-aware devices; entertainment devices; and industry-specific devices used in industries such as education, hospitality and healthcare. We are the leader in the PDA market and are now actively extending our product line into these other segments as well. Our primary product offering, Palm OS, provides a flexible platform that enables the creation of powerful, innovative and easy-to-use mobile information devices. The Palm OS platform has attracted a large and loyal following, with approximately 30 million Palm Powered devices sold to date. There are more than 275,000 third-party developers who have registered to use Palm OS developer tools to create software applications for our platform. According to PalmGear.com, an on-line provider of handheld applications, there are currently more than 19,000 applications available for Palm Powered devices. To extend our software platform, we provide professional services and support for our licensees and developers.

For both professionals and individual consumers, it has become increasingly important to have personal and professional information such as addresses, calendars, to-do lists, customer information and other reference information close at hand and easily managed. As people have become increasingly mobile, the need for convenient, portable devices to store and manage information has grown rapidly. Traditionally, storing and managing personal and professional information was accomplished using paper-based products, and later, stand-alone portable computers or specialized electronic devices. These tools often are cumbersome, expensive, difficult to use and offer limited functionality. The invention of the pen-based PDA in the early 1990s provided consumers a more useful electronic option for holding and organizing information and allowed users to synchronize the information in the handheld device with information on a personal computer. As these products have continued to evolve, they have become less expensive, more intuitive and easier to operate, and consumers are using them much more. According to an IDC reported dated June 2003, annual worldwide sales of pen-based handheld devices are projected to increase from approximately 10.1 million units in 2000 to an estimated 16.5 million units in 2007 and according to this report Palm OS will power approximately 46% of these devices by 2007.

In addition, professionals and individual consumers increasingly need to communicate while mobile, as evidenced by the rapid adoption of mobile phones throughout the world. In an effort to reduce the number of devices that they need to carry to stay connected to critical information, users have begun to adopt a new class of converged handheld devices that provide the combined functionality of mobile phones and traditional PDAs. According to the June 2003 IDC report, annual worldwide sales of converged handheld devices are projected to increase from approximately 0.41 million units in 2000 to an estimated 81.0 million units in 2007, and Palm OS is projected to power 11.3% of these devices by 2007. In addition, manufacturers are incorporating information capabilities into a wide range of other devices, including location-aware devices and other consumer products such as wristwatches and game devices.

While most mobile information devices historically have been purchased by individuals, continued pressure to raise productivity is causing enterprises to seek new ways to enable professionals and other workers to be more connected and more efficient in both traditional and non-traditional work settings. As a result, information technology managers are playing an increasing role in purchase decisions by setting standards for mobile

Index to Financial Statements

computing within their organizations. Direct enterprise purchases of mobile devices are also expected to rise, driven in part by high interest in mobile e-mail.

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

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

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

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

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

Flexible Platform that Enables Mass Customization. Palm OS was designed for mobile information devices, for which ease of use, instant access to information, low power consumption and wireless capabilities

Index to Financial Statements

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

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

Efficiency, Performance and Reliability. The Palm OS platform offering has been designed to provide significant power and performance advantages over competitive solutions. These advantages include significantly lower operating system memory and processor requirements than competitive solutions. Device manufacturers that build products based on our platform can therefore achieve similar device features and functionality while lowering component cost beyond that achievable using competing operating systems. For example, a complete and fully featured version of our operating system will fit within a device as small as a wristwatch with as little as two megabytes of storage memory, while a comparable version of our closest competitor’s currently available offering would require eight megabytes of storage memory and a substantially larger device. In addition, our platform architecture is uniquely designed to provide a more reliable operating environment for mobile information devices. For example, our operating system is designed to cope with power loss and other unplanned events in a manner that will not compromise data.

Cooperative Development that Speeds Innovation. We work with our licensees and other technology providers to speed the introduction of new and innovative products. We provide to our licensees support and professional services that enable them to bring products to market more quickly and effectively. As our licensees develop technology enhancements, the terms of our licensing and support agreements ensure that we maintain the right to include most of the broadly applicable technology advancements in future versions of Palm OS. This approach allows us to more rapidly develop next generations of Palm OS and make technology advancements available to the broader community of Palm OS licensees and their customers. For example, Sony recently developed next generation digital imaging capabilities for its Palm Powered Sony Clié, which we were able to incorporate back into Palm OS and make available to our licensees. We also have introduced the Palm OS Ready program, through which we license a subset of our software tool kit to a select number of industry-leading technology providers that supply components, such as processors and graphics chips, to mobile information device manufacturers. By having access to these tools, members of the program can customize their technology for Palm OS and subsequently sell those products directly to our licensees earlier in the design cycle. The objectives of the Palm OS Ready program and our cooperative development approach are a time-to-market advantage for our licensees and reduced support costs.

Extensive Community of Third-Party Developers and Applications. The Palm OS platform has attracted a large and loyal following, with approximately 30 million Palm Powered devices sold to date. Our broad user base has also attracted a large community of third-party developers creating software applications, peripherals and accessories that increase the performance and functionality of Palm Powered devices. More than 275,000 developers have registered to use Palm OS developer tools to create software applications for our platform. According to PalmGear.com, an on-line provider of handheld applications, there are currently more than 19,000 applications available for Palm Powered devices. We make development tools available for our developer community, and we share select parts of the Palm OS source code to enable developers to optimize the interface

Index to Financial Statements

of their applications with our software platform. We believe that the existence of these third-party software applications, peripherals and accessories increases the value to the end-user of Palm Powered devices and helps to expand the market for our licensees’ products and services.

Our objective is to extend our leadership position as a developer and licensor of a software platform that enables mobile information devices. The key elements of our strategy to achieve this objective include the following:

Extend Our Success in PDAs to Smartphones and Other Next Generation Mobile Information Devices

Palm Powered devices have held the number one PDA market share position as measured in units sold in each of the past six annual reports prepared by IDC. We intend to continue to build on our leadership position and experience in PDAs to become the leading licensor of a software platform for smartphones and other next generation mobile information devices. By working in a number of emerging product categories, we intend to increase our overall market opportunity and reduce our dependence on any given industry.

We intend to facilitate greater adoption of Palm Powered devices by enterprise customers. To increase our overall presence in the enterprise, we will continue to target market-leading device manufacturers as new licensees and develop software features attractive to both end-users and the decision makers responsible for the deployment of mobile information devices throughout the enterprise. For example, the next generation of Palm OS will feature more enhanced security, integration and performance features that further enable enterprise solutions. In addition, we will continue to work with leading enterprise solutions, applications and service providers, such as IBM and Novell, to provide business-critical solutions that enable handheld computing in the enterprise.

Our licensees sell Palm Powered products in approximately 60 countries. We intend to expand our international presence by targeting countries with large populations and propensities for adopting new technologies. Accordingly, we have developed a version of Palm OS that supports simplified Chinese character sets, and we expect our licensees to ship in the next few months. We intend to aggressively pursue licensees that are well positioned to capitalize on these emerging opportunities and encourage our developer community to focus on providing solutions for these regions.

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

We believe that the performance and flexibility of our software architecture represent significant competitive advantages. We plan to continue to invest in our research and development strategy to further these competitive advantages. Additionally, under our licensing arrangements, we have the right to incorporate broadly

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applicable technology advancements that our licensees develop into future versions of our operating system. We also intend to continue to build upon the technology advances of our licensees to extend our technological advantage relative to our competitors.

We believe that the Palm Powered ingredient brand has become a symbol for quality, ease of use, and elegant simplicity in the mobile information device industry. This brand identity has enabled us to create a large and loyal user base worldwide that represents an attractive opportunity for our global developer community. We intend to continue to invest in the tools, marketing, and programs offered to our developers so that we may continue to offer the widest selection of applications to our licensees and the end-users of Palm Powered products. As we continue to evolve our platform, we intend to maintain the compatibility, tools and support necessary for a large number of applications to continue to be available to our users.

We license to our customers a product development kit that enables our customers to build a version of Palm OS specifically for their products. The product development kit includes the operating system and supporting technology components, such as applications and tools, and reference materials, which are the foundation for Palm Powered devices manufactured by our licensees. Palm OS has been optimized for mobile information devices, for which instant access to information, low power consumption and wireless capabilities are critical.

The current version of our operating system, Palm OS 5, is the first version of Palm OS running on integrated circuits using ARM Holdings PLC’s design for microprocessor architecture, which enables faster processing speeds and more advanced functionality than prior hardware components. We have designed Palm OS 5 to enable applications that were written for prior versions of our operating system to run on Palm OS 5. The first products using Palm OS 5 shipped in October 2002.

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We offer a number of applications and other products that our licensees can incorporate into Palm Powered products. These include:

We released Bluetooth support for Palm OS in Spring 2002. Bluetooth is an industry standard local area networking technology used to enable devices within a short range of each other to communicate and interoperate with one another. A common application for this technology with our licensees is to facilitate wireless communication between a handheld and a separate mobile phone.

The following table sets forth our licensees who are actively shipping or developing Palm Powered products as of August 31, 2003, but is not a complete list of all parties who have merely licensed Palm OS and are not currently developing or shipping product that incorporates Palm OS, the type of device they have developed or are developing incorporating Palm OS and the target markets for their Palm Powered devices:

Index to Financial Statements

Individual customers that accounted for more than 10% or more of total revenues for the fiscal year ended May 31, 2003 were Palm and Sony.

We have forged strategic relationships with several technology providers through our Palm OS Ready program. Through this program we license a subset of our toolkits to a select number of industry leading component manufacturers. By having access to these tools, these manufacturers can invest in the development and tuning of their technology for Palm OS and can subsequently sell those products directly to our licensees. The objective is a time-to-market advantage and reduced support costs for our mutual customers. Palm OS Ready partners currently include ATI Technologies, Inc., Intel Corporation, MediaQ, Inc., Motorola, Inc., Samsung and Texas Instruments Incorporated.

The combination of our large user base and the architecture of Palm OS has attracted a large and growing community of third-party developers. This community has created a broad selection of software applications that allow further customization of Palm Powered devices by the end user. There are more than 275,000 registered Palm OS developers, approximately one-third of which are registered internationally. According to PalmGear.com, an on-line provider of hand held applications, there are currently more than 19,000 applications available for Palm Powered devices in a broad range of categories, including web browsers, e-mail and Internet communications, sales force and field automation, personal productivity, groupware, financial management and games.

We have over 94,000 registered developers developing enterprise applications. These developers include system integrators, enterprise independent software vendors, and corporate in-house developers.

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

We license and market our products and services in North America, Europe and the Asia Pacific region, primarily through our direct sales force and marketing team. For further discussion regarding geographic information, see Note 16 of Notes to Combined and Consolidated Financial Statements. Our sales activities are focused on developing relationships with potential licensees through our direct sales force, which is located in the United States, France, Hong Kong, Japan and the United Kingdom. As of August 31, 2003, we had 17 sales professionals.

Our direct sales force targets customers who we believe will expand the market for our Palm Powered devices. Our sales cycle typically ranges from three to 12 months depending on the size of the licensee and the complexity of the solution. In targeting potential licensees, we consider a partner’s brand identity, distribution channels and technical capabilities. We typically focus on large, well-established device manufacturers like Palm and Sony, and have recently begun to explore new markets with licensees such as AlphaSmart, Fossil, Garmin, HuneTec and Tapwave.

Our marketing team promotes our company, our licensees’ products and our developer’s applications through global marketing and co-marketing programs. These marketing efforts are designed to create demand for Palm Powered devices and applications, to educate the market and create awareness for the Palm OS value

Index to Financial Statements

proposition in key market segments, to re-position and strengthen the Palm Powered ingredient brand worldwide. Our licensees are generally required to include the Palm Powered ingredient brand in their mass-media and targeted advertising. In addition, we conduct public relations efforts and market our products at industry tradeshows and on our website. We also receive extensive feedback from the end users of Palm Powered products and the third-party developer community through market research.

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

Our licensee support programs provide three distinct types of maintenance and support: an annual or subscription-based program that is tied to a specific master Palm OS license agreement, a silicon provider or Palm OS Ready partner support program, and a custom support program. Maintenance updates are included with the first two programs, but are billed separately when associated with a custom support program. As part of the maintenance agreement, licensees generally also receive updated versions of the Palm OS software that are available as part of the Palm OS product development kit. Our licensee support also consists of issue resolution and post-development support to address issues escalated by our licensees after a product has been shipped by our licensee.

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

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

Our licensee support, developer services and professional services organizations consisted of 14 employees as of August 31, 2003. These employees are supplemented by our internal engineering organization and a network of sub-contractors to our professional services team for expertise in specific markets or technologies.

Our research and product development efforts are focused on enhancing the available features and functions of the Palm OS product development kit, including improving its capability and efficiency. These enhancements are intended to reduce time-to-market for our licensees. In addition, we work with licensees and third-party developers to increase the proliferation of Palm OS-based solutions. We supplement our research and development efforts with our licensing strategy, which specifies that our licensees contribute their broadly applicable derivative development works and give us the rights to include these works back into our Palm OS platform. We believe that our success will depend, in part, on our ability to develop and introduce new versions of the Palm OS platform that continue to address the rapidly expanding needs of the mobile information device market. In the past, we have made, and we intend to continue to make, significant investments in research and development in response to the fluctuations of market conditions and economic trends. As of August 31, 2003, we had 201 employees engaged in engineering and product development activities.

Competition in the market for platform software for mobile information devices is intense and characterized by rapid change and complex technology. We compete primarily with Microsoft and Symbian. Microsoft offers

Index to Financial Statements

several operating systems focused on different markets including: Windows CE for sub-PC computers, Pocket PC for handheld devices, Smartphone 2002, and Pocket PC 2002 Phone Edition for voice enabled handhelds or communication devices. Symbian offers an operating system that is predominantly being marketed today by Nokia and Sony Ericsson for smartphones. Symbian has also recently signed Samsung and Matsushita as licensees. In addition, Research in Motion licenses its “reference platform” for other companies to design devices based on its software and hardware specifications. Our Palm OS platform also competes with the proprietary operating systems of other companies, including the proprietary systems of our potential licensees, as well as alternative operating systems such as Linux and Java for handheld devices.

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

We rely on and benefit from a portfolio of intellectual property. We currently have 41 U.S. patents issued, and we have 154 U.S. patent applications pending. Our issued patents expire anywhere from July 2014 to September 2020. We have four foreign patent issued and 11 foreign patent applications pending. Subject to certain restrictions, we have an exclusive license from Palm Trademark Holding Company to use “Palm” marks, other than palmOne and certain transition marks, in connection with our business, including various usages of Palm, PalmSource, Palm OS, the Palm logo, Palm Powered and Palm Computing. Palm Trademark Holding Company has 25 trademarks registered in the United States and 213 trademark registrations in other countries. Palm Trademark Holding Company also has 19 trademark applications pending in the United States and 258 trademark applications pending in other countries. We also have 12 trademarks registered in the United States and 1 trademark application pending in the United States. We, including through Palm Trademark Holding Company, are working to increase and enforce our rights in the PalmSource trademark portfolio, the protection of which is important to our reputation and branding. See the section titled “The PalmSource Separation—Trademark Agreements.” We also own copyrights relating to our software development applications including HotSync Manager, Palm OS and other software.

We rely on a combination of patent, trademark, copyright and trade secret laws and restrictions on disclosure to protect our intellectual property rights. While we rely on these methods to protect our intellectual property, we also believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements are essential to establishing and maintaining a technology leadership position. We cannot assure you that others will not develop technologies that are similar or superior to our technology.

As of August 31, 2003, we had a total of 309 employees, of which 14 were in support and service, 201 were in engineering and product development, 61 were in sales and marketing and 33 were in finance, administration and operations. Our future performance depends, in significant part, on our ability to attract new personnel and retain existing personnel in key areas including engineering and sales. None of our employees is subject to a collective bargaining agreement. We consider our relationship with our employees to be good.

Index to Financial Statements

On August 15, 2002, we entered into a three-year lease for one building in Sunnyvale, California for a total of 88,096 square feet. We also lease facilities in Massachusetts and Montpellier, France and lease sales offices internationally. We believe that our existing facilities are adequate for our current needs and anticipated growth.

To date, no lawsuit, which we believe could have a material adverse effect on our operations, has been filed against us, but from time to time we have received claims related to the conduct of our business. In the course of Palm’s business, it occasionally receives claims related to consumer protection, general commercial claims related to the conduct of its business and the performance of its products and services and other litigation claims, such as stockholder derivative class action lawsuits. In the course of Palm’s business, it also receives claims of infringement or otherwise becomes aware of potentially relevant patents or other intellectual property rights held by other parties. Palm is currently subject to a number of these claims. Palm believes that it has defenses to the cases set forth below and is vigorously contesting these matters. Though the claims currently do not name us as defendants, the substance of their claims may implicate us and result in claims against us in the future or require that we indemnify Palm pursuant to our separation agreements with Palm, which could materially adversely affect our business, results of operations or financial condition.

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

Index to Financial Statements

to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation. As part of our separation agreements with Palm, Palm has agreed to indemnify us for any damages that we may incur due to the Xerox litigation. If Palm is not successful in the Xerox litigation and is unable to or does not indemnify us, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. While we believe that there are adequate defenses to the claims made by Xerox, we cannot assure you that Palm will be successful or that an adverse outcome will not significantly harm our business.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against “3Com, Inc.” in the United States District Court for the Southern District of New York and later filed, on March 6, 2000, an amended complaint against Palm and 3Com. The case is now captioned E-Pass Technologies, Inc. v. 3Com Corporation, a/k/a 3Com, Inc. and Palm, Inc. (Civil Action No. 00 CIV 1523). The amended complaint alleges willful infringement of U.S. Patent No. 5,276,311, titled “Method and Device for Simplifying the Use of Credit Cards, or the Like.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patent in the future. The case was transferred to the U.S. District Court for the Northern District of California. In an Order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. The issues on appeal before the CAFC have been fully briefed and argued by the parties. On August 21, 2003, the CAFC issued a ruling reversing the claim construction of the District Court and the attendant summary judgment motion and remanded the case to the District Court for further proceedings. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses, which may arise out of the E-Pass litigation.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, titled, respectively, “Portable Personal Terminal for Use in a System for Handling Transactions” and “System for Handling Transactions Including a Portable Personal Terminal.” The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. The case was referred to Magistrate Judge Mary P. Thynge. In a Memorandum Opinion dated July 11, 2002, the Magistrate Judge indicated that she would recommend that the District Court grant the defendants’ motion for summary judgment that there was no infringement. NCR filed objections to the recommendations of the Magistrate Judge, and Palm has filed a response to NCR’s objections. On August 28, 2003, the District Court granted Palm’s motion for summary judgment, ruling that Palm products do not infringe the NCR patents, and denied NCR’s motion.

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

In June 2001, the first of several putative stockholder class action lawsuits was filed in United States District Court, Southern District of New York against certain of the underwriters for Palm’s initial public offering, Palm and several of its officers. The complaints, which have been consolidated under the caption In re Palm, Inc. Initial Public Offering Securities Litigation, No. 01 CV 5613, assert that the prospectus from Palm’s March 2, 2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The complaints allege claims against Palm and the officers under Sections 11 and 15 of the Securities Act of 1933, as amended. Certain of the complaints also allege claims under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended. Other actions have been filed making similar allegations regarding the initial

Index to Financial Statements

public offerings of more than 300 other companies. All of these various consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with the plaintiffs. The Court has denied Palm’s motion to dismiss. A special committee of Palm’s Board of Directors recently approved a tentative settlement proposal from the plaintiffs, which includes a guaranteed recovery to be paid by the issuer defendants’ insurance carriers and an assignment of certain claims the issuers, including Palm, may have against the underwriters. There is no guarantee that the settlement will become final, however, as it is subject to a number of conditions, including court approval. Palm believes that it has meritorious defenses to the claims against it and intends to defend the action vigorously if settlement is not reached.

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

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

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

In October 2002, a purported consumer class action lawsuit was filed against Palm in Illinois Circuit Court, Cook County. The case is captioned Goldstein v. Palm, Inc., Case No. 02CH19678. The case alleges consumer

Index to Financial Statements

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

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

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

On or about June 17 and 19, 2003, respectively, two putative class action lawsuits were filed in the Court of Chancery in the State of Delaware in and for the County of New Castle against Palm, Handspring and various officers and directors of Handspring. The cases are captioned Goldhirsch v. Handspring, Inc., et al., Civil Action No. 20376-NC and Majarian v. Handspring, Inc., et al., Civil Action No. 20381-NC. The Majarian complaint was amended on or about June 23, 2003 to, among other things, delete certain previously named officer defendants. Both complaints allege that the officers and directors of Handspring breached their fiduciary duties to Handspring stockholders by, among other things, failing to undertake an appropriate evaluation of Handspring’s net worth as a merger or acquisition candidate and failing to maximize Handspring stockholder value by not engaging in a meaningful auction of Handspring. The Majarian complaint also alleges, among other things, that the officers and directors of Handspring breached their fiduciary duties by failing to act independently so that the interests of Handspring’s public stockholders would be protected and enhanced. Both complaints allege that Palm aided and abetted the alleged breaches of fiduciary duty of Handspring’s officers and directors. Both complaints seek, among other things, a preliminary and permanent injunction against the transaction, a recission of the transaction if it is consummated and unspecified damages. The Goldhirsch complaint also requests, among other things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or an unspecified market check. Palm and Handspring believe that the lawsuits are without merit and intend to vigorously defend the cases.

Index to Financial Statements

We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any dividends in the foreseeable future. However, the payment and amount of dividends after the distribution will be subject to the discretion of our board of directors.

In connection with the separation of the Palm and PalmSource businesses, Palm issued to us an inter-company loan of $20.0 million, which will be contributed to us as a capital contribution immediately prior to the distribution, and since our incorporation has made additional net capital contributions to us in cash of $28.2 million, consisting of capital contributions of $31.1 million in fiscal year 2002 reduced by a capital distribution of $2.9 million during fiscal year 2003. An additional $6.0 million will be contributed to us as a capital contribution by Palm upon the distribution and we intend to issue a $15.0 million 5% convertible subordinated note payable to Texas Instruments, due December 2006, following the distribution. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.”

The following table sets forth our unaudited capitalization as of May 31, 2003. Our capitalization is presented:

You should read the information set forth below together with “Summary Combined and Consolidated Financial Data,” our historical combined and consolidated financial statements, the notes to those statements, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Certain Relationships and Related Transactions” included elsewhere in this prospectus.

Index to Financial Statements

The following selected combined and consolidated financial data of PalmSource reflect our historical results of operations and balance sheet data. Our combined and consolidated statement of operations data set forth below for the years ended May 31, 2001, 2002, and 2003 and the combined and consolidated balance sheet data as of May 31, 2002 and 2003 are derived from our audited combined and consolidated financial statements included in this prospectus.

The combined and consolidated statement of operations data for the year ended May 31, 1999 and the combined and consolidated balance sheet data as of May 31, 1999 and 2000 are derived from our unaudited combined and consolidated financial statements that are not included in this prospectus. The combined and consolidated statement of operations data for the year ended May 31, 2000 and the combined and consolidated balance sheet data as of May 31, 2001 are derived from our audited combined and consolidated financial statements that are not included in this prospectus.

The unaudited pro forma data is presented giving effect to a one for five reverse stock split on September 22, 2003 and assuming the conversion of outstanding Series A mandatorily redeemable convertible preferred stock to common stock, and the re-capitalization of the issued and outstanding shares of common stock of PalmSource prior to the distribution. The unaudited pro forma balance sheet also gives effect to the intended issuance by PalmSource of a $15.0 million 5% convertible subordinated note due December 2006, payable to Texas Instruments and the contribution of the $20.0 million note payable to Palm as additional paid in capital, immediately prior to the distribution in accordance with the terms of the amended and restated intercompany loan agreement. The related accrued interest on the contributed Palm note will be due and payable to Palm within seven days of the distribution date. In addition, the unaudited pro forma balance sheet also gives effect to the contribution by Palm, in accordance with the terms of the letter agreement regarding cash contributions, of an additional $6.0 million in cash upon the distribution date. The unaudited pro forma basic and diluted net loss per share does not include the impact of interest expense related to the intended issuance of a $15.0 million 5% convertible subordinated note which will occur following the distribution. Interest payable on this note is payable semi-annually and the note is due and payable on December 6, 2006. For a description of the 5% convertible subordinated note, see the section titled, “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note.”

The financial information presented below may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as a separate, stand-alone entity during the periods presented. See “Risk Factors—Risks Relating to Our Separation from Palm—Our historical financial information may not be representative of our results as a stand-alone company and, therefore, may not be reliable as an indicator of future results.” In addition, due to the acquisitions that we have made, and the change in our method of accounting for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets effective June 1, 2001, our results of operations are not necessarily comparable between the periods presented. In addition, our historical combined and consolidated balance sheet data is not comparable to the pro forma balance sheet data due to the transactions anticipated to occur as of the distribution date discussed above. You should also read the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which describes a number of factors that have affected our financial results.

Index to Financial Statements

The following should be read in conjunction with the combined and consolidated financial statements and the related notes that appear elsewhere in this prospectus. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, in “Risk Factors” and elsewhere in this prospectus.

We are a leading developer and licensor of a software platform that enables mobile information devices. Our software platform consists of operating system software and software development tools. We have also extended our platform with applications such as personal information management software, web browsers and e-mail. We license Palm OS to leading mobile information device manufacturers, including Garmin, Handspring, Kyocera, Lenovo (formerly known as Legend), Palm, Samsung and Sony. A wide range of mobile information devices incorporate our solutions, including PDAs, mobile phones, location-aware devices, entertainment devices, and industry-specific devices used in industries such as education, hospitality and healthcare.

Our 52-53 week fiscal year ends on the Friday nearest to May 31. Our fiscal quarters end on a Friday and are generally 13 weeks in length. For presentation purposes, we have presented our fiscal quarters as ending on August 31, November 30, February 28 and May 31. Unless otherwise stated, all years and dates refer to our fiscal year and fiscal quarters.

We were incorporated in December 2001 as a wholly-owned subsidiary of Palm to conduct substantially all of the business of its operating system software group. In connection with the separation of the two businesses, Palm contributed to us substantially all of the assets and liabilities comprising the Palm operating system software group, issued to us an inter-company loan of $20.0 million, which will be a contribution as additional paid-in-capital immediately prior to the distribution and since our incorporation has made additional net capital contributions to us of $28.2 million in cash, consisting of capital contributions of $31.1 million in fiscal year 2002 reduced by a capital distribution of $2.9 million during fiscal year 2003. An additional $6.0 million will be contributed to us as a capital contribution by Palm upon the distribution and we intend to issue a $15.0 million 5% convertible subordinated note payable to Texas Instruments, due December 6, 2006, following the distribution. For a description of the 5% convertible subordinated note see the section titled “—Liquidity and Capital Resources—The Convertible Note.”

We have entered into a number of agreements that govern the separation of our business operations from Palm. In general, these agreements provide for the transfer from Palm to us of assets comprising our business and the assumption by us of liabilities relating to our business. The separation agreements, in some cases, allocate various costs between the parties and require us to indemnify Palm for certain liabilities Palm may incur. We have also entered into an agreement with Palm for the licensing to Palm of Palm OS for use in the manufacturing of Palm’s mobile information devices. All of the agreements we entered into with Palm were entered into in the context of a parent-subsidiary relationship and were negotiated in the overall context of our separation from Palm. As a result, the terms of these agreements may be more or less favorable to us than if they had been negotiated with unaffiliated third parties. Please see the section titled “The PalmSource Separation” for a more detailed summary of the separation related agreements with Palm and the software license agreement with Palm.

Our operating results historically have been included in Palm’s consolidated U.S. income tax return and consolidated, combined or unitary state income returns and in tax returns of certain foreign subsidiaries. The income tax provision in our financial statements has been determined on a separate-return basis. Pursuant to our

Index to Financial Statements

tax sharing agreement with Palm, $65.4 million of deferred tax assets are deemed attributes of Palm. Accordingly, we will not be able to use these deferred tax assets to offset our corresponding tax liabilities.

We must also negotiate new or revised agreements with various third parties as a separate, stand-alone entity. We cannot assure you that the terms we will be able to negotiate will be as favorable as those we enjoyed as part of Palm. In addition, we benefited from various economies of scale as part of Palm, including shared administrative functions, facilities and sales and marketing organizations. We expect that our costs in some cases will increase as a result of the loss or renegotiation of these agreements, which may not be offset by cost savings in other areas.

Our revenues consist of license and royalty and support and service revenues. We primarily generate revenue by licensing Palm OS to mobile information device manufacturers and providing support and services to our licensees. We also derive revenues from our Palm OS Ready program participants. We present revenues from Palm and Sony separately as related party revenues.

License and royalty revenues consist principally of revenues earned under software license agreements with manufacturers of mobile information devices. Historically, our license agreements with these manufacturers generally provide for an upfront license fee and additional royalties based on the number of units sold by the licensee incorporating Palm OS. We recognize license and royalty revenues when a signed contract exists, the software has been shipped or electronically delivered, the license fee is fixed or determinable, and collection of the resulting receivable is probable. License and royalty revenues from upfront license fees under our agreements are generally recognized over the term of the agreement. License and royalty revenues from royalty fees are generally recognized on a per-unit or net sales royalty basis based on contractually reported information from licensees. Currently, the majority of our royalty revenue stream is derived from licensees with a royalty fee that is calculated on a net sales basis. The royalty rate generally ranges from 3% to 6% of net sales based on the average selling price of the licensee’s Palm Powered device. Payments received in advance of royalties being earned are recorded as deferred revenue.

Our license agreements with licensees may contain minimum commitments. For example, under the Palm software license agreement, minimum annual license and royalty commitments consist of $40.0 million, $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring on December 3, 2002, 2003, 2004, 2005, and 2006, respectively. Handspring currently has minimum license and royalty commitments of $1.5 million for each of Handspring’s fiscal quarters through the term of its license agreement with us. However, as a result of the Handspring merger, the Handspring license agreement will terminate, we will no longer be entitled to the $1.5 million quarterly minimum commitments and revenue from the sale of Handspring products may be used instead by Palm to satisfy Palm’s minimum commitments if necessary. As a result of the merger, we are losing $6.0 million in annual contractual minimum commitments through June 2009 and our revenue from Palm and Handspring will decline if the merger does not result in significant increased sales by Palm following the merger. We calculate minimum commitment shortfalls on a quarterly or annual basis based on the terms of the respective license agreement. Shortfalls, if any, are recorded in the period that the minimum commitment becomes due to us.

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

Generally, our licensees experience higher seasonal demand for their products during our second and third fiscal quarters. We believe that this seasonality is primarily the result of the winter holiday season. In addition,

Index to Financial Statements

certain licensees, including Palm, satisfy the remaining amount of their yearly minimum commitments, if necessary, in our third fiscal quarter. Historically, these factors have resulted in a substantial increase in revenues for our third fiscal quarter as compared to other quarters in the fiscal year.

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

Concentration of Our Customers. We currently depend on Palm and, to a lesser extent, Sony and Handspring for a large percentage of our revenues. Revenues from Palm were not recorded until December 3, 2001, the effective date of our software license agreement with Palm. Had we applied the terms of the software license agreement to the periods prior to December 3, 2001 when we were an integrated business unit within Palm, the percentage of our revenue from Palm would have been substantially higher for the years ended May 31, 2001 and 2002. Revenues and percentage of total revenues from Palm, Sony and Handspring for the years ended May 31, 2001, 2002 and 2003 were as follows (in millions):

Although we have recently expanded our number of licensees, many of these new licensees have yet to introduce products on the market or sell significant numbers of units based on Palm OS. We expect that Palm and Sony will continue to account for a substantial portion of our revenue for the foreseeable future. However, we expect that revenue from Palm will gradually decline over time as a percentage of our overall revenue. Our license agreement with Palm will expire in December 2006, our license arrangement with Sony will expire in October 2012 and our license agreement with Handspring will expire upon the closing of the Handspring merger. Following the Handspring merger, royalties from the sale of Handspring products will be subject to the terms of our license agreement with Palm and revenue from the sale of Handspring products may be used by Palm to satisfy Palm’s minimum commitments if necessary. Each of these licensees can cease selling Palm Powered products at any time, subject to their minimum commitment requirements, if any. We cannot assure you that we will be able to renegotiate these licensing agreements on favorable terms, if at all, once they expire.

Industry Dynamics. The software industry is characterized by several trends that may have a material impact on our strategic planning, results of operations and financial condition. One key trend has been the decline in spending on information technology by enterprises and consumers as a result of the weakened global economy. Simultaneously with this economic weakness, we are seeing an increasingly competitive environment among mobile information device manufacturers. As a result of a number of competitive factors, mobile device manufacturers are increasingly developing products at lower price points in addition to facing downward pricing pressures on higher end products. As a result, some of our licensees, including Palm, are experiencing declining average selling prices and declining volume. These declines adversely impact the royalties that we earn on licenses that are based on a percentage of Palm Powered device revenues. Currently, minimum commitments, primarily from Palm, and to a lesser extent other licensees, partially offset the impact of these declining royalties on our operating results. We cannot assure you that we will be able to renegotiate new minimum commitments from these licensees when these contracts expire or that we will be able to sufficiently increase our revenue from other sources to offset this decline. The Handspring merger will result in the termination of our license agreement

Index to Financial Statements

with Handspring and the associated $1.5 million quarterly minimum commitment. Partially in response to these trends, we have undertaken a number of restructuring efforts to realign our cost structure with our business operations. During the third quarter of fiscal year 2003, restructuring actions consisted of workforce reductions primarily in the United States and facilities and property and equipment disposed of or removed from service. Restructuring charges relate to the implementation of these actions to better align our expense structure with our revenues. Prior restructuring actions were taken in the second quarter of fiscal year 2002 and the fourth quarter of both fiscal years 2001 and 2002.

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

As the market for PDAs matures, we expect that our future revenue growth will come from other mobile information devices, in particular smartphones, that incorporate Palm OS. If we are unsuccessful in penetrating the markets for these other devices or such markets do not develop as anticipated, our revenues will suffer. To compete in the smartphone and other new markets and as we continue to expand our product offering to penetrate new markets and industries, we expect to enhance Palm OS by licensing additional technologies from third-party vendors. We will need to negotiate favorable terms on these third-party royalty contracts, or our cost of license revenue and our gross margins could decrease.

During November 2001, we purchased specific assets of Be Incorporated, or Be, including substantially all of Be’s intellectual property and other technology assets, and hired a substantial majority of Be’s engineers. Be was a provider of software solutions designed specifically for Internet appliances and digital media. During March 2001, we completed the acquisition of peanutpress.com, Inc., or peanutpress, which is now known as Palm Digital Media. peanutpress was a provider of electronic books, or eBooks, and Internet-based content management services. peanutpress developed, archived, hosted, and securely distributed eBook collections on behalf of publishers of books. During February 2001, we completed the acquisition of WeSync.com, Inc., or WeSync, which was a provider of wireless synchronization technologies. WeSync’s technologies enabled work and personal groups using the company’s free web-based service to share and synchronize changes to calendars and contacts on handhelds running Palm OS and PCs. During May 2000, we completed the acquisition of Actual Software Corporation, or Actual Software, which was a developer of e-mail software for the Palm OS operating system. In February 1999, we acquired Smartcode Technologie SARL, or Smartcode, which was a developer and provider of wireless data communications and Internet access software technology. We acquired Smartcode for its engineering resources and familiarity with wireless technologies and related areas of expertise. All of these acquisitions were accounted for under the purchase method of accounting and, accordingly, our results of operations are not necessarily comparable between periods.

On August 29, 2003, we sold the Palm Digital Media product line to PalmGear. For a more detailed discussion of the sale of the Palm Digital Media product line, see Note 16 to the Combined and Consolidated Financial Statements.

On August 1, 2003, in connection with the option exchange program approved by our board of directors on June 30, 2003, certain key PalmSource executives returned for cancellation 1,042,000 stock options to purchase

Index to Financial Statements

our common stock. On August 4, 2003, in exchange for these cancelled options, these executive officers received 689,490 shares of our restricted common stock, at a per share price equal to the par value of our common stock, subject to a repurchase right in our favor, which lapses over the next two years. On August 4, 2003, we also made grants of restricted stock to certain of our executive officers outside of the option exchange program in an aggregate amount of 243,475 shares, consisting of waiver grants of 170,300 shares and stock bonus grants of 73,175 shares at a price per share equal to the par value of our common stock, subject to a repurchase right in our favor, which lapses over the next two years. The granting of such restricted stock at a price below our common stock’s assumed fair market value will result in a non-cash compensation charge of an aggregate of approximately $14.0 million, which is to be amortized over the vesting period. Amortization under the accelerated method will result in a stock-based compensation charge of approximately $8.7 million, $4.7 million, and $0.6 million in fiscal years 2004, 2005 and 2006, respectively. Any repurchases of unvested restricted stock would result in a reversal of a portion of this charge.

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

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

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in PalmSource’s combined and consolidated financial statements and the accompanying notes. The amounts of assets and liabilities reported on our balance sheets and the amounts of revenues and expenses reported for each of our fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, allocations from Palm, goodwill impairment, loss contingencies, restructuring, and income taxes. Actual results could differ from these estimates. The following critical accounting policies are significantly affected by judgments, assumptions and estimates used in the preparation of the combined and consolidated financial statements.

Index to Financial Statements

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

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

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

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

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

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

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

Index to Financial Statements

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

Related party license and royalty revenues. Related party license and royalty revenues were $1.0 million in fiscal year 2001, $22.7 million in fiscal year 2002, and $49.0 million in fiscal year 2003, representing an increase of 2092% from fiscal year 2001 to 2002, and an increase of 116% from fiscal year 2002 to 2003. License and royalty revenues from Palm, consisting primarily of royalty fees received from shipment of PDAs were $0 million, $17.6 million, and $38.1 million in fiscal year 2001, 2002, and 2003, respectively. License and royalty revenues from Sony were $1.0 million, $5.1 million, and $10.9 million in fiscal years 2001, 2002, and 2003, respectively. The increase in license and royalty revenues from fiscal year 2001 to 2002 was due to no Palm revenues recorded prior to December 3, 2001, the effective date of the software license agreement, compared to five months of Palm revenue recorded in fiscal year 2002. PalmSource recognizes royalty revenue from Palm in the period royalty information is reported to us, generally one month subsequent to the ship date.

Index to Financial Statements

The increase in license and royalty revenues from fiscal year 2002 to 2003 was due to a full year of Palm revenue recorded in fiscal year 2003, compared to five months of Palm revenue reported in fiscal year 2002. In fiscal year 2003, we received a payment of $3.6 million from Palm as a result of Palm’s shortfall under its minimum annual commitment for the annual contractual period ending December 3, 2002.

PalmSource’s business principally supported the operating system for Palm Powered devices prior to December 3, 2001, which is the effective date of the software license agreement with Palm. No revenue prior to the effective date of the software license agreement has been imputed. For fiscal years 2001, 2002 and 2003, we believe the handheld market experienced an overall decline caused by reduced growth in the handheld industry. For example, Palm revenue was $1.6 billion in fiscal year 2001, $1.0 billion in fiscal year 2002 and $0.9 billion in fiscal year 2003 as a result of lower average selling prices and lower unit shipments. If the software license agreement with Palm had been in place prior to December 3, 2001, our revenue would have shown a corresponding decline in revenue reflective of the market conditions and our reliance on revenue from Palm.

Third party license and royalty revenues. Third party license and royalty revenues were $24.3 million in fiscal year 2001, $19.5 million in fiscal year 2002, and $18.4 million in fiscal year 2003, representing a decrease of 20% from fiscal year 2001 to 2002 and a decrease of 6% from fiscal year 2002 to 2003. License and royalty revenues from Handspring were $16.7 million in fiscal year 2001, $9.8 million in fiscal year 2002, and $6.2 million in fiscal year 2003. The decreases in license and royalty revenues from fiscal year 2001 to 2002 and from fiscal year 2002 to 2003 were principally due to lower royalties received from Handspring on royalties that are computed as a percentage of Handspring revenues from the sale of Palm Powered devices, offset by increased license fees from new license agreements. On completion of the Handspring merger with Palm, Handspring contractual minimum commitments of $1.5 million per quarter will cease.

Related party support and service revenues. Related party support and service revenues were $0.2 million in fiscal year 2001, $1.0 million in fiscal year 2002, and $1.5 million in fiscal year 2003, representing an increase of 399% from fiscal year 2001 to 2002, and 48% from fiscal year 2002 to 2003. Support and service revenues from Palm were $0 million in fiscal year 2001, $0.8 million in fiscal year 2002, and $1.2 million in fiscal year 2003. Support and service revenues from Sony were $0.2 million in both fiscal years 2001 and 2002, and $0.3 million in fiscal year 2003. The increases from fiscal year 2001 and 2002 and from fiscal year 2002 to 2003 were primarily due to no Palm revenues reported prior to December 3, 2001, the effective date of the software license agreement, compared to six months of Palm revenues reported in fiscal year 2002 and to the establishment of the professional services business during the fourth quarter of fiscal year 2002.

Third party support and service revenues. Third party support and service revenues were $0.8 million in fiscal year 2001, $1.8 million in fiscal year 2002, and $4.5 million in fiscal year 2003, representing an increase of 135% from fiscal year 2001 to 2002, and 152% from fiscal year 2002 to 2003. The increases from fiscal year 2001 to 2002 and from fiscal year 2002 to 2003 were due to the increase in the number of new and existing licensees with maintenance and support agreements and the establishment of the professional services business during the fourth quarter of fiscal year 2002.

Cost of license and royalty revenues. Cost of license and royalty revenues principally represents royalty payments to third party technology vendors and amortization of purchased intangible assets. The majority of our cost of license and royalty revenues are of a fixed nature and are not directly related to or allocable to either third party or related party revenues. Cost of license and royalty revenues was $4.0 million in fiscal year 2001, $8.5 million in fiscal year 2002, and $7.5 million in fiscal year 2003, representing 15.2%, 18.9%, and 10.2% of total revenues, respectively. The increases in cost of license and royalty revenues from fiscal year 2001 to 2002 in absolute dollars and as a percentage of total revenues were primarily due to the increase of $2.8 million in amortization of purchased intangibles from the WeSync, peanutpress, and Be acquisitions. In addition, royalty payments to eBook content providers contributed to the increase in cost of license and royalty revenues by $0.6 million. The remaining increase in cost of license and royalty revenues was primarily due to additional royalty payments to new and existing third-party technology vendors. The decrease in cost of license and royalty

Index to Financial Statements

revenues from fiscal year 2002 to 2003 in absolute dollars and as a percentage of total revenues was primarily due to a reduction of approximately $1.1 million in amortization of purchased intangibles as certain WeSync and Smartcode intangible assets became fully amortized, which was partially offset by the increase in royalty payments to new and existing third-party technology vendors. We expect a decline of approximately $3.8 million in amortization of purchased intangible assets from fiscal year 2003 to fiscal year 2004 as certain intangible assets become fully amortized. We expect this decrease to be partially offset by increased royalty payments to third-party vendors to support new versions and features of PalmOS.

Cost of support and service revenues. Cost of support consists of costs to provide software updates and technical support for software products, and cost of service represents costs to provide product development, engineering services, consulting and training. The cost of our support revenues are principally of a fixed nature and are not directly related to or allocable to either third party or related party revenues. The cost of service revenues vary by project, but are generally comparable for both third party and related party service revenues. Cost of support and service revenues was $1.5 million in fiscal year 2001, $2.1 million in fiscal year 2002, and $2.7 million in fiscal year 2003, representing 5.6%, 4.7%, and 3.7% of total revenues, respectively. The increases in cost of support and service revenues in absolute dollars from fiscal year 2001 to 2002 was due to increased support and service personnel to support new licensees and approximately $0.3 million increased costs associated with the establishment of our professional services organization in the fourth quarter of 2002. The decrease as a percentage of total revenues from fiscal year 2001 to 2002 was due to the increase in total revenues in fiscal year 2002 compared to fiscal year 2001 and partially offset by increased personnel related costs. The increase in cost of support and service revenues in absolute dollars from fiscal year 2002 to 2003 was primarily due to approximately $0.6 million in costs associated with the growth of our professional services business. The decrease as a percentage of total revenues from fiscal year 2002 to 2003 was due to the increase in total revenues in fiscal year 2003. We expect support and service gross profit to increase in the future as professional services revenue continues to grow and economies of scale are achieved in the support organization.

Research and development expenses. Research and development expenses consist primarily of personnel and related costs to support our product development and related information technology and facilities costs. Research and development expenses were $55.9 million in fiscal year 2001, $49.6 million in fiscal year 2002, and $39.8 million in fiscal year 2003, representing a decrease of 11% from fiscal year 2001 to 2002 and a decrease of 20% from fiscal year 2002 to 2003. Research and development expenses as a percentage of total revenues were 213.0% in fiscal year 2001, 110.3% in fiscal year 2002, and 54.2% in fiscal year 2003. The decreases in research and development expenses in absolute dollars from all years were due to restructuring efforts effected to realign our resources with our business plan. The decrease in research and development expenses as a percentage of total revenues from fiscal year 2001 to 2002 was due to the approximately $6.4 million decline in research and development expenses and the increase in total revenues in fiscal year 2002 compared to fiscal year 2001, as revenues from Palm were not recorded until December 3, 2001, the effective date of the software license agreement. The decrease in research and development expenses as a percentage of total revenues from fiscal year 2002 to 2003 was primarily due to the approximately $9.8 million decline in research and development expenses. We expect research and development expense to fluctuate in response to market conditions and economic trends.

Sales and marketing expenses. Sales and marketing expenses consist primarily of personnel and related costs of our direct sales force and marketing staff and the cost of marketing programs, including advertising, trade shows, promotional materials and customer conferences and related information technology and facilities costs. Sales and marketing expenses were $25.6 million in fiscal year 2001, $19.3 million in fiscal year 2002, and $17.2 million in fiscal year 2003, representing a decrease of 25% from fiscal year 2001 to 2002 and a decrease of 11% from fiscal year 2002 to 2003. Sales and marketing expenses as a percentage of total revenues were 97.5% in fiscal year 2001, 43.0% in fiscal year 2002, and 23.4% in fiscal year 2003. The decrease in absolute dollars from fiscal year 2001 to fiscal year 2002 were primarily due to a decrease of $2.9 million in costs allocated from Palm and a decrease of $2.3 million from downsizing our international operations. The decrease in absolute dollars from fiscal year 2002 to fiscal year 2003 were due to lower expenses incurred associated with the

Index to Financial Statements

PalmSource developer conference. The cost of the PalmSource developer conference decreased approximately $2.7 million, from fiscal year 2002 to fiscal year 2003, due to a shift in format from a large global conference to lower cost regional conferences. The decreases in sales and marketing expenses as a percentage of total revenues are due to the above factors and the increase in total revenues from 2001 to 2002 and 2002 to 2003. We expect sales and marketing expenses to fluctuate in response to market conditions, economic trends, the cost and timing of future PalmSource developer conferences and the impact of stock-based compensation charges.

General and administrative expenses. General and administrative expenses consist primarily of personnel and related costs for general corporate functions, including executive, legal, finance, accounting, human resources and related information technology and facilities costs. General and administrative expenses were $12.9 million in fiscal year 2001 and $12.8 million in both fiscal years 2002 and 2003, representing a decrease of 1% from fiscal year 2001 to 2002 and no change from fiscal year 2002 to 2003. General and administrative expenses as a percentage of total revenues were 49.0% in fiscal year 2001, 28.4% in fiscal year 2002, and 17.4% in fiscal year 2003. The decrease in general and administrative expenses as a percentage of total revenues from fiscal year 2001 to 2002 was due to an increase in total revenues in fiscal year 2002 compared to fiscal year 2001 as revenues from Palm were not recorded until December 3, 2001, the effective date of the software license agreement. The decrease in general and administrative expenses as a percentage of total revenues from fiscal year 2002 to 2003 was primarily due to an increase in total revenues in fiscal year 2003. We expect general and administrative expenses to increase as we establish our own, separate administrative functions and negotiate new or revised agreements with various third parties as a separate, stand-alone company and as result of a stock-based compensation charge we will incur in connection with the issuance of our restricted stock on August 4, 2003. See the section titled “—Non-cash Compensation Charge.” These cost increases include additional expenses such as directors and officers insurance. In addition, we may not enjoy the benefits of economies of scale that were previously available to us as part of Palm.

Amortization of intangibles. Amortization of intangibles consisting of amortization related to our acquisitions was $6.5 million in fiscal year 2001, $0.3 million in fiscal year 2002, and $0.4 million in fiscal year 2003. The decrease in amortization of intangibles from fiscal year 2001 to 2002 was due to the cessation of amortization of goodwill on adoption of SFAS No. 142 “Goodwill and Other Intangible Assets” effective June 2, 2001. Goodwill amortization was $5.7 million in fiscal year 2001, whereas no goodwill was amortized in fiscal year 2002 due to the accounting change. The slight increase in amortization of intangibles from fiscal year 2002 to 2003 was primarily due to a full year’s amortization cost in fiscal year 2003 related to our acquisition of Be in November 2001. We expect a decline of approximately $0.2 million in amortization of intangibles from fiscal year 2003 to fiscal year 2004 as certain intangible assets become fully amortized.

Restructuring charges. Restructuring charges principally consisted of workforce reductions, including severance, benefits, related expenses and facility closings. Restructuring charges were $2.2 million in fiscal year 2001, $2.0 million in fiscal year 2002 and $2.2 million in fiscal year 2003. The restructuring charges in fiscal year 2001 related to the implementation of a series of cost reduction actions in response to the economic slowdown. The restructuring charges primarily consisted of workforce reduction costs for severance, benefits and related costs and costs related to lease commitments for excess facilities. The restructuring charges in fiscal year 2002 consisted of an estimated loss on lease commitments for excess facilities, as well as workforce reduction costs primarily related to severance, benefits and related costs. The restructuring actions initiated in fiscal year 2002 have been completed. The restructuring charges in fiscal year 2003 were primarily workforce reduction costs for severance, benefits and related costs associated with a reduction of 60 regular employees. In accordance with SFAS No. 146, restructuring costs are recorded as incurred. Restructuring charges for employee workforce reductions are recorded upon employee notification for employees whose required continuing service period is 60 days or less. Headcount reductions from the fiscal year 2003 restructuring action are essentially complete and remaining costs are expected to be settled in fiscal year 2004, resulting in annual savings of approximately $9.6 million.

Separation costs. Separation costs are generally consulting and professional fees related to separating our business from Palm’s Solutions Group business. Separation costs were $1.5 million in fiscal year 2001, $0.5 million in fiscal year 2002, and $5.0 million in fiscal year 2003. Separation costs in fiscal year 2001

Index to Financial Statements

consisted of costs related to Palm’s separation from 3Com based on the allocation methodology for Palm corporate expenses described in Note 13 of Notes to Combined and Consolidated Financial Statements. Separation costs in fiscal years 2002 and 2003 primarily consisted of costs related to the establishment of PalmSource as a separate independent company. We expect to continue to incur separation costs related to our separation from Palm through the second quarter of fiscal year 2004.

Purchased in-process technology. Purchased in-process technology in fiscal year 2001 was a result of our acquisition of peanutpress. Approximately $0.2 million of the purchase price of peanutpress represented purchased in-process technology that had not yet reached technological feasibility, had no alternative future use and was charged to operations. There was no purchased in-process technology in fiscal years 2002 and 2003.

Interest expense. Interest expense was $0.1 million in fiscal year 2001, $0.3 million in fiscal year 2002, and $0.5 million in fiscal year 2003. The increase in interest expense from fiscal year 2001 to 2002 and from fiscal year 2002 to 2003 was primarily due to interest on our $20.0 million 2.48% note payable to Palm. We expect interest expense to increase after the distribution date due to interest on the $15.0 million 5% convertible subordinated note payable to Texas Instruments intended to be issued, partially offset by the decrease in interest paid to Palm as a result of the contribution to our capital by Palm of the $20 million note payable to Palm that bears interest at 2.48%.

Interest and other income (expense), net. Other income was $0.1 million in fiscal year 2001. Other expense was $0.4 million in fiscal year 2002 and $4.6 million in fiscal year 2003. The change in other income (expense) from fiscal year 2001 to 2002 was primarily due to $0.3 million paid to Palm for expenses relating to a $50.0 million bond posted by Palm pending resolution of the Xerox litigation and a $0.1 million increase in foreign currency fluctuations on realized gains and losses, partially offset by a $0.1 million increase in interest income as we established our own cash accounts subsequent to our separation from Palm in December 2001. The increase in other expense from fiscal years 2002 to 2003 was primarily due to a $3.2 million charge to write down an investment in a private equity security, which had been carried at cost and for which we determined the decline in value of our entire investment to $0.8 million to be other than temporary. The increase was also due to $1.3 million paid to Palm for expenses relating to a $50.0 million bond posted by Palm pending resolution of the Xerox litigation. The bond was released in April 2003, and accordingly, we expect other expense to decrease in future periods.

Income tax provision. Income tax provision was $9,000 in fiscal year 2001, $0.4 million in fiscal year 2002, and $2.4 million in fiscal year 2003. We incurred net operating losses for the three fiscal years and, as a result, we did not record a benefit for temporary differences and maintained a full valuation allowance. The increase in income tax provision from fiscal years 2002 to 2003 was primarily due to $2.0 million of foreign withholding taxes for which no credit is currently available against U.S. taxes due to our net loss position.

Historically, Palm has managed cash on a centralized basis, collecting cash receipts associated with our business and providing us with funding to cover our expenses. We established our own cash accounts upon our separation from Palm in December 2001. Net transfers to and from Palm have historically been recorded as additional net investment by Palm or as a distribution to Palm.

Net cash used for operating activities was $72.8 million in fiscal year 2001, $45.4 million in fiscal year 2002, and $8.9 million in fiscal year 2003, resulting primarily from our net losses. We received no revenues from Palm prior to December 3, 2001, the effective date of our software license agreement with Palm. Accordingly, our historical net loss and net cash used for operating activities for fiscal year 2001 and fiscal year 2002 may not be representative of our results had we been a stand-alone company or if our software license agreement with

Index to Financial Statements

Palm had been in effect for all periods presented. Our net cash flows from operating activities have fluctuated significantly between periods, partially due to the timing and amount of upfront initial license fees. If we are unable to obtain significant upfront fees or increase our revenues faster than our expenses, we may be unable to generate positive cash flows from operations in the future.

Net cash used for investing activities was $50.8 million in fiscal year 2001, $2.6 million in fiscal year 2002, and $3.4 million in fiscal year 2003. We have historically used cash for acquisitions of businesses with complementary technologies and for the purchase of property, plant and equipment. We anticipate capital expenditures for property, plant and equipment to be approximately $3.0 million in fiscal year 2004. We may use cash resources to pursue strategic acquisitions or investments in other companies that provide products and services that are complementary to ours.

Net cash provided by financing activities was $123.2 million in fiscal year 2001, $78.3 million in fiscal year 2002, and $19.1 million in fiscal year 2003. Historically Palm has been our principal source of cash from financing activities. Palm provided a $20.0 million long-term note to us to fund our working capital requirements. Immediately prior to the distribution, Palm will contribute the $20.0 million note payable to us as a capital contribution. Since our incorporation, Palm has made additional net capital contributions in cash of $28.2 million. An additional $6.0 million in cash will be contributed as capital by Palm and a $15.0 million 5% convertible subordinated note due December 2006, is intended to be issued by us following the distribution. See the section titled “—The Convertible Note” below for a more detailed description of the note. Palm will no longer be a source of financing to us subsequent to the distribution; therefore, we may require or choose to obtain additional debt or equity financing in the future. In October 2002, we received an investment of $20.0 million from Sony Corporation for 3,333,333 shares of our Series A preferred stock at a purchase price of $6.00 per share, which will convert into 666,666 shares of our common stock upon the distribution (taking into account the one for five reverse stock split). The shares of preferred stock automatically convert into shares of our common stock immediately prior to the distribution.

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

In connection with the PalmSource separation, Palm and Texas Instruments have agreed that the existing Palm note will be divided into and replaced by two notes: one issued by Palm, or the new Palm note, and one issued by PalmSource, or the PalmSource note. The new Palm note will be issued in the principal amount of $35 million and the PalmSource note will be issued in the principal amount of $15 million. The new Palm note will be convertible only into Palm common stock and the PalmSource note will be convertible only into PalmSource common stock. The conversion prices and conversion rates of each of the two notes will be set according to formulas agreed to by Palm and Texas Instruments.

Index to Financial Statements

If after the distribution the trading price of PalmSource stock increases to be higher than the conversion price of the PalmSource note, it is likely that the PalmSource note will be converted, resulting in dilution of PalmSource stockholders’ interest in PalmSource. If the decline in the stock price of Palm is very small and/or the actual market capitalization of PalmSource is much smaller than expected in relation to the PalmSource note, the dilution of the PalmSource stockholders’ interest could be substantial. This description of the formula to determine the conversion prices and conversion rates of the new Palm note and the PalmSource note are qualified in their entirety by the 5% convertible subordinated note due 2006 issued by Palm to Texas Instruments, which is incorporated by reference to Palm’s registration statement on Form S-4 of which this prospectus forms a part.

then the PalmSource note would be convertible into shares of PalmSource common stock at $72.54, representing a conversion premium of 282% to the $19.00 price per share of the PalmSource common stock, which would convert into 206,773 shares of common stock of PalmSource, which shares would represent 1.75% dilution to the PalmSource stockholders. However, the PalmSource note would be likely to be converted only if the trading price of our common stock were to increase to at least $72.54.

Index to Financial Statements

then the PalmSource note would be convertible into shares of PalmSource common stock at $11.50 (due to the 115% minimum conversion price discussed above), representing a conversion premium of 15% to the $10.00 price per share of the PalmSource common stock, which would convert into 1,304,347 shares of common stock of PalmSource, which shares would represent 10.11% dilution to the PalmSource stockholders. However, the PalmSource note would be likely to be converted only if the trading price of our common stock were to increase to at least $11.50.

If the decline in value in Palm common stock after the distribution date under the above calculations were less than the above examples, and especially if the PalmSource price per share were lower than the second example, then the conversion price of the PalmSource note would be lower, the conversion premium would be less, the PalmSource note would convert into more shares of our common stock and the dilution to PalmSource stockholders would be greater. If such variances are substantial, then the changes in the conversion price, the conversion premium, the number of shares that the PalmSource note would convert into and the dilution to PalmSource stockholders would be substantial.

Future payments under contractual obligations and other commercial commitments, as of May 31, 2003, were as follows (in millions):

Our facility leases are under noncancelable lease agreements. Our leases expire at various dates through September 2005.

In June 2002, we entered into two royalty agreements with third-party vendors for certain licensed technology, which include minimum commitments. Future minimum commitments under these agreements are $1.3 million in fiscal year 2004, $2.0 million in fiscal year 2005, $2.2 million in fiscal year 2006, $0.5 million in fiscal year 2007, $0.4 million in fiscal year 2008, and $0.3 million in fiscal year 2009.

Index to Financial Statements

In addition, we have certain payments due to Palm under the business services and other agreements that we have entered into with Palm, including indemnification of Palm under the tax sharing agreement for, among other matters, any tax liability incurred by Palm on account of the sale of PalmSource’s common stock in connection with the distribution (See Note 12 to the Combined and Consolidated Financial Statements).

In July 2002, Palm engaged Morgan Stanley to provide it with advice and assistance in connection with a possible separation transaction of PalmSource. In accordance with the amended and restated separation agreements, PalmSource is required to pay fees due to Morgan Stanley in connection with this engagement. Such fees are subject to adjustment based on the market value of PalmSource at the date of separation and estimated at approximately $3.4 million of which $3.1 million is payable upon completion of the PalmSource distribution.

In August 2002, Palm engaged Needham & Company, Inc. to provide it with advice and assistance in connection with a possible separation transaction of PalmSource. In accordance with the amended and restated separation agreements PalmSource is required to pay fees due to Needham and Company, Inc. in connection with this engagement. The fees payable to Needham & Company, Inc. in connection with this engagement are $0.4 million, $0.3 million of which are payable upon completion of the PalmSource distribution.

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

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

As part of our separation agreements with Palm, Palm has agreed to indemnify us for damages that we may incur due to the Xerox litigation. We believe that there are adequate defenses to the claims made by Xerox and Palm intends to continue to defend itself vigorously. However, we cannot assure you that Palm will be successful. If Palm is not successful in the litigation, Xerox might again seek an injunction from the court preventing us from licensing Palm OS with Graffiti handwriting recognition software. As a result and if Palm is unable to or does not indemnify us, we might be required to pay Xerox significant damages or license fees or pay our licensees significant amounts to indemnify them for their losses. The pending litigation may also result in other indirect costs and expenses. Accordingly, if Xerox is successful in its claims against Palm and Palm is unable to or does not indemnify us for these claims, our business, results of operations and financial condition would be significantly harmed. For further discussion, see the section titled “PalmSource Business—Legal Proceedings.”

In September 2001, David Nagel, our President and Chief Executive Officer, received two restricted stock grants in the aggregate of 7,500 shares of Palm common stock (as adjusted for Palm’s October 2002, one for 20 reverse stock split) under a two-year vesting schedule subject to vesting restrictions and a guarantee that the fair market value of the related 7,500 shares of Palm common stock would be $2.0 million at September 2003. The guaranteed amount was recorded ratably over the vesting period. Pursuant to the terms of this arrangement, Mr. Nagel received a cash payment from us on September 15, 2003 of approximately $1.8 million, the difference between $2.0 million and the fair market value of 7,500 shares of Palm common stock.

In November 2002, the EITF reached a consensus on EITF No. 00-21, Revenue Arrangements with Multiple Deliverables, which provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We believe that the adoption of EITF No. 00-21 will not have a significant impact on our historical financial position or results of operations.

Index to Financial Statements

In November 2002, the Financial Accounting Standards Board, or the FASB, issued FASB Interpretation No. 45, or FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. We adopted this interpretation in fiscal year 2003, which did not have an impact on our historical financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, an amendment of SFAS No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. In addition, it amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The adoption of this statement did not have an impact on our historical financial position or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. In general, a variable interest entity, or VIE, is a corporation, partnership, trust, or any other legal structure used for business purposes that either: (i) does not have equity investors with voting rights; or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the VIE’s residual returns or both. The consolidation requirements of FIN No. 46 are effective immediately for VIEs created after January 31, 2003. The consolidation requirements for older VIEs are effective for financial statements of interim or annual periods beginning after June 15, 2003. Certain of the disclosure requirements are effective for all financial statements issued after January 31, 2003, regardless of when the VIE was established. The adoption of FIN No. 46 will not have an impact on our historical financial position or results of operations.

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

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that falls within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, which for PalmSource is the second quarter of fiscal year 2004. The adoption of SFAS No. 150 will not have an impact on our historical financial position or results of operations.

Index to Financial Statements

Set forth below is certain information concerning our directors, executive officers and key employees and their ages as of August 31, 2003.

David C. Nagel has served as our President and Chief Executive Officer since December 2001. Mr. Nagel also has served as a director since December 2001. From September 2001 to December 2001, Mr. Nagel served as the Chief Executive Officer of the Platform Solutions Group at Palm. Prior to Palm, from April 1996 to September 2001, Mr. Nagel was the Chief Technology Officer of AT&T Corp., a communications services corporation, President of AT&T Labs, a corporate research and development unit of AT&T, and the Chief Technology Officer of Concert, a partnership between AT&T and British Telecom. Prior to AT&T, from 1988 to 1996, Mr. Nagel held various positions at Apple Computer, Inc., a manufacturer of personal computing devices, the last of which was Senior Vice President, Research and Development. Mr. Nagel’s earlier positions at Apple Computer included General Manager and Vice President, Apple Soft, and Vice President, Advanced Technology. Mr. Nagel currently is a member of the board of directors of Liberate Technologies and Palm. Mr. Nagel has a bachelor’s degree in engineering, a master’s degree in engineering and a Ph.D. in experimental psychology from the University of California, Los Angeles.

David A. Limp has served as our Senior Vice President of Corporate and Business Development since June 2003. Prior to PalmSource, from July 1997 to August 2002, Mr. Limp was Executive Vice President and Chief Strategy Officer of Liberate Technologies, a provider of infrastructure software and services for cable and telecommunications networks. Prior to Liberate Technologies, from 1996 to 1997, Mr. Limp was Vice President of Marketing for Navio Communications, Inc., an Internet software company that was acquired by Liberate Technologies in 1997. Prior to that role, from 1988 to 1996, Mr. Limp held various positions at Apple Computer, the last of which was Director of the North and South American PowerBook division. Mr. Limp has bachelor’s degrees in computer science and mathematics from Vanderbilt University and a master’s degree in management from Stanford University, Graduate School of Business.

Lamar Potts has served as our Vice President of Worldwide Licensing and Sales since December 2002. Prior to that role, from July 2002 to December 2002, Mr. Potts served as our Vice President of Licensing Sales. Prior to PalmSource, from July 2001 to June 2002, Mr. Potts was Vice President of Worldwide Licensing Sales for Insignia Solutions plc, a provider of software solutions for mobile devices. Prior to Insignia Solutions, from February 1999 to July 2001, Mr. Potts served as Vice President of Business Development and later Vice President of Worldwide Licensing Sales for Be, a developer of computer operating systems. Prior to Be, from June 1997 to February 1999, Mr. Potts was the owner and principal of LP Resource Group, a business

Index to Financial Statements

development and technology licensing consulting company. Prior to LP Resource Group, from March 1986 to May 1997, Mr. Potts held various positions at Apple Computer, including Vice President of Licensing, Financial Services Manager, Director of Worldwide Financial Services and Director of Research and Development Technology Licensing. Mr. Potts has a bachelor’s degree in liberal arts from West Georgia College.

Gabriele R. Schindler has served as our Senior Vice President of Worldwide Marketing since April 2002. Prior to PalmSource, from December 1996 to January 2002, Ms. Schindler was the Vice President of Marketing and Industry Relations of AT&T Labs. Prior to AT&T Labs, from January 1996 to December 1996, Ms. Schindler was the Senior Director of Worldwide Communications at Apple Computer. Prior to Apple Computer, from June 1988 to March 1994, Ms. Schindler was a principal at Regis McKenna Inc., a marketing consulting firm. Ms. Schindler has a bachelor’s degree in communications from San Jose State University.

Lawrence Slotnick has served as our Chief Products Officer since June 2003. Prior to PalmSource, from March 2002 to March 2003, Mr. Slotnick was sole proprietor of a technology management consulting business. Prior to his sole proprietorship, from April 2001 to March 2002, Mr. Slotnick served as Senior Vice President of Engineering at Pixo, Inc., a provider of telecommunications software products for handsets and wireless services. Prior to Pixo, from April 1999 to April 2001, Mr. Slotnick served as Vice President of Engineering at Noosh, Inc., a provider of web-based commercial print procurement products. Prior to Noosh, from March 1997 to April 1999, Mr. Slotnick held several roles at Apple Computer, including Vice President of Engineering. Prior to Apple Computer, from July 1995 to March 1997, Mr. Slotnick was Vice President of Engineering of Octel Communications Corporation, a provider of voice, fax and electronic messaging technologies that was acquired by Lucent Technologies in September 1997. Prior to Octel Communications, from March 1991 to June 1995, Mr. Slotnick was Vice President of Product Development of Claris, a subsidiary of Apple Computer focused on database software. Mr. Slotnick has a bachelor’s degree in computer science and a master’s degree in electrical engineering and computer science from the University of California, Berkeley.

Albert J. Wood has served as our Chief Financial Officer since October 2002 and our Treasurer since December 2002. Prior to PalmSource, from March 2001 to October 2002, Mr. Wood was Chief Financial Officer of Insignia Solutions. Prior to Insignia Solutions, from June 1999 to March 2001, Mr. Wood was the Chief Financial Officer of Cohera Corporation, a catalog management and content integration software provider acquired by PeopleSoft, Inc. in August 2001. Prior to Cohera, from December 1997 to June 1999, Mr. Wood was the Vice President of Finance for Indus International, Inc., a provider of software for asset and customer management. Prior to Indus International, from September 1996 to December 1997, Mr. Wood was the Controller of Prism Solutions, Inc., an enterprise solutions provider acquired by Ardent Software, Inc., in January 1999. Prior to Prism Solutions, Mr. Wood held various senior finance positions at Pyramid Technology Corporation, a subsidiary of Siemens-Nixdorf specializing in UNIX computer manufacturing, and Oracle Corporation, a supplier of software for enterprise information management. Mr. Wood has a bachelor’s degree in psychology from Chico State University and a master’s in business administration from San Jose University.

Doreen S. Yochum has served as our Chief Administrative Officer since January 2002 and our Secretary since December 2002. Prior to PalmSource, from 1996 to 2002, Ms. Yochum was Vice President and Chief Operating Officer of AT&T Labs. Prior to AT&T’s trivestiture, which spun off NCR and Lucent Technologies Inc. from AT&T, from 1994 to 1996, Ms. Yochum was the Human Resources and Business Planning Vice President in the Chief Information Technology Services organization of AT&T Labs. Prior to that role, from 1990 to 1993, Ms. Yochum was Vice President and Chief Operating Officer of AT&T’s Microelectronics Interconnection Technologies business. Ms. Yochum has a bachelor’s degree in history from Wilson College.

Eric A. Benhamou was appointed as Chairman of our board of directors in December 2001. Mr. Benhamou also has been serving as the interim Chief Executive Officer of Palm since November 2001. Prior to Palm, from September 1990 until December 2000, Mr. Benhamou served as Chief Executive Officer of 3Com Corporation, a provider of voice and data networking products, services and solutions. Prior to 1990, Mr. Benhamou held a variety of senior management positions in engineering, operations and management at 3Com. Prior to 3Com, in

Index to Financial Statements

1981, Mr. Benhamou co-founded Bridge Communications, an early networking pioneer, and was Vice President of Engineering until its merger with 3Com in 1987. Prior to Bridge Communications, from 1977 to 1981, Mr. Benhamou served as Project Manager, Software Engineering Manager and Design Engineer at Zilog, Inc., a designer, manufacturer and marketer of semiconductors for worldwide-embedded control markets. Mr. Benhamou currently serves on the board of directors of Cypress Semiconductor Corporation and Legato Systems, Inc. and is the chairman of the board of directors of Palm and 3Com. Mr. Benhamou has a masters of science degree in electrical engineering from Stanford University and a Diplôme d’Ingénieur from Ecole Nationale Supérieure d’Arts et Métiers, Paris.

Satjiv S. Chahil was appointed to our board of directors in May 2002. From February 2000 to May 2002, Mr. Chahil served as Chief Marketing Officer of Palm. Prior to Palm, from February 1999 to February 2000, Mr. Chahil was the Chief Marketing Officer and Executive Vice President of Global Marketing for Newbridge Networks Corporation, a distributor of networking products and systems, which was acquired by Alcatel in May 2000. Prior to Newbridge Networks, from July 1997 to February 1999, Mr. Chahil was the Digital Convergence Advisor of Sony Electronics, Inc., a U.S. business unit of Sony Corporation focused on the manufacture, sale and marketing of consumer and professional audio and video equipment and other electronic components. Prior to Sony Electronics, from September 1988 to February 1997, Mr. Chahil served in various capacities, including Senior Vice President of Worldwide Marketing and the founding general manager of the New Media, Internet and Entertainment division, at Apple Computer. Prior to Apple Computer, from September 1976 to September 1988, Mr. Chahil held various international sales, marketing and general management positions at IBM and Xerox. Mr. Chahil currently serves on the board of directors of Universal Electronics, Inc. Mr. Chahil has a bachelor’s degree in commerce from Punjab University and a master’s degree in business from the American (Thunderbird) Graduate School of International Management.

P. Howard Edelstein was appointed to our board of directors in June 2003. From January 2002 to the present, Mr. Edelstein has served as an entrepreneur in residence at Warburg Pincus, LLC, a private equity and venture capital firm. Prior to Warburg Pincus, from June 1993 to April 2001, Mr. Edelstein served as President and Chief Executive Officer of Thomson Financial ESG, a provider of technology-based workflow solutions to the global investment community, which now is OMGEO, a provider of global trade management services. Mr. Edelstein currently serves on the board of directors of Alacra Inc. and Skillsoft Corporation. Mr. Edelstein has a bachelor’s degree in electrical engineering from the College of the City of New York and a master’s degree in electrical engineering from Stanford University.

Robert J. Finocchio was appointed to our board of directors in May 2002. From July 1997 to September 2000, Mr. Finocchio served as Chairman of Informix Corporation, a database software provider which now is Ascential Software Corporation. From July 1997 to July 1999, Mr. Finocchio served as the President and Chief Executive Officer of Informix. Prior to Informix, from December 1988 until May 1997, Mr. Finocchio held various positions at 3Com, most recently serving as President, 3Com Systems. Prior to 3Com, from December 1978 to June 1987, Mr. Finocchio held various executive positions in sales and service at Rolm Corporation and IBM, which acquired Rolm in 1984. The last such position Mr. Finocchio held was as Vice President of Rolm Systems Marketing for IBM. Mr. Finocchio currently serves on the board of directors of Latitude Communications, Inc., Turnstone Systems, Inc., Echelon Corporation and Altera Corporation. Mr. Finocchio has a bachelor’s degree in economics from Santa Clara University and a master’s in business administration from Harvard Business School.

Jean-Louis F. Gassée was appointed to our board of directors in May 2002. From January 2002 to October 2002, Mr. Gassée served as a Chief Executive Officer and a director of Computer Access Technology Corporation, or CATC, a global communication protocols expert company. Prior to CATC, in 1990, Mr. Gassée co-founded Be and served as President, Chief Executive Officer and Chairman of the board of Be from October 1990 to December 2001. Prior to co-founding Be, from December 1980 to September 1990, Mr. Gassée served in numerous capacities, including President of Apple Products, at Apple Computer. Prior to Apple Computer, from 1979 to 1980, Mr. Gassée was President and General Manager of the French subsidiary of Exxon Corporation, an energy and

Index to Financial Statements

petrochemical provider, which now is Exxon Mobil Corporation. Mr. Gassée currently serves on the board of directors of Electronics for Imaging, Inc. Mr. Gassée has a bachelor’s degree in mathematics and physics from Orsay University (France) and a master’s of science from the University of Paris (France).

John B. Shoven, Ph.D. was appointed to our board of directors in September 2002. From September 1973 to the present, Dr. Shoven has held various positions in the Economics Department of Stanford University. From September 1992 to the present, Dr. Shoven has served as the Charles R. Schwab Professor of Economics at Stanford University. Dr. Shoven also has served as the Wallace R. Hawley Director of the Stanford Institute for Economic Policy Research since November 1999 and he previously served in such position from 1989 to 1993. Dr. Shoven also has served as the West Coast Director of the National Bureau of Economic Research since December 1988. From 1993 to 1998, Dr. Shoven served as the Dean of the School of the Humanities and Sciences at Stanford University. From 1986 to 1989, Dr. Shoven held the position of Chairman of the Economics Department at Stanford University. Dr. Shoven currently serves on the board of directors of Cadence Design Systems, Inc., Watson Wyatt & Company and American Century (Mountain View Funds). Dr. Shoven has a bachelor’s degree in physics from the University of California, San Diego and a Ph.D. in economics from Yale University.

Our board of directors consists of seven members. Our certificate of incorporation provides for a classified board of directors consisting of three classes of directors, each serving staggered three-year terms. As a result, a portion of our board of directors will be elected each year. To implement the classified board structure, prior to the consummation of the transaction, two of the members of the board will be elected to one-year terms, two will be elected to two-year terms and three will be elected to three-year terms. Thereafter, directors will be elected for three-year terms as follows:

This classification of our board of directors may delay or prevent a change of control of our company or in our management. See the section titled “Description of Capital Stock—Anti-Takeover Effects of PalmSource’s Certificate, Bylaws and Delaware Law.”

In connection with the transaction, PalmSource is granting certain nonemployee members of PalmSource’s Board of Directors nonstatutory stock options to purchase shares of PalmSource common stock. The following table shows, for each director, the number of options to be granted.

Grant Date. Options will be granted on any business day, in our board of directors’ sole discretion, within 30 days after the transaction.

Exercise Price. The per-share exercise price for options will be the fair market value of a share of PalmSource common stock on the date of grant.

Vesting Schedule. Each option will vest as to 25% of the shares subject to the option on each yearly anniversary of the date of grant. Each option will fully vest upon the death of the director.

With the exception of PalmSource’s chairman of the board who will receive 30,000 shares, non-employee directors will receive a grant of an option to purchase 20,000 shares of our common stock following the

Index to Financial Statements

distribution date. New non-employee directors will receive a grant of an option to purchase 20,000 shares of our common stock upon joining our board of directors. In addition, all non-employee directors who have served for PalmSource’s entire fiscal year, including the last business day, will receive on the last business day of PalmSource’s fiscal year beginning in 2004 an annual option to purchase 10,000 shares, which vests 100% on the one year anniversary of the date of grant. We reimburse our directors for costs associated with attending board meetings and each non-employee director receives an annual retainer fee of $15,000, paid on a quarterly basis, plus $3,500 for each board or committee meeting attended that lasts four or more hours and $1,500 for each board or committee meeting attended that lasts less than four hours.

The audit committee of our board of directors consists of Messrs. Edelstein and Finocchio and Dr. Shoven. Our audit committee:

In addition, the audit committee will undertake such other duties and responsibilities as the board of directors may from time to time prescribe.

The compensation committee of our board of directors consists of Mr. Edelstein, Mr. Gassée and Dr. Shoven. Our compensation committee has overall responsibility for approving and evaluating our executive officer compensation plans, policies and programs. The compensation committee also is responsible for producing an annual report on executive compensation for inclusion in our proxy statement.

The nominating and governance committee of our board of directors consists of Mr. Benhamou, Mr. Edelstein and Dr. Shoven. The nominating and governance committee ensures that the board of directors is properly constituted to meet its fiduciary obligations to our stockholders and to us and that we have and follow appropriate governance standards. To carry out its purpose, the nominating and governance committee: (i) assists the board of directors by identifying prospective director nominees and recommends to the board of directors the director nominees for the next annual meeting of stockholders; (ii) develops and recommends to the board of directors the governance principles applicable to us; (iii) oversees the evaluation of the board of directors and management; and (iv) recommends to the board of directors director nominees for each committee.

None of our executive officers serves as a member of the compensation committee of any entity that has one or more executive officers serving as a member of our board of directors or compensation committee. Furthermore, none of our executive officers serves as a director of any entity that has one or more executive officers serving as a member of our compensation committee.

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Our certificate of incorporation limits the liability of directors to the maximum extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:

The limitation of liability does not apply to liabilities arising under the federal securities laws and does not affect the availability of equitable remedies such as injunctive relief or rescission.

Our certificate of incorporation provides that we may indemnify our directors, officers, employees and other agents to the fullest extent permitted by law. We will enter into agreements to indemnify our directors and executive officers. These agreements, among other things, will provide for indemnification for judgments, fines, settlement amounts and certain expenses, including attorneys’ fees incurred by the director or executive officer, in any action or proceeding, including any action by or in our right, arising out of the person’s services as a director or executive officer of us, any of our subsidiaries or any other company or enterprise to which the person provides services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers.

The limited liability and indemnification provisions that are contained in our certificate of incorporation may discourage stockholders from bringing a lawsuit against our directors for breach of their fiduciary duty and may reduce the likelihood of derivative litigation against our directors and officers, even though a derivative action, if successful, might otherwise benefit us and our stockholders. A stockholder’s investment in us may be adversely affected to the extent we pay the costs of settlement or damage awards against our directors and officers under these indemnification provisions.

Other than the matters described in the section titled “PalmSource Business—Legal Proceedings” there is no pending litigation or proceeding involving any of our directors, officers or employees in which indemnification by us is sought, nor are we aware of any threatened litigation that may result in claims for indemnification by us.

Index to Financial Statements

The following table sets forth all compensation awarded to, earned by, or paid for services rendered to PalmSource in all capacities during the fiscal years ended May 31, 2003, 2002 and 2001 for: (i) our chief executive officer; (ii) certain of our other executive officers who, based on compensation from PalmSource, were the most highly compensated for the fiscal year ended May 31, 2003; and (iii) one additional individual who would have been included as a highly compensated officer for the fiscal year ended May 31, 2003, but for the fact such individual was not serving as our executive officer as of May 31, 2003. Collectively we refer to these individuals as our “named executive officers.”

Index to Financial Statements

The following table sets forth for each of the named executive officers certain information concerning Palm stock options granted during the fiscal year ended May 31, 2003. See the section titled “—Treatment of Palm Options” for an explanation of how Palm options will be treated following the distribution date.

PalmSource did not grant any stock options to any of its named executive officers during the fiscal year ended May 31, 2003.

The following table sets forth, for each of the named executive officers, certain information regarding the exercise of stock options for the purchase of Palm common stock in the last fiscal year and the year-end value of unexercised options for the purchase of Palm common stock as of May 31, 2003:

Index to Financial Statements

The following table sets forth, for each of the named executive officers, certain information regarding the exercise of stock options for the purchase of PalmSource common stock in the last fiscal year and the year-end value of unexercised options for the purchase of PalmSource common stock as of May 31, 2003:

David C. Nagel is our President and Chief Executive Officer and is a member of our board of directors.

Index to Financial Statements

David A. Limp is our Senior Vice President of Corporate and Business Development.

Index to Financial Statements

In connection with the transaction, PalmSource offered certain of its key executives the opportunity to exchange outstanding stock option grants for new grants of (i) nonstatutory stock options and (ii) restricted stock.

Index to Financial Statements

The following table shows, for each eligible key executive, the stock option grant that was tendered by the executive in exchange for the opportunity to receive the restricted stock grant, which were granted on August 4, 2003, and the stock option grant listed in the following table:

Grant Date. New options will be granted on the later of: (i) the first business day that is at least six months and one day after outstanding stock option grants were cancelled, August 1, 2003, and (ii) any business day, in PalmSource’s sole discretion, within 30 days of the transaction. Notwithstanding the foregoing, new options will be granted no later than July 1, 2005. New shares of restricted stock were granted on August 4, 2003.

Exercise and Purchase Price. The per-share exercise price for new options will be the fair market value of a share of PalmSource common stock on the date of grant. The purchase price for a share of restricted stock was the par value of a share of PalmSource common stock on the date of grant.

Vesting Schedule. We have a repurchase option on the restricted stock that lapses as to: (i) 50% of the shares on the first anniversary following the grant date, and (ii) 50% of the shares on the second anniversary following the grant date. Each new option grant will vest monthly over two years following the date of grant.

In connection with the transaction, PalmSource offered certain of its key executives the opportunity to waive their rights to promised stock option grants for new grants of: (i) nonstatutory stock options and (ii) restricted stock. The following table shows, for each eligible key executive, the promised option grant that was waived by such executive in exchange for the opportunity to receive the restricted stock grant and the stock option grant listed in the following table:

Grant Date. New options will be granted on the earlier of: (i) any business day, in PalmSource’s sole discretion, within 30 days of the transaction, and (ii) July 1, 2005. New shares of restricted stock were granted on August 4, 2003.

Index to Financial Statements

Vesting Schedule. We have a repurchase option on the restricted stock that lapses as to: (i) 50% of the shares on the first anniversary following the grant date, and (ii) 50% of the shares on the second anniversary following the grant date. Each new option will vest monthly from the date of grant over the time period specified in the following table:

In connection with the transaction, PalmSource granted certain of its key executives shares of restricted stock as a bonus. The following table shows, for each key executive, the number of shares granted.

Purchase Price. The purchase price for a share of bonus restricted stock was the par value of a share of PalmSource common stock on the date of grant.

Other Information. Messrs. Limp and Slotnick were promised these grants in connection with the commencement of their employment. In exchange for their restricted stock bonus grants, Messrs. Limp and Slotnick will be required to waive all additional rights they have to receive a grant of restricted stock in connection with the commencement of their employment.

A number of PalmSource employees hold options to purchase shares of Palm common stock pursuant to the Palm option plans. Following the distribution, we do not intend to assume these options or convert the Palm options into options to purchase PalmSource common stock and these employees will be considered terminated by Palm. Accordingly, the vesting by these PalmSource employees in Palm options will cease on the distribution date and, as a general matter, the PalmSource employees will have 90 days following the distribution date to exercise their vested options to purchase Palm common stock following which time such options will terminate.

The 2001 Stock Plan was adopted by our board of directors on April 26, 2002 and approved by our stockholders on May 9, 2002. After the distribution we will not grant any awards from the 2001 Stock Plan. Our

Index to Financial Statements

2001 Stock Plan permits the grant of incentive stock options to our employees, including officers and employee directors, and the grant of nonstatutory stock options and stock purchase rights to our employees, directors and consultants. A total of 2,000,000 shares of our common stock have been reserved for issuance under the 2001 Stock Plan. In addition, unpurchased shares attributable to options or stock purchase rights granted under the 2001 Stock Plan that become unexercisable or expire, as well as unvested shares that are repurchased at their original cost, shall become available for future grant.

Administration of the 2001 Stock Plan. The administrator, which is either our board of directors or a committee of the board, administers the 2001 Stock Plan. The administrator has the power to determine the terms of the options and stock purchase rights granted, including the exercise price, the number of shares of our common stock subject to each option or stock purchase right, the exercisability of the options and stock purchase rights and the form of consideration payable upon exercise of the options.

Options. The administrator determines the exercise price of options granted under the 2001 Stock Plan. The exercise price of incentive stock options must be at least 100% of the fair market value of our common stock on the grant date, except that with respect to any optionee who owns more than 10% of the voting power of all classes of our outstanding stock, the exercise price must be at least 110% of the fair market value of our common stock on the grant date. The exercise price of nonstatutory options must be at least 85% of the fair market value of our common stock on the grant date, except with respect to any optionee who owns more than 10% of the voting power of all classes of our outstanding stock, the exercise price must be at least 110% of the fair market value of our common stock on the grant date. The term of an option may not exceed ten years, except that with respect to any optionee who owns 10% of the voting power of all classes of our outstanding capital stock, the term must not exceed five years.

After an optionee’s termination of employment or service, an optionee may exercise his or her option (to the extent then exercisable) for the period of time stated in the applicable option agreement. However, an option may never be exercised later than the expiration of its original term.

Stock Purchase Rights. The administrator determines the exercise price of stock purchase rights granted under our 2001 Stock Plan. Unless the administrator determines otherwise, the restricted stock purchase agreement will grant us a repurchase option that we may exercise upon the voluntary or involuntary termination of the purchaser’s service with us for any reason, including death or disability. The purchase price for shares we repurchase will generally be the original price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to us. The administrator determines the rate at which our repurchase option will lapse.

Transferability of Options and Stock Purchase Rights. Our 2001 Stock Plan generally does not allow for the transfer of options or stock purchase rights and only the optionee may exercise an option or stock purchase right during his or her lifetime.

Adjustments upon Merger or Change of Control. In the event of our merger with or into another corporation or a change of control, the successor corporation may assume or substitute an equivalent award for each option or stock purchase right. If the outstanding options or stock purchase rights are not assumed or substituted for, the administrator will provide notice to the optionee that he or she has the right to exercise the option or stock purchase right as to all of the shares subject to the option or stock purchase right, including shares which would not otherwise be exercisable, for a period of 15 days from the date of the notice. The option or stock purchase right will terminate upon the expiration of the 15-day period.

Amendment and Termination of Our 2001 Stock Plan. The 2001 Stock Plan was terminated by our board of directors, as of August 1, 2003.

Index to Financial Statements

Our board of directors adopted our 2003 Equity Incentive Plan, which we refer to as the “Equity Incentive Plan,” on June 30, 2003 and our stockholders approved the Equity Incentive Plan on September 22, 2003. The Equity Incentive Plan became effective on August 1, 2003. The Equity Incentive Plan provides for the grant of the following types of incentive awards: (i) stock options; (ii) stock appreciation rights; (iii) restricted stock; (iv) performance units; and (v) performance shares, which we refer to individually as an “Award.”

Number of Shares of Common Stock Available Under the Equity Incentive Plan. We have reserved a total of 3,626,294 shares of our common stock for grant under the Equity Incentive Plan, which total includes shares that have been reserved but not granted pursuant to options under our 2001 Stock Plan and any shares returned to our 2001 Stock Plan as a result of the termination of options or the repurchase of unvested shares issued under the 2001 Stock Plan. In addition, the Equity Incentive Plan provides for annual increases in the number of shares available for grant on January 1st of each year, beginning in 2005, equal to the lesser of: (i) 5% of the outstanding shares of common stock on the immediately preceding date; (ii) 1,000,000 shares; or (iii) another amount determined by our board of directors. If an Award granted under the Equity Incentive Plan expires or is cancelled without having been fully exercised or vested, the unvested or cancelled shares generally will become available for future grants under our Equity Incentive Plan. Also, if we experience a stock dividend, reorganization or other change in our capital structure, including a merger or change in control, our board of directors or the Compensation Committee of our board of directors, which we collectively refer to as the “Administrator,” has discretion to adjust the number of shares available under the Equity Incentive Plan, the outstanding Awards, and the per-person limits on Awards, as appropriate to reflect the stock dividend or other change.

Administration of the Equity Incentive Plan. The Administrator administers the Equity Incentive Plan. Members of the Compensation Committee must qualify as “non-employee directors” under Rule 16b-3 of the Securities Exchange Act of 1934, as amended, and “outside directors” under Section 162(m) of the Code. Subject to the terms of the Equity Incentive Plan, the Administrator has sole discretion to select the employees, directors and consultants who will receive Awards, determine the terms and conditions of Awards and interpret the provisions of the Equity Incentive Plan for outstanding Awards.

Options. The Administrator may grant nonqualified stock options and incentive stock options under the Equity Incentive Plan. The number of shares covered by each option will be determined by the Administrator, but no participant may be granted options covering more than 600,000 shares during any of our fiscal years. The Administrator determines the exercise price of options granted under the Equity Incentive Plan, but with respect to nonstatutory stock options intended to qualify as “performance-based compensation” within the meaning of Section 162(m) of the Code and all incentive stock options, the exercise price must at least be equal to the fair market value of our common stock on the date of grant. In addition, the exercise price of an incentive stock option granted to any participant who owns more than 10% of the total voting power of all classes of our outstanding stock, must be at least 110% of the fair market value of our common stock on the grant date.

The term of an incentive stock option may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding capital stock, the term must not exceed five years. Nonstatutory options generally terminate on the earlier of: (i) the date set forth in the option agreement; or (ii) ten years from the date of grant.

After termination of one of our employees, he or she may exercise his or her option for the period of time stated in the option agreement to the extent vested. If no such period of time is so stated, such employee may exercise his or her option for three months following his or her termination. However, in no event may an option be exercised later than the expiration of its term.

Automatic Option Grants to Outside Directors. Our non-employee directors will receive annual, automatic, non-discretionary grants of nonqualified stock options. Each new non-employee director will receive

Index to Financial Statements

an option to purchase 20,000 shares on the date he or she first becomes a non-employee director. Each non-employee director also will receive an option to purchase 10,000 shares on the last business day of each subsequent fiscal year, provided that he or she has served as a non-employee director for the entire preceding fiscal year, which vests 100% one year after the date of grant.

The exercise price for each option granted to a non-employee director pursuant to the automatic grant provision is equal to 100% of the fair market value of the shares covered by the option on the date of grant. The option granted to a non-employee director when he or she first becomes a non-employee director vests in four equal annual installments, commencing on the first anniversary of the grant date. All options granted thereafter to the non-employee director pursuant to the automatic grant provision become 100% vested on the first anniversary of the applicable grant date. Generally, when a participant ceases to be an outside director (other than due to death) all of the participant’s unexercisable options shall terminate. Upon an outside director’s death, all of the participant’s options shall vest.

Options granted to non-employee directors generally expire no later than 10 years after the date of grant. If a non-employee director terminates his or her service on the board prior to an option’s normal expiration date, the period of exercisability varies, depending on the reason for the termination. However, the option may not be exercised later than the original expiration date (except in the cases of death, in which case the non-employee director’s option would remain exercisable for one year after the date of death).

Stock Appreciation Rights. A stock appreciation right is the right to receive the appreciation in fair market value of common stock between the exercise date and the date of grant. We can pay the appreciation in either cash or in shares of our common stock. Stock appreciation rights become exercisable at the times and on the terms established by the Administrator. During any of our fiscal years, no participant may be granted stock appreciation rights covering more than 200,000 shares during any fiscal year.

Restricted Stock. Restricted stock awards are shares of our common stock that vest in accordance with terms and conditions established by the Administrator. The number of shares of restricted stock granted to any employee will be determined by the Administrator, but during any of our fiscal years, no participant may be granted more than 600,000 shares of restricted stock. The Administrator may impose whatever conditions to vesting it determines to be appropriate. For example, the Administrator may set restrictions based on the achievement of specific performance goals. Unvested shares are subject to our right of repurchase or forfeiture.

Performance Units, Performance Shares. Performance units and performance shares are Awards that will result in a payment to a participant only if performance goals established by the Administrator are achieved or the Awards otherwise vest. The Administrator will establish organizational or individual performance goals in its discretion, which, depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants. During any of our fiscal years, no participant may receive performance units with an initial value greater than $1,000,000 and no participant shall receive more than 200,000 performance shares. Performance units shall have an initial dollar value established by the Administrator prior to the grant date. Performance shares shall have an initial value equal to the fair market value of a share of our common stock on the grant date.

Transferability of Awards. Our Equity Incentive Plan generally does not allow for the transfer of Awards, and all rights with respect to an Award granted to a participant generally shall be available during a participant’s lifetime only to the participant.

Amendment and Termination of the Equity Incentive Plan. The Administrator has the authority to amend, suspend or terminate our Equity Incentive Plan, provided it does not alter or impair any rights or obligations under any Award previously granted under our Equity Incentive Plan. Our Equity Incentive Plan shall terminate on the earlier of July 31, 2013 or ten years following the date the 2003 Equity Incentive Plan is approved by our stockholders.

Index to Financial Statements

Our board of directors adopted the Employee Stock Purchase Plan, which we refer to as the “ESPP,” on June 30, 2003 and our stockholders approved the ESPP on September 22, 2003. The ESPP provides eligible employees, including employees of participating subsidiaries, with the opportunity to purchase shares of our common stock through payroll deductions. The ESPP is intended to qualify as an employee stock purchase plan under Section 423 of the Code.

Eligibility. Most of our employees and employees of participating subsidiaries are eligible to participate in the ESPP. However, an employee is not eligible to participate if: (i) he or she has the right to acquire five percent or more of the voting power or value of our stock or the stock of any of our subsidiaries; or (ii) he or she is normally scheduled to work no more than 20 hours per week or five months per calendar year. Also, the Administration or other committee appointed by the board of directors to administer the ESPP, which we refer to as the “Committee,” has discretion to exclude: (i) employees who have worked for less than two years; and (ii) officers or other highly compensated employees.

Number of Shares of Common Stock Available Under the ESPP. We have reserved a total of 400,000 shares of common stock for issuance pursuant to the ESPP. In addition, our ESPP provides for annual increases in the number of shares available for grant on January 1^st of each year, beginning in 2005, equal to the lesser of: (i) 180,000 shares; (ii) 1.5% of the outstanding common stock on the immediately preceding date; or (iii) an amount determined by our board of directors. Shares sold under the ESPP may be newly issued shares or treasury shares. In the event of any stock split, reorganization or other change in our corporate structure affecting our shares, the Committee may adjust the number, kind and purchase price of the shares available for purchase under the ESPP and the formula for adding shares to the ESPP to prevent dilution or enlargement of the benefits intended to be provided under the ESPP.

Administration, Amendment and Termination. The Committee administers the ESPP. The members of the Committee serve at the pleasure of the board of directors. Subject to the terms of the ESPP, the Committee has all discretion and authority necessary or appropriate to control and manage the operation and administration of the ESPP. The Committee may delegate one or more of functions of the Committee under the ESPP.

Enrollment and Contributions. Eligible employees voluntarily elect whether or not to enroll in the ESPP. Employees join for an option period of six months, unless the Committee sets a longer or shorter period of time. Employees who have joined the ESPP automatically are re-enrolled for additional rolling six-month periods; provided, however, that an employee may cancel his or her participation at any time. Employees contribute to the ESPP through payroll deductions. Participating employees generally may contribute from 1% to 10% of their eligible compensation through after-tax payroll deductions. From time to time, the Committee may establish a different maximum permitted contribution percentage, change the definition of eligible compensation, or change the length of the option periods (but in no event may any enrollment period exceed 27 months). After an option period has begun, an employee may not increase or decrease his or her contribution percentage, unless the Committee provides otherwise.

Option Periods. The option periods for the ESPP are each April 1 and October 1, with the first option period beginning on the distribution date and ending on April 1, 2004.

Purchase of Shares. On the last business day of each six-month option period, we use each participating employee’s payroll deductions to purchase shares of our common stock for the employee. The price of the shares purchased will be 85% of the lower of: (i) the stock’s market value on the first day of the option period; or (ii) the stock market’s value on the last day of the option period. Market value for this purpose means the closing price of our common stock on the Nasdaq National Market for the day in question. However, on any purchase date, no employee may purchase more than 800 shares of stock. The Committee has discretion to change this limit without a formal amendment to the ESPP. Also, in any single calendar year, no employee may purchase more than $25,000 of common stock (based on the fair market value on the applicable enrollment date(s)).

Index to Financial Statements

Termination of Participation. Participation in the ESPP terminates when a participating employee’s employment with us or any participating subsidiary ceases for any reason, the employee withdraws from the ESPP, or we terminate or amend the ESPP such that the employee no longer is eligible to participate.

Amendment and Termination of the ESPP. The Committee or our board of directors may amend or terminate the ESPP at any time and for any reason. However, as required by Section 423 of the Code, our stockholders must approve certain material amendments.

Index to Financial Statements

Effective as of November 12, 1999, Palm and Sony entered into a software license agreement, as amended, under which Sony receives a royalty-bearing license to use Palm OS in Sony’s handheld computing products. The license was assigned to us as part of the separation and, effective October 7, 2002, we entered into Amendment No. 6 to the License Agreement with Sony, which we refer to as “Amendment No. 6.” Under Amendment No. 6, Sony may examine and make specified types of modifications to the source code for Palm OS, subject to our compatibility and certification requirements for Palm OS. Amendment No. 6 also provides terms under which we receive ownership of modifications made by Sony and a perpetual, royalty-free license to pre-existing materials incorporated by Sony into Palm OS, with the right to sublicense as part of our products. The term of Amendment No. 6 expires in October 2012.

Effective October 7, 2002, we entered into a business collaboration agreement with Sony under which we and Sony agreed to share certain information regarding ongoing product and development plans and, for a period of at least three years, to establish mutually agreed written co-development plans for potential areas of joint development, with at least one active mutually agreed co-development project at any given time. Under the business collaboration agreement, all co-development will be subject to a definitive written co-development agreement to be mutually agreed by the parties prior to the commencement of the respective project(s), and will provide us with ownership of modifications made by Sony, and a perpetual, royalty-free license to pre-existing materials incorporated by Sony into Palm OS, with the right to sublicense as part of our products. Under the business collaboration agreement, prior to October 7, 2003, we will not engage another licensee of Palm OS as a development partner under a joint development agreement to participate in a co-development program for new versions of Palm OS, where the licensee develops material portions of the source code for the new versions of Palm OS and has the right to access and modify all or substantially all of the source code of Palm OS for the execution of such co-development program. Under the business collaboration agreement, from October 7, 2003 until October 7, 2005, we will not engage more than two development partners meeting the above requirements in addition to Sony and will first offer to discuss new projects with Sony prior to engaging such additional development partners. Sony has agreed that these provisions shall not restrict us from conducting development and other activities in the ordinary course of our business as of the effective date of the business collaboration agreement and as similar activities thereto that may be conducted in the future. The business collaboration agreement expires in October 2012, but may be terminated earlier upon the occurrence of various termination events.

Effective October 7, 2002, we entered into a master development agreement with Sony pursuant to the business collaboration agreement. Under the master development agreement, we provide certain development code to Sony, and Sony performs development projects for a new version of Palm OS using the development code. The development projects are to be identified in greater detail in statements of work to be mutually agreed by the parties from time to time. We receive ownership and licenses with respect to the deliverables provided by Sony under the master development agreement. The master development agreement expires upon the earlier of completion of the development milestones and October 7, 2003.

In October 2002, we sold an aggregate of 3,333,333 shares of our Series A Preferred Stock at a purchase price of $6.00 per share to Sony, which convert into 666,666 shares of common stock upon the PalmSource

Index to Financial Statements

distribution (taking into account the one for five reverse stock split). In connection with the sale of our Series A Preferred Stock, we entered into a registration rights agreement, pursuant to which Sony has registration rights with respect to the shares of common stock into which the shares of our Series A Preferred Stock are convertible.

PalmSource’s Chairman of the Board, Eric Benhamou, is also the Chairman of the Board of 3Com Corporation. Under the terms of a software license agreement between PalmSource and 3Com, PalmSource recorded $0.1 million, $0.2 million, and $0.4 million of support revenues for fiscal years 2001, 2002, and 2003, respectively.

Satjiv S. Chahil, one of our directors, entered into a Consulting Agreement with us effective as of August 1, 2003 for a term of one year, to provide services to us for four days per month. Under the terms of the Consulting Agreement, Mr. Chahil will be paid $11,200 per month for consulting services outlined by our chief executive officer. Initially, these services will include: (i) developing our business in India; (ii) developing our current market in Japan, including, but not limited to, obtaining additional business from Sony and introductions to Toshiba, Sharp and other key Japanese companies; and (iii) penetrating the entertainment business and making a market for Palm Powered devices and software.

Effective as of December 3, 2001 and in connection with the separation, we entered into a software license agreement with Palm. In June 2003, Palm and PalmSource amended and restated the agreement. Under the terms of this agreement, we had revenues from Palm of $18.4 million and $39.3 million for the fiscal years ended May 31, 2002 and 2003, respectively. In addition, the agreement establishes minimum annual license and royalty commitments for Palm, which was $40 million for the contract year ended on December 3, 2002, and is $37.5 million for the contract year ending on December 3, 2003. See the section titled “The PalmSource Separation” for additional agreements entered into between Palm and PalmSource.

Index to Financial Statements

The following table sets forth certain information regarding the beneficial ownership of our common stock as of August 31, 2003 by:

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock underlying stock options held by that person that are currently exercisable or exercisable within 60 days of August 31, 2003 are deemed beneficially owned. These shares, however, are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Percentage ownership is based on 11,599,631 shares of our common stock outstanding on August 31, 2003.

To the extent our directors and officers own shares of Palm common stock at the time of the distribution, they will participate in the distribution on the same terms as other holders of Palm common stock. The following table assumes a distribution ratio of 0.32 shares of PalmSource common stock for each share of Palm common stock held based upon the shares of Palm common stock outstanding as of August 31, 2003.

Unless otherwise indicated, the address of each of the beneficial owners listed in this table is: c/o PalmSource, Inc., 1240 Crossman Avenue, Sunnyvale, California 94089.

Index to Financial Statements

For purposes of the description of our capital stock, we are assuming that our amended and restated certificate of incorporation, which authorizes the issuance of up to 100,000,000 shares of common stock, $0.001 par value per share, and 5,000,000 shares of undesignated preferred stock, par value $0.001 per share, and our amended and restated bylaws are each effective. The summary description of our capital stock and other rights are qualified in their entirety by the governing documents attached as exhibits to the registration statement.

As of August 31, 2003, after giving effect to the one for five reverse stock split on September 22, 2003 and the distribution of PalmSource common stock by Palm, 11,599,631 shares of PalmSource common stock were outstanding and held by ten stockholders of record.

Each holder of our common stock is entitled to one vote for each share on all matters to be voted upon by the stockholders and there are no cumulative voting rights. Subject to preferences to which holders of preferred stock issued after the distribution of the common stock by Palm may be entitled, holders of common stock are entitled to receive ratably dividends, if any, as may be declared from time to time by the board of directors out of funds legally available therefor. Please see the section titled “Dividend Policy.”

In the event of a liquidation, dissolution or winding up of PalmSource, holders of common stock would be entitled to share in our assets remaining after the payment of liabilities and the satisfaction of any liquidation preference granted to the holders of any outstanding shares of preferred stock. Holders of common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking fund provisions applicable to the common stock. All of the shares of common stock to be distributed by Palm to you are fully paid and nonassessable. The rights, preferences and privileges of the holders of common stock are subject to, and may be adversely affected by the rights of the holders of shares of any series of preferred stock, which our board of directors may designate in the future.

Our board of directors will be authorized, subject to any limitations prescribed by law, without stockholder approval, from time to time to issue up to an aggregate of 5,000,000 million shares of preferred stock, $0.001 par value per share, in one or more series, each of such series to have rights and preferences, including voting rights, dividend rights, conversion rights, redemption privileges and liquidation preferences, as shall be determined by our board of directors. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that we may issue in the future. Issuances of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, a majority of our outstanding voting stock.

Pursuant to a registration and information rights agreement, dated October 7, 2002, or the rights agreement, the holder of 666,666 shares of our common stock, Sony, has the right to require us to register those shares under the Securities Act of 1933 or to transfer such rights if certain transfer requirements are met. If we register any of our common stock for our own account or for the account of other stockholders (excluding this registration), the holder of the registrable securities (and its transferee) would be entitled to include their shares of common stock in the registration, subject to the ability of the underwriters to limit the number of shares included in the offering. In addition, subject to limitations in the rights agreement, the holder and its transferee, may require, on two

Index to Financial Statements

occasions, the first being at least six months after the spin-off, that we use our best efforts to register their shares for public resale, provided that the holders of at least 20% of those shares make the request. Furthermore, the holder of the shares or its transferee may require us to register all or a portion of its registrable securities on Form S-3 when PalmSource is eligible to use such form, provided, among other limitations, that the proposed aggregate price to the public is at least $5,000,000. We will bear all fees, costs and expenses of such registration, other than underwriting discounts and commissions. Upon the effectiveness of any registration statement filed to register our common stock, such shares would become freely tradable, without any restrictions imposed by the Securities Act.

Anti-Takeover Effects of PalmSource’s Certificate, Bylaws and Delaware Law

Certain provisions of our amended and restated certificate of incorporation and bylaws, and of Delaware law could make the following transactions more difficult:

These provisions, summarized below, are expected to discourage certain types of unsolicited, coercive takeover proposals, and are designed to encourage persons seeking to acquire control of us to negotiate with our board of directors.

We believe that the benefits of increased protection against an unsolicited takeover proposal to acquire us outweigh the disadvantages of discouraging these types of proposals. Among other things, negotiation of such proposals could result in improved terms for our stockholders.

We are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested stockholder, unless: (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the number of shares outstanding those shares owned by persons who are directors and also officers and by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or (iii) on or subsequent to such date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66²/3% of the outstanding voting stock which is not owned by the interested stockholder.

Election and Removal of Directors. Following the distribution, our board of directors will be divided into three classes with each class serving staggered three-year terms. The classification system of electing directors may tend to discourage a third party from making a tender offer or otherwise attempting to obtain control of us and may maintain the incumbency of the board of directors, as the classification of the board of directors generally increases the difficulty of replacing a majority of the directors. In addition, our directors may only be removed for “cause” which limits the ability of a stockholder or a group of stockholders from removing current directors. “Cause” is not defined in our certificate of incorporation or bylaws.

Index to Financial Statements

Elimination of Stockholder Action by Written Consent. Our certificate of incorporation eliminates the right of stockholders to act by written consent without a meeting. This provision will make it more difficult for stockholders to take action opposed by the board of directors.

Elimination of Cumulative Voting. Our certificate of incorporation and bylaws eliminate the right of stockholders to cumulate their votes in the election of directors.

Undesignated Preferred Stock. The authorization of 5.0 million shares of undesignated preferred stock will make it possible for the board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire control of us.

Amendment of certain provisions of our certificate of incorporation or bylaws. Our certificate of incorporation requires that at least 80% of our outstanding common stock approves amendments to certain provisions of our bylaws and certificate of incorporation.

Stockholder Meetings. Our bylaws and certificate of incorporation eliminate the right of stockholders to call a special meeting of stockholders.

Requirements for Advance Notification of Stockholder Nominations and Proposals. Our bylaws contain advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of the board of directors or a committee of the board of directors.

The transfer agent and registrar for our common stock is Equiserve Trust Company, N.A.

Index to Financial Statements

Prior to the distribution, there has been no market for our common stock, and there can be no assurance that a significant public market for our common stock will develop or be sustained after the distribution. Future sales of substantial amounts of our common stock, including shares issued upon exercise of outstanding options, in the public market following the distribution could adversely affect market prices prevailing from time to time and could impair our ability to raise capital through sale of our equity securities.

Upon completion of the distribution, we will have 11,599,631 shares of common stock outstanding based upon shares outstanding as of August 31, 2003, assuming no exercise of outstanding options after the distribution. Of these outstanding shares, the 10,000,000 shares distributed by Palm will be freely tradable without restriction under the Securities Act, unless distributed to our “affiliates,” as that term is defined in Rule 144 under the Securities Act, or security holders subject to the lock-up agreements. 666,666 shares of our common stock held by Sony which were outstanding prior to the distribution are subject to a lock-up agreement. Beginning 90 days after the distribution and upon the expiration of the lock-up agreements, the 666,666 shares held by Sony will be available for sale in the public market, subject to compliance with the volume and other limitations of Rule 144. The 932,965 shares are held by our officers and are subject to repurchase by us. Our repurchase right will lapse as to 466,483 shares on August 4, 2004.

Assuming: (i) options underlying 713,914 shares of our common stock are granted to certain of our executives on February 5, 2004 pursuant to our option exchange program, (ii) options underlying 419,415 shares of our common stock are granted to certain of our executives on November 1, 2003 pursuant to waiver grants and (iii) options underlying 130,000 shares of our common stock are granted to certain of our non-employee directors on November 1, 2003, the following shares of common stock could be sold in the market on the following dates:

In addition, we intend to issue a $15 million 5% convertible subordinated note, due December 2006, payable to Texas Instruments following the distribution. If this note is converted into our common stock, such shares of common stock will be eligible for sale one year after the issuance of the note, at the latest, pursuant to Rule 144. See the section titled “PalmSource Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—The Convertible Note,” for a description of the PalmSource note.

In general, under Rule 144 as currently in effect, beginning 90 days after the date of the distribution, a person who has beneficially owned shares of our common stock for at least one year including the holding period of any prior owner, except an affiliate of PalmSource, would be entitled to sell within any three-month period a number of shares that does not exceed the greater of:

Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about us. Under Rule 144(k), a person who is not deemed to have been our affiliate at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years including the holding period of any prior owner, except an affiliate of PalmSource, is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144.

Index to Financial Statements

Rule 701, as currently in effect, permits resales of shares in reliance upon Rule 144 but without compliance with certain restrictions. Any employee, officer, director or consultant who purchased shares under a written compensatory plan or contract may be entitled to rely on the resale provisions of Rule 701. Rule 701 permits affiliates to sell their Rule 701 shares under Rule 144 without complying with the holding period requirements of Rule 144. Rule 701 further provides that non-affiliates may sell such shares in reliance on Rule 144 without having to comply with the holding period, public information, volume limitation or notice provisions of Rule 144. All holders of Rule 701 shares are required to wait until 90 days after the date of the distribution before selling such shares. As of August 29, 2003, no holders of options are eligible to sell their shares pursuant to Rule 701 or pursuant to registration on Form S-8.

Following the effectiveness of this registration statement, we will file a registration statement on Form S-8 registering shares of common stock subject to outstanding options and reserved for future issuance under our stock plans. As of August 29, 2003, options to purchase a total of 36,000 shares were outstanding under our 2001 Stock Plan, 932,965 shares of restricted common stock were outstanding under our 2003 Equity Incentive Plan, a total of 2,657,329 shares were reserved for future issuance under our 2003 Equity Incentive Plan and 400,000 shares were reserved for future issuance under our 2003 Employee Stock Purchase Plan. Common stock issued upon exercise of outstanding vested options or issued under our 2003 Employee Stock Purchase Plan, other than common stock issued to affiliates, are available for immediate resale in the open market.

Beginning 90 days after the distribution date, the holder of 666,666 shares of common stock will be entitled to certain demand registration rights for sale in the public market. Registration of such shares under the Securities Act would result in such shares becoming freely tradable without restriction under the Securities Act, except for shares held by affiliates, immediately upon the effectiveness of such registration.

Index to Financial Statements

We have filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933, as amended, with respect to the shares of common stock being distributed to the Palm stockholders. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules that were filed with the registration statement. Certain items are omitted in accordance with the rules and regulations of the Securities and Exchange Commission. For further information with respect to us and our common stock, reference is made to the registration statement and the exhibits and any schedules filed with the registration statement. This prospectus contains a summary of the material terms of contracts or other documents that were filed as exhibits to the registration statement. Statements contained in this prospectus about the contents of any of these contracts or any other documents are not necessarily complete. A copy of the registration statement and the exhibits and schedules that were filed with the registration statement may be inspected without charge at the public reference facilities maintained by the Securities and Exchange Commission in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or any part of the registration statement may be obtained from the Securities and Exchange Commission upon payment of the prescribed fee. The Securities and Exchange Commission maintains a website that contains reports, proxies and prospectuses and other information regarding registrants that file electronically with the Securities and Exchange Commission. The address of the website is http://www.sec.gov.

After the distribution, we will be subject to the information and periodic reporting requirements of the Securities Exchange Act of 1934, as amended, and, in accordance with the requirements of the Securities Exchange Act, will file periodic reports, proxy statements and other information with the Securities and Exchange Commission. These periodic reports, proxy statements and other information will be available for inspection and copying at the regional offices, public reference facilities and website of the Securities and Exchange Commission referred to above.

All documents filed by PalmSource pursuant to Section 13(a), 13(c), 14 (to the extent incorporated into our annual report on Form 10-K) or 15(d) of the Securities Exchange Act of 1934, as amended, after the date of this prospectus are incorporated by reference into and are to be a part of this prospectus from the date of filing of such documents.

You should rely only on the information contained in or incorporated by reference into this prospectus. PalmSource has not authorized anyone else to provide you with information that is different.

Any statement contained herein or in a document incorporated or deemed to be incorporated by reference into this prospectus will be deemed to be modified or superceded for purposes of this prospectus to the extent that a statement contained in this prospectus or any other subsequently filed document that is deemed to be incorporated by reference into this prospectus modifies or supercedes such statement. Any statement so modified or superceded will not be deemed, except as so modified or superceded, to constitute a part of this prospectus.

Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California will pass upon the validity of the shares of PalmSource common stock distributed in connection with this prospectus.

Index to Financial Statements

The combined and consolidated financial statements of PalmSource, Inc. and its subsidiaries as of May 31, 2003 and 2002 and for each of the three years in the period ended May 31, 2003 included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting.

Index to Financial Statements

PRO FORMA COMBINED FINANCIAL STATEMENTS AND FINANCIAL STATEMENTS OF ACQUIRED COMPANIES/SUBSIDIARIES

Index to Financial Statements

In our opinion, the accompanying combined and consolidated balance sheets and the related combined and consolidated statements of operations, of stockholders’ equity / net investment (deficit) and of cash flows present fairly, in all material respects, the financial position of PalmSource, Inc. and its subsidiaries at May 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2003 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

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

As discussed in Note 2, effective June 1, 2001, the Company changed its method of accounting for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

Index to Financial Statements

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

Index to Financial Statements

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

Index to Financial Statements

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

Index to Financial Statements

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

Index to Financial Statements

On August 27, 2001, Palm, Inc. (“Palm”) announced its plan to form a wholly owned subsidiary to own and operate Palm’s operating system platform and licensing business, subsequently named PalmSource, Inc. (“PalmSource” or the “Company”). PalmSource develops and licenses operating system software, personal information management applications and software development tools for mobile information devices. PalmSource targets device manufacturers, as well as developers, enterprises and consumers with its Palm operating system, or Palm OS. PalmSource’s product offerings include Palm OS, Palm Digital Media and services and support.

In December 2001, PalmSource was incorporated in Delaware as a wholly owned subsidiary of Palm, and as of December 3, 2001, authorized and issued 50,000 shares of Series A preferred stock to Palm in exchange for the assignment to PalmSource of certain of Palm’s assets and liabilities, including intellectual property. Effective May 9, 2002, PalmSource’s Board of Directors authorized a re-capitalization of the authorized and outstanding Series A preferred stock into Class C Common Stock and a simultaneous 1,000-for-1 stock split, resulting in 50,000,000 shares of PalmSource Class C common stock issued and outstanding and owned by Palm which was re-capitalized as 10,000,000 shares of Class C common stock via a one for five reverse stock split. The one for five reverse stock split was approved by the Company’s Board of Directors on June 30, 2003 and became effective on September 22, 2003. Shares outstanding and net loss per share have been adjusted for all periods presented. On October 7, 2002, Sony Corporation (“Sony”) invested $20.0 million in PalmSource, purchasing 3,333,333 shares of the Company’s Series A redeemable convertible preferred stock.

Palm intends, subject to the satisfactory resolution of certain conditions, to distribute all of the outstanding shares of PalmSource’s common stock owned by Palm to Palm’s stockholders on a pro rata basis on the distribution date. In December 2002, Palm received a ruling from the Internal Revenue Service that a distribution of PalmSource stock to Palm stockholders, if it occurs in accordance with the terms of the ruling, will be tax-free to the Company and its U.S. stockholders.

In December 2001, Palm and PalmSource entered into a Master Separation and Distribution Agreement, as amended June 3, 2003, (the “Separation Agreement”) under which Palm transferred to PalmSource at December 3, 2001, the date of legal separation (the “Separation Date”), substantially all of the assets and liabilities of Palm’s operating system and software business except for the Palm brands, trademarks and certain other related intellectual property which were transferred at a later date. (See Note 13, Transactions with Palm.) Palm’s net investment in PalmSource converted to common stock and additional paid-in-capital on the Separation Date.

Palm sells devices that incorporate PalmSource software to its customers under the terms of a Software License Agreement, as amended, (the “Software License Agreement”). Under the terms of this agreement, PalmSource has granted Palm certain rights to use, produce, grant end user sublicenses and distribute certain software for the period December 3, 2001 to December 3, 2006, and may be renewed by mutual written consent. PalmSource receives license and royalty fees based upon the shipment of Palm’s products, which incorporate PalmSource software or on distribution by Palm of PalmSource software, subject to minimum annual commitments of $40.0 million, $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring December 3, 2006. PalmSource also receives fees for support and services. For periods prior to December 3, 2001, there is no revenue recorded from Palm, as the Software License Agreement was not effective until December 3, 2001. However, costs were incurred during these periods as the Company was supporting Palm. (See Note 13, Transactions with Palm.)

Index to Financial Statements

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

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

Related party revenues in the combined and consolidated financial statements included revenues from Palm and Sony. The majority of the Company’s cost of revenues are of a fixed nature and are not directly related or allocable to either third party or related party revenues. The Company incurred separately identifiable costs directly associated with related party professional services revenue of $0 million, $0.2 million and $0.3 million for the years ended May 31, 2001, 2002 and 2003, respectively. Receivable from related parties in the combined and consolidated financial statements included receivables from Palm and Sony.

PalmSource’s 52-53 week fiscal year ends on the Friday nearest to May 31. Fiscal years 2001, 2002 and 2003 each contained 52 weeks. PalmSource’s fiscal quarters end on a Friday and are generally thirteen weeks in length. For presentation purposes, the periods have been presented as ending on May 31.

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

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported in PalmSource’s combined and consolidated financial statements and the accompanying notes. The Company bases its estimates and judgments on historical experience and on various other assumptions that it believes are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. The amounts of assets and liabilities reported in the Company’s balance sheets and the amounts of revenues and expenses reported for each of its fiscal periods are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, allocations from Palm, goodwill impairments, loss contingencies, restructuring, and income taxes. Actual results could differ from these estimates.

Index to Financial Statements

The unaudited pro forma net loss per share for the year ended May 31, 2003 and the unaudited pro forma balance sheet as of May 31, 2003 assumes the conversion of outstanding Series A redeemable convertible preferred stock to common stock that will occur automatically upon the distribution.

The unaudited pro forma balance sheet also gives effect to the intended issuance by PalmSource of a $15.0 million convertible subordinated note to Texas Instruments, which bears interest at 5.0% per annum and will be due December 6, 2006. The PalmSource note will be convertible into PalmSource common stock and the conversion price will be set according to a formula based upon the decrease in the trading price of Palm’s common stock five days before and five days after the PalmSource distribution, but subject to minimum and maximum conversion prices. (See Note 13, Transactions with Palm.)

In addition, in accordance with the terms of the Amended and Restated InterCompany Loan Agreement, the unaudited pro forma balance sheet gives effect to the re-capitalization of the $20.0 million note payable to Palm as additional paid in capital immediately prior to the distribution date. The related accrued interest on the note payable to Palm will be due and payable within seven days after the distribution date, or, if the distribution is not completed prior to December 3, 2004, then the $20 million note payable to Palm and the related accrued interest will be due and payable on December 3, 2004.

The unaudited pro forma balance sheet also gives effect to the contribution by Palm, in accordance with the terms of the Letter Agreement regarding Cash Contributions, of an additional $6.0 million in cash upon the distribution date. This additional cash contribution, that is subject to such distribution not being preceded by an initial public offering of PalmSource’s capital stock, has been reflected as additional cash and a capital contribution in the unaudited pro forma balance sheet.

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

Cash equivalents comprise money market accounts and highly liquid debt investments acquired with remaining maturities of three months or less at the time of purchase. Cash equivalents consist principally of money market accounts. Cash receipts associated with PalmSource’s business were collected by Palm, and Palm funded PalmSource’s disbursements with net transfers being recorded as contributions or distributions in the Palm net investment account. Subsequent to the Separation Date, PalmSource maintains its own cash and cash equivalents. (See Note 13, Transactions with Palm.)

Financial instruments, which potentially subject PalmSource to significant concentrations of credit risk, consist principally of accounts receivable. Sales to customers are predominately denominated in U.S. dollars.

Index to Financial Statements

While a significant portion of PalmSource’s accounts receivable is concentrated with a few customers as shown below, generally credit risk is mitigated on the basis that the Company’s customer base is comprised of well-established companies. PalmSource generally sells on open account and performs periodic credit evaluations of its customers’ financial condition. The Company has historically not experienced significant losses from its accounts receivable. There is no allowance for doubtful accounts at May 31, 2001, 2002 and 2003.

The following individual customers accounted for 10% or more of total revenues for the fiscal periods ended:

Receivable from related parties in the combined and consolidated financial statements included receivables from Palm and Sony. The outstanding receivable from Palm was $6.6 million and $5.1 million at May 31, 2002 and 2003, respectively. The outstanding receivable from Sony was $30,000 and $0.1 million at May 31, 2002 and 2003, respectively. On June 3, 2003 Palm and Handspring entered into a definitive agreement for Palm to acquire Handspring.

The following individual customers accounted for 10% or more of gross accounts receivable at:

Restricted investments consist of U.S. government obligations and certificates of deposit with maturities of three months or less. These investments serve primarily as collateral for certain leases and are restricted as to withdrawal. Restricted investments are held in brokerage accounts in PalmSource’s name.

Property and equipment are stated at cost less accumulated depreciation. Costs related to internal use software are capitalized in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The Company capitalized $1.8 million related to internal use software during the year ended May 31, 2003. Depreciation and amortization are computed over the shorter of the estimated useful lives, lease or license terms on a straight-line basis (generally three to five years).

Index to Financial Statements

PalmSource adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets on June 1, 2001, and upon adoption, reclassified acquired workforce to goodwill and ceased amortization of goodwill. PalmSource evaluates the recoverability of goodwill annually, or more frequently if there are indicators such assets may be impaired.

Long lived assets, including identifiable intangible assets and property and equipment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable based on the estimated undiscounted future cash flows resulting from the use of the assets and its eventual disposition. When any such impairment exists, the related assets are written down to fair value.

Identifiable intangible assets are amortized using the straight-line method over estimated useful lives ranging from six months to three years.

Costs for the development of new software and substantial enhancements to existing software are expensed as incurred until technological feasibility has been established, at which time any additional development costs would be capitalized in accordance with SFAS No. 86, Computer Software To Be Sold, Leased, or Otherwise Marketed. PalmSource believes its current process for developing software is essentially completed concurrent with the product launch; accordingly, no costs have been capitalized to date.

Investments in equity securities with readily available fair values are classified as available-for-sale and recorded at cost with subsequent unrealized gains or losses included as a component of other comprehensive income (loss). Investments in equity securities whose fair values are not readily available and for whom PalmSource does not have the ability to exercise significant influence over the investee’s operating and financial policies are recorded at cost. PalmSource evaluates its investments in equity securities on a regular basis and records an impairment charge to interest and other income (expense) when the decline in the fair value below the cost basis is judged to be other-than-temporary. For these investments, management reviews the company’s cash position, recent financing activities, financing needs, earnings/revenue trends, operational performance, management/ownership changes and competition to determine whether a decline in fair value is other than temporary. At May 31, 2003 PalmSource had one investment in a privately held company with a fair value of $0.8 million included in other assets. The Company recognized a charge of $3.2 million during the year ended May 31, 2003 for an other-than-temporary impairment of this investment.

Palm net investment (deficit) represents Palm’s cumulative net cash and net asset transfers to PalmSource. That portion of receivable from related parties applicable to Palm represents the uncollected amount due to PalmSource principally for royalties due under the terms of the software license agreement with Palm and for professional services provided to Palm. Payable to Palm represents the net amount due to Palm for centralized legal, accounting, treasury, real estate, information technology and other Palm corporate services and infrastructure costs. Note payable to Palm bears interest at 2.48% per annum. Immediately prior to the distribution of Palm’s interest in PalmSource stock to Palm’s stockholders, $20.0 million of the note will be recapitalized as additional paid in capital. The related accrued interest will be due and payable seven days after

Index to Financial Statements

the distribution date or, if the distribution is not completed prior to December 3, 2004, then the $20 million note payable and the related accrued interest will be due and payable on December 3, 2004. Also, immediately prior to the distribution, it is intended that PalmSource will issue a $15.0 million 5% convertible subordinated note payable to Texas Instruments, due December 6, 2006, and upon the distribution will receive $6.0 million of additional capital contributions from Palm. (See Note 13, Transactions with Palm.)

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

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

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

Advertising costs consist of direct expenses and allocations from Palm, are expensed as incurred and were $0.2 million, $0.3 million and $1.8 million for fiscal years 2001, 2002 and 2003, respectively.

Effective for calendar year 2003, in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which supercedes Emerging Issues Task Force Issue (“EITF”) No. 94-3, Liability

Index to Financial Statements

Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), PalmSource records liabilities for costs associated with exit or disposal activities when the liability is incurred instead of at the date of commitment to an exit or disposal activity. Prior to calendar year 2003, in accordance with EITF No. 94-3, the Company accrued for restructuring costs on commitment to a firm exit plan that specifically identified all significant actions to be taken. PalmSource records initial restructuring charges based on assumptions and related estimates it deems appropriate for the economic environment at the time these estimates are made. PalmSource reassesses restructuring accruals on a quarterly basis to reflect changes in the costs of the restructuring activities, and records new restructuring accruals as liabilities are incurred.

Separation costs consist of costs related to the separation of PalmSource from Palm and the proposed distribution of the outstanding shares of PalmSource’s common stock to Palm’s stockholders, such as consulting and professional fees. In addition, separation costs include allocated costs related to Palm’s separation from 3Com, based on the allocation methodology for Palm corporate expenses. (See Note 13, Transactions with Palm.)

For all periods (both prior and subsequent to the Separation Date), PalmSource’s operating results have historically been included in Palm’s consolidated U.S. income tax return and consolidated, combined or unitary state income tax returns and in tax returns of certain foreign subsidiaries. The provision for income taxes in PalmSource’s combined and consolidated financial statements has been determined on a separate-return basis for all periods. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized by the Company. Prior to July 27, 2000, Palm’s operating results were included in certain 3Com-consolidated U.S., state, and foreign income tax returns.

For foreign subsidiaries with their local currency as their functional currency, assets and liabilities are translated to U.S. dollars, at year-end exchange rates as of the balance sheet date, and revenues, expenses, gains and loses are translated at average exchange rates during the year. Resulting foreign currency translation adjustments are included as a component of other comprehensive income (loss).

For PalmSource entities with the U.S. dollar as the functional currency, foreign currency denominated assets and liabilities are translated to U.S. dollars at the year-end exchange rates except for non-monetary balance sheet items, which are translated at historical exchange rates. Gains or losses resulting from foreign currency translation of $0, $0.1 million and $0.4 million in fiscal years 2001, 2002 and 2003, respectively, are included in interest and other income (expense) in the combined and consolidated statements of operations.

PalmSource employees participate in Palm and PalmSource employee stock plans, which are described more fully in Note 8, Stockholders’ Equity. The Company accounts for activity under the employee stock plans using the intrinsic value method prescribed by Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and Financial Accounting Standards Board Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation (an Interpretation of APB No. 25) and has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation.

Index to Financial Statements

PalmSource accounts for stock-based compensation relating to equity instruments issued to non-employees based on the fair value of options or warrants estimated using the Black-Scholes option valuation model on the date of grant and re-measured until the measurement date in compliance with the EITF No. 96-18, Accounting for Equity Instruments that are issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Compensation expense resulting from non-employee options is amortized using the multiple option approach in compliance with FIN No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

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

Pursuant to FIN No. 44, options assumed in a purchase business combination are valued at the date of acquisition at their fair value calculated using the Black-Scholes option valuation model. The fair value of the assumed options is included as part of the purchase price. The intrinsic value attributable to the unvested options is recorded as unearned stock-based compensation and amortized over the remaining vesting period of the related options. Options assumed by Palm related to the business combination made on behalf of PalmSource subsequent to July 1, 2000 (the effective date of FIN No. 44) have been accounted for pursuant to FIN No. 44 and reflected in the financial statements of PalmSource as a component of net assets transferred from Palm related to business acquisitions. Subsequent amortization of deferred stock-based compensation by Palm has been reflected in the financial statements of PalmSource as transfer of stock-based compensation from Palm and included in the operating results of PalmSource.

The following table illustrates the effect on net loss and net loss per share if PalmSource had elected to recognize stock-based compensation expense based on the fair value of the options granted at the date of grant as prescribed by SFAS No. 123. For the purposes of this pro forma disclosure, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods, using the multiple option approach. Net loss per share and pro forma net loss per share are calculated assuming common stock outstanding of 10,000,000 shares for each period, as adjusted for the one for five reverse stock split prior to the distribution date.

SFAS No. 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. The Black-Scholes option valuation model was developed for use in estimating the fair

Index to Financial Statements

value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because options held by PalmSource employees and directors have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of these options. See Note 8, Stockholders’ Equity, for a discussion of the assumptions used in the option valuation model and estimated fair value for employee stock options.

For periods prior to the Separation Date, basic and diluted net loss per share amounts have been computed by dividing the net loss for the period by the 10,000,000 shares of PalmSource common stock outstanding after the incorporation of PalmSource in Delaware, adjusted for the re-capitalization of the authorized and outstanding Series A preferred stock into Class C Common Stock, the 1,000-for-1 conversion of the PalmSource common stock held by Palm and the one for five reverse stock split. (See Note 1, Background and Basis of Presentation and Note 16, Subsequent Events.)

Basic net loss per share is calculated based on the weighted average shares of common stock outstanding during the period, excluding shares of restricted stock subject to repurchase. Diluted net loss per share is calculated based on the weighted average shares of common stock outstanding and shares of common stock equivalents. Common stock equivalents consist of stock options and common stock subject to repurchase, calculated using the treasury stock method, and convertible preferred stock, calculated using the if-converted method. Diluted net loss per share does not include outstanding Palm options held by PalmSource employees, as these are not options to purchase PalmSource stock. The following weighted average stock options and convertible preferred stock outstanding were excluded from the calculation of diluted net loss per share because the effect would have been anti-dilutive for the years ended May 31, 2001, 2002 and 2003 of none, 99,000 and 1,604,000, respectively.

Comprehensive income (loss) consists of net loss plus net unrealized gain (loss) on investments and accumulated foreign currency translation adjustments.

In November 2002, the EITF reached a consensus on EITF No. 00-21, Revenue Arrangements with Multiple Deliverables, which provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company believes that the adoption of EITF No. 00-21 will not have a significant impact on the Company’s historical financial position or results of operations.

In November 2002, the Financial Accounting Standards Board (“FASB”) issued FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN No. 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified

Index to Financial Statements

after December 31, 2002, irrespective of the guarantor’s fiscal year end. The disclosure requirements of FIN No. 45 are effective for financial statements of interim or annual periods ending after December 15, 2002. PalmSource adopted this interpretation during the third quarter of fiscal year 2003, which had no impact on the Company’s historical financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation, an amendment of SFAS No. 123, to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. In addition, it amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. PalmSource adopted this statement in fiscal year 2003, which had no impact on the Company’s historical financial position or results of operations.

In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. In general, a variable interest entity (“VIE”) is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the VIE’s residual returns or both. The consolidation requirements of FIN No. 46 are effective immediately for VIEs created after January 31, 2003. The consolidation requirements for older VIEs are effective for financial statements of interim or annual periods beginning after June 15, 2003. Certain of the disclosure requirements are effective for all financial statements issued after January 31, 2003, regardless of when the VIE was established. The adoption of FIN No. 46 is not expected to have a material impact on the Company’s historical financial position and results of operations.

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

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that falls within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, which for PalmSource is the second quarter of fiscal year 2004. The adoption of SFAS No. 150 will not have an impact on the Company’s historical financial position or results of operations.

Index to Financial Statements

During the second quarter of fiscal year 2002, Palm completed its purchase of specified assets of Be Incorporated (“Be”), including substantially all of Be’s intellectual property and other technology assets. The assets acquired were assumed to have been contributed to the Company by Palm at the date of acquisition. Be was a provider of software solutions designed specifically for Internet appliances and digital media. In addition to the asset purchase, Palm hired a substantial majority of Be’s engineers to work for the PalmSource business. Potential benefits of the acquisition include the possibility of integrating Be’s operating system technology into future versions of the Palm OS to provide greater Internet, communications and multimedia capability. The total purchase price of $12.2 million consisted of $11.0 million of Palm common stock (205,223 shares issued, as adjusted for Palm’s October 2002, 1-for-20 reverse stock split) and $1.2 million of direct transaction costs. The transaction was accounted for as a purchase pursuant to SFAS No. 141, Business Combinations. Pursuant to SFAS No. 142, Goodwill and Other Intangible Assets, goodwill related to the acquisition is not amortized and will be tested at least annually for impairment. The goodwill for the Be acquisition is deductible for tax purposes. The consolidated financial statements include the operating results of the business from the date of acquisition. Pro forma results of operations have been presented below as if this acquisition had occurred at the beginning of the year ended May 31, 2001.

During the fourth quarter of fiscal year 2001, Palm completed the acquisition of peanutpress.com, Inc. (“peanutpress”). The total purchase price of $5.3 million consisted of $5.0 million of cash and $0.3 million of direct transaction costs. Total liabilities assumed in the transaction of $0.1 million included accounts payable, accrued liabilities, and contractual commitments. The net assets acquired (excluding cash acquired) were assumed to have been contributed to the Company by Palm at the date of acquisition. peanutpress was a provider of eBooks and Internet-based content management services. peanutpress developed, archived, hosted, and securely distributed eBook collections on behalf of publishers of books. This acquisition has been accounted for using the purchase method of accounting under APB No. 16, Business Combinations. Approximately $0.2 million of the purchase price of peanutpress represented purchased in-process technology that had not yet reached technological feasibility, had no alternative future use and was charged to operations. Pro forma results of operations have been presented below as if this acquisition had occurred at the beginning of the periods presented.

During the third quarter of fiscal year 2001, Palm completed the acquisition of WeSync.com, Inc. (“WeSync”). The total purchase price of $46.1 million consisted of $39.5 million of cash, $5.8 million of stock options assumed and direct transaction costs of $0.8 million. The net assets acquired (excluding cash acquired) were assumed to have been contributed to the Company by Palm at the date of acquisition. WeSync was a provider of wireless synchronization technologies. WeSync’s technologies enabled work and personal groups using the company’s free web-based service to share and synchronize changes to calendars and contacts on handhelds running the Palm operating system and PCs. This acquisition has been accounted for using the purchase method of accounting under APB No. 16, Business Combinations. Pro forma results of operations have been presented below as if this acquisition had occurred at the beginning of the periods presented.

Index to Financial Statements

The purchase prices were allocated based on the valuations, generally using a discounted cash flow approach, of purchased core technology, purchased in-process technology, non-compete covenants, assembled workforce and other identifiable intangible assets as follows (in thousands):

Identifiable intangible assets are being amortized over periods ranging from six months to three years. Under APB No. 16, acquired workforce was identified in the purchase price allocations for peanutpress, and WeSync and upon the adoption of SFAS No. 142 has been reclassified to goodwill. (See Note 5, Goodwill and Other Intangible Assets.)

The following unaudited pro forma results of operations present the combined results of operations of PalmSource, Be, peanutpress and WeSync as if the acquisitions had occurred as of the beginning of the periods presented. These unaudited pro forma results have been prepared for comparative purposes only and include certain adjustments, such as additional amortization expense as a result of goodwill and other intangible assets, elimination of goodwill and intangible assets recorded on the books of peanutpress due to their prior acquisition by netLibrary and the elimination of amounts paid to Be for professional services.

The historical results of PalmSource for fiscal year 2002 and the five and half months ended November 12, 2001 for Be have been combined for purposes of presenting these unaudited pro forma results of operations. (In thousands, except per share data):

These unaudited pro forma results of operations have been presented for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had the acquisitions occurred on the earliest dates presented, or which may result in the future. Unaudited pro forma net loss per share is calculated using common stock outstanding of 10,000,000 shares as adjusted for the one for five reverse stock split.

Index to Financial Statements

Depreciation and amortization expense related to property and equipment was $1.3 million, $1.6 million, $2.2 million for the years ended May 31, 2001, 2002, and 2003, respectively.

PalmSource adopted SFAS No. 142, Goodwill and Other Intangible Assets, on June 1, 2001. On adoption, PalmSource determined that its operations represent a single reporting unit. During the year ended May 31, 2002, PalmSource completed the transitional and annual impairment tests, and determined the fair value to exceed the carrying amount and that no impairment of goodwill was indicated.

All of PalmSource’s identifiable intangible assets are subject to amortization. On adoption of SFAS No. 142 on June 1, 2001 acquired workforce was reclassified as goodwill and no longer amortized.

Index to Financial Statements

Estimated future amortization expense of identifiable intangible assets is $0.9 million and $0.1 million for the years ending May 31, 2004 and 2005, respectively.

The changes in the carrying amount of goodwill for the three years ended May 31, 2003 are as follows (in thousands):

Had the provisions of SFAS No. 142 been applied for the year ended May 31, 2001, PalmSource net loss and net loss per share would have been as follows (in thousands, except per share amounts):

Net loss per share has been calculated using common stock outstanding of 10,000,000 shares as adjusted for the one for five reverse stock split for each period presented.

PalmSource’s facilities are leased under operating leases expiring at various dates through September 2005. Certain facility leases have renewal options with rentals based upon changes in the Consumer Price Index or the fair market rental value of the property.

Future minimum lease payments are $1.9 million, $1.4 million and less than $0.1 million for the years ending May 31, 2004, 2005 and 2006, respectively.

Rent expense was $4.4 million, $6.4 million, and $4.0 million for the years ended May 31, 2001, 2002 and 2003, respectively.

Index to Financial Statements

In September 2001, the Company’s President and Chief Executive Officer received two restricted stock grants in aggregate of 7,500 shares of Palm common stock (as adjusted for Palm’s October 2002, 1-for-20 reverse stock split) under a two-year vesting schedule subject to vesting restrictions and a guarantee that the fair market value of the related 7,500 shares of Palm common stock would be at least $2.0 million at September 2003. The guaranteed amount is recorded ratably over the vesting period. If on September 1, 2003, the fair market value is less than $2.0 million, the Company’s President and Chief Executive Officer will receive a cash payment, on September 15, 2003, equal to the difference between $2.0 million and the fair market value of 7,500 shares of Palm common stock. As of May 31, 2003, the total fair market value of 7,500 shares of Palm common stock was approximately $0.1 million and $1.7 million was recorded as a liability related to this guarantee.

In June 2002, PalmSource entered into two royalty agreements with third party vendors for certain licensed technology which include minimum commitments. Future minimum commitments under these agreements are $1.3 million, $2.0 million, $2.2 million, $0.5 million, $0.4 million and $0.3 million for the years ending May 31, 2004, 2005, 2006, 2007, 2008 and thereafter, respectively.

PalmSource has certain payments due to Palm under the business services and other agreements that have been entered into with Palm. The agreements with Palm also include certain indemnifications including indemnifications of Palm under the tax sharing agreement, among other matters, of any tax liability incurred by Palm on account of the sale of PalmSource’s common stock in connection with the distribution. The terms of such indemnification provide for no limitation for the maximum potential payments for such obligations and accordingly the maximum potential amount of future payments is undeterminable at this time. The Company has not been notified of any claims under these indemnifications and has no liabilities recorded for these indemnifications as of May 31, 2003. (See Note 13, Transactions with Palm.)

Under the indemnification of the Company’s standard software license agreements, the Company agrees to defend the licensee against third party claims asserting infringement by Company’s products of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay any judgments entered on such claims against the licensee. The Company has never incurred significant expense under its product or services warranties. As a result, the Company believes the estimated fair value on these agreements is minimal. Accordingly, the Company has no liabilities recorded for these agreements as of May 31, 2003.

As permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The

Index to Financial Statements

maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and enables the Company to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal. These indemnification agreements were grandfathered under the provisions of FIN 45 as they were in effect prior to December 31, 2002, however, new directors added under these arrangements will not be grandfathered. Accordingly, the Company had no liabilities recorded for these agreements as of May 31, 2003.

PalmSource’s Board of Directors has the authority to issue up to 50,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions of ownership. In December 2001, PalmSource issued 50,000 shares of Series A preferred stock to Palm. Effective May 9, 2002, PalmSource’s Board of Directors authorized a re-capitalization of the authorized and outstanding Series A preferred stock into Class C common stock and a simultaneous 1,000-for-1 stock split, resulting in 50,000,000 shares of PalmSource Class C common stock issued and outstanding and owned by Palm which was re-capitalized as 10,000,000 shares of PalmSource Class C common stock via the one for five reverse stock split.

On October 7, 2002, Sony invested $20.0 million purchasing 3,333,333 shares of the Company’s Series A redeemable convertible preferred stock (“Series A”) at a purchase price of $6.00 per share, representing a 6.25% interest in PalmSource. PalmSource’s Board of Directors had designated 10,000,000 shares of the authorized 50,000,000 of preferred stock as Series A. In connection with the sale of Series A the Company entered into a registration rights agreement pursuant to which Sony has registration rights with respect to the shares of common stock into which the shares of Series A are convertible. The holders of Series A have various rights and preferences as follows:

Voting: Holders of Series A are entitled to the number of votes equal to the equivalent number of shares of common stock into which the Series A is convertible and vote together as one class with the holders of Class A common stock.

Dividends: Holders of Series A are entitled to receive a proportionate share of any dividend declared by the Board of Directors as though the holders of the Series A were the holders of an equivalent number of shares of common stock into which the Series A is convertible. No dividends on the redeemable convertible preferred stock or common stock have been declared by the Board of Directors since inception.

Liquidation: In the event of any liquidation, dissolution or winding up of the Company, including a merger, acquisition or sale of assets where the beneficial owners of the Company’s common stock and redeemable convertible preferred stock own less than 50% of the resulting voting power of the surviving entity, but excluding a tax free spin-off, the holders of Series A as a class will be entitled to receive in preference to the common shareholders $6.00 per preferred share. In the event that funds are insufficient to pay the full preferential amounts entitled, then the assets and funds of the Company will be distributed ratably among the holders of Series A. Any remaining assets and funds of the Company after the distribution of the preferential amounts to Series A shall be distributed ratably to the common shareholders.

Redemption: Outside certain preferences granted upon liquidation which result in the classification of the Series A as redeemable, the holders of the Series A have no redemption rights.

Conversion: Each share of Series A shall be convertible to nonassessable shares of Class A common stock at the option of the holder at any time after the date of issuance of such share. The initial conversion price was

Index to Financial Statements

$6.00 per share which became $30.00 per share based on the one for five reverse stock split. In addition, each share of Series A shall automatically be converted into shares of Class A common stock at the effective conversion price immediately prior to a tax-free spin-off, upon the closing of a firm commitment underwritten public offering, or at the election by seventy-five percent of the holders. Subsequent to conversion, holders of Class A common stock are entitled to certain deemed registration rights for sale in the public market.

The holders of PalmSource’s common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to the preferences that may be applicable to any outstanding preferred stock, the holders of the Company’s common stock are entitled to receive ratably such dividends, if any, as may be declared from time to time by PalmSource’s Board of Directors out of funds legally available for that purpose. In the event of liquidation, dissolution or winding up, the holders of PalmSource’s common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The holders of PalmSource’s common stock have no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to PalmSource’s common stock.

Prior to the distribution date, eligible PalmSource employees can contribute up to 10% of their compensation, as defined in the Palm Employee Stock Purchase Plan, towards the purchase of shares of Palm common stock at a price of 85% of the lower of the fair market value at the beginning of the 2-year offering period or the end of each six-month purchase period. The Palm employee stock purchase plan provides for annual increases in the number of shares available for issuance on the first day of each fiscal year equal to the lesser of 2% of the outstanding shares of common stock on the first day of the fiscal year, 500,000 shares, or a lesser amount as may be determined by the Palm Board of Directors. As of the distribution date, PalmSource employees cease to be employees of Palm or a subsidiary of Palm and in accordance with the terms of the plan, their right to purchase shares under the Palm Employee Stock Purchase Plan will terminate and any amounts withheld will be refunded.

Certain eligible PalmSource employees have been granted options to purchase PalmSource common stock under PalmSource’s 2001 Stock Option Plan. These options are granted at prices not less than the fair market value at date of grant, typically vest over a one- to four-year period and expire ten years after the date of grant. PalmSource’s stock option plan also allows for the issuance of restricted stock awards, under which shares of common stock may be issued at par value to key employees, subject to vesting restrictions. For restricted stock awards, compensation expense equal to the fair market value on the date of the grant is recognized over the vesting period. To the extent that PalmSource grants restricted stock in the future, compensation expense will be recognized as the granted shares vest. No PalmSource restricted stock awards had been granted as of May 31, 2003. The maximum aggregate number of shares that may be subject to option and sold under the Plan is 2,000,000 shares as adjusted for the one for five reverse stock split prior to the distribution date, of the issued and outstanding shares of common stock.

Certain PalmSource employees hold options to purchase shares of Palm common stock granted under the Palm Stock Option Plan. Under the Palm Stock Option Plan, options are generally granted at not less than the fair

Index to Financial Statements

market value at date of grant, typically vest over a one- to four-year period and expire ten years after the date of grant. The Palm Stock Option Plan also allows for the issuance of restricted stock awards, under which shares of common stock are issued at par value to key employees, subject to vesting restrictions. For restricted stock awards, compensation expense equal to the fair market value on the date of the grant is recognized over the vesting period. During the years ended May 31, 2001, 2002 and 2003 PalmSource recognized compensation expense of $1.0 million, $1.8 million and $2.1 million, respectively, related to Palm restricted stock grants, including the guarantee of fair value of Palm restricted stock. As of the distribution date PalmSource employees cease to be employees of Palm or a subsidiary of Palm and in accordance with the terms of the plan, employees who have Palm restricted stock grants will forfeit the unvested portion of such grants at the distribution date.

As of the distribution date, PalmSource employees cease to be employees of Palm or a subsidiary of Palm, and in accordance with the terms of the Palm Stock Option Plan, PalmSource employees who have Palm stock options will forfeit the unvested portion of such stock options on that date. The number of shares and the exercise price of vested Palm stock options held by PalmSource employees will be adjusted at the distribution date using a conversion formula. The adjustment of the vested portion of Palm options will be done in such a manner that (1) the aggregate intrinsic value of the options immediately before and after the distribution are the same, and (2) the ratio of the exercise price per option to the market value per share is not reduced. In accordance with the terms of the Palm Stock Option Plan, PalmSource employees will generally have three months from the distribution date to exercise adjusted vested Palm stock options.

The following table summarizes the activity of options held by PalmSource employees under the Palm and PalmSource stock option plans. PalmSource shares and weighted average exercise prices have been adjusted for the one for five reverse stock split of the issued and outstanding shares of common stock (in thousands, except exercise price):

Index to Financial Statements

A summary of Palm stock options held by PalmSource employees under the Palm Stock Option Plans (in thousands, except exercise price) as of May 31, 2003 is as follows:

PalmSource stock options outstanding as of May 31, 2003 include options to purchase 1,078,000 shares of PalmSource common stock (adjusted for the one for five reverse stock split) at a weighted average exercise price of $39.92 per share, with a weighted average contractual life remaining of 8.95 years. As of May 31, 2003, 416,958 shares of PalmSource common stock (adjusted for the one for five reverse stock split) were exercisable at an exercise price of $40.00 per share.

The fair value of each option grant during the years ended May 31, 2003, 2002 and 2001 reported above in Note 2, Significant Accounting Policies, was estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:

The weighted average estimated fair value of Palm stock options granted during the years ended May 31, 2001, 2002 and 2003 was $209.52, $50.89 and $8.88 per share, respectively (as adjusted for Palm’s October 2002 1-for-20 reverse stock split). The weighted average estimated fair value of shares granted under the Palm Employee Stock Purchase Plan during the years ended May 31, 2001, 2002 and 2003 was $150.91, $32.10 and $14.73 per share, respectively, (as adjusted for Palm’s October 2002 1-for-20 reverse stock split). The weighted average estimated fair value of PalmSource stock options granted during the years ended May 31, 2002 and 2003 was $4.01 and $1.52 per share respectively (adjusted for PalmSource’s one for five reverse stock split).

Index to Financial Statements

The Company has entered into a Tax Sharing Agreement with Palm. (See Note 13, Transactions with Palm.)

The Company’s foreign taxes are primarily foreign withholding taxes on license revenue reported in the U.S. for which no credit is currently available against U.S. taxes due to the Company’s net loss position.

The income tax provision differs from the amount computed by applying the federal statutory income tax rate to loss before income taxes as follows:

Index to Financial Statements

The significant components of PalmSource’s deferred income tax assets are (in thousands):

The valuation allowance reduces deferred tax assets to estimated realizable value due to PalmSource’s history of operating losses. The increase in the valuation allowance is $16.7 million and $6.5 million for the years ended May 31, 2002 and 2003, respectively.

The Company’s operating results historically have been included in Palm’s consolidated U.S. income tax return and consolidated, combined or unitary state income tax returns and in tax returns of certain foreign subsidiaries. The income tax provision in the Company’s combined and consolidated financial statements have been determined on a separate-return basis. Pursuant to the Company’s tax sharing agreement with Palm, $65.4 million of deferred tax assets which arose prior to the formation of the Company as a legal entity on December 3, 2001 are deemed attributes of Palm.

In the third quarter of fiscal year 2003, PalmSource recorded restructuring charges of $2.2 million related to restructuring actions which consisted of workforce reductions of approximately 60 regular employees, primarily in the U.S., facilities and property and equipment that will be disposed of or removed from service. The charge was recorded as incurred in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Charges for employee workforce reductions were recorded upon employee notification for employees whose required continuing service period is 60 days or less. Restructuring charges relate to the implementation of a series of actions to better align the Company’s expense structure with its revenues. As of May 31, 2003, headcount reductions were essentially complete.

In the fourth quarter of fiscal year 2002, PalmSource recorded restructuring charges of $1.8 million related to decisions and commitments made in that quarter. These restructuring charges consist of workforce reduction costs and excess facilities charges. PalmSource recorded a charge of approximately $1.6 million related to lease commitments on excess facilities that PalmSource exited and removed from service in fiscal year 2003. PalmSource recorded approximately $0.2 million related to workforce reductions primarily related to severance, benefits and related costs due to the reduction of a small number of regular employees in Europe. As of May 31,

Index to Financial Statements

2003, headcount reductions were complete and the lease commitments have expired. The adjustment of $0.1 million is due to changes from the original estimate in the settlement of the lease commitments on excess facilities.

In the second quarter of fiscal year 2002, PalmSource reduced its cost structure and recorded charges of $0.2 million for these actions. The second quarter fiscal year 2002 restructuring charge consisted of workforce reduction costs across all geographic regions. Workforce reductions affected approximately ten regular employees. As of May 31, 2003, the headcount reductions were complete.

In the fourth quarter of fiscal year 2001, PalmSource recorded restructuring charges of $2.2 million which consisted of workforce reduction costs of $2.0 million across all geographic regions and costs related to lease commitments of $0.2 million on excess facilities. These workforce reductions affected approximately 45 regular employees. As of May 31, 2002, the headcount reductions were essentially complete and excess facilities had been exited.

Cost reduction actions initiated in the fourth quarter of fiscal year 2001 and the second and fourth quarters of fiscal year 2002 are substantially complete. Cost reduction actions initiated in the third quarter of fiscal year 2003 are expected to be complete by the end of the first quarter of fiscal year 2004. PalmSource cannot assure that current estimates of the costs associated with these restructuring actions will not change during the implementation period.

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

Eligible PalmSource employees may participate in Palm’s 401(k) Plan (“the Plan”). As allowed under Section 401(k) of the Internal Revenue Code, the Plan provides tax-deferred salary deductions for eligible employees. Participants may elect to contribute from 1% to 22% of their annual compensation to the Plan each calendar year, limited to a maximum annual amount as set periodically by the Internal Revenue Service. In addition, the Plan provides for Company matching contributions as determined by the Board of Directors. Palm matches 50% for each dollar on the first 6% of target income contributed by the employee. Employees become vested in Palm matching contributions according to a three-year vesting schedule based on initial date of hire.

Index to Financial Statements

PalmSource’s expense related to 401(k) matching contributions was $0.5 million, $0.5 million and $0.7 million for the years ended May 31, 2001, 2002 and 2003, respectively.

To date, no lawsuit has been filed against PalmSource but from time to time the Company has received claims related to the conduct of its business. In the course of Palm’s business, it occasionally receives claims related to consumer protection, general commercial claims related to the conduct of its business and the performance of its products and services and other litigation claims, such as stockholder derivative class action lawsuits. In the course of Palm’s business, it also receives claims of infringement or otherwise becomes aware of potentially relevant patents or other intellectual property rights held by other parties. Palm is currently subject to a number of these claims. Palm believes that it has defenses to the cases set forth below and is vigorously contesting these matters. Though the claims currently do not name PalmSource as defendants, the substance of their claims may implicate PalmSource and result in claims against the Company in the future or require that PalmSource indemnify Palm pursuant to our separation agreements with Palm.

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

Index to Financial Statements

3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses which may arise out of the Xerox litigation. As part of the separation agreements with Palm, Palm has agreed to indemnify PalmSource for any damages that PalmSource may incur due to the Xerox litigation. If Palm is not successful in the Xerox litigation and is unable to or does not indemnify the Company, PalmSource might be required to pay Xerox significant damages or license fees or pay licensees significant amounts to indemnify them for their losses. PalmSource believes that Palm has adequate defenses to the claims made by Xerox. PalmSource further believes that it is remote that PalmSource will incur a loss resulting from any fees or damages in excess of amounts recoverable from Palm under Palm’s indemnification of PalmSource.

On February 28, 2000, E-Pass Technologies, Inc. filed suit against 3Com, Inc. in the United States District Court for the Southern District of New York and later filed, on March 6, 2000, an amended complaint against Palm and 3Com. The case is now captioned E-Pass Technologies, Inc. v. 3Com Corporation, a/k/a 3Com, Inc. and Palm, Inc. (Civil Action No. 00 CIV 1523). The amended complaint alleges willful infringement of U.S. Patent No. 5,276,311, titled Method and Device for Simplifying the Use of Credit Cards, or the Like. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patent in the future. The case was transferred to the U.S. District Court for the Northern District of California. In an Order dated August 12, 2002, the Court granted Palm’s motion for summary judgment that there was no infringement. E-Pass appealed the Court’s decision to the CAFC. The issues on appeal before the CAFC have been fully briefed and argued by the parties. On August 21, 2003, the CAFC issued a ruling reversing the claim construction of the District Court and the attendant summary judgment motion and remanded the case to the District Court for further proceedings. In connection with Palm’s separation from 3Com, pursuant to the terms of the Indemnification and Insurance Matters Agreement between 3Com and Palm, Palm may be required to indemnify and hold 3Com harmless for any damages or losses, which may arise out of the E-Pass litigation.

On March 14, 2001, NCR Corporation filed suit against Palm and Handspring, Inc. in the United States District Court for the District of Delaware. The case is captioned NCR Corporation v. Palm, Inc. and Handspring, Inc., Civil Action No. 01-169. The complaint alleges infringement of U.S. Patent Nos. 4,634,845 and 4,689,478, titled, respectively, Portable Personal Terminal for Use in a System for Handling Transactions and System for Handling Transactions Including a Portable Personal Terminal. The complaint seeks unspecified compensatory and treble damages and to permanently enjoin the defendants from infringing the patents in the future. The case was referred to Magistrate Judge Mary P. Thynge. In a Memorandum Opinion dated July 11, 2002, the Magistrate Judge indicated that she would recommend that the District Court grant the defendants motion for summary judgment that there was no infringement. NCR filed objections to the recommendations of the Magistrate Judge, and Palm has filed a response to NCR’s objections. On August 28, 2003, the District Court granted Palm’s motion for summary judgment, ruling that Palm products do not infringe the NCR patents, and denied NCR’s motion.

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

Index to Financial Statements

2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The complaints allege claims against Palm and the officers under Sections 11 and 15 of the Securities Act of 1933, as amended. Certain of the complaints also allege claims under Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended. Other actions have been filed making similar allegations regarding the initial public offerings of more than 300 other companies. All of these various consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Civil Action No. 21-MC-92. An amended consolidated complaint was filed in April 2002. The claims against the individual defendants have been dismissed without prejudice pursuant to an agreement with the plaintiffs. The Court has denied Palm’s motion to dismiss. A special committee of Palm’s Board of Directors recently approved a tentative settlement proposal from plaintiffs, which includes a guaranteed recovery to be paid by the issuer defendants’ insurance carriers and an assignment of certain claims the issuers, including Palm, may have against the underwriters. There is no guarantee that the settlement will become final however, as it is subject to a number of conditions, including court approval. Palm believes that it has meritorious defenses to the claims against it and intends to defend the action vigorously if settlement is not reached.

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

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

On March 11, 2002, a purported consumer class action lawsuit was filed against Palm in the Wayne County Circuit Court, Detroit, Michigan. The case is captioned Hayman, et al. v Palm, Inc (Case No. 02-208249-CP). Plaintiffs allege that certain of Palm, Inc.’s advertisements for its Palm III, V and m100 handheld devices were false or misleading regarding the ability of the device to wirelessly and remotely access e-mails or the Internet

Index to Financial Statements

without the need for additional hardware or software sold separately. Plaintiffs allege violations of the Michigan Consumer Protection Act, breach of express and implied warranties and Michigan common law, and seek to recover the purchase price of the device from Palm for themselves and a class of all similarly situated consumers. Palm has filed a motion to dismiss the lawsuit in its entirety. The Court has heard arguments on that motion, and it has advised that it would rule on Palm’s motion to dismiss before considering the suitability of this lawsuit for class treatment.

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

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

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

Index to Financial Statements

seek, among other things, a preliminary and permanent injunction against the transaction, a recission of the transaction if it is consummated and unspecified damages. The Goldhirsch complaint also requests, among other things, that the Court order Handspring’s officers and directors to take all necessary steps to maximize stockholder value, including open bidding and/or a market check. Palm believes that the lawsuits are without merit and intends to vigorously defend the cases.

For the periods subsequent to the Separation Date, intercompany transactions and balances between PalmSource and Palm consisted of the following (in thousands):

For the periods presented, PalmSource’s costs and expenses included allocations from Palm for centralized legal, finance, treasury, real estate, information technology, customer support, sales, marketing, engineering, and other Palm corporate services and infrastructure costs. These allocations were determined on the bases that Palm and PalmSource considered to be reasonable reflections of the utilization of services provided or the benefit received by PalmSource. The allocation methods include relative revenues or headcount.

Allocated costs included in the accompanying consolidated statements of operations were as follows (in thousands):

Index to Financial Statements

Subsequent to the Separation Date, during fiscal year 2002, Palm made capital contributions to PalmSource of approximately $31.1 million in cash and $7.0 million in net asset transfers. During fiscal year 2003, Palm made additional capital contributions in accordance with the terms of the Master Separation and Distribution Agreement of approximately $1.5 million in net asset transfers offset by a capital distribution by PalmSource of approximately $2.9 million in cash.

For purposes of governing certain of the ongoing relationships between PalmSource and Palm at and after the Separation Date and to provide for an orderly transition, PalmSource and Palm have entered into various agreements. A brief description of each of the agreements follows.

Under the Software License Agreement, as amended and restated, PalmSource agreed to grant to Palm certain licenses to develop, manufacture, test, maintain and support their products. In addition, PalmSource agreed to grant to Palm a source code license and certain rights to use, produce, grant end user sublicenses and distribute certain software. Palm will pay PalmSource license and royalty fees based upon the shipment of Palm’s products which incorporate PalmSource’s software and maintenance and support fees. The Software License Agreement expires December 3, 2006 and includes a minimum annual royalty and license commitment of $40.0 million, $37.5 million, $39.0 million, $41.0 million and $42.5 million during each of the contract years expiring December 3, 2006. Under the terms of the Software License Agreement, PalmSource has recognized license and royalty revenues of $0, $17.6 million, and $38.1 million, for the years ended May 31, 2001, 2002 and 2003, respectively. In addition, PalmSource has recognized support and service revenues of $0, $0.8 million, and $1.2 million for the years ended May 31, 2001, 2002 and 2003, respectively. These amounts have been included in related party revenues on the face of the combined and consolidated financial statements. (See Note 15, Other Related Party Transactions.)

The Trademark Agreements contain the key provisions relating to the use of all Palm-formative trademarks which have been assigned from PalmSource and Palm to a brand holding company, Palm Trademark Holding Company LLC, to be owned 55% by PalmSource and 45% by Palm, which will license the marks to PalmSource and Palm. Under the various agreements, PalmSource has been granted the right to use and sublicense the Palm Marks and Palm has been granted the right to use and sublicense certain transitional Palm-formative marks.

The Master Separation and Distribution Agreement contains the key provisions relating to the separation of PalmSource from Palm. The agreement lists the documents and items that the parties were required to deliver in order to have accomplished the transfer of assets and liabilities from Palm to PalmSource effective on the Separation Date. The parties also entered into both short-term and long term covenants, including covenants relating to business service agreements, exchange of information, auditor and auditing practices, dispute resolution and employee matters.

The General Assignment and Assumption Agreement as amended, identifies the assets that Palm transferred to PalmSource and the liabilities that PalmSource assumed from Palm in the separation. The assets that were transferred and the liabilities that were assumed were listed in the agreement.

Index to Financial Statements

The Master Technology Ownership and License Agreement and the Master Patent Ownership and License Agreement together are referred to as the Intellectual Property Agreements. Under the Intellectual Property Agreements, Palm grants, conveys and assigns to PalmSource all its right, title and interest in and to the PalmSource technology as well as all causes of action and rights of recovery for past infringement of Copyrights and Database Rights in and to the PalmSource technology and for past misappropriation of trade secrets in and to the PalmSource technology. Palm also grants, conveys and assigns to PalmSource all its right, title and interest in and to the PalmSource data and PalmSource Patents as well as causes of action and rights of recovery for past infringement of PalmSource Patents and the right to claim priority from PalmSource Patents. The agreement confirm that Palm and PalmSource jointly own all right, title and interest in and to the Joint Data and Palm grants, conveys and assigns to PalmSource an undivided one-half interest in and to the Joint Data.

In addition, PalmSource and Palm grant licenses to each other on certain Copyrights, trade secrets, Database Rights, patents and other intellectual property rights in and to the Licensed PalmSource Technology and Licensed Palm Technology which were jointly developed with PalmSource. Both Palm and PalmSource have agreed not to disclose confidential information of the other party except in specific circumstances.

The amended and restated Tax Sharing Agreement (the “tax sharing agreement”) sets forth the principal arrangements between Palm and PalmSource regarding the filing of tax returns, the payment of taxes and the conduct of tax audits or other disputes. The tax sharing agreement provides for the calculation of PalmSource’s tax liability as if PalmSource were a stand-alone corporation; i.e., to the extent that PalmSource would have been liable for taxes on a stand-alone basis, it will pay Palm for such tax liability. Conversely, to the extent that any PalmSource operating losses reduce PalmSource’s tax liability as a stand-alone company in a future period, any required payment to Palm under the agreement will be reduced.

Under the tax sharing agreement, Palm is required to prepare and file all Palm/ PalmSource consolidated tax returns through the distribution date, including the final consolidated Palm/PalmSource federal income tax return. PalmSource has the right to review and consent to any Palm/PalmSource consolidated returns filed after the distribution date, provided that it does not withhold such consent unreasonably. In addition, Palm has sole and complete authority to control and resolve all tax audits and other disputes relating to any Palm/ PalmSource consolidated returns filed before and after the distribution date. After the distribution date, however, Palm may not enter into any dispute settlement that would materially increase PalmSource’s liability under the tax sharing agreement without PalmSource’s consent, which consent PalmSource cannot withhold unreasonably.

The tax sharing agreement also contains provisions requiring PalmSource to indemnify Palm for, among other things, (i) any increases in PalmSource’s stand-alone income tax liability or other consolidated tax liabilities arising as a result of any amended return, audit or other dispute and attributable to periods after December 3, 2001, (ii) any increases in certain non-income taxes (e.g., payroll, employee withholding, etc.) attributable to PalmSource’s business, (iii) any transfer taxes incurred on the transfer of assets by Palm to PalmSource, and (iv) any tax liability incurred by Palm on account of the sale of PalmSource’s common stock in connection with the distribution.

The Business Services Agreement governs individual business services as requested by PalmSource and provided by Palm on an interim basis, for one year from the Separation Date, which was extended through

Index to Financial Statements

May 31, 2003, for specific services or otherwise indicated in the agreement. The services include corporate development, corporate marketing, corporate strategy, finance, global corporate procurement, human resources, information technology, insurance and risk management, legal, real estate and site services, security and environmental health and safety, stock administration, tax and trade, travel and meeting services and treasury. Specified charges for such services are generally intended to allow the providing company to recover the direct and indirect costs of providing the services. If PalmSource becomes an externally separate company prior to the termination of the Business Services Agreement, PalmSource will pay Palm the direct and indirect costs of providing the services plus 5% for services provided to PalmSource after the distribution date. Services provided by Palm to PalmSource prior to the distribution date are at cost.

The Business Services Agreement also will cover the provision of certain additional services identified from time to time after the Separation Date that were inadvertently or unintentionally omitted from the specified services, or that are essential to effectuate an orderly transition under the Master Separation and Distribution Agreement, so long as such services would not significantly disrupt Palm’s operations or materially increase the scope of its responsibility under the agreement.

Under the Confidential Disclosure Agreement, the receiving party shall protect the confidential information of the disclosing party by using the same degree of care to prevent the unauthorized use, dissemination, or publication of the confidential information as receiving party uses to protect its own confidential information of a like nature. The receiving party will not use such confidential information in violation of any use restriction in any transaction agreement and not disclose such confidential information to any third party without prior written consent of the disclosing party, except as expressly permitted under agreements entered between the parties.

Under the amended and restated Indemnification and Insurance Matters Agreement, on the distribution date, PalmSource and Palm will each release and forever discharge the other from any and all liabilities arising under any contract or agreement and from events occurring on or before the distribution date, including events occurring in connection with the activities to implement the separation and distribution. The agreement also contains provisions governing indemnification. In general, PalmSource and Palm will each indemnify the other from all liabilities arising from their respective businesses or contracts, as well as liabilities arising from a breach of the separation agreement or any ancillary agreement. In addition, Palm and PalmSource will each indemnify the other against liability for specified environmental actions and conditions. PalmSource will reimburse Palm for the cost of any insurance premium expenses to be allocated between Palm and PalmSource according to their respective shared percentages.

The Xerox litigation agreement governs Palm and PalmSource’s obligations with respect to the current patent litigation with Xerox. Prior to the effectiveness of the litigation agreement, the responsibility for the defense and indemnity of the Xerox litigation rested with PalmSource and PalmSource had been paying Palm’s defense costs and reimbursing Palm for any payments required as a result of its posting of a bond required in connection with the litigation through May 31, 2003. PalmSource reimbursed Palm for $1.1 million of expenses associated with Palm’s posting of such bond for the year ended May 31, 2003.

Under the Xerox litigation agreement, Palm assumes responsibility for managing the Xerox litigation, determining strategy and making most settlement decisions. Additionally, if any claim is brought against

Index to Financial Statements

PalmSource or its OS licensees alleging infringement of the Xerox patent by covered OS versions, then Palm also must manage the defense, bear the costs and pay the damages awarded or agreed to in settlement of such claim. Although Palm has management control over the Xerox litigation, the litigation agreement prohibits Palm from consenting to any judgment or settlement that would: allow injunctive or declaratory relief to be ordered against PalmSource, require PalmSource to pay any future royalties or otherwise require PalmSource to make any payment that is not fully indemnified, require PalmSource to license its intellectual property, or otherwise affect the business, financial condition or operations of PalmSource or its licensees in a material way.

The litigation agreement also obligates Palm to bear the costs of the Xerox litigation that are incurred after June 1, 2003, not including the imputed costs of PalmSource’s personnel or of any independent advice PalmSource may choose to seek. Palm also must pay the amount of any damages awarded in, or agreed to in settlement of, the Xerox litigation.

Under the Sublease agreement, Palm assigns the rights, title and interest under the 3Com lease for certain premises to PalmSource and under the Assignment of Lease agreement, Palm assigns all rights, title and interest under the Regus Business Centre Corp and EOP-Northwest Properties, L.L.C. leases to PalmSource. The assignments are effective as of December 3, 2001, the “Effective Date”. Under the PalmSource-Palm Real Estate License agreement, PalmSource licenses to Palm the nonexclusive right to use certain areas of the Portland premises and office furniture and equipment located at the premises.

Palm and PalmSource have also entered into a number of other agreements including the SDIO license agreement, the Elaine software license and services agreement, and the development agreement. These agreements generally cover the use of various internally developed software by both parties. In addition, Palm and PalmSource also entered into a strategic collaboration agreement for the development of new versions of Palm OS. Under the agreements, Palm has certain rights to first discussion prior to PalmSource entering into collaboration projects with other licensees.

The terms of the note payable to Palm for $20.0 million are set forth in the amended and restated intercompany loan agreement. The note payable to Palm bears interest at 2.48% per annum. Immediately prior to a distribution, $20.0 million will be contributed as additional paid-in-capital. The related accrued interest will be due and payable within seven days after the distribution date or, if the distribution is not completed prior to December 3, 2004, then the $20.0 million note payable to Palm and the related accrued interest will be due and payable on December 3, 2004. The agreement does not require collateral but contains a list of events that will constitute a default resulting in the note payable becoming immediately due and payable.

Immediately prior to the distribution date, it is intended that PalmSource will issue a $15.0 million convertible subordinated note to Texas Instruments, which will bear interest at 5.0% per annum and be due December 6, 2006.

Index to Financial Statements

The PalmSource note will be convertible into PalmSource common stock and the conversion price will be set according to a formula. To the extent that the principal amount of the convertible subordinated note issued to Texas Instruments is less than $15.0 million, PalmSource will make a new note in favor of Palm with a principal amount equal to the difference between $15.0 million and the principal amount of the note issued to Texas Instruments.

The conversion formula for the PalmSource note provides that the conversion price for the PalmSource note resulting from the change in Palm’s trading price based on the difference between the average closing price for Palm for the five trading days before and the five trading days after the distribution will bear the same relationship to the value of a share of PalmSource, assuming for purposes of this calculation that the expected decrease in the Palm stock price after the distribution, represents the value of PalmSource, as the conversion price of the existing Palm note bears to the Palm stock price prior to the distribution. The existing Palm note has a conversion price of $92.6316 per Palm share and a conversion rate of 10.79545 Palm shares per $1,000 of principal amount (in each case, after giving effect to Palm’s one for twenty reverse stock split, which took place effective October 15, 2002). Because the actual price of a share of PalmSource common stock may differ from the conversion price determined by the formula, the formula further provides that at a minimum, the PalmSource note conversion price will be 15% greater than the volume weighted average PalmSource stock price on the first trading day after the distribution and that the conversion price will not be greater than 300% higher than that volume weighted average PalmSource stock price.

The letter agreement provides for the contribution of an additional $6.0 million from Palm to PalmSource upon the distribution of shares of PalmSource capital stock held by Palm to Palm’s stockholders, provided that such distribution transaction is not preceded by an initial public offering of PalmSource’s capital stock.

Under the terms of the License Agreement between PalmSource and Sony, PalmSource has recognized license and royalty revenues of $1.0 million, $5.1 million, and $10.9 million for the years ended May 31, 2001, 2002 and 2003, respectively. In addition, PalmSource has recognized support and service revenues of $0.2 million, $0.2 million, and $0.3 million for the years ended May 31, 2001, 2002 and 2003, respectively. These amounts have been included in related party revenues on the face of the combined and consolidated financial statements. As of May 31, 2002 and 2003, approximately $30,000 and $0.1 million, respectively, represents outstanding receivables from Sony and is included in Receivable from related parties in the combined and consolidated financial statements.

Effective October 7, 2002, PalmSource entered into a business collaboration agreement which expires in October 2012 with Sony under which PalmSource and Sony agreed to share certain information regarding ongoing product and development plans and, for a period of at least three years, to establish mutually agreed written co-development plans for potential areas of joint development. Under the business collaboration agreement, prior to October 7, 2003, PalmSource will not engage another licensee of Palm OS as a development partner under a joint development agreement to participate in a co-development program for new versions of Palm OS and from October 7, 2003 until October 7, 2005, PalmSource will not engage more than two development partners meeting the above requirements in addition to Sony and PalmSource will first offer to discuss new projects with Sony prior to engaging such additional development partners.

PalmSource’s Chairman of the Board, Eric Benhamou, is also the Chairman of the Board to 3Com Corporation. Under the terms of a software license agreement between PalmSource and 3Com, PalmSource recorded $0.1 million, $0.2 million and $0.4 million of support revenues for fiscal years 2001, 2002 and 2003, respectively.

Index to Financial Statements

PalmSource’s headquarters and most of its operations are located in the United States. PalmSource conducts its sales, marketing and customer service activities throughout the world and also has a research and development facility in France. Geographic revenue information is based on the location of the customer. Geographic long lived tangible asset information is based on the physical location of the assets. All restricted investments are located in the United States. For the years ended May 31, 2001, 2002 and 2003 no country outside the United States, Finland or Japan accounted for 10% or more of total revenues. Revenues and net property and equipment by geographic region are as follows (in thousands):

On June 30, 2003, the Company’s Board of Directors approved a one for five reverse stock split of the issued and outstanding shares of common stock of the Company. The one for five reverse stock split became effective on September 22, 2003.

On June 30, 2003, the Company’s Board of Directors approved a voluntary stock option exchange program. Under the program, certain of the Company’s key executives were offered the opportunity to exchange outstanding stock option grants for restricted stock and replacement stock options. In connection with the program, 1,042,000 stock options, as adjusted for the one for five reverse stock split, were cancelled on August 4, 2003 and, on the same date, 689,490 shares of restricted stock with a purchase price equal to the par value of a share of PalmSource common stock were granted in exchange. Each restricted stock award vests as to 50% of the shares on the first anniversary of the grant date and 50% on the second anniversary of the grant date. In addition 713,914 replacement options are expected to be granted on the later of (i) the first business day that is at least six months and one day after August 4, 2003 and (ii) any business day, in PalmSource’s sole discretion, within thirty days of the PalmSource distribution from Palm. The per-share exercise price for new options will be the fair market value of a share of PalmSource common stock on the date of grant. The issuance of restricted stock will result in a non-cash stock compensation charge of $10.3 million, which is to be amortized over the vesting

Index to Financial Statements

period. The restricted stock charge was calculated based on the intrinsic value of each share of restricted stock. The intrinsic value represents the difference between the imputed fair value of $14.98 per share of PalmSource stock on August 4, 2003 and the par value of each share of restricted stock of $0.001 per share. The imputed fair value was determined based on the respective market price of Handspring and Palm common stock as of August 4, 2003 and the contractual exchange ratio.

On June 30, 2003, the Company’s Board of Directors offered certain of its key executives the opportunity to waive their rights to promised stock option grants, in exchange for restricted stock and new grants of nonstatutory stock options. Under the option waiver program, rights to 335,200 stock options were waived and on August 4, 2003, 170,300 shares of restricted stock with a purchase price equal to the par value of a share of PalmSource common stock were granted in exchange. Each restricted stock award vests as to 50% of the shares on the first anniversary of the grant date and 50% on the second anniversary of the grant date. In addition, the Company intends to grant 419,415 new options with an exercise price equal to the fair value of a share of PalmSource common stock on the date of grant within thirty days of the effective date of the distribution from Palm. The issuance of restricted stock will result in a non-cash stock compensation charge of $2.6 million, which is to be amortized over the vesting period. The restricted stock charge was calculated based on the intrinsic value of each share of restricted stock. The intrinsic value represents the difference between the imputed fair value of $14.98 per share of PalmSource stock on August 4, 2003 and the par value of each share of restricted stock of $0.001 per share. The imputed fair value was determined based on the respective market price of Handspring and Palm common stock as of August 4, 2003 and the contractual exchange ratio.

On June 30, 2003, the Company’s Board of Directors approved an aggregate of 73,175 shares of bonus-restricted stock, as adjusted for the one for five reverse stock split, to be granted to certain of its key executives. Shares of bonus-restricted stock were granted on August 4, 2003. Each restricted stock award vests as to 50% of the shares on the first anniversary of the grant date and 50% on the second anniversary of the grant date. The issuance of restricted stock will result in a non-cash stock compensation charge of $1.1 million, which is to be amortized over the vesting period. The restricted stock charge was calculated based on the intrinsic value of each share of restricted stock. The intrinsic value represents the difference between the imputed fair value of $14.98 per share of PalmSource stock on August 4, 2003 and the par value of each share of restricted stock of $0.001 per share. The imputed fair value was determined based on the respective market price of Handspring and Palm common stock as of August 4, 2003 and the contractual exchange ratio.

On June 30, 2003, the Company’s Board of Directors adopted the PalmSource 2003 Employee Stock Purchase Plan (“ESPP”). The ESPP provides eligible employees, including employees of participating subsidiaries, with the opportunity to purchase shares of the Company’s common stock through payroll deductions. The ESPP is intended to qualify as an employee stock purchase plan under section 423 of the Code. The Company has reserved a total of 400,000 shares of common stock, as adjusted for the one for five reverse stock split prior to the distribution date, for issuance pursuant to the ESPP.

On June 30, 2003, the Company’s Board of Directors approved the adoption of the PalmSource 2003 Equity Incentive Plan and the termination of the 2001 Stock Option Plan effective as of August 1, 2003. The Equity Incentive Plan provides for the grant of the following types of incentive awards: (1) stock options, (2) stock appreciation rights, (3) restricted stock, (4) performance units and (5) performance shares. The Company has reserved a total of 3,626,294 shares of its common stock, as adjusted for the one for five reverse stock split prior to the distribution date, for grant under the Equity Incentive Plan, which total includes shares that have been reserved but not granted pursuant to options under our 2001 Stock Plan and any shares returned to our 2001 Stock Plan as a result of the termination of options or the repurchase of unvested shares issued under the 2001 Stock Plan.

Index to Financial Statements

On June 30, 2003, the Company’s Board of Directors adopted a form of amended and restated certificate of incorporation, effective immediately following the distribution date adjusting the authorized common and preferred stock of the Company.

On August 29, 2003, PalmSource and PalmGear, Inc. consummated certain transactions related to a stock purchase agreement, strategic alliance and service provider agreement and a brand license agreement between the parties. In connection with the closing of the transactions, PalmSource sold the Palm Digital Media product line to PalmGear. In addition, as part of the strategic alliance, PalmGear agreed to support an online store, at PalmSource’s U.S. web site, for Palm OS applications. The initial term of the strategic alliance is three-years. The total initial payments from the above described transactions equaled $4.0 million, however, this amount is subject to a maximum $0.3 million contingent holdback by PalmGear unless Palm Digital Media meets certain financial metrics for the five month period ending January 31, 2004, thereby, resulting in current total proceeds of $3.7 million. The net proceeds of $3.4 million are to be recognized ratably over the three-year term of the arrangement. In addition, PalmSource is guaranteed additional future minimum fees from the strategic alliance and service provider agreement of $1.4 million over the three-year term of the arrangement. Revenues from the Palm Digital Media product line were $0.3 million, $2.0 million and $2.5 million for the years ended May 31, 2001, 2002, and 2003, respectively.

On September 15, 2003, the Company paid approximately $1.8 million to PalmSource’s President and Chief Executive Officer, David Nagel, pursuant to the terms of two restricted stock grants issued in September 2001, representing the difference between the guaranteed value of $2.0 million and the fair market value of 7,500 shares of Palm common stock.

Index to Financial Statements

The following tables present PalmSource’s condensed operating results for each of the eight fiscal quarters for the period ended May 31, 2003. The information for each of these quarters is unaudited and has been prepared on the same basis as the audited combined and consolidated financial statements included in this prospectus. In the opinion of management, all necessary adjustments, which consist only of normal and recurring accruals, have been included to fairly present the unaudited quarterly results. This data should be read together with PalmSource’s combined and consolidated financial statements and the notes to those statements included in this prospectus.

The combined and consolidated financial statements have been derived from the consolidated financial statements and accounting records of Palm and reflect significant assumptions and allocations. The historical financial information may not be indicative of PalmSource’s future performance and does not necessarily reflect what the Company’s financial position and results of operations would have been had PalmSource operated as a separate, stand-alone entity during the periods presented. For periods prior to December 3, 2001, there is no revenue recorded from Palm, as the Software License Agreement was not effective until December 3, 2001. In addition, as a result of PalmSource’s acquisitions, the Company’s results of operations are not necessarily comparable between the periods presented.

For each period presented, basic and diluted net loss per share has been calculated using common stock outstanding, as adjusted for the one for five reverse stock split.

Index to Financial Statements

In our opinion, the accompanying consolidated balance sheets and related consolidated statements of operations and of cash flows present fairly, in all material respects, the financial position of Be Incorporated and its subsidiaries at December 31, 2000 and 1999, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These consolidated financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has an accumulated deficit. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. These consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Index to Financial Statements

Be Incorporated (Be, or “Company”) was founded in 1990 and offers software platforms designed for Internet appliances and digital media applications. The Company’s software platforms (i) BeIA: consisting of three components; BeIA Client Platform, BeIA Management and Administration Platform, and BeIA Integrations Services, (ii) Home Audio Reference Platform (HARP), a BeIA-based reference platform or prototype for Internet-enabled home stereo devices, and (iii) BeOS, the Company’s operating system designed for digital media applications and serves as the development platform for BeIA.

The Company’s revenues to date have been primarily generated from the following sources: sale of BeOS to resellers and distributors, and direct sales of BeOS to end users through its BeDepot.com website. The Company also generated revenues by collecting commission from sales of third party software through its BeDepot.com website. In 2000, the Company shifted its resources to focus primarily on the market for Internet appliances and the further development and marketing of BeIA, its software solution intended for Internet appliances. At the same, time it announced that it would be making available at no charge a version of BeOS for personal use, and a more fully featured version would be available for a charge through third party publishers. During 2000, the Company discontinued sales of software through its BeDepot.com website. Since inception, the Company has experienced losses and negative cash flow from operations and expects to continue to experience significant negative cash flow in the foreseeable future.

These consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred losses since its inception and has an accumulated deficit at December 31, 2000 of $94.4 million. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

The Company believes that existing cash and cash equivalents will not be sufficient to meet the Company’s operating and capital requirements at its currently anticipated level of operations beyond the end of the second quarter of 2001. Additional capital will be necessary in order to fund the Company’s operations at the currently anticipated levels beyond the second quarter of 2001. While the Company is actively considering various funding alternatives, the Company has not secured or entered into any arrangements to obtain additional capital. There can be no assurance that the Company will be able to obtain additional funds on acceptable terms or at all. If the Company cannot raise additional capital to continue its present level of operations, it will have to scale back its business which could include, among other things, a reduction in its workforce. As a result, it may not be able to further develop or enhance its product offering, take advantage of future opportunities or respond to competitive pressures, any of which could have a material adverse effect on its business and results of operations. The Company’s liquidity may also be adversely affected in the future by factors such as higher interest rates, inability to borrow without collateral, availability of capital financing and continued operating losses.

The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

Index to Financial Statements

The functional currency of the Company’s foreign subsidiary is the U.S. dollar. Nonmonetary assets and liabilities are remeasured into U.S. dollars at historical rates, monetary assets and liabilities are remeasured at exchange rates in effect at the end of the year and income statement accounts are remeasured at average rates for the period. Remeasurement gains and losses of the Company’s foreign subsidiary are included in the results of operations and are not significant.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

The Company considers all highly liquid investments with an original or remaining maturities of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents are deposited with two major banks in the United States. Deposits in these banks may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on its deposits of its cash and cash equivalents.

Management has classified all of its short-term investments as available for sale. Realized gains and losses are calculated using the specific identification method. Realized gains and losses for the years ended December 31, 1999 and 2000 were not significant. Unrealized gains and losses at December 31, 1999 and 2000 are shown in the Consolidated Statements of Operations and Stockholders’ Equity (Deficit).

The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and notes payable approximate fair value due to their short maturities. The fair value of short-term investments is set forth in Note 3, “Balance Sheet Accounts”, of notes to the consolidated financial statements.

To date, the Company’s revenue has been derived entirely of sales of BeOS. In the first quarter of 2000, the Company shifted its resources to focus primarily on the market for Internet appliances and the further development and marketing of BeIA, its software solution intended for Internet appliances. The Company may be unsuccessful in its attempt to focus primarily on this market and has not yet recognized revenues from its BeIA product.

The Company’s success depends in large part on its ability to establish and maintain strategic relationships with industry-leading computer and consumer electronic companies, hardware and systems manufacturers, and Internet service and content providers. If the Company is unable to develop or maintain relationships with strategic partners and customers, it will have difficulty selling and gaining market acceptance for its products and its business and results of operations will be materially adversely affected.

The demand and acceptance of the Company’s product is dependent upon its ability to support a wide range of industry standards such as those used for streaming media and Internet browsing and access to key enabling technologies. These key technologies include a Web browser under license from one software vendor. If the

Index to Financial Statements

Company was to lose its rights to this Web browser or any other key technology incorporated into its products, it may be required to devote significant time and resources to replace such browser or other key technologies. This could, in turn, be costly, resulting in the unavailability or delay in the release of its products, and would materially adversely affect its business and operating results. The Company also licenses other enabling technologies for inclusion in its product, such as third party compression and decompression algorithms known as “codecs.” The Company may be unable to license these enabling technologies at favorable terms or at all which may result in lower demand for its products.

The Company depends on development tools provided by a limited number of third party vendors. Together with application developers, the Company relies primarily upon software development tools provided by two companies. If one or both of these companies fail to support or maintain these development tools, the Company will have to support the tools itself or transition to another vendor. Any maintenance or support of the tools by the Company or transition could be time consuming, could delay product release and upgrade schedule and could delay the development and availability of third party applications used on the Company’s products. Failure to procure the needed software development tools or any delay in availability of third party applications could negatively impact the Company’s ability and the ability of third party application developers to release and support its software solution and the applications that run it. These factors could negatively and materially affect the acceptance and demand for BeOS, its business and prospects.

Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, which is generally three years. Upon disposal, the cost of the asset and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in the results of operations.

Depreciation expense for the years ended December 31, 1999 and 2000 was $0.3 million in both years.

The Company reviews its property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount these assets may not be recoverable. Recoverability is measured by comparison of its carrying amount to future net cash flows the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future cash flows arising from the asset.

At each balance sheet date, the unamortized cost of purchased software is compared to the net realizable value of the related software product. The amount by which the unamortized cost exceeds the net realizable value of the software is charged to operations. The net realizable value of the software product is determined by estimating future gross revenues and reduced by the estimated future costs of selling the product.

The Company accounts for its income taxes in accordance with the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

Index to Financial Statements

Advertising costs, included in sales and marketing expenses, are expensed as incurred and were $0.2 million and $0.1 million, for the years ended December 31, 1999 and 2000, respectively.

Costs incurred in the research and development of new software products are expensed as incurred, including minimum payments made and due to third parties for technology incorporated into the Company’s product, until technological feasibility is established. Development costs are capitalized beginning when a product’s technological feasibility has been established and ending when the product is available for general release to customers. To date, products and enhancements have generally reached technological feasibility and have been released for sale at substantially the same time.

In the second half of 2000, the Company’s revenue was primarily derived from royalties on sales of BeOS by third party publishers. In prior periods, revenue was generated from licensing fees on sales to end-users either by direct-order on the Company’s website or sales by distributors.

The Company recognized product revenues from orders on the Company’s website upon shipment, provided a credit card authorization was received, the fee was fixed and determinable, collection of resulting receivables was probable and product returns were reasonably estimable. The Company used a standard shrink wrap license for all of its sales. Under the license, the Company was obligated to provide limited telephone support to end users who purchase the Company’s product and provided a 5-day money back guarantee. The Company accrued the costs of providing telephone support upon shipment of the product based on the historical cost of providing such support to its customers. In addition, upon shipment of its product, the Company recorded an allowance for estimated sales returns.

Product revenues for sales to its distributors were recognized upon sell through to an end user provided a signed contract existed, the fee was fixed and determinable and collection was probable. The Company recognized revenue from these distributors upon sale by the distributors to an end user because the Company did not have sufficient experience with the distributors to reasonably estimate returns.

During 1999, under certain circumstances, the Company offered an upgrade to its product in conjunction with product sales at no additional charge. Generally, such rights were offered prior to new versions being released and gave the customers who purchase products between established dates the right to such an upgrade. Revenue was allocated to an upgrade right based on the price for upgrades when sold separately. The Company recognized upgrade revenue when the criteria for product revenue recognition from end users set forth above are met.

At December 31, 1999, deferred revenue consisted of revenue related to distributor sales not sold through to end users. At December 31, 2000, deferred revenue consisted primarily of prepaid royalties for BeIA.

In December 1999, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101, or SAB 101, “Revenue Recognition in Financial Statements,” which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company adopted SAB 101 in the fourth quarter of 2000. The adoption of SAB 101 did not have a material impact on the Company’s financial position or results of operations in 2000.

Index to Financial Statements

The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, or APB 25, “Accounting for Stock Issued to Employees,” and Financial Accounting Standards Board Interpretation (“FIN”) No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,” and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, or SFAS 123, “Accounting for Stock-Based Compensation.” Under APB 25, compensation expense is based on the difference, if any, on the date of grant, between the estimated fair value of the Company’s common stock and the exercise price. SFAS 123 defines a “fair value” based method of accounting for an employee stock option or similar equity investment. The pro forma disclosures of the difference between the compensation expense included in net loss and the related cost measured by the fair value method are presented in Note 5. The Company accounts for equity instruments issued to nonemployees in accordance with the provisions of SFAS 123 and Emerging Issues Task Force 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”

In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, or FIN 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25.” FIN 44 clarifies the application of APB No. 25 for (i) the definition of employee for purposes of applying APB 25, (ii) the criteria for determining whether a plan qualifies as a noncompensatory plan, (iii) the accounting consequences of various modifications to the terms of a previously fixed stock option award, and (iv) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 was effective July 1, 2000, but certain conclusions cover specific events that occurred either after December 15, 1998, or January 12, 2000. The adoption of FIN 44 did not have a material impact on the results of operations or financial position of the Company.

Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The differences between net loss and comprehensive loss are shown in the Consolidated Statements of Operations.

Index to Financial Statements

Basic net loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of vested common shares outstanding for the period. Diluted net loss per common share is computed giving effect to all dilutive potential common shares, including options, warrants and preferred stock. Options, warrants and preferred stock were not included in the computation of diluted net loss per common share in 1999 and 2000 because the effect would be antidilutive. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per common share follows (in thousands, except per share data):

In June 1998, the Financial Accounting Standards Board, (“FASB”), issued Statement of Financial Accounting Standards (“SFAS”) No. 133, (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that the corresponding gains or losses be reported either in the statement of operations or as a deferred item depending on the type of hedge relationship that exists with respect of such derivatives. In July 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133 (“SFAS No. 137”). SFAS No. 137 deferred the effective date until fiscal years beginning after June 30, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for Derivative Instruments and Hedging Activities—An Amendment of FASB Statement 133 (“SFAS No. 138”). SFAS No. 138 amends the accounting and reporting standards for certain derivative activities such as net settlement contracts, foreign currency transactions and intercompany derivatives. The Company will adopt SFAS No. 133 effective January 1, 2001. To date, the Company has not engaged in derivative or hedging activities and does not expect the adoption of SFAS No. 133 and SFAS No. 138 to have a material impact on its financial position or results of operations.

Index to Financial Statements

In various areas, including revenue recognition and stock-based compensation accounting, standards and practices continue to evolve. The SEC continues to issue interpretative guidance relating to SAB 101, and the FASB and the Emerging Issues Task Force continue to address revenue and other related accounting issues. The management of the Company believes it is in compliance with all of the rules and related guidance as they currently exist. However, any changes to generally accepted accounting principles in these areas could impact the Company’s accounting for its operations.

Certain prior year amounts have been reclassified for consistency with current year financial statement presentation.

Index to Financial Statements

The Company leases its facilities under non-cancelable operating leases expiring at various dates through January, 2003. Future annual minimum lease payments as of December 31, 2000 are as follows (in thousands):

Total rent expense was $1.2 million and $1.3 million for the years ended December 31, 1999 and 2000, respectively.

Index to Financial Statements

In addition, the Company has entered into several technology licensing agreements, which include non-cancelable payments. These payments have been recorded at the net present value using a discount rate of 10% per annum. The future minimum payments under these agreement are as follows:

In November 2000, the Company’s stock transfer agent, Wells Fargo Bank Minnesota, N.A., received a demand letter from a stockholder alleging damages resulting form the transfer agent’s failure to timely issue its stock certificates. While the Company was not a party named in such demand letter and no claim has yet been filed with any court of competent jurisdiction, it is named as a party on the stockholder’s draft claim attached to the demand letter. The Company has been participating in communications with the parties in an effort to resolve the matter prior to a lawsuit being filed. Be management believes that the allegations as they relate to Be in the potential and draft claim are without merit and intends to vigorously defend Be against any potential future related legal action. However, there can be no assurance this threatened claim will be resolved without costly litigation, or require Be’s participation in the settlement of such claim, in a manner that is not adverse to its financial position, results of operations or cash flows. No estimate can be made of the possible loss or possible range of loss associated with the resolution of this contingency. If Be were held liable, it is the Company’s intent to seek reimbursement under its D&O insurance policy.

In July 1999, the Company completed its initial public offering and sold 6,000,000 shares of its common stock at a price of $6.00 per share. The Company received approximately $32.2 million in cash, net of underwriting discounts, commissions and other offering expenses. Simultaneously with the closing of the initial public offering, the Company’s mandatorily redeemable convertible preferred stock outstanding at December 31, 1998 automatically converted into 22,498,874 shares of common stock. The Company’s shares as of December 31, 2000 were traded on the NASDAQ national market system under the symbol “BEOS”.

In August 1999, the underwriters exercised their over-allotment option and the Company sold an additional 557,465 shares of its common stock at a price of $6.00 per share, thereby raising proceeds of approximately $3.1 million, net of underwriting discounts.

On closing of the Company’s initial public offering in July 1999, the mandatorily redeemable preferred stock automatically converted into 22,498,874 shares of common stock (see above).

Index to Financial Statements

Changes in the mandatorily redeemable convertible preferred stock during 1999 were as follows (in thousands):

The Company has issued fully exercisable warrants to purchase common stock. None of these warrants were exercised prior to 1999. Warrant activity can be analyzed as follows:

In 1992, the Company adopted a stock option plan (“1992 Plan”) under which 5,000 shares of the Company’s common stock had been reserved for issuance of stock options to employees, directors, or consultants under terms and provisions established by the Board of Directors. In 1997 and 1998, the Company reserved an additional 5,995,000 shares and 2,000,000 shares, respectively, for issuance under the 1992 Plan. Options granted under the 1992 Plan are immediately exercisable; however, shares exercised under the 1992 Plan are subject to the Company’s right of repurchase at the end of the holder’s association with the Company. The Company’s right of repurchase generally lapses as to 20% of the shares one year from the date of grant and 1/60th each month thereafter or as to 25% of the shares one year from the date of grant and 1/48th each month thereafter. The options expire ten years from the date of grant.

On March 30, 1999, the Board of Directors terminated the 1992 Plan. No further options will be granted under the 1992 Plan.

On March 30, 1999, the Company adopted the Equity Incentive Plan (“1999 Plan”) under which a total of up to 8,000,000 shares of common stock were initially reserved for issuance. This number of shares initially reserved was reduced by the 1,943,347 shares reserved for issuance under options then outstanding under the 1992 Plan. If any of these 1,943,437 options are cancelled, the number of shares reserved under the 1999 Plan will be increased by the number of such cancellations. In addition, at the end of each year, an additional number of shares will automatically be added to the number of shares already reserved for issuance under the 1999 Plan. This additional number of shares will be not more than the lesser of 5% of the number of shares of the Company’s issued and outstanding common stock as of year end or the number equal to 8% of the number of shares of common stock issued and outstanding at year end less the number of shares of common stock reserved

Index to Financial Statements

for issuance under the 1999 Plan but not subject to outstanding awards. The 1999 Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock purchase rights and stock bonuses to employees, consultants and directors. Incentive stock options may be granted only to employees. The exercise price of incentive stock options granted under the 1999 Plan must be at least equal to the fair market value of the Company common stock on the date of grant. The exercise price of non-qualified stock options is set by the administrator of the 1999 Plan, but can be no less than 85% of the fair market value. The maximum term of options granted under the 1999 Plan is ten years. Options granted under the terms of the 1999 Plan become exercisable as to 25% of the shares awarded after one year and 1/48th of the award monthly thereafter.

Activity under the Company’s Plans is set forth below (in thousands, except per share and share numbers):

At December 31, 1999 and 2000, 2,435,895 and 2,339,767 outstanding options were exercisable at weighted average exercise prices of $2.01 and $4.52. Of these shares, 848,685 shares and 295,869 shares at weighted average exercise prices of $0.33 and $0.33, respectively, are subject to the Company’s right of repurchase upon exercise. In addition, 499,069 and 221,743 shares of the Company’s outstanding common stock is subject to the Company’s right of repurchase at weighted average prices of $0.24 and $0.29, respectively.

On March 30, 1999 the Board of Directors also adopted the Non-Employee Directors’ Stock Option Plan (“Directors’ Plan”), and reserved a total of 1,500,000 shares of common stock for issuance thereunder. The exercise price of options under the Directors’ Plan will be equal to the fair market value of the common stock on the date of grant. The maximum term of the options granted under the Directors’ Plan is ten years. Each initial grant under the Directors’ Plan will vest at 1/4th of the shares subject to the option one year after the date of grant and 1/48th of the shares each month thereafter. The rate of vesting of each subsequent grant will be 1/48th of the shares on a monthly schedule after the date of grant. The Board may amend (subject to stockholder approval as necessary) or terminate the Directors’ Plan at any time.

Index to Financial Statements

Activity under the 1999 Non-Employee Director’s Stock Option Plan is set forth below (in thousands, except per share and share numbers):

At December 31, 1999 and 2000, zero and 285,416 options outstanding were exercisable at weighted average exercise prices of zero and $5.08, respectively.

The options outstanding and currently exercisable by exercise price at December 31, 2000 are as follows:

In accordance with the requirements of APB 25, the Company has recorded deferred compensation for the difference between the exercise price of the stock options granted before its initial public offering and the fair market value of the Company’s stock at the date of grant. This deferred compensation is amortized to expense over the period during which the Company’s right to repurchase the stock lapses or the options become exercisable, generally four or five years, using the multiple options method.

At December 31, 2000, the Company had recorded deferred compensation related to these options in an amount of $15.8 million (net of cancellations), of which $6.2 million and $2.6 million had been amortized to expense during fiscal years 1999 and 2000, respectively.

During 1999, options to purchase 4,173,000 shares of the Company’s common stock were granted with exercise prices below the estimated market value at the date of grant; the weighted average exercise prices were

Index to Financial Statements

$4.98 per share and the deemed weighted average market values of the common stock was $6.81 per share. During 2000, all options were granted with an exercise price equal to the fair market value of the underlying common stock on the date of grant.

The fair value of each option grant is estimated on the date of grant using a type of Black-Scholes option pricing model with the following assumptions used for grants:

For the period prior to the Company’s Initial Public Offering, volatility for the purposes of the SFAS No. 123 calculation was 0%.

Based on the above assumptions, the aggregate fair value and weighted average fair value per share of options granted in during fiscal years 1999 and 2000 were $13.9 million and $29.4 million, and $2.77 and $7.24, respectively.

On May 4, 1999, the Company adopted an Employee Stock Purchase Plan (“Purchase Plan”). The Company has reserved a total of 1,500,000 shares of common stock for issuance under the Purchase Plan. Under the terms of the Purchase Plan, employees who work at least 20 hours a week and have been employed for at least five months in a calendar year may contribute, during an offering period, a specified percentage, not to exceed 15% of their compensation to purchase shares of common stock of the Company. Each offering period runs for a period of 24 months and will be divided into consecutive purchase periods of approximately six months. New offering periods commence every six months on August 1st and February 1st each year.

The price of the common stock purchased under the Purchase Plan is equal to 85% of the fair market value of the common stock on the first day of the applicable offering period or the last day of the applicable purchase period, whichever is lower. No person may purchase shares under the Purchase Plan to the extent that such person would own 5% or more of the total combined value or voting power of all classes of the capital stock of the Company or to the extent that such person’s rights to purchase stock under stock purchase plans would accrue at a rate in excess of $25,000 per year.

The first purchases under the Plan occurred in 2000, during which 166,914 shares were issued under the plan at a weighted average purchase price of $4.21. At December 31, 2000, 1,333,086 shares were reserved for future issuance under the plan, respectively.

Index to Financial Statements

Under SFAS No. 123, compensation cost is also recognized for the fair value of employee’s purchase rights under the Purchase Plan, which was estimated using the following assumptions:

Based on the above assumptions, the aggregate fair value and weighted average fair value per share of those purchase rights granted in 1999 and 2000 was $0.1 million and $0.4 million, and $1.94 and $3.45, respectively.

Had compensation cost been determined based on the fair value at the grant date for the awards made in 1995 and thereafter under the Company’s stock option plans and employee stock purchase plan consistent with the provisions of SFAS No. 123, the Company’s net loss would have been as follows (in thousands, except per share amounts):

Such pro forma disclosures may not be representative of future compensation cost because options vest over several years and additional grants are made each year.

Due to uncertainty surrounding the realization of the favorable tax attributes in future tax returns, the Company has placed a valuation allowance against its net deferred tax assets. The valuation allowance increased $7.9 million in December 31, 1999 and $9.4 million in December 31, 2000.

Index to Financial Statements

The principal items accounting for the difference between income taxes benefit at the U.S. statutory rate and the benefit from income taxes reflected in the statement of operations are as follows (in thousands):

At December 31, 2000, the Company had approximately $73.4 million of net operating loss carryforwards and $1.3 million of research and development credits to offset future federal income taxes. The Company also had $43.4 million of net operating loss carryforwards and $0.5 million of research and development credits to offset future state income taxes. In addition to the net operating loss carryforwards referred to above, there are approximately $6.9 million of net operating loss carryforwards for federal purposes and $3.5 million of net operating loss carryforwards for state purposes as of December 31, 2000, which relate to stock option deductions. The tax benefit of these additional losses will be credited to additional paid in capital if the Company’s deferred tax asset is recognized. These carryforwards expire in the years 2005 through 2020 if not utilized. Due to changes in ownership, the Company’s net operating loss and credit carryforwards may become subject to certain annual limitations.

The Company has a 401(k) Profit Sharing Plan which covers all employees. Under the plan, employees are permitted to contribute up to 15% of gross compensation not to exceed the annual limitation for any plan year ($10,500 in 2000). Discretionary contributions may be made by the Company. No contributions were made by the Company during fiscal years 1999 and 2000.

Management uses one measurement of profitability for its business. The Company markets its products and related services to customers in the United States, Europe and Asia.

All long lived assets are maintained in the United States. Revenue information by geographic area is as follows (in thousands):

Index to Financial Statements

On August 16, 2001, the Board of Directors of the Company unanimously adopted resolutions approving the sale of substantially all of the Company’s intellectual property and other technology assets (the “Asset Sale”) to ECA Subsidiary Acquisition Corporation, a Delaware corporation and an indirect wholly owned subsidiary of Palm, Inc. (“Palm”), pursuant to an Asset Purchase Agreement dated August 16, 2001.

On October 9, 2001, the Company filed a definitive proxy statement soliciting stockholder approval for the Asset Sale and the dissolution of the Company pursuant to a plan of dissolution (the “Plan of Dissolution”). The Plan of Dissolution provides for the orderly liquidation of Be’s remaining assets, the winding-up of Be’s business and operations and the dissolution of the Company. In accordance with the terms of the Plan of Dissolution, Be will pay, or provide for the payment of, all of its liabilities and obligations following the approval of the Board to proceed with the liquidation and dissolution of the company. If there are any remaining assets after the payment, or the provision for payment, of all of its liabilities and obligations, Be will then distribute such assets to its stockholders in one or more distributions.

At a special meeting of stockholders held on November 12, 2001, the stockholders of Be approved the Asset Sale and the Plan of Dissolution. The Asset Sale was completed on November 13, 2001. Under the terms of the Purchase Agreement, Be received an aggregate of 4,104,478 shares of Palm common stock valued at approximately $11,000,000 on the closing date of the transaction.

On March 15, 2002, the Company filed a certificate of dissolution with the Delaware Secretary of State in accordance with the plan of dissolution approved by stockholders on November 12, 2001 and as set forth in the Definitive Proxy Statement filed on October 9, 2001. Although the Company filed a certificate of dissolution on March 15, 2002 with the State of Delaware, the Company will continue to exist for three years following this date or for such longer period as the Delaware Court of Chancery shall direct for the purpose of prosecuting and defending lawsuits and enabling the Company to close its business, to dispose of its property, to discharge its liabilities and to distribute to its stockholders any remaining assets.

Additionally, Be’s common stock was delisted from the NASDAQ National Market effective March 15, 2002.

On February 15, 2002, Be engaged Susman Godfrey LLP on a contingency basis to bring forth claims against Microsoft Corporation for the destruction of Be’s business resulting from anticompetitive business practices. On February 19, 2002, the Company filed a lawsuit in the United States District Court in San Francisco alleging, among other things, Microsoft harmed Be through a series of illegal, exclusionary and anticompetitive acts designed to maintain its monopoly in the Intel-compatible PC operating system market and created exclusive dealing arrangements with PC OEMs prohibiting the sale of PCs with multiple preinstalled operating systems. On August 21, 2002, the Judicial Panel on Multidistrict Litigation ordered the lawsuit against Microsoft transferred to the federal district court for the District of Maryland in Baltimore, to be coordinated by Judge Frederick Motz.

On September 5, 2003, Be announced a settlement with Microsoft Corporation. Under the terms of the settlement agreement Microsoft is required to pay Be approximately $23 million to end further litigation, with each party agreeing to a general release of claims against the other.

Be is currently in the process of completing its dissolution pursuant to the plan that was approved by Be’s stockholders in November 2001. In accordance with that plan and upon completion of its dissolution, Be’s net cash will be distributed to shareholders of record as of March 15, 2002, after payment of any taxes, officer’s and directors’ compensation, and other expenses, and the satisfaction of any and all of Be’s remaining liabilities.

Index to Financial Statements

Be Incorporated (the “Company” or “Be”) was founded in 1990. Be offers software solutions designed for Internet appliances and digital media applications. An Internet appliance is a dedicated device designed specifically to access information from the Internet for a given purpose. An Internet appliance’s hardware and software are seamlessly integrated together to provide users with a responsive and easy to use interface. Be’s software solutions are BeIA: the Complete Internet Appliance Solution^(TM) and BeOS, its operating system designed for digital media applications. In early 2000, Be shifted the primary focus of its business from the marketing and distribution of BeOS, its desktop operating system, to the development, marketing and deployment of BeIA, its software solution intended for Internet appliances. Be shifted its focus as a result of the intense competition in the market for the BeOS operating system, the anticipated market for the BeIA product and the limited resources available to Be for the development and marketing of its products. BeIA gives customers the ability to create customized Internet appliances that deliver unique services, information and entertainment to their targeted end users. Unfortunately, the Internet appliance market as a whole has failed to materialize as anticipated. Consumer response to early Internet appliances has been unenthusiastic. Major manufacturers have either removed their products from the market or have not undertaken significant development efforts, and the economic realities of the last four quarters have made success even more difficult. Despite Be’s efforts in the Internet appliance market, its financial difficulties have continued, and Be has been unable to generate revenues sufficient to meet operating expenses.

On August 16, 2001, Be entered into an asset purchase agreement with Palm, Inc., a Delaware corporation headquartered in Santa Clara, California, and ECA Subsidiary Acquisition Corporation, a wholly owned subsidiary of Palm. Under the terms of the asset purchase agreement, Be will sell substantially all of its intellectual property and other technology assets (“Asset Sale”), including those related to its BeOS and BeIA operating systems, to Palm and will receive an aggregate number of shares of Palm common stock equal in value to $11.0 million, as determined on the closing date of the transaction and subject to the approval of Be’s stockholders. A special meeting of Be’s stockholders is scheduled to be held on November 12, 2001, whereby stockholders of record shall consider and vote upon (i) the approval of the asset sale with Palm and (ii) the approval of the dissolution of Be through adoption of a plan of dissolution.

Under the proposed Asset Sale, Be will sell substantially all of its intellectual property and other technology assets. As a result, the remaining technology assets will not be used to generate any future cash flows. According to SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to be Disposed Of, an entity shall recognize an impairment loss when expected future cash in flows is less than the carrying amount of the asset. Therefore, Be decided to write-off the outstanding balance of its technology license assets of $0.5 million at September 30, 2001.

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

The condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) applicable to interim financial information. Certain information and footnote disclosures included in financial statements prepared in accordance with generally accepted accounting principles have been omitted in these interim statements pursuant to such SEC rules and regulations. Management recommends that these interim financial statements be read in conjunction with the audited financial statements of the Company for the year ended December 31, 2000 and the notes thereto contained in the Company’s Annual Report on Form 10-K. The December 31, 2000 balance sheet was derived

Index to Financial Statements

from audited financial statements, but does not include all disclosures required by generally accepted accounting principles.

In management’s opinion, the condensed consolidated financial statements include all adjustments necessary to present fairly the financial position and results of operations for each interim period shown. Interim results are not necessarily indicative of results to be expected for a full fiscal year.

If the Asset Sale is not completed, it is likely that Be will file for or be forced to resort to bankruptcy protection. If the Asset Sale is completed, Be intends to wind up its business and pay, or provide for the payment of, all of its outstanding liabilities and obligations in accordance with applicable law and the plan of dissolution. Until it winds up its business, Be will continue to experience losses from operations and negative cash flows and will continue to require working capital to fund its remaining operations. Be believes that existing cash and cash equivalents will not be sufficient to meet operating and capital requirements at its currently anticipated level of operations beyond the end of fiscal 2001.

The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

In September 1998, the Financial Accounting Standards Board, (“FASB”), issued Statement of Financial Accounting Standards No. 133, (SFAS No. 133), “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. SFAS No. 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that the corresponding gains or losses be reported either in the statement of operations or as a deferred item depending on the type of hedge relationship that exists with respect of such derivatives. In July 1999, the FASB issued SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133 (“SFAS No. 137”). SFAS No. 137 deferred the effective date until fiscal years beginning after September 30, 2000. In September 2000, the Financial Accounting Standards Board issued SFAS No. 138, “Accounting for Derivative Instruments and Hedging Activities—An Amendment of FASB Statement 133 (“SFAS No. 138”) SFAS No. 138 amends the accounting and reporting standards for certain derivative activities such as net settlement contracts, foreign currency transactions and intercompany derivatives. The Company’s implementation of SFAS No. 133 since January 1, 2001, has not had a material impact on its financial position or results of operations.

In September 2001, the FASB unanimously approved the issuance of two statements, Statement of SFAS No. 141, “Business Combinations,” and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses financial accounting and reporting for business combinations and amends APB No. 16 “Business Combinations.” It requires the purchase method of accounting for business combinations initiated after September 30, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB No. 17, “Intangible Assets.” It changes the accounting for goodwill from an amortization method to an impairment only approach. It is effective for fiscal year beginning after December 15, 2001. Early adoption of SFAS No. 142 is permitted for companies with a fiscal year beginning after March 15, 2001. The adoption of these statements is not expected to have a significant impact on the Company’s financial position and results of operations.

In October 2001, the FASB SFAS No. 144, Accounting for the Impairment or Disposal of Long lived Assets, which is required to be applied starting with fiscal years beginning after December 12, 2001. SFAS No. 144 requires among other things, the application of one accounting model for long lived assets that are

Index to Financial Statements

impaired or to be disposed of by sale. The adoption of SFAS No. 144 is not expected to have a significant impact on the Company’s financial statements.

Basic net loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of vested common shares outstanding for the period. Diluted net loss per common share is computed giving effect to all dilutive potential common shares, including options, warrants and unvested common shares. Options, warrants and unvested common shares were not included in the computation of diluted net loss per common share because the effect would be antidilutive. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per common share follows (in thousands, except per share data):

Statement of Financial Accounting Standard No. 130, (“SFAS 130”), Reporting Comprehensive Income establishes rules for reporting and display of comprehensive income (loss) and its components. The following are the components of comprehensive loss (in thousands):

The components of accumulated other comprehensive income, net of related tax are as follows (in thousands):

Index to Financial Statements

On April 2, 2001, the Company announced its decision, made at the end of the first quarter, to restructure its operations to reflect current market and financial conditions by closing its European office in Paris and eliminating positions principally in the Company’s sales, marketing and general administration departments in the United States. As a result, the Company recorded a restructuring charge of $0.3 million in the first quarter for the closing of its European office, which is comprised of $0.3 million for involuntary termination benefits and $35,000 for termination of operating contracts and professional fees. The Company recorded a restructuring charge of approximately $0.1 million in the second quarter for the involuntary termination benefits related to the elimination of 22 positions in the U.S. At September 30, 2001, this restructuring plan was substantially completed and all amounts had been paid.

On July 31, 2001, the Company announced the elimination of 28 positions. In addition to the elimination of the sales and marketing departments, positions in administration and engineering were also affected. The eliminated positions represent approximately 33% of the Company’s existing workforce. The Company’s remaining 57 positions are primarily engaged in product development. The Company did not incur any associated restructuring charge.

In November 2000, the Company’s stock transfer agent, Wells Fargo Bank Minnesota, N.A., received a demand letter from Financial Square Partners, a Be stockholder, alleging damages resulting from the transfer agent’s failure to timely issue its stock certificates. While Be was not a party named in such demand letter, Be was named as a party on the stockholder’s draft claim attached to the demand letter. On May 9, 2001, the claim was in fact filed, naming Be and Wells Fargo Bank Minnesota, N.A. as defendants, and is currently active in the Superior Court of California. The stockholder is seeking damages in the amount of approximately $2.4 million. Prior to this filing, the Company had been participating in communications with the parties in an effort to resolve the matter prior to a lawsuit being filed.

Be management continues to believe that the allegations as they relate to Be in the filed claim are without merit and intends to defend Be against this legal action. However, there can be no assurance this claim will be resolved without costly litigation, or require Be’s participation in the settlement of such claim, in a manner that is not adverse to its financial position, results of operations or cash flows. No estimate can be made of the possible loss or possible range of loss associated with the resolution of this contingency. If Be were held liable, it is its intent to seek reimbursement under its D&O insurance policy.

On August 16, 2001, the Company entered into a definitive agreement with Palm, Inc. for the sale of substantially all of its intellectual property and other technology assets for a purchase price of $11 million, to be paid in common stock of Palm, Inc. Closing of the transaction is subject to the satisfaction of certain conditions, including obtaining approval of the stockholders of the Company.

A Special Meeting of stockholders has been scheduled for November 12, 2001 seeking approval of (1) the sale of substantially all of Be’s intellectual property and other technology assets to ECA Subsidiary Acquisition Corporation, a wholly owned subsidiary of Palm, Inc., and (2) the subsequent dissolution of Be pursuant to a plan of dissolution.

Index to Financial Statements

On October 9, 2001, the Company filed a definitive proxy statement soliciting stockholder approval for the Asset Sale (See Note 1, Organization and Business) and the dissolution of the Company pursuant to a plan of dissolution (the “Plan of Dissolution”). The Plan of Dissolution provides for the orderly liquidation of Be’s remaining assets, the winding-up of Be’s business and operations and the dissolution of the Company. In accordance with the terms of the Plan of Dissolution, Be will pay, or provide for the payment of, all of its liabilities and obligations following the approval of the Board to proceed with the liquidation and dissolution of the company. If there are any remaining assets after the payment, or the provision for payment, of all of its liabilities and obligations, Be will then distribute such assets to its stockholders in one or more distributions.

Additionally, Be’s common stock was delisted from the NASDAQ National Market effective March 15, 2002.

Index to Financial Statements

This AGREEMENT AND PLAN OF REORGANIZATION (this “Agreement”) is made and entered into as of June 4, 2003, by and among Palm, Inc., a Delaware corporation (“Parent”), Peace Separation Corporation, a Delaware corporation and direct wholly-owned subsidiary of Parent (“Separation Sub”), Harmony Acquisition Corporation, a Delaware corporation and direct wholly-owned subsidiary of Parent (“Merger Sub”) and Handspring, Inc., a Delaware corporation (the “Company”).

A. The parties contemplate a transaction pursuant to which (i) the common stock of PalmSource, Inc., a Delaware corporation (“Source”), held by Parent will be distributed to the existing stockholders of Parent by means of the merger of Separation Sub with and into Parent (the “Parent Merger”) and (ii) following such distribution, the remaining business of Parent and the Company will be combined in a business combination transaction by means of the merger of Merger Sub with and into the Company (the “Company Merger”). The Parent Merger and the Company Merger are sometimes collectively referred to herein as the “Mergers.”

B. The Board of Directors of Parent has unanimously approved, in accordance with applicable provisions of the laws of the state of Delaware (“Delaware Law”), this Agreement and the transactions contemplated hereby, including the Mergers and the issuance of Parent Common Stock (as defined in Section 1.8(a)) in connection with the Company Merger.

C. The Board of Directors of Parent has unanimously resolved to recommend to its stockholders adoption and approval of this Agreement and approval of the Parent Merger and approval of the issuance of Parent Common Stock in connection with the Company Merger.

D. The Board of Directors of the Company has unanimously approved, in accordance with applicable provisions of Delaware Law, this Agreement and the transactions contemplated hereby, including the Company Merger.

E. The Board of Directors of the Company has unanimously resolved to recommend to its stockholders adoption and approval of this Agreement and approval of the Company Merger.

F. The Board of Directors of Separation Sub has unanimously approved, in accordance with applicable provisions of Delaware Law, this Agreement and the transactions contemplated hereby, including the Parent Merger.

G. Parent, as the sole stockholder of Separation Sub, has approved and adopted this Agreement and approved the Parent Merger.

H. The Board of Directors of Merger Sub has unanimously approved, in accordance with applicable provisions of Delaware Law, this Agreement and the transactions contemplated hereby, including the Company Merger.

Index to Financial Statements

I. Parent, as the sole stockholder of Merger Sub, has approved and adopted this Agreement and approved the Company Merger.

J. Concurrent with the execution and delivery of this Agreement, and as a material inducement for Parent to consummate the Mergers, (i) certain employees of the Company identified on Schedule 6.3(e) are accepting offers of employment from Parent, contingent upon the Closing (as defined in Section 1.3) and (ii) certain stockholders of the Company are entering into non-competition and non-solicitation agreements substantially in the form attached hereto as Exhibit A (the “Non-Competition Agreement”) with Parent, each of which shall become effective as of the Effective Time of the Company Merger (as defined in Section 1.4).

K. Concurrent with the execution and delivery of this Agreement, and as a material inducement for Parent to consummate the Mergers, certain stockholders who are executive officers, directors and principal stockholders of the Company are executing and delivering to Parent voting agreements and irrevocable proxies (the “Company Voting Agreements”), substantially in the form attached hereto as Exhibit B-1 and Exhibit B-2.

M. Concurrent with the execution and delivery of this Agreement, and as a material inducement for Parent to consummate the Mergers, certain stockholders who are executive officers, directors and principal stockholder of the Company are executing and delivering to the Parent transfer restriction agreements (the “Company Transfer Agreements”), substantially in the form attached hereto as Exhibit C-1 and Exhibit C-2.

N. Concurrent with the execution and delivery of this Agreement, and as a material inducement for the Company to consummate the Company Merger, certain stockholders who are executive officers and directors of Parent are executing and delivering to the Company voting agreements and irrevocable proxies (the “Parent Voting Agreements”), substantially in the form attached hereto as Exhibit D.

O. Concurrent with the execution and delivery of this Agreement, and as a material inducement for the Company to consummate the Company Merger, Parent and the Company are entering into that certain Loan Agreement, substantially in the form attached hereto as Exhibit E (the “Loan Agreement”), and the Company is entering into that certain Security Agreement, substantially in the form attached as Exhibit A to the Loan Agreement, in favor of Parent.

P. For United States federal income tax purposes, Parent intends that the distribution of Source Common Stock to the stockholders of Parent pursuant to Sections 1.8(a) and 1.10(b) qualify as a tax-free distribution under Section 355 of the Internal Revenue Code of 1986, as amended (the “Code”).

Q. For United States federal income tax purposes, the parties intend that the Company Merger qualify as a reorganization under the provisions of Section 368(a) of the Code, and the parties intend, by executing this Agreement, to adopt a plan of reorganization within the meaning of Treasury Regulations Sections 1.368-2(g) and 1.368-3.

NOW, THEREFORE, in consideration of the covenants, promises and representations set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:

Index to Financial Statements

1.1 The Parent Merger. Subject to and upon the terms and conditions of this Agreement and the applicable provisions of Delaware Law, Parent shall cause a certificate of merger to be filed with the Secretary of State of the State of Delaware in accordance with the relevant provisions of Delaware Law (the “Parent Certificate of Merger”) providing for the Parent Merger. Upon the Parent Merger, the separate corporate existence of Separation Sub shall cease and Parent shall continue as the surviving corporation in the Parent Merger (Parent, as the surviving corporation in the Parent Merger, is sometimes referred to herein as the “Surviving Corporation in the Parent Merger”).

1.2 The Company Merger. Subject to and upon the terms and conditions of this Agreement and the applicable provisions of Delaware Law, and following filing of the Parent Certificate of Merger, the Company shall cause a certificate of merger to be filed with the Secretary of State of the State of Delaware in accordance with the relevant provisions of Delaware Law (the “Company Certificate of Merger”) providing for the Company Merger. The Company Certificate of Merger shall provide that the Company Merger shall only be effective upon consummation of the Parent Merger. Upon the Company Merger, the separate corporate existence of Merger Sub shall cease and the Company shall continue as the surviving corporation in the Company Merger (the Company, as the surviving corporation in the Company Merger, is sometimes referred to herein as the “Surviving Corporation in the Company Merger”).

1.3 Closing. Subject to the provisions of this Agreement, including the satisfaction of the conditions set forth in Article VI, the closing of the transactions contemplated hereby (the “Closing”) shall take place at the offices of Wilson Sonsini Goodrich & Rosati, Professional Corporation, located at 650 Page Mill Road, Palo Alto, California 94304, at a time and date to be specified by the parties, which shall be no later than the second business day after the satisfaction or waiver of the conditions set forth in Article VI, or at such other time, date and location as the parties hereto agree in writing (the “Closing Date”).

1.4 Effective Time. As soon as practicable following the Closing, the parties hereto shall cause the Mergers to be consummated by filing the Parent Certificate of Merger and the Company Certificate of Merger with the Secretary of State of the State of Delaware in such form as is required by, and executed and acknowledged in accordance with, the applicable provisions of Delaware Law. The Parent Merger shall become effective at the date and time at which the Parent Certificate of Merger is duly filed with the Secretary of State of the State of Delaware in accordance with the applicable provisions of Delaware Law or such subsequent date and time as the parties hereto shall mutually agree and as shall be specified in the Parent Certificate of Merger (the “Effective Time of the Parent Merger”). The Company Merger shall become effective (and the Company Certificate of Merger shall state the Company Merger shall become effective) immediately following the Parent Merger or such subsequent date and time as the parties hereto shall mutually agree and as shall be specified in the Company Certificate of Merger (the “Effective Time of the Company Merger”).

1.5 Effects of the Mergers. At the Effective Time of the Parent Merger, the effect of the Parent Merger shall be as provided in this Agreement and the applicable provisions of Delaware Law. At the Effective Time of the Company Merger, the effect of the Company Merger shall be as provided in this Agreement and the applicable provisions of Delaware Law.

Index to Financial Statements

(a) Parent. At the Effective Time of the Parent Merger, the Certificate of Incorporation of Parent, as in effect immediately prior to the Effective Time of the Parent Merger, shall be the Certificate of Incorporation of the Surviving Corporation in the Parent Merger until thereafter amended as provided by law and such Certificate of Incorporation of the Surviving Corporation in the Parent Merger. At the Effective Time of the Parent Merger, the Bylaws of Parent, as in effect immediately prior to the Effective Time of the Parent Merger, shall be the Bylaws of the Surviving Corporation in the Parent Merger until thereafter amended as provided by law and such Bylaws of the Surviving Corporation in the Parent Merger.

(b) Company. At the Effective Time of the Company Merger, the Certificate of Incorporation of the Company shall be amended and restated in its entirety to be identical to the Certificate of Incorporation of Merger Sub, as in effect immediately prior to the Effective Time of the Company Merger, until thereafter amended in accordance with Delaware Law and as provided in such Certificate of Incorporation of Merger Sub; provided, however, that at the Effective Time of the Company Merger, Article I of the Certificate of Incorporation of the Surviving Corporation in the Company Merger shall be amended and restated in its entirety to read as follows: “The name of the corporation is Handspring, Inc.” At the Effective Time of the Company Merger, the Bylaws of the Company shall be amended and restated in their entirety to be identical to the Bylaws of Merger Sub, as in effect immediately prior to the Effective Time of the Company Merger, until thereafter amended in accordance with Delaware Law and as provided in such Bylaws of the Surviving Corporation in the Company Merger.

(a) Parent. Subject to Section 5.18, the initial directors of the Surviving Corporation in the Parent Merger shall be the directors of Parent immediately prior to the Effective Time of the Parent Merger, until their respective successors are duly elected or appointed and qualified. The initial officers of the Surviving Corporation in the Parent Merger shall be the officers of Parent immediately prior to the Effective Time of the Parent Merger, until their respective successors are duly appointed.

(b) Company. The initial directors of the Surviving Corporation in the Company Merger shall be the directors of Merger Sub immediately prior to the Effective Time of the Company Merger, until their respective successors are duly elected or appointed and qualified. The initial officers of the Surviving Corporation in the Company Merger shall be the officers of Merger Sub immediately prior to the Effective Time of the Company Merger, until their respective successors are duly appointed.

1.8 Effect of Parent Merger on Capital Stock. Subject to the terms and conditions of this Agreement, at the Effective Time of the Parent Merger, by virtue of the Parent Merger and without any action on the part of Parent, Separation Sub, Merger Sub or the Company or the holders of any shares of capital stock of the Parent, the following shall occur:

(a) Parent Common Stock. Each share of the Common Stock, par value $0.001 per share, of Parent (together with the associated Parent Right (as defined in Section 3.2(a)) under the Parent Rights Agreement (as defined in Section 3.2(a)) (“Parent Common Stock”) issued and outstanding immediately prior to the Effective Time of the Parent Merger will be automatically converted into

Index to Financial Statements

(i) one validly issued, fully paid and nonassessable share of Parent Common Stock (together with the associated Parent Right) and (ii) the right to receive a number of shares of the Common Stock, par value $0.001 per share of Source (“Source Common Stock”) currently outstanding and held by Parent such that all shares of Source Common Stock outstanding and held by Parent immediately prior to the Effective Time of the Parent Merger are distributed to all holders of Parent Common Stock issued and outstanding immediately prior to the Effective Time of the Parent Merger, on a pro rata basis (based on the number of shares of Parent Common Stock held).

(b) Parent Restricted Stock. If any shares of Parent Common Stock are unvested or are subject to a repurchase option, risk of forfeiture or other condition under any applicable restricted stock purchase agreement or other agreement with Parent (“Parent Restricted Stock”), then the shares of Parent Common Stock shall remain unvested and subject to the same repurchase option, risk of forfeiture or other condition, and the certificates representing such shares of Parent Common Stock will accordingly continue to be marked with appropriate legends.

(c) Capital Stock of Separation Sub. Each share of common stock, par value $0.001, of Separation Sub (the “Separation Sub Common Stock”) issued and outstanding immediately prior to the Effective Time of the Parent Merger shall be canceled and extinguished without any conversion thereof, and no consideration shall be issued in exchange therefor.

(d) Stock Options; Employee Stock Purchase Plan. At the Effective Time of the Parent Merger, all options to purchase Parent Common Stock then outstanding shall either continue in effect at the Surviving Corporation in the Parent Merger or be assumed by the Surviving Corporation in the Parent Merger, as necessary, in accordance with Section 5.9(a). At the Effective Time of the Parent Merger, rights outstanding under Parent’s 1999 Employee Stock Purchase Plan (the “Parent Purchase Plan”) shall remain outstanding and exercisable for Parent Common Stock without alteration.

(e) Fractional Shares. No fraction of a share of Source Common Stock will be issued by virtue of the Parent Merger, but in lieu thereof each holder of shares of Parent Common Stock who would otherwise be entitled to a fraction of share of Source Common Stock (after aggregating all fractional shares of Source Common Stock that would otherwise be received by such holder) shall receive from Parent an amount of cash (rounded to the nearest whole cent), without interest, equal to the product of: (i) such fraction, multiplied by (ii) the average closing price of one share of Source Common Stock for the five (5) most recent trading days that Source Common Stock has traded following the Effective Time of the Parent Merger, as reported by The Nasdaq Stock Market, Inc.’s National Market (“Nasdaq”). Notwithstanding the foregoing, at the election of Parent in its sole discretion, each holder of shares of Parent Common Stock who would otherwise have been entitled to receive a fraction of a share of Source Common Stock shall receive from the Exchange Agent (as defined in Section 1.11(a)) a cash payment in lieu of such fractional share of Source Common Stock representing such holder’s proportionate interest in the net proceeds from the sale by the Exchange Agent in one or more transactions (which sale transactions shall be made at such times, in such manner and on such terms as the Exchange Agent shall determine in its reasonable discretion) on behalf of all such holders of the aggregate of the fractional shares of Source Common Stock, as applicable, which would otherwise have issued (the “Excess Source Common Stock”). The sale of the Excess Source Common Stock by the Exchange Agent shall be executed on Nasdaq and shall be executed in round lots to the extent practicable. Until the proceeds of such sale or sales have been distributed to the holders of Parent Common Stock, the Exchange Agent shall hold such proceeds for the benefit of such holders

Index to Financial Statements

without liability or obligation to invest such amounts or to pay interest thereon to such holders. Parent shall reimburse the Exchange Agent for all reasonable commissions, transfer taxes and other out-of-pocket transaction costs, including expenses incurred and commissions paid by the Exchange Agent in connection with the sale of the Excess Source Common Stock. The Exchange Agent shall determine the portion of such net proceeds to which each holder of shares of Parent Common Stock shall be entitled, if any, by multiplying the amount of the aggregate net proceeds by a fraction the numerator of which is the amount of the fractional share interest of Source Common Stock to which such holder of shares of Parent Common Stock is entitled (after taking into account all shares of Source Common Stock to be received held by such holder) and the denominator of which is the aggregate amount of fractional interests to which all holders of certificates representing shares of Source Common Stock are entitled.

1.9 Effect of Company Merger on Capital Stock. Subject to the terms and conditions of this Agreement, at the Effective Time of the Company Merger, by virtue of the Company Merger and without any action on the part of Parent, Separation Sub, Merger Sub or the Company or the holders of any shares of capital stock of the Company, the following shall occur:

(a) Company Common Stock. Each share of the Common Stock, par value $0.001 per share, of the Company (together with any associated Company Right (as defined in Section 5.15) under the Company Rights Agreement (as defined in Section 5.15)) (“Company Common Stock”) issued and outstanding immediately prior to the Effective Time of the Company Merger, other than any shares of the Company Common Stock to be canceled pursuant to Section 1.9(c), will be canceled and extinguished and automatically converted (subject to Section 1.9(f)) into the right to receive 0.09 of a validly issued, fully paid and nonassessable share (the “Exchange Ratio”) of Parent Common Stock upon surrender of the certificate representing such share of the Company Common Stock in the manner provided in Section 1.11 (or in the case of a lost, stolen or destroyed certificate, upon delivery of an affidavit (and bond, if required) in the manner provided in Section 1.13).

(b) Company Restricted Stock. If any shares of Company Common Stock are unvested or are subject to a repurchase option, risk of forfeiture or other condition under any applicable restricted stock purchase agreement or other agreement with the Company (“Company Restricted Stock”), then, except as otherwise provided in such restricted purchase agreement or other agreement relating to such Company Restricted Stock, the shares of Parent Common Stock issued in exchange for such shares of the Company Restricted Stock will also be unvested and subject to the same repurchase option, risk of forfeiture or other condition, and the certificates representing such shares of Parent Common Stock may accordingly be marked with appropriate legends. The Company shall take all action that may be necessary to ensure that, except as otherwise provided in such restricted purchase agreement or other agreement relating to such Company Restricted Stock, from and after the Effective Time of the Company Merger, the Surviving Corporation in the Company Merger will be entitled to exercise any such repurchase option or other right set forth in any such restricted stock purchase agreement or other agreement.

(c) Cancellation of Treasury and Parent Owned Stock. Each share of the Company Common Stock held by the Company or Parent or any direct or indirect wholly-owned Subsidiary (as defined in Section 2.1(a)) of the Company or of Parent immediately prior to the Effective Time of the Company Merger shall be canceled and extinguished without any conversion thereof.

Index to Financial Statements

(d) Capital Stock of Company Merger Sub. Each share of common stock, par value $0.001, of Merger Sub (the “Company Merger Sub Common Stock”) issued and outstanding immediately prior to the Effective Time of the Company Merger shall be converted into one validly issued, fully paid and nonassessable share of common stock, par value $0.001 per share, of the Surviving Corporation in the Company Merger.

(e) Company Stock Options and Warrants; Company Employee Stock Purchase Plan. At the Effective Time of the Company Merger, all outstanding Company Options (as defined in Section 2.2(b)) and Company Warrants (as defined in Section 2.2(d)) shall be assumed by Parent in accordance with Section 5.9(b) and Section 5.9(c). Rights outstanding under the Company’s 2000 Employee Stock Purchase Plan (the “Company Purchase Plan”) shall be treated as set forth in Section 5.9(d).

(f) Fractional Shares. No fraction of a share of Parent Common Stock will be issued by virtue of the Company Merger, but in lieu thereof each holder of shares of Company Common Stock who would otherwise be entitled to a fraction of share of Parent Common Stock (after aggregating all fractional shares of Parent Common Stock that would otherwise be received by such holder) shall, upon surrender of such holder’s Certificate(s) (as defined in Section 1.11(c)) (or in the case of a lost, stolen or destroyed certificate, upon delivery of an affidavit (and bond, if required) in the manner provided in Section 1.13), receive from Parent an amount of cash (rounded to the nearest whole cent), without interest, equal to the product of: (i) such fraction, multiplied by (ii) the average closing price of one share of Parent Common Stock for the ten (10) most recent trading days that Parent Common Stock has traded ending on and including the trading day one day prior to the Effective Time of the Company Merger, as reported by Nasdaq.

(g) Adjustment to Exchange Ratio. The Exchange Ratio shall be adjusted to reflect fully the appropriate effect of any stock split, reverse stock split, stock dividend (including any dividend or distribution of securities convertible into Parent Common Stock or Company Common Stock), reorganization, recapitalization, reclassification or other like change with respect to Parent Common Stock or Company Common Stock having a record date on or after the date hereof and prior to the Effective Time of the Company Merger; provided, however, no adjustment shall be made hereunder to the Exchange Ratio with respect to the distribution of the shares of common stock owned by Parent of Source to the stockholders of Parent (the “Source Distribution”).

(a) No Exchange of Parent Certificates. Following the Parent Merger, each certificate previously representing shares of Parent Common Stock shall, without any action on the part of the holder thereof, continue to represent the same number of shares of Parent Common Stock

(b) Distribution of Source Stock. Promptly following the Parent Merger, Parent shall cause its transfer agent to distribute to each holder of shares of Parent Common Stock at the Effective Time of the Parent Merger the number of shares of Source Common Stock to which such holder is entitled pursuant to Section 1.8(a).

(c) Required Withholding. Each of the transfer agent and the Surviving Corporation in the Parent Merger shall be entitled to deduct and withhold from any consideration payable or

Index to Financial Statements

otherwise deliverable pursuant to this Agreement to any holder of the Parent Common Stock such amounts as may be required to be deducted or withheld therefrom under the Code or under any provision of state, local or foreign Tax law or under any other applicable Legal Requirement (as defined in Section 2.2(d)). To the extent such amounts are so deducted or withheld, the amount of such consideration shall be treated for all purposes under this Agreement as having been paid to the Person to whom such consideration would otherwise have been paid.

(a) Exchange Agent for Company Merger. Parent shall designate a bank or trust company reasonably satisfactory to the Company to act as the exchange agent (the “Exchange Agent”) in the Company Merger.

(b) Parent to Provide Common Stock. Prior to or promptly after the Effective Time of the Company Merger, Parent shall enter into an agreement with the Exchange Agent, reasonably satisfactory to the Company, which shall provide that, promptly after the Effective Time of the Company Merger, Parent shall make available to the Exchange Agent for exchange in accordance with this Article I, the shares of Parent Common Stock issuable pursuant to Section 1.9(a) in exchange for outstanding shares of the Company Common Stock in the Company Merger. In addition, Parent shall make available promptly after the Effective Time of the Company Merger and as necessary from time to time after the Effective Time of the Company Merger, in each case as needed, cash in an amount sufficient for payment in lieu of fractional shares pursuant to Section 1.9(f) and any dividends or distributions which holders of shares of Company Common Stock may be entitled to pursuant to Section 1.11(d). Any cash and Parent Common Stock deposited with the Exchange Agent shall hereinafter be referred to as the “Exchange Fund.”

(c) Exchange Procedures. Promptly after the Effective Time of the Company Merger, Parent shall cause the Exchange Agent to mail to each holder of record (as of the Effective Time of the Company Merger) of a certificate or certificates (the “Certificates”) which immediately prior to the Effective Time of the Company Merger represented outstanding shares of the Company Common Stock whose shares were converted into the right to receive shares of Parent Common Stock pursuant to Section 1.9(a), cash in lieu of any fractional shares pursuant to Section 1.9(f) and any dividends or other distributions pursuant to Section 1.11(d): (i) a letter of transmittal (which shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon delivery of the Certificates to the Exchange Agent and shall be in such form and have such other provisions as Parent may reasonably specify) and (ii) instructions for use in effecting the surrender of the Certificates in exchange for certificates representing whole shares of Parent Common Stock, cash in lieu of any fractional shares pursuant to Section 1.9(f) and any dividends or other distributions pursuant to Section 1.11(d). Upon surrender of Certificates for cancellation to the Exchange Agent or to such other agent or agents as may be appointed by Parent, together with such letter of transmittal, duly completed and validly executed in accordance with the instructions thereto and such other documents as may reasonably be required by the Exchange Agent, the holder of such Certificates shall be entitled to receive in exchange therefor the number of whole shares of Parent Common Stock (after taking into account all Certificates surrendered by such holder) to which such holder is entitled pursuant to Section 1.9(a), payment in lieu of fractional shares which such holder has the right to receive pursuant to Section 1.9(f) and any dividends or distributions payable pursuant to Section 1.11(d), and the Certificates so surrendered shall forthwith be canceled. Until so surrendered, outstanding Certificates

Index to Financial Statements

will be deemed from and after the Effective Time of the Company Merger, for all corporate purposes, to evidence the ownership of the number of full shares of Parent Common Stock into which such shares of the Company Common Stock shall have been so converted and the right to receive an amount in cash in lieu of the issuance of any fractional shares in accordance with Section 1.9(f) and any dividends or distributions payable pursuant to Section 1.11(d).

(d) Distributions With Respect to Unexchanged Shares. No dividends or other distributions declared or made after the date hereof with respect to Parent Common Stock with a record date after the Effective Time of the Company Merger and no payment in lieu of fractional shares pursuant to Section 1.9(f) will be paid to the holders of any unsurrendered Certificates with respect to the shares of Parent Common Stock represented thereby until the holders of record of such Certificates shall surrender such Certificates. Subject to applicable law, following surrender of any such Certificates, the Exchange Agent shall deliver to the record holders thereof, without interest (i) promptly after such surrender, the number of whole shares of Parent Common Stock issued in exchange therefor along with payment in lieu of fractional shares pursuant to Section 1.9(f) and the amount of any such dividends or other distributions with a record date after the Effective Time of the Company Merger and theretofore paid with respect to such whole shares of Parent Common Stock and (ii) at the appropriate payment date, the amount of dividends or other distributions with a record date after the Effective Time of the Company Merger and a payment date subsequent to such surrender payable with respect to such whole shares of Parent Common Stock.

(e) Transfers of Ownership. If shares of Parent Common Stock are to be issued in connection with the Company Merger in a name other than that in which the Certificates surrendered in exchange therefor are registered, it will be a condition of the issuance thereof that the Certificates so surrendered will be properly endorsed and otherwise in proper form for transfer and that the Persons (as defined in Section 8.3(d)) requesting such exchange will have paid to Parent or any agent designated by it any transfer or other Taxes (as defined in Section 2.6(a)) required by reason of the issuance of shares of Parent Common Stock in any name other than that of the registered holder of the Certificates surrendered, or established to the satisfaction of Parent or any agent designated by it that such Tax has been paid or is not payable.

(f) Required Withholding. Each of the Exchange Agent and the Surviving Corporation in the Company Merger shall be entitled to deduct and withhold from any consideration payable or otherwise deliverable pursuant to this Agreement to any holder or former holder of the Company Common Stock such amounts as may be required to be deducted or withheld therefrom under the Code or under any provision of state, local or foreign Tax law or under any other applicable Legal Requirement. To the extent such amounts are so deducted or withheld, the amount of such consideration shall be treated for all purposes under this Agreement as having been paid to the Person to whom such consideration would otherwise have been paid.

(g) No Liability. Notwithstanding anything to the contrary in this Section 1.11, neither the Exchange Agent, the Surviving Corporation in the Company Merger nor any party hereto shall be liable to a holder of shares of Parent Common Stock or Company Common Stock for any amount properly paid to a public official pursuant to any applicable abandoned property, escheat or similar law.

Index to Financial Statements

(h) Investment of Exchange Fund. The Exchange Agent shall invest any cash included in the Exchange Fund as directed by Parent on a daily basis; provided that no such investment or loss thereon shall affect the amounts payable to the Company stockholders pursuant to this Article I. Any interest and other income resulting from such investment shall become a part of the Exchange Fund, and any amounts in excess of the amounts payable to the Company stockholders pursuant to this Article I shall promptly be paid to Parent.

(i) Termination of Exchange Fund. Any portion of the Exchange Fund which remains undistributed to the holders of Certificates six (6) months after the Effective Time of the Company Merger shall, at the request of the Surviving Corporation in the Company Merger, be delivered to the Surviving Corporation in the Company Merger or otherwise on the instruction of the Surviving Corporation in the Company Merger, and any holders of the Certificates who have not surrendered such Certificates in compliance with this Section 1.11 shall after such delivery to Surviving Corporation look only to the Surviving Corporation in the Company Merger for the shares of Parent Common Stock pursuant to Section 1.9(a), cash in lieu of any fractional shares pursuant to Section 1.9(f) and any dividends or other distributions pursuant to Section 1.11(d) with respect to the shares of the Company Common Stock formerly represented thereby. Any such portion of the Exchange Fund remaining unclaimed by holders of shares of Company Common Stock immediately prior to such time as such amounts would otherwise escheat to or become property of any Governmental Entity (as defined in Section 2.3(c)) shall, to the extent permitted by applicable law, become the property of Parent free and clear of any claims or interest of any Person previously entitled thereto.

1.12 No Further Ownership Rights in the Company Common Stock. All shares of Parent Common Stock issued upon the surrender for exchange of shares of Company Common Stock in accordance with the terms hereof (including any cash paid in respect thereof pursuant to Section 1.9(f) and 1.11(d)) shall be deemed to have been issued in full satisfaction of all rights pertaining to such shares of Company Common Stock, and there shall be no further registration of transfers on the records of the Surviving Corporation in the Company Merger of shares of Company Common Stock which were outstanding immediately prior to the Effective Time of the Company Merger. If, after the Effective Time of the Company Merger, Certificates are presented to the Surviving Corporation for any reason, they shall be canceled and exchanged as provided in this Article I.

1.13 Lost, Stolen or Destroyed Certificates. In the event any Certificates shall have been lost, stolen or destroyed, the Exchange Agent shall issue in exchange for such lost, stolen or destroyed Certificates, upon the making of an affidavit of that fact by the holder thereof, such shares of Parent Common Stock, cash for fractional shares, if any, as may be required pursuant to Section 1.9(f) and any dividends or distributions payable pursuant to Section 1.11(d); provided, however, that Parent may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed Certificates to deliver a bond in such sum as it may reasonably direct as indemnity against any claim that may be made against Parent, the Company or the Exchange Agent with respect to the Certificates alleged to have been lost, stolen or destroyed.

(a) Parent Merger. It is intended by Parent that the distribution of Source Common Stock pursuant to Sections 1.8(a) and 1.10(b) shall constitute a tax-free distribution under Section 355 of the Code.

Index to Financial Statements

(b) Company Merger. It is intended by the parties hereto that the Company Merger shall constitute a reorganization within the meaning of Section 368(a) of the Code. The parties hereto adopt this Agreement as a plan of reorganization within the meaning of Treasury Regulations Sections 1.368-2(g) and 1.368-3(a).

1.15 Further Action. At and after the Closing, the officers and directors of Parent (as the Surviving Corporation in the Parent Merger) and the Surviving Corporation in the Company Merger, as the case may be, will be authorized to execute and deliver, in the name and on behalf of the Company, Separation Sub and Merger Sub, as applicable, any deeds, bills of sale, assignments or assurances and to take and do, in the name and on behalf of the Company, Separation Sub and Merger Sub, as applicable, any other actions and things to vest, perfect or confirm of record or otherwise in Parent (as the Surviving Corporation in the Parent Merger) or the Surviving Corporation in the Company Merger, as the case may be, any and all right, title and interest in, to and under any of the rights, properties or assets acquired or to be acquired by Parent (as the Surviving Corporation in the Parent Merger) or the Surviving Corporation, as the case may be, as a result of, or in connection with, the Parent Merger or the Company Merger, as the case may be.

The Company represents and warrants to Parent, subject to the exceptions specifically disclosed (subject to the last sentence of Section 8.3(a)) in writing in the disclosure letter supplied by Company to Parent dated as of the date hereof and certified by a duly authorized executive officer of Company (the “Company Disclosure Letter”) as follows:

(a) Organization; Standing and Power. The Company and each of its Subsidiaries (as defined below) (i) is a corporation or other organization duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization, (ii) has the requisite power and authority to own, lease and operate its properties and to carry on its business as now being conducted, and (iii) is duly qualified or licensed and in good standing to do business in each jurisdiction in which the nature of its business or the ownership or leasing of its properties makes such qualification or licensing necessary, other than in such jurisdictions where the failure to so qualify or to be in good standing, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect (as defined in Section 8.3(c)) on the Company. For purposes of this Agreement, “Subsidiary,” when used with respect to any party, shall mean any corporation or other organization, whether incorporated or unincorporated, at least a majority of the securities or other interests of which having by their terms ordinary voting power to elect a majority of the Board of Directors or others performing similar functions with respect to such corporation or other organization is directly or indirectly owned or controlled by such party or by any one or more of its Subsidiaries, or by such party and one or more of its Subsidiaries, including, in the case of the Company only, Handspring Facility Company, LLC (“HFC”).

(b) Charter Documents. The Company has delivered or made available to Parent: (i) a true and correct copy of the Certificate of Incorporation (including any Certificate of Designations) and Bylaws of the Company, each as amended to date (collectively, the “Company Charter

Index to Financial Statements

Documents”) and (ii) the certificate of incorporation and bylaws, or like organizational documents (collectively, “Subsidiary Charter Documents”), of each of its Subsidiaries, and each such instrument is in full force and effect. The Company is not in violation of any of the provisions of the Company Charter Documents and each Subsidiary is not in violation of its respective Subsidiary Charter Documents.

(c) Minutes. The Company has made available to Parent and its representatives true and complete copies of the minutes of all meetings of the stockholders, the Board of Directors and each committee of the Board of Directors of the Company and each of its Subsidiaries since the Company’s inception.

(d) Subsidiaries. Section 2.1(d) of the Company Disclosure Letter sets forth a list of each Subsidiary of the Company. All the outstanding shares of capital stock of, or other equity or voting interests in, each such Subsidiary have been duly authorized, validly issued and are fully paid and nonassessable and are owned by the Company, a wholly-owned Subsidiary of the Company, or, in the case of foreign Subsidiaries, the Company, another wholly-owned Subsidiary of the Company or solely to the extent required to comply with local laws regarding ownership, a nominee of the Company, free and clear of all material Liens. For purposes of this Agreement, the term “Lien” shall mean all pledges, liens, charges, encumbrances, options and security interests of any kind or nature whatsoever, including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other ownership interests, except for restrictions imposed by applicable securities laws. Other than the Subsidiaries of the Company, neither the Company nor any of its Subsidiaries owns any capital stock of, or other equity or voting interests of any nature in, or any interest convertible, exchangeable or exercisable for, capital stock of, or other equity or voting interests of any nature in, any other Person except for passive investments of less than one percent (1%) in the equity interests of public companies as part of the cash management program of the Company.

(a) Capital Stock. The authorized capital stock of Company consists of: (i) 1,000,000,000 shares of Company Common Stock, par value $0.001 per share and (ii) 10,000,000 shares of preferred stock, par value $0.001 per share (the “Company Preferred Stock”). At the close of business on May 28, 2003: (i) 148,318,397 shares of Company Common Stock were issued and outstanding, excluding shares of Company Common Stock held by the Company in its treasury, (ii) no shares of Company Common Stock were issued and held by the Company in its treasury, and (iii) no shares of Company Preferred Stock were issued and outstanding. From May 28, 2003 and through the date hereof, there has been no change in the capitalization of the Company set forth above other than as a result of the exercise of outstanding Company Options. No shares of Company Common Stock are owned or held by any Subsidiary of the Company. All of the outstanding shares of capital stock of Company are duly authorized and validly issued, fully paid and nonassessable and not subject to any preemptive rights. Section 2.2(a) of the Company Disclosure Letter sets forth a list of each holder of Company Restricted Stock and (a) the name and address of the holder of such Company Restricted Stock, (b) the number of shares of Company Restricted Stock held by such holder, (c) the repurchase price of such Company Restricted Stock, (d) the date on which such Company Restricted Stock was purchased or granted, (e) the applicable vesting schedule pursuant to which the Company’s right of repurchase or forfeiture lapses, and (f) the extent to which such Company right of repurchase or forfeiture has lapsed as of the date hereof. Upon consummation of the Company Merger, (A) the shares

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of Parent Common Stock issued in exchange for any shares of Company Restricted Stock will, without any further act of Parent, Merger Sub, the Company or any other Person, become subject to the restrictions, conditions and other provisions contained in the Contract (as defined in Section 2.2(d)) relating to such Company Restricted Stock and (B) Parent will automatically succeed to and become entitled to exercise the Company’s rights and remedies under any such Contract without modification. There are no commitments or agreements of any character to which the Company is bound obligating the Company to waive (in whole or in part) its right of repurchase or forfeiture with respect to any Company Restricted Stock as a result of the Company Merger (whether alone or upon the occurrence of any additional or subsequent events).

(b) Stock Options. As of the close of business on the date hereof: (i) 21,388,695 shares of Company Common Stock are subject to issuance pursuant to outstanding options to purchase Company Common Stock (such options to purchase Company Common Stock, whether or not outstanding, “Company Options”) under the Company’s 1998 Equity Incentive Plan, 1999 Executive Equity Incentive Plan, 2000 Equity Incentive Plan and Bluelark 2000 Equity Incentive Plan (collectively, the “Company Stock Plans”) or otherwise (other than the Company Purchase Plan); and (ii) as of the date hereof, 1,237,661 shares of Company Common Stock are reserved for future issuance under the Company Purchase Plan. Section 2.2(b) of the Company Disclosure Letter sets forth a list of each outstanding Company Option issued other than pursuant to the Company Purchase Plan, and (a) the particular Company Stock Plan (if any) pursuant to which such Company Option was granted), (b) the name of the holder of such Company Option, (c) the number of shares of Company Common Stock subject to such Company Option, (d) the exercise price of such Company Option, (e) the date on which such Company Option was granted, (f) the applicable vesting schedule, and the extent to which such Company Option is vested and exercisable as of the date hereof, and (g) the date on which such Company Option expires. All shares of Company Common Stock subject to issuance pursuant to the exercise of Company Options and the Company Purchase Plan, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable, will be duly authorized, validly issued, fully paid and nonassessable. There are no commitments or agreements of any character to which the Company is bound obligating the Company to accelerate the vesting of any Company Option as a result of the Company Merger (whether alone or upon the occurrence of any additional or subsequent events). There are no outstanding or authorized stock appreciation, phantom stock, profit participation or other similar rights with respect to the Company.

(c) Voting Debt. No Voting Debt (as defined below) of the Company or any of its Subsidiaries is issued or outstanding as of the date hereof. For purposes of this Agreement, “Voting Debt” shall mean all bonds, debentures, notes or other indebtedness (i) having the right to vote on any matters on which stockholders may vote (or which is convertible into, or exchangeable for, securities having such right) or (ii) the value of which is any way based upon or derived from capital or voting stock.

(d) Warrants. As of the close of business on the date hereof, 9,150,000 shares of Company Common Stock are subject to issuance pursuant to outstanding warrants to purchase Company Common Stock (“Company Warrants”). Section 2.2(d) of the Company Disclosure Letter sets forth a list of each outstanding Company Warrant and (a) the name of the holder of such Company Warrant, (b) the number of shares of Company Common Stock subject to such Company Warrant, (c) the exercise or strike price of such Company Warrant, (d) the date on which such Company Warrant was issued, (e) the applicable vesting schedule, and the extent to which such Company Warrant is vested and

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exercisable as of the date hereof, and (f) the date on which such Company Warrant expires. All shares of Company Common Stock subject to issuance pursuant to the exercise of Company Warrants, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable, will be duly authorized, validly issued, fully paid and nonassessable. There are no commitments or agreements of any character to which the Company is bound obligating Company to accelerate the vesting of any Company Warrant as a result of the Company Merger (whether alone or upon the occurrence of any additional or subsequent events).

(e) Other Securities. Except as otherwise set forth in this Agreement, the Company Rights Plan or Section 2.2 of the Company Disclosure Letter, as of the date hereof, there are no securities, options, warrants, calls, rights, Contracts, commitments, agreements, instruments, arrangements, understandings, obligations or undertakings of any kind to which the Company or any of its Subsidiaries is a party or by which any of them is bound obligating Company or any of its Subsidiaries to (including on a deferred basis) issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock, Voting Debt or other voting securities of Company or any of its Subsidiaries, or obligating the Company or any of its Subsidiaries to issue, grant, extend or enter into any such security, option, warrant, call, right, Contract, commitment, agreement, instrument, arrangement, understanding, obligation or undertaking. All outstanding shares of Company Common Stock, all outstanding Company Options, and all outstanding shares of capital stock of each Subsidiary of Company have been issued and granted in compliance in all material respects with (i) all applicable securities laws and all other applicable Legal Requirements (as defined below) and (ii) all requirements set forth in applicable Contracts. Except for shares of Company Restricted Stock, there are not any outstanding Contracts of the Company or any of its Subsidiaries to (i) repurchase, redeem or otherwise acquire any shares of capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries or (ii) dispose of any shares of the capital stock of, or other equity or voting interests in, any of its Subsidiaries. The Company is not a party to any voting agreement with respect to shares of the capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries and, to the Knowledge (as defined in Section 8.3(b)) of the Company, other than the Company Voting Agreements and the irrevocable proxies granted pursuant to the Company Voting Agreements and the Company Rights Agreement, there are no irrevocable proxies and no voting agreements, voting trusts, rights plans, anti-takeover plans or registration rights agreements with respect to any shares of the capital stock of, or other equity or voting interests in, the Company or any of its Subsidiaries. For purposes of this Agreement, “Contract” shall mean any written or oral agreement, contract, subcontract, settlement agreement, lease, binding understanding, instrument, promissory note, option, warranty, purchase order, license, sublicense, insurance policy, benefit plan or legally binding commitment or undertaking of any nature, as in effect as of the date hereof or as may hereinafter be in effect. For purposes of this Agreement, “Legal Requirements” shall mean any federal, state, local, municipal, foreign or other law, statute, constitution, principle of common law, resolution, ordinance, code, order, edict, decree, rule, regulation, ruling or requirement issued, enacted, adopted, promulgated, implemented or otherwise put into effect by or under the authority of any Governmental Entity.

(a) Authority. The Company has all requisite corporate power and authority to enter into this Agreement and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby has been duly authorized by all necessary corporate action on the part of the Company and no other corporate

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proceedings on the part of the Company are necessary to authorize the execution and delivery of this Agreement or to consummate the Company Merger and the other transactions contemplated hereby, subject only to the approval and adoption of this Agreement and the approval of the Company Merger by the Company’s stockholders as required by Delaware Law and the filing of the Company Certificate of Merger pursuant to Delaware Law. The affirmative vote of the holders of a majority of the outstanding shares of Company Common Stock to approve and adopt this Agreement and approve the Company Merger is the only vote of the holders of any class or series of Company capital stock necessary to approve and adopt this Agreement, approve the Company Merger and consummate the Company Merger and the other transactions contemplated hereby. This Agreement has been duly executed and delivered by the Company and, assuming due execution and delivery by Parent, Separation Sub and Merger Sub, constitutes the valid and binding obligation of the Company, enforceable against the Company in accordance with its terms.

(b) Non-Contravention. The execution and delivery of this Agreement by the Company does not, and performance of this Agreement by the Company and the consummation of the Company Merger and the transactions contemplated hereby will not: (i) conflict with or violate the Company Charter Documents or any Subsidiary Charter Documents of any Subsidiary of the Company; (ii) subject to obtaining the approval and adoption of this Agreement and the approval of the Company Merger by the Company’s stockholders as contemplated in Section 5.2 and compliance with the requirements set forth in Section 2.3(c), conflict with or violate any material Legal Requirement applicable to the Company or any of its Subsidiaries or by which the Company or any of its Subsidiaries or any of their respective material properties is bound or affected; or (iii) result in any material breach of or constitute a material default (or an event that with notice or lapse of time or both would become a material default) under, or materially impair the Company’s rights or materially alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, or result in the creation of a material Lien on any of the properties or assets of the Company or any of its Subsidiaries pursuant to, any Company Material Contract (as defined in Section 2.15). Section 2.3(b) of the Company Disclosure Letter lists as of the date hereof all consents, waivers and approvals under any of the Company’s or any of its Subsidiaries’ Contracts currently in effect required to be obtained in connection with the consummation of the transactions contemplated hereby, which, if individually or in the aggregate are not obtained, would result in a material loss of benefits to the Company, Parent or the Surviving Corporation as a result of the Company Merger.

(c) Necessary Consents. No consent, approval, order or authorization of, or registration, declaration or filing with any supranational, national, state, municipal, local or foreign government, any instrumentality, subdivision, court, administrative agency or commission or other governmental authority or instrumentality, or any quasi-governmental or private body exercising any regulatory, taxing, importing or other governmental or quasi-governmental authority (a “Governmental Entity”) or any other Person is required to be obtained or made by the Company in connection with the execution and delivery of this Agreement or the consummation of the Company Merger and other transactions contemplated hereby and thereby, except for: (i) the filing of the Parent Certificate of Merger with the Secretary of State of the State of Delaware and appropriate documents with the relevant authorities of other states in which Parent is qualified to do business; (ii) the filing of the Company Certificate of Merger with the Secretary of State of the State of Delaware and appropriate documents with the relevant authorities of other states in which the Company and/or Parent are qualified to do business; (iii) the approval and adoption of this Agreement and the Company Merger by the requisite vote under applicable Legal Requirements by the stockholders of the Company; and (iv) the approval

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and adoption of this Agreement and the Parent Merger approval of the issuance of Parent Common Stock in connection with the Company Merger by the requisite vote under applicable Legal Requirements, by the stockholders of Parent; (v) the filing of the Prospectus/Proxy Statement (as defined in Section 2.16) with the SEC in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the effectiveness of the Registration Statement (as defined in Section 2.16) and the effectiveness of the Source Registration Statement (as defined in Section 5.1(b)); (vi) such consents, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable federal, foreign and state securities (or related) laws and the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”); (vii) the consents listed on Section 2.3(c) of the Company Disclosure Letter; (viii) such consents, approvals, orders, authorizations, registrations, declarations and filings as may be required under applicable state securities or “blue sky” laws and the securities laws of any foreign country; (ix) those consents, approvals, orders, authorizations, registrations, declarations or filings that have already been made or obtained; and (x) such other consents, authorizations, filings, approvals and registrations which if not obtained or made would not be material to the Company or Parent or materially adversely affect the ability of the parties hereto to consummate the Company Merger within the time frame in which the Company Merger would otherwise be consummated in the absence of the need for such consent, approval, order, authorization, registration, declaration or filings. The consents, approvals, orders, authorizations, registrations, declarations and filings set forth in (i) through (viii) are referred to herein as the “Necessary Consents.”

(a) SEC Filings. The Company has filed all required registration statements, prospectuses, reports, schedules, forms, statements and other documents (including exhibits and all other information incorporated by reference) required to be filed by it with the SEC since March 31, 2000. The Company has made available to Parent all such registration statements, prospectuses, reports, schedules, forms, statements and other documents in the form filed with the SEC. All such required registration statements, prospectuses, reports, schedules, forms, statements and other documents (including those that the Company may file subsequent to the date hereof) are referred to herein as the “Company SEC Reports.” As of their respective dates, the Company SEC Reports (i) were prepared in accordance and complied in all material respects with the requirements of the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, as the case may be, and the rules and regulations of the SEC thereunder applicable to such Company SEC Reports and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. None of the Company’s Subsidiaries is required to file any forms, reports or other documents with the SEC. The Company has previously furnished to Parent a complete and correct copy of any amendments or modifications, which have not yet been filed with SEC but which are required to be filed, to agreements, documents or other instruments which previously had been filed by the Company with the SEC pursuant to the Securities Act or the Exchange Act and complete and correct copies of any correspondence with, and inquiries from the SEC with respect to previously filed Company SEC Reports.

(b) Financial Statements. Each of the consolidated financial statements (including, in each case, any related notes thereto) contained in the Company SEC Reports (the “Company

Index to Financial Statements

Financials”), including each Company SEC Report filed after the date hereof until the Closing: (i) complied as to form in all material respects with the published rules and regulations of the SEC with respect thereto; (ii) was prepared in accordance with United States generally accepted accounting principles (“GAAP”) applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto or, in the case of unaudited interim financial statements, as may be permitted by the SEC on Form 10-Q, 8-K or any successor form under the Exchange Act); and (iii) fairly presented in all material respects the consolidated financial position of the Company and its consolidated Subsidiaries as at the respective dates thereof and the consolidated results of the Company operations and cash flows for the periods indicated. The balance sheet of the Company contained in the Company SEC Reports as of March 29, 2003 is hereinafter referred to as the “Company Balance Sheet.” Except as disclosed in the Company Financials, since the date of the Company Balance Sheet, neither Company nor any of its Subsidiaries has any liabilities (absolute, accrued, contingent or otherwise) of a nature required to be disclosed on a consolidated balance sheet or in the related notes to the consolidated financial statement prepared in accordance with GAAP which are, individually or in the aggregate, material to the business, results of operations or financial condition of the Company and its Subsidiaries taken as a whole, except those liabilities incurred in the ordinary course of business, consistent with past practice, of the type which ordinarily recur, and liabilities incurred in connection with the Loan Agreement and the transactions contemplated thereby and with respect to fees and expenses of accountants, brokers, financial advisors, consultants, legal counsel or other Persons retained by the Company to provide services in connection with this Agreement or the transactions contemplated hereby.

(c) Internal Controls. The Company has established and maintains disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 promulgated under the Exchange Act) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s Chief Executive Officer and Chief Financial Officer. There are no significant deficiencies or material weaknesses in the design or operation of the Company’s internal controls which could adversely affect the Company’s ability to record, process, summarize and report financial data. To the Company’s Knowledge, there is no fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal controls.

2.5 Absence of Certain Changes or Events. Since the date of the Company Balance Sheet, there has not been: (i) any Material Adverse Effect on the Company; (ii) any declaration, setting aside or payment of any dividend on, or other distribution (whether in cash, stock or property) in respect of, any of the Company’s or any of its Subsidiaries’ capital stock, or any purchase, redemption or other acquisition by the Company or any of its Subsidiaries of any of the Company’s capital stock or any other securities of the Company or its Subsidiaries or any options, warrants, calls or rights to acquire any such shares or other securities except for repurchases from Company Employees following their termination pursuant to the terms of their pre-existing stock option or purchase agreements; (iii) any split, combination or reclassification of any of the Company’s or any of its Subsidiaries’ capital stock; (iv) any granting by the Company or any of its Subsidiaries of any increase in compensation or increase in benefits, except for normal increases of cash compensation in the ordinary course of business consistent with past practice (other than to directors or executive officers of the Company), or any payment by the Company or any of its Subsidiaries of any bonus, except for bonuses made in the ordinary course of business consistent with past practice (other than to directors or executive officers of the Company), or any granting by the Company or any of its Subsidiaries of any increase in severance or

Index to Financial Statements

termination pay or any entry by the Company or any of its Subsidiaries into, or modification or amendment of, any currently effective employment, severance, termination or indemnification agreement or any agreement the benefits of which are contingent or the terms of which are materially altered upon the occurrence of a transaction involving the Company of the nature contemplated hereby; (v) entry by the Company or any of its Subsidiaries into any licensing or other agreement with regard to the acquisition or disposition of any material Intellectual Property (as defined in Section 2.7(a)(i)) other than licenses entered into in the ordinary course of business consistent with past practice, (vi) any amendment or consent with respect to any Company Material Contract (as defined in Section 2.15(a)) in effect since the date of the Company Balance Sheet; (vii) any material change by the Company in its accounting methods, principles or practices, except as required by concurrent changes in GAAP; (viii) any material revaluation by the Company of any of its assets, including writing down the value of capitalized inventory or writing off notes or accounts receivable other than in the ordinary course of business consistent with past practice; (ix) any written communication from Nasdaq with respect to the delisting of the Company Common Stock; (x) any cancellation by the Company or any of its Subsidiaries of any material debts or waiver of any claims or rights of material value; (xi) any sale, transfer or other disposition outside of the ordinary course of business of any properties or assets (real, personal or mixed, tangible or intangible) by the Company or any of its Subsidiaries; or (xii) any agreement, whether in writing or otherwise, to take any action described in this section by the Company or any of its Subsidiaries.

(a) Definition. For the purposes of this Agreement, the term “Tax” or, collectively, “Taxes” shall mean (i) any and all federal, state, local and foreign taxes, assessments and other governmental charges, duties, impositions and liabilities, including taxes based upon or measured by gross receipts, income, profits, sales, use and occupation, and value added, ad valorem, transfer, franchise, withholding, payroll, recapture, employment, excise and property taxes, together with all interest, penalties and additions imposed with respect to such amounts, (ii) any liability for the payment of any amounts of the type described in clause (i) of this Section 2.6(a) as a result of being a member of an affiliated, consolidated, combined or unitary group for any period, and (iii) any liability for the payment of any amounts of the type described in clauses (i) or (ii) of this Section 2.6(a) as a result of any express or implied obligation to indemnify any other person or as a result of any obligations under any agreements or arrangements with any other person with respect to such amounts and including any liability for taxes of a predecessor or transferor entity.

(i) The Company and each of its Subsidiaries have filed all required federal, state, local and foreign returns, estimates, information statements and reports and any amendments thereto (“Tax Returns”) relating to any and all Taxes concerning or attributable to the Company, its Subsidiaries or their respective operations. Such Tax Returns are true and correct, and have been completed in accordance with applicable law and were timely filed, except in each case as would not be material to the Company.

(ii) The Company and each of its Subsidiaries have paid all Taxes required to be paid and withheld with respect to their Employees or other third parties and paid over to the

Index to Financial Statements

appropriate Taxing authority all Taxes and any other amounts required to be paid or withheld. Such Taxes were timely paid except as would not be material to the Company.

(iii) Neither the Company nor any of its Subsidiaries is currently delinquent in the payment of any Tax, nor is there any material Tax deficiency outstanding, assessed or, to the Knowledge of the Company, proposed against the Company or any of its Subsidiaries, nor has the Company or any of its Subsidiaries executed any outstanding waiver of any statute of limitations on or extension of the period for the assessment or collection of any Tax.

(iv) No audit or other examination of any Tax Return of the Company or any of its Subsidiaries is presently in progress, nor has the Company or any of its Subsidiaries been notified of any request for such an audit or other examination. No outstanding adjustment relating to any Tax Return filed by the Company or any of its Subsidiaries has been proposed formally or, to the Knowledge of the Company or any of its Subsidiaries, informally by any tax authority to the Company, any of its Subsidiaries or any representative thereof.

(v) Neither the Company nor any of its Subsidiaries has any liabilities for unpaid Taxes as of the date of the Company Balance Sheet which have not been accrued or reserved on the Company Balance Sheet in accordance with GAAP, whether asserted or unasserted, contingent or otherwise, and neither the Company nor any of its Subsidiaries has incurred any liability for Taxes since the date of the Company Balance Sheet other than in the ordinary course of business.

(vi) The Company has made available to Parent or its legal counsel, copies of all federal and California income and all other material Tax Returns for the Company and each of its Subsidiaries filed for all periods since inception.

(vii) There are no Liens on the assets of the Company or any of its Subsidiaries relating to or attributable to Taxes, other than customary Liens for Taxes not yet due and payable. To the Knowledge of the Company, there is no basis for the assertion of any material claim relating or attributable to Taxes which, if adversely determined, would result in any Lien for Taxes on the assets of the Company or any of its Subsidiaries.

(viii) Neither the Company nor any of its Subsidiaries has filed any consent agreement under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as defined in Section 341(f)(4) of the Code) owned by the Company or any of its Subsidiaries.

(ix) Neither the Company nor any of its Subsidiaries is, nor has been at any time, a “United States Real Property Holding Corporation” within the meaning of Section 897(c)(2) of the Code.

(x) Neither the Company nor any of its Subsidiaries (a) has ever been a member of an affiliated group (within the meaning of Code §1504(a)) filing a consolidated federal income Tax Return (other than a group the common parent of which was Company), (b) is a party to any Tax sharing, indemnification or allocation agreement (other than between the Company and any of its Subsidiaries), nor does the Company or any of its Subsidiaries owe any amount under any such agreement, (c) has any material liability for the Taxes of any person (other than Company or any of its Subsidiaries) under Treas. Reg. § 1.1502-6 (or any similar provision of state, local or foreign law), as a

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transferee or successor, by contract, or otherwise, or (d) is a party to any joint venture, partnership or other agreement that could be treated as a partnership for Tax purposes.

(xi) Neither the Company nor any of its Subsidiaries has constituted either a “distributing corporation” or a “controlled corporation” in a distribution of stock intended to qualify for tax-free treatment under Section 355 of the Code (a) in the two years prior to the date of this Agreement or (b) in a distribution which could otherwise constitute part of a “plan” or “series of related transactions” (within the meaning of Section 355(e) of the Code) in conjunction with the Company Merger.

(xii) Neither the Company nor any of its Affiliates has taken or agreed to take any action that would prevent the Company Merger from qualifying as a reorganization within the meaning of Section 368(a) of the Code. The Company has no Knowledge of any agreement, plan, fact or other circumstance that would prevent the Company Merger from qualifying as a reorganization within the meaning of Section 368(a) of the Code.

(a) Definitions. For the purposes of this Agreement, the following terms have the following meanings:

(i) “Intellectual Property” shall mean any or all of the following and all rights in, arising out of, or associated therewith: (a) all United States, international and foreign patents and applications therefor and all reissues, divisions, renewals, extensions, provisionals, continuations and continuations- in-part thereof; (b) all inventions (whether patentable or not), invention disclosures, improvements, trade secrets, proprietary information, know how, technology, technical data and customer lists, and all documentation relating to any of the foregoing; (c) all copyrights, copyrights registrations and applications therefor, and all other rights corresponding thereto throughout the world; (d) all mask works, mask work registrations and applications therefor, and any equivalent or similar rights in semiconductor masks, layouts, architectures or topology; (e) domain names, uniform resource locators (“URLs”) and other names and locators associated with the Internet (collectively, “Domain Names”), (f) all computer software, including all source code, object code, firmware, development tools, files, records and data, and all media on which any of the foregoing is recorded; (g) all schematics, netlists, test methodologies, test vectors, emulation and simulation tools and reports, hardware development tools, and all rights in prototypes, breadboards and other devices; (h) all industrial designs and any registrations and applications therefor throughout the world; (i) all trade names, logos, common law trademarks and service marks, trademark and service mark registrations and applications therefor throughout the world; (j) all databases and data collections and all rights therein throughout the world; (k) all moral and economic rights of authors and inventors, however denominated, throughout the world, and (l) any similar or equivalent rights to any of the foregoing anywhere in the world, and all tangible embodiments of the foregoing.

(ii) “Company Intellectual Property” shall mean any Intellectual Property that is owned by, or exclusively licensed to, the Company or any of its Subsidiaries.

(iii) “Registered Intellectual Property” shall mean all United States, international and foreign: (a) patents and patent applications (including provisional applications);

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(b) registered trademarks, applications to register trademarks, intent-to-use applications, or other registrations or applications related to trademarks; (c) registered copyrights and applications for copyright registration; and (d) any other rights in or to an application, certificate, filing, registration or other document issued, filed with, or recorded by any Governmental Authority with respect to Intellectual Property.

(iv) “Company Registered Intellectual Property” shall mean all of the Registered Intellectual Property owned by, registered or filed in the name of, the Company or any of its Subsidiaries.

(v) “Software” shall mean any and all computer software and code, including assemblers, applets, compilers, source code, object code, data (including image and sound data) and databases and data collections, design tools and user interfaces, in any form or format, however fixed. Software shall include source code listings and documentation.

(vi) “Company Products” shall mean all products, Software or service offerings (i) that have been sold or offered for sale, distributed or otherwise disposed of prior to the date of this Agreement by or on behalf of the Company or any of its Subsidiaries, or (ii) for which significant development work has been done and which the Company or any of its Subsidiaries currently intends to sell, distribute or otherwise dispose of in the future, including the product referred to internally at the Company as “Duo.”

(b) Registered Intellectual Property; Proceedings. Section 2.7(b) of the Company Disclosure Letter sets forth, as of the date hereof, (i) all Company Registered Intellectual Property and specifies, where applicable, the jurisdictions in which each such item of Company Registered Intellectual Property has been issued or registered, and (ii) all proceedings or actions with respect to which Company has Knowledge or has received notice, and which is currently before any court or tribunal (including the United States Patent and Trademark Office (the “PTO”) or equivalent authority anywhere else in the world) related to any of the Company Intellectual Property.

(c) Company Products. Section 2.7(c) of the Company Disclosure Letter sets forth, as of the date hereof, a list (by name and version number) of all Company Products.

(d) Documentation of Defects. The Company maintains a policy of documenting all bugs, errors and defects in all the Company Products. The Company has documented all material bugs, errors and defects of which the Company has Knowledge in compliance with such policy, and such documentation is retained and is available internally at the Company.

(e) No Order. None of the Company Intellectual Property, the Company Products (excluding Intellectual Property owned by a third party), the Company or any of its Subsidiaries is subject to any judgment, order, writ, injunction, or decree of any court or Governmental Entity or arbitrator, or any stipulation made to any court, Governmental Entity or arbitrator or in connection with any proceeding before any such entity, or any settlement agreement restricting the use, transfer, or licensing by the Company or any of its Subsidiaries of any Company Intellectual Property, any Company Product or, to the Company’s Knowledge, any Intellectual Property owned by a third party (including any Intellectual Property that is or is included in a Company Product) that the Company or any of its Subsidiaries has a right to use, exploit or practice by virtue of a license grant, immunity from

Index to Financial Statements

suit or otherwise, or which may affect the validity, use or enforceability of any such Company Intellectual Property, Company Product (excluding Intellectual Property owned by a third party) or, to the Company’s Knowledge, any Intellectual Property owned by a third party (including any Intellectual Property that is or is included in a Company Product).

(f) Registration. Each item of Company Registered Intellectual Property is valid and subsisting, all necessary registration, maintenance and renewal fees currently due in connection with such Company Registered Intellectual Property have been made and all necessary documents, recordations and certificates in connection with such Company Registered Intellectual Property have been filed with the relevant patent, copyright, trademark or other authorities in the United States or foreign jurisdictions, as the case may be, for the purposes of prosecuting, maintaining or perfecting such Company Registered Intellectual Property, except for any failure to pay fees or failure to so file as would not (with or without the lapse of time) adversely affect the Company’s rights in any such item of Company Registered Intellectual Property and except that the foregoing shall not apply to any Company Intellectual Property with respect to which Company has intentionally abandoned its rights as listed in Section 2.7(f) of the Company Disclosure Letter.

(g) Further Actions. Section 2.7(g) of the Company Disclosure Letter sets forth a list of all actions that are required to be taken by the Company within ninety (90) days of the date hereof with respect to any of the Company Registered Intellectual Property.

(h) Absence of Liens. The Company owns and has good and exclusive title to each item of Company Registered Intellectual Property and other material Company Intellectual Property owned by it, free and clear of any Liens (excluding non-exclusive licenses and related restrictions granted in the ordinary course of business consistent with past practice and Liens in connection with the Loan Agreement), and, after the Closing, all Company Intellectual Property will be fully transferable, alienable or licensable by Parent without restriction and without payment of any kind to any third party. Without limiting the generality of the foregoing, (i) the Company is the exclusive owner of all registered trademarks and, to the Company’s Knowledge, has valid and sufficient rights to use all other trademarks used in connection with the operation or conduct of the business of the Company and its Subsidiaries, including the sale, distribution or provision of any Company Products by the Company or any of its Subsidiaries, (ii) to the Company’s Knowledge, the Company owns exclusively, or has valid and sufficient rights to use, all copyrighted works that are included or incorporated into Company Products or which the Company or any of its Subsidiaries otherwise purports to own, and (iii) to the extent that any patents would be infringed by any Company Products or the operation or conduct of the business of the Company and its Subsidiaries as currently conducted or currently contemplated to be conducted, to the Company’s Knowledge, the Company is the exclusive owner of, or has valid and sufficient rights to use, such patents.

(i) Source Code. Neither the Company nor any of its Subsidiaries has disclosed the source code for any of the Software owned by it or incorporated in any Company Products to any third party, and the Company has taken commercially reasonable measures to prevent disclosure of such source code.

(j) Open Source Software. No Software that is open source, public source or freeware, or any modification or derivative thereof, including any version of Software licensed pursuant to any GNU general public license or lesser general public license (collectively, “Open Source

Index to Financial Statements

Software”) was or is used in, incorporated into, integrated or bundled with any Company Products (only to the Company’s Knowledge with respect to Company Products owned by third parties) or Company Intellectual Property, or was, is or is currently planned to be used in the Company’s business or the development or compilation of any Company Products, except in each case for any such Open Source Software whose terms: (i) do not grant any third party rights to, or otherwise impair the exclusive ownership of the Company or its Subsidiaries of, the modifications or improvements by the Company or any of its Subsidiaries to such Software; (ii) do not require the distribution by the Company or any Subsidiary of any source code; (iii) do not prohibit the Company or its Subsidiaries from charging a fee or otherwise restricts the ability of the Company or any of its Subsidiaries to seek compensation for any such Software; (iv) allow use and distribution of such Software in the manner used and distributed and proposed to be distributed by the Company or any of its Subsidiaries; (v) do not contain any other material restrictions or obligations that the Company and its Subsidiaries has not complied with; and (vi) do not, have not and will not otherwise result in any material liability to the Company or any of its Subsidiaries.

(k) Third-Party Development. (i) To the extent that any technology, Software or Intellectual Property incorporated into a Company Product or any other material item of technology, Software or Intellectual Property has been developed or created independently or jointly by a third party for the Company or any of its Subsidiaries, the Company and its Subsidiaries have a written agreement with such third party with respect thereto pursuant to which the Company and its Subsidiaries have obtained complete, unencumbered and unrestricted ownership of, and are the exclusive owners of all such third party’s Intellectual Property in such work, material or invention and such third party has not retained any rights or licenses with respect thereto. (ii) To the extent that (a) any technology, Software or Intellectual Property developed or otherwise owned by a third party is incorporated into or integrated with any of the Company Products, or (b) any material item of technology, Software or Intellectual Property developed or otherwise owned by a third party is bundled with or used by the Company or its Subsidiaries in the development, manufacture or compilation of any of the Company Products (such technology, Software or Intellectual Property described in this Section 2.7(k)(ii)(a) and (b), the “Third Party Product Technology”), the Company and its Subsidiaries have a written agreement with respect thereto pursuant to which the Company and its Subsidiaries either (A) have obtained complete, unencumbered and unrestricted ownership of, and are the exclusive owners of, or (B) have obtained a license with a term not less than the projected life of such Company Product to all such Intellectual Property in such work, material or invention. (iii) Section 2.7(k)(iii) of the Company Disclosure Letter sets forth a list of all Contracts currently in effect granting the Company or its Subsidiaries rights with respect to Third Party Product Technology, and copies of all such contracts have been provided or made available to Parent. (iv) To the extent any technology, Software or Intellectual Property incorporated into any of the Company Products or any other item of material technology, Software or Intellectual Property was originally owned, invented or created by a Company employee, (a) all right, title and interest in and to such Intellectual Property was transferred and assigned to the Company, by contract or operation of law, and (b) no such employee or consultant has retained any rights (other than the right to be named as an inventor or author) in or to such Intellectual Property.

(l) Transfers. Neither the Company nor any of its Subsidiaries has transferred ownership of, or granted any exclusive license with respect to, any Intellectual Property that is or was material Company Intellectual Property, to any third party, or knowingly permitted the Company’s rights in such Company Intellectual Property to lapse or enter the public domain (other than through the expiration of Registered Intellectual Property at the end of its statutory term).

Index to Financial Statements

(m) Licenses. Other than “shrink wrap,” “click wrap” and similar widely available commercial end-user licenses that have an individual acquisition cost of $25,000 or less, Section 2.7(m) of the Company Disclosure Letter sets forth a list of all Contracts currently in effect to which the Company or any of its Subsidiaries is a party (i) with respect to Company Intellectual Property licensed or transferred to any third party, (ii) pursuant to which a third party has licensed or transferred any Intellectual Property to the Company or any of its Subsidiaries, or (iii) pursuant to which the Company or any of its Subsidiaries has agreed to any restriction on the right of the Company or any of its Subsidiaries to use or enforce any Company Intellectual Property. None of the Contracts required to be listed in Section 2.7(m) of the Company Disclosure Letter grants any third party exclusive rights to or under any Company Intellectual Property, and none of the Contracts required to be listed in Section 2.7(m) of the Company Disclosure Letter grants any third party the right to sublicense any Company Intellectual Property.

(n) No Conflict. (i) The consummation of the transactions contemplated by this Agreement will neither materially violate nor result in the material breach, or the material modification, cancellation, termination, suspension of, or acceleration of any payments with respect to the Contracts required to be listed in Section 2.7(m) of the Company Disclosure Letter, or give any non-Company party to any such Contract the right to do any of the foregoing. Following the Closing Date, the Surviving Corporation in the Company Merger will be permitted to exercise all of the Company’s and its Subsidiaries’ rights under such Contracts to the same extent the Company and its Subsidiaries would have been able to had the transactions contemplated by this Agreement not occurred and without the payment of any additional amounts or consideration other than ongoing fees, royalties or payments which the Company or any of its Subsidiaries would otherwise be required to pay. (ii) Neither this Agreement nor the transactions contemplated by this Agreement, including the assignment to Parent or Merger Sub by operation of law or otherwise of any contracts or agreements to which the Company or any of its Subsidiaries are a party, will result in (a) either Parent’s or the Merger Sub’s granting to any third party any right or license to or with respect to any material Intellectual Property right owned by, or licensed to, either of them prior to the Closing, (b) either Parent or Merger Sub being bound by, or subject to, any non-compete or other material restriction on the operation or scope or their respective businesses (including a covenant not to sue), or (c) either Parent or Merger Sub being obligated to pay any royalties or other material amounts to any third party in excess of those payable by Parent or Merger Sub, respectively, prior to the Closing.

(o) No Infringement. To the Knowledge of the Company, the operation of the business of the Company and its Subsidiaries as such business currently is conducted and as currently proposed to be conducted, including the Company’s and its Subsidiaries’ design, development, manufacture, distribution, reproduction, marketing or sale of the products, Software or services of the Company and its Subsidiaries (including Company Products) has not, does not and will not, as so proposed, infringe or misappropriate the Intellectual Property of any third party or, to its Knowledge, constitute unfair competition or unfair trade practices under the laws of any jurisdiction.

(p) All Necessary Intellectual Property. The Company Intellectual Property, and the Company’s rights in the Third Party Product Technology, constitute, to the Knowledge of the Company, all the material Intellectual Property used in and/or necessary to the conduct of the business of the Company and its Subsidiaries as it currently is conducted, and as it is currently planned to be conducted by the Company and its Subsidiaries, including the design, development, manufacture, use, import and sale of products, technology and performance of services (including the Company Products).

Index to Financial Statements

(q) No Notice of Infringement. Neither the Company nor any of its Subsidiaries has received written notice from any third party that the operation of the business of the Company or any of its Subsidiaries or any Company Product, infringes or misappropriates the Intellectual Property of any third party or constitutes unfair competition or unfair trade practices under the laws of any jurisdiction.

(r) No Third Party Infringement. To the Knowledge of the Company, no person has or is infringing or misappropriating any Company Intellectual Property.

(s) Government Funding. No government funding, facilities of a university, college, other educational institution or research center or development funding from third parties was used in the development of any Company Intellectual Property. To the Knowledge of the Company, no current or former employee, consultant or independent contractor of the Company, who was involved in, or who contributed to, the creation or development of any Company Intellectual Property, has performed services for the government, university, college, or other educational institution or research center during a period of time during which such employee, consultant or independent contractor was also performing services for the Company.

(t) Proprietary Information Agreements. The Company and each of its Subsidiaries has taken reasonable steps to protect the Company’s and its Subsidiaries’ rights in the Company’s confidential information and trade secrets that it wishes to protect or any trade secrets or confidential information of third parties provided to the Company or any of its Subsidiaries, and, without limiting the foregoing, each of the Company and its Subsidiaries has and enforces a policy requiring each Employee to execute a proprietary information/confidentiality agreement substantially in the form provided to Parent, and all Employees of the Company and any of its Subsidiaries have executed such an agreement, except where the failure to do so is not reasonably expected to be material to the Company.

(u) Privacy and Data Protection. The Company and its Subsidiaries have at all times complied in all material respects with all applicable Legal Requirements relating to privacy, data protection and the collection and use personal information and user information gathered or accessed in the course of the operations of the Company or any of its Subsidiaries. The Company and its Subsidiaries have at all times complied in all material respects with all rules, policies and procedures established by the Company or any of its Subsidiaries from time to time with respect to privacy, data protection or collection and use of personal information and user information gathered or accessed in the course of the operations of the Company or any of its Subsidiaries, current versions of which are set forth in Section 2.7(u) of the Company Disclosure Letter. No claims have been asserted in writing or, to the Knowledge of the Company, threatened against the Company or any of its Subsidiaries by any person or entity alleging a violation of such person’s or entity’s privacy, personal or confidentiality rights under any such rules, policies or procedures. The execution of this Agreement and the consummation of the transactions contemplated herein will not breach or otherwise cause any violation of any such applicable Legal Requirements related to privacy, data protection or the collection and use of personal information and user information gathered or accessed in the course of the operations of the Company or any of its Subsidiaries.

(v) Protection of Information. With respect to all personal and user information described in Section 2.7(u), the Company and its Subsidiaries have at all times taken all reasonable steps (including implementing and monitoring compliance with adequate measures with respect to technical and physical security) to ensure that the information is protected against loss and against unauthorized

Index to Financial Statements

access, use, modification, disclosure or other misuse. To the Knowledge of the Company, there has been no material unauthorized access to or other misuse of that information.

(a) Compliance. Neither the Company nor any of its Subsidiaries is in conflict with, or in default or in violation of any material Legal Requirement applicable to the Company or any of its Subsidiaries or by which the Company or any of its Subsidiaries or any of their respective businesses or properties is, or the Company believes is reasonably likely to be, bound or affected, except, in each case, or in the aggregate, for those conflicts, violations and defaults that would not cause the Company to lose any material benefit or incur any material liability. To the Knowledge of the Company, no investigation or review by any Governmental Entity is pending or, has been threatened in writing against the Company or any of its Subsidiaries. There is no judgment, injunction, order or decree binding upon the Company or any of its Subsidiaries which has or would reasonably be expected to have the effect of prohibiting or impairing any business practice of the Company or any of its Subsidiaries, any acquisition of property by the Company or any of its Subsidiaries or the conduct of business by the Company and its Subsidiaries as currently conducted.

(b) Permits. The Company and its Subsidiaries hold, to the extent legally required, all permits, licenses, variances, clearances, consents, commissions, franchises, exemptions, orders, authorizations and approvals from Governmental Entities (“Permits”) that are required for the operation of the business of the Company (collectively, “Company Permits”) except where the failure to hold such Permits would not be material to the Company or its Subsidiaries. As of the date hereof, no suspension or cancellation of any of the Company Permits is pending or, to the Knowledge of the Company, threatened. The Company and its Subsidiaries are in compliance in all material respects with the terms of the Company Permits.

2.9 Litigation. There are no material claims, suits, actions or proceedings pending or, to the Knowledge of the Company, threatened against the Company or any of its Subsidiaries, before any court, governmental department, commission, agency, instrumentality or authority, or any arbitrator.

2.10 Brokers’ and Finders’ Fees; Fees and Expenses. Except for fees payable to Credit Suisse First Boston LLC pursuant to an engagement letter dated March 4, 2003, a copy of which has been provided to Parent (the “CSFB Engagement Letter”), the Company has not incurred, nor will it incur, directly or indirectly, any liability for brokerage or finders’ fees or agents’ commissions or any similar charges in connection with this Agreement or any transaction contemplated hereby and, except pursuant to the CSFB Engagement Letter, the Company has not entered into any indemnification agreement or indemnification arrangement with any Person in connection with this Agreement and the transactions contemplated hereby. An itemized good faith estimate of the fees and expenses of any accountant, broker, financial advisor, consultant, legal counsel or other Person retained by the Company in connection with this Agreement or the transactions contemplated hereby incurred through the date hereof by the Company in connection with this Agreement and the transactions contemplated hereby (including any agreement or understanding with respect to such agreement or understanding, whether written or oral), other than the CSFB Engagement Letter, is set forth in Section 2.10 of the Company Disclosure Letter. Other than the CSFB Engagement Letter, as of the date hereof, the Company is not a party to any Contract with any accountant, broker, financial advisor, consultant, legal counsel or other Person retained by the Company in connection with this Agreement or the transactions contemplated

Index to Financial Statements

hereby, other than Contracts for the provision of services on a “time and materials” basis at reasonable and customary rates.

2.11 Transactions with Affiliates. Except as set forth in the Company SEC Reports, since the date of the Company’s last proxy statement filed with the SEC until the date hereof, no event or transaction has occurred of the type that would be reportable by the Company pursuant to Item 404 of Regulation S-K promulgated by the SEC. Section 2.11 of the Company Disclosure Letter identifies each Person who the Company deems to be an “affiliate” (as that term is used in Rule 145 promulgated under the Securities Act) of the Company as of the date hereof.

(a) Schedule. Section 2.12(a) of the Company Disclosure Letter contains a list of (i) each plan, program, policy, practice, contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation, performance awards, stock or stock-related awards, fringe benefits or other employee benefits or remuneration of any kind, whether written or unwritten or otherwise, funded or unfunded, including each “employee benefit plan,” within the meaning of Section 3(3) of ERISA which is or has been, within the past three years, maintained, contributed to, or required to be contributed to, by the Company or any Subsidiary of the Company or any other person or entity under common control with the Company or any Subsidiaries within the meaning of Section 414(b), (c), (m) or (o) of the Code and the regulations issued thereunder (each a “Company ERISA Affiliate”) for the benefit of any current or former or retired employee, consultant or director of the Company or any Company ERISA Affiliate (each a “Company Employee”), or with respect to which the Company or any Company ERISA Affiliate has or may have any liability or obligation (collectively, the “Company Employee Plans”), and (ii) each employment, severance or consulting agreement between the Company or any Company ERISA Affiliate and any current Company Employee or former Company Employee, to the extent the Company or any Company ERISA Affiliate has or may have any liability or obligation (each a “Company Employee Agreement”), except to the extent a Company Employee Agreement provides for “at-will” employment and does not provide for severance payments or benefits. Neither the Company nor any Company ERISA Affiliate has any plan or commitment to establish any new Company Employee Plan or Company Employee Agreement, to modify any Company Employee Plan or Company Employee Agreement (except to the extent required by law or to conform any such Company Employee Plan or Company Employee Agreement to the requirements of any applicable law, in each case as previously disclosed to Parent in writing, or as required by this Agreement), or to adopt or enter into any Company Employee Plan or Company Employee Agreement.

(b) Documents. The Company has provided or made available to Parent correct and complete copies of: (i) all documents embodying each Company Employee Plan and each Company Employee Agreement including all amendments thereto and all related trust documents, administrative service agreements, group annuity contracts, group insurance contracts, and policies pertaining to fiduciary liability insurance covering the fiduciaries for each Company Employee Plan; (ii) each relocation, repatriation and expatriation agreement; (iii) the most recent annual actuarial valuations, if any, prepared for each Company Employee Plan; (iv) the three (3) most recent annual reports (Form Series 5500 and all schedules and financial statements attached thereto), if any, required under ERISA or the Code in connection with each Company Employee Plan; (v) if the Company Employee Plan is funded, the most recent annual and periodic accounting of Company Employee Plan assets; (vi) the most

Index to Financial Statements

recent summary plan description together with the summary(ies) of material modifications thereto, if any, required under ERISA with respect to each Company Employee Plan; (vii) all IRS determination, opinion, notification and advisory letters; (viii) all material communications made to any Company Employee or Company Employees after January 1, 2002, relating to any Company Employee Plan and any proposed Company Employee Plans, in each case, relating to any amendments, terminations, establishments, increases or decreases in benefits, acceleration of payments or vesting schedules or other events which would result in any material liability to the Company; (ix) all COBRA (as defined below) forms and related notices (or such forms and notices as required under comparable law); (x) all material correspondence to or from any governmental agency in the past three years relating to any Company Employee Plan (including any filings with any governmental agency); (xi) the most recent plan years discrimination tests for each Company Employee Plan; and (xii) all prospectuses prepared in connection with each Company Employee Plan. As used in this Agreement, “COBRA” shall mean the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended and as codified in Section 4980B of the Code and Section 601 et. seq. of ERISA.

(c) Company Employee Plan Compliance. The Company and its Company ERISA Affiliates have performed in all material respects all obligations required to be performed by them under each Company Employee Plan, and each Company Employee Plan has been established and maintained in all material respects in accordance with its terms and in material compliance with all applicable laws, statutes, orders, rules and regulations, including but not limited to ERISA or the Code. Any Company Employee Plan intended to be qualified under Section 401(a) of the Code and each trust intended to qualify under Section 501(a) of the Code (i) has either applied for, prior to the expiration of the requisite period under applicable Treasury Regulations or IRS pronouncements, or obtained a favorable determination, notification, advisory and/or opinion letter, as applicable, as to its qualified status from the IRS or still has a remaining period of time under applicable Treasury Regulations or IRS pronouncements in which to apply for such letter and to make any amendments necessary to obtain a favorable determination, and (ii) incorporates or has been amended to incorporate all provisions required to comply with the Tax Reform Act of 1986 and subsequent legislation. To the Knowledge of the Company, for each Company Employee Plan that is intended to be qualified under Section 401(a) of the Code there has been no event, condition or circumstance that has adversely affected or is likely to adversely affect such qualified status. No “prohibited transaction,” within the meaning of Section 4975 of the Code or Sections 406 and 407 of ERISA, and not otherwise exempt under Section 408 of ERISA, has occurred with respect to any Company Employee Plan. There are no actions, suits or claims pending, or, to the Knowledge of the Company, threatened or reasonably anticipated (other than routine claims for benefits) against any Company Employee Plan or against the assets of any Company Employee Plan. Each Company Employee Plan can be amended, terminated or otherwise discontinued after the Effective Time of the Company Merger in accordance with its terms, without material liability to Parent, Company or any of its Company ERISA Affiliates (other than ordinary administration expenses). There are no audits, inquiries or proceedings pending or, to the Knowledge of the Company or any Company ERISA Affiliates, threatened by the IRS, the U.S. Department of Labor (“DOL”), or any other Governmental Entity with respect to any Company Employee Plan. Neither the Company nor any Company ERISA Affiliate is subject to any penalty or tax with respect to any Company Employee Plan under Section 502(i) of ERISA or Sections 4975 through 4980 of the Code. The Company and each Company ERISA Affiliate have timely made all contributions and other payments required by and due under the terms of each Company Employee Plan, except as would not result in material liability to the Company or its Subsidiaries.

Index to Financial Statements

(d) No Pension or Welfare Plans. Neither the Company nor any Company ERISA Affiliate has ever maintained, established, sponsored, participated in, or contributed to, any (i) Company Employee Plan which is an “employee pension benefit plan,” within the meaning of Section 3(2) of ERISA (a “Pension Plan”) and is subject to Title IV of ERISA or Section 412 of the Code, (ii) Pension Plan which is a “multiemployer plan,” as defined in Section 3(37) of ERISA, (iii) “multiple employer plan” as defined in ERISA or the Code, or (iv) “funded welfare plan” within the meaning of Section 419 of the Code. Neither the Company nor any ERISA Affiliate has maintained, established, sponsored, participated in or contributed to any self-insured Company Employee Plan or created any such similar obligation under any Company Employee Agreement nor has the Company or any ERISA Affiliate established a policy or practice that would give rise to the creation of a self-insured Company Employee Plan or obligation under any Company Employee Agreement (including any such plan or practice pursuant to which a stop-loss policy or contract applies).

(e) No Post-Employment Obligations. No Company Employee Plan provides, or reflects or represents any liability to provide post-termination or retiree welfare benefits to any person for any reason, except as may be required by COBRA or other applicable statute, and neither the Company nor any Company ERISA Affiliate has ever represented, promised or contracted (other than in written form) to any Employee (either individually or to Company Employees as a group) or any other person that such Employee(s) or other person would be provided with post-termination or retiree welfare benefits, except to the extent required by statute.

(f) Health Care Compliance. Neither the Company nor any Company ERISA Affiliate has, prior to the Effective Time of the Company Merger and in any material respect, violated any of the health care continuation requirements of COBRA, the requirements of the Family Medical Leave Act of 1993, as amended, the requirements of the Health Insurance Portability and Accountability Act of 1996, the requirements of the Women’s Health and Cancer Rights Act of 1998, the requirements of the Newborns’ and Mothers’ Health Protection Act of 1996, or any amendment to each such act, or any similar provisions of state law applicable to its Employees.

(g) Loans and Advances. Section 2.12(g) of the Company Disclosure Letter contains an accurate and complete list of all loans and advances made by the Company or any Company ERISA Affiliate to any employee, director, consultant or independent contractor outstanding as of the date of this Agreement, other than routine travel and expense advances made to employees in the ordinary course of business. Neither the Company nor any Company ERISA Affiliate has, since July 30, 2002, extended credit, arranged for the extension of credit, or renewed an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of the Company.

(i) The execution of this Agreement and the consummation of the transactions contemplated hereby will not (either alone or upon the occurrence of any additional or subsequent events) constitute an event under any Company Employee Plan, Company Employee Agreement, trust or loan that will or may result in any payment (whether of severance pay or otherwise), acceleration, forgiveness of indebtedness, vesting, distribution, increase in benefits or obligation to fund benefits with respect to any Company Employee.

Index to Financial Statements

(ii) No payment or benefit which will or may be made by the Company or its Company ERISA Affiliates with respect to any Company Employee will be characterized as a “parachute payment,” within the meaning of Section 280G(b)(2) of the Code. There is no contract, agreement, plan or arrangement to which Company or any of its Company ERISA Affiliates is a party or by which it is bound to compensate any Company Employee for excise taxes paid pursuant to Section 4999 of the Code.

(i) Employment Matters. The Company: (i) is in compliance in all material respects with all applicable foreign, federal, state and local laws, rules and regulations respecting employment, employment practices, terms and conditions of employment and wages and hours, in each case, with respect to Employees; and (ii) is not liable for any payment to any trust or other fund governed by or maintained by or on behalf of any governmental authority, with respect to unemployment compensation benefits, social security or other benefits or obligations for Employees (other than routine payments to be made in the normal course of business and consistent with past practice). There are no pending, threatened or reasonably anticipated claims or actions against the Company under any workers’ compensation policy or long-term disability policy. Neither the Company nor any Company ERISA Affiliate has or reasonably anticipates any direct or indirect material liability with respect to any misclassification of any person as an independent contractor rather than as an employee, or with respect to any employee leased from another employer.

(j) Labor. No work stoppage or labor strike against the Company or any Company ERISA Affiliate is pending, or to the Company’s Knowledge, threatened or reasonably anticipated. The Company does not know of any activities or proceedings of any labor union to organize any Company Employees. There are no actions, suits, claims, labor disputes or grievances pending, or, to the Knowledge of the Company, threatened or reasonably anticipated relating to any labor, safety or discrimination matters involving any Company Employee, including charges of unfair labor practices or discrimination complaints, which, if adversely determined, would, individually or in the aggregate, result in any material liability to the Company. Neither the Company nor any of its Subsidiaries has engaged in any unfair labor practices within the meaning of the National Labor Relations Act. The Company is not presently, nor has it been in the past, a party to, or bound by, any collective bargaining agreement or union contract with respect to Company Employees and no collective bargaining agreement is being negotiated with respect to Company Employees. Neither the Company nor any of its Subsidiaries have incurred any material liability or material obligation under the Worker Adjustment and Retraining Notification Act or any similar state or local law which remains unsatisfied.

(k) International Employee Plan. Each Company Employee Plan that has been adopted or maintained by the Company or any Company ERISA Affiliate, whether informally or formally, or with respect to which the Company or any Company ERISA Affiliate will or may have any material liability, for the benefit of Company Employees who perform services outside the United States (each a “Company International Employee Plan”) has been established, maintained and administered in material compliance with its terms and conditions and with the requirements prescribed by any and all statutory or regulatory laws that are applicable to such Company International Employee Plan. Furthermore, no Company International Employee Plan has material unfunded liabilities, that as of the Effective Time of the Company Merger, will not be offset by insurance or fully accrued. Except as required by law, no condition exists that would prevent the Company or Parent from terminating or amending any Company International Employee Plan at any time for any reason without liability to the

Index to Financial Statements

Company or its Company ERISA Affiliates (other than ordinary administration expenses or routine claims for benefits).

(a) Properties. Neither Company nor any of its Subsidiaries owns any real property. Section 2.13 of the Company Disclosure Letter sets forth a list, as of the date hereof, of all real property currently leased, subleased, licensed or otherwise occupied by the Company or any of its Subsidiaries, the name of the lessor, the date of the lease and each amendment thereto and the aggregate annual rental fees payable under any such lease. All such current leases are in full force and effect, are valid and effective in accordance with their respective terms, and there is not, under any of such leases, any existing material default or material event of default (or event which with notice or lapse of time, or both, would constitute a material default). The Company has provided or made available to Parent true, correct and complete copies of all such real property leases, lease guaranties, licenses, subleases and occupancy agreements, including all amendments, terminations and modifications thereof. The Company or its Subsidiaries currently occupies all of such real property for the operation of its business, and there are no other parties occupying, or with a right to occupy, such real property. Such real property is in good operating condition and repair in all material respects.

(b) Lease Restructures. The “Close of Escrow”, as defined in that certain Property Purchase and Lease Modification Agreement dated January 16, 2003 (the “Lease Modification Agreement”) executed by the Company, HFC and M-F Downtown Sunnyvale, LLC, a Delaware limited liability company (“M-F Downtown”), has occurred and all of the conditions to the Close of Escrow were satisfied or waived in accordance with the terms of the Lease Modification Agreement, other than the conditions to the Close of Escrow set forth in Sections 11(c)(iv), 11(e), 11(f), 11(g), 12(d) and 12(e), which were satisfied in accordance with the terms of the Lease Modification Agreement. The Company did not use the services of a broker, and no broker is entitled to, or has made a claim for, any compensation from the Company, in connection with the Lease Modification Agreement or any efforts to sublet the subject premises. No “Occupancy” or “Reinstatement” has occurred, as such terms are defined in that certain Amended and Restated Lease Agreement (Building 3) dated January 29, 2003 between M-F Downtown and HFC. The Company is the sole member of HFC. As of the date hereof, Domenic Borriello of CT Corporation Staffing is the “Independent Manager” of HFC. EOP-Industrial Portfolio, L.L.C. (“EOP”), has drawn in full on the letter of credit provided by the Company under its lease of 380 North Bernardo Avenue, Mountain View, California as contemplated under the First Amendment dated January 31, 2003 between EOP and the Company.

(c) Valid Title. The Company and each of its Subsidiaries has good and valid title to, or, in the case of leased properties and assets, valid leasehold interests in, all of its material tangible properties and assets, real, personal and mixed, used or held for use in its business (including for the manufacture of the Company Products), free and clear of any Liens except (i) as reflected in the Company Financials, (ii) Liens in connection with the Loan Agreement, (iii) Liens imposed by law in respect of obligations not yet delinquent, including in respect of taxes, or (iv) Liens which are not material in character, amount or extent, and which do not materially detract from the value, or materially interfere with the present use, of the property subject thereto or affected thereby (the Liens referred to in subparagraphs (iii) and (iv) above being collectively referred to as the “Permitted Liens”).

Index to Financial Statements

(a) Hazardous Material. Except as would not result in a material liability to the Company, no underground storage tanks and no amount of any substance that has been designated by any Governmental Entity or by applicable federal, state or local law to be radioactive, toxic, hazardous or otherwise a danger to health or the environment, including PCBs, asbestos, petroleum, urea-formaldehyde and all substances listed as hazardous substances pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or defined as a hazardous waste pursuant to the United States Resource Conservation and Recovery Act of 1976, as amended, and the regulations promulgated pursuant to said laws, but excluding office and janitorial supplies properly and safely maintained, (a “Hazardous Material”) are present in violation of any rule, regulation, treaty or statute promulgated by any Governmental Entity in effect as of the date hereof, as a result of the actions of the Company or any of its Subsidiaries or any affiliate of the Company, or, to the Knowledge of the Company, as a result of any actions of any third party or otherwise, in, on or under any property, including the land and the improvements, ground water and surface water thereof, that the Company or any of its Subsidiaries has at any time owned, operated, occupied or leased.

(b) Hazardous Materials Activities. Except as would not result in a material liability to the Company, neither the Company nor any of its Subsidiaries has transported, stored, used, manufactured, disposed of, released or exposed any Company Employees or others to Hazardous Materials in violation of any Legal Requirement in effect on or before the Closing Date. Except as would not result in a material liability to the Company, neither the Company nor any of its Subsidiaries has disposed of, transported, sold, used, released, exposed any Company Employees or others to or manufactured any product containing a Hazardous Material (collectively, “Hazardous Materials Activities”) in violation of any Legal Requirement promulgated by any Governmental Entity in effect prior to or as of the date hereof to prohibit, regulate or control Hazardous Materials or any Hazardous Material Activity.

(c) Permits. The Company and its subsidiaries currently hold all environmental Permits materially necessary for the conduct of the Company’s and its Subsidiaries’ Hazardous Material Activities (the “Company Environmental Permits”) and other businesses of the Company and its Subsidiaries as such activities and businesses are currently being conducted.

(d) Environmental Liabilities. No action, proceeding, revocation proceeding, amendment procedure, writ or injunction is pending, or to the Company’s Knowledge, has been threatened in writing by any Governmental Entity against the Company or any of its Subsidiaries concerning any Company Environmental Permit, Hazardous Material or any Hazardous Materials Activity of the Company or any of its Subsidiaries.

(a) Material Contracts. For purposes of this Agreement, “Company Material Contract” shall mean any of the following Contracts of the Company or its Subsidiaries:

(i) any “material contracts” (as such term is defined in Item 601(b)(10) of Regulation S-K of the SEC) with respect to the Company and its Subsidiaries (including any agreement that is required to be filed in a future filing);

Index to Financial Statements

(ii) any employment or consulting Contract with any executive officer or other employee of the Company earning an annual base salary in excess of $125,000 or a member of the Company’s Board of Directors other than those that are terminable by the Company or any of its Subsidiaries on no more than thirty (30) days notice without liability or financial obligation to the Company;

(iii) any joint venture Contract or similar arrangement or any other agreement which has involved or is expected to involve a sharing of revenues of $250,000 per annum or more with other Persons;

(iv) any Contract, including any stock option plan, stock appreciation right plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, by the occurrence of any of the transactions contemplated by this Agreement, or the value of any of the benefits of which will be calculated on the basis of any of the transactions contemplated by this Agreement, or which may, by its terms, have any of the obligations of such Contract terminated or adjusted as a result of the execution of this Agreement or the Voting Agreements, the Company Transfer Agreements or the consummation of the Company Merger;

(v) any agreement of indemnification or any guaranty by the Company or any of its Subsidiaries other than any agreement of indemnification entered into in connection with the sale or license of Company Products in the ordinary course of business;

(vi) any Contract containing any covenant (a) limiting in any material respect the right of the Company or any of its Subsidiaries to engage in any line of business, to make use of any Intellectual Property, develop market or distribute products or services or compete with any Person, (b) granting any exclusive rights, or (c) otherwise limiting the right of the Company or any of its Subsidiaries to sell, distribute or manufacture any products or services or to purchase or otherwise obtain any Software, components, parts, subassemblies or services;

(vii) any Contract relating to the disposition or acquisition by the Company or any of its Subsidiaries after the date of this Agreement of a material amount of assets not in the ordinary course of business, or pursuant to which the Company or any of its Subsidiaries has any material ownership interest in any other Person or other business enterprise other than the Company’s Subsidiaries;

(viii) any dealer, distributor, joint marketing or development agreement, under which the Company or any of its Subsidiaries have continuing obligations or costs in excess of $250,000 per year, which may not be canceled without penalty upon notice of ninety (90) days or less;

(ix) any agreement pursuant to which the Company or any of its Subsidiaries have continuing obligations to jointly develop any material item of Intellectual Property;

(x) any Contract to provide source code to any third party for any product or technology of the Company;

(xi) any Contract containing any support, service or maintenance obligation on the part of the Company or any of its Subsidiaries outside of the ordinary course of business consistent with past practice;

Index to Financial Statements

(xii) any Contract to license any third party to manufacture or reproduce any of the products, services or technology of the Company or any of its Subsidiaries or any Contract to sell or distribute any of the products, services or technology of the Company or any of its Subsidiaries;

(xiii) any mortgages, indentures, guarantees, loans or credit agreements, security agreements or other Contracts relating to the borrowing of money or extension of credit, other than accounts receivables and payables in the ordinary course of business;

(xiv) any settlement agreement entered into within three (3) years prior to the date of this Agreement;

(xv) any lease for (a) real property in which the amount of payments which the Company or any of its Subsidiaries is required to make on an annual basis exceeds $100,000 or (b) personal property in which the amount of payments which the Company or any of its Subsidiaries is required to make on an annual basis exceeds $100,000;

(xvi) any agreement, contract or commitment pursuant to which the Company or any of its Subsidiaries is obligated to pay in the future in excess of $250,000 in any one year period which is not terminable by the Company or its Subsidiaries without penalty in excess of $10,000 upon notice of ninety (90) days or less, other than any agreement, contract or commitment to purchase inventory in the ordinary course of business consistent with past practice;

(xvii) any other agreement, contract or commitment that has a value of $375,000 or more in any individual case not described in clauses (i) through (xv) above; or

(xviii) any Contract, or group of Contracts with a Person (or group of affiliated Persons), not described in clauses (i) through (xvii) above the termination or breach of which would be reasonably expected to have a material adverse effect on any material product or service offerings of the Company or its Subsidiaries or otherwise have a Material Adverse Effect on the Company.

(b) Schedule. Section 2.15(b) of the Company Disclosure Letter sets forth a list of all Company Material Contracts to which the Company or any of its Subsidiaries is a party or is bound by as of the date hereof which are described in Sections 2.15(a)(i) through 2.15(a)(xviii) hereof.

(c) No Breach. All Company Material Contracts and all Contracts listed in Section 2.7(m) of the Company Disclosure Letter are valid and in full force and effect except to the extent they have previously expired in accordance with their terms or if the failure to be in full force and effect, individually or in the aggregate, would not reasonably be expected to be material to the Company. Neither the Company nor any of its Subsidiaries has violated any provision of, or committed or failed to perform any act which, with or without notice, lapse of time or both would constitute a default under the provisions of, any Company Material Contract or any Contract listed in Section 2.7(m) of the Company Disclosure Letter, except in each case for those violations and defaults which, individually or in the aggregate, would not reasonably be expected to be material to the Company.

2.16 Disclosure. None of the information supplied or to be supplied by or on behalf of the Company for inclusion or incorporation by reference in the registration statement on Form S-4 (or similar successor form) to be filed with the SEC by Parent in connection with the issuance of Parent Common Stock in the Company Merger (including amendments or supplements thereto) (the

Index to Financial Statements

“Registration Statement”) will, at the time the Registration Statement becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. None of the information supplied or to be supplied by or on behalf of the Company for inclusion or incorporation by reference in the Prospectus/Proxy Statement to be filed with the SEC as part of the Registration Statement (the “Prospectus/Proxy Statement”), will, at the time the Prospectus/Proxy Statement is mailed to the stockholders of Parent and the Company, at the time of the Company Stockholders’ Meeting (as defined in Section 5.2(a)), at the time of the Parent Stockholders’ Meeting (as defined in Section 5.2(a)), as of the Effective Time of the Parent Merger, or as of the Effective Time of the Company Merger, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. The Prospectus/Proxy Statement will comply as to form in all material respects with the applicable provisions of the Securities Act, the Exchange Act and the rules and regulations promulgated by the SEC thereunder. Notwithstanding the foregoing, no representation or warranty is made by the Company with respect to statements made or incorporated by reference therein about Parent, Separation Sub or Merger Sub supplied by Parent, Separation Sub or Merger Sub for inclusion or incorporation by reference in the Registration Statement or the Prospectus/Proxy Statement.

2.17 Board Approval. The Board of Directors of the Company has, by resolutions duly adopted by unanimous vote at a meeting of all Directors duly called and held and not subsequently rescinded or modified on or prior to the date hereof in any way (the “Company Board Approval”) (i) determined that the Company Merger is fair to, and in the best interests of, the Company and its stockholders and declared the Company Merger to be advisable, (ii) approved this Agreement and the transactions contemplated thereby, including the Company Merger, and (iii) unanimously recommended that the stockholders of the Company approve and adopt this Agreement and approve the Company Merger and directed that such matter be submitted to the Company’s stockholders at the Company Stockholders’ Meeting. The Board of the Directors the Company has, by resolutions duly adopted by unanimous vote at a meeting of all Directors duly called and held and not subsequently rescinded or modified on or prior to the date hereof in any way, (i) approved the Company Rights Agreement (as defined in Section 5.15); and (ii) authorized and directed the dividend of the Company Rights (as defined in Section 5.15) with a record date of June 5, 2003 and a payment date of not later than June 5, 2003.

2.18 Fairness Opinion. The Company’s Board of Directors has received an opinion from Credit Suisse First Boston Corporation, dated as of June 3, 2003, to the effect that, as of such date, the Exchange Ratio is fair, from a financial point of view, to the Company stockholders, and has delivered to Parent a written copy of such opinion.

2.19 Takeover Statutes. The Board of Directors of the Company has taken all actions so that the restrictions contained in Section 203 of the Delaware General Corporation Law applicable to a “business combination” (as defined in such Section 203), and any other similar Legal Requirement, will not apply to Parent during the pendency of this Agreement, including the execution, delivery or performance of this Agreement and the Voting Agreements and the consummation of the Company Merger and the other transactions contemplated hereby.

Index to Financial Statements

Parent represents and warrants to the Company, subject to the exceptions specifically disclosed (subject to the last sentence of Section 8.3(a)) in writing in the disclosure letter supplied by Parent to the Company dated as of the date hereof and certified by a duly authorized executive officer of Parent (the “Parent Disclosure Letter”), as follows; subject to the following clause, it is understood and agreed that Parent makes no representations or warranties in this Agreement, express or implied, with respect to Source or its Subsidiaries, or the business, assets, capitalization, financial condition or results of operations of Source or its Subsidiaries; however, to the extent a representation or warranty in the Agreement refers to “Parent” or its Subsidiaries, such reference shall be deemed to specifically exclude such matters with respect to Source and its Subsidiaries except to the extent that the failure of such representation or warranty to be true and correct with respect to Source and its Subsidiaries would or would be reasonably likely to adversely affect Parent following the Mergers (taking into account the terms of the Separation Agreements (as defined in Section 3.21(a)):

(a) Organization; Standing and Power. Parent and each of its Subsidiaries (i) is a corporation or other organization duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization, (ii) has the requisite power and authority to own, lease and operate its properties and to carry on its business as now being conducted, and (iii) is duly qualified or licensed and in good standing to do business in each jurisdiction in which the nature of its business or the ownership or leasing of its properties makes such qualification or licensing necessary, other than in such jurisdictions where the failure to so qualify or to be in good standing, individually or in the aggregate, would not reasonably be expected to have a Material Adverse Effect on Parent.

(b) Charter Documents. Parent has delivered or made available to the Company (i) a true and correct copy of the Certificate of Incorporation (including any Certificate of Designations) and Bylaws of Parent, each as amended to date (collectively, the “Parent Charter Documents”) and (ii) the Subsidiary Charter Documents of each of its Significant Subsidiaries (as defined Rule 1.02 of Regulation of S-X of the SEC), and each such instrument is in full force and effect. Parent is not in violation of any of the provisions of the Parent Charter Documents and each Significant Subsidiary of Parent is not in violation of its respective Subsidiary Charter Documents.

(c) Significant Subsidiaries. Exhibit 21 to Parent’s Annual Report on Form 10-K for the fiscal year ended May 31, 2002 includes all the Subsidiaries of Parent which are Significant Subsidiaries. All the outstanding shares of capital stock of, or other equity or voting interests in, each such Significant Subsidiary have been duly authorized, validly issued and are fully paid and nonassessable and are owned by Parent, a Subsidiary of Parent, or Parent and another Subsidiary or Parent, or, in the case of foreign Significant Subsidiaries, Parent, another Subsidiary of Parent or solely to the extent required to comply with local laws regarding ownership, a nominee of Parent or a Subsidiary of Parent, free and clear of all Liens, including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other ownership interests, except for restrictions imposed by applicable securities laws, except as would not reasonably be expected to have a Material Adverse Effect on Parent or a Material Adverse Effect on such Subsidiary.

Index to Financial Statements

(a) Capital Stock. The authorized capital stock of Parent consists of: (i) 2,000,000,000 shares of Parent Common Stock, par value $0.001 per share and (ii) 125,000,000 shares of preferred stock, par value $0.001 per share (the “Parent Preferred Stock”), of which 2,000,000 shares have been designated as Series A Participating Preferred Stock, all of which will be reserved for issuance upon exercise of preferred stock purchase rights (the “Parent Rights”) issuable pursuant to the Preferred Stock Rights Agreement dated as of September 25, 2000 by and between Parent and EquiServe Trust Company, N.A. (formerly Fleet National Bank) (the “Parent Rights Agreement”), a true and complete copy of which is filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed with the Commission on November 22, 2000. At the close of business on May 28, 2003: (i) 29,230,405 shares of Parent Common Stock were issued and outstanding, excluding shares of Parent Common Stock held by Parent in its treasury, (ii) no shares of Parent Common Stock were issued and held by Parent in its treasury, and (iii) no shares of Parent Preferred Stock were issued and outstanding. From May 28, 2003 and through date hereof, there has been no material change in the capitalization of Parent. All of the outstanding shares of capital stock of Parent are, and all shares of capital stock of Parent which may be issued as contemplated by this Agreement will be, when issued, duly authorized and validly issued, fully paid and nonassessable and not subject to any preemptive rights. All shares of capital stock of Parent which may be issued as contemplated by this Agreement will be free of all Liens and will be registered in compliance with the Securities Act and registered or exempt from registration or qualification under applicable blue sky laws.

(b) Stock Options. As of the close of business on May 28, 2003: (i) 4,028,209 shares of Parent Common Stock are subject to issuance pursuant to outstanding options to purchase Parent Common Stock (such options, whether or not outstanding, “Parent Options”) under the stock option, stock award, stock appreciation or phantom stock plans of Parent (the “Parent Stock Option Plans”) other than the Parent Purchase Plan, an aggregate of 2,146,206 of which were unvested, (ii) 1,376,303 shares of Parent Common Stock are reserved for future issuance under the Parent Purchase Plan, and (iii) 1,091,435 shares of Parent Common Stock are reserved for future issuance under the Parent Stock Option Plans. All Parent Options granted since May 28, 2003 have been granted in the ordinary course of business. All shares of Parent Common Stock subject to issuance pursuant to the exercise of Parent Options and the Parent Purchase Plans, upon issuance on the terms and conditions specified in the instruments pursuant to which they are issuable, will be duly authorized, validly issued, fully paid and nonassessable. There are no commitments or agreements of any character to which Parent is bound obligating Parent to accelerate the vesting of any Parent Option as a result of the Parent Merger or the Company Merger (whether alone or upon the occurrence of any additional or subsequent events). There are no outstanding or authorized stock appreciation, phantom stock, profit participation or other similar rights with respect to Parent. There will be no acceleration of the vesting of any Parent Options held by any employee, director or consultant of Peace, Source or any other Subsidiary of Peace, pursuant to the Parent Stock Option Plans or otherwise, as a result of the Parent Merger or the Company Merger. Upon closing of the Parent Merger, the employees of Source shall be considered as having terminated their employment with Parent or its Subsidiaries effective as of such closing under the terms of the Parent Stock Option Plans and shall have a period of time from such date of termination within which to exercise any vested Parent Options following which such Parent Options shall expire in accordance with the terms of the applicable Option agreements. At the Effective Time of Parent Merger, each Parent Option will be adjusted so that it will be exercisable (or will become exercisable in accordance with its terms) for a number of share of Parent Common Stock equal in fair market value to the consideration

Index to Financial Statements

received by holders of Parent Common Stock pursuant to Section 1.8(a) hereof pursuant to the formula described in Section 3.2(b) of the Parent Disclosure Letter.

(d) Other Securities. Except as otherwise set forth in this Agreement, the Parent Rights Plan or Section 3.2(d) of the Parent Disclosure Letter, as of the date hereof, there are no securities, options, warrants, calls, rights, Contracts, commitments, agreements, instruments, arrangements, understandings, obligations or undertakings of any kind to which Parent or any of its Subsidiaries is a party or by which any of them is bound obligating Parent or any of its Subsidiaries to (including on a deferred basis) issue, deliver or sell, or cause to be issued, delivered or sold, additional shares of capital stock, Voting Debt or other voting securities of Parent or any of its Subsidiaries, or obligating Parent or any of its Subsidiaries to issue, grant, extend or enter into any such security, option, warrant, call, right, Contract, commitment, agreement, instrument, arrangement, understanding, obligation or undertaking. All outstanding shares of Parent Common Stock, all outstanding Parent Options, and all outstanding shares of capital stock of each Subsidiary of Parent have been issued and granted in compliance in all material respects with (i) all applicable securities laws and all other applicable Legal Requirements and (ii) all requirements set forth in applicable Contracts. Parent is not a party to any voting agreement with respect to shares of the capital stock of, or other equity or voting interests in, Parent or any of its Subsidiaries with respect to this Agreement or the transactions contemplated hereby (including the Parent Merger and the Company Merger and, to the Knowledge of Parent, other than the Parent Voting Agreements and the irrevocable proxies granted pursuant to the Parent Voting Agreements, there are no irrevocable proxies and no voting agreements or voting trusts with respect to any shares of the capital stock of, or other equity or voting interests in, Parent or any of its Subsidiaries, in each case with respect to this Agreement or the transactions contemplated hereby (including the Parent Merger and the Company Merger).

(e) Separation Sub Capital Stock. The authorized capital stock of Separation Sub consists of 1,000 shares of common stock, par value $0.001 per share, of which 1,000 shares are issued and outstanding. Parent is the sole stockholder of Separation Sub and is the legal and beneficial owner of all 1,000 issued and outstanding shares. Separation Sub was formed by counsel to Parent at the direction of Parent on May 30, 2003, solely for purposes of effecting the Parent Merger and the other transactions contemplated hereby. Except as contemplated by this Agreement, Separation Sub does not hold, nor has it held, any material assets or incurred any material liabilities nor has Separation Sub carried on any business activities other than in connection with the Parent Merger and the transactions contemplated by this Agreement. All of the outstanding shares of capital stock of Separation Sub have been duly authorized and validly issued, and are fully paid and nonassessable and not subject to any preemptive rights.

(f) Merger Sub Capital Stock. The authorized capital stock of Merger Sub consists of 1,000 shares of common stock, par value $0.001 per share, of which 1,000 shares are issued and outstanding. Parent is the sole stockholder of Merger Sub and is the legal and beneficial owner of all 1,000 issued and outstanding shares. Merger Sub was formed by counsel to Parent at the direction of Parent on May 30, 2003, solely for purposes of effecting the Company Merger and the other transactions contemplated hereby. Except as contemplated by this Agreement, Merger Sub does not hold, nor has it held, any material assets or incurred any material liabilities nor has Merger Sub carried on any business

Index to Financial Statements

activities other than in connection with the Company Merger and the transactions contemplated by this Agreement. All of the outstanding shares of capital stock of Merger Sub have been duly authorized and validly issued, and are fully paid and nonassessable and not subject to any preemptive rights.

(a) Authority. Each of Parent, Separation Sub and Merger Sub has all requisite corporate power and authority to enter into this Agreement and to consummate the transactions contemplated hereby. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate and stockholder action on the part of Parent, Separation Sub and Merger Sub and no other corporate proceedings on the part of Parent, Separation Sub or Merger Sub are necessary to authorize the execution and delivery of this Agreement or to consummate the Mergers and the other transactions contemplated hereby, subject only to (i) the adoption and approval of this Agreement and approval of the Parent Merger by Parent’s stockholders and approval of the issuance of Parent Common Stock in connection with the Company Merger, as required under Delaware Law and the rules of Nasdaq, and (ii) the filing of the Parent Certificate of Merger pursuant to Delaware Law. The affirmative vote of the holders of (i) a majority of the outstanding shares of Parent Common Stock to approve and adopt this Agreement and approve the Parent Merger and (ii) a majority in interest of the Parent Common Stock present or represented by proxy at the Parent Stockholders’ Meeting to approve the issuance of Parent Common Stock in connection with the Company Merger is the only vote of the holders of any class or series of Parent capital stock necessary to approve and adopt this Agreement, approve the Parent Merger, approve the Company Merger, and consummate the Parent Merger and the Company Merger and the other transactions contemplated hereby. This Agreement has been duly executed and delivered by Parent, Separation Sub and Merger Sub and, assuming due execution and delivery by the Company, constitutes the valid and binding obligation of each of Parent, Separation Sub and Merger Sub, enforceable against each of Parent, Separation Sub and Merger Sub in accordance with its terms.

(b) Non-Contravention. The execution and delivery of this Agreement by Parent, Separation Sub and Merger Sub does not, and performance of this Agreement by Parent, Separation Sub and Merger Sub and the consummation of the Mergers and the transactions contemplated hereby will not: (i) conflict with or violate the Parent Charter Documents, the certificate of incorporation or bylaws of Separation Sub, the certificate of incorporation or bylaws of Merger Sub or any other Subsidiary Charter Documents of any other Subsidiary of Parent; (ii) subject to compliance with the requirements set forth in Section 3.3(c), conflict with or violate any material Legal Requirement applicable to Parent, Separation Sub, Merger Sub or any of Parent’s other Subsidiaries or by which Parent, Separation Sub, Merger Sub or any of Parent’s other Subsidiaries or any of their respective material properties is bound or affected; or (iii) result in any material breach of or constitute a material default (or an event that with notice or lapse of time or both would become a material default) under, or materially impair Parent’s or any of its Subsidiaries’ rights or materially alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, or result in the creation of a material Lien on any of the material properties or assets of Parent or any of its Subsidiaries pursuant to, any Parent Material Contract (as defined in Section 3.15).

(c) Necessary Consents. No consent, approval, order or authorization of, or registration, declaration or filing with any Governmental Entity or any other Person is required to be obtained or made by Parent or any of its Subsidiaries in connection with the execution and delivery of

Index to Financial Statements

this Agreement or the consummation of the Mergers and other transactions contemplated hereby and thereby, except for (i) the Necessary Consents, (ii) those consents, approvals, orders, authorizations, registrations, declarations or filings that have already been made or obtained, and (iii) such other consents, authorizations, filings, approvals and registrations which if not obtained or made would not be material to Parent or the Company or materially adversely affect the ability of the parties hereto to consummate the Mergers within the time frame in which the Mergers would otherwise be consummated in the absence of the need for such consent, approval, order, authorization, registration, declaration or filings.

(a) SEC Filings. Parent has filed all required registration statements, prospectuses, reports, schedules, forms, statements and other documents (including exhibits and all other information incorporated by reference) required to be filed by it with the SEC since March 31, 2000. Parent has made available to the Company all such registration statements, prospectuses, reports, schedules, forms, statements and other documents in the form filed with the SEC. All such required registration statements, prospectuses, reports, schedules, forms, statements and other documents (including those that Parent may file subsequent to the date hereof) are referred to herein as the “Parent SEC Reports.” As of their respective dates, the Parent SEC Reports (i) were prepared in accordance and complied in all material respects with the requirements of the Securities Act, or the Exchange Act, as the case may be, and the rules and regulations of the SEC thereunder applicable to such Parent SEC Reports and (ii) did not at the time they were filed (or if amended or superseded by a filing prior to the date of this Agreement then on the date of such filing) contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. None of Parent’s Subsidiaries is required to file any forms, reports or other documents with the SEC.

(b) Financial Statements. Each of the consolidated financial statements (including, in each case, any related notes thereto) contained in the Parent SEC Reports (the “Parent Financials”), including each Parent SEC Report filed after the date hereof until the Closing: (i) complied as to form in all material respects with the published rules and regulations of the SEC with respect thereto, (ii) was prepared in accordance with GAAP applied on a consistent basis throughout the periods involved (except as may be indicated in the notes thereto or, in the case of unaudited interim financial statements, as may be permitted by the SEC on Form 10-Q, 8-K or any successor form under the Exchange Act), and (iii) fairly presented in all material respects the consolidated financial position of Parent and its consolidated Subsidiaries as at the respective dates thereof and the consolidated results of Parent’s operations and cash flows for the periods indicated. The balance sheet of Parent contained in the Parent SEC Reports as of February 28, 2003 is hereinafter referred to as the “Parent Balance Sheet.” Except as disclosed in the Parent Financials, since the date of the Parent Balance Sheet, neither Parent nor any of its Subsidiaries has any liabilities (absolute, accrued, contingent or otherwise) of a nature required to be disclosed on a consolidated balance sheet or in the related notes to the consolidated financial statement prepared in accordance with GAAP which are, individually or in the aggregate, material to the business, results of operations or financial condition of Parent and its Subsidiaries taken as a whole, except those liabilities incurred in the ordinary course of business, consistent with past practice, and liabilities incurred in connection with this Agreement and the transactions contemplated hereby.

Index to Financial Statements

(c) Internal Controls. Parent has established and maintains disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 promulgated under the Exchange Act) designed to ensure that material information relating to Parent, including its consolidated subsidiaries, is made known to the Chief Executive Officer and Chief Financial Officer. There are no significant deficiencies or material weaknesses in the design or operation of Parent’s internal controls which could adversely affect Parent’s ability to record, process, summarize and report financial data. To Parent’s Knowledge, there is no fraud, whether or not material, that involves management or other employees who have a significant role in Parent’s internal controls.

3.5 Absence of Certain Changes or Events. Since the date of the Parent Balance Sheet through the date hereof there has not been: (i) any Material Adverse Effect on Parent; (ii) any declaration, setting aside or payment of any dividend on, or other distribution (whether in cash, stock or property) in respect of, any of Parent’s or any of its Subsidiaries’ capital stock, or any purchase, redemption or other acquisition by Parent or any of its Subsidiaries of any of Parent’s capital stock or any other securities of Parent or its Subsidiaries or any options, warrants, calls or rights to acquire any such shares or other securities except for repurchases from employees following their termination pursuant to the terms of their pre-existing stock option or purchase agreements; (iii) any split, combination or reclassification of any of Parent’s or any of its Subsidiaries’ capital stock, (iv) any material change by Parent in its accounting methods, principles or practices, except as required by concurrent changes in GAAP; (v) any material revaluation by Parent of any of its assets, including writing down the value of capitalized inventory or writing off notes or accounts receivable other than in the ordinary course of business consistent with past practice; (vi) any written communication from Nasdaq with respect to the delisting of the Parent Common Stock; or (vii) any agreement, whether in writing or otherwise, to take any action described in this section by Parent or any of its Subsidiaries.

(i) Parent and each of its Subsidiaries have filed all required Tax Returns relating to any and all Taxes concerning or attributable to Parent, its Subsidiaries or their respective operations. Such Tax Returns are true and correct, have been completed in accordance with applicable law and were timely filed, except, in each case, as would not be material to Parent.

(ii) Parent and each of its Subsidiaries have paid all Taxes to be paid and withheld with respect to their employees or other third parties and paid over to the appropriate Taxing authority all Taxes and any other amounts required to be paid or withheld. Such Taxes were timely paid except as would not be material to Parent.

(iii) Neither Parent nor any of its Subsidiaries is currently delinquent in the payment of any Tax, nor is there any material Tax deficiency outstanding, assessed or, to the Knowledge of Parent, proposed against Parent or any of its Subsidiaries, nor has Parent or any of its Subsidiaries executed any outstanding waiver of any statute of limitations on or extension of the period for the assessment or collection of any Tax.

(iv) No audit or other examination of any Tax Return of Parent or any of its Subsidiaries is presently in progress, nor has Parent or any of its Subsidiaries been notified of any

Index to Financial Statements

request for such an audit or other examination. No outstanding adjustment relating to any Tax Return filed by Parent or any of its Subsidiaries has been proposed formally or, to the Knowledge of Parent or any of its Subsidiaries, informally by any tax authority to Parent, any of its Subsidiaries or any representative thereof.

(v) Neither Parent nor any of its Subsidiaries has any liabilities for unpaid Taxes as of the date of the Parent Balance Sheet which have not been accrued or reserved on the Parent Balance Sheet in accordance with GAAP, whether asserted or unasserted, contingent or otherwise and neither Parent nor any of its Subsidiaries has incurred any liability for Taxes since the date of the Parent Balance Sheet other than in the ordinary course of business, consistent with past practice.

(vi) There are no Liens on the assets of Parent or any of its Subsidiaries relating to or attributable to Taxes, other than Liens for Taxes not yet due and payable. To the Knowledge of Parent, there is no basis for the assertion of any material claim relating or attributable to Taxes, which, if adversely determined, would result in any Lien for Taxes on the assets of Parent or any of its Subsidiaries.

(vii) Neither Parent nor any of its Subsidiaries has filed any consent agreement under Section 341(f) of the Code or agreed to have Section 341(f)(2) of the Code apply to any disposition of a subsection (f) asset (as defined in Section 341(f)(4) of the Code) owned by Parent or any of its Subsidiaries.

(viii) Neither Parent nor any of its Subsidiaries is, nor has been at any time, a “United States Real Property Holding Corporation” within the meaning of Section 897(c)(2) of the Code.

(ix) Neither Parent nor any of its Subsidiaries (a) has ever been a member of an affiliated group (within the meaning of Code §1504(a)) filing a consolidated federal income Tax Return (other than a group the common parent of which was Parent), (b) is a party to any Tax sharing, indemnification or allocation agreement (other than between Parent and any of its Subsidiaries), nor does Parent or any of its Subsidiaries owe any amount under any such agreement, (c) has any material liability for the Taxes of any person (other than Parent or any of its Subsidiaries) under Treas. Reg. § 1.1502-6 (or any similar provision of state, local or foreign law), as a transferee or successor, by contract, or otherwise, or (d) is a party to any joint venture, partnership or other agreement that could be treated as a partnership for Tax purposes.

(x) Neither Parent nor any of its Subsidiaries has constituted either a “distributing corporation” or a “controlled corporation” in a distribution of stock intended to qualify for tax-free treatment under Section 355 of the Code (x) in the two years prior to the date of this Agreement or (y) in a distribution which could otherwise constitute part of a “plan” or “series of related transactions” (within the meaning of Section 355(e) of the Code) in conjunction with the Company Merger.

(xi) Neither Parent nor any of its Affiliates has taken or agreed to take any action that would prevent the Company Merger from qualifying as a reorganization within the meaning of Section 368(a) of the Code. Parent has no Knowledge of any agreement, plan, fact or other

Index to Financial Statements

circumstance that would prevent the Company Merger from qualifying as a reorganization within the meaning of Section 368(a) of the Code.

(xii) Parent has obtained a ruling from the United States Internal Revenue Service (the “IRS”) that the distribution of Source Common Stock to the stockholders of Parent (which will be effected through the Parent Merger) will qualify as a tax-free distribution under Section 355 of the Code. The information, representations and statements submitted to the IRS by Parent in obtaining such ruling were at the time of submission and, as of the date hereof, are, materially true and correct, and neither Parent nor any of its Affiliates has taken, or agreed to take, or will knowingly take any action that would make any material representation given to the IRS for such IRS ruling materially untrue.

(a) To the Knowledge of Parent, (i) the operation of the Solutions Group Business (as defined below) of Parent and each of its Subsidiaries, including their products and services, does not infringe or misappropriate in any material respect the Intellectual Property of any third party or constitute unfair competition or unfair trade practices under the laws of any jurisdiction, and (ii) Parent and its Subsidiaries (after giving effect to the Separation Agreements) own or possess sufficient rights to all material Intellectual Property used in or necessary for the operation of the Solutions Group Business. “Solutions Group Business” shall mean the business of Parent contemplated to be conducted by Parent (after giving effect to the Separation Agreements) following the distribution of the Source Common Stock to each holder of Parent Stock and shall not include the business of Source (after giving effect to the Separation Agreements), including the development, licensing or provision of the Palm operating system.

(b) Neither Parent nor any of its Subsidiaries have received any written notice from any third party as of the date hereof, and, to the Knowledge of Parent, there is no other assertion or pending threat from any third party, that the operation of the Solutions Group Business by Parent or any of its Subsidiaries, or any of the products or services of the Solutions Group Business, infringes or misappropriates the Intellectual Property of any third party or constitutes unfair competition or unfair trade practices under the laws of any jurisdiction. Neither Parent nor any its Subsidiaries have brought or have been a party to any suits, arbitrations or other adversarial proceedings with respect to a third party’s Intellectual Property that remain unresolved.

(c) To the Knowledge of Parent, as of the date hereof, no person is infringing or misappropriating any material Intellectual Property owned or exclusively licensed by Parent or any of its Subsidiaries relating to the Solutions Group Business. Neither Parent nor any its Subsidiaries have brought or have been a party to any suits, arbitrations or other adversarial proceedings with respect to the Intellectual Property of the Solutions Group Business against any third party that remain unresolved.

(d) Parent and its Subsidiaries are not subject to any judgment, order, writ, injunction or decree of any court or any Federal, state, local, foreign or other governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, or any arbitrator, which restricts or impairs the use of any Parent Intellectual Property used in the Solutions Group Business. The Intellectual Property of the Solutions Group Business owned or exclusively licensed by Parent and its Subsidiaries is free and clear of any material Liens.

Index to Financial Statements

(e) Parent and each of its Subsidiaries are in material compliance with, and have not materially breached any term of any contracts, licenses or other agreements in which Parent and its Subsidiaries have granted or received any Intellectual Property of the Solutions Group Business (“Parent IP Agreements”).

(f) The Mergers will not result in the termination or breach of any Parent IP Agreements, or any material loss or change in the rights or obligations of Parent or its Subsidiaries or any third party to such Parent IP Agreements. The Mergers will not result in the obligation of Parent or its Subsidiaries to pay any consideration, royalties or other amounts to any third party in excess of those amounts otherwise owed by Parent or its Subsidiaries immediately prior to the Mergers.

(g) Parent and each of its Subsidiaries has complied in all material respects with all Legal Requirements relating to the collection and use of user information gathered in the course of its respective operations, and Parent and each of its Subsidiaries has complied with the rules, policies and procedures established by Parent from time to time with respect to the foregoing in each case, in the aggregate, except as would not result in a Material Adverse Effect on Parent.

(a) Compliance. Neither Parent nor any of its Subsidiaries is in conflict with, or in default or in violation of any material Legal Requirement applicable to Parent or any of its Subsidiaries or by which Parent or any of its Subsidiaries or any of their respective businesses or properties is, or Parent believes is reasonably likely to be, bound or affected, except, in each case, or in the aggregate, for conflicts, violations and defaults that would not cause Parent to lose any material benefit or incur any material liability. To Parent’s Knowledge, no investigation or review by any Governmental Entity is pending or has been threatened in writing against Parent or any of its Subsidiaries. There is no judgment, injunction, order or decree binding upon Parent or any of its Subsidiaries which has or would reasonably be expected to have the effect of prohibiting or impairing any business practice of Parent or any of its Subsidiaries, any acquisition of property by Parent or any of its Subsidiaries or the conduct of business by Parent and its Subsidiaries as currently conducted.

(b) Permits. Parent and its Subsidiaries hold, to the extent legally required, all Permits that are required for the operation of the Solutions Group business of Parent (collectively, “Parent Permits”) except where the failure to hold such Permits would not be material to Parent. As of the date hereof, no suspension or cancellation of any of the Parent Permits is pending or, to the Knowledge of Parent, threatened. Parent and its Subsidiaries are in compliance in all material respects with the terms of the Parent Permits.

3.9 Litigation. There are no material claims, suits, actions or proceedings (i) pending or, to the Knowledge of Parent, threatened against Parent or any of its Subsidiaries, or (ii) pending or, to the Knowledge of Parent, threatened against Source or any of its Subsidiaries for which Parent or any of its Subsidiaries has or may have any indemnity obligation pursuant to any Separation Agreement required to be listed in Section 3.21(a) of the Parent Disclosure Letter to indemnify Source or any of its Subsidiaries, in each case before any court, governmental department, commission, agency, instrumentality or authority, or any arbitrator.

Index to Financial Statements

3.10 Brokers’ and Finders’ Fees. The Company shall not be liable for any brokerage or finders’ fees or agents’ commissions or any similar charges incurred by Parent in connection with this Agreement or any transaction contemplated hereby.

3.11 Transactions with Affiliates. Except as set forth in the Parent SEC Reports, since the date of Parent’s last proxy statement filed with the SEC until the date hereof, no event or transaction has occurred of the type that would be reportable by Parent pursuant to Item 404 of Regulation S-K promulgated by the SEC.

(a) Definitions. For purposes of this Agreement, the following terms have the following meanings:

(i) “Parent Employee Agreement” shall mean each employment, severance or consulting agreement between Parent or any Parent ERISA Affiliate and any current Parent Employee or former Parent Employee, to the extent Parent or any Parent ERISA Affiliate has or may have any liability or obligation, except to the extent a Parent Employee Agreement provides for “at-will” employment and does not provide for severance payments or benefits.

(ii) “Parent Employee Plan” shall mean each plan, program, policy, practice, contract, agreement or other arrangement providing for compensation, severance, termination pay, deferred compensation, performance awards, stock or stock-related awards, fringe benefits or other employee benefits or remuneration of any kind, whether written or unwritten or otherwise, funded or unfunded, including each “employee benefit plan,” within the meaning of Section 3(3) of ERISA which is or has been, within the past three years, maintained, contributed to, or required to be contributed to, by Parent or any Subsidiary of Parent or any Parent ERISA Affiliate for the benefit of any current or former or retired employee, consultant or director of Parent or any Parent ERISA Affiliate (each a “Parent Employee”), or with respect to which Parent or any Parent ERISA Affiliate has or may have any liability or obligation.

(iii) “Parent ERISA Affiliate” shall mean any person or entity under common control with Parent or any Subsidiary within the meaning of Section 414(b), (c), (m) or (o) of the Code and the regulations issued thereunder.

(b) Parent Employee Plan Compliance. Parent and its Parent ERISA Affiliates have performed in all material respects all obligations required to be performed by them under each Parent Employee Plan, and each Parent Employee Plan has been established and maintained in all material respects in accordance with its terms and in material compliance with all applicable laws, statutes, orders, rules and regulations, including but not limited to ERISA or the Code. Any Parent Employee Plan intended to be qualified under Section 401(a) of the Code and each trust intended to qualify under Section 501(a) of the Code (i) has either applied for, prior to the expiration of the requisite period under applicable Treasury Regulations or IRS pronouncements, or obtained a favorable determination, notification, advisory and/or opinion letter, as applicable, as to its qualified status from the IRS or still has a remaining period of time under applicable Treasury Regulations or IRS pronouncements in which to apply for such letter and to make any amendments necessary to obtain a favorable determination, and (ii) incorporates or has been amended to incorporate all provisions required to comply with the Tax

Index to Financial Statements

Reform Act of 1986 and subsequent legislation. For each Parent Employee Plan that is intended to be qualified under Section 401(a) of the Code there has been no event, condition or circumstance that has adversely affected or is likely to adversely affect such qualified status, except as would not result in material liability to Parent or its Subsidiaries. No “prohibited transaction,” within the meaning of Section 4975 of the Code or Sections 406 and 407 of ERISA, and not otherwise exempt under Section 408 of ERISA, has occurred with respect to any Parent Employee Plan. There are no actions, suits or claims pending, or, to the Knowledge of Parent, threatened or reasonably anticipated (other than routine claims for benefits) against any Parent Employee Plan or against the assets of any Parent Employee Plan. Each Parent Employee Plan can be amended, terminated or otherwise discontinued after the Effective Time of the Company Merger in accordance with its terms, without material liability to the Company, Parent or any of its Parent ERISA Affiliates (other than ordinary administration expenses). There are no audits, inquiries or proceedings pending or, to the Knowledge of Parent or any Parent ERISA Affiliates, threatened by the IRS or DOL, or any other Governmental Entity with respect to any Parent Employee Plan. Neither Parent nor any Parent ERISA Affiliate is subject to any penalty or tax with respect to any Parent Employee Plan under Section 502(i) of ERISA or Sections 4975 through 4980 of the Code. Parent and each Parent ERISA Affiliate have timely made all contributions and other payments required by and due under the terms of each Parent Employee Plan, except as would not result in material liability to Parent or its Subsidiaries.

(c) No Pension or Welfare Plans. Neither Parent nor any Parent ERISA Affiliate has ever maintained, established, sponsored, participated in, or contributed to, any (i) Parent Employee Plan which is a Pension Plan and is subject to Title IV of ERISA or Section 412 of the Code, (ii) Pension Plan which is a “multiemployer plan,” as defined in Section 3(37) of ERISA, (iii) “multiple employer plan” as defined in ERISA or the Code, or (iv) a “funded welfare plan” within the meaning of Section 419 of the Code. Neither the Parent nor any ERISA Affiliate has maintained, established, sponsored, participated in or contributed to any self-insured Parent Employee Plan or created any such similar obligation under any Parent Employee Agreement nor has Parent or any ERISA Affiliate established a policy or practice that would give rise to the creation of a self-insured Parent Employee Plan or obligation under any Parent Employee Agreement (including any such plan or practice pursuant to which a stop-loss policy or contract applies).

(d) No Post-Employment Obligations. No Parent Employee Plan provides, or reflects or represents any liability to provide post-termination or retiree welfare benefits to any person for any reason, except as may be required by COBRA or other applicable statute, and neither Parent nor any Parent ERISA Affiliate has ever represented, promised or contracted (other than in written form) to any Parent Employee (either individually or to Parent Employees as a group) or any other person that such Parent Employee(s) or other person would be provided with post-termination or retiree welfare benefits, except to the extent required by statute.

(e) Health Care Compliance. Neither Parent nor any Parent ERISA Affiliate has, prior to the Effective Time of the Company Merger and in any material respect, violated any of the health care continuation requirements of COBRA, the requirements of the Family Medical Leave Act of 1993, as amended, the requirements of the Health Insurance Portability and Accountability Act of 1996, the requirements of the Women’s Health and Cancer Rights Act of 1998, the requirements of the Newborns’ and Mothers’ Health Protection Act of 1996, or any amendment to each such act, or any similar provisions of state law applicable to its Parent Employees.

Index to Financial Statements

(f) Loans and Advances. Neither Parent nor any Parent ERISA Affiliate has, since July 30, 2002, extended credit, arranged for the extension of credit, or renewed an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of Parent.

(g) Employment Matters. Parent: (i) is in compliance in all material respects with all applicable foreign, federal, state and local laws, rules and regulations respecting employment, employment practices, terms and conditions of employment and wages and hours, in each case, with respect to Parent Employees; (ii) is not liable for any payment to any trust or other fund governed by or maintained by or on behalf of any governmental authority, with respect to unemployment compensation benefits, social security or other benefits or obligations for Parent Employees (other than routine payments to be made in the normal course of business and consistent with past practice). There are no pending, threatened or reasonably anticipated claims or actions against Parent under any workers’ compensation policy or long-term disability policy. Neither Parent nor any Parent ERISA Affiliate has or reasonably anticipates any direct or indirect material liability with respect to any misclassification of any person as an independent contractor rather than as an employee, or with respect to any employee leased from another employer.

(h) Labor. No work stoppage or labor strike against Parent or any Parent ERISA Affiliate is pending, or to the Knowledge of Parent, threatened or reasonably anticipated. Parent does not know of any activities or proceedings of any labor union to organize any Parent Employees. There are no actions, suits, claims, labor disputes or grievances pending, or, to the Knowledge of Parent, threatened or reasonably anticipated relating to any labor, safety or discrimination matters involving any Parent Employee, including charges of unfair labor practices or discrimination complaints, which, if adversely determined, would, individually or in the aggregate, result in any material liability to Parent. Neither Parent nor any of its Subsidiaries has engaged in any unfair labor practices within the meaning of the National Labor Relations Act. Parent is not presently, nor has it been in the past, a party to, or bound by, any collective bargaining agreement or union contract with respect to Parent Employees and no collective bargaining agreement is being negotiated with respect to Parent Employees. Neither Parent nor any of its Subsidiaries have incurred any material liability or material obligation under the Worker Adjustment and Retraining Notification Act or any similar state or local law which remains unsatisfied.

(i) Parent International Employee Plan. Each Parent Employee Plan that has been adopted or maintained by Parent or any Parent ERISA Affiliate, whether informally or formally, or with respect to which Parent or any Parent ERISA Affiliate will or may have any material liability, for the benefit of Parent Employees who perform services outside the United States (each a “Parent International Employee Plan”) has been established, maintained and administered in material compliance with its terms and conditions and with the requirements prescribed by any and all statutory or regulatory laws that are applicable to such Parent International Employee Plan. Furthermore, no Parent International Employee Plan has material unfunded liabilities, that as of the Effective Time of the Company Merger, will not be offset by insurance or fully accrued.

(j) Effect of Transactions. The execution of this Agreement and the consummation of the transactions contemplated hereby will not (either alone or upon the occurrence of any additional or subsequent events) constitute an event under any Parent Employee Plan, Parent Employee Agreement, trust or loan that will or may result in any payment (whether of severance pay or otherwise), acceleration, forgiveness of indebtedness, vesting, distribution, increase in benefits or obligation to fund

Index to Financial Statements

benefits with respect to any Parent Employee. No payment or benefit which will or may be made by Parent or any Parent ERISA Affiliates with respect to any Parent Employee will be characterized as a “parachute payment,” within the meaning of Section 280G(b)(2) of the Code. There is no contract, agreement, plan or arrangement to which Parent or any of Parent ERISA Affiliates is a party or by which it is bound to compensate any Parent Employee for excise taxes paid pursuant to Section 4999 of the Code.

(a) Properties. Section 3.13 of the Parent Disclosure Letter lists, as of the date hereof, the real property owned by Parent or any of its Subsidiaries. All current leases of real property of Parent or any of its Subsidiaries are in full force and effect, are valid and effective in accordance with their respective terms, and there is not, under any of such leases, any existing material default or material event of default by Parent nor any of its Subsidiaries (or event which with notice or lapse of time, or both, would constitute a material default).

(b) Valid Title. Parent and each of its Subsidiaries has good and valid title to, or, in the case of leased properties and assets, valid leasehold interests in, all of its material tangible properties and assets, real, personal and mixed, used or held for use in the Solutions Group Business, free and clear of any Liens except (i) as reflected in the Parent Financials or (ii) Permitted Liens.

(a) Hazardous Material. Except as would not result in a material liability to Parent, no underground storage tanks and no amount of any Hazardous Material are present in violation of any rule, regulation, treaty or statute promulgated by any Governmental Entity in effect as of the date hereof, as a result of the actions of Parent or any of its Subsidiaries or any affiliate of Parent, or, to the Knowledge of Parent, as a result of any actions of any third party or otherwise, in, on or under any property, including the land and the improvements, ground water and surface water thereof, that Parent or any of its Subsidiaries has at any time owned, operated, occupied or leased.

(b) Hazardous Materials Activities. Except as would not result in a material liability to Parent, neither Parent nor any of its Subsidiaries has transported, stored, used, manufactured or, disposed of, released or exposed its employees or others to Hazardous Materials in violation of any Legal Requirement in effect on or before the Closing Date. Except as would not result in a material liability to Parent, neither Parent nor any of its Subsidiaries has conducted any Hazardous Material Activities in violation of any Legal Requirement promulgated by any Governmental Entity in effect prior to or as of the date hereof to prohibit, regulate or control Hazardous Materials or any Hazardous Material Activity.

(a) Material Contracts. For purposes of this Agreement, “Parent Material Contract” shall mean any “material contracts” (as such term is defined in Item 601(b)(10) of Regulation S-K of the SEC) with respect to Parent and its Significant Subsidiaries (including any agreement that is required to be filed in a future filing) of the Solutions Group Business and any Contract, or group of Contracts of the Solutions Group Business with a Person (or group of affiliated Persons), the termination or breach of which would be reasonably expected to have a material adverse effect on any material

Index to Financial Statements

product or service offerings of the Solutions Group Business of Parent or otherwise have a Material Adverse Effect on Parent.

(b) No Breach. All Parent Material Contracts are valid and in full force and effect except to the extent they have previously expired in accordance with their terms or if the failure to be in full force and effect, individually or in the aggregate, would not reasonably be expected to be material to Parent. Neither Parent nor any of its Subsidiaries has violated any provision of, or committed or failed to perform any act which, with or without notice, lapse of time or both would constitute a default under the provisions of, any Parent Material Contract, except in each case for those violations and defaults which, individually or in the aggregate, would not reasonably be expected to be material to Parent.

3.16 Disclosure. None of the information supplied or to be supplied by or on behalf of Parent, Separation Sub or Merger Sub for inclusion or incorporation by reference in the Registration Statement or the Source Registration Statement (as defined in Section 5.1(b)) will, at the time the Registration Statement or the Source Registration Statement becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. None of the information supplied or to be supplied by or on behalf of Parent, Separation Sub and Merger Sub for inclusion or incorporation by reference in the Prospectus/Proxy Statement, will, at the time it is mailed to the stockholders of Parent and the Company, at the time of the Parent Stockholders’ Meeting, at the time of the Company Stockholders’ Meeting, as of the Effective Time of the Parent Merger, or as of the Effective Time of the Company Merger, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. None of the information supplied or to be supplied by or on behalf of Parent, Separation Sub and Merger Sub for inclusion or incorporation by reference in the Source Prospectus (as defined in Section 5.1(b)), will, at the time it is mailed to the stockholders of Parent, at the time of the Parent Stockholders’ Meeting or as of the Effective Time of the Parent Merger contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they are made, not misleading. The Prospectus/Proxy Statement and the Source Prospectus will comply as to form in all material respects with the applicable provisions of the Securities Act and the Exchange Act and the rules and regulations promulgated by the SEC thereunder. Notwithstanding the foregoing, no representation or warranty is made by Parent, Separation Sub or Merger Sub with respect to statements made or incorporated by reference therein about the Company supplied by the Company for inclusion or incorporation by reference in the Registration Statement or the Prospectus/Proxy Statement.

3.17 Board Approval; Subsidiary Stockholder Approval. The Board of Directors of Parent has, by resolutions duly adopted by unanimous vote at a meeting of all Directors duly called and held and not subsequently rescinded or modified on or prior to the date hereof in any way (the “Parent Board Approval”) (i) determined that the Mergers are fair to, and in the best interests of, Parent and its stockholders and declared the Mergers to be advisable, (ii) approved this Agreement and the transactions contemplated hereby, including the Mergers and the issuance of Parent Common Stock in the Company Merger, and (iii) unanimously recommended that the stockholders of Parent adopt and approve this Agreement and approve the Parent Merger and approve the issuance of Parent Common Stock in connection with the Company Merger and directed that such matter be submitted to Parent’s stockholders at the Parent Stockholders’ Meeting. Parent has approved the Parent Merger as Separation

Index to Financial Statements

Sub’s sole stockholder and has approved the Company Merger as Merger Sub’s sole stockholder, which approvals have not been rescinded, withdrawn or modified.

3.18 Fairness Opinion. Parent’s Board of Directors has received an opinion from Morgan Stanley & Co., dated as of June 3, 2003, to the effect that, as of such date, the Exchange Ratio is fair, from a financial point of view, to Parent, and has delivered to the Company a written copy of such opinion.

3.19 Rights Plan. Parent has taken all action so that (i) the Company shall not be an “Acquiring Person” under the Parent Rights Agreement and (ii) the entering into of this Agreement and the Mergers and the other transactions contemplated hereby will not result in the grant of any rights to any Person under the Parent Rights Agreement or enable or require the Parent Rights to be exercised, distributed or triggered.

3.20 Takeover Statutes. Neither Parent nor any Affiliate is, or has been during the last three years, an “interested stockholder” (as defined in Section 203 of the Delaware Law) of the Company, other than as contemplated pursuant to this Agreement.

(a) Schedule. Section 3.21(a) of the Parent Disclosure Letter sets forth as of the date hereof a true and complete list of all Separation Agreements entered, or currently contemplated to be entered, into. True and complete copies of all Separation Agreements listed in Section 3.21(a) of the Parent Disclosure Letter have been delivered or made available to the Company. “Separation Agreement” shall mean any Contracts between or among Parent and/or any of its Subsidiaries (other than Source and its Subsidiaries), on the one part, and Source and/or any of Source’s Subsidiaries, on the other part, which Contracts would govern, following the Parent Merger, the commercial or economic relationships between Parent and/or any of its Subsidiaries (other than Source and its Subsidiaries), on the one part, and Source and/or any of Source’s Subsidiaries, on the other part, and/or define the allocation of assets and liabilities between or among Parent and/or any of its Subsidiaries (other than Source and its Subsidiaries), on the one part, and Source and/or any of Source’s Subsidiaries, on the other part, in all cases following the Parent Merger.

(b) No Conflict. The execution and delivery of the Separation Agreements required to be listed in Section 3.21(a) of the Parent Disclosure Letter by Parent does not, and the performance of such Separation Agreements by Parent and its Subsidiaries and the consummation of the transactions contemplated thereby by Parent will not: (i) conflict with or violate the Parent Charter Documents or the Subsidiary Charter Documents of any Subsidiary of Parent, (ii) conflict with or violate any material Legal Requirement applicable to Parent or any of its Subsidiaries or by which Parent or any of its Subsidiaries or any of their respective material properties is bound or affected, or (iii) result in any material breach of or constitute a material default (or an event that with notice or lapse of time or both would become a material default) under, or materially impair the rights of Parent or its Subsidiaries (after giving effect to the Parent Merger and the transactions contemplated by the Separation Agreements) or materially alter the rights or obligations of any third party under, or give to others any rights of termination, amendment, acceleration or cancellation of, or result in the creation of a material Lien on any of the material properties or assets of Parent or any of its Subsidiaries (after giving effect to the Parent Merger and the transactions contemplated by the Separation Agreements) pursuant to, any

Index to Financial Statements

Parent Contract, except as would not reasonably be expected to be material to Parent. Section 3.21(b) of the Parent Disclosure Letter lists all consents, waivers and approvals under any of the Contracts of Parent or any of its Subsidiaries required to be obtained in connection with the consummation of the transactions contemplated by the Separation Agreements, which, if individually or in the aggregate are not obtained, would result in a material loss of benefits to the Surviving Corporation in the Parent Merger (after giving effect to the Parent Merger and the transactions contemplated by the Separation Agreements) or would prevent or materially impair the consummation of the transactions contemplated by the Parent Merger or the Separation Agreements.

(c) Nasdaq Requirements. As of February 28, 2003 and, to the Knowledge of Parent, as of the date hereof, Source substantially met all of the requirements under Rule 4420(b) of the National Association of Securities Dealers, Inc. Manual (the “Manual”) to be designated for Nasdaq. As of the date hereof, Source substantially met all of the requirements under Rule 4350 of the Manual required to be met by issuers prior to designation on Nasdaq.

(a) Ordinary Course. During the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time of the Company Merger, the Company shall and shall cause each of its Subsidiaries to, except as otherwise expressly contemplated by this Agreement or Section 4.1 of the Company Disclosure Letter or to the extent that Parent shall otherwise consent in writing, (i) carry on its business in the usual, regular and ordinary course, in all material respects and in substantially the same manner as heretofore conducted and in material compliance with all applicable laws and regulations, (ii) pay its debts and taxes when due, pay or perform other material obligations when due (provided that the Company shall not pre-pay or accelerate payment of obligations outside the ordinary course of its business consistent with past practice) subject to any good faith dispute of such debts, taxes or obligations, (iii) use commercially reasonable efforts to collect accounts receivables when due and not take any affirmative action to extend credit outside the ordinary course of business consistent with past practice, and (iv) use commercially reasonable efforts consistent with past practice and policies to (x) preserve intact its present business organization, (y) keep available the services of its present executive officers and Company Employees, and (z) preserve its relationships with customers, suppliers, licensors, licensees, and others with which it has business dealings In addition, the Company shall promptly notify in writing Parent of any material adverse event involving its business or operations.

(b) Required Consent. In addition, without limiting the generality of Section 4.1(a), except as permitted by the terms of this Agreement or Section 4.1 of the Company Disclosure Letter, without the prior written consent of Parent, during the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time of the Company Merger, the Company shall not do any of the following, and shall not permit any of its Subsidiaries to do any of the following:

Index to Financial Statements

(ii) Declare, set aside or pay any dividends on or make any other distributions (whether in cash, stock, equity securities or property) in respect of any capital stock or split, combine or reclassify any capital stock or issue or authorize the issuance of any other securities in respect of, in lieu of or in substitution for any capital stock, other than any such transaction by a wholly-owned Subsidiary of it that remains a wholly-owned Subsidiary of it after consummation of such transaction, in the ordinary course of business consistent with past practice;

(iii) Purchase, redeem or otherwise acquire, directly or indirectly, any shares of its capital stock or the capital stock of its Subsidiaries, except repurchases of unvested shares at cost in connection with the termination of the employment relationship with any employee pursuant to stock option or purchase agreements then in effect;

(iv) Issue, deliver, sell, authorize, pledge or otherwise encumber any shares of capital stock, Voting Debt or any securities convertible into shares of capital stock or Voting Debt, or subscriptions, rights, warrants or options to acquire any shares of capital stock or Voting Debt or any securities convertible into shares of capital stock or Voting Debt, or enter into other agreements or commitments of any character obligating it to issue any such securities or rights, other than (a) issuances of Company Common Stock upon the exercise of Company Options, Company Warrants or other rights of the Company existing on the date hereof in accordance with their present terms, (b) issuance of shares of Company Common Stock to participants in the Company Purchase Plan pursuant to the terms thereof, (c) the grant of stock options at the then current fair market value of the Company Common Stock to newly hired non-officer employees of the Company, in the ordinary course of business consistent with past practice, (d) the grant of stock options at the then current fair market value of the Company Common Stock to existing non-officer employees of the Company in connection with the promotion of such employees, in the ordinary course of business consistent with past practice, or (e) the grant of stock options at the then current fair market value of the Company Common Stock to existing non-officer employees of the Company in connection with the retention of such employees, provided that in the case of (c), (d) and (e) that the number of shares subject to issuance upon exercise of such stock option grants shall not exceed 50,000 in total to any single individual or 2,000,000 in the aggregate and have a vesting schedule no more favorable than one quarter of the shares subject to such stock option vesting upon the first anniversary of the date of grant and 1/48 of the shares subject to such stock option vesting on each monthly anniversary of the date of grant thereafter and do not accelerate, or become subject to acceleration, directly or indirectly, as a result of the approval of or consummation of the Mergers and/or termination of employment following the Mergers, other than acceleration of twenty-five percent (25%) of the shares of Company Common Stock subject to such award following a “Termination” (as such term is defined in the Company Stock Plans) without “Cause” (as such term is defined in the Company Stock Plans) within one year from the date a “Corporate Transaction” (as such term is defined in the Company Stock Plans);

(v) Cause, permit or propose any amendments to the Company Charter Documents or any of the Subsidiary Charter Documents of the Company’s Subsidiaries;

(vi) Acquire or agree to acquire by merging or consolidating with, or by purchasing any equity or voting interest in or a portion of the assets of, or by any other manner, any business or any Person or division thereof, or otherwise acquire or agree to acquire any assets which are material, individually or in the aggregate, to the business of the Company;

Index to Financial Statements

(vii) Enter into, amend or renew any Contract with a telecommunications carrier relating to the provision or development of Company Products for wireless communications (a “Carrier Contract”), provided that such Parent consent will not be unreasonably withheld or delayed with respect to any Carrier Contract substantially in the ordinary course of business consistent with past practice (any such Carrier Contract, a “Carrier Transaction”).

(viii) Enter into any binding agreement, agreement in principle, letter of intent, memorandum of understanding or similar agreement with respect to any joint venture, strategic partnership or alliance, other than a Carrier Transaction;

(ix) Sell, lease, license, encumber or otherwise dispose of any properties or assets except (a) sales of inventory in the ordinary course of business consistent with past practice, (b) the sale, lease or disposition (other than through licensing) of property or assets which are not material, individually or in the aggregate, to the business of Company and its Subsidiaries, including used material, equipment and furniture not material to the business, or (c) the sale of Company Products in the ordinary course of business consistent with past practice, other than a Carrier Transaction;

(x) Make any loans, advances or capital contributions to, or investments in, any other Person, other than employee advances for travel and entertainment expenses made in the ordinary course of business consistent with past practice provided such employee loans are in compliance with applicable law, other than ordinary course funding to Subsidiaries exclusively in order to fund operations in amounts consistent with prior periods;

(xi) Except as required by GAAP or the SEC as concurred in by its independent auditors and following notice to Parent, make any material change in its methods or principles of accounting since the date of the Company Balance Sheet;

(xii) Make or change any material Tax election, settle or compromise any claim or assessment in respect of Taxes or consent to any extension or waiver of any limitation period with respect to any claim or assessment for Taxes;

(xiii) Except as required by GAAP and following notice to Parent, revalue any of its assets except in the ordinary course of business in an amount that is not material to the Company and its Subsidiaries;

(xiv) (a) Pay, discharge, settle or satisfy any liabilities or obligations (absolute, accrued, asserted or unasserted, contingent or otherwise), other than the payment, discharge, settlement or satisfaction for money of liabilities or obligations in the ordinary course of business consistent with past practice or in accordance with their terms, (b) pay, discharge or settle any litigation (whether or not commenced prior to the date of this Agreement), (c) pay, discharge, settle or satisfy any claims (including any Tax claim), other than the payment, discharge, settlement or satisfaction for money, of claims not material to the Company, or (d) waive the benefits of, agree to modify in any manner, terminate, release any person from or knowingly fail to enforce any confidentiality or similar agreement to which Company or any of its Subsidiaries is a party or of which Company or any of its Subsidiaries is a beneficiary;

(xv) (a) Increase in any manner the amount of base compensation of any Employee of the Company or any Subsidiary of the Company, except for increases in connection with

Index to Financial Statements

ordinary course focal reviews and in an amount (the amount of any such increase for an individual being determined to be the amount of any increase on an annual basis) that does not exceed $600,000 in the aggregate, (b) materially increase the amount of employee benefits of any Employee or director of the Company or any Subsidiary of the Company, except pursuant to contractual arrangements or a Company Employee Plan in effect as of the date hereof, except upon the expiration by its terms of any such Company Employee Plan solely in connection with the renewal of such Company Employee Plan for the period after December 31, 2003 for a renewal term consistent with past practices and that provides no greater benefits than are currently provided under such Company Employee Plan, (c) pay any bonus to any Employee or director of the Company or any Subsidiary of the Company, except pursuant to contractual arrangements or a Company Employee Plan in effect as of the date hereof, (d) grant severance or termination pay to any Employee or director of the Company or any Subsidiary of the Company, except pursuant to contractual arrangements or a Company Employee Plan in effect as of the date hereof, (e) adopt or amend or make any commitment to adopt or amend any Company Employee Plan, except in connection with the renewal of any such Company Employee Plan, upon the natural expiration of such Company Employee Plan, on terms substantially similar to those in effect as of the date hereof, (f) waive any stock repurchase rights, accelerate, amend or change the period of exercisability of Company Options or Company Restricted Stock, or reprice any Company Options or authorize cash payments in exchange for any Company Options, (g) enter into any employment, severance, termination or indemnification agreement with any Company Employee or enter into any collective bargaining agreement (other than offer letters and letter agreements entered into in the ordinary course of business consistent with past practice with employees who are terminable “at will”), (h) make any material oral or written representation or commitment with respect to any material aspect of any Company Employee Plan that is not materially in accordance with the existing written terms and provision of such Company Employee Plan, (i) grant any stock appreciation right, phantom stock award, stock-related award or performance award (whether payable in cash, shares or otherwise) to any Person (including any Company Employee), other than as permitted pursuant to Section 4.1(b)(iv)(c), (d) and (e), (j) enter into any agreement with any Company Employee the benefits of which are (in whole or in part) contingent or the terms of which are materially altered in favor of the Company Employee upon the occurrence of a transaction involving Company of the nature contemplated hereby;

(xvi) Grant any exclusive rights with respect to any Company Intellectual Property, other than pursuant to a Carrier Transaction;

(xvii) Enter into, amend or renew any Contracts containing any non-competition or exclusivity restrictions, or otherwise subject the Surviving Corporation or Parent, or any of their respective businesses, to any other material restrictions relating to the Company’s business activities following the Closing; other than a Carrier Transaction;

(xviii) Enter into any agreement or commitment the effect of which would be to grant to a third party following the Company Merger any actual or potential right of license to any Intellectual Property owned prior to Closing by Parent or any of its Subsidiaries;

(xix) Engage in any action that could reasonably be expected to cause the Company Merger to fail to qualify as a “reorganization” under Section 368(a) of the Code;

(xx) Hire or offer to hire (a) any officer level employees or (b) other employees with an annual base salary of more than $125,000;

Index to Financial Statements

(xxi) Incur any indebtedness for borrowed money or guarantee any such indebtedness of another Person, issue or sell any debt securities or options, warrants, calls or other rights to acquire any debt securities of the Company or any of its Subsidiaries, guarantee any debt securities of another Person, enter into any “keep well” or other agreement to maintain any financial statement condition of any other Person or enter into any arrangement having the economic effect of any of the foregoing, other than indebtedness incurred, or agreements or arrangements entered into, with respect to (a) the incurrence of accounts payable in the ordinary course of business consistent with past practice, (b) equipment financing in the ordinary course of business consistent with past practice not to exceed the principal aggregate amount of $750,000, and (c) pursuant to the Loan Agreement;

(xxii) Make or commit to make capital expenditures beyond those contained in the Company’s capital expenditure budget in effect on the date hereof, a copy of which is attached hereto as Schedule 4.1(b)(xxii);

(xxiii) Modify or amend (including by entering into a new Contract with such party or otherwise) in a manner adverse in any material respect to the Company, or terminate, any existing real property lease, real property sublease or Company Material Contract, or waive, release or assign any material rights or claims thereunder, in each case, in a manner adverse in any material respect to the Company, other than any modification, amendment or termination of any such Company Material Contract in the ordinary course of business, consistent with past practice, or enter into any new real property lease or real property sublease or cause or permit a Reinstatement or Occupancy to occur;

(xxiv) Enter into any Contract requiring the Company or any of its Subsidiaries to pay to any Person in excess of an aggregate of $375,000 as determinable or reasonably estimable on the face of such Contract, except Contracts which are of the type or within the category of Contracts specifically identified in (i) through (xxiii) above (whether or not consent of Parent is required thereunder for such type or category of Contracts) and purchases of inventory in the ordinary course of business consistent with past practice;

(xxv) Enter into any Contract with any accountant, broker, financial advisor, consultant, legal counsel or other Person retained by the Company in connection with this Agreement or the transactions contemplated hereby, other than Contracts for the provision of services on a “time and materials” basis at reasonable and customary rates, provided that Parent shall not unreasonably withhold consent with respect to any such Contract that is not on a time and materials basis if such Contract is of the type and structure customarily entered into for such services and is otherwise at reasonable and customary rates; or

(xxvi) Agree in writing or otherwise to take any of the actions described in (i) through (xxv) above.

4.2 Certain Parent Actions. Except as permitted by the terms of this Agreement, Parent shall not, and shall not permit any of its Subsidiaries (other than Source and its Subsidiaries) to, without the prior written consent of the Company, during the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time of the Company Merger, (i) acquire or agree to acquire by merging or consolidating with, or by purchasing any equity or voting interest in or a material portion of the assets of, or by any other manner, any business or any Person or division thereof, (ii) declare, set aside or pay any dividends on or make any other distributions

Index to Financial Statements

(whether in cash, stock, equity securities or property) in respect of any capital stock or split, combine or reclassify any capital stock or issue or authorize the issuance of any other securities in respect of, in lieu of or in substitution for any capital stock, other than (a) any such transaction by a wholly-owned Subsidiary of it that remains a wholly-owned Subsidiary of it after consummation of such transaction and (b) any such transaction by Source and its Subsidiaries, (iii) purchase, redeem or otherwise acquire, directly or indirectly, any shares of its capital stock or the capital stock of its Subsidiaries (other than Source and its Subsidiaries), except repurchases of unvested shares at cost in connection with the termination of the employment relationship with any employee pursuant to stock option or purchase agreements then in effect, and (iv) cause, permit or propose any amendments to the Parent Charter Documents or any of the Subsidiary Charter Documents of Parent’s Subsidiaries (other than Source and its Subsidiaries). Without the consent of the Company, which consent shall not be unreasonably withheld, during the period from the date hereof and continuing until the earlier of the termination of this Agreement pursuant to its terms or the Effective Time of the Company Merger, neither Parent nor any of its Subsidiaries shall materially amend or modify the Separation Agreements required to be listed in Section 3.21(a) of the Parent Disclosure Letter or enter into material new Separation Agreements following the Company Merger.

(a) Prospectus/Proxy Statement; Registration Statement. As promptly as practicable after the execution of this Agreement, Parent and the Company will prepare and file with the SEC the Prospectus/Proxy Statement, and Parent will prepare and file with the SEC the Registration Statement in which the Prospectus/Proxy Statement is to be included as a prospectus. Parent and the Company will provide each other with any information which may be required in order to effectuate the preparation and filing of the Prospectus/Proxy Statement and the Registration Statement pursuant to this Section 5.1. Each of Parent and the Company will respond to any comments from the SEC, will use all reasonable efforts to cause the Registration Statement to be declared effective under the Securities Act as promptly as practicable after such filing and to keep the Registration Statement effective as long as is necessary to consummate the Mergers and the transactions contemplated hereby. Each of Parent and the Company will notify the other promptly upon the receipt of any comments from the SEC or its staff in connection with the filing of, or amendments or supplements to, the Registration Statement and/or the Prospectus/Proxy Statement. Whenever any event occurs which is required to be set forth in an amendment or supplement to the Prospectus/Proxy Statement and/or the Registration Statement, Parent or the Company, as the case may be, will promptly inform the other of such occurrence and cooperate in filing with the SEC or its staff, and/or mailing to stockholders of Parent and/or the Company, such amendment or supplement. Each of Parent and the Company shall cooperate and provide the other (and its counsel) with a reasonable opportunity to review and comment on any amendment or supplement to the Registration Statement and Prospect/Proxy Statement prior to filing such with the SEC, and will provide each other with a copy of all such filings made with the SEC. Each of Parent and the Company will cause the Prospectus/Proxy Statement to be mailed to its respective stockholders at the earliest practicable time after the Registration Statement and the Source Registration Statement (as defined in Section 5.1(b) are declared effective by the SEC. Parent shall also use all reasonable efforts to take any action required to be taken by it under any applicable state securities laws in connection with the issuance of Parent Common Stock in the Company Merger and the conversion of Company Options into

Index to Financial Statements

options to acquire Parent Common Stock, and the Company shall furnish any information concerning the Company and the holders of the Company Common Stock and the Company Options as may be reasonably requested in connection with any such action.

(b) Source Registration Statement. As promptly as practicable after the execution of this Agreement, Parent will cause Source to prepare and file with the SEC a Registration Statement on Form S-4 (or similar successor form) (the “Source Registration Statement”), and the prospectus contained therein (the “Source Prospectus”), in connection with the distribution of Source Common Stock in the Parent Merger. Parent will cause Source to respond to any comments from the SEC, will use all reasonable efforts to cause the Registration Statement to be declared effective under the Securities Act as promptly as practicable after such filing and to keep the Registration Statement effective as long as is necessary to consummate the Parent Merger. Parent will promptly keep the Company reasonably informed on an ongoing basis regarding the status of the Source Registration Statement. Whenever any event occurs which is required to be set forth in an amendment or supplement to the Source Prospectus and/or the Source Registration Statement, Parent will promptly inform the Company of such occurrence and cause Source to file with the SEC or its staff, and/or mailing to stockholders of Parent, such amendment or supplement. Parent will cause the Source Prospectus to be mailed to its stockholders, concurrently with the Proxy Statement/Prospectus at the earliest practicable time after the Registration Statement and the Source Registration Statement are declared effective by the SEC. Parent shall also use all reasonable efforts to take any action required to be taken by it under any applicable state securities laws in connection with the distribution of Source Common Stock in the Parent Merger.

(a) Meetings of Stockholders. Promptly after the Registration Statement and the Source Registration Statement are declared effective under the Securities Act, each of Parent and the Company will take all action necessary in accordance with Delaware Law and its Certificate of Incorporation and Bylaws to call, hold and convene a meeting of its stockholders to consider, in the case of Parent, the adoption and approval of this Agreement and approval of the Parent Merger and approval of the issuance of Parent Common Stock in connection with the Company Merger, to the extent permissible, as a single proposal (the “Parent Proposal”), and, in the case of the Company, the adoption and approval of this Agreement and approval of the Company Merger (the “Company Proposal”) (each, a “Stockholders’ Meeting” and, in the case of Parent, the “Parent Stockholders’ Meeting” and, in the case of the Company, the “Company Stockholders’ Meeting”) to be held as promptly as practicable (and within 45 days, if practicable) after the declaration of effectiveness of the Registration Statement and the Source Registration Statement. Each of Parent and the Company will use all reasonable efforts to hold their respective Stockholders’ Meeting on the same date. Subject to Section 5.3(d), each of Parent and the Company will use all reasonable efforts to solicit from its stockholders proxies in favor of, in the case of Parent, the Parent Proposal, and, in the case of the Company, the Company Proposal, and will take all other action necessary or advisable to secure the vote or consent of its stockholders required by the rules of Nasdaq or Delaware Law to obtain such approvals. Notwithstanding anything to the contrary contained in this Agreement, Parent or the Company, as the case may be, may adjourn or postpone its Stockholders’ Meeting to the extent necessary to ensure that any necessary supplement or amendment to the Prospectus/Proxy Statement is provided to its respective stockholders in advance of a vote on, in the case of Parent, the Parent Proposal or, in the case of the Company, the Company Proposal, or, if as of the time for which such Stockholders’ Meeting is

Index to Financial Statements

originally scheduled (as set forth in the Prospectus/Proxy Statement) there are insufficient shares of Common Stock of Parent or the Company, as the case may be, represented (either in person or by proxy) to constitute a quorum necessary to conduct the business of such Stockholders’ Meeting. Each of Parent and the Company shall ensure that its Stockholders’ Meeting is called, noticed, convened, held and conducted, and that all proxies solicited by it in connection with the Stockholders’ Meeting are solicited in compliance with Delaware Law, its Certificate of Incorporation and Bylaws, the rules of Nasdaq and all other applicable Legal Requirements.

(b) Board Recommendation. Except to the extent expressly permitted by Section 5.3(d), (i) the Board of Directors of each of Parent and the Company shall recommend that its respective stockholders vote in favor of, in the case of Parent, the Parent Proposal, and in the case of the Company, the Company Proposal, (ii) the Prospectus/Proxy Statement shall include a statement to the effect that the Board of Directors of Parent has recommended that the stockholders of Parent vote in favor of the Parent Proposal at the Parent Stockholders’ Meeting and that the Board of Directors of the Company has recommended that the stockholders of the Company vote in favor of the Company Proposal at the Company Stockholders’ Meeting, and (iii) neither the Board of Directors of Parent or the Company, nor any committee thereof, shall withdraw, amend or modify, or propose or resolve to withdraw, amend or modify in a manner adverse to the other party, its recommendation that the respective stockholders of Parent or the Company, as the case may be, vote in favor of, in the case of Parent, the Parent Proposal, and, in the case of the Company, the Company Proposal, as applicable. Notwithstanding the foregoing, the Board of Directors of each of Parent and the Company may withhold, withdraw, amend or modify its recommendation in favor of, in the case of Parent, the Parent Proposal, and in the case of the Company, the Company Proposal, to the extent it is expressly permitted by Section 5.3(d).

(a) No Solicitation. Each of the Company and Parent agrees that neither it nor any of its Subsidiaries nor any of the officers and directors of it or its Subsidiaries shall, and that it shall use all reasonable efforts to cause its and its Subsidiaries’ Employees, agents and representatives (including any investment banker, attorney or accountant retained by it or any of its Subsidiaries) not to (and shall not to) directly or indirectly: (i) solicit, initiate, knowingly encourage, knowingly facilitate or induce any inquiry with respect to, or the making, submission or announcement of, any Acquisition Proposal (as defined in Section 5.3(g)(i)) with respect to itself, (ii) participate in any discussions or negotiations regarding, or furnish to any person any nonpublic information with respect to, or take any other action to facilitate any inquiries or the making of any proposal that constitutes or may reasonably be expected to lead to, any Acquisition Proposal with respect to itself, (iii) engage in discussions with any person with respect to any Acquisition Proposal, except as to the existence of these provisions, (iv) approve, endorse or recommend any Acquisition Proposal with respect to itself (except to the extent specifically permitted pursuant to Section 5.3(d)), or (v) enter into any letter of intent or similar document or any contract, agreement or commitment contemplating or otherwise relating to any Acquisition Proposal or transaction contemplated thereby with respect to itself. Each of Parent and the Company, and its respective Subsidiaries, will each immediately cease any and all existing activities, discussions or negotiations with any third parties conducted heretofore with respect to any Acquisition Proposal with respect to itself.

Index to Financial Statements

(i) As promptly as practicable after receipt of any Acquisition Proposal or any request for nonpublic information or bona fide inquiry which it reasonably believes would lead to an Acquisition Proposal with respect to itself, Parent or the Company, as applicable, shall provide to the other party oral and written notice of the material terms and conditions of such Acquisition Proposal, request or inquiry, and the identity of the Person or group making any such Acquisition Proposal, request or inquiry and a copy of all written materials provided in connection with such Acquisition Proposal, request or inquiry. The recipient of the Acquisition Proposal, request or inquiry shall provide the other party as promptly as practicable with oral and written notice setting forth all such information as is reasonably necessary to keep such party informed in all material respects of the status and details (including material amendments or proposed material amendments) of any such Acquisition Proposal, request or inquiry and shall promptly provide to the other party a copy of all written materials subsequently provided in connection with such Acquisition Proposal, request or inquiry.

(ii) The Company or Parent, as applicable shall provide the other party with forty-eight (48) hours prior notice (or such lesser prior notice as is provided to the members Board of Directors of such notifying party) of any meeting of Board of Directors of the Company or Parent, as applicable, at which the Board of Directors of the Company or Parent, as applicable, is reasonably expected to discuss any Acquisition Proposal with respect to such company.

(c) Superior Offers. Notwithstanding anything to the contrary contained in Section 5.3(a), in the event that the Company or Parent receives an unsolicited, bona fide written Acquisition Proposal from a third party that its Board of Directors has in good faith concluded (following the receipt of the advice of its outside legal counsel and its financial advisor), is, or is reasonably likely to result in, a Superior Offer (as defined in Section 5.3(g)(ii)), it may then take the following actions (but only if and to the extent that its Board of Directors concludes in good faith, following the receipt of advice of its outside legal counsel, that the failure to do so would result in a breach of its fiduciary obligations under applicable law):

(i) Furnish nonpublic information to the third party making such Acquisition Proposal, provided that (a) (1) concurrently with furnishing any such nonpublic information to such party, it gives the other party written notice of its intention to furnish nonpublic information and (2) it receives from the third party an executed confidentiality agreement containing customary limitations on the use and disclosure of all nonpublic written and oral information furnished to such third party on its behalf, the terms of which are at least as restrictive as the terms contained in the Confidentiality Agreement (as defined in Section 5.4), it being understood that such confidentiality agreement and any related agreements shall not include any provision calling for any exclusive right to negotiate with such third party or having the purported effect of restricting it from satisfying its obligations under this Agreement and (b) contemporaneously with furnishing any such nonpublic information to such third party making an Acquisition Proposal, it furnishes such nonpublic information to the other party (to the extent such nonpublic information has not been previously so furnished), together with a complete list identifying all nonpublic information furnished to the party making the Acquisition Proposal; and

(ii) Engage in discussions and/or negotiations with the third party with respect to the Acquisition Proposal, provided that concurrently with entering into discussions and/or

Index to Financial Statements

negotiations with such third party, it gives the other party hereto written notice of its intention to enter into negotiations with such third party.

(d) Changes of Recommendation. In response to the receipt of a Superior Offer, with respect to Parent or the Company, as the case may be, the Board of Directors of such party may withhold, withdraw, amend or modify its recommendation with respect to the Mergers, and, in the case of a Superior Offer that is a tender or exchange offer made directly to its stockholders, may recommend that its stockholders accept the tender or exchange offer (any of the foregoing actions, whether by the Company Board of Directors, the Parent Board of Directors, or a committee thereof, a “Change of Recommendation” with respect to such party), if all of the following conditions in clauses (i) through (iv) are met:

(i) A Superior Offer with respect to it has been made and has not been withdrawn;

(iii) It shall have (a) delivered to the other party written notice (a “Change of Recommendation Notice”) at least three (3) business days prior to publicly effecting such Change of Recommendation, which notice shall state expressly (A) that it has received an Acquisition Proposal which may constitute a Superior Offer, (B) the material terms and conditions of such Acquisition Proposal and the identity of the person or group making the Acquisition Proposal, and (C) that it intends (or may intend) to effect a Change of Recommendation and the manner and timing in which it intends (or may intend) to do so,

(iv) In the case of the Company only, the Company has (a) provided to Parent a copy of all written materials delivered to the person or group making the Acquisition Proposal which may constitute a Superior Proposal (described in clause (iii) of this Section 5.3(d)) in connection with such Acquisition Proposal, and (b) made available to Parent all materials and information made available to the person or group making the Acquisition Proposal which may constitute a Superior Proposal (described in clause (iii) of this Section 5.3(d)) in connection with such Acquisition Proposal, together with a complete list identifying all such materials and information furnished to such person or group; and

(v) Its Board of Directors has concluded in good faith, after receipt of advice of its outside legal counsel, that, in light of such Superior Offer, the failure of the Company Board of Directors or Parent Board of Directors, as applicable, to effect a Change of Recommendation would result in a breach of its fiduciary obligations to its stockholders under applicable law.

In addition, in the case of the Company, after delivering the Change of Recommendation Notice to Parent, the Company shall provide Parent a reasonable opportunity (which opportunity shall begin no later than the delivery of the Change of Recommendation Notice and shall continue until the occurrence of the Change of Recommendation, but which opportunity shall not otherwise by itself extend the amount of time after delivery of Change of Recommendation Notice upon which the Company may effect of Change of Recommendation in accordance with this Section 5.3(d)) to make such adjustments in the terms and conditions of this Agreement, and negotiate in good faith with respect thereto, as would

Index to Financial Statements

enable the Company to proceed with its recommendation to stockholders without making a Change of Recommendation.

(e) Continuing Obligation to Call, Hold and Convene Company Stockholders’ Meeting and Parent Stockholders’ Meeting; No Other Vote. Notwithstanding anything to the contrary contained in this Agreement, the obligations of Parent and the Company to call, give notice of, convene and hold its respective Stockholders’ Meeting shall not be limited or otherwise affected by the commencement, disclosure, announcement or submission to it of any Acquisition Proposal with respect to it, or by any Change of Recommendation with respect to it. Prior to the termination of this Agreement by its terms, neither Parent nor the Company shall submit to the vote of its stockholders any Acquisition Proposal (other than, in the case of Parent, the Parent Proposal and, in the case of the Company, the Company Proposal), or propose to do so.

(f) Compliance with Tender Offer Rules. Nothing contained in this Agreement shall prohibit Parent or the Company, or its Board of Directors, from taking and disclosing to its stockholders a position contemplated by Rules 14d-9 and 14e-2(a) promulgated under the Exchange Act; provided that the content of any such disclosure thereunder shall be governed by the terms of this Agreement. Without limiting the foregoing proviso, neither Parent nor the Company shall effect a Change of Recommendation unless specifically permitted pursuant to the terms of Section 5.3(d).

(g) Certain Definitions. For purposes of this Agreement, the following terms shall have the following meanings:

(i) “Acquisition Proposal,” with respect to a party, shall mean any offer or proposal, relating to any transaction or series of related transactions involving: (a) any purchase from such party or acquisition by any Person or “group” (as defined under Section 13(d) of the Exchange Act and the rules and regulations thereunder) of more than a ten percent (10%) interest in the total outstanding voting securities of such party or any of its Subsidiaries or any tender offer or exchange offer that if consummated would result in any person or group beneficially owning ten percent (10%) or more of the total outstanding voting securities of such party or any of its Subsidiaries or any merger, consolidation, business combination or similar transaction involving the Company or Parent or any of its Subsidiaries, (b) any sale, lease (other than in the ordinary course of business), exchange, transfer, license (other than in the ordinary course of business), acquisition or disposition of assets of such party (including its Subsidiaries taken as a whole) representing more than ten percent (10%) of the assets of such party (including its Subsidiaries taken as a whole), or (c) any liquidation or dissolution (or the adoption of a plan pertaining thereto) of such party or the declaration or payment of an extraordinary dividend (whether in cash or other property) other than the Source Distribution; provided, however, the Mergers and the transactions contemplated hereby shall not be deemed an Acquisition Proposal in any case; and

(ii) “Superior Offer,” with respect to a party, shall mean an unsolicited, bona fide written offer made by a third party to acquire, directly or indirectly, pursuant to a tender offer, exchange offer, merger, consolidation or other business combination, all or substantially all of the assets of such party or in excess of eighty percent (80%) of the outstanding voting securities of such party and as a result of which the stockholders of such party immediately preceding such transaction would cease to hold at least eighty percent (80%) of the equity interests in the surviving or resulting entity of such transaction or any direct or indirect parent or Subsidiary thereof, on terms that the Board of Directors of

Index to Financial Statements

such party, as applicable, has in good faith concluded (following the receipt of advice of its outside legal counsel), taking into account, among other things, all legal, financial, regulatory and other aspects of the offer and the Person making the offer, to be more favorable, from a financial point of view, to such party’s stockholders (in their capacities as stockholders) than the terms of the Company Merger and is reasonably capable of being consummated; provided, that in the case of Parent only, such offer shall be conditioned upon the termination of this Agreement.

5.4 Confidentiality; Access to Information; No Modification of Representations, Warranties or Covenants

(a) Confidentiality. The parties acknowledge that the Company and Parent have previously executed a Mutual Nondisclosure Agreement dated September 11, 2002 (the “Confidentiality Agreement”), which Confidentiality Agreement will continue in full force and effect in accordance with its terms and each of Parent and the Company will hold, and will cause its respective directors, officers, Employees, agents and advisors (including attorneys, accountants, consultants, bankers and financial advisors) to hold, any Evaluation Material (as defined in the Confidentiality Agreement) confidential in accordance with the terms of the Confidentiality Agreement.

(b) Access to Information. The Company will afford Parent and Parent’s accountants, counsel and other representatives reasonable access during normal business hours to its properties, books, records and personnel during the period prior to the Effective Time of the Company Merger to obtain all information concerning its business, including the status of product development efforts, properties, results of operations and personnel, as Parent may reasonably request; provided, however, that the Company may restrict the foregoing access to the extent that any law, treaty, rule or regulation of any Governmental Entity applicable to the Company requires the Company or its Subsidiaries to restrict or prohibit access to any such properties or information.

(c) No Modification of Representations and Warranties or Covenants. No information or knowledge obtained in any investigation or notification pursuant to this Section 5.4, Section 5.6 or Section 5.7 shall affect or be deemed to modify any representation or warranty contained herein, the covenants or agreements of the parties hereto or the conditions to the obligations of the parties hereto under this Agreement.

5.5 Public Disclosure. Without limiting any other provision of this Agreement, Parent and the Company will consult with each other before issuing, and provide each other the opportunity to review, comment upon and concur with, and use all reasonable efforts to agree on any press release or public statement with respect to this Agreement and the transactions contemplated hereby, including the Mergers, and any Acquisition Proposal and will not issue any such press release or make any such public statement prior to such consultation and (to the extent practicable) agreement, except as may be required by law or any listing agreement with Nasdaq or any other applicable national or regional securities exchange; provided that following a Change in Recommendation by Parent or the Company following the receipt by such party of a Superior Offer, then if such party confirms in writing to the other party that a Change in Recommendation has occurred, the foregoing shall not be applicable to any press releases or public statements regarding the Superior Offer. The parties have agreed to the text of the joint press release announcing the signing of this Agreement.

Index to Financial Statements

(a) Regulatory Filings. Each of Parent, Merger Sub and the Company shall coordinate and cooperate with one another and shall each use all reasonable efforts to comply with, and shall each refrain from taking any action that would impede compliance with, all Legal Requirements, and as promptly as practicable after the date hereof, each of Parent, Separation Sub, Merger Sub and the Company shall make all filings, notices, petitions, statements, registrations, submissions of information, application or submission of other documents required by any Governmental Entity in connection with the Mergers and the transactions contemplated hereby, including: (i) Notification and Report Forms with the United States Federal Trade Commission (the “FTC”) and the Antitrust Division of the United States Department of Justice (“DOJ”) as required by the HSR Act, (ii) any other filing necessary to obtain any Necessary Consent, (iii) filings under any other comparable pre-merger notification forms required by the merger notification or control laws of any applicable jurisdiction, as agreed by the parties hereto, and (iv) any filings required under the Securities Act, the Exchange Act, any applicable state or securities or “blue sky” laws and the securities laws of any foreign country, or any other Legal Requirement relating to the Mergers. Each of Parent and the Company will cause all documents that it is responsible for filing with any Governmental Entity under this Section 5.6(a) to comply in all material respects with all applicable Legal Requirements.

(b) Exchange of Information. Parent, Separation Sub, Merger Sub and the Company each shall promptly supply the other party with any information that may be required in order to effectuate any filings or application pursuant to Section 5.6(a). Except where prohibited by applicable Legal Requirements, and subject to the Confidentiality Agreement, each of the Company and Parent shall consult with the other party prior to taking a position with respect to any such filing, shall permit the other to review and discuss in advance, and consider in good faith the views of the other in connection with any analyses, appearances, presentations, memoranda, briefs, white papers, arguments, opinions and proposals before making or submitting any of the foregoing to any Governmental Entity by or on behalf of any party hereto in connection with any investigations or proceedings in connection with this Agreement or the transactions contemplated hereby (including under any antitrust or fair trade Legal Requirement), coordinate with the other in preparing and exchanging such information and promptly provide the other (and its counsel) with copies of all filings, presentations or submissions (and a summary of any oral presentations) made by such party with any Governmental Entity in connection with this Agreement or the transactions contemplated hereby, provided that with respect to any such filing, presentation or submission, each of Parent and the Company need not supply the other (or its counsel) with copies (or in case of oral presentations, a summary) to the extent that any law, treaty, rule or regulation of any Governmental Entity applicable to such party requires such party or its Subsidiaries to restrict or prohibit access to any such properties or information.

(c) Notification. Each of Parent, Separation Sub, Merger Sub and the Company will notify the other promptly upon the receipt of: (i) any comments from any officials of any Governmental Entity in connection with any filings made pursuant hereto and (ii) any request by any officials of any Governmental Entity for amendments or supplements to any filings made pursuant to, or information provided to comply in all material respects with, any Legal Requirements. Whenever any event occurs that is required to be set forth in an amendment or supplement to any filing made pursuant to Section 5.6(a), Parent, Separation Sub, Merger Sub or the Company, as the case may be, will promptly inform the others of such occurrence and cooperate in filing with the applicable Governmental Entity such amendment or supplement.

Index to Financial Statements

(d) Reasonable Efforts. Subject to the express provisions of Section 5.2 and Section 5.3 hereof and upon the terms and subject to the conditions set forth herein, each of the parties agrees to use all reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other parties in doing, all things necessary, proper or advisable to consummate and make effective, in the most expeditious manner practicable, the Mergers and the other transactions contemplated by this Agreement, including using all reasonable efforts to accomplish the following: (i) the taking of all reasonable acts necessary to cause the conditions precedent set forth in Article VI to be satisfied, (ii) the obtaining of all necessary actions or nonactions, waivers, consents, approvals, orders and authorizations from Governmental Entities and the making of all necessary registrations, declarations and filings (including registrations, declarations and filings with Governmental Entities, if any) and the taking of all reasonable steps as may be necessary to avoid any suit, claim, action, investigation or proceeding by any Governmental Entity, (iii) the obtaining of all necessary consents, approvals or waivers from third parties, including all Necessary Consents, (iv) the defending of any suits, claims, actions, investigations or proceedings, whether judicial or administrative, challenging this Agreement or the consummation of the transactions contemplated hereby, including seeking to have any stay or temporary restraining order entered by any court or other Governmental Entity vacated or reversed, and (v) the execution or delivery of any additional instruments necessary to consummate the transactions contemplated by, and to fully carry out the purposes of, this Agreement. In connection with and without limiting the foregoing, the Company and its Board of Directors shall, if any takeover statute or similar Legal Requirement is or becomes applicable to the Company Merger, this Agreement or any of the transactions contemplated by this Agreement, use all reasonable efforts to ensure that the Company Merger and the other transactions contemplated by this Agreement may be consummated as promptly as practicable on the terms contemplated by this Agreement and otherwise to minimize the effect of such Legal Requirement on the Company Merger, this Agreement and the transactions contemplated hereby.

(e) Limitation on Divestiture. Notwithstanding anything in this Agreement to the contrary, nothing contained in this Agreement shall be deemed to require Parent or any Subsidiary or affiliate of Parent to agree to any Action of Divestiture (as defined below). The Company shall not take or agree to take any Action of Divestiture without the prior written consent of Parent. For purposes of this Agreement, an “Action of Divestiture” shall mean making proposals, executing or carrying out agreements (including consent decrees) or submitting to Legal Requirements providing for the license, sale or other disposition or holding separate (through the establishment of a trust or otherwise) of any assets or categories of assets that are material to Parent, the Company or any of their respective Subsidiaries or the holding separate of the Company capital stock or imposing or seeking to impose any material limitation on the ability of Parent, the Company or any of their respective Subsidiaries, to conduct their respective businesses or own such assets or to acquire, hold or exercise full rights of ownership of the Company’s business.

(a) By the Company. The Company shall give prompt notice to Parent, Separation Sub and Merger Sub of any representation or warranty made by it contained in this Agreement becoming untrue or inaccurate, or any failure of the Company to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it under this Agreement, in each case, such that the conditions set forth in Section 6.3(a) or 6.3(b) would not be satisfied.

Index to Financial Statements

(b) By Parent. Parent, Separation Sub and Merger Sub shall give prompt notice to the Company of any representation or warranty made by it contained in this Agreement becoming untrue or inaccurate, or any failure of Parent to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it under this Agreement, in each case, such that the conditions set forth in Section 6.2(a) or 6.2(b) would not be satisfied.

(a) Company Efforts. As soon as practicable following the date hereof, the Company will use all reasonable efforts to obtain any material consents, waivers and approvals under any of its or its Subsidiaries’ respective Contracts required to be obtained in connection with the consummation of the transactions contemplated hereby. The Company shall use all reasonable efforts to obtain from M-F Downtown for the benefit of Parent an estoppel certificate dated within two (2) weeks prior to the Closing Date certifying such information as Parent may reasonably require (the “M-F Downtown Estoppel Certificate”), including that (i) the Close of Escrow has occurred and all of the conditions thereto were satisfied or waived in accordance with the terms of the Lease Modification Agreement, other than the conditions to the Close of Escrow set forth in Sections 11(c)(iv), 11(e), 11(f), 11(g), 12(d) and 12(e), which were satisfied in accordance with the terms of the Lease Modification Agreement, and (ii) no Reinstatement or Occupancy has occurred.

(b) Parent Efforts. As soon as practicable following the date hereof, Parent will use all reasonable efforts to obtain any material consents, waivers and approvals under any of its or its Subsidiaries’ respective Contracts required to be obtained in connection with the consummation of the transactions contemplated hereby.

(a) Assumption of Parent Options. At the Effective Time of the Parent Merger, each then outstanding Parent Option, whether or not exercisable at the Effective Time of the Parent Merger and regardless of the respective exercise prices thereof, shall either continue in effect at the Surviving Corporation in the Parent Merger or be assumed by the Surviving Corporation in the Parent Merger, as necessary. Each Parent Option so continued or assumed under this Agreement will continue to have, and be subject to, the same terms and conditions set forth in the applicable Parent Option (including any applicable stock option agreement or other document evidencing such Parent Option) immediately prior to the Effective Time of the Parent Merger (including any repurchase rights or vesting provisions), except that each Parent Option will be adjusted so that it will be exercisable (or will become exercisable in accordance with its terms) for a number of share of Parent Common Stock equal in fair market value to the consideration received by holders of Parent Common Stock pursuant to Section 1.8(a) hereof.

(b) Assumption of Company Options and Warrants. At the Effective Time of the Company Merger, each then outstanding Company Option and each then outstanding Company Warrant, whether or not exercisable at the Effective Time of the Company Merger and regardless of the respective exercise prices thereof, will be assumed by the Surviving Corporation in the Parent Merger. Each Company Option and each Company Warrant so assumed by Surviving Corporation in the Parent Merger under this Agreement will continue to have, and be subject to, the same terms and conditions set forth in the applicable Company Option (including any applicable stock option agreement or other document evidencing such Company Option) or Company Warrant immediately prior to the Effective

Index to Financial Statements

Time of the Company Merger (including any repurchase rights or vesting provisions), except that (i) each Company Option or Company Warrant will be exercisable (or will become exercisable in accordance with its terms) for that number of whole shares of Parent Common Stock equal to the product of the number of shares of Company Common Stock that were issuable upon exercise of such Company Option or Company Warrant immediately prior to the Effective Time of the Company Merger multiplied by the Exchange Ratio, rounded down to the nearest whole number of shares of Parent Common Stock and (ii) the per share exercise price for the shares of Parent Common Stock issuable upon exercise of such assumed Company Option or Company Warrant will be equal to the quotient determined by dividing the exercise price per share of the Company Common Stock at which such Company Option or Company Warrant was exercisable immediately prior to the Effective Time of the Company Merger by the Exchange Ratio, rounded up to the nearest whole cent. Subject to the terms of such assumed Company Option or Company Warrant, as the case may be, each assumed Company Option or Company Warrant, as the case may be, shall be vested immediately following the Effective Time of the Company Merger as to the same percentage of the total number of shares subject thereto as it was vested as to immediately prior to the Effective Time of the Company Merger. As soon as reasonably practicable after the Effective Time of the Company Merger, Parent will issue to each Person who holds an assumed Company Option a document evidencing the foregoing assumption of such Company Option by Parent.

(c) Incentive Stock Options. The conversion of the Company Options provided for in Section 5.9(a), with respect to any options which qualify as “incentive stock options” (as defined in Section 422 of the Code) prior to the Effective Time of the Company Merger shall be effected in a manner such that, to the maximum extent permissible, such Company Options continue to qualify as incentive stock options after the Effective Time of the Company Merger consistent with Section 424(a) of the Code.

(d) Company Stock Purchase Plan. Prior to the Effective Time of the Company Merger, the Company Purchase Plan shall be terminated. The rights of participants in the Company Purchase Plan with respect to any offering period then underway under such Company Purchase Plan shall be determined by treating the last business day prior to, or if more administratively advisable, the last payroll date of the Company immediately prior to, the Effective Time of the Company Merger, as the last day of such offering period and by making such other pro-rata adjustments as may be necessary to reflect the shortened offering period but otherwise treating such shortened offering period as a fully effective and completed offering period for all purposes under such Company Purchase Plan. Prior to the Effective Time of the Company Merger, the Company shall take all actions (including, if appropriate, amending the terms of such Company Purchase Plan that are necessary to give effect to the transactions contemplated by this Section 5.9(d)).

(e) Termination of 401(k) Plans. To the extent requested in writing by Parent no later than five (5) business days prior to the Closing Date, the Company shall take (or cause to be taken) all actions necessary or appropriate to terminate, effective no later than the date immediately preceding the Closing Date, any Company Employee Plan that contains a cash or deferred arrangement intended to qualify under Section 401(k) of the Code (the “401(k) Plans”). If Parent provides such notice to the Company prior to such five (5) business day period, Parent shall receive from the Company, prior to the Effective Time of the Company Merger, evidence that the Company’s Board of Directors has adopted resolutions to terminate the 401(k) Plans (the form and substance of which resolutions shall be subject to review and approval of Parent, which approval shall not be unreasonably withheld), effective no later

Index to Financial Statements

than the date immediately preceding the Closing Date. The Company shall also take such other actions in furtherance of terminating the 401(k) Plans as Parent may reasonably require.

(f) Certain Employee Benefits. As soon as practicable after the execution of this Agreement, the Company and Parent shall confer and work together in good faith to agree upon mutually acceptable authorize any of them employee benefit and compensation arrangements for employees of the Company and its Subsidiaries following the Effective Time of the Company Merger (and the termination of Company Employee Plans immediately prior to the Effective Time if appropriate). Employees of the Company and its Subsidiaries will be granted credit for all service with the Company, its Subsidiaries or its Affiliates (except to the extent such service credit will result in the duplication of benefits) under each current employee benefit plan, program or arrangement of Parent or its Affiliates in which such employees are eligible to participate for purposes of eligibility and vesting, except for purposes of Parent’s sabbatical plan and benefit accrual under a Parent retirement plans. If employees become eligible to participate in a medical, dental or vision plan of Parent or its Affiliates, Parent shall use commercially reasonable efforts to cause such plan to (i) waive any preexisting condition exclusions and waiting period limitations for conditions covered under the applicable medical, dental or vision plans maintained or contributed to by Company (but only to the extent corresponding exclusions and limitations were satisfied by such employees under the applicable medical, dental or health plans maintained or contributed to by Company); and (ii) credit any deductible or out of pocket expenses incurred by the employees and their beneficiaries under such plans during the portion of the calendar year prior to such participation. Parent shall use all reasonable efforts to provide to employees of the Company who continue their employment with the Company following the Effective Time of the Company Merger the opportunity to enroll in a special offering period under the Parent Employee Stock Purchase Plan, which special offering period shall commence as soon as is administratively practicable following the Effective Time of the Company Merger.

5.10 Form S-8. Parent agrees to file a registration statement on Form S-8 for the shares of Parent Common Stock issuable with respect to assumed Company Options to the extent Form S-8 is available as soon as is reasonably practicable (within ten (10) calendar days, if practicable) after the Effective Time of the Company Merger and shall maintain the effectiveness of such registration statement thereafter for so long as any of such options or other rights remain outstanding.

(a) Indemnity. From and after the Effective Time of the Company Merger, Parent will cause the Surviving Corporation in the Company Merger to fulfill and honor in all respects the obligations of the Company pursuant to any indemnification agreements between the Company and its directors and officers immediately prior to the Effective Time of the Company Merger (the “Indemnified Parties”), subject to applicable law. The Certificate of Incorporation and Bylaws of the Surviving Corporation in the Company Merger will contain provisions with respect to exculpation and indemnification that are at least as favorable to the Indemnified Parties as those contained in the Certificate of Incorporation and Bylaws of the Company as in effect on the date hereof, which provisions will not be amended, repealed or otherwise modified for a period of six (6) years from the Effective Time of the Company Merger in any manner that would adversely affect the rights thereunder of individuals who, immediately prior to the Effective Time of the Company Merger, were directors or officers of the Company, unless such modification is required by law.

Index to Financial Statements

(b) Insurance. For a period of six (6) years after the Effective Time of the Company Merger, the Surviving Corporation in the Company Merger will maintain directors’ and officers’ liability insurance covering those persons who are covered by the Company’s directors’ and officers’ liability insurance policy as of the date hereof on terms comparable to those applicable to the current directors and officers of the Company; provided, however, that in no event will the Surviving Corporation in the Company Merger be required to expend in excess of two hundred percent (200%) of the annual premium currently paid by the Company for such coverage (and to the extent the annual premium would exceed two hundred percent (200%) of the annual premium currently paid by the Company for such coverage, the Surviving Corporation in the Company Merger shall maintain the maximum amount of coverage, if any, as is available for two hundred percent (200%) of such annual premium).

(c) Third-Party Beneficiaries. This Section 5.11 is intended to be for the benefit of, and shall be enforceable by the Indemnified Parties and their heirs and personal representatives and shall be binding on Parent, the Surviving Corporation in the Company Merger and their successors and assigns.

5.12 Nasdaq Listing. Prior to the Effective Time of the Company Merger, Parent agrees to use all reasonable efforts to (i) to authorize for listing on Nasdaq the shares of Parent Common Stock issuable, and those required to be reserved for issuance, in connection with the Company Merger, subject to official notice of issuance and (ii) authorize for listing on Nasdaq the shares of Source Common Stock to be distributed to each holder of shares of Parent Common Stock at the Effective Time of the Parent Merger.

5.13 Company Affiliates; Restrictive Legend. The Company will use all reasonable efforts to deliver or cause to be delivered to Parent, as promptly as practicable on or following the date hereof, from each person who may reasonably be deemed to be an affiliate of the Company for purposes of Rule 145 promulgated under the Securities Act an executed affiliate agreement pursuant to which such affiliate shall agree to be bound by the provision of Rule 145 promulgated under the Securities Act in a form provided by Parent and reasonably acceptable to the Company. Parent will give stop transfer instructions to its transfer agent with respect to any Parent Common Stock received pursuant to the Company Merger by any stockholder of the Company who may reasonably be deemed to be an affiliate of the Company for purposes of Rule 145 promulgated under the Securities Act and there will be placed on the certificates representing such Parent Common Stock, or any substitutions therefor, a legend stating in substance that the shares were issued in a transaction to which Rule 145 promulgated under the Securities Act applies and may only be transferred (i) in conformity with Rule 145 or (ii) in accordance with a written opinion of counsel, reasonably acceptable to Parent, in form and substance that such transfer is exempt from registration under the Securities Act.

5.14 Treatment as Tax Free Distribution; Treatment as Reorganization. Parent will not knowingly take, and will not knowingly cause Source, Separation Sub or Merger Sub to take, any action that would reasonably be expected to cause the distribution of Source Common Stock to the stockholders of Parent pursuant to Sections 1.8(a) and 1.10(b) to fail to qualify as a tax-free distribution under Section 355 of the Code. None of Parent, Separation Sub, Merger Sub or the Company shall, and they shall not permit any of their respective Subsidiaries to, take any action prior to or following the Closing that would reasonably be expected to cause the Company Merger to fail to qualify as a reorganization with the meaning of Section 368(a) of the Code.

Index to Financial Statements

(a) Company Rights Plan. The Company shall, and shall cause its transfer agent, as rights agent, to enter into a preferred stock rights agreement in substantially the form of Exhibit F attached hereto (the “Company Rights Agreement”) as promptly as practicable after the date hereof (but in no event later than the earlier of (i) three (3) business days following the date hereof and (ii) the date upon which the Company files its current report on Form 8-K disclosing its entry into this Agreement), and shall reserve shares of Company Preferred Stock for issuance upon exercise of preferred stock purchase rights (the “Company Rights”) issuable pursuant to the Company Rights Agreement. The Company shall take all action necessary so that (i) Parent shall not be an “Acquiring Person” under the Company Rights Plan and (ii) the entering into of this Agreement and the Company Merger and the other transactions contemplated hereby will not result in the grant of any rights to any Person under the Company Rights Agreement or enable or require the Company Rights to be exercised, distributed or triggered as a result thereof. The Company shall set the record date for the Company Rights Dividend as June 5, 2003 and shall pay the Company Rights Dividend not later than June 5, 2003. The Company shall not redeem the Company Rights or amend or modify (including by delay of the “Distribution Date” thereunder) or terminate the Company Rights Plan prior to the Effective Time of the Company Merger unless, and only to the extent that: (i) it is required to do so by order of a court of competent jurisdiction or (ii) the Board of Directors of the Company has effected or is permitted to effect, in compliance with the terms of this Agreement, a Change of Recommendation.

(a) Company. The Board of Directors of the Company, or a committee of two or more Non-Employee Directors thereof (as such term is defined for purposes of Rule 16b-3 under the Exchange Act), shall adopt resolutions prior to the Effective Time of the Company Merger, providing that the disposition by the Company Insiders (as defined below) of Company Common Stock and Company Options, in each case pursuant to the transactions contemplated hereby, are intended to be, to the extent legally permissible, exempt from liability under Section 16(b) of the Exchange Act. Such resolutions shall comply with the approval conditions of Rule 16b-3 under the Exchange Act and no-action letters issued thereunder for purposes of such Section 16(b) exemption, including, but not limited to, specifying the name of the Company Insiders, the number of securities to be disposed of for each such person, the material terms of any derivative securities, and that the approval is intended to make the disposition of such securities exempt pursuant to Rule 16b-3(e). “Company Insiders” shall mean those officers and directors of the Company who are subject to the reporting requirement of Section 16(b) of the Exchange Act immediately prior to the Effective Time of the Company Merger.

(b) Parent. The Board of Directors of Parent, or a committee of two or more Non-Employee Directors thereof (as such term is defined for purposes of Rule 16b-3 under the Exchange Act), and provided that the Company delivers to Parent the Section 16 Information (as defined below) in a timely fashion, shall adopt resolutions prior to the Effective Time of the Parent Merger, providing that the acquisition by the Parent Insiders (as defined below) of Parent Common Stock and Parent Options, in each case pursuant to the transactions contemplated hereby, are intended to be, to the extent legally permissible, exempt from liability under Section 16(b) of the Exchange Act. Such resolutions shall comply with the approval conditions of Rule 16b-3 under the Exchange Act and no-action letters issued thereunder for purposes of such Section 16(b) exemption, including, but not limited to, specifying the name of the Parent Insiders, the number of securities to be acquired by each such person, the material

Index to Financial Statements

terms of any derivative securities, and that the approval is intended to make the acquisition of such securities exempt pursuant to Rule 16b-3(d). “Parent Insiders” shall mean those officers and directors of Company who will be subject to the reporting requirement of Section 16(b) of the Exchange Act with respect to Parent following the Effective Time of the Company Merger. “Section 16 Information” shall mean information regarding the Company Insiders, the number of shares of Company capital stock held by each such Company Insider and expected to be exchanged for Parent Common Stock in connection with the Company Merger, and the number and description of the Company Options held by each such Company Insider and expected to be converted into Parent Options in connection with the Company Merger.

5.17 Merger Sub Compliance. Parent shall cause each of Separation Sub and Merger Sub to comply with all of its obligations under or relating to this Agreement. Separation Sub shall not engage in any business which is not in connection with the Parent Merger Pursuant to this Agreement. Merger Sub shall not engage in any business which is not in connection with the Company Merger pursuant to this Agreement.

5.18 Board of Directors. The Board of Directors of Parent shall take all actions necessary such that effective as of immediately following the Effective Time of the Company Merger, the Board of Directors of Parent shall be comprised of ten (10) directors, and shall include three (3) directors, Donna Dubinsky, Bruce Dunlevie and John Doerr (collectively, the “Company Designated Directors”). If any of the above named Company Designated Directors is unable or unavailable to serve as a director of Parent at the Effective Time of the Company Merger, then the Company shall be entitled to designate another Person to serve as a Company Designated Director, as long as such alternate Person serves as a director on the Board of Directors of the Company on the date hereof, is acceptable to Parent and at least two of the Company Designated Directors are “independent directors” (as defined under Section 4200(a)(14) of the rules of Nasdaq, or any successor rule then in effect) with respect to the Company and Parent.

5.19 Comfort Letter. The Company shall use all commercially reasonable efforts to cause its independent public accountants to deliver a letter dated not more than five (5) days prior to the date on which the Registration Statement shall become effective and addressed to itself and Parent and their respective Boards of Directors in form and substance reasonably satisfactory to Parent and customary in scope and substance for agreed-upon procedures letters delivered by independent public accountants in connection with registration statements and prospectus/proxy statements similar to the Registration Statement and the Prospectus/Proxy Statement.

6.1 Conditions to the Obligations of Each Party to Effect the Mergers. The respective obligations of each party to this Agreement to effect the Mergers shall be subject to the satisfaction at or prior to the Closing Date of the following conditions:

(a) Stockholder Approval. This Agreement shall have been approved and adopted, and the Company Merger shall have been duly approved, by the requisite vote under applicable Legal Requirements, by the stockholders of the Company and this Agreement shall have been approved and adopted, and the Parent Merger shall have been duly approved, and the issuance of Parent Common

Index to Financial Statements

Stock in connection with the Company Merger shall have been duly approved, by the requisite vote under applicable Legal Requirements, by the stockholders of Parent.

(b) No Order. No Governmental Entity of competent jurisdiction shall have enacted, issued, promulgated, enforced or entered any statute, rule, regulation, executive order, decree, injunction or other order (whether temporary, preliminary or permanent) which (i) is in effect and (ii) has the effect of making the Mergers illegal or otherwise prohibiting consummation of the Mergers.

(c) Registration Statements Effective; Prospectus/Proxy Statement. The SEC shall have declared the Registration Statement and the Source Registration Statement effective. No stop order suspending the effectiveness of the Registration Statement or the Source Registration Statement, or any part of either the Registration Statement or the Source Registration Statement, shall have been issued and no proceeding for that purpose, and no similar proceeding in respect of the Prospectus/Proxy Statement or the Source Prospectus, shall have been initiated or threatened in writing by the SEC.

(d) HSR Act. All waiting periods (and any extension thereof) under the HSR Act relating to the transactions contemplated hereby will have expired or terminated early. All other material foreign antitrust approvals required to be obtained prior to the Company Merger in connection with the transactions contemplated hereby shall have been obtained.

(e) Tax Opinions. Parent and the Company shall each have received written opinions from Wilson Sonsini Goodrich & Rosati, Professional Corporation and Fenwick & West LLP, respectively, in form and substance reasonably satisfactory to them, to the effect that the Company Merger will constitute a reorganization within the meaning of Section 368(a) of the Code and such opinions shall not have been withdrawn. Parent and the Company shall deliver, and tax counsel shall be entitled to rely upon, such tax representations as are reasonably requested by tax counsel in connection with rendering such opinions.

(f) Nasdaq Listing. The shares of Parent Common Stock to be issued in the Company Merger shall have been authorized for listing on Nasdaq, subject to official notice of issuance.

(g) No Change in Tax Law. There shall not have occurred any change in law (including for this purpose any statutory or regulatory change or any issuance of an IRS Revenue Ruling or Notice) under which the distribution of Source Common Stock to the stockholders of Parent pursuant to Sections 1.8(a) and 1.10(b) would fail to qualify as a tax-free distribution under Section 355 of the Code.

6.2 Additional Conditions to the Obligations of the Company. The obligation of the Company to consummate and effect the Mergers shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by the Company:

(a) Representations and Warranties. The representations and warranties of Parent contained in this Agreement shall be true and correct on the date hereof and as of the Closing Date (but disregarding as of the Closing Date any qualifications or limitations regarding the “Knowledge of Parent” or phrases of similar effect) with the same force and effect as if made on the Closing Date (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date), except, in each case, or in the aggregate, as does not

Index to Financial Statements

constitute a Material Adverse Effect on Parent at the Closing Date (it being understood that, in each case, for purposes of determining the accuracy of such representations and warranties, any update of or modification to the Parent Disclosure Letter made or purported to have been made after the execution of this Agreement shall be disregarded). The Company shall have received a certificate with respect to the foregoing signed on behalf of Parent by an authorized executive officer of Parent.

(b) Agreements and Covenants. Parent shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Closing Date, and the Company shall have received a certificate with respect to the foregoing signed on behalf of Parent by an authorized executive officer of Parent.

(c) Material Adverse Effect. No Material Adverse Effect on Parent shall have occurred since the date hereof and be continuing.

(d) Parent Board. Parent shall have taken all action necessary such that the Company Designated Directors become directors of Parent as of immediately following the Effective Time of the Company Merger in accordance with Section 5.18.

6.3 Additional Conditions to the Obligations of Parent, Separation Sub and Merger Sub. The obligations of Parent, Separation Sub and Merger Sub to consummate and effect the Mergers shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by Parent:

(a) Representations and Warranties. The representations and warranties of the Company contained in this Agreement shall be true and correct on the date hereof and as of the Closing Date (but disregarding as of the Closing Date any qualifications or limitations regarding the “Knowledge of the Company” or phrases of similar effect) with the same force and effect as if made on the Closing Date (except that those representations and warranties which address matters only as of a particular date shall have been true and correct only on such date), except, in each case, or in the aggregate, as does not constitute a Material Adverse Effect on the Company at the Closing Date (it being understood that in each case, for purposes of determining the accuracy of such representations and warranties, any update of or modification to the Company Disclosure Letter made or purported to have been made after the execution of this Agreement shall be disregarded). Parent, Separation Sub and Merger Sub shall have received a certificate with respect to the foregoing signed on behalf of the Company by an authorized executive officer of the Company.

(b) Agreements and Covenants. The Company shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it at or prior to the Closing Date, and Parent, Separation Sub and Merger Sub shall have received a certificate to such effect signed on behalf of the Company by an authorized executive officer of the Company.

(c) Material Adverse Effect. No Material Adverse Effect on the Company shall have occurred since the date hereof and be continuing.

(d) No Governmental Restriction. There shall not be any pending or overtly threatened suit, action or proceeding asserted by any Governmental Authority (i) challenging or seeking to restrain or prohibit the consummation of the Mergers or any of the other transactions contemplated by

Index to Financial Statements

this Agreement, the effect of which restraint or prohibition if obtained would cause the condition set forth in Section 6.1(b) to not be satisfied or (ii) seeking to require Parent or the Company or any Subsidiary or affiliate of either of them to effect an Action of Divestiture.

(e) Employment Offers. All of the Key Employees identified on Schedule 6.3(e)(i) and at least eighty percent (80%) of the Key Employees identified on Schedule 6.3(e)(ii) shall have accepted and not revoked offers of employment from Parent on the terms previously agreed between Parent and such Key Employees.

(f) Material Consents and Certificates; Real Estate Matters. All third party consents, permits and approvals listed in Schedule 6.3(f) shall have been obtained. The Close of Escrow shall have occurred and no Occupancy or Reinstatement shall have occurred.

(g) Nasdaq Listing. The shares of Source Common Stock to be distributed to each holder of shares of Parent Common Stock at the Effective Time of the Parent Merger shall have been authorized for listing on Nasdaq, subject to official notice of the completion of such distribution.

6.4 Condition to the Company Merger. It shall be a condition to the respective obligations of each party to this Agreement to effect the Company Merger that the Parent Merger shall have been consummated.

6.5 Condition to the Parent Merger. It shall be a condition to Parent’s obligations to effect the Parent Merger that all conditions to the respective obligations of each party to this Agreement to effect the Company Merger (other than the condition in Section 6.4) shall have been satisfied or duly waived.

7.1 Termination. This Agreement may be terminated at any time prior to the Effective Time of the Company Merger, by action taken or authorized by the Board of Directors of the terminating party or parties, and except as provided below, whether before or after the requisite approvals of the stockholders of the Company or Parent:

(a) by mutual written consent duly authorized by the Boards of Directors of Parent and the Company;

(b) by either the Company or Parent if the Mergers shall not have been consummated by January 31, 2004 (which date shall be extended to April 30, 2004, if the Mergers shall not have been consummated as a result of a failure to satisfy the conditions set forth in Section 6.1(b), Section 6.1(d) or Section 6.3(d)) (as appropriate, the “End Date”); provided, however, that the right to terminate this Agreement under this Section 7.1(b) shall not be available to any party whose action or failure to act has been a principal cause of or resulted in the failure of the Mergers to occur on or before such date and such action or failure to act constitutes a material breach of this Agreement;

(c) by either the Company or Parent if a Governmental Entity shall have issued an order, decree or ruling or taken any other action (including the failure to have taken an action), in any

Index to Financial Statements

case having the effect of permanently restraining, enjoining or otherwise prohibiting the Mergers, which order, decree, ruling or other action is final and nonappealable;

(d) by either the Company or Parent if the required approval of the stockholders of Parent contemplated by this Agreement shall not have been obtained by reason of the failure to obtain the required vote at a meeting of Parent stockholders duly convened therefor or at any adjournment thereof; provided, however, that the right to terminate this Agreement under this Section 7.1(d) shall not be available to Parent where the failure to obtain Parent stockholder approval shall have been caused by the action or failure to act of Parent and such action or failure to act constitutes a material breach by Parent of this Agreement;

(e) by either the Company or Parent if the required approval of the stockholders of the Company contemplated by this Agreement shall not have been obtained by reason of the failure to obtain the required vote at a meeting of the Company stockholders duly convened therefore or at any adjournment thereof; provided, however, that the right to terminate this Agreement under this Section 7.1(e) shall not be available to the Company where the failure to obtain the Company stockholder approval shall have been caused by the action or failure to act of the Company and such action or failure to act constitutes a material breach by the Company of this Agreement;

(f) by Parent (at any time prior to the adoption and approval of this Agreement and the Company Merger by the required vote of the stockholders of the Company) if a Parent Triggering Event (as defined below) shall have occurred;

(g) by the Company (at any time prior to the adoption and approval of this Agreement and the approval the Parent Merger and approval of the issuance of Parent Common Stock in connection with the Company Merger by the required vote of the stockholders of the Parent) if a Company Triggering Event (as defined below) shall have occurred;

(h) by the Company, upon a breach of any representation, warranty, covenant or agreement on the part of Parent set forth in this Agreement, or if any representation or warranty of Parent shall have become untrue, in either case such that the conditions set forth in Section 6.2(a) or Section 6.2(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue, provided that, other than in the case of a willful breach, if such inaccuracy in Parent’s representations and warranties or breach by Parent is curable by Parent, then the Company may not terminate this Agreement under this Section 7.1(h) prior to twenty (20) days following the receipt of written notice from the Company to Parent of such breach (it being understood that the Company may not terminate this Agreement pursuant to this paragraph 7.1(g) if such breach by Parent is cured within such twenty (20) day period or if the Company shall be in material breach of this Agreement);

(i) by Parent, upon a breach of any representation, warranty, covenant or agreement on the part of the Company set forth in this Agreement, or if any representation or warranty of the Company shall have become untrue, in either case such that the conditions set forth in Section 6.3(a) or Section 6.3(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue, provided that, other than in the case of a willful breach, that if such inaccuracy in the Company’s representations and warranties or breach by the Company is curable by the Company, then Parent may not terminate this Agreement under this Section 7.1(i) prior to twenty

Index to Financial Statements

(20) days following the receipt of written notice from Parent to the Company of such breach (it being understood that Parent may not terminate this Agreement pursuant to this paragraph 7.1(i) if such breach by the Company is cured within such twenty (20) day period or if Parent shall be in material breach of this Agreement);

(j) by Parent, if a Material Adverse Effect on the Company shall have occurred since the date hereof; and

(k) by the Company, if a Material Adverse Effect on Parent shall have occurred since the date hereof.

For the purposes of this Agreement, a “Parent Triggering Event” shall be deemed to have occurred if: (i) the Company’s Board of Directors or any committee thereof shall for any reason have withdrawn or shall have amended or modified in a manner adverse to Parent its recommendation in favor of, the adoption and approval of the Agreement or the approval of the Company Merger, (ii) the Company shall have failed to include in the Prospectus/Proxy Statement the recommendation of the Company’s Board of Directors in favor of the adoption and approval of the Agreement and the approval of the Company Merger, (iii) the Company’s Board of Directors fails to reaffirm (publicly, if so requested) its recommendation in favor of the adoption and approval of the Agreement and the approval of the Company Merger within ten (10) business days after Parent requests in writing that such recommendation be reaffirmed, (iv) the Company’s Board of Directors or any committee thereof shall have approved or recommended any Acquisition Proposal, or (v) a tender or exchange offer relating to the Company’s securities shall have been commenced by a Person unaffiliated with Parent and the Company shall not have sent to its securityholders pursuant to Rule 14e-2 promulgated under the Exchange Act, within ten (10) business days after such tender or exchange offer is first published, sent or given, a statement disclosing that the Board of Directors of the Company recommends rejection of such tender or exchange offer.

For purposes of this Agreement, a “Company Triggering Event” shall be deemed to have occurred if: (i) Parent’s Board of Directors or any committee thereof shall for any reason have withdrawn or shall have amended or modified in a manner adverse to the Company its recommendation in favor of, the adoption and approval of the Agreement or the approval of the Parent Merger or the issuance of Parent Common Stock in connection with the Company Merger, (ii) Parent shall have failed to include in the Prospectus/Proxy Statement the recommendation of Parent’s Board of Directors in favor of the adoption and approval of the Agreement and the approval of the Parent Merger and approval of the issuance of Parent Common Stock in connection with the Company Merger, (iii) Parent’s Board of Directors fails to reaffirm (publicly, if so requested) its recommendation in favor of the adoption and approval of the Agreement and the approval of the Parent Merger and approval of the issuance of Parent Common Stock in connection with the Company Merger within ten (10) business days after the Company requests in writing that such recommendation be reaffirmed, (iv) Parent’s Board of Directors or any committee thereof shall have approved or recommended any Acquisition Proposal, or (v) a tender or exchange offer relating to Parent’s securities shall have been commenced by a Person unaffiliated with the Company and Parent shall not have sent to its security holders pursuant to Rule 14e-2 promulgated under the Exchange Act, within ten (10) business days after such tender or exchange offer is first published, sent or given, a statement disclosing that the Board of Directors of Parent recommends rejection of such tender or exchange offer.

Index to Financial Statements

7.2 Notice of Termination; Effect of Termination. Any termination of this Agreement under Section 7.1 above will be effective immediately upon the delivery of a valid written notice of the terminating party to the other party hereto. In the event of the termination of this Agreement as provided in Section 7.1, this Agreement shall be of no further force or effect, except (i) as set forth in Section 5.4(a), this Section 7.2, Section 7.3 and Article VIII, each of which shall survive the termination of this Agreement and (ii) nothing herein (including Section 8.1) shall relieve any party from liability for any willful breach of this Agreement. No termination of this Agreement shall affect the obligations of the parties contained in the Confidentiality Agreement, all of which obligations shall survive termination of this Agreement in accordance with their terms.

(a) General. Except as set forth in this Section 7.3, all fees and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring such expenses whether or not the Mergers are consummated; provided, however, that (i) Parent and the Company shall share equally the registration fees with the SEC of the Registration Statement (it being understood and agreed that Parent shall be solely responsible for the registration fees with the SEC for the Source Registration Statement), (ii) Parent shall pay seventy percent (70%) and the Company shall pay thirty percent (30%) of all other fees and expenses incurred in relation to the printing and filing (with the SEC) and mailing to stockholders of the Prospectus/Proxy Statement (including any preliminary materials related thereto) and the Registration Statement (including financial statements and exhibits) and any amendments or supplements thereto and any other soliciting material (it being understood and agreed that Parent shall be solely responsible for the fees and expenses incurred to file (with the SEC) the Source Prospectus and the Source Registration Statement (including financial statements and exhibits) and any amendments or supplements thereto), other than (a) attorneys’ and accountants’ fees and expenses which fees shall be paid for by the party incurring such expense, (b) the direct costs of actually printing and mailing the Prospectus/Proxy Statement and any amendments or supplements thereto) to the stockholders of Parent which shall be solely paid by Parent, and (c) any fees and expenses incurred in relation to the printing and filing (with the SEC) of any amendments or supplements to the Registration Statement and Prospectus/Proxy Statement required or requested by the Company or Parent, as the case may be, and any other solicitation material filed by such party following a Change of Recommendation by such party which fees shall be solely paid by such party; and (iii) Parent and the Company shall share equally the filing fee for the Notification and Report Forms filed with the FTC and DOJ under the HSR Act, and premerger notification and reports forms under similar applicable laws of other jurisdictions, in each case pursuant to Section 5.6(a). Notwithstanding the foregoing, in the event that the lessor or licensor of any real property described in Section 2.13 above conditions its grant of a required consent (including by threatening to exercise a “recapture” or other termination right) upon the payment of a consent fee, “profit sharing” payment or other consideration, including increased rent payments, the Company shall be responsible for making all payments required to obtain such consent and shall indemnify, defend, protect and hold harmless Parent from all losses, costs, claims, liabilities and damages arising from the same.

Index to Financial Statements

(1) Stockholder Vote. In the event that (i) this Agreement is terminated by either Parent or the Company pursuant to Section 7.1(e), (ii) following the date hereof and prior to the termination of this Agreement there has been public disclosure of an Acquisition Proposal with respect to the Company, and (iii) either (A) within twelve (12) months following such termination of this Agreement the Company enters into an agreement providing for an Acquisition (as defined in Section 7.3(b)(iv) of the Company or (B) within twelve (12) months following such termination of this Agreement an Acquisition of the Company is consummated, then upon the earlier to occur of the events described in clause (A) or (B) above, the Company shall promptly, but in no event later than two (2) business days after the date of such event, pay Parent a fee equal to Four Million Five Hundred Thousand Dollars ($4,500,000) in immediately available funds

(2) Change of Recommendation. In the event that this Agreement is terminated by Parent pursuant to Section 7.1(f), (i) the Company shall promptly, but in no event later than two (2) business days after the date of such termination, pay Parent a fee equal to One Million Five Hundred Thousand ($1,500,000), and (ii) in the event either (A) within twelve (12) months following such termination of this Agreement the Company enters into an agreement providing for an Acquisition of the Company or (B) within twelve (12) months following such termination of this Agreement an Acquisition of the Company is consummated, , then upon the earlier to occur of the events described in clause (A) or (B) above, the Company shall promptly, but in no event later than two (2) business days after the date of such event, pay Parent a fee equal to Three Million Dollars ($3,000,000) in immediately available funds.

(1) Stockholder Vote. In the event that (i) this Agreement is terminated by either Parent or the Company pursuant to Section 7.1(d), (ii) following the date hereof and prior to the termination of this Agreement there has been public disclosure of an Acquisition Proposal with respect to the Parent, and (iii) either (A) within twelve (12) months following such termination of this Agreement Parent enters into an agreement providing for an Acquisition of Parent or (B) within twelve (12) months following such termination of this Agreement an Acquisition of Parent is consummated, then upon the earlier to occur of the events described in clause (A) or (B) above, Parent shall promptly, but in no event later than two (2) business days after the date of such event, pay the Company a fee equal to Four Million Five Hundred Thousand Dollars ($4,500,000) in immediately available funds.

(2) Change of Recommendation. In the event that this Agreement is terminated by the Company pursuant to Section 7.1(g), (i) Parent shall promptly, but in no event later than two (2) business days after the date of such termination, pay the Company a fee equal to One Million Five Hundred Thousand ($1,500,000), and (ii) in the event either (A) within twelve (12) months following such termination of this Agreement Parent enters into an agreement providing for an Acquisition of Parent or (B) within twelve (12) months following such termination of this Agreement an Acquisition of Parent is consummated, then upon the earlier to occur of the events described in clause (A) or (B) above, Parent shall promptly, but in no event later than two (2) business days after the date of

Index to Financial Statements

such event, pay the Company a fee equal to Three Million Dollars ($3,000,000) in immediately available funds.

(iii) Interest and Costs; Other Remedies. Each of Parent and the Company acknowledges that the agreements contained in this Section 7.3(b) are an integral part of the transactions contemplated by this Agreement, and that, without these agreements, the other party hereto would not enter into this Agreement; accordingly, if Parent or the Company, as the case may be, fails to pay in a timely manner the amounts due pursuant to this Section 7.3(b), and, in order to obtain such payment, the other party hereto makes a claim that results in a judgment against the party failing to pay for the amounts set forth in this Section 7.3(b), the party so failing to pay shall pay to the other party its reasonable costs and expenses (including reasonable attorneys’ fees and expenses) in connection with such suit, together with interest on the amounts set forth in this Section 7.3(b) at the prime rate of Citibank, N.A. in effect on the date such payment was required to be made. Payment of the fees described in this Section 7.3(b) shall not be in lieu of damages incurred in the event of breach of this Agreement.

(iv) Certain Definitions. For the purposes of this Section 7.3(b) only, “Acquisition,” with respect to a party hereto, shall mean any of the following transactions (other than the transactions contemplated by this Agreement): (i) a merger, consolidation, business combination, recapitalization, liquidation, dissolution or similar transaction involving the party pursuant to which the stockholders of the party immediately preceding such transaction hold less than fifty percent (50%) of the aggregate equity interests in the surviving or resulting entity of such transaction or any direct or indirect parent thereof, (ii) a sale or other disposition by the party of assets representing in excess of fifty percent (50%) of the aggregate fair market value of the party’s business immediately prior to such sale, or (iii) the acquisition by any Person or group (including by way of a tender offer or an exchange offer, open market or block purchase from stockholders, or issuance by the party to such Person or group), directly or indirectly, of beneficial ownership or a right to acquire beneficial ownership of shares representing in excess of fifty percent (50%) of the voting power of the then outstanding shares of capital stock of the party.

7.4 Amendment. Subject to applicable law, this Agreement may be amended by the parties hereto, by action taken or authorized by their respective Boards of Directors, at any time before or after approval of the matters presented in connection with the Mergers by the stockholders of Parent and the Company, provided, after any such approval, no amendment shall be made which by law or in accordance with the rules of any relevant stock exchange or market requires further approval by such stockholders without such further stockholder approval. This Agreement may not be amended except by execution of an instrument in writing signed on behalf of each of Parent, Separation Sub, Merger Sub and the Company.

7.5 Extension; Waiver. At any time prior to the Effective Time of the Company Merger either party hereto, by action taken or authorized by their respective Board of Directors, may, to the extent legally allowed: (i) extend the time for the performance of any of the obligations or other acts of the other parties hereto, (ii) waive any inaccuracies in the representations and warranties made to such party contained herein or in any document delivered pursuant hereto, and (iii) waive compliance with any of the agreements or conditions for the benefit of such party contained herein. Any agreement on the part of a party hereto to any such extension or waiver shall be valid only if set forth in an instrument

Index to Financial Statements

in writing signed on behalf of such party. Delay in exercising any right under this Agreement shall not constitute a waiver of such right.

8.1 Non-Survival of Representations and Warranties. The representations and warranties of the Company, Parent, Separation Sub and Merger Sub contained in this Agreement, or any instrument delivered pursuant to this Agreement, shall terminate at the Effective Time of the Company Merger, and only the covenants that by their terms survive the Effective Time of the Company Merger and this Article VIII shall survive the Effective Time of the Company Merger.

8.2 Notices. All notices and other communications hereunder shall be in writing and shall be deemed duly given (i) on the date of delivery if delivered personally, (ii) on the date of confirmation of receipt (or, the first business day following such receipt if the date is not a business day) of transmission by telecopy or telefacsimile, or (iii) on the date of confirmation of receipt (or, the first business day following such receipt if the date is not a business day) if delivered by a nationally recognized courier service. All notices hereunder shall be delivered as set forth below, or pursuant to such other instructions as may be designated in writing by the party to receive such notice:

Index to Financial Statements

(a) When a reference is made in this Agreement to Exhibits, such reference shall be to an Exhibit to this Agreement unless otherwise indicated. When a reference is made in this Agreement to Sections, such reference shall be to a section of this Agreement unless otherwise indicated. For purposes of this Agreement, the words “include,” “includes” and “including,” when used herein, shall be deemed in each case to be followed by the words “without limitation.” The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. When reference is made herein to “the business of” an entity, such reference shall be deemed to include the business of all such entity and its Subsidiaries, taken as a whole. An exception or disclosure made in the Company Disclosure Letter with regard to a representation of the Company, or in the Parent Disclosure Letter with regard to a representation of Parent or Merger Sub, shall be deemed made with respect to any other representation by such party to which such exception or disclosure is clearly relevant on its face.

(b) For purposes of this Agreement, the term “Knowledge” means, with respect to a party hereto, with respect to any matter in question, that any of the executive officers of such party, has actual knowledge of such matter, after inquiry of their respective direct reports.

(c) For purposes of this Agreement, the term “Material Adverse Effect,” when used in connection with an entity, means any change, event, violation, inaccuracy (but disregarding any qualifications or limitations regarding the “Knowledge” of a party or words of similar effect), circumstance or effect (any such item, an “Effect”), individually or when taken together with all other Effects that have occurred prior to the date of determination of the occurrence of the Material Adverse Effect, that is or is reasonably likely to (i) be materially adverse to the business, assets (including intangible assets), capitalization, financial condition or results of operations of such entity taken as a whole with its Subsidiaries (or if such entity is the Company, the Company taken as whole with its Subsidiaries or Parent taken as whole with its Subsidiaries) or (ii) materially impede the authority of such entity to consummate the transactions contemplated by this Agreement in accordance with the

Index to Financial Statements

terms hereof and applicable Legal Requirements; provided, however, that, for purposes of clause (i) above, in no event shall any of the following be deemed to constitute a Material Adverse Effect on any entity: (A) any Effect resulting from the announcement or pendency of the Mergers, including stockholder litigation arising out of the transactions contemplated by this Agreement (provided that the exception in this clause (A) shall not apply to the use of the term “Material Adverse Effect” in Sections 6.2(a) and 6.3(a) with respect to the representations and warranties contained in Section 2.3, Section 2.7, Section 2.17, Section 2.19, Section 3.3, Section 3.7, Section 3.17, Section 3.19 and Section 3.21(b)), (B) any Effect that results from changes affecting any of the industries in which such entity operates generally or the United States economy generally (to the extent that such changes in each case do not disproportionately affect such entity in any material respect), (C) the failure by such entity to meet published analyst revenue or earnings projections, in and of itself; or (D) any change in such entity’s stock price or trading volume, in and of itself; provided, further, that for purposes of determining whether a Material Adverse Effect with respect to Parent has occurred, subject to the exception below, only Effects relating to the Solutions Group Business of Parent shall be taken into account and no Effects relating to Source or its Subsidiaries, or the business, assets, capitalization, financial condition or results of operations of Source or its Subsidiaries, including the development, licensing or provision of the Palm operating system, shall be taken into account, except to the extent that such Effects would or would be reasonably likely to adversely affect Parent following the Mergers (taking into account the terms of the Separation Agreements).

(d) For purposes of this Agreement, the term “Person” shall mean any individual, corporation (including any non-profit corporation), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any limited liability company or joint stock company), firm or other enterprise, association, organization, entity or Governmental Entity.

8.4 Counterparts. This Agreement may be executed in two or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party, it being understood that all parties need not sign the same counterpart.

8.5 Entire Agreement; Third-Party Beneficiaries. This Agreement and the documents and instruments and other agreements among the parties hereto as contemplated by or referred to herein, including the Company Disclosure Letter and the Parent Disclosure Letter : (i) constitute the entire agreement among the parties with respect to the subject matter hereof and supersede all prior agreements and understandings, both written and oral, among the parties with respect to the subject matter hereof, it being understood that the Confidentiality Agreement shall continue in full force and effect until the Closing and shall survive any termination of this Agreement and (ii) are not intended to confer upon any other Person any rights or remedies hereunder, except as specifically provided, following the Effective Time of the Company Merger, in Section 5.11. Without limiting the foregoing, it is expressly understood and agreed that the provisions of Sections 5.9(f) and 5.10 are statements of intent only no Company Employee or other Person (including any party hereto) shall have any rights or remedies, including rights of enforcement, with respect thereto and no Company Employee or other Person is or is intended to be a third-party beneficiary thereof.

8.6 Severability. In the event that any provision of this Agreement or the application thereof, becomes or is declared by a court of competent jurisdiction to be illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision

Index to Financial Statements

to other Persons or circumstances will be interpreted so as reasonably to effect the intent of the parties hereto. The parties further agree to replace such void or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the greatest extent possible, the economic, business and other purposes of such void or unenforceable provision.

(a) Other Remedies. Except as otherwise provided herein, any and all remedies herein expressly conferred upon a party will be deemed cumulative with and not exclusive of any other remedy conferred hereby, or by law or equity upon such party, and the exercise by a party of any one remedy will not preclude the exercise of any other remedy. The parties hereto agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached.

(b) Specific Performance. It is accordingly agreed that the parties shall be entitled to seek an injunction or injunctions to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof in any court of the United States or any state having jurisdiction, this being in addition to any other remedy to which they are entitled at law or in equity.

8.8 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, regardless of the laws that might otherwise govern under applicable principles of conflicts of law thereof.

8.9 Rules of Construction. The parties hereto agree that they have been represented by counsel during the negotiation and execution of this Agreement and, therefore, waive the application of any law, regulation, holding or rule of construction providing that ambiguities in an agreement or other document will be construed against the party drafting such agreement or document.

8.10 Assignment. No party may assign either this Agreement or any of its rights, interests, or obligations hereunder without the prior written approval of the other parties. Any purported assignment in violation of this Section 8.10 shall be void. Subject to the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns.

8.11 Waiver of Jury Trial. EACH OF PARENT, SEPARATION SUB, MERGER SUB AND THE COMPANY HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE ACTIONS OF PARENT, MERGER SUB OR THE COMPANY IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE AND ENFORCEMENT HEREOF.

Index to Financial Statements

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized respective officers as of the date first written above.

PALM, INC.

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

PEACE SEPARATION CORPORATION

By:		/S/ PHILIPPE MORALI
		Name: Philippe Morali
		Title: President

HARMONY ACQUISITION CORPORATION

By:		/S/ PHILIPPE MORALI
		Name: Philippe Morali
		Title: President

HANDSPRING, INC.

By:		/S/ DONNA L. DUBINSKY
		Name: Donna L. Dubinsky
		Title: CEO

Index to Financial Statements

We understand that Palm, Inc. (“Palm” or “Parent”), Handspring, Inc. (“Handspring” or the “Company”), Peace Separation Corporation, a direct wholly-owned subsidiary of Parent (“Separation Sub”), and Harmony Acquisition Corporation, a direct wholly-owned subsidiary of Parent (“Merger Sub”), propose to enter into an Agreement and Plan of Reorganization, substantially in the form of the draft dated June 2, 2003 (the “Agreement”). The Agreement provides for transactions pursuant to which (i) the common stock of Palm Source, Inc. held by the Parent will be distributed to the stockholders of Parent by means of the merger of Separation Sub with and into Parent (the “Parent Merger”) and (ii) following such distribution, the remaining business of Parent and the Company will be combined in a business combination transaction by means of the merger of Merger Sub with and into the Company (the “Company Merger”). Pursuant to the Company Merger, Handspring will become a wholly-owned subsidiary of Palm and each outstanding share of common stock, $0.001 par value per share (the “Handspring Common Stock”), of Handspring, other than shares held in treasury or held by Handspring, Palm or any of their respective subsidiaries, will be converted into the right to receive 0.09 shares (the “Exchange Ratio”) of common stock, $0.001 par value per share (the “Palm Common Stock”), of Palm. The terms and conditions of the Company Merger and the Parent Merger are more fully set forth in the Agreement.

You have asked for our opinion as to whether the Exchange Ratio pursuant to the Agreement is fair from a financial point of view to Palm.

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We have assumed and relied upon, without independent verification, the accuracy and completeness of the information reviewed by us for the purposes of this opinion. With respect to the internal financial statements, other financial and operating data, and financial projections, including certain projections and information relating to the strategic, financial and operational costs and benefits anticipated from the Company Merger, we have assumed that they were reasonably prepared on bases reflecting the best currently available estimates and judgments of the future financial performance of Palm and Handspring, respectively. In addition, we have assumed that the Parent Merger and Company Merger will be consummated in accordance with the terms set forth in the Agreement without material modification or waiver, including among other things, that the Company Merger and the Parent Merger will be treated as a tax-free reorganization and distribution, each pursuant to the Internal Revenue Code of 1986, as amended.

We have relied upon the assessment by the managements of Palm and Handspring of their ability to retain key employees of Palm and Handspring, respectively. We have also relied upon, without independent verification, the assessment by the managements of Palm and Handspring of: (i) the strategic, financial and other costs and benefits expected to result from the Company Merger; (ii) the timing and risks associated with the integration of Palm and Handspring; and (iii) the validity of, and risks associated with, Palm’s and Handspring’s existing and future technologies, services or business models. We have not made any independent valuation or appraisal of the assets or liabilities or technology of Palm and Handspring, nor have we been furnished with any such appraisals. Our opinion is necessarily based on financial, economic, market and other conditions as in effect on, and the information made available to us as of, the date hereof.

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We have not been asked to consider, and our opinion does not address, the relative merits of the Company Merger as compared to any alternative strategies or transactions that might exist for Palm or the effect of such strategies or transactions, whether or not such strategies or transactions may be available.

We have acted as financial advisor to the Board of Directors of Palm in connection with this transaction and will receive a fee for our services. In the ordinary course of our business we may actively trade the securities of Palm and Handspring for our own account and for the accounts of our customers and, accordingly, may at any time hold a long or short position in such securities. In the past Morgan Stanley & Co. Incorporated (“Morgan Stanley”) has provided financial advisory services for Palm and has received fees for rendering these services.

It is understood that this letter is for the information of the Board of Directors of Palm and may not be used for any other purpose without our prior written consent, except that this opinion may be included in its entirety in any filing made by Palm in respect of the Parent Merger and the Company Merger with the Securities and Exchange Commission. In addition, this opinion does not in any manner address the prices at which the Palm Common Stock or the common stock of Palm Source, Inc. will trade following the consummation of the Company Merger and the Parent Merger, and Morgan Stanley expresses no opinion or recommendation as to how the stockholders of Palm should vote at the stockholders’ meeting to be held in connection with the Company Merger and the Parent Merger. In addition, Morgan Stanley expresses no opinion as to the terms of the Loan Agreement (as defined in the Agreement).

Based upon and subject to the foregoing, we are of the opinion on the date hereof that the Exchange Ratio pursuant to the Agreement is fair from a financial point of view to Palm.

Very truly yours, MORGAN STANLEY & Co. INCORPORATED

By:		/s/ MICHAEL F. WYATT

		Michael F. Wyatt
		Executive Director

Index to Financial Statements

You have asked us to advise you with respect to the fairness, from a financial point of view, to the holders of shares of common stock, par value $0.001 per share (“Handspring Common Stock”), of Handspring, Inc. (“Handspring”), other than such holders who are both directors and officers of Handspring or affiliates of such holders, of the Exchange Ratio (as defined below) set forth in the Agreement and Plan of Reorganization, dated as of June 4, 2003 (the “Merger Agreement”), by and among Palm, Inc. (“Palm”), Peace Separation Corporation, a wholly owned subsidiary of Palm (“Separation Sub”), Harmony Acquisition Corporation, a wholly owned subsidiary of Palm (“Merger Sub”), and Handspring. The Merger Agreement provides for, among other things, the merger of Merger Sub with and into Handspring (the “Handspring Merger”) pursuant to which Handspring will become a wholly owned subsidiary of Palm and each share of Handspring Common Stock issued and outstanding immediately prior to the effective time of the Handspring Merger will be converted into the right to receive 0.09 (the “Exchange Ratio”) of a share of common stock, par value $0.001 per share, of Palm (“Palm Common Stock). The consummation of the Handspring Merger is conditioned upon, among other things, the distribution of the shares of common stock of PalmSource, Inc. (“Source”) held by Palm to the stockholders of Palm prior to the consummation of the Handspring Merger (the “Source Distribution”) by means of the merger of Separation Sub with and into Palm (the “Palm Merger” and, together with the Handspring Merger, the “Mergers”) as set forth in the Merger Agreement, pursuant to which, among other things, each share of Palm Common Stock issued and outstanding immediately prior to the effective time of the Palm Merger will be converted into (i) one share of Palm Common Stock and (ii) the right to receive a number of shares of the common stock, par value $0.001 per share, of Source (“Source Common Stock”) currently outstanding and held by Palm such that all shares of Source Common Stock outstanding and held by Palm immediately prior to the effective time of the Palm Merger are distributed to all holders of Palm Common Stock issued and outstanding immediately prior to the effective time of the Palm Merger (which means that holders of Handspring Common Stock will not receive shares of Source Common Stock), on a pro rata basis (based on the number of shares of Palm Common Stock held).

In arriving at our opinion, we have reviewed the Merger Agreement and certain other related agreements, as well as certain publicly available business and financial information relating to Handspring and Palm. We have also reviewed certain other information relating to (i) Handspring and (ii) Palm and Source, including financial forecasts, provided to us by Handspring and Palm, respectively, and have met with the managements of Handspring and Palm to discuss the business and prospects of (i) Handspring and (ii) Palm and Source (after taking into account the Source Distribution), respectively. We have also considered certain financial and stock market data of Handspring and Palm, and we have compared that data with similar data for other publicly held companies in businesses we deemed similar to those of

Index to Financial Statements

Handspring and Palm, and we have considered, to the extent publicly available, the financial terms of certain other business combinations and other transactions which have recently been effected or announced. We also considered such other information, financial studies, analyses and investigations and financial, economic and market criteria which we deemed relevant.

In connection with our review, we have not assumed any responsibility for independent verification of any of the foregoing information and have relied on such information being complete and accurate in all material respects. With respect to the financial forecasts for Handspring that we have reviewed, we have been advised, and we have assumed, that such forecasts have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Handspring as to the future financial performance of Handspring. With respect to the financial forecasts for Palm and Source (after taking into account the Source Distribution) that we have reviewed, we have been advised, and we have assumed, that such forecasts have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the management of Palm as to the future financial performance of Palm and Source, respectively. In addition, we have relied upon, without independent verification, the assessment of the managements of Handspring and Palm as to (i) their ability to retain key employees, (ii) the strategic benefits and potential cost savings and other synergies (including the amount, timing and achievability thereof) anticipated to result from the Handspring Merger and the Source Distribution, (iii) the existing technology, products, and services of Handspring and Palm and the validity of, and risks associated with, the future technology, products and services of Handspring and Palm and (iv) their ability to integrate the businesses of Handspring and Palm.

You have also informed us, and we have assumed, that the Handspring Merger and the Source Distribution will be treated as a tax-free reorganization and tax-free spin-off, respectively, for federal income tax purposes. We also have assumed, with your consent, that in the course of obtaining necessary regulatory and third party approvals and consents for the Handspring Merger and the Source Distribution, no modification, delay, limitation, restriction or condition will be imposed that will have a material adverse effect on Handspring, Palm or the contemplated benefits of the Handspring Merger and the Source Distribution, that the Handspring Merger and the Source Distribution will be consummated in accordance with the terms of the Merger Agreement, without waiver, modification or amendment of any material term, condition or agreement therein, and that the Source Distribution and the separation of Palm and Source will occur in the manner described to us by the management of Palm. In addition, we have not been requested to make, and have not made, an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of Handspring, Palm or Source, nor have we been furnished with any such evaluations or appraisals. Our opinion is necessarily based upon information made available to us as of the date hereof, and upon financial, economic, market and other conditions as they exist and can be evaluated on the date hereof. We are not expressing any opinion as to what the value of shares of Palm Common Stock actually will be when issued to holders of Handspring Common Stock pursuant to the Handspring Merger or the prices at which shares of Palm Common Stock will trade at any time. Our opinion does not address the relative merits of the Handspring Merger as compared to other business strategies that might be available to Handspring, nor does it address the underlying business decision of Handspring to proceed with the Handspring Merger. We were not requested to, and did not, solicit third party indications of interest in acquiring all or any part of Handspring.

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We do not express any opinion as to any legal matters involving Palm, as to which we understand that Handspring has conducted such investigations, and has obtained such advice from qualified professionals, as it has deemed necessary. With respect to outstanding litigation involving Palm in which significant damages are alleged, you, after consultation with management of Handspring and its outside counsel, have instructed us to assume, and we have assumed, without independent verification, and based solely upon the assessment and judgment of management of Handspring after taking into account the advice of Handspring’s outside counsel, (i) that the aggregate amount of damages, if any, that could be assessed against or agreed to by Palm in any pending litigation will not exceed the amount estimated by management of Handspring, and (ii) that no such pending litigation involving Palm will otherwise have an adverse impact on the current or future results of operations of Palm.

We have acted as financial advisor to Handspring in connection with the Handspring Merger and will receive a fee for our services, a significant portion of which is contingent upon the consummation of the Handspring Merger. We will also receive a fee for rendering this opinion. We and our affiliates have in the past provided financial and investment banking services to Handspring unrelated to the Handspring Merger for which we have received compensation and we may in the future provide such services to Palm for which we would expect to receive compensation. In the ordinary course of our business, we and our affiliates may actively trade the debt and equity securities of both Handspring and Palm for our and such affiliates’ own accounts and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities.

It is understood that this letter is for the information of the Board of Directors of Handspring in connection with its consideration of the Handspring Merger and does not constitute a recommendation to any stockholder as to how such stockholder should vote or act on any matter relating to the proposed Mergers or Source Distribution.

Based upon and subject to the foregoing, it is our opinion that, as of the date hereof, the Exchange Ratio is fair, from a financial point of view, to the holders of Handspring Common Stock, other than such holders who are both directors and officers of Handspring or affiliates of such holders.

Index to Financial Statements

The purpose of the Audit Committee (the “Audit Committee”) of the Board of Directors (the “Board of Directors”) of Palm, Inc. (the “Company”) shall be to: (a) oversee the accounting and financial reporting processes of the Company and audits of the financial statements of the Company; (b) assist the Board of Directors in oversight of (i) the integrity of the Company’s financial statements, (ii) the Company’s compliance with legal and regulatory requirements, (iii) the independent auditor’s qualifications, independence and performance, and (iv) the Company’s internal accounting and financial controls; (c) prepare the report that the rules of the Securities and Exchange Commission (“SEC”) require to be included in the Company’s proxy statement for the annual meeting of the Company’s stockholders; (d) provide the Company’s Board of Directors with the results of its monitoring and recommendations derived therefrom; and (e) provide to the Board of Directors such additional information and materials as it may deem necessary to make the Board of Directors aware of significant financial matters that require the attention of the Board of Directors. In addition, the Audit Committee will undertake those specific responsibilities listed below and such other duties or responsibilities as the Board of Directors may from time to time prescribe.

The Audit Committee shall be composed of at least three directors of the Company. The members of the Audit Committee will be appointed by the Nominating and Governance Committee of the Board of Directors and will serve at the discretion of the Board of Directors. All of the members must meet the qualification and other applicable requirements, including, without limitation, the rules of the SEC and the Nasdaq Stock Market, as such rules and applicable legal requirements may change from time to time. The members of the Audit Committee are to be independent as determined in accordance with applicable law, including the Sarbanes-Oxley Act of 2002 (the “Act”) and the rules and regulations of the SEC promulgated thereunder, and the rules of the Nasdaq Stock Market, except as otherwise permitted by applicable law and the rules of the Nasdaq Stock Market. In addition, in accordance with the rules of the Nasdaq Stock Market, each member of the Audit Committee will be able to read and understand fundamental financial statements (including a company’s balance sheet, income statement and cash flow statement), and at least one member will have past employment experience in finance or accounting, requisite professional certification in accounting, or other comparable experience or background, including a current or past position as a chief executive officer or chief financial officer or other senior officer with financial oversight responsibilities. At least one member of the Audit Committee shall be a “financial expert” (as such term is defined by SEC and Nasdaq rules) by the time the Company would be required to have a “financial expert” serve on the Audit Committee.

Index to Financial Statements

The Audit Committee shall annually review its own charter (including the structure, processes and membership requirements of the Audit Committee) and recommend any proposed changes to the Board of Directors for approval. In addition, the Audit Committee shall annually review its own performance.

The Audit Committee will meet at least four times each year. The Audit Committee may establish its own schedule, which it will provide to the Board of Directors in advance.

The Audit Committee will meet separately, at least quarterly, with each of management, the internal auditors and the independent auditor to review the financial affairs of the Company.

The Audit Committee shall have the authority to engage independent counsel and other advisors, as it deems necessary to carry out its duties. The Company shall provide for the appropriate funding, as determined by the Audit Committee, in its capacity as a committee of the Board of Directors, for payment of: (i) compensation to any such counsel and other advisors engaged by the Audit Committee; (ii) compensation to the independent auditor employed by the Company for the purpose of rendering or issuing an audit report or performing other audit, review or attest services; and (iii) ordinary administrative expenses of the Audit Committee that are necessary or appropriate in carrying out its duties.

In addition to preparing the report in the Company’s proxy statement in accordance with the rules and regulations of the SEC, the Audit Committee will summarize its examinations and recommendations to the Board of Directors as may be appropriate, consistent with the Audit Committee’s charter.

Members of the Audit Committee shall receive such fees, if any, for their service as Audit Committee members as may be determined by the Board of Directors in its sole discretion. Such fees may include retainers, per meeting fees and fees for service as Chair of the Audit Committee. Fees may be paid in such form of consideration as is determined by the Board of Directors.

Members of the Audit Committee may not receive any compensation from the Company except the fees that they receive for service as a member of the Board of Directors or any committee thereof or as Chairman of the Board of Directors or Chair of any committee of the Board of Directors.

The Audit Committee may form and delegate authority to subcommittees when appropriate. In addition, the Audit Committee may delegate to one or more designated members of the Audit Committee who are independent directors the authority to pre-approve any transaction for which such delegation is permissible under applicable law and the rules of the Nasdaq Stock Market, provided that such pre-approval decision is subsequently presented to the full Audit Committee at its scheduled meetings.

Index to Financial Statements

The undersigned hereby appoints Eric A. Benhamou and Judy Bruner, and each of them, as proxy holders and attorneys-in-fact of the undersigned, with full power of substitution, to vote all shares of stock that the undersigned is entitled to vote at the annual meeting of stockholders of Palm, Inc., to be held at 580 N. McCarthy Blvd., Building 10, Milpitas, California 95035, on , 2003 at 8:00 a.m., local time, and at any postponement or adjournment thereof, with all the powers that the undersigned would have if personally present at the meeting. The undersigned hereby acknowledges receipt of the notice of annual meeting and joint proxy statement/prospectus enclosed with this proxy card and a copy of Palm’s annual report for the fiscal year ended May 30, 2003.

This proxy, when properly executed and returned, will be voted in the manner directed herein by the undersigned stockholder. IF THIS PROXY IS PROPERLY EXECUTED AND RETURNED BUT NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED: “FOR” THE APPROVAL AND ADOPTION OF THE AGREEMENT AND PLAN OF REORGANIZATION DATED JUNE 4, 2003 BY AND AMONG PALM, INC., PEACE SEPARATION CORPORATION, HARMONY ACQUISITION CORPORATION AND HANDSPRING, INC. (ITEM 1); “FOR” ALL OF THE NOMINEES FOR CLASS I DIRECTORS SET FORTH BELOW UNDER ITEM 2; AND “FOR” RATIFICATION OF THE APPOINTMENT OF DELOITTE & TOUCHE LLP AS PALM’S INDEPENDENT PUBLIC ACCOUNTANTS FOR THE FISCAL YEAR ENDING MAY 28, 2004 (ITEM 3). WHETHER OR NOT DIRECTION IS MADE, THIS PROXY, WHEN PROPERLY EXECUTED AND RETURNED, WILL BE VOTED IN THE DISCRETION OF THE PROXY HOLDERS UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE ANNUAL MEETING OF STOCKHOLDERS OR AT ANY POSTPONEMENT OR ADJOURNMENT THEREOF. THE UNDERSIGNED HEREBY REVOKES ALL PROXIES PREVIOUSLY GIVEN BY THE UNDERSIGNED WITH RESPECT TO THE SHARES OF STOCK REPRESENTED BY THIS PROXY AND ENTITLED TO VOTE AT THE ANNUAL MEETING OF STOCKHOLDERS OR AT ANY POSTPONEMENT OR ADJOURNMENT THEREOF. THIS PROXY MAY BE REVOKED AT ANY TIME PRIOR TO THE TIME IT IS VOTED.

Index to Financial Statements

If you vote over the internet or by telephone, please do not mail your card.

Index to Financial Statements

The undersigned hereby appoints Donna L. Dubinsky and David G. Pine, or either of them, each with the power of substitution, to represent the undersigned at the Special Meeting of Stockholders of Handspring, Inc. (the “Company”) to be held at on , 2003 at , local time, and any adjournment or postponement thereof, and to vote the number of shares the undersigned would be entitled to vote if personally present at the meeting on the following matters.

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THIS PROXY WILL BE VOTED AS DIRECTED ABOVE. IN THE ABSENCE OF DIRECTION ABOVE, THIS PROXY WILL BE VOTED FOR PROPOSAL 1. In their discretion, the proxies are authorized to vote upon such other business as may properly come before the meeting or any adjournment or postponement thereof to the extent authorized by Rule 14a-4(c) promulgated by the Securities and Exchange Commission. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY.

Please sign exactly as your name(s) appear(s) on your stock certificate. If shares are held of record in the names of two or more persons or in the name of husband and wife, whether as joint tenants or otherwise, both or all of such persons should sign the proxy. If shares are held by a corporation, the proxy should be executed by the president or vice president and the secretary or assistant secretary. Executors, administrators, or other fiduciaries who execute the proxy for a deceased stockholder should give their full title. Please date the proxy. WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE COMPLETE, DATE, SIGN AND PROMPTLY RETURN THIS PROXY IN THE ENCLOSED, POSTAGE PAID ENVELOPE SO THAT YOUR SHARES MAY BE REPRESENTED AT THE MEETING.

Index to Financial Statements

(As Amended and Restated Effective as of , 2003, subject to stockholder approval at the 2003 Annual Meeting of the Company’s stockholders)

Index to Financial Statements

(As Amended and Restated Effective as of , 2003, subject to stockholder approval at the 2003 Annual Meeting of the Company’s stockholders)

PALM, INC., having adopted the Palm, Inc. 2001 Stock Option Plan for Non-Employee Directors (the “Plan”) effective as of October 11, 2001 and amended and restated the Plan in its entirety effective as of October 15, 2002, hereby further amends and restates the Plan in its entirety effective as of , 2003, subject to the approval of the stockholders at the 2003 Annual Meeting of the Company’s stockholders, as follows:

1.1 Effective Date. The Plan became effective as of October 11, 2001. This amended and restated Plan is effective as of , 2003 subject to the approval of the stockholders at the 2003 Annual Meeting of the Company’s stockholders.

1.2 Purpose of the Plan. The Plan is intended to closely align the interests of the Non-Employee Directors with the interests of the Company’s stockholders. This is achieved by making a significant portion of Non-Employee Director compensation directly related to the total return performance of the Shares. The Plan also is intended to encourage Share ownership on the part of Non-Employee Directors.

The following words and phrases shall have the following meanings unless a different meaning is plainly required by the context:

2.1 “1934 Act” means the Securities Exchange Act of 1934, as amended. Reference to a specific section of the 1934 Act or regulation thereunder shall include such section or regulation, any valid regulation promulgated under such section, and any comparable provision of any future legislation or regulation amending, supplementing or superseding such section or regulation.

2.3 “Change of Control” means the occurrence of any of the following events:

(a) Any “person” (as such term is used in Sections 13(d) and 14(d) of the 1934 Act) becomes the “beneficial owner” (as defined in Rule 13d-3 under the 1934 Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the total voting power represented by the Company’s then outstanding voting securities; or

(b) The consummation of the sale or disposition by the Company of all or substantially all the Company’s assets; or

Index to Financial Statements

(c) The consummation of a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining out-standing or by being converted into voting securities of the surviving entity or its parent) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity or its parent outstanding immediately after such merger or consolidation; or

(d) A change in the composition of the Board occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. “Incumbent Directors” shall mean directors who either (1) are directors of the Company as of the effective date of the Plan, or (2) are elected, or nominated for election, to the Board with the affirmative votes of at least a majority of those directors whose election or nomination was not in connection with any transaction described in subsections (a), (b), or (c) above, or in connection with an actual or threatened proxy contest relating to the election of directors to the Company.

2.4 “Committee” means the committee appointed pursuant to Section 3.1 to administer the Plan.

2.5 “Company” means Palm, Inc., a Delaware corporation, or any successor thereto.

2.7 “Disability” means a permanent and total disability, as determined by the Committee (in its discretion) in accordance with uniform and non-discriminatory standards adopted by the Committee from time to time.

2.8 “Exercise Price” means the price at which a Share may be purchased by a Participant pursuant to the exercise of an Option.

2.9 “Fair Market Value” means the closing per share selling price for the Shares, as quoted on the Nasdaq National Market for the date in question.

2.10 “Grant Date” means, with respect to a particular Option, the date on which the Option was granted.

2.11 “Non-Employee Director” means a Director who is an employee of neither the Company nor of any Subsidiary.

2.12 “Option” means an option to purchase Shares granted pursuant to Section 5.

2.13 “Option Agreement” means the written agreement setting forth the terms and provisions applicable to each Option granted under the Plan.

2.14 “Participant” means a Non-Employee Director who has an outstanding Option.

2.15 “Plan” means the Palm, Inc. 2001 Stock Option Plan for Non-Employee Directors, as set forth in this instrument and as hereafter amended from time to time.

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2.16 “Shares” means the shares of the Company’s common stock, $0.001 par value.

2.17 “Subsidiary” means any corporation in an unbroken chain of corporations beginning with the Company if each of the corporations other than the last corporation in the unbroken chain then owns stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain.

2.18 “Termination of Service” means a cessation of the Participant’s service on the Board for any reason.

3.1 The Committee. The Plan shall be administered by the Committee. The Committee shall consist of one or more Directors who shall be appointed by, and serve at the pleasure of, the Board. Until otherwise determined by the Board, the Compensation Committee of the Board shall serve as the Committee.

3.2 Authority of the Committee. It shall be the duty of the Committee to administer the Plan in accordance with the Plan’s provisions. The Committee shall have all powers and discretion necessary or appropriate to administer the Plan and to control its operation, including, but not limited to, the power to (a) interpret the Plan and the Options, (b) adopt rules for the administration, interpretation and application of the Plan as are consistent therewith, (c) interpret, amend or revoke any such rules, and (d) adopt such procedures and subplans as are necessary or appropriate to permit participation in the Plan by Non-Employee Directors who are foreign nationals or employed outside of the United States.

3.3 Decisions Binding. All determinations and decisions made by the Committee shall be final, conclusive, and binding on all persons, and shall be given the maximum deference permitted by law.

4.1 Number of Shares. Subject to adjustment as provided in Section 4.3, the total number of Shares available for grant under the Plan shall not exceed 950,000. Shares issued under the Plan may be either authorized but unissued Shares or treasury Shares.

The total number of Shares available for grant under the Plan shall be appropriately increased from time to time for any increase in the number of issued Shares resulting from any adjustment pursuant to Section 4.3.1 in connection with the transaction in which the Company’s interest in its PalmSource, Inc. subsidiary is distributed to the Company’s stockholders.

4.2 Lapsed Options. If an Option terminates or expires for any reason, any Shares subject to such Option again shall be available to be the subject of an Option.

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4.3.1 Changes in Capitalization. Subject to any required action by the shareholders of the Company, the number and class of Shares which may be delivered under the Plan, and the number, class, and Exercise Price of Shares subject to outstanding Options and future grants, shall be proportionately adjusted by the Committee for any increase or decrease in the number of issued Shares resulting from a stock split, reverse stock split, stock dividend, spin-off combination or reclassification of the Shares, or any other increase or decrease in the number of issued Shares effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been “effected without receipt of consideration.” Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of Shares subject to an Option.

4.3.2 Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, to the extent that an Option has not been previously exercised, it shall terminate immediately prior to the consummation of such proposed action.

4.3.3 Merger or Asset Sale. In the event of a merger of the Company with or into another corporation or the sale of substantially all of the assets of the Company, outstanding Options may be assumed or equivalent options may be substituted by the successor corporation or a parent or subsidiary thereof (the “Successor Corporation”). If the Successor Corporation does not assume an outstanding Option or substitute for it an equivalent option, the Option shall become fully vested and exercisable, including as to Shares for which it would not otherwise be exercisable. In such event the Committee shall notify the Participant that the Option shall be fully exercisable for a period of thirty (30) days from the date of such notice, and upon the expiration of such period the Option shall terminate. For this purpose, an Option shall be considered assumed if, following the merger or sale of assets, the Option confers the right to purchase or receive, for each Share covered by the Option immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Shares for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares). If such consideration received in the merger or sale of assets is not solely common stock of the Successor Corporation, the Committee may, with the consent of the Successor Corporation, provide for the consideration to be received upon the exercise of the Option, for each Share subject to the Option, to be solely common stock of the Successor Corporation equal in fair market value to the per share consideration received by holders of Shares in the merger or sale of assets.

Index to Financial Statements

5.1.1 Initial Grants. Each individual who first becomes a Non-Employee Director on or after the 2003 Annual Meeting of the Company’s stockholders automatically shall receive an Option on the date that he or she first is appointed or elected as a Non-Employee Director. The number of Shares covered by each Option described in this Section 5.1.1 shall equal 28,000.

5.1.2 Ongoing Grants for Service on the Board. Each Non-Employee Director automatically shall receive an Option on the date of each Annual Meeting of the Company’s stockholders that occurs on or after the 2003 Annual Meeting of the Company’s stockholders, provided that the individual will receive such Option only if he or she both (a) is a Non-Employee Director on that date, and (b) has served as a Non-Employee Director for at least the six (6) months immediately preceding that date. The number of Shares covered by each Option described in this Section 5.1.2 shall equal 14,000.

5.1.3 Grants for Service as a Committee Chair. Each Non-Employee Director who first becomes the Chairman of a standing committee of the Board (a “Committee Chair”) on or after the 2003 Annual Meeting of the Company’s stockholders automatically shall receive an Option on the date that he or she first is appointed as a Committee Chair. Each Non-Employee Director who either has (a) received an Option pursuant to the foregoing sentence, or (b) received an Option pursuant to this Section 5.1.3 as in effect before the 2003 Annual Meeting of the Company’s stockholders also automatically shall receive an Option on the date of each subsequent Annual Meeting of the Company’s stockholders, provided that the individual will receive such Option only if he or she both (i) is a Committee Chair on that date, and (ii) has served in such position for at least the six (6) months immediately preceding that date. A Non-Employee Director shall be entitled to more than one Option pursuant to this Section 5.1.3 to the extent that on any Grant Date, he or she is the Chairman of more than one standing committee of the Board. The number of Shares covered by each Option described in this Section 5.1.3 shall equal 2,500. Each Option granted pursuant to this Section 5.1.3 shall be in addition to any other Option(s) to which the Non-Employee Director may be entitled under any other subsection of Section 5.1.

5.1.4 Grants for Service as a Committee Member. Each Non-Employee Director who first becomes a member of a standing committee of the Board (a “Committee Member”) on or after the 2003 Annual Meeting of the Company’s stockholders automatically shall receive an Option on the date that he or she first is appointed as a Committee Member. Each Non-Employee Director who either has (a) received an Option pursuant to the foregoing sentence, or (b) received an Option pursuant to this Section 5.1.4 as in effect before the 2003 Annual Meeting of the Company’s stockholders also automatically shall receive an Option on the date of each subsequent Annual Meeting of the Company’s stockholders, provided that the individual will receive such Option only if he or she both (i) is a Committee Member on that date, and (ii) has served in such position for at least the six (6) months immediately preceding that date. A Non-Employee Director shall be entitled to more than one Option pursuant to this Section 5.1.4 to the extent that on any Grant Date, he or she has qualifying membership on more than one standing committee of the Board. The number of Shares covered by each Option described in this Section 5.1.4 shall equal 2,000. Each Option granted pursuant to this Section 5.1.4 shall be in addition to any other Option(s) to which the Non-

Index to Financial Statements

Employee Director may be entitled under any other subsection of Section 5.1, except that a Non-Employee Director shall not receive an Option under this Section 5.1.4 for service on any committee with respect to which he or she is entitled to receive an Option under Section 5.1.3.

5.1.5 Grants for Service as Chairman of the Board. Each Non-Employee Director who is the Chairman of the Board on the date of an Annual Meeting of the Company’s stockholders that occurs on or after the 2003 Annual Meeting of the Company’s stockholders automatically shall receive an Option to purchase 4,000 Shares on that date. Each Option granted pursuant to this Section 5.1.5 shall be in addition to any other Option(s) to which the Non-Employee Director may be entitled under any other subsection of Section 5.1.

5.2.1 Option Agreement. Each Option shall be evidenced by a written Option Agreement (satisfactory to the Committee) which shall be executed by the Participant and the Company.

5.2.2 Exercise Price. The Exercise Price for the Shares subject to each Option shall be 100% of the Fair Market Value of such Shares on the Grant Date.

(a) Each Option shall become exercisable in three (3) equal annual installments, commencing on the first anniversary of the applicable Grant Date, except as follows. If a Change of Control occurs while the Non-Employee Director is such and the Non-Employee Director will cease to be such as an immediate and direct consequence of the Change of Control, the Option (if not yet expired) shall become fully exercisable on the date of the Change of Control. Notwithstanding the preceding, once a Participant ceases to be a Director, his or her Options which are not then exercisable shall never become exercisable and shall be immediately forfeited, except to the limited extent provided in Section 5.2.3(b).

(b) Upon a Non-Employee Director’s death, all unvested and unexpired Options held by such person shall immediately become exercisable.

5.2.4 Expiration of Options. Each Option shall terminate upon the first to occur of the following events:

(b) The expiration of three (3) months from the date of the Participant’s Termination of Service prior to age 65 for any reason other than the Participant’s death or Disability;

Index to Financial Statements

(d) The expiration of one (1) year from the date of the Participant’s Termination of Service at or after age 65 for any reason other than the Participant’s death or Disability.

5.2.5 Death of Director. Notwithstanding Section 5.2.4, if a Director dies prior to the expiration of his or her Option(s) in accordance with Section 5.2.4, his or her Option(s) which are exercisable on the date of his or her death shall terminate one (1) year after the date of death.

5.3 Exercise. Options shall be exercised by the Participant’s delivery of a notice of exercise in such form and manner as the Company (or its designee) may designate from time to time. In all events, the notice shall set forth the number of Shares with respect to which the Option is to be exercised, and be accompanied by full payment for the Shares. Upon the exercise of any Option, the Exercise Price shall be payable to the Company in full in cash or its equivalent. The Committee, in its sole discretion, also may permit exercise by (a) tendering previously acquired Shares having an aggregate Fair Market Value at the time of exercise equal to the total Exercise Price, or (b) any other means which the Committee, in its sole discretion, determines to both provide legal consideration for the Shares, and to be consistent with the purposes of the Plan. As soon as practicable after receipt of a written notification of exercise and full payment for the Shares purchased, the Company shall deliver to the Participant (or the Participant’s designated broker), Share certificates (which may be in book-entry form) representing such Shares.

5.4 Options are not Incentive Stock Options. Options are not intended to be incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended.

6.1 No Effect on Service. Nothing in the Plan shall (a) create any obligation on the part of the Board to nominate any Participant for reelection by the Company’s stockholders, or (b) interfere with or limit in any way the right of the Company to terminate any Participant’s service.

6.2 Indemnification. Each person who is or shall have been a member of the Committee, or of the Board, shall be indemnified and held harmless by the Company against and from (a) any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit, or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan or any Option Agreement, and (b) from any and all amounts paid by him or her in settlement thereof, with the Company’s approval, or paid by him or her in satisfaction of any judgment in any such claim, action, suit, or proceeding against him or her, provided he or she shall give the Company an opportunity, at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such persons may be entitled under the Company’s Certificate of Incorporation or Bylaws, by contract, as a matter of law, or otherwise, or under any power that the Company may have to indemnify them or hold them harmless.

6.3 Successors. All obligations of the Company under the Plan shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect

Index to Financial Statements

purchase, merger, consolidation, or otherwise, of all or substantially all of the business or assets of the Company.

6.4 Beneficiary Designations. If permitted by the Committee, a Participant may name a beneficiary or beneficiaries to whom any vested but unpaid Option shall be paid in the event of the Participant’s death. Each such designation shall revoke all prior designations by the Participant and shall be effective only if given in a form and manner acceptable to the Committee. In the absence of any such designation, any vested benefits remaining unpaid at the Participant’s death shall be paid to the Participant’s estate and, subject to the terms of the Plan and of the applicable Option Agreement, any unexercised vested Option may be exercised by the administrator or executor of the Participant’s estate.

6.5 Nontransferability of Options. No Option granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will, by the laws of descent and distribution, or to the limited extent provided in Section 6.4. All rights with respect to an Option granted to a Participant shall be available during his or her lifetime only to the Participant. Notwithstanding the foregoing, the Participant may, if permitted by the Committee and in a manner specified by the Committee, transfer an Option by bona fide gift and not for any consideration, to a member of the Participant’s immediate family or to a trust or other entity for the exclusive benefit of the Participant and/or a member or members of the Participant’s immediate family.

6.6 No Rights as Stockholder. No Participant (nor any beneficiary) shall have any of the rights or privileges of a stockholder of the Company with respect to any Shares issuable pursuant to an Option (or exercise thereof), unless and until certificates representing such Shares shall have been issued, recorded on the records of the Company or its transfer agents or registrars, and delivered to the Participant or beneficiary.

6.7 Withholding Requirements. Prior to the delivery of any Shares or cash pursuant to an Option (or exercise thereof), the Company shall have the power and the right to deduct or withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy the minimum Federal, state, and local taxes required to be withheld with respect to such Option (or exercise thereof).

7.1 Amendment or Termination. The Board, in its sole discretion, may amend or terminate the Plan, or any part thereof, at any time and for any reason. The amendment, suspension, or termination of the Plan shall not, without the consent of the Participant, alter or impair any rights or obligations under any Option theretofore granted to such Participant.

7.2 Duration of the Plan. This amended and restated Plan is effective as of , 2003, subject to the approval of the stockholder at the 2003 Annual Meeting of the Company’s stockholders, and subject to Section 7.1 (regarding the Board’s right to amend or terminate the Plan), shall remain in effect thereafter.

Index to Financial Statements

8.1 Gender and Number. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural.

8.2 Severability. In the event any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included.

8.3 Requirements of Law. The granting of Options and the issuance of Shares under the Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required.

8.4 Compliance with Rule 16b-3. For the purpose of ensuring that transactions under the Plan do not subject Participants to liability under Section 16(b) of the 1934 Act, all transactions under the Plan are intended to comply with all applicable conditions of Rule 16b-3 promulgated under the 1934 Act, and any future regulation amending, supplementing or superseding such regulation. To the extent any provision of the Plan, Option Agreement or action by the Committee or a Participant fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee.

8.5 Governing Law. The Plan and all Option Agreements shall be construed in accordance with and governed by the laws of the State of California without giving effect to any choice or conflict of law provision or rule (whether of the State of California or otherwise) which would cause the application of the laws of any jurisdiction other than the State of California.

8.6 Captions. Captions provided herein are for convenience only, and shall not serve as a basis for interpretation or construction of the Plan.

IN WITNESS WHEREOF, Palm, Inc., by its duly authorized officer, has executed this amended and restated Plan on the date indicated below.

Index to Financial Statements

Section 145(a) of the Delaware General Corporation Law provides, in general, that a corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation), because the person is or was a director or officer of the corporation. Such indemnity may be against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding, if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation and if, with respect to any criminal action or proceeding, the person did not have reasonable cause to believe the person’s conduct was unlawful.

Section 145(b) of the Delaware General Corporation Law provides, in general, that a corporation shall have the power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor because the person is or was a director or officer of the corporation, against any expenses (including attorneys’ fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation.

Section 145(g) of the Delaware General Corporation Law provides, in general, that a corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director or officer of the corporation against any liability asserted against the person in any such capacity, or arising out of the person’s status as such, whether or not the corporation would have the power to indemnify the person against such liability under the provisions of the law.

The certificate of incorporation and bylaws of Palm, both as amended, provide in effect that, subject to certain limited exceptions, Palm may indemnify its directors and officers to the extent authorized or permitted by the Delaware General Corporation Law. The directors and officers of Palm are insured under policies of insurance maintained by Palm, subject to the limits of the policies, against certain losses arising from any claims made against them by reason of being or having been such directors or officers. In addition, Palm has entered into contracts with certain of its directors and officers providing for indemnification of such persons by Palm to the full extent authorized or permitted by law, subject to certain limited exceptions.

Index to Financial Statements

Insofar as indemnification for liabilities under the Securities Act of 1933, as amended, may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 20 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. In the event that a claim of indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in a successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

Index to Financial Statements

Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Milpitas, State of California, on September 24, 2003.

Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statement has been signed by the following persons in the capacities and on the dates indicated.

Delaware	3575	94-3150688
(State or other jurisdiction of incorporation or organization)	(Primary Standard Industrial Classification Code Number)	(I.R.S. Employer Identification Number)

	400 N. McCarthy Blvd. Milpitas, California 95035 (408) 503-7000

		Page
Treatment of Handspring Stock Options and Warrants		114
Treatment of Rights under the Handspring Employee Stock Purchase Plan		114
Employee Benefits Matters		114
Board of Directors of Palm Following the Merger		115
Regulatory Filings; Antitrust Matters; Reasonable Efforts to Obtain Regulatory Approvals		115
Limitation on Reasonable Efforts to Obtain Regulatory Approvals		116
Conditions to Completion of the Transaction		116
Definition of Material Adverse Effect		118
Termination of the Merger Agreement		119
Payment of Termination Fee		120
Extension, Waiver and Amendment of the Merger Agreement		121
OTHER AGREEMENTS		122
Voting Agreements		122
Transfer Restriction Agreements		123
Non-Competition and Non-Solicitation Agreements		123
Loan Agreement		124
THE PALMSOURCE SEPARATION		126
Description of the Separation		126
Amended and Restated Master Separation Agreement		126
General Assignment and Assumption Agreement		127
Amended and Restated Software License Agreement		128
SDIO License Agreement		132
Development Agreement		132
Amended and Restated Tax Sharing Agreement		133
Amended and Restated Intercompany Loan Agreement		133
Amended and Restated Indemnification and Insurance Matters Agreement		134
Xerox Litigation Agreement		135
Master Technology Ownership and License Agreement		135
Master Confidential Disclosure Agreement		136
Master Patent Ownership and License Agreement		136

		Page
PALM, INC. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED MAY 31, 2001		174
PALM, INC. NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS		175
Pro Forma Adjustments—Separation of PalmSource		175
Pro Forma Adjustments—Handspring Merger		176
COMPARISON OF STOCKHOLDER RIGHTS		179
Indemnification of Directors and Officers		189
PROPOSAL NO. 2—ELECTION OF THREE CLASS I DIRECTORS		191
Vote Required		191
Nominees and Other Directors		191
Board and Committee Meetings		195
Compensation of Directors		195
Compensation Committee Interlocks and Insider Participation		197
Section 16(a) Beneficial Ownership Reporting Compliance		197
Recommendation of the Palm Board of Directors		198
PROPOSAL NO. 3—RATIFICATION OF DELOITTE & TOUCHE LLP		199
Vote Required		199
Recommendation of the Palm Board of Directors		199
PROPOSAL NO. 4—AMENDMENT AND RESTATEMENT OF PALM’S 2001 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS		200
Summary of the Amended and Restated 2001 Director Plan		201
Vote Required		204
Recommendation of the Palm Board of Directors		204
EXECUTIVE COMPENSATION AND OTHER MATTERS		205
Executive Compensation		205
Grants of Stock Options		206
Exercises of Stock Options		207
Employment, Severance and Change of Control Agreements		207

		Page
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS		211
Transactions with 3Com Corporation		211
Transactions between Palm and PalmSource		211
Other Transactions and Relationships		211
REPORT OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS		213
AUDIT AND RELATED FEES		215
Audit Fees		215
Audit-Related Fees		215
Tax Fees		215
All Other Fees		215
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION		216
Summary of Compensation Policies for Executive Officers		216
Cash Compensation		216
Equity-Based Compensation		216
CEO Compensation		217
COMPARISON OF STOCKHOLDER RETURN		218
LEGAL AND TAX MATTERS		219
EXPERTS		219
WHERE YOU CAN FIND MORE INFORMATION		220
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE		221

		Page
DELIVERY OF DOCUMENTS TO PALM STOCKHOLDERS SHARING AN ADDRESS		222
STOCKHOLDER PROPOSALS TO BE PRESENTED AT THE NEXT PALM ANNUAL MEETING		222
TRANSACTION OF OTHER BUSINESS AT THE PALM ANNUAL MEETING		222
TRANSACTION OF OTHER BUSINESS AT THE HANDSPRING SPECIAL MEETING		223
VOTING BY INTERNET OR TELEPHONE		224
ANNEX A—PALMSOURCE PROSPECTUS DATED
ANNEX B—AGREEMENT AND PLAN OF REORGANIZATION BY AND AMONG PALM, INC., PEACE SEPARATION CORPORATION, HARMONY ACQUISITION CORPORATION AND HANDSPRING, INC.
ANNEX C—OPINION OF FINANCIAL ADVISOR OF PALM, INC.
ANNEX D—OPINION OF FINANCIAL ADVISOR OF HANDSPRING, INC.
ANNEX E—PALM AUDIT COMMITTEE CHARTER
APPENDIX A—FORM OF PROXY OF PALM, INC.
APPENDIX B—FORM OF PROXY OF HANDSPRING, INC.

		Page
QUESTIONS AND ANSWERS ABOUT THE TRANSACTION		v
SUMMARY OF THE JOINT PROXY STATEMENT/PROSPECTUS		1
Forward-Looking Information		1
The Transaction		1
The Companies		3
Risk Factors		4
Legal Proceedings Regarding the Transaction		5
Reasons for the Transaction		5
Recommendation of the Palm Board of Directors		6
Opinion of Palm Financial Advisor Regarding the Handspring Merger		6
Recommendation of the Handspring Board of Directors		6
Opinion of Handspring Financial Advisor Regarding the Handspring Merger		6
Interests of Certain Persons in the Merger		7
Security Ownership of Certain Beneficial Owners, Directors and Management of Palm and Handspring		9
Conditions to the Completion of the Transaction		9
Prohibitions on the Solicitation of Other Offers		10
Termination of the Merger Agreement by Palm and Handspring under Specified Circumstances		10
Payment of a Termination Fee under Specified Circumstances		11
Treatment of Awards Outstanding under Stock Plans and Outstanding Warrants		11
Loan Agreement between Palm and Handspring		12
The PalmSource Separation		12
Relationship between Palm and PalmSource Following the Transaction		12
Material U.S. Federal Income Tax Consequences of the PalmSource Distribution and Handspring Merger		13
Accounting Treatment		13
Regulatory Approvals		13
Nasdaq Listing		13
Appraisal Rights		13
PALM, INC. SUMMARY SELECTED HISTORICAL CONDENSED CONSOLIDATED FINANCIAL DATA		14

		Page
HANDSPRING, INC. SUMMARY SELECTED HISTORICAL CONDENSED CONSOLIDATED FINANCIAL DATA		16
PALMSOURCE, INC. SUMMARY COMBINED AND CONSOLIDATED FINANCIAL DATA		18
PALM, INC. SUMMARY UNAUDITED PRO FORMA COMBINED CONDENSED SELECTED FINANCIAL DATA		20
COMPARATIVE HISTORICAL AND PRO FORMA PER SHARE DATA		22
COMPARATIVE PER SHARE MARKET PRICE DATA		24
RISK FACTORS		25
Risks Related to the Transaction		25
Risk Related to the Combined Company Following the Transaction		33
Risks Related to the Securities Markets and Ownership of Our Common Stock		44
RECENT DEVELOPMENTS		45
THE PALM ANNUAL MEETING OF STOCKHOLDERS		46
General Information		46
THE HANDSPRING SPECIAL MEETING OF STOCKHOLDERS		50
Date, Time and Place of the Special Meeting		50
Matters for Consideration		50
Board of Directors’ Recommendation		50
Record Date		50
Quorum and Vote Required		50
Voting of Proxies		51
How to Revoke a Proxy		51
Solicitation of Proxies and Expenses		52
Voting Agreements		52
Future Stockholder Proposals of Handspring		52
Security Ownership of Certain Beneficial Owners and Management of Handspring		53
PALM AND HANDSPRING PROPOSAL NO. 1—APPROVAL AND ADOPTION OF THE MERGER AGREEMENT		55
THE TRANSACTION		55
Overview of the Transaction		55
Background of the Transaction		56
Reasons for the Transaction		67

		Page
Consideration of the Transaction by, and Recommendation of, the Board of Directors of Palm		69
Opinion of Palm’s Financial Advisor		71
Consideration of the Handspring Merger by, and Recommendation of, the Handspring Board of Directors		78
Opinion of Handspring’s Financial Advisor		81
Vote Required		92
Interests of Certain Persons in the Handspring Merger		93
Governmental and Regulatory Approvals Required to Complete the Transaction		99
Accounting Treatment of the PalmSource distribution and Handspring merger		99
Material U.S. Federal Income Tax Consequences of the PalmSource distribution and Handspring merger		99
Listing of Palm Common Stock on the Nasdaq National Market		101
Listing of PalmSource Common Stock on the Nasdaq National Market		101
Delisting and Deregistration of Handspring Common Stock After the Transaction		102
Legal Proceedings Regarding the Transaction		102
Appraisal and Dissenters’ Rights		102
THE MERGER AGREEMENT		103
Structure of the Transaction		103
Completion and Effectiveness of the Transaction		103
Distribution of PalmSource Common Stock		103
Conversion of Handspring Common Stock		104
Fractional Shares		104
Exchange of Stock Certificates		105
Representations and Warranties		106
Conduct of Business Before Completion of the Transaction		107
Palm and Handspring Prohibited from Soliciting Other Offers		110
Obligations of the Palm Board of Directors and Handspring Board of Directors with Respect to their Recommendations and Holding a Meeting of their Stockholders		112
Treatment of Awards Outstanding under Palm Stock Plans and Outstanding Warrants		113

		Page
Business Services Agreement		137
Strategic Collaboration Agreement		138
Employee Matters Agreement		139
Trademark Agreements		139
Other Agreements		142
THE SOLUTIONS GROUP BUSINESS		144
Overview		144
Strategy		144
Products and Services		145
Customers		146
Competition		147
Sales and Marketing		147
Customer Service and Support		148
Research and Development		148
Manufacturing and Supply Chain		148
Backlog		148
Seasonality		148
Intellectual Property		149
Employees		149
Financial Information About Geographic Areas		150
Properties		150
THE SOLUTIONS GROUP MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		151
Overview		151
Critical Accounting Policies		151
Results of Operations		154
Comparison of fiscal years ended May 31, 2003 and 2002		154
Comparison of fiscal years ended May 31, 2002 and 2001		159
Liquidity and Capital Resources		163
Effects of Recent Accounting Pronouncements		167
PALM, INC. UNAUDITED PRO FORMA FINANCIAL STATEMENTS		168
PALM, INC. UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET AS OF MAY 31, 2003		171
PALM, INC. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED MAY 31, 2003		172
PALM, INC. UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS FOR THE YEAR ENDED MAY 31, 2002		173

	Years Ended May 31,(1)
	1999			2000		2001			2002			2003

Consolidated Statements of Operations Data:(3)
Revenues	$	563,525		$	1,057,597	$	1,559,312		$	1,030,831		$	871,946
Costs and operating expenses:
Cost of revenues		315,607			612,278		1,060,878			745,525			591,329
Cost of revenues—charge (benefit) for special excess inventory and related costs		—			—		268,930			(101,844	)		—
Sales and marketing		127,756			236,734		337,275			237,225			177,903
Research and development		45,161			73,272		159,050			141,698			110,611
General and administrative		23,692			50,916		87,842			56,444			50,179
Amortization of goodwill and intangible assets*		845			3,378		37,321			12,531			6,069
Separation costs		—			19,570		5,468			1,542			9,282
Impairment charges		—			—		106,669			—			102,540
Restructuring charges		—			—		60,888			46,553			39,488
Purchased in-process technology		2,125			—		1,063			—			—

Total costs and operating expenses		515,186			996,148		2,125,384			1,139,674			1,087,401
Operating income (loss)		48,339			61,449		(566,072	)		(108,843	)		(215,455	)
Interest and other income (expense), net		(223	)		16,364		41,881			938			(2,129	)

Income (loss) before income taxes		48,116			77,813		(524,191	)		(107,905	)		(217,584	)
Income tax provision (benefit)		18,488			31,903		(167,715	)		(25,737	)		224,998

Net income (loss)	$	29,628		$	45,910	$	(356,476	)	$	(82,168	)	$	(442,582	)

Net income (loss) per share:(2)
Basic	$	1.11		$	1.70	$	(12.59	)	$	(2.87	)	$	(15.23	)
Diluted	$	1.11		$	1.70	$	(12.59	)	$	(2.87	)	$	(15.23	)
Shares used in computing net income (loss) per share:(2)
Basic		26,600			26,987		28,307			28,640			29,069
Diluted		26,600			26,993		28,307			28,640			29,069
*Amortization of goodwill and intangible assets:
Cost of revenues	$	338		$	1,350	$	4,135		$	6,306		$	5,164
Sales and marketing		127			506		529			11			—
Research and development		373			1,494		32,609			6,137			775
General and administrative		7			28		48			77			130

Total amortization of goodwill and intangible assets	$	845		$	3,378	$	37,321		$	12,531		$	6,069

	As of May 31,(1)
	1999		2000		2001		2002		2003

Condensed Consolidated Balance Sheet Data:(3)
Cash and cash equivalents	$	478	$	1,062,128	$	513,769	$	278,547	$	242,432
Short-term investments		—		—		—		17,970		—
Working capital		12,682		1,012,476		350,668		245,181		133,677
Total assets		152,247		1,282,676		1,297,251		989,096		576,626
Payable to 3Com Corporation		40,509		18,374		—		—		—
Long-term convertible debt		—		—		—		50,000		50,000
Minority interests in consolidated subsidiary		—		—		—		—		20,000
Total stockholders’ equity		34,018		1,029,188		734,152		690,848		255,786

	Period from July 29, 1998 (date of inception) to June 30, 1999			Years Ended June 30,(1)
				2000			2001			2002			2003

Consolidated Statements of Operations Data:(2)
Revenues	$	—		$	101,937		$	370,943		$	240,651		$	147,256
Costs and operating expenses:
Cost of revenues		—			69,921			292,311			205,917			112,152
Research and development		2,738			10,281			23,603			24,739			22,226
Selling, general and administrative		2,451			42,424			145,132			85,612			61,053
Amortization of deferred stock compensation and intangible assets (*)		3,646			40,077			32,830			20,181			8,516
In-process research and development		—			—			12,225			—			—
Sunnyvale lease restructuring		—			—			—			—			75,931

Total costs and operating expenses		8,835			162,703			506,101			336,449			279,878
Loss from operations		(8,835	)		(60,766	)		(135,158	)		(95,798	)		(132,622	)
Interest and other income, net		446			675			12,195			5,259			1,802

Loss before taxes		(8,389	)		(60,091	)		(122,963	)		(90,539	)		(130,820	)
Income tax provision		—			200			3,000			1,050			238

Net loss	$	(8,389	)	$	(60,291	)	$	(125,963	)	$	(91,589	)	$	(131,058	)

Net loss per share:
Basic and diluted	$	(0.71	)	$	(1.77	)	$	(1.21	)	$	(0.71	)	$	(0.91	)
Shares used in computing net loss per share:
Basic and diluted		11,772			34,015			103,896			128,221			144,444
(*)Amortization of deferred stock compensation and intangible assets:
Cost of revenues	$	526		$	5,904		$	4,521		$	2,586		$	1,080
Research and development		1,217			8,059			6,926			4,672			1,966
Selling, general and administrative		1,903			26,114			21,383			12,923			5,470

Total amortization of deferred stock compensation and intangible assets	$	3,646		$	40,077		$	32,830		$	20,181		$	8,516


	As of June 30,(1)
	1999			2000			2001			2002			2003

Condensed Consolidated Balance Sheet Data:(2)
Cash and cash equivalents	$	7,533		$	196,548		$	87,580		$	85,554		$	31,308
Short-term investments		6,234			—			33,943			15,235			5,602
Restricted investments		—			2,114			53,634			49,482			8,185
Working capital		13,108			182,662			48,670			(22,217	)		(517	)
Total assets		15,631			230,472			253,235			290,154			80,767
Long-term liabilities, net of current portion		—			57			—			—			16,441
Redeemable convertible preferred stock		17,972			—			—			—			—
Total stockholder’s equity (deficit)		(3,616	)		194,229			145,202			122,906			6,627

	Years Ended May 31,
	1999			2000			2001			2002			2003
	(Unaudited)
	(in thousands, except per share amounts)
Combined and Consolidated Statement of Operations Data:
Related party revenues	$	—		$	83		$	1,235		$	23,682		$	50,539
Third party revenues		987			6,879			25,017			21,268			22,875

Total revenues		987			6,962			26,252			44,950			73,414
Cost of revenues		1,404			2,941			5,449			10,603			10,221

Gross profit		(417	)		4,021			20,803			34,347			63,193
Total operating expenses		33,464			63,177			104,823			84,496			77,399

Loss from operations		(33,881	)		(59,156	)		(84,020	)		(50,149	)		(14,206	)
Interest expense		(11	)		(12	)		(65	)		(256	)		(507	)
Interest and other income (expense), net		85			(50	)		76			(421	)		(4,627	)

Loss before income taxes		(33,807	)		59,218			(84,009	)		(50,826	)		(19,340	)
Income tax provision		—			1,499			9			421			2,420

Net loss	$	(33,807	)	$	(60,717	)	$	(84,018	)	$	(51,247	)	$	(21,760	)


Basic and diluted net loss per share	$	(3.38	)	$	(6.07	)	$	(8.40	)	$	(5.12	)	$	(2.18	)
Weighted average shares used in computing basic and diluted net loss per share(1)		10,000			10,000			10,000			10,000			10,000
Unaudited pro forma basic and diluted net loss per share													$	(2.04	)

Shares used in computing unaudited pro forma basic and diluted net loss per share amounts														10,667

	As of May 31,													Pro Forma As of May 31,
	1999			2000			2001			2002		2003		2003
	(Unaudited)													(Unaudited)
	(in thousands)
Combined and Consolidated Balance Sheet Data:
Cash and cash equivalents	$	478		$	656		$	383		$	30,688	$	37,465	$	43,465
Working capital (deficit)		(1,514	)		(15,669	)		(21,457	)		16,890		20,750		26,006
Total assets		18,017			16,992			61,490			107,316		104,607		110,607
Note payable to Palm, including accrued interest		—			—			—			20,238		20,744		—
Long-term convertible note		—			—			—			—		—		15,000
Series A redeemable convertible preferred stock		—			—			—			—		20,000		—
Total stockholders’ equity / net investment (deficit)		12,431			(12,869	)		29,611			48,299		26,280		57,280

	Year Ended May 31, 2003
	(In thousands, except per share amounts)
Pro Forma Combined Condensed Statement of Operations Data:
Revenues	$	984,893
Net loss	$	(582,585	)
Net loss per share, basic and diluted	$	(13.69	)

	As of May 31, 2003
	(In thousands)
Pro Forma Combined Condensed Balance Sheet Data:
Cash and cash equivalents	$	230,275
Short-term investments	$	5,602
Working capital	$	89,290
Total assets	$	776,626
Long-term debt	$	37,150
Total stockholders’ equity	$	426,676

	Year Ended May 31, 2003(7)
PALM HISTORICAL:
Net loss per share:
Basic and diluted	$	(15.23	)
Book value per share at the end of the period(1)	$	8.75
PALMSOURCE HISTORICAL(2):
Net loss per share:
Basic and diluted	$	(2.18	)
Book value per share at the end of the period(1)	$	2.63
HANDSPRING HISTORICAL:
Net loss per share:
Basic and diluted	$	(0.91	)
Book value per share at the end of the period(1)	$	(0.04	)
PALM PRO FORMA:
Pro forma net loss per Palm share(3):
Basic and diluted	$	(13.69	)
Pro forma book value per Palm share(4)	$	9.99
PALMSOURCE PRO FORMA(2):
Pro forma net loss per equivalent PalmSource share(5):
Basic and diluted	$	(2.04	)
Pro forma book value per equivalent PalmSource share(4)	$	5.37
HANDSPRING PRO FORMA:
Pro forma net loss per equivalent Handspring share(6):
Basic and diluted	$	1.23
Pro forma book value per Handspring equivalent share(6)	$	0.90

	Palm Common Stock				Handspring Common Stock				Handspring Equivalent Price Per Share
	High		Low		High		Low		High		Low
June 3, 2003	$	12.24	$	12.00	$	1.25	$	1.06	$	1.10	$	1.08
_____, 2003	$	___	$	___	$	___	$	___	$	___	$	___

Name and Address of Beneficial Owner(1)	Amount and Nature of Beneficial Ownership(2)		Percent of Common Stock Outstanding(3)
FMR Corp. 82 Devonshire Street, Boston, MA 02109	3,193,483	(4)	10.1	%
Wellington Management Company, LLP 75 State Street, Boston, MA 02109	2,661,075	(5)	8.4
Eric A. Benhamou	134,303	(6)	*
R. Todd Bradley	84,696	(7)	*
Judy Bruner	64,844	(8)	*
Gordon A. Campbell	8,850	(9)	*
Gareth C.C. Chang	4,834	(10)	*
Jean-Jacques Damlamian	7,000	(11)	*
Michael Homer	8,418	(12)	*
Marianne F. Jackson	20,447	(13)	*
David C. Nagel	12,250	(14)	*
Susan G. Swenson	8,850	(15)	*
All current directors and executive officers as a group (10 persons)	354,492	(16)	1.1

Name and Address of Beneficial Owner(1)	Amount and Nature of Beneficial Ownership(2)	Percent of Class
Jeffrey C. Hawkins(3)	36,879,608	24.8	%
Donna L. Dubinsky(4)	21,800,728	14.7
L. John Doerr(5) Kleiner Perkins Caufield & Byers 2750 Sand Hill Road Menlo Park, California 94205	14,885,985	10.0
M-F Downtown Sunnyvale, LLC(6) c/o The Mozart Development Company 1068 East Meadow Circle Palo Alto, California 94303	10,000,000	6.3
Edward T. Colligan(7)	5,685,088	3.7
Bruce W. Dunlevie(8) Benchmark Capital Partners II, LP 2480 Sand Hill Road Menlo Park, California 94205	5,012,462	3.4
Celeste S. Baranski(9)	1,166,606	*
Gregory S. Woock(10)	450,087	*
John Hartnett(11)	349,648	*
David G. Pine(12)	347,916	*
Mitchell E. Kertzman(13)	37,186	*
William E. Kennard(14)	27,811	*
All Directors and Named Executive Officers (11 Persons)(15)	86,643,125	56.1	%

Period Ending June 2, 2003		Range of Closing Prices
Last 90 Trading Days		$0.62–$1.22
Last Twelve Months		$0.58–$2.14

Company		Aggregate Value to Estimated Calendar Year 2004 Revenues
Motorola		0.7
Nokia		2.0
Palm		0.1
Research in Motion		2.1
Symbol Technologies		1.8

Period (ending June 2, 2003)	Average Exchange Ratio	Merger Agreement Exchange Ratio (0.09) Premium/(Discount) to Average Exchange Ratio
Current
Excluding PalmSource ($50 million illustrative value)	0.118	(24)	%
Excluding PalmSource ($100 million illustrative value)	0.142	(37)	%
Last 30 days
Excluding PalmSource ($50 million illustrative value)	0.089	1	%
Excluding PalmSource ($100 million illustrative value)	0.110	(18)	%
Last 60 days
Excluding PalmSource ($50 million illustrative value)	0.086	4	%
Excluding PalmSource ($100 million illustrative value)	0.108	(17)	%
Last 90 days
Excluding PalmSource ($50 million illustrative value)	0.080	13	%
Excluding PalmSource ($100 million illustrative value)	0.098	(8)	%
Last Twelve Months
Excluding PalmSource ($50 million illustrative value)	0.074	22	%
Excluding PalmSource ($100 million illustrative value)	0.086	4	%

	Implied Pro Forma Ownership of the Combined Company by
	Palm		Handspring
Revenue
Fiscal Year 2002 Estimated	78	%	22	%
Fiscal Year 2003 Estimated	80		20
Fiscal Year 2004 Estimated	81		19
Fiscal Year 2005 Estimated	78		22
Fiscal Year 2006 Estimated	74		26
Gross Profit
Fiscal Year 2002 Estimated	81	%	19	%
Fiscal Year 2003 Estimated	80		20
Fiscal Year 2004 Estimated	81		19
Fiscal Year 2005 Estimated	77		23
Fiscal Year 2006 Estimated	73		27
Net Cash
As of 3/31/03	76	%	24	%

Financial Statistic	Precedent Transaction Statistic Range	Implied Exchange Ratio Based on Precedent Statistics
Current implied exchange ratio	20%–40%	0.142–0.199
(0.118–0.142)
30 Day implied exchange ratio	20%–40%	0.107–0.154
(0.089–0.110)

	Proposed transaction assuming hypothetical value loss due to PalmSource distribution of
	$25 million			$50 million			$75 million
Implied current exchange ratio based on prices as of June 2, 2003		0.109	x		0.118	x		0.129	x
Merger exchange ratio		0.090	x		0.090	x		0.090	x
Premium/(discount) of Merger exchange ratio to June 2 exchange ratio		(17.7	)%		(24.0	)%		(30.3	)%
Premium/(discount) of Merger exchange ratio to 5-day average exchange ratio		0.6	%		(7.2	)%		(15.0	)%
Premium/(discount) of Merger exchange ratio to 10-day average exchange ratio		6.8	%		(1.6	)%		(10.0	)%
Premium/(discount) of Merger exchange ratio to 30-day average exchange ratio		10.5	%		0.9	%		(8.7	)%
Premium/(discount) of Merger exchange ratio to 60-day average exchange ratio		14.4	%		4.1	%		(6.3	)%
Implied price per Handspring share	$	1.00		$	0.93		$	0.85
Implied fully-diluted Handspring equity value (millions)	$	155		$	143		$	131
Implied fully-diluted Handspring aggregate value (millions)	$	104		$	92		$	80
Implied aggregate value/CY2003E revenues—Street Revenue Estimates		1.00	x		0.88	x		0.77	x
Implied aggregate value/CY2003E revenues—Management Revenue Estimates		0.95			0.84			0.73
Implied aggregate value/CY2004E revenues—Management Revenue Estimates		0.50			0.44			0.38
Implied Handspring fully-diluted % ownership in Palm		32.3	%		32.2	%		32.2	%

Period Ended June 2, 2003	Average Palm Closing Price
June 2, 2003	$	12.01
Last 5 trading days	$	11.89
Last 10 trading days	$	11.73
Last 30 trading days	$	10.77
Last 60 trading days	$	10.37
Last 90 trading days	$	11.51

Based on Aggregate Value/Calendar Year 2003 Estimated Revenues
Multiple range derived from selected comparable companies		0.17x–0.92x
Implied Palm aggregate value (after giving effect to the PalmSource distribution) (millions)		$151–$820
Implied Palm equity value (after giving effect to the PalmSource distribution) (millions)		$333–$1,003
Implied price per Palm share (after giving effect to the PalmSource distribution)		$11.39–$32.61
Based on Aggregate Value/Calendar Year 2004 Estimated Revenues
Multiple range derived from selected comparable companies		0.15x–0.74x
Implied Palm aggregate value (after giving effect to the PalmSource distribution) (millions)		$140–$689
Implied Palm equity value (after giving effect to the PalmSource distribution) (millions)		$322–$871
Implied price per Palm share (after giving effect to the PalmSource distribution)		$11.02–$28.45

Implied Palm equity value (millions) (after giving effect to the PalmSource distribution)		$485–$690
Implied price per Palm share (after giving effect to the PalmSource distribution)		$16.23–$22.71

Period Ended June 2, 2003	Average Handspring Closing Price
June 2, 2003	$	1.22
Last 5 trading days	$	0.99
Last 10 trading days	$	0.92
Last 30 trading days	$	0.81
Last 60 trading days	$	0.75
Last 90 trading days	$	0.76

Implied Handspring equity value (millions)		$183–$281
Implied price per Handspring share		$0.88–$1.31
Implied premium/(discount) to market price per Handspring share on June 2, 2003		(28)%–8%
Implied premium/(discount) to 10-day average price per Handspring share prior to June 2, 2003		(4)%–43%
Implied premium/(discount) to 30-day average price per Handspring share prior to June 2, 2003		8%–62%

	Change from June 3, 2002		Change from March 3, 2003
Handspring	(29	)%	74	%
Palm	(62	)%	16	%
Index of comparable companies	(12	)%	15	%
Nasdaq	2	%	20	%

Period Ended June 2, 2003	Average Hypothetical Exchange Ratio over Period	Premium/(Discount) of Merger Exchange Ratio to Average Hypothetical Exchange Ratio over Period
Since March 3, 2003	0.086x	4.2	%
Last 60 trading days	0.086x	4.1	%
Last 45 trading days	0.088x	2.4	%
Last 30 trading days	0.089x	0.9	%
Last 20 trading days	0.094x	(3.9	)%
Last 15 trading days	0.092x	(2.6	)%
Last 10 trading days	0.091x	(1.6	)%
Last 5 trading days	0.097x	(7.2	)%
June 2, 2003	0.118x	(24.0	)%

	Implied Pro Forma Fully-Diluted Handspring Ownership in Palm		Implied Exchange Ratio		Premium of Merger Exchange Ratio to Implied Exchange Ratio
Revenue
Calendar Year 2002 actual	20.0	%	0.048	x	88	%
Calendar Year 2003 estimated	16.1	%	0.037	x	145	%
Calendar Year 2004 estimated	20.0	%	0.048	x	88	%
Fiscal Year 2003 estimated	18.1	%	0.042	x	113	%
Fiscal Year 2004 estimated	17.8	%	0.042	x	116	%
Fiscal Year 2005 estimated	21.9	%	0.054	x	68	%

Gross Profit
Calendar Year 2003 estimated	16.0	%	0.036	x	147	%
Calendar Year 2004 estimated	21.5	%	0.052	x	72	%
Fiscal Year 2003 estimated	17.5	%	0.041	x	122	%
Fiscal Year 2004 estimated	18.6	%	0.044	x	106	%
Fiscal Year 2005 estimated	24.1	%	0.060	x	49	%

Implied exchange ratio		0.054x–0.058x
Premium of merger exchange ratio		66%–55%

Implied Palm equity value (after giving effect to the PalmSource distribution and the Handspring merger) (millions)		$663–$976
Implied price per Palm share (after giving effect to the PalmSource distribution and the Handspring merger)		$15.04–$21.63
Implied price per Handspring share		$1.35–$1.95
Implied premium to market price per Handspring share on June 2, 2003		11%–60%
Implied premium to 10-day average price per Handspring share prior to June 2, 2003		48%–112%
Implied premium to 30-day average price per Handspring share prior to June 2, 2003		67%–140%