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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED FEBRUARY 25, 2000 COMMISSION FILE NO. 0-29597
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------------
PALM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3150688
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5470 GREAT AMERICA PARKWAY 95052
SANTA CLARA, CALIFORNIA -----
----------------------- (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 326-9000
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT: N/A
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES NO X
----- -----
AS OF APRIL 3, 2000, 564,488,427 SHARES OF THE REGISTRANT'S COMMON STOCK WERE
OUTSTANDING.
THIS REPORT CONTAINS A TOTAL OF 36 PAGES OF WHICH THIS PAGE IS NUMBER 1.
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PALM, INC.
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Income Statements
THREE AND NINE MONTHS ENDED FEBRUARY 25, 2000 AND FEBRUARY 26, 1999 3
Condensed Consolidated Balance Sheets
FEBRUARY 25, 2000 AND MAY 28, 1999 4
Condensed Consolidated Statements of Cash Flows
NINE MONTHS ENDED FEBRUARY 25, 2000 AND FEBRUARY 26, 1999 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 32
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 33
ITEM 2. Changes in Securities and Use of Proceeds 34
ITEM 6. Exhibits and Reports on Form 8-K 34
Signatures 36
Palm OS is a registered trademark and Palm, Palm VII and Palm.Net are
trademarks of Palm, Inc. or its subsidiaries.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PALM, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
------------------ -----------------
February 25, February 26, February 25, February 26,
2000 1999 2000 1999
------------- ------------ ------------ ------------
Revenues $ 272,292 $ 125,889 $ 707,352 $ 389,191
Cost of revenues 153,479 67,583 399,821 214,870
------------- ------------- ------------- -------------
Gross profit 118,813 58,306 307,531 174,321
------------- ------------- ------------- -------------
Operating expenses:
Sales and marketing 57,591 28,725 160,277 86,587
Research and development 21,450 10,989 50,001 31,449
General and administrative 12,202 5,739 29,158 17,043
Purchased in-process
technology - 2,125 - 2,125
Separation costs 8,203 - 11,983 -
------------- ------------- ------------- -------------
Total operating expenses 99,446 47,578 251,419 137,204
------------- ------------- ------------- -------------
Operating income 19,367 10,728 56,112 37,117
Interest and other income
(expense), net 418 (15) 632 (115)
------------- ------------- ------------- -------------
Income before income taxes 19,785 10,713 56,744 37,002
Income tax provision 8,832 4,116 23,271 14,218
------------- --------------- ------------- -------------
Net income $ 10,953 $ 6,597 $ 33,473 $ 22,784
============= ============= ============= =============
Net income per share:
Basic and diluted $ 0.02 $ 0.01 $ 0.06 $ 0.04
Shares used in computing
per share amounts:
Basic and diluted 532,000 532,000 532,000 532,000
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
PALM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
February 25, May 28,
2000 1999
---- ----
(Unaudited)
ASSETS
Current assets:
Cash and equivalents $ 40,005 $ 478
Accounts receivable, net 114,320 95,839
Inventories 29,774 12,186
Deferred income taxes 26,712 20,688
Prepaids and other 1,692 1,038
------------- ---------------
Total current assets 212,503 130,229
Property and equipment, net 10,553 8,136
Goodwill, intangibles and other assets 13,550 13,829
Deferred income taxes 1,938 53
------------- ---------------
Total assets $ 238,544 $ 152,247
============ ===============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable $ 88,818 $ 35,577
Payable to 3Com Corporation 125,988 40,509
Other accrued liabilities 102,725 40,793
Current portion of long-term debt 162 668
------------- ---------------
Total current liabilities 317,693 117,547
Long-term debt 383 682
Commitments and contingencies - -
Stockholder's equity (deficiency):
Preferred stock, $.001 par value, 125,000 shares
authorized; none outstanding - -
Common stock, $.001 par value, 2,000,000 shares
authorized; outstanding: February 25, 2000,
532,000; May 28, 1999, 532,000 - -
3Com Corporation equity (deficiency) (79,377) 34,151
Accumulated other comprehensive income (loss) (155) (133)
-------------- ---------------
Total stockholder's equity (deficiency) (79,532) 34,018
-------------- ---------------
Total liabilities and stockholder's equity $ 238,544 $ 152,247
============== ===============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
PALM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
-----------------
February 25, February 26,
2000 1999
---- ----
Cash flows from operating activities:
Net income $ 33,473 $ 22,784
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 6,644 2,368
Loss on disposal of property and equipment 897 1,658
Deferred income taxes (7,909) (6,474)
Purchased in-process technology - 2,125
Changes in assets and liabilities:
Accounts receivable (18,481) (31,698)
Inventories (17,588) (2,025)
Prepaids and other (2,908) (547)
Accounts payable 53,241 (1,255)
Payable to 3Com Corporation (64,521) 22,022
Other accrued liabilities 61,932 26,051
-------------- --------------
Net cash provided by operating activities 44,780 35,009
-------------- --------------
Cash flows from investing activities:
Purchase of property and equipment (7,425) (3,804)
Business acquired in purchase transaction - (16,831)
-------------- --------------
Net cash used for investing activities (7,425) (20,635)
-------------- --------------
Cash flows from financing activities:
Net transfers (to) from 3Com 2,977 (13,761)
Repayments of debt (805) -
-------------- --------------
Net cash used for financing activities 2,172 (13,761)
-------------- --------------
Increase in cash and equivalents 39,527 613
Cash and equivalents, beginning of period 478 -
-------------- --------------
Cash and equivalents, end of period $ 40,005 $ 613
============== ==============
Noncash investing and financing activities
Dividend payable to 3Com $ 150,000 $ -
============== ==============
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
PALM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The unaudited condensed consolidated financial statements have been
prepared by Palm, Inc. ("Palm," "us," "we," or "our"), pursuant to the
rules of the Securities and Exchange Commission ("SEC"). In the opinion
of management, these unaudited condensed consolidated financial
statements include all adjustments necessary for a fair presentation of
Palm's financial position as of February 25, 2000, results of
operations for the three and nine months ended February 25, 2000 and
February 26, 1999, and cash flows for the nine months ended February
25, 2000 and February 26, 1999.
Palm has a 52-53 week fiscal year ending on the Friday nearest to May
31. Accordingly, fiscal 2000 will end on June 2, 2000, resulting in a
53-week fiscal 2000, rather than 52 weeks as reported in fiscal 1999.
For fiscal year 2000, the first three quarters will contain 13 weeks,
and the fourth quarter will contain 14 weeks. The results of operations
for the three and nine months ended February 25, 2000 may not be
indicative of the results to be expected for the fiscal year ending
June 2, 2000. These condensed consolidated financial statements should
be read in conjunction with the consolidated financial statements and
related notes thereto included in Palm's Registration Statement on Form
S-1 filed with the SEC on December 13, 1999, as amended.
Through February 25, 2000, we were wholly-owned by 3Com Corporation
("3Com"). Our condensed consolidated financial statements reflect the
historical results of operations and cash flows of the handheld
computing business of 3Com during each respective period. The condensed
consolidated financial statements have been prepared using 3Com's
historical bases in the assets and liabilities and the historical
results of operations of Palm. The financial information included
herein may not reflect the consolidated financial statements, operating
results and cash flows of Palm in the future or what they would have
been had Palm been a separate stand-alone entity during the periods
presented.
The condensed consolidated financial statements include allocations of
certain 3Com expenses, including centralized legal, accounting,
treasury, real estate, information technology, distribution, customer
service, sales, marketing, engineering, and other 3Com corporate
services and infrastructure costs. The expense allocations have been
determined on the bases that 3Com and Palm considered to be reasonable
reflections of the utilization of services provided or the benefit
received by Palm. The allocation methods include relative revenues,
headcount or square footage. Management believes that the expenses
allocated to Palm are representative of the operating expenses it would
have incurred had Palm been operated on a stand-alone basis.
6
The allocated amounts from 3Com included in our results of operations
were as follows (in thousands):
Nine Months Ended
-----------------------------
February 25, February 26,
2000 1999
----------- -----------
Cost of revenues $ 10,443 $ 6,199
Sales and marketing 20,541 11,114
Research and development 6,125 2,164
General and administrative 14,550 9,466
Other (income) and expense, net (632) 115
2. Separation from 3Com and Initial Public Offering
On September 13, 1999, 3Com announced its plan to create an independent
publicly-traded company, Palm, Inc., comprised of 3Com's handheld
computing business. Following the completion of Palm's initial public
offering in March 2000, 3Com owns approximately 94% of Palm's
outstanding common stock. 3Com has announced that it intends to
distribute its remaining shares of Palm common stock to 3Com
stockholders approximately four to six months following the initial
public offering ("the distribution date"), subject to receiving 3Com
board approval and a ruling from the Internal Revenue Service that the
distribution will be not be taxable.
3Com and Palm have entered into a Master Separation and Distribution
Agreement. In accordance with the separation agreement, 3Com
transferred to Palm the 3Com-owned assets and liabilities which related
to Palm prior to the date of separation from 3Com ("the separation
date"), except for most of Palm's accounts receivable and accounts
payable, which were retained by 3Com for administrative convenience.
Palm began incurring separation costs in the second quarter of fiscal
year 2000, which are costs associated with the process of becoming a
stand-alone, publicly-held company, including consulting and
professional fees.
Palm's legal separation from 3Com occurred on February 26, 2000, at
which time Palm began to operate independently from 3Com. Beginning in
the fourth quarter of fiscal year 2000, Palm's consolidated financial
statements will no longer include an allocated portion of 3Com's
corporate services and infrastructure costs. However, Palm will incur
amounts payable to 3Com under transitional service agreements, under
which 3Com will provide services such as information systems, real
estate and transaction processing in accounting, human resources, and
order processing.
Palm completed its initial public offering in March 2000, receiving net
proceeds of $942.3 million, after deducting underwriting commissions
and estimated offering expenses, from the sale of 26,450,000 shares of
common stock. Palm also received net proceeds of $225.0 million from
the sale of a total of 5,921,052 shares of common stock to America
Online, Motorola and Nokia in private placements. Using a portion of
the proceeds from the offering, Palm paid a dividend of $150.0 million
to 3Com in March 2000. This dividend was declared in January 2000 and
was payable to 3Com as the sole stockholder of record on February 25,
2000. The dividend
7
payable is included in Palm's condensed consolidated balance sheet
under the caption "Payable to 3Com Corporation", along with other
amounts due from and payable to 3Com.
3. Comprehensive Income
The components of comprehensive income are as follows (in thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
February 25, February 26, February 25, February 26,
2000 1999 2000 1999
---- ---- ---- ----
Net income $ 10,953 $ 6,597 $ 33,473 $ 22,784
Other comprehensive income:
Change in accumulated
translation adjustments (191) (30) (22) (30)
----------- ------------ ----------- -----------
Total comprehensive incom $ 10,762 $ 6,567 $ 33,451 $ 22,754
============ ============ ============ ===========
4. Net Income Per Share
For each period presented, basic and diluted net income per share are
calculated based on the 532,000,000 shares of Palm common stock owned
by 3Com. Pursuant to the requirements of SEC Staff Accounting Bulletin
Topic 1.B(3), pro forma net income per share for each period is
calculated based on the 532,000,000 shares of Palm owned by 3Com, plus
the 4,217,011 shares of common stock whose proceeds are assumed to be
used to pay the $150 million dividend to 3Com. Such pro forma net
income per share amounts are the same as the basic and diluted net
income per share amounts for each period.
In future periods, basic net income per share will be calculated based
on the weighted average shares of common stock outstanding during the
period, and diluted earnings per share will be calculated based on the
weighted average shares of common stock outstanding, plus the dilutive
effect of stock options, calculated using the treasury stock method. At
the time of Palm's initial public offering, Palm granted options to
purchase approximately 9.4 million shares of Palm common stock to its
employees and directors at the initial public offering price, and also
issued approximately 117,000 shares of restricted stock to certain key
employees. At the distribution date, options held by Palm employees to
purchase 3Com common stock will be converted into options to purchase
Palm common stock as described in Palm's Registration Statement on Form
S-1 filed on December 13, 1999, as amended.
5. Inventories
Inventories, net, consist of (in thousands):
February 25, May 28,
2000 1999
---- ----
Finished goods $ 26,334 $ 5,900
Work-in-process 2,963 4,011
Purchased components 477 2,275
----------- -----------
Total Inventories $ 29,774 $ 12,186
=========== ===========
8
6. Litigation
Palm is a party to lawsuits in the normal course of its business.
Litigation in general, and intellectual property litigation in
particular, can be expensive and disruptive to normal business
operations. Moreover, the results of complex legal proceedings are
difficult to predict. Palm believes that it has defenses to the cases
set forth below and is vigorously contesting these matters. Palm is not
currently able to estimate the possible loss, or range of loss, if any,
from the cases listed below and an unfavorable resolution of these
lawsuits could adversely affect Palm's business, results of operations
or financial condition.
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States
District Court for the Western District of New York. The case is now
captioned: XEROX CORPORATION v. U.S. ROBOTICS CORPORATION, U.S.
ROBOTICS ACCESS CORP., PALM COMPUTING, INC. AND 3COM CORPORATION, Civil
Action No. 97-CV-6182T. The complaint alleges willful infringement of a
Xerox United States patent, relating to computerized interpretation of
handwriting. The complaint seeks unspecified damages and injunctive
relief. Xerox has asserted that Graffiti software and certain of our
products infringe the patent. On January 18, 2000, the court held a
status hearing during which it ordered that all of the parties' briefs
relating to motions for summary judgment would be filed with the court
by April 28, 2000. Palm anticipates that oral argument on these motions
will be heard thereafter. No trial date has been set.
On July 22, 1999, Palm filed a copyright infringement action against
Olivetti and CompanionLink in the United States District Court for
the Northern District of California and obtained a preliminary
injunction against further distribution, sale, import or export of
Olivetti Office USA's "Royal daVinci" handheld device and the
daVinci OS Software Development Kit, distributed by CompanionLink
Software, Inc. The injunction is to remain in effect pending the
outcome of the lawsuit. Palm also initiated a copyright infringement
action in Hong Kong on July 21, 1999, against EchoLink Design Ltd.,
the company responsible for developing the operating system software
contained in the daVinci products. The High Court of the Hong Kong
Special Administrative Region issued an order the same day
restraining EchoLink from further copying, distribution, sale,
import or export of Palm OS-Registered Trademark- operating system
source code or EchoLink's "NEXUS OS" source code, which Palm
maintains infringes its copyrights.
On December 13, 1999, WaveWare Communications, Inc. filed suit against
3Com, Palm and others in the Superior Court of California, San Mateo
County. The case is captioned WAVEWARE COMMUNICATIONS, INC. v. 3COM
CORPORATION, PALM COMPUTING, INC., AND MARK BERCOW, No. 411331. The
complaint alleges breach of contract, constructive fraud, fraud and
deceit, negligent misrepresentation, misappropriation of assets and
trade secrets, unfair competition, unjust enrichment and intentional
interference with economic advantage in connection with Palm and 3Com's
discussions with WaveWare concerning WaveWare's potential acquisition
by 3Com. The complaint seeks unspecified monetary damages and
injunctive relief. The case is in the early stages of discovery. No
trial date has been set.
On December 27, 1999, Telxon Corporation and Penright! Corporation
filed a complaint in the U.S. District Court for the Northern District
of Ohio, Eastern Division (Case No. 1:99CV3157) against 3Com and Palm
alleging copyright infringement, unfair competition and theft of trade
9
secrets. The plaintiffs allege that the Palm OS operating system
contains graphical user interface software copied from the
plaintiffs' software. The complaint seeks unspecified compensatory
and treble damages and to enjoin, among other things, distribution
and sales of the Palm OS operating system. No trial date has been
set. No discovery has been exchanged.
On February 28, 2000, E-Pass Technologies, Inc. filed suit against 3Com
in the United States District Court for the Southern District of New
York (case no. 00CIV1523). The complaint alleges infringement and
induced infringement of United States patent 5,276,311 by Palm's
handheld devices in connection with a method and device for simplifying
the use of credit cards. The complaint seeks unspecified compensatory
and treble damages and, among other things, to permanently enjoin Palm
from infringing or inducing infringement of the patent as alleged. Palm
is in the preliminary stages of investigating the allegations contained
in the suit. No trial date has been set. No discovery has been
exchanged.
In connection with Palm's separation from 3Com, pursuant to the terms
of the Indemnification and Insurance Matters Agreement between Palm and
3Com, Palm will indemnify and hold 3Com harmless for any damages or
losses which may arise out of the Xerox, WaveWare, Telxon and Penright!
and E-Pass litigation.
7. Recent Accounting Pronouncements
In March 1999, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP
98-1 requires that entities capitalize certain costs related to
internal-use software if certain criteria are met. Palm adopted SOP
98-1 for its fiscal year ending June 2, 2000. The adoption of SOP 98-1
did not have a significant impact on Palm's financial results for the
nine months ended February 25, 2000.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 133,
"Accounting for Derivative Investments and Hedging Activities." This
statement provides a comprehensive and consistent standard for the
recognition and measurement of derivatives and hedging activities. In
July 1999, the FASB issued FAS 137, which defers the effective date of
FAS 133 for one year. Accordingly, Palm will now be required to adopt
FAS 133 during fiscal 2001. Palm does not expect the adoption of FAS
133 to have a significant effect on Palm's financial position or
results of operations.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report on Form 10-Q contains forward-looking statements, including
statements concerning expected revenues from Palm platform licensing and
Internet services, expected international revenue, continued strong growth in
unit shipments of Palm devices, investments for strategic initiatives, future
gross and operating margins, expansion into new customer segments and geographic
regions, offering new wireless Internet solutions, and the launch of an
aggressive marketing campaign. These statements are subject to certain risks and
uncertainties. Some of the factors that could cause future events or results to
materially differ from those projected in the forward-looking statements are
discussed in this report (see, in particular, "Business Environment and Risk
Factors").
OVERVIEW
We were founded in 1992 and introduced our first handheld device in 1996.
Immediately prior to our initial public offering in March 2000, we were a
wholly-owned subsidiary of 3Com. To date, our business has focused primarily on
developing and selling our Palm-branded handheld devices, and as of February 25,
2000, we had sold over 6 million Palm-TM- devices worldwide. In 1999, we
expanded our strategy of licensing our Palm platform and developed our wireless
Internet access service to support Internet-enabled handheld devices.
Substantially all of our revenues to date have been generated from sales of our
handheld devices and related peripherals and accessories. A small percentage of
our revenues has been derived from licensing our Palm platform or from
subscriptions to our wireless Internet access service. With our expanded focus
on Palm platform licensing and Internet services and solutions, we expect that
an increasing portion of our revenues in future periods will come from these
sources. International revenues represented 34% of total revenues for the nine
months ended February 25, 2000, and we expect that international revenues are
likely to increase as a percentage of total revenues as we expand into
international markets.
We believe that we will continue to experience strong growth in unit shipments
of our Palm devices, although the year over year growth rates may decline on a
percentage basis compared to recent levels. Factors which we believe may impact
gross margins include increased competition, introduction of new Palm handheld
devices, supply constraints for certain components, and expansion of our revenue
from licensing and Internet services and solutions. We anticipate that the net
impact of these factors is that gross margins may be lower over the next 12-18
months when compared to recent quarters.
In line with our strategy to expand our business, we expect to make significant
strategic investments over the next 12-18 months. We intend to expand into new
customer segments and new geographic regions, offer new wireless Internet
solutions, and launch an aggressive marketing campaign to strengthen brand
awareness and target new business areas. We also expect to incur some
duplication of costs over the next 12-18 months, as we build the infrastructure
for a stand-alone public company, while also paying 3Com to perform these
services under transition service agreements. In addition, for at least the next
several quarters, we expect to incur costs related to our separation from 3Com.
We anticipate that our operating margins may be lower over the next 12-18 months
as compared to recent quarters, and there may be several quarters in which we
report operating losses as we invest to expand our business, take advantage of
market opportunities and execute our strategic plan as an independent
stand-alone company.
11
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage of
total revenues represented by the line items reflected in Palm's condensed
consolidated income statements:
Three months ended Nine months ended
------------------ -----------------
February 25, February 26, February 25, February 26,
2000 1999 2000 1999
---- ---- ---- ----
Revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 56.4 53.7 56.5 55.2
------ ------ ------ ------
Gross profit 43.6 46.3 43.5 44.8
Operating expenses:
Sales and marketing 21.1 22.8 22.7 22.2
Research and development 7.9 8.7 7.1 8.1
General and administrative 4.5 4.6 4.1 4.4
Purchased in-process
technology - 1.7 - 0.6
Separation costs 3.0 - 1.7 -
------ ------ ------ ------
Total operating expenses 36.5 37.8 35.6 35.3
------ ------ ------ ------
Operating income 7.1 8.5 7.9 9.5
Interest and other
income (expense) 0.2 - 0.1 -
------ ------ ------ ------
Income before income taxes 7.3 8.5 8.0 9.5
Income tax provision 3.3 3.3 3.3 3.6
------ ------ ------ ------
Net income 4.0% 5.2% 4.7% 5.9%
====== ====== ====== ======
Effective tax rate 44.6% 38.4% 41.0% 38.4%
Excluding purchased
in-process technology
and separation costs:
Total operating expenses 33.5% 36.1% 33.9% 34.7%
Operating income 10.1% 10.2% 9.6% 10.1%
REVENUES
Revenues for the quarter ended February 25, 2000 were $272.3 million, an
increase of $146.4 million or 116% over revenues for the same quarter of the
previous year. This increase was due to higher unit shipments, offset by a
slight decline in the average selling price. Revenues increased in all
geographic areas, with Europe experiencing the highest growth rate.
International revenues for the third quarter of fiscal 2000 were 32% of revenues
compared with 27% of revenues in the same period of fiscal 1999.
Revenues for the nine months ended February 25, 2000 were $707.4 million, an
increase of $318.2 million or 82% over revenues for the same period of the
previous year. This increase was due primarily to higher unit shipments while
the average selling price remained relatively constant. Revenues increased in
all geographic areas, with revenues in Asia-Pacific and Europe growing at a
faster rate than in the United States. International revenues for the first nine
months of fiscal 2000 were 34% of revenues compared with 26% of revenues in the
same period of fiscal 1999.
12
GROSS PROFIT
Gross profit was $118.8 million and $307.5 million for the third quarter and
first nine months of fiscal 2000, increasing by 104% and 76%, respectively, over
the corresponding periods in fiscal 1999. Gross profit as a percentage of
revenues was 43.6% and 43.5% for the third quarter and first nine months of
fiscal 2000, declining by 2.7 and 1.3 percentage points, respectively, compared
to the corresponding periods in fiscal 1999. These declines were primarily
attributable to costs related to providing wireless Internet access services,
which we introduced during the first quarter of fiscal 2000. For the third
quarter of fiscal 2000, gross profit as a percentage of revenue also declined
due to a change in our product mix as compared to the prior year quarter.
SALES AND MARKETING
Sales and marketing expenses were $57.6 million and $160.3 million for the third
quarter and first nine months of fiscal 2000, increasing by 100% and 85%,
respectively, as compared to the same periods in fiscal 1999. For the year to
date periods, sales and marketing expenses increased slightly as a percentage of
revenue. The increases in absolute dollars compared to the prior year periods
were due to increased spending on U.S. demand generation activities and media
advertising, headcount and related expenses, and expanded sales and marketing
activities in Europe.
RESEARCH AND DEVELOPMENT
Research and development expenses were $21.5 million and $50.0 million for the
third quarter and first nine months of fiscal 2000, increasing by 95% and 59%,
respectively, as compared to the same periods in fiscal 1999. For the year to
date periods, research and development expenses declined moderately as a
percentage of revenue, as certain fixed costs were spread over a higher revenue
base. The increases in absolute dollars compared to the prior year periods were
due to increased spending on headcount and related expenses, and development
costs in new product areas, including Bluetooth and other wireless
communications technology.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $12.2 million and $29.2 million for the
third quarter and first nine months of fiscal 2000, increasing by 113% and 71%,
respectively, as compared to the same periods in fiscal 1999. For the year to
date periods, general and administrative expenses remained relatively constant
as a percentage of revenue. The increases in absolute dollars compared to the
prior year periods were due primarily to increased spending for headcount and
related expenses to support the growth in revenues. For the third quarter of
fiscal 2000, the increase also related to building the infrastructure for a
stand-alone public company. General and administrative expenses also increased
due to higher allocated costs from 3Com due to Palm's revenue increasing as a
percentage of 3Com's total revenue.
PURCHASED IN-PROCESS TECHNOLOGY
Purchased in-process technology for the third quarter and nine months ended
February 26, 1999 relates to the acquisition of Smartcode Technologie SARL in
February 1999. Approximately $2.1 million of the purchase price represented
purchased in-process technology that had not yet reached technological
feasibility, had no alternative future use and was charged to operations in the
third quarter of fiscal 1999. The primary project related to the purchased
in-process technology was completed in the first quarter of
13
fiscal 2000 and Palm began to derive revenue from the developed technology
beginning in the second quarter of fiscal 2000.
SEPARATION COSTS
Separation costs for the third quarter and nine months ended February 25, 2000
consist of costs associated with the process of becoming a stand-alone,
publicly-held company, including consulting and professional fees. Separation
costs were $8.2 million and $12.0 million for the third quarter and nine months
ended February 25, 2000, respectively. We expect to continue to incur separation
costs for at least the next several quarters.
INTEREST AND OTHER INCOME (EXPENSE)
Interest and other income (expense), on a net basis was $0.4 million and
$0.6 million for the third quarter and first nine months of fiscal 2000,
compared to a nominal expense for each period in fiscal 1999. We anticipate
that interest income will increase significantly in future periods, due to the
receipt of the net proceeds from the initial public offering and private
placements in March 2000.
INCOME TAX PROVISION
The effective tax rate for the first nine months of fiscal 2000 was 41.0%, up
from 38.4% for the first nine months of fiscal 1999. The increase in the
effective tax rate is primarily due to non-deductible separation costs and the
establishment of Palm's international legal structure, which in the initial year
is expected to create losses in certain foreign jurisdictions for which no
current tax benefit is obtained. We currently anticipate that our tax rate will
decline slightly in fiscal 2001, and will decline further in subsequent years.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at February 25, 2000 were $40.0 million, compared to
$0.5 million at May 28, 1999. The increase of $39.5 million for the nine months
ended February 25, 2000 was attributable to cash generated from operating
activities of $44.8 million and cash provided by financing activities of
$2.1 million, offset by cash used by investing activities of $7.4 million.
Cash provided by operating activities consisted of net income, adjusted for
non-cash charges and changes in working capital assets. The most significant
changes in working capital assets were increases in accounts payable and other
accrued liabilities, offset partially by a decrease in the payable to 3Com, and
by increases in accounts receivable and inventory. The decrease in the payable
to 3Com excludes the effect of the accrual of the $150 million dividend to 3Com,
which is classified as a non-cash investing and financing activity. Cash used by
investing activities of $7.4 million consisted entirely of capital expenditures.
Cash provided by financing activities of $2.1 million consisted of net transfers
from 3Com, offset by repayments of debt.
Based on current plans and business conditions, we believe that our existing
cash and cash equivalents, combined with the net proceeds of $1.17 billion
generated from the initial public offering and private placements, less the
payment of the dividend to 3Com of $150 million, will be sufficient to satisfy
our anticipated cash requirements for at least the next twelve months.
14
BUSINESS ENVIRONMENT AND RISK FACTORS
RISKS RELATED TO OUR BUSINESS
IF WE FAIL TO DEVELOP AND INTRODUCE NEW PRODUCTS AND SERVICES RAPIDLY AND
SUCCESSFULLY, WE WILL NOT BE ABLE TO COMPETE EFFECTIVELY AND OUR ABILITY TO
GENERATE REVENUES WILL SUFFER.
We operate in a highly competitive, quickly changing environment, and our future
success depends on our ability to develop and introduce new products and
services that our customers and end users choose to buy. If we are unsuccessful
at developing and introducing new products and services that are appealing to
end users, our business and operating results would be negatively impacted
because we would not be able to compete effectively and our ability to generate
revenues would suffer.
The development of new products and services can be very difficult and requires
high levels of innovation. The development process is also lengthy and costly.
If we fail to anticipate our end users' needs and technological trends
accurately or are otherwise unable to complete the development of products and
services quickly, we will be unable to introduce new products and services into
the market on a timely basis, if at all. For example, the Palm VII-TM- device
took more than two years to develop. In addition, because the Palm VII device
requires Internet services and applications to support it, we must also continue
to develop new services to maintain and broaden its user appeal.
Because the sales and marketing life cycle of our handheld devices is generally
12 to 18 months or less, we must:
continue to develop updates to our Palm platform, new handheld devices and
new Internet services, or our existing products and services will quickly
become obsolete;
manage the timing of new product introductions so that we minimize the
impact of customers delaying purchases of existing products in anticipation
of new product releases;
manage the timing of new product introductions to meet seasonal market
demands, including the holiday shopping season;
manage the levels of existing and older product and component inventories
to minimize inventory write-offs; and
adjust the prices of our existing products and services in order to
increase or maintain customer demand for these products and services.
IF WE DO NOT CORRECTLY ANTICIPATE DEMAND FOR OUR PRODUCTS, WE MAY NOT BE ABLE TO
SECURE SUFFICIENT QUANTITIES OR COST-EFFECTIVE PRODUCTION OF OUR HANDHELD
DEVICES OR WE COULD HAVE COSTLY EXCESS PRODUCTION OR INVENTORIES.
Historically, we have seen steady increases in demand for our products and have
generally been able to increase production to meet that demand. However, the
demand for our products depends on many factors and will be difficult to
forecast. As we introduce and support multiple handheld device products and as
competition in the market for our products intensifies, we expect that it will
become more difficult to forecast demand. Significant unanticipated fluctuations
in demand could cause the following problems in our operations:
If demand increases beyond what we forecast, we would have to rapidly
increase production at our third-party manufacturers. We would depend on
suppliers to provide additional volumes of
15
components and those suppliers might not be able to increase production
rapidly enough to meet unexpected demand. There is the risk that even if
we are able to procure enough components, our third-party manufacturers
might not be able to produce enough of our devices to meet the market
demand for our products. The inability of either our manufacturers or
our suppliers to increase production rapidly enough could cause us to
fail to meet customer demand.
Rapid increases in production levels to meet unanticipated demand could
result in higher costs for manufacturing and supply of components and other
expenses. These higher costs could lower our profits. Further, if
production is increased rapidly, manufacturing yields could decline, which
may also lower our profits.
If forecasted demand does not develop, we could have excess production
resulting in higher inventories of finished products and components, which
would use cash and could lead to write-offs of some or all of the excess
inventories. Lower than forecasted demand could also result in excess
manufacturing capacity at our third party manufacturers and failure to meet
some minimum purchase commitments, each of which could result in lower
margins.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO FLUCTUATIONS AND SEASONALITY, AND
IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR
SHARE PRICE MAY DECREASE SIGNIFICANTLY.
Our operating results are difficult to predict. Our future quarterly operating
results may fluctuate significantly and may not meet the expectations of
securities analysts or investors. If this occurs, the price of our stock would
likely decline. Factors that may cause fluctuations in our operating results
include the following:
Seasonality. Historically, our revenues have usually been weaker in the
first and third quarters of each fiscal year and have, from time to time,
been lower than the preceding quarter. This weakness is due to the fact
that our devices are highly consumer-oriented, and consumer buying is
traditionally lower in these quarters. As our licensing revenues grow, we
expect that they will contribute to the fluctuations in our quarterly
results because the products offered by our licensees are also primarily
consumer-oriented. In addition, we attempt to time our new product releases
to coincide with relatively higher consumer spending in the second and
fourth fiscal quarters, which contributes to these seasonal variations.
However, our revenues for the third fiscal quarter this year were greater
than revenues in the second fiscal quarter this year, due to stronger
demand for our products in the third fiscal quarter. This pattern may not
occur in the future.
Increases in Operating Expenses. As we expand our operations, we expect
that our operating expenses, particularly our sales, marketing and research
and development costs, will continue to increase. We also expect to make
significant expenditures to expand our Internet services through increased
marketing activities and investments in network expansion related to our
subscription-based Internet access service. These Internet services
expenditures as well as a significant portion of our sales, marketing and
research and development costs are fixed, at least in the short term. If
revenues decrease and we are unable to reduce those costs rapidly, our
operating results would be negatively affected. In addition, we will add
new fixed costs to continue building an independent business and
administration infrastructure following our recent separation from 3Com.
Over the next several quarters we expect expenses to grow more rapidly than
revenues, which will hurt our quarterly operating results.
16
Product Mix. Our profit margins differ among the handheld device, Palm
platform licensing and Internet services parts of our business. In
addition, the product mix of our device sales affects profit margins in any
particular quarter. As our business evolves and the mix of revenues from
devices, licenses and services varies from quarter to quarter, our
operating results will likely fluctuate.
New Product Introductions. As we introduce new products and services, the
timing of these introductions will affect our quarterly operating results.
We may have difficulty predicting the timing of new product and service
introductions and the user acceptance of these new products and services.
If products and services are introduced earlier or later than anticipated,
or if user acceptance is unexpectedly high or low, our quarterly operating
results may fluctuate unexpectedly. In addition, we typically increase
sales and marketing expenses to support new product introductions.
Use of Purchase Orders with Customers. We rely on one-time purchase orders
rather than long-term contracts with our distributor customers. Because we
cannot predict with certainty incoming purchase orders, decreases in orders
or failure to fulfill orders may cause our operating results to fluctuate.
WE RELY ON THIRD-PARTY MANUFACTURERS TO PRODUCE OUR HANDHELD DEVICES, AND OUR
REPUTATION AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED BY OUR
INABILITY TO CONTROL THEIR OPERATIONS.
We outsource all of our manufacturing to Manufacturers' Services Limited and
Flextronics. We depend on these third-party manufacturers to produce sufficient
volume of our products in a timely fashion and at satisfactory quality levels.
If our third-party manufacturers fail to produce quality products on time and in
sufficient quantities, our reputation and results of operations would suffer. We
depend on Flextronics to manufacture some of our device products at its
facilities in Mexico, California and Malaysia, and the rest of our device
products are manufactured by Manufacturers' Services Limited at its Utah
facility. The cost, quality and availability of third-party manufacturing
operations are essential to the successful production and sale of our handheld
devices. Our reliance on third parties exposes us to the following risks outside
our control:
unexpected increases in manufacturing costs;
interruptions in shipments if one of our manufacturers is unable to
complete production;
inability to control quality of finished device products;
inability to control delivery schedules;
unpredictability of manufacturing yield;
potential lack of adequate capacity; and potential inability to secure
adequate volumes of components.
We began working with Manufacturers' Services Limited when it purchased 3Com's
Utah facility in November 1999. As a result, we have not had significant working
experience with Manufacturers'
17
Service Limited. If we are unable to manage our relationship with
Manufacturers' Services Limited successfully, our ability to manufacture our
products would be harmed and our results of operations would suffer.
We do not have a manufacturing agreement with Flextronics, upon whom we rely to
manufacture a significant number of our device products. We presently order our
products on a purchase order basis from Flextronics. The absence of a
manufacturing agreement means that, with little or no notice, Flextronics could
refuse to continue to manufacture all or some of the units of our devices that
we require or change the terms under which it manufactures our device products.
If Flextronics were to stop manufacturing our devices, we may be unable to
replace the lost manufacturing capacity on a timely basis and our results of
operations could be harmed. In addition, if Flextronics were to change the terms
under which they manufacture for us, our manufacturing costs could increase and
our profitability could suffer.
WE DEPEND ON OUR SUPPLIERS, MANY OF WHICH ARE THE SOLE SOURCE FOR OUR
COMPONENTS, AND OUR PRODUCTION WOULD BE SERIOUSLY HARMED IF THESE SUPPLIERS ARE
NOT ABLE TO MEET OUR DEMAND AND ALTERNATIVE SOURCES ARE NOT AVAILABLE.
Our products contain components, including liquid crystal displays, touch
panels, memory chips and microprocessors, that are procured from a variety of
suppliers. The cost, quality and availability of components are essential to the
successful production and sale of our device products. Recently, we have
experienced shortages of certain key components, including flash memory chips
and liquid crystal displays. We believe that these supply limitations are due to
unexpectedly high demand from cellular telephone manufacturers. In addition, in
1999 we modified the design of our Palm VII device as a result of our inability
to obtain adequate supplies of the radio crystals and memory chips.
Some components, such as displays, power supply integrated circuits, digital
signal processors, microprocessors, crystals and several radio frequency and
discrete components, come from sole or single source suppliers. Alternative
sources are not currently available for these sole and single source components.
If suppliers are unable to meet our demand for sole source components and if we
are unable to obtain an alternative source or if the price for an alternative
source is prohibitive, our ability to maintain timely and cost-effective
production of our handheld computing device products would be seriously harmed.
In addition, because we rely on one-time purchase orders with our suppliers,
including our sole and single source suppliers, we cannot predict with certainty
our ability to procure components if the demand for our products exceeds our
forecast. If either the shortage in radio crystals, memory chips, liquid crystal
displays or any other key component persists or worsens, we will likely not be
able to deliver sufficient quantities of our products to satisfy demand. In
addition our costs to purchase these components would increase, which would
lower our profits.
WE DO NOT KNOW IF THE PALM PLATFORM LICENSING AND INTERNET SERVICES PARTS OF OUR
BUSINESS WILL BE ABLE TO GENERATE SIGNIFICANT REVENUE IN THE FUTURE, AND WE WILL
CONTINUE TO RELY ON OUR HANDHELD DEVICE PRODUCTS AS THE PRIMARY SOURCE OF OUR
REVENUE FOR THE FORESEEABLE FUTURE.
Our future growth and a significant portion of our future revenue depend on the
commercial success of our Palm handheld devices, which comprise the primary
product line that we currently offer. We expanded our Palm platform licensing
and Internet services parts of our business only recently, and these parts of
our business have generated a small percentage of our revenues. If revenues from
our device business do not grow, our other business activities will not be able
to compensate for this shortfall.
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A SIGNIFICANT PORTION OF OUR REVENUES CURRENTLY COMES FROM A SMALL NUMBER OF
DISTRIBUTORS, AND ANY DECREASE IN REVENUES FROM THESE DISTRIBUTORS COULD HARM
OUR RESULTS OF OPERATIONS.
A significant portion of our revenues comes from only a small number of
distributors. Ingram Micro and Tech Data represented approximately 30% and 10%,
respectively, of our revenues in the nine months ended February 25, 2000. We
expect that the majority of our revenues will continue to depend on sales of our
handheld devices to a small number of distributors. Any downturn in the business
of these customers could seriously harm our revenues and results of operations.
WE RELY ON DISTRIBUTORS, RETAILERS AND RESELLERS TO SELL OUR PRODUCTS, AND
DISRUPTIONS TO THESE CHANNELS WOULD ADVERSELY AFFECT OUR ABILITY TO GENERATE
REVENUES FROM THE SALE OF OUR HANDHELD DEVICES.
Because we sell a significant portion of our products to distributors, retailers
and traditional and Internet based resellers, we are subject to many risks,
including risks related to their inventory levels and support for our products.
Our distributors, retailers and resellers have traditionally maintained
significant levels of our products in their inventories. If distributors,
retailers and resellers attempt to reduce their levels of inventory or if they
do not maintain sufficient levels to meet customer demand, our sales could be
negatively impacted. If we reduce the prices of our products to these customers,
we may have to compensate them for the difference between the higher price they
paid to buy their inventory and the new lower prices. In addition, like other
manufacturers, we are exposed to the risk of product returns from distributors,
either through their exercise of contractual return rights or as a result of our
strategic interest in assisting distributors in balancing inventories.
Our distributors, retailers and resellers also sell products offered by our
competitors. If our competitors offer our distributors, retailers and resellers
more favorable terms, those distributors, retailers and resellers may
de-emphasize or decline to carry our products. In the future, we may not be able
to retain or attract a sufficient number of qualified distributors, retailers
and resellers. Further, distributors, retailers and resellers may not recommend,
or continue to recommend, our products. If we are unable to maintain successful
relationships with distributors, retailers and resellers or to expand our
distribution channels, our business will suffer.
We believe our distributors, retailers and traditional resellers are
experiencing heightened competition from Internet-based suppliers that
distribute directly to end-user customers. We also sell our products directly to
end-user customers from our Palm.com website. These actions could cause conflict
among our channels of distribution, which could seriously harm our revenues and
results of operations.
IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH EXISTING OR NEW COMPETITORS, OUR
RESULTING LOSS OF COMPETITIVE POSITION COULD RESULT IN PRICE REDUCTIONS, FEWER
CUSTOMER ORDERS, REDUCED MARGINS AND LOSS OF MARKET SHARE.
We compete in the handheld device, operating system software and Internet
services markets. The markets for these products and services are highly
competitive and we expect competition to increase in the future. Some of our
competitors or potential competitors have significantly greater financial,
technical and marketing resources than we do. These competitors may be able to
respond more rapidly than Palm to new or emerging technologies or changes in
customer requirements. They may also devote greater resources to the
development, promotion and sale of their products than we do.
19
Our handheld computing device products compete with a variety of smart
handheld devices, including keyboard-based devices, sub-notebook computers,
smart phones and two-way pagers. Our principal competitors include Casio,
Compaq, Hewlett-Packard, Psion, Sharp and Palm platform licensees such as
TRG and Handspring.
Our Palm platform competes primarily with operating systems such as
Microsoft's Windows CE for palm-sized personal computers and Symbian's EPOC
for wireless devices. New product introductions based on both the Windows
CE and EPOC operating systems have recently been announced. Licensees of
our Palm platform are under no obligation to introduce new products based
on our operating system, and may elect to use an alternative operating
system, in which case we may not be able to increase our revenue from
licensing the Palm platform, or expand the proliferation of the Palm
economy.
Our Internet services compete with a variety of alternative technologies
and services, such as those based on different industry standards for
wireless Internet access, information appliances that provide Internet
connectivity and other traditional and developing methods. Potential
competitors to our wireless internet services include Research in Motion
Limited and Omnisky.
We expect our competitors to continue to improve the performance of their
current products and services and to introduce new products, services and
technologies. For example, Microsoft has announced that it is planning to
introduce a new version of its Windows CE operating system within the next
month. We believe that Microsoft plans to invest aggressively to assist its
licensees in marketing the Pocket PC line of handheld computers based on this
new version of the Windows CE operating system. Successful new product
introductions or enhancements by our competitors could reduce the sales and
market acceptance of our products and services, cause intense price competition
or make our products obsolete. To be competitive, we must continue to invest
significant resources in research and development, sales and marketing and
customer support. We cannot be sure that we will have sufficient resources to
make these investments or that we will be able to make the technological
advances necessary to be competitive. Increased competition could result in
price reductions, fewer customer orders, reduced margins and loss of market
share. Our failure to compete successfully against current or future competitors
could seriously harm our business, financial condition and results of
operations.
IF WE FAIL TO EFFECTIVELY RESPOND TO COMPETITION FROM PRODUCTS INTRODUCED BY
LICENSEES OF OUR PALM PLATFORM OR IF OUR LICENSEES FAIL TO SELL PRODUCTS BASED
ON THE PALM PLATFORM, OUR RESULTS OF OPERATIONS MAY SUFFER AS THE REVENUES WE
RECEIVE FROM LICENSE FEES MAY NOT COMPENSATE FOR THE LOSS OF REVENUES FROM OUR
DEVICE PRODUCTS.
The success of our business depends on both the sale of handheld device
products and the licensing of our Palm platform. However, licensees of our
Palm platform offer products that compete directly or indirectly with our
handheld computing devices. For example, licensees such as Nokia, Sony or
QUALCOMM may use our Palm platform in devices such as mobile phones or other
similar products that can compete indirectly with our handheld devices. In
addition, while we expect to receive licensing revenue from Handspring and
TRG, our device products compete directly for users and distributors with
their devices. If revenues from our handheld devices suffer because of
competition from licensees of our Palm platform, our results of operations
would suffer and our ability to implement our business model would be
seriously challenged. In addition, our licensees may not be successful in
selling products based on the Palm platform, which could harm our business
and results of operations.
20
OUR PALM PLATFORM AND HANDHELD DEVICES MAY CONTAIN ERRORS OR DEFECTS, WHICH
COULD RESULT IN THE REJECTION OF OUR PRODUCTS AND DAMAGE TO OUR REPUTATION, AS
WELL AS LOST REVENUES, DIVERTED DEVELOPMENT RESOURCES AND INCREASED SERVICE
COSTS AND WARRANTY CLAIMS.
Our Palm platform and our devices are complex and must meet stringent user
requirements. We must develop our software and hardware products quickly to keep
pace with the rapidly changing handheld device market. Products and services as
sophisticated as ours are likely to contain undetected errors or defects,
especially when first introduced or when new models or versions are released. We
have in the past experienced delays in releasing some models and versions of our
products until problems were corrected. Our products may not be free from errors
or defects after commercial shipments have begun, which could result in the
rejection of our products, damage to our reputation, lost revenues, diverted
development resources and increased customer service and support costs and
warranty claims. Any of these results could harm our business.
IF WE FAIL TO MANAGE OUR GROWTH EFFECTIVELY, WE MAY NOT BE ABLE TO SUCCESSFULLY
MANAGE OUR BUSINESS, WHICH COULD CAUSE US TO FAIL TO MEET OUR CUSTOMER DEMAND OR
TO ATTRACT NEW CUSTOMERS.
Our ability to successfully offer our products and implement our business plan
in a rapidly evolving market requires an effective planning and management
process. We continue to increase the scope of our operations domestically and
internationally and have grown our shipments and headcount substantially. At
December 31, 1999, we had a total of approximately 652 employees. At February
25, 2000 we had a total of approximately 878 employees. In addition, we plan to
continue to hire a significant number of employees this year. This growth has
placed, and our anticipated growth in future operations will continue to place,
a significant strain on our management systems and resources and increase our
expenses.
We expect that we will need to continue to improve our financial and managerial
controls, reporting systems and procedures. While we are currently implementing
stand-alone versions of most of the transaction processing systems historically
used by 3Com, we may decide to purchase new systems in the future that more
closely match our business needs and incur significant additional expenses in
connection with those systems. In addition, we will need to continue to expand,
train and manage our work force worldwide.
Furthermore, we expect that we will be required to manage multiple relationships
with various customers and other third parties. In particular, we are
implementing a new administrative and managerial infrastructure due to our
separation from 3Com. Our future success depends on the implementation of this
infrastructure.
THE MARKET FOR THE DELIVERY OF INTERNET SERVICES THROUGH HANDHELD DEVICES IS
NEW AND RAPIDLY EVOLVING, AND OUR BUSINESS AND OUR ABILITY TO GENERATE
REVENUES FROM OUR HANDHELD DEVICES, PALM PLATFORM OR INTERNET SERVICES COULD
SUFFER IF THIS MARKET DOES NOT DEVELOP OR WE FAIL TO ADDRESS THIS MARKET
EFFECTIVELY.
The market for the delivery of Internet services through handheld devices is
new and rapidly evolving. In addition, our Internet services strategy has
been developed only recently, and we must continue to adapt it to compete in
the rapidly evolving Internet services market. We only recently introduced
our Palm.Net(TM) service, a subscription-based wireless access service that
enables Palm VII users to access
21
web-clipped content on the Internet. Other competitors
have introduced or developed, or are in the process of introducing or
developing, products that facilitate the delivery of Internet services through
handheld devices. We cannot assure you that individuals currently using
competing products to access the Internet remotely, such as portable personal
computers and wireless telephones, will widely adopt handheld devices as a means
of accessing Internet services. Accordingly, it is extremely difficult to
predict which products will be successful in this market or the future size and
growth of this market. In addition, given the limited history and rapidly
evolving nature of this market, we cannot predict the price that wireless
subscribers will be willing to pay for these products and services. These risks
could affect our ability to support the Palm.Net service on a large scale and
price the service at a level that produces expected returns.
WE MAY NOT BE ABLE TO DELIVER INTERNET ACCESS IF OUR TELECOMMUNICATIONS CARRIER
RAISES ITS RATES, DISCONTINUES DOING BUSINESS WITH US OR DOES NOT DELIVER
ACCEPTABLE SERVICE.
The future success of our Internet services business substantially depends on
the capacity, affordability, reliability and security of our telecommunications
networks. Only a small number of telecommunications providers offer the network
services we require. We currently rely on BellSouth to provide all of our Palm
VII wireless network services pursuant to an agreement. Our agreement with
BellSouth permits each party to terminate the agreement on an annual basis. If
BellSouth failed to provide us with service at rates acceptable to us or at all,
we may not be able to provide Internet access to our users. In addition, our
Palm VII products are configured around the frequency standard used by
BellSouth. If we needed to switch to another telecommunications carrier, we
would have to redesign significant portions of our software and hardware to
permit transmission on a different frequency and service to users of existing
Palm VII products would be disrupted. If we were required to redesign these
elements, our Internet services part of our business could be adversely
affected. If BellSouth delivers unacceptable service, the quality of our
Internet services would suffer and we would likely lose users who are
dissatisfied with our service. In addition, BellSouth provides service only in
the continental United States.
WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR WIRELESS INTERNET SERVICES INTO
INTERNATIONAL MARKETS.
We intend to expand our network services to support Internet services
internationally, but doing so will require us to enter into new relationships
with telecommunications providers abroad. We may not be able to enter into
relationships with international telecommunications providers which are on
favorable terms to us. In addition, because many international
telecommunications providers use different standards and transmit data on
different frequencies than BellSouth, we are likely to incur incremental
expenses related to the redesign of significant portions of our software and
hardware.
OUR REPUTATION AND ABILITY TO GENERATE REVENUES WILL BE HARMED IF DEMAND FOR OUR
INTERNET SERVICES EXCEEDS OUR TELECOMMUNICATIONS AND NETWORK CAPACITY.
We may from time to time experience increases in our Internet services usage
which exceed our available telecommunications capacity and the capacity of our
third-party network servers. As a result, users may be unable to register or log
on to our service, may experience a general slow-down in their Internet access
or may be disconnected from their sessions. Excessive user demand could also
result in system failures of our third-party network servers' networks.
22
Inaccessibility, interruptions or other limitations on the ability to access our
service due to excessive user demand, or any failure of our third-party network
servers to handle user traffic, would have a material adverse effect on our
reputation and our revenues.
WE PLAN TO EXPAND OUR DIRECT E-COMMERCE OPERATION, AND OUR ABILITY TO GENERATE
REVENUES FROM OUR INTERNET SERVICES COULD BE HARMED IF THIS OPERATION IS NOT
SUCCESSFUL.
We may not be able to achieve any or all of the necessary components of a
successful e-commerce operation. We intend to expand our Palm.com and Palm.Net
websites. This expansion will require additional expenditures. These
expenditures are anticipated to exceed revenues from these services over the
next few years. We have little experience in implementing or operating a direct
e-commerce business, and if we are not successful in operating it or in
successfully managing our current sales channels alongside our direct e-commerce
channel, our business and financial condition could be materially harmed.
OUR INTERNET SERVICES BUSINESS PROSPECTS COULD SUFFER IF THE INTERNET DOES NOT
CONTINUE TO GROW AS A MEDIUM FOR INTERACTIVE CONTENT AND SERVICES.
Our future success depends in part on the continued growth and reliance by
consumers and businesses on the Internet, particularly in the market for
Internet services and networking of handheld computing devices. Use and growth
of the Internet will depend in significant part on continued rapid growth in the
number of households and commercial, educational and government institutions
with access to the Internet. The use and growth of the Internet will also depend
on the number and quality of products and services designed for use on the
Internet. Because use of the Internet as a source of information, products and
services is a relatively recent phenomenon, it is difficult to predict whether
the number of users drawn to the Internet will continue to increase and whether
the market for commercial use of the Internet will continue to develop and
expand. Internet use patterns may decline as the novelty of the medium recedes.
The rapid rise in the number of Internet users and the growth of electronic
commerce and applications for the Internet has placed increasing strains on the
Internet's communications and transmission infrastructure. This could lead to
significant deterioration in transmission speeds and the reliability of the
Internet as a commercial medium and could reduce the use of the Internet by
businesses and individuals. The Internet may not be able to support the demands
placed upon it by this continued growth. Any failure of the Internet to support
growth due to inadequate infrastructure or for any other reason would seriously
limit its development as a viable source of commercial and interactive content
and services. This could impair the development and acceptance of our Internet
services which could in turn harm our business prospects.
IF THE SECURITY OF OUR WEBSITES IS COMPROMISED, OUR REPUTATION COULD SUFFER
AND CUSTOMERS MAY NOT BE WILLING TO USE OUR INTERNET SERVICES, WHICH COULD
CAUSE OUR REVENUES TO DECLINE.
A significant barrier to widespread use of electronic commerce sites, such as
our Palm.com site, and network services sites, such as our Palm.Net site, is
concern for the security of confidential information transmitted over public
networks. Despite our efforts to protect the integrity of our Palm.com and
Palm.Net sites, a party may be able to circumvent our security measures and
could misappropriate proprietary information or cause interruptions in our
operations and damage our reputation. Any such
23
action could negatively affect our customers' willingness to engage in online
commerce with us. We may be required to expend significant capital and other
resources to protect against these security breaches or to alleviate problems
caused by these breaches.
WE MAY NOT BE ABLE TO MAINTAIN AND EXPAND OUR BUSINESS IF WE ARE NOT ABLE TO
RETAIN, HIRE AND INTEGRATE SUFFICIENT QUALIFIED PERSONNEL.
Our future success depends partly on the continued contribution of our key
executive, technical, sales, marketing, supply chain and administrative
personnel. It also depends on our ability to expand, integrate and retain our
management team. Many members of our senior management have been with the
business only a short time. In addition, recruiting and retaining skilled
personnel, including software and hardware engineers, is highly competitive. If
we fail to retain, hire and integrate qualified employees and contractors, we
will not be able to maintain and expand our business.
THIRD PARTIES HAVE CLAIMED AND MAY CLAIM IN THE FUTURE WE ARE INFRINGING THEIR
INTELLECTUAL PROPERTY, AND WE COULD SUFFER SIGNIFICANT LITIGATION OR LICENSING
EXPENSES OR BE PREVENTED FROM SELLING PRODUCTS IF THESE CLAIMS ARE SUCCESSFUL.
In the course of our business, we frequently receive claims of infringement or
otherwise become aware of potentially relevant patents or other intellectual
property rights held by other parties. We evaluate the validity and
applicability of these intellectual property rights, and determine in each case
whether we must negotiate licenses or cross-licenses to incorporate or use the
proprietary technologies in our products. Third parties may claim that we or our
customers or Palm platform licensees are infringing their intellectual property
rights, and we may be found to infringe those intellectual property rights and
require a license to use those rights. We may be unaware of intellectual
property rights of others that may cover some of our technology, products and
services. Moreover, in connection with future intellectual property infringement
claims, we will not have the benefit of asserting counterclaims based on 3Com's
intellectual property portfolio, and we will not be able to offer licenses to
3Com's intellectual property rights in order to resolve claims.
Any litigation regarding patents or other intellectual property could be costly
and time-consuming, and divert our management and key personnel from our
business operations. The complexity of the technology involved and the
uncertainty of intellectual property litigation increase these risks. Claims of
intellectual property infringement might also require us to enter into costly
royalty or license agreements or indemnify our Palm platform licensees. However,
we may not be able to obtain royalty or license agreements on terms acceptable
to us, or at all. We also may be subject to significant damages or injunctions
against development and sale of our products.
We often rely on licenses of intellectual property for use in our business. We
cannot assure you that these licenses will be available in the future on
favorable terms or at all. In addition, our position with respect to the
negotiation of licenses may deteriorate as a result of our separation from 3Com.
For example, we are currently re-negotiating a Patent Cross License Agreement
between 3Com and IBM to name us as an additional licensee. The re-negotiation
will likely require us to pay additional royalties to IBM. If we do not
successfully re-negotiate this agreement, we may not be able to continue to
license certain IBM technology after our separation from 3Com on favorable
terms, or at all, which could have a material adverse effect on our business.
24
IF THIRD PARTIES INFRINGE OUR INTELLECTUAL PROPERTY, WE MAY EXPEND SIGNIFICANT
RESOURCES ENFORCING OUR RIGHTS OR SUFFER COMPETITIVE INJURY.
Our success depends in large part on our proprietary technology. We rely on a
combination of patents, copyrights, trademarks and trade secrets,
confidentiality provisions and licensing arrangements to establish and protect
our proprietary rights. If we fail to protect or to enforce our intellectual
property rights successfully, our competitive position could suffer, which could
harm our operating results.
Our pending patent and trademark registration applications may not be allowed or
competitors may challenge the validity or scope of these patent applications or
trademark registrations. In addition, our patents may not provide us a
significant competitive advantage.
We may be required to spend significant resources to monitor and police our
intellectual property rights. We may not be able to detect infringement and may
lose competitive position in the market before we do so. In addition,
competitors may design around our technology or develop competing technologies.
Intellectual property rights may also be unavailable or limited in some foreign
countries, which could make it easier for competitors to capture market share.
In the past, there have been several thefts of computer equipment from us and
our employees. This computer equipment has contained proprietary information. We
have formulated a security plan to reduce the risk of any future thefts and have
cooperated with state and federal law enforcement officials in an investigation
of past incidents. We may not be successful in preventing future thefts, or in
preventing those responsible for past thefts from using our technology to
produce competing products. The unauthorized use of Palm technology by
competitors could have a material adverse effect on our ability to sell our
products in some markets.
OUR FUTURE RESULTS COULD BE HARMED BY ECONOMIC, POLITICAL, REGULATORY AND OTHER
RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS.
Since we sell our products worldwide, our business is subject to risks
associated with doing business internationally. We anticipate that revenue from
international operations will represent an increasing portion of our total
revenue. In addition, two of the facilities where our devices are manufactured
are located outside the United States. Accordingly, our future results could be
harmed by a variety of factors, including:
changes in foreign currency exchange rates;
changes in a specific country's or region's political or economic
conditions, particularly in emerging markets;
trade protection measures and import or export licensing requirements;
potentially negative consequences from changes in tax laws;
difficulty in managing widespread sales and manufacturing operations; and
less effective protection of intellectual property.
25
WE INTEND TO PURSUE STRATEGIC ACQUISITIONS AND WE MAY NOT BE ABLE TO
SUCCESSFULLY MANAGE OUR OPERATIONS IF WE FAIL TO SUCCESSFULLY INTEGRATE ACQUIRED
BUSINESSES.
We often evaluate acquisition opportunities that could provide us with
additional product or services offerings or additional industry expertise. Any
future acquisition could result in difficulties assimilating acquired operations
and products, diversion of capital and management's attention away from other
business issues and opportunities and amortization of acquired intangible
assets. Integration of acquired companies may result in problems related to
integration of technology and inexperienced management teams. Our management has
had limited experience in assimilating acquired organizations and products into
our operations. We may not successfully integrate any operations, personnel or
products that we may acquire in the future. If we fail to successfully integrate
acquisitions, our business could be materially harmed.
OUR ABILITY TO PURSUE MERGERS AND ACQUISITIONS MAY BE LIMITED.
3Com has sought a ruling from the Internal Revenue Service that the distribution
of 3Com's shares of Palm common stock to 3Com's stockholders will be not be
taxable. Such ruling is expected to require 3Com and Palm, for up to two years
following the distribution date, not to engage in certain transactions that
would constitute a change of more than 50% of the equity interest in either
company. In addition, the ruling is expected to require that until the
distribution date, 3Com must maintain at least an 80% controlling interest in
Palm. Consequently, our ability to engage in mergers and acquisitions may be
limited by these requirements. If either 3Com or Palm fail to conform to
requirements set forth in the ruling, there would be material adverse
consequences, potentially including making the distribution taxable, and causing
the company which was responsible for such non-conformance to indemnify the
other company for any resulting damages.
RISKS RELATED TO OUR SEPARATION FROM 3COM
WE CURRENTLY USE 3COM'S OPERATIONAL AND ADMINISTRATIVE INFRASTRUCTURE, AND OUR
ABILITY TO SATISFY OUR CUSTOMERS AND OPERATE OUR BUSINESS WILL SUFFER IF WE DO
NOT DEVELOP OUR OWN INFRASTRUCTURE QUICKLY AND COST-EFFECTIVELY.
We currently use 3Com's systems to support our operations, including systems to
manage inventory, order processing, human resources, shipping, accounting,
payroll and internal computing operations. Many of these systems are proprietary
to 3Com and are very complex. These systems have been modified, and are in the
process of being further modified, to enable us to separately track items
related to our business. These modifications, however, may result in unexpected
system failures or the loss or corruption of data.
We are in the process of creating our own systems to replace 3Com's systems. We
may not be successful in implementing these systems and transitioning data from
3Com's systems to ours.
Any failure or significant downtime in 3Com's or our own information systems
could prevent us from taking customer orders, shipping products or billing
customers and could harm our business. In addition, 3Com's and our
information systems require the services of employees with extensive
knowledge of these information systems and the business environment in which
we operate. In order to successfully implement and operate our systems, we
must be able to attract and retain a significant
26
number of highly skilled employees. If we fail to attract and retain the
highly skilled personnel required to implement, maintain, and operate our
information systems, our business could suffer.
In addition, we currently have office space in 3Com's Santa Clara campus. We
have entered into arrangements with 3Com to lease these facilities under a lease
that is terminable with six months notice beginning in July 2001 and expires in
July 2002. After this transition period, we will need to find alternative
facilities. If we fail to find replacement facilities in a timely fashion, our
business will be harmed.
OUR STOCK PRICE MAY DECLINE AND WE WILL NOT BE ABLE TO OPERATE OUR BUSINESS
WITHOUT 3COM'S CONTROL IF 3COM DOES NOT COMPLETE ITS DISTRIBUTION OF OUR COMMON
STOCK.
Approximately four to six months following our initial public offering, 3Com
intends to distribute its remaining shares of Palm common stock to 3Com
stockholders, subject to receiving 3Com board approval and a ruling from the
Internal Revenue Service that the distribution will not be taxable. This
distribution may not occur by that time or at all. We do not know yet what the
ruling from the Internal Revenue Service regarding the tax treatment of the
separation and the distribution will be. If 3Com does not receive a favorable
tax ruling, it is not likely to make the distribution in the expected time frame
or at all. In addition, until this distribution occurs, the risks discussed
below relating to 3Com's control of us and the potential business conflicts of
interest between 3Com and us will continue to be relevant to our stockholders.
If the distribution is delayed or not completed at all, the liquidity of our
shares in the market will be severely constrained unless and until 3Com elects
to sell some of its significant ownership. There are no limits on these sales
and the sale or potential sale by 3Com could adversely affect market prices. In
addition, because only approximately 5% of our outstanding common stock is
publicly traded, trades of a relatively small percentage of our outstanding
stock could have a disproportionate effect on our stock price. Also, if 3Com
does not distribute its shares, we will face significant difficulty hiring and
retaining key personnel, many of whom are attracted by the potential of
operating our business as a fully independent entity.
WE WILL BE CONTROLLED BY 3COM AS LONG AS IT OWNS A MAJORITY OF OUR COMMON STOCK,
AND OUR OTHER STOCKHOLDERS WILL BE UNABLE TO AFFECT THE OUTCOME OF STOCKHOLDER
VOTING DURING SUCH TIME.
3Com owns approximately 94% of our outstanding common stock. As long as 3Com
owns a majority of our outstanding common stock, 3Com will be able to change the
composition of our board of directors without calling a special meeting, and
therefore, control any aspect of our business direction and policies.
Stockholders other than 3Com will not be able to affect the outcome of any
stockholder vote prior to the planned distribution of our stock to the 3Com
stockholders.
OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR RESULTS AS
A SEPARATE COMPANY.
Our consolidated financial statements have been carved out from the
consolidated financial statements of 3Com using the historical results of
operations and historical bases of the assets and liabilities of the 3Com
handheld computing business that we comprise. Accordingly, the historical
financial information does not necessarily reflect what our financial
position, results of operations and cash flows would have been had we been a
separate, stand-alone entity during the periods presented. 3Com did not
account for us, and we were not operated, as a separate, stand-alone entity
for the periods presented.
27
Our costs and expenses include allocations from 3Com for centralized
corporate services and infrastructure costs, including:
legal;
accounting;
treasury;
real estate;
information technology;
distribution;
customer service;
sales;
marketing; and
engineering.
These allocations have been determined on bases that 3Com and Palm considered to
be reasonable reflections of the utilization of services provided to or the
benefit received by Palm. The historical financial information is not
necessarily indicative of what our results of operations, financial position and
cash flows will be in the future. We have not made adjustments to our historical
financial information to reflect many significant changes that will occur in our
cost structure, funding and operations as a result of our separation from 3Com,
including increased costs associated with reduced economies of scale, increased
marketing expenses related to building a company brand identity separate from
3Com and increased costs associated with being a publicly traded, stand-alone
company.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH 3COM WITH RESPECT TO
OUR PAST AND ONGOING RELATIONSHIPS AND, BECAUSE OF 3COM'S CONTROLLING OWNERSHIP,
WE MAY NOT RESOLVE THESE CONFLICTS ON THE MOST FAVORABLE TERMS TO US.
Conflicts of interest may arise between 3Com and us in a number of areas
relating to our past and ongoing relationships, including:
labor, tax, employee benefit, indemnification and other matters arising
from our separation from 3Com;
intellectual property matters;
employee retention and recruiting;
sales or distributions by 3Com of all or any portion of its ownership
interest in us;
the nature, quality and pricing of transitional services 3Com has agreed to
provide us; and
business opportunities that may be attractive to both 3Com and us.
Nothing restricts 3Com from competing with us.
We may not be able to resolve any potential conflicts, and even if we do, the
resolution may be less favorable than if we were dealing with an unaffiliated
party. The agreements we have entered into with
28
3Com may be amended upon agreement between the parties. While we are
controlled by 3Com, 3Com may be able to require us to agree to amendments to
these agreements that may be less favorable to us than the current terms of
the agreements.
OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST BECAUSE OF
THEIR OWNERSHIP OF 3COM COMMON STOCK.
Many of our directors and executive officers have a substantial amount of their
personal financial portfolios in 3Com common stock and options to purchase 3Com
common stock. Their options to purchase 3Com common stock may not convert into
options to purchase our common stock if the distribution does not occur.
Ownership of 3Com common stock by our directors and officers could create
potential or perceived conflicts of interest when directors and officers are
faced with decisions that could have different implications for 3Com and us.
IF THE TRANSITIONAL SERVICES BEING PROVIDED TO US BY 3COM ARE NOT SUFFICIENT TO
MEET OUR NEEDS, OR IF WE ARE NOT ABLE TO REPLACE THESE SERVICES AFTER OUR
AGREEMENTS WITH 3COM EXPIRE, WE WILL BE UNABLE TO MANAGE CRITICAL OPERATIONAL
FUNCTIONS OF OUR BUSINESS.
3Com is providing transitional services to us, including services related to:
information technology systems;
supply chain;
human resources administration;
product order administration;
customer service;
buildings and facilities;
treasury; and
legal, finance and accounting.
Although 3Com is contractually obligated to provide us with these services,
these services may not be provided at the same level as when we were part of
3Com, and we may not be able to obtain the same benefits. We will also lease
and sublease office space from 3Com. These transitional service and leasing
arrangements generally have a term of less than two years following the
separation. After the expiration of these various arrangements, we may not be
able to replace the transitional services or enter into appropriate leases in
a timely manner or on terms and conditions, including cost, as favorable as
those we will receive from 3Com.
29
These agreements were made in the context of a parent-subsidiary relationship
and were negotiated in the overall context of our separation from 3Com. The
prices charged to us under these agreements may be lower than the prices that we
may be required to pay third parties for similar services or the costs of
similar services if we undertake them ourselves.
RISKS RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
SUBSTANTIAL SALES OF COMMON STOCK MAY OCCUR IN CONNECTION WITH THE DISTRIBUTION,
WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.
3Com intends to distribute the remaining shares of our common stock to 3Com
stockholders approximately four to six months after our initial public offering.
Substantially all of these shares will be eligible for immediate resale in the
public market. 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, or by 3Com if the distribution does not occur. 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 harm the market price of our common stock.
OUR SECURITIES HAVE NOT BEEN PUBLICLY TRADED VERY LONG AND OUR STOCK PRICE MAY
BE SUBJECT TO SIGNIFICANT FLUCTUATIONS AND VOLATILITY.
Our common stock has been publicly traded only since March 2, 2000. The market
price of our common stock has been subject to significant fluctuations since the
date of our initial public offering. These fluctuations could continue. Among
the factors that could affect our stock price are:
quarterly variations in our operating results;
changes in revenue or earnings estimates or publication of research reports
by analysts;
speculation in the press or investment community;
strategic actions by us or our competitors, such as acquisitions or
restructurings;
actions by institutional stockholders or by 3Com prior to its distribution
of our stock;
fluctuations in 3Com's stock price;
general market conditions; and
domestic and international economic factors unrelated to our performance.
The stock markets in general, and the markets for high technology stocks in
particular, have experienced extreme volatility that has often been unrelated to
the operating performance of particular companies. These broad market
fluctuations may adversely affect the trading price of our common stock.
30
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT
ACQUISITION OF US, WHICH COULD DECREASE THE VALUE OF YOUR SHARES.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could make it harder for a third party to acquire us without the consent of
our board of directors, although these provisions have little significance while
we are controlled by 3Com. These provisions include a classified board of
directors and limitations on actions by our stockholders by written consent. 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. 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. 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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE SENSITIVITY
As of February 25, 2000, we had cash and cash equivalents of $40.0 million which
consisted of highly liquid money market instruments with maturities less than 90
days. Because of the short maturities of these instruments, a sudden change in
market interest rates would not have a material impact on the fair value of the
portfolio. We would not expect our operating results or cash flows to be
affected to any significant degree by the effect of a sudden change in market
interest rates on our portfolio. Subsequent to the end of the quarter, the net
proceeds from our initial public offering and private placements have been
invested in highly liquid money market funds and other high credit quality
short-term securities.
FOREIGN CURRENCY EXCHANGE RISK
Historically, our exposure to exchange rate risk has been managed on an
enterprise-wide basis as part of 3Com's risk management strategy. This
strategy has utilized foreign exchange forward and option contracts to hedge
certain balance sheet exposures and intercompany balances against future
movements in foreign exchange rates. Gains and losses on the forward and
option contracts are largely offset by gains and losses on the underlying
exposure and consequently a sudden or significant change in foreign exchange
rates would not have a material impact on future net income or cash flows. We
are currently evaluating our exchange rate risk management strategy. We do
not currently and do not intend in the future to utilize derivative financial
instruments for trading purposes.
32
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District Court
for the Western District of New York. The case is now captioned: XEROX
CORPORATION v. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP., PALM
COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T. The
complaint alleges willful infringement of a Xerox United States patent, relating
to computerized interpretation of handwriting. The complaint seeks unspecified
damages and injunctive relief. Xerox has asserted that Graffiti software and
certain of our products infringe the patent. On January 18, 2000, the court held
a status hearing during which it ordered that all of the parties' briefs
relating to motions for summary judgment would be filed with the court by April
28, 2000. We anticipate that oral argument on these motions will be heard
thereafter. No trial date has been set.
On July 22, 1999, we filed a copyright infringement action against Olivetti and
CompanionLink in the United States District Court for the Northern District of
California and obtained a preliminary injunction against further distribution,
sale, import or export of Olivetti Office USA's "Royal daVinci" handheld device
and the daVinci OS Software Development Kit, distributed by CompanionLink
Software, Inc. The injunction is to remain in effect pending the outcome of the
lawsuit. We also initiated a copyright infringement action in Hong Kong on July
21, 1999, against EchoLink Design Ltd., the company responsible for developing
the operating system software contained in the daVinci products. The High Court
of the Hong Kong Special Administrative Region issued an order the same day
restraining EchoLink from further copying, distribution, sale, import or export
of Palm OS operating system source code or EchoLink's "NEXUS OS" source code,
which we maintain infringes our copyrights.
On December 13, 1999, WaveWare Communications, Inc. filed suit against 3Com,
Palm and others in the Superior Court of California, San Mateo County. The case
is captioned WAVEWARE COMMUNICATIONS, INC. v. 3COM CORPORATION, PALM COMPUTING,
INC., AND MARK BERCOW, No. 411331. The complaint alleges breach of contract,
constructive fraud, fraud and deceit, negligent misrepresentation,
misappropriation of assets and trade secrets, unfair competition, unjust
enrichment and intentional interference with economic advantage in connection
with our and 3Com's discussions with WaveWare concerning WaveWare's potential
acquisition by 3Com. The complaint seeks unspecified monetary damages and
injunctive relief. The case is in the early stages of discovery. No trial date
has been set.
On December 27, 1999, Telxon Corporation and Penright! Corporation filed a
complaint in the U.S. District Court for the Northern District of Ohio, Eastern
Division (Case No. 1:99CV3157) against 3Com and Palm alleging copyright
infringement, unfair competition and theft of trade secrets. The plaintiffs
allege that the Palm OS operating system contains graphical user interface
software copied from the plaintiffs' software. The complaint seeks unspecified
compensatory and treble damages and to enjoin, among other things, distribution
and sales of the Palm OS operating system. No trial date has been set. No
discovery has been exchanged.
On February 28, 2000, E-Pass Technologies, Inc. filed suit against 3Com in the
United States District Court for the Southern District of New York (case no.
00CIV1523). The complaint alleges infringement and induced infringement of
United States patent 5,276,311 by our handheld devices in connection with a
method and device for simplifying the use of credit cards. The complaint seeks
unspecified compensatory and treble damages and, among other things, to
permanently enjoin us from infringing or
33
inducing infringement of the patent as alleged. We have not yet responded to
the complaint. No trial date has been set. No discovery has been exchanged.
In connection with our separation from 3Com, pursuant to the terms of the
Indemnification and Insurance Matters Agreement between us and 3Com, we will
indemnify and hold 3Com harmless for any damages or losses which may arise out
of the Xerox, WaveWare, Telxon and Penright! and E-Pass litigation.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 7, 2000, simultaneously with the closing of our initial public
offering, we sold in private placements to America Online, Inc., Motorola, Inc.
and Nokia at $38.00 per share 2,105,263 shares, 1,710,526 shares and 2,105,263
shares, respectively, of our common stock. The aggregate proceeds from these
sales were $225 million. The transactions were exempt from registration pursuant
to Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit
Number Description
------- -----------
2.1(1) Master Separation and Distribution Agreement between 3Com and
the registrant effective as of December 13, 1999, as amended.
2.2 General Assignment and Assumption Agreement between 3Com and
the registrant, as amended.
2.3 Master Technology Ownership and License Agreement between 3Com
and the registrant.
2.4 Master Patent Ownership and License Agreement between 3Com and
the registrant.
2.5 Master Trademark Ownership and License Agreement between 3Com
and the registrant.
2.6 Employee Matters Agreement between 3Com and the registrant.
2.7 Tax Sharing Agreement between 3Com and the registrant.
2.8 Master Transitional Services Agreement between 3Com and the
registrant.
2.9 Real Estate Matters Agreement between 3Com and the registrant.
2.10 Master Confidential Disclosure Agreement between 3Com and the
registrant.
2.11 Indemnification and Insurance Matters Agreement between 3Com
and the registrant.
2.12(1) Form of Non-U.S. Plan.
3.1(1) Amended and Restated Certificate of Incorporation.
3.2(1) Bylaws.
4.1(1) Reference is made to Exhibits 3.1 and 3.2 hereof.
4.2(1) Specimen Stock Certificate.
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(a) Exhibits. (continued)
Exhibit
Number Description
------- -----------
10.1(1)* 1999 Stock Plan.
10.2(1)* Form of 1999 Stock Plan Agreements.
10.3(1)* 1999 Employee Stock Purchase Plan.
10.4(1)* Form of 1999 Employee Stock Purchase Plan Agreements.
10.5(1)* 1999 Director Option Plan.
10.6(1)* Form of 1999 Director Option Plan Agreements.
10.7(1)* Management Retention Agreement dated as of December 1, 1999 by
and between Carl J. Yankowski and the registrant.
10.8(1)* Form of Indemnification Agreement entered into by the
registrant with each of its directors and executive officers.
10.9(1)** RAM Mobile Data USA Limited Partnership Value Added Reseller
Agreement between RAM Mobile Data USA Limited Partnership (now
BellSouth Wireless Data, L.P.) and the registrant.
10.10(1)** Supply Agreement between Manufacturers' Services Salt Lake
City Operations, Inc. and the registrant.
10.11(1) Common Stock Purchase Agreement between America Online and the
registrant.
10.12(1) Common Stock Purchase Agreement between Motorola and the
registrant.
10.13(1) Common Stock Purchase Agreement Between Nokia and the
registrant.
10.14(1) Form of Management Retention Agreement.
27.1 Financial Data Schedule.
(1) - Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (No. 333-92657) filed with the Commission on December 13, 1999,
as amended.
* - Denotes an executive or director compensation plan or arrangement.
** - Confidential treatment granted on portions of this exhibit.
(b) Reports on Form 8-K
None.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Palm, Inc.
(Registrant)
Dated: April 7, 2000 By: /s/ Judy Bruner
------------- -----------------
Judy Bruner
Senior Vice President, Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
36