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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the fiscal year ended May 28, 2004

OR

Commission File Number: 0-50402

PALMSOURCE, INC.

(Exact name of registrant as specified in its charter)

1240 Crossman Avenue

Sunnyvale, California 94089-1116

(Address of principal executive offices)

(408) 400-3000

(Registrant’s telephone number, including area code)

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

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

Common Stock $0.001 par value

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

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

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

As of November 28, 2003, based on the closing sales price as quoted by the Nasdaq, 10,687,761 shares of common stock, having an aggregate market value of approximately $274,247,947 were held by non-affiliates. For purposes of the above statement only, all directors and executive officers of the registrant are assumed to be affiliates.

The number of shares of common stock outstanding at July 23, 2004 was 15,101,231 shares.

DOCUMENTS INCORPORATED BY REFERENCE

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

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PalmSource, Inc.

Form 10-K

For The Fiscal Year Ended May 28, 2004

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Special Note Regarding Forward-Looking Statements

Certain statements set forth or incorporated by reference in this Form 10-K, as well as in our Annual Report to Stockholders for the year ended May 28, 2004, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks and uncertainties that could cause our industry’s results, level of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in this Form 10-K. In some cases, you can identify forward-looking statements by terminology such as “anticipates,” “believes,” “ continue,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “will,” or the negative of any of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of these statements. We are under no duty to update any of the forward-looking statements after the date of this Form 10-K to conform these statements to actual results.

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PART I

Item 1. Business

Overview

We are a leading developer and licensor of platform software that enables mobile information devices. Our software platform consists of operating system software, or Palm OS, and software development tools. We have also enhanced our platform with applications such as personal information management software, web browsers and e-mail. A wide range of smart mobile devices incorporate our solutions, including personal digital assistants, or PDAs; smartphones; location-aware devices; entertainment devices; and industry-specific devices used in industries such as education, hospitality and healthcare. We license Palm OS to leading smart mobile information device manufacturers, including palmOne, Sony, Garmin, GSPDA, Kyocera, and Samsung. Products using Palm OS, or Palm Powered products, have held the number one PDA market share position in each of the reports filed in the past six years by IDC, as measured in units sold.

Our primary product offering, Palm OS, provides a flexible platform that enables the creation of powerful, innovative and easy-to-use smart mobile devices. Historically, the majority of our licensees have developed PDAs and Palm OS has attracted a large and loyal following, with approximately 34 million Palm Powered products sold to date. We have begun to license Palm OS to smartphone manufacturers and intend to continue to build on our leadership position and experience in PDAs to become a leading licensor of platform software for smartphones and other next generation smart mobile products. An increasing portion of our revenue and units shipped are coming from these smartphone licensees. There are approximately 300,000 registrants in our Palm OS developer program which offers Palm OS developer tools, programs, and support to enable the creation of software applications for our platform. According to PalmGear.com, a leading online provider of handheld applications with whom we have a strategic relationship, there are currently more than 20,000 software titles available for Palm Powered products. To further promote our software platform, we provide professional services and support for our licensees and developers.

Company Background

We were incorporated on December 3, 2001 as a wholly-owned subsidiary of Palm, Inc., or Palm, an event that we refer to in this report as the separation and the date of which we refer to as the separation date. The purpose of the separation was to establish PalmSource as an independent company to conduct substantially all of Palm’s operating system software group business. In October 2003, Palm distributed to its stockholders on a pro-rata basis all of the outstanding shares of our common stock owned by Palm, an event that we refer to in this report as the distribution. At the same time as the distribution, Palm acquired Handspring, Inc., an event that we refer to in this report as the Handspring merger, and the combined entity changed its name to palmOne, Inc. In this document, we refer to palmOne, Inc. as “palmOne” or “Palm” interchangeably, depending upon the time and context of the event described. References in this report to “PalmSource,” “we,” “our,” and “us” refer to PalmSource, Inc. Our principal executive offices are located at 1240 Crossman Avenue, Sunnyvale, California 94089-1116 and our telephone number is (408) 400-3000. Our website can be found at www.palmsource.com.

Industry Background

The Proliferation of Mobile Information Devices

For both professionals and individual consumers, it has become increasingly important to have personal and professional information such as addresses, calendars, to-do lists, customer information and other reference information close at hand and easily managed to facilitate better communications. As people have become increasingly mobile, the need for convenient, portable devices to store, manage and communicate information has grown rapidly. Traditionally, storing and managing personal and professional information was accomplished using paper-based products, and later, stand-alone portable computers or specialized electronic devices. These tools often are cumbersome, expensive, difficult to use and offer limited functionality. The invention of the pen-based PDA in the early 1990s provided consumers a more useful electronic option for holding and

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

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

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

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

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

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

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

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

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

Limitations of Existing Software Solutions

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

Our Solution

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

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

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

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Efficiency, Performance and Reliability. Palm OS has been designed to provide significant power and performance advantages over competitive solutions. These advantages include significantly lower operating system memory and processor requirements than competitive solutions. Device manufacturers that build products based on our platform can therefore achieve similar device features and functionality while lowering component cost beyond that achievable using competing operating systems. For example, a complete and fully featured version of our operating system will fit within a device as small as a wristwatch with as little as two megabytes of storage memory, while a comparable version of our closest competitor’s currently available offering would require sixteen megabytes of storage memory and a substantially larger device. In addition, our platform architecture is specifically designed to provide a highly reliable operating environment for mobile information devices. For example, our operating system is designed to cope with power loss and other unplanned events in a manner that will not compromise data.

Cooperative Development that Speeds Innovation. We work with our licensees and other technology providers to speed the introduction of new and innovative products. We provide to our licensees support and professional services that enable them to bring products to market more quickly and effectively. As our licensees develop technology enhancements, the terms of our licensing and support agreements ensure that we maintain the right to include most of the broadly applicable technology advancements in future versions of Palm OS. This approach allows us to more rapidly develop next generations of Palm OS and make technology advancements available to the broader community of Palm OS licensees and their customers. We also have introduced the Palm OS Ready program, through which we license a subset of our software tool kit to a select number of industry-leading technology providers that supply components, such as processors and graphics chips, to mobile information device manufacturers. By having access to these tools, members of the program can customize their technology for Palm OS and subsequently sell those products directly to our licensees earlier in the design cycle. The objectives of the Palm OS Ready program and our cooperative development approach are a time-to-market advantage for our licensees and reduced support costs.

Extensive Community of Third-Party Developers and Applications. The Palm OS platform has attracted a large and loyal following, with approximately 34 million Palm Powered devices sold to date. Our broad user base has also attracted a large community of third-party developers creating software applications, peripherals and accessories that increase the performance and functionality of Palm Powered devices. There are approximately 300,000 registrants in our Palm OS developer program which offers Palm OS developer tools, program, and support to enable the creation of software applications for our platform. According to PalmGear.com, a leading online provider of handheld applications, there are currently more than 20,000 software titles available for Palm Powered devices. We make development tools available for our developer community, and we share select parts of the Palm OS source code to enable developers to optimize the interface of their applications with our software platform. We believe that the existence of these third-party software applications, peripherals and accessories increases the value to the end-user of Palm Powered devices and helps to expand the market for our licensees’ products and services.

Our Strategy

Our objective is to be a leading licensor of platform software for smartphone and other next generation smart mobile products. The key elements of our strategy to achieve this objective include the following:

Extend Our Success in PDAs to Smartphones and Other Next Generation Smart Mobile Products

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

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Increase Penetration of Palm Powered Products in the Enterprise

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

Expand Internationally

We intend to expand our international presence by targeting countries with large populations and propensities for adopting new technologies. For example, we have developed a version of Palm OS that supports simplified Chinese character sets. We intend to aggressively pursue licensees that are well positioned to capitalize on these emerging opportunities and encourage our developer community to focus on providing solutions for these regions.

Pursue Additional Opportunities in Vertical Industries

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

Continue to Extend Our Technological Advantages

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

Continue to Grow and Support Our Developer Community

We believe that the Palm Powered ingredient brand has become a symbol for quality, ease of use, and elegant simplicity in the mobile information device industry. This brand identity has enabled us to create a large and loyal user base worldwide that represents an attractive opportunity for our global developer community. We intend to continue to invest in the tools, marketing, and programs offered to our developers so that we may continue to offer a wide selection of applications to our licensees and the end-users of Palm Powered products. As we continue to evolve our platform, we intend to maintain the compatibility, tools and support necessary for a large number of applications to continue to be available to our users. We believe the availability of a wide selection of Palm OS applications is important to attracting and retaining loyal end users.

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Products

Palm OS

We license to our customers a product development kit, or PDK, that enables them to build a version of Palm OS specifically tailored to their products. The PDK includes the operating system and supporting technology components, such as applications and tools, and reference materials, which are the foundation for Palm Powered devices manufactured by our licensees. We allow licensees to customize the platform and applications, including through limited access to source code. Palm OS has been optimized for mobile information devices, for which instant access to information, low power consumption and wireless capabilities are critical.

Palm OS consists of several components:

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

Palm OS Cobalt is an extensive redesign of Palm OS including a full multi-tasking, multi-threaded architecture and introduces a framework construct for multimedia, security, messaging and device management. This framework allows our licensees and developers to extend the platform functionality to address their specific product needs by writing plug-in modules for each specific function. In addition, the communication architecture has been redesigned to make it easier to implement communication-centric solutions like phones and wireless devices. Palm OS Cobalt also runs on most ARM-based microprocessors and is first targeted at multimedia and enterprise smart mobile devices including smartphones. As with Palm OS 5, we have designed Palm OS Cobalt to run applications designed for previous versions of the operating system. We delivered Palm OS Cobalt to licensees in December 2003 and, based on prior Palm OS introductions, we expect one or more licensees to begin initial shipments of products based on Palm OS Cobalt in the second half of calendar year 2004.

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Applications and Other Products

We offer a number of applications and other products that our licensees can incorporate into Palm Powered products. These include:

In addition, we offer a number of sample applications as examples for our customers and developers to use as a starting point for creating their own customized solutions.

We also released Bluetooth support for Palm OS in spring 2002. Bluetooth is an industry standard local area networking technology used to enable devices within a short range of each other to communicate and interoperate with one another. A common application for this technology with our licensees is to facilitate wireless communication between a handheld and a separate mobile phone.

Tools

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

The Palm OS software development kit, or Palm OS SDK, is a set of libraries and headers for building applications for Palm Powered handhelds. The Palm OS SDK includes a number of sample applications, including the PIM applications, for developers to use as a starting point for development.

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

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

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The Palm OS Simulator is Palm OS running in a Windows environment and is available to test and debug applications on Palm OS and to test for compatibility.

The conduit development kit includes the libraries and header files necessary to develop HotSync conduits for Palm Desktop and allows our customers and developers to enable applications to communicate with the desktop to provide a synchronized data set on both devices.

The Eclipse Integrated Development Environment is an open source framework designed to support a variety of software tools. The Palm OS Developer Suite, or PODS, is the product name for the suite of products based on the Eclipse framework that enable our developers to create applications for Palm OS.

Customers

Our licensees who were actively shipping or developing Palm Powered products as of July 23, 2004 include those in the following table.

Individual customers that accounted for 10% or more of total revenues for the fiscal year ended May 31, 2003 and 2004 were Palm/palmOne and Sony.

Strategic Relationships

We have forged strategic relationships with several technology providers through the Palm OS Ready program. Through this program, we license a subset of our toolkits to a select number of industry leading component manufacturers. By having access to these tools, these manufacturers can invest in the development and tuning of their technology for Palm OS and can subsequently sell those products directly to our licensees. The objective is a time-to-market advantage and reduced support costs for our mutual customers. Palm OS Ready partners currently include ATI Technologies, Inc., Intel Corporation, M-Systems, Inc., Motorola, Inc., nVidia Corporation, Samsung, SyChip, Inc., and Texas Instruments.

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

Developer Community

The combination of our large user base and the architecture of Palm OS has attracted a large and growing community of third-party developers. This community has created a broad selection of software applications that allow further customization of Palm Powered products by the end user. There are approximately 300,000 registrants in our Palm OS developer program which offers Palm OS developer tools, programs, and support to enable the creation of software applications for our platform. According to PalmGear.com, a leading online provider of handheld applications, there are currently more than 20,000 applications available for Palm Powered products in a broad range of categories, including web browsers, e-mail and Internet communications, sales force and field automation, personal productivity, groupware, financial management and games.

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

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

Online Store

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

Sales and Marketing

We license and market our products and services primarily through our direct sales force and marketing team. For further discussion regarding geographic information, see Note 16 of Notes to Combined and Consolidated Financial Statements. Our sales activities are focused on developing relationships with potential licensees through our direct sales force, which is located in the United States, France, Hong Kong and Japan. As of July 23, 2004, we employed 13 sales professionals, a majority of whom are in the United States.

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

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shipment of the product. This product development and commercial shipment process by our licensees is often eight to 12 months or longer, depending upon the complexity of the product, the licensee’s experience with Palm OS, and other factors. Because of the length of time our licensees must spend to first develop, and then commence shipment of the product, the period before we receive revenue, if any, from a new licensee can be lengthy. In targeting potential licensees, we consider a partner’s brand identity, distribution channels and technical capabilities. We typically focus on large, well-established device manufacturers and distributors and have begun to explore new markets with licensees such as AlphaSmart, Fossil, Garmin, GSPDA, Lenovo and Tapwave. Increasingly, we see that other partners such as ODMs will be important to deliver Palm Powered devices to licensees.

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

Support and Services

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

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

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

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

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

Research and Development

Our research and product development efforts are focused on enhancing the available features and functions of the Palm OS PDK, including improving its capability and efficiency. These enhancements are intended to reduce time-to-market for our licensees. In addition, we work with licensees and third-party developers to

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increase the proliferation of Palm OS-based solutions. We supplement our research and development efforts with our licensing strategy, which specifies that our licensees contribute their broadly applicable derivative development works and give us the rights to include these works back into the Palm OS platform. We believe that our success will depend, in part, on our ability to develop and introduce new versions of the Palm OS platform that continue to address the rapidly expanding needs of the mobile information device market. In the past, we have made, and we intend to continue to make, significant investments in research and development in response to the fluctuations of market conditions and economic trends. As of July 23, 2004, we had 189 employees engaged in engineering and product development activities.

Competition

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

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

Intellectual Property

We rely on and benefit from a portfolio of intellectual property. We currently have numerous patents issued in the United States and abroad, and numerous U.S. and foreign patent applications pending. Our issued patents expire anywhere from July 2014 to September 2020. Palm Trademark Holding Company has over 25 trademark registrations and several pending applications in the United States for trademarks associated with the business of PalmSource. Abroad, it has over 200 trademark registrations and numerous pending applications, most of which are intended for exclusive use by PalmSource in its businesses. Subject to certain restrictions, we have an exclusive license from Palm Trademark Holding Company to use “Palm” marks, other than palmOne and certain transition marks, in connection with our business, including various usages of Palm, PalmSource, Palm OS, the Palm logo, Palm Powered and Palm Computing. We also have our own trademarks registered in the United States and abroad. We also own copyrights relating to our software development applications including HotSync Manager, Palm OS and other software.

We also license technologies from third parties for integration into our products. We believe that the licensing of complementary technologies from parties with specific expertise is an effective means of expanding the features and functionality of our products.

We rely on a combination of patent, trademark, copyright and trade secret laws and restrictions on disclosure to protect our intellectual property rights. While we rely on these methods to protect our intellectual property, we also believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements are essential to establishing and maintaining a technology leadership position. We cannot assure you that others will not develop technologies that are similar or superior to our technology.

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The Separation and Distribution

Description of the Separation and Distribution

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

A summary description of the provisions of the principal separation agreements that relate to our current and future operations is set forth below. The following summary describes some of the provisions of the principal separation agreements, but the provisions of the separation agreements are complicated and not easily summarized. This summary may not contain all of the information about the separation agreements that is important to you. Each separation agreement has been filed with the Securities and Exchange Commission and is available to you upon request.

Amended and Restated Master Separation Agreement

The amended and restated master separation agreement, or master separation agreement, outlines the general terms and conditions of the separation of us from Palm and these matters were undertaken and completed. In addition, the agreement outlines future obligations of palmOne and us related to the separation.

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

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

Accounting Practices. So long as Palm is required to consolidate our results of operations and financial position, we agreed to cooperate as appropriate to allow Palm to prepare its financial statements and other related matters. Palm agreed to provide us with all relevant information to enable us to prepare our financial statements and to grant our auditors access to Palm’s records.

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

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

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

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No Representations and Warranties. Palm did not make any representations or warranties to us regarding:

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

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

General Assignment and Assumption Agreement

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

Amended and Restated Software License Agreement

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

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

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

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

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test criteria, in connection with alpha, beta and gold master releases of the operating system software. We retain broad discretion under the agreement to determine whether source code modifications made by Palm may be released and the test criteria that will apply to those modifications.

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

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

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

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

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

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

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

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

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

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

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