Sources also said Microsoft will announce the new handheld OS on Sept. 6 and officially call it Pocket PC 2002.
The new handhelds will be part of HP's Jornada 560 series, the sources said. One will come with 32MB of memory and the other with 64MB. Both devices will use Intel's StrongARM SA-1110 processor and will have active-matrix screens that can display 16-bit color.
Palo Alto, Calif.-based HP would only confirm that it will use the upcoming version of Pocket PC and that it plans to announce two new devices.
Merlin is designed to make Pocket PC look and feel more like Windows XP, Microsoft's upcoming desktop OS, according to one source familiar with Merlin. Like the current Pocket PC, Merlin is based on version 3.0 of Windows CE.
Some devices using Pocket PC 2002 will also get a boost this year from Intel's upcoming XScale processors. Current Intel processors for handheld devices top out at 206MHz, but sources have said the new chips will enable devices to hit 400MHz and will help expand built-in wireless capabilities in handhelds.
HP plans to support the new XScale chips and to add built-in wireless capabilities to its devices, a company representative said.
Although there isn't tremendous demand for handheld devices with high-end processors and business applications right now, IDC analyst Kevin Burden said, licensees of Pocket PC are simply laying the groundwork for when there is demand.
"The enterprise market is not placing a lot of 1,000-unit orders for Pocket PC devices right now, but the Pocket PC camp is getting itself ready for the time when there are. And there definitely will be," Burden said. In addition to HP, Pocket PC licensees include Compaq Computer and Casio.
Burden added that the corporate market is the next fertile ground for major growth in the handheld market and "in the view of IT managers, it looks like Palm is standing still."
Palm has relied heavily on its licensees and 160,000 developers to drive innovation, but Burden said it may be time for Palm to take a more active role in leading the way.
"Allowing partners to significantly help with and, in some cases, lead innovation was a good strategy to start with. But now the market is too competitive for a market leader to take such a passive role," Burden said.
Palm OS licensee Sony, for example, was the first Palm OS-based handheld maker to use a 320-by-320-pixel screen and to build in an MP3 player. Handspring was the first to use a USB port.
Palm has been making changes within the company to improve development of its OS. In late July, it announced it would create a separate subsidiary for its operating system.
The company also announced Aug. 16 that it would acquire the technology assets and intellectual property of software maker Be for $11 million in stock. The move is meant to boost the communications and multimedia capabilities of the Palm OS and make it more competitive with Pocket PC.
Palm maintains its No. 1 position in the handheld and handheld OS market, but its lead is eroding.
The company's share of unit shipments worldwide slipped from 47 percent in the second quarter of 2000 to 37 percent in the same period this year, according to market researcher IDC. Compaq was hot on Palm's heels in the No. 2 spot, with 19 percent in the second quarter of this year, up considerably from 2 percent in the same period in 2000. Handspring was third with 13 percent, and HP rounded out the top four spots with 8.1 percent.
The worldwide market share of Palm's OS was 58 percent in the second quarter, down from 69 percent in the same period last year.