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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number 000-31803

Transmeta Corporation

3990 Freedom Circle, Santa Clara, CA 95054

(408) 919-3000

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

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

     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 þ         No o

     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.    þ

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

     As of June 28,2002, the aggregate market value of the shares of common stock held by non-affiliates of the Registrant (based on the average bid and asked prices price of $2.35 for the common stock as quoted by the Nasdaq National Market on that date,) was approximately $250,580,726.

     As of March 21, 2003, there were 138,530,976 shares of the Registrant’s common stock, $0.00001 par value per share, outstanding. This is the only outstanding class of common stock of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held in May 2003 are incorporated by reference into Parts II and III of this report on Form 10-K.

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TRANSMETA CORPORATION

INDEX

      We were incorporated in California in March 1995 and reincorporated in Delaware in October 2000. Our principal executive offices are located at 3990 Freedom Circle, Santa Clara, California 95054, and our telephone number at that address is (408) 919-3000. Transmeta®, the Transmeta logo, Crusoe®, the Crusoe logo, Code Morphing^TM, LongRun® and Midori^TM are trademarks of Transmeta Corporation in the United States and other countries. All other trademarks or trade names appearing in this report are the property of their respective owners.

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CAUTION REGARDING FORWARD-LOOKING STATEMENTS

      This Report contains forward-looking statements that are based upon our current expectations, estimates and projections about our industry, and that reflect our beliefs and certain assumptions based upon information made available to us at the time of this Report. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “could,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. Such statements include, but are not limited to, statements concerning anticipated trends or developments in our business and the markets in which we operate, the competitive nature and anticipated growth of those markets, our expectations for our future performance and the market acceptance of our products, our ability to migrate our products to smaller process geometries, and our future gross margins, operating expenses and need for additional capital.

      Investors are cautioned that such forward-looking statements are only predictions, which may differ materially from actual results or future events. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Some of the important risk factors that may affect our business, results of operations and financial condition are set out and discussed below in the section entitled “Risks That Could Affect Future Results.” You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to invest in our company or to maintain or change your investment. Investors are cautioned not to place reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this Report. We undertake no obligation to revise or update any forward-looking statement for any reason.

PART I

Overview

      Transmeta Corporation develops and sells software-based microprocessors and develops additional hardware, software and system technologies that enable manufacturers to build highly efficient computing systems characterized by low power consumption, reduced heat dissipation and the high performance required to run standard x86 compatible programs. We originally developed our family of Crusoe microprocessors for lightweight notebook computers and other mobile computing devices, but we have developed and are continuing to develop microprocessors suitable for a variety of existing and emerging end markets in which x86 program compatibility and energy and thermal efficiency are desirable.

The Microprocessor Market

      The microprocessor market includes at least two categories, which are distinguished by the basic function of the microprocessor. A microprocessor that performs general computing tasks is known as the central processing unit (CPU) of a computer system. A microprocessor used for control applications is often referred to as an embedded processor. We have historically supplied processors in the CPU category and have focused particularly on supplying energy efficient microprocessors for notebook and other mobile personal computers (PCs). More recently, in January 2003, we publicly announced our line of Crusoe Special Embedded (SE) processors, which are energy efficient microprocessors suited for embedded applications.

      A CPU processor is an integrated circuit, generally consisting of millions of transistors, that serves as the brain of a computer system, such as a PC. The CPU processor is typically the component most critical to the performance and efficiency of PCs. The CPU processor controls data flowing through the electronic system and manipulates data as specified by the hardware and software that controls the system. In 1981, International Business Machines Corporation (IBM) introduced its first PC containing a microprocessor based upon the x86 instruction set developed by Intel Corporation and utilizing the Microsoft Corporation MS-DOS® operating system. As circuit design and large scale integration process technology have evolved, the performance and functionality of each new generation of x86 microprocessors have increased. Personal computers that retained software compatibility with the x86 computer instruction language have thrived, while

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      The x86 microprocessor market is characterized by intense competition, short product life cycles and rapid advances in product design and process technology. Today, we believe that the greatest demand for microprocessors is from PC manufacturers. With few exceptions, PC manufacturers require x86 microprocessors that are compatible with Microsoft Windows® operating systems. Improvements in the performance characteristics of microprocessors and decreases in production costs resulting from advances in process technology have broadened the market for PCs and, as a result, increased the demand for microprocessors.

      The market in which PC original equipment manufacturers (OEMs) operate is intensely competitive. Most PC suppliers have evolved from fully integrated manufacturers with proprietary system designs to vendors focused on building brand recognition and distribution capabilities. Almost all of these suppliers now rely on Intel or other third-party manufacturers for the major subsystems of their PCs, such as the motherboard and chipsets. These suppliers are also increasingly outsourcing the design and manufacture of complete systems. The third-party manufacturers of these subsystems, based primarily in Asia, are focused on providing PCs, motherboards and complementary chipset devices that incorporate the latest trends in features and performance at low prices. Increasingly, these third-party manufacturers are also supplying fully configured PC systems through alternative distribution channels.

      Embedded processors also comprise a significant segment of the microprocessor market. Embedded processors are general purpose devices that perform dedicated applications with limited or no user interface and programmability. A system designed around an embedded processor is typically preprogrammed to execute a specific task or function, making it a closed system which cannot be programmed by an end user. Markets for embedded processors include industrial automation, scientific instrumentation, retail kiosks, point-of-sale terminals, automotive infotainment, process control and home automation systems.

Transmeta’s Product Technologies

      We develop and sell software-based microprocessors and develop additional hardware, software, and system technologies that enable manufacturers to build highly efficient computing systems characterized by low power consumption, reduced heat dissipation and the high performance required to run standard x86 compatible programs. We originally developed our family of Crusoe microprocessors for lightweight notebook computers and other mobile computing devices, but we have developed and are continuing to develop microprocessors suitable for a variety of existing and emerging end markets in which x86 program compatibility and energy and thermal efficiency are desirable.

      Our approach to microprocessor design implements substantial portions of the microprocessor functionality in software. Our microprocessors are unique because, unlike traditional microprocessors that are built entirely with silicon hardware, they are composed of both software and hardware components. When combined, these two components form a microprocessor solution that is compatible with software programs designed for x86 PC compatible computers, operates using less power than most other x86 microprocessors and runs standard PC software and Internet applications. We believe that there are several technical and economic benefits to this approach. By partitioning the complex problem of designing a microprocessor into two pieces, each piece is individually simpler to implement. A substantial portion of the functionality of our microprocessor is implemented with software, which allows the remaining functionality to be implemented in a relatively simple semiconductor chip.

      We have developed substantial technical expertise and technology in the following core elements of our microprocessors:

	•	Code Morphing Software. The software component of our microprocessors is called Code Morphing software, because it dynamically translates, or morphs, x86 instructions into instructions for our very long instruction word processors. Code Morphing software dynamically translates from the ones and

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		zeros of the x86 software instructions into a functionally equivalent but simpler set of ones and zeros for our hardware chip to decode and execute. The technology involved in Code Morphing software is similar to that used in advanced compilers, but with the input being binary programs rather than high-level language source code. Code Morphing software translates small groups of instructions incrementally, on an as-needed basis. Once a group of instructions is translated, those translated instructions are cached for successive executions without the need for further translation. Since instructions in an application often execute millions of times or more, performance costs associated with translation are quickly amortized. Code Morphing software constantly monitors the programs a user is running in order to re-optimize the operation of those programs so as to maximize the energy efficiency and performance of our microprocessors.
	•	Very Long Instruction Word (VLIW) Processor Hardware. The hardware component of our microprocessors is a VLIW processor chip. Our VLIW chip is responsible for basic arithmetic computation, and the control and caching functions. It currently supports 128-bit and 64-bit wide instructions, and will support 256-bit instructions for our next generation TM8000 processor. Each of these wide instructions can control multiple functional units in parallel for high performance under software control. For example, a single 128-bit VLIW instruction might simultaneously control an integer addition, an integer subtraction, a memory load and a branch. Our microprocessors currently employ a number of advanced features. Our microprocessors have relatively large Level 1 instruction caches and large Level 1 data caches. Our microprocessors also contain on-chip Level 2 caches that improve performance by reducing the average time to access data from memory, and also help reduce power by decreasing the number of power-burning memory accesses to dynamic random access memory, or DRAM.
	•	LongRun Power Management. Our proprietary LongRun technology is enabled by the monitoring and optimization capabilities of Code Morphing software. LongRun monitors levels of user activity to determine how much performance is actually needed. Our chip has special purpose hardware that allows LongRun to rapidly adjust the frequency and voltage of the chip to a variety of levels to closely match the needed level of performance. Reducing frequency and voltage can substantially reduce the power consumed by our microprocessors, which in turn leads to longer battery life.
	•	Integrated Northbridge Chipset. Because we have moved many traditional chip functions from hardware into software, the basic processor requires a relatively small chip area. This provides the opportunity to integrate a full PCI bus controller, a synchronous DRAM, or SDRAM, memory interface, and, on some Crusoe microprocessors, a double data rate SDRAM, or DDR SDRAM, memory interface. A PCI bus connects a processor to user input/output devices such as a graphics controller or modem. These functions have been traditionally provided in a second chip, called a northbridge. Our microprocessors integrate this northbridge functionality onto the same silicon die as the processor. This increased level of integration reduces both power requirements and motherboard area, which are critical resources in small mobile devices.

      Our innovative software-based microprocessor technologies can enable computers engineered with our microprocessors to achieve a variety of benefits, including extended battery life, reduced heat dissipation, lighter weight, and competitive performance and full compatibility with x86 and Internet software.

      In support of our microprocessor development and business, we are also are engaged in the research, design, product development and system integration of many of the software and hardware technologies that make up a complete x86 PC compatible computer system. In addition to the microprocessor, the quality of the final computer system depends on the successful integration and optimization of all of the various hardware and software components in the computer. For example, we have developed tools, methodologies, techniques and related expertise in the development of basic input/output software, or BIOS, power management technologies for energy efficiency and battery life, and thermal management technologies to reduce heat dissipation. We have also invested substantial resources in developing tools, expertise and test environments for compatibility testing. We test compatibility across three major areas: x86 compatibility, hardware compatibility, and full operating system and application compatibility. Our understanding of the complete

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      We also design and build, on a limited scale, PC-compatible computer systems based on our microprocessors. We build these systems for internal engineering use in order to test our microprocessors in a real system environment. We believe that the detailed design specifications are valuable to our customers as known working reference designs. By providing schematics, motherboard layout and extensive design notes, we can help our customers save time to market. We have a systems engineering department that develops and builds reference designs suitable for use in notebook computers and embedded systems. We also use these systems for many in-house purposes, such as testing new Code Morphing software, testing basic input/output systems, benchmarking and compatibility testing. We also take an active role in helping our customers debug and optimize the design of their platforms for battery life and performance.

Transmeta’s Strategy

      Our objective is to supply industry-leading energy efficient microprocessor solutions that deliver x86 software compatibility at a variety of compelling cost and performance points. Key elements of our strategy include:

      Extending Our Expertise in Software-Based Microprocessor Technologies. We plan to continue to extend our expertise in software-based microprocessor technology in order to develop and bring to market differentiated microprocessor products. We have and will continue to develop successive generations of hardware architectures and Code Morphing software optimizations to further enhance power management and performance, while maintaining x86 software compatibility. We also will continue to exploit the unique characteristics of software to continue to move additional functions from hardware into software, and to develop and implement new features, such as security. We plan to continuously extend the ability of our Code Morphing software to “learn” about the characteristics of an application program while it is running, and to use this knowledge to improve performance and reduce power consumption.

      Focusing on Mobile Computer Markets. Our initial goal has been to target our microprocessors at growing markets where energy efficiency, mobility and x86 PC software compatibility are paramount, such as in the mobile Internet computing market. We believe that mobile Internet computing devices are at the convergence point between communications and computing. Our current products are directed at the market for ultra-light mobile notebook computers, which typically weigh less than three pounds and feature extended battery life. We are also focused on evolving markets, where energy efficiency and low cost are important.

      Developing New Markets Beyond Mobile Computing. We also believe that there are new market opportunities for our microprocessors where energy efficiency and x86 software compatibility are particularly important, but where mobility and battery life may not be a factor. Next generation cable television set-top boxes, for example, will need x86 compatibility to provide Internet connectivity and web browsing, and sufficient performance to deliver streaming media in a home environment where a cool and quiet system without a noisy fan will be desired. Other emerging markets for which the energy efficiency advantages and software-based design of our products are particularly attractive include quiet desktop PCs, small office/home office servers and high-density blade servers.

      Collaborating with Other Companies that Enhance Our Business. We work closely with our OEM customers to collaborate on the specifications for our next generation products. We have continued to develop our working relationship with Microsoft in order both to ensure compatibility between our microprocessors and Microsoft’s software products and to collaborate on future products. We work with our foundry partner Taiwan Semiconductor Manufacturing Co., or TSMC, to fabricate silicon wafers using advanced manufacturing process technologies rather than developing our own manufacturing facilities. We additionally work with Advanced Semiconductor Engineering, or ASE, for substantially all of our assembly and test services.

      Developing and Sharing with Customers Our Systems Expertise. To speed the adoption of our technology and improve our customers’ time-to-market, we often provide potential customers with complete reference computer system solutions. By building an entire computer system, we can innovate across all the

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Products

      In January 2000, we announced our first family of microprocessor products under the brand name Crusoe. The Crusoe microprocessor family has evolved to include multiple models that feature different levels of performance and different cost structures. Our current products include the TM5400/ TM5600 generation and TM5500/ TM5800 generation Crusoe microprocessors, the Crusoe Special Embedded (SE) microprocessors, and our next generation TM8000 microprocessor expected to be commercially available during the third quarter of 2003.

      The TM5400 and TM5600 processors were manufactured prior to 2002 in a 0.18 micron CMOS technology. These microprocessors are similar except in the size of their level 2 cache. The TM5400 has a 256 KByte level 2 cache, and the TM5600 has a 512 KByte level 2 cache. Both processors have a 64 KByte level 1 data cache and 64 KByte level 1 instruction cache as well as an integrated “northbridge”, which consists of a PCI bus controller, a SDR DRAM controller, and a DDR DRAM controller. These processors feature maximum operating frequencies up to 667 MHz.

      The TM5500 and TM5800 processors are manufactured in a 0.13 micron CMOS technology. These microprocessors are similar except in the size of their level 2 cache. The TM5500 has a 256 KByte level 2 cache, and the TM5800 has a 512 KByte level 2 cache. Both processors have a 64 KByte level 1 data cache and 64 KByte level 1 instruction cache as well as an integrated “northbridge”, which consists of a PCI bus controller, a SDR DRAM controller, and a DDR DRAM controller. These processors currently feature maximum operating frequencies up to 1000 MHz. We introduced the TM5500/ TM5800 in June 2001 and began to derive product revenue from TM5500/ TM5800 sales during the fourth quarter of 2001.

      The Crusoe SE processors are x86 software compatible general purpose processors designed specifically for embedded applications. They are also manufactured in a 0.13 micron CMOS technology.

      The TM8000 processor, our next generation microprocessor product, was publicly demonstrated in November 2002. We publicly announced information about the TM8000 in February 2003. Our TM8000 processors will also be manufactured in a 0.13 micron CMOS technology. In addition to our legacy Code Morphing software and LongRun technologies, the TM8000 includes three new high performance bus interfaces. It has an on-chip 400 MHz HyperTransport^TM bus interface, for increased input/output efficiency. The new processor also includes an on-chip Double Date Rate 400 (DDR-400) SDRAM memory interface, which will substantially increase throughput over earlier DDR-266 interfaces. The TM8000 also has an on-chip AGP-4X graphics interface for industry standard, high performance graphics solutions. All three of these new interfaces allow the TM8000 processor to achieve more work per clock, which results in greater energy efficiency and longer battery life for mobile computer users. The first TM8000 processors are expected to feature maximum operating frequencies up to 1200 MHz, and to be commercially available in the third quarter of 2003.

Customers

      We currently sell our products to many of the computing industry’s leaders who in turn produce cutting edge mobile computing solutions. Our customers include, among others, Sony Electronics, Fujitsu, Uniquest (acting as the distributor of our product for the Hewlett-Packard Tablet PC), Toshiba, NEC, Hitachi, Sharp, Casio and Siltrontech Electronics. Our server customers include RLX Technologies and NEC. Sony Electronics and Fujitsu accounted for 37% and 26%, respectively, of our net product revenue in fiscal 2002.

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Sales and Marketing

      We sell our products directly to OEMs and, to a lesser extent, through distributors, stocking representatives and manufacturers’ representatives. We have added manufacturers’ representatives and distributors in Europe, and manufacturers’ representatives in North America. Etron Corporation Ltd. is our manufacturers’ representative for Korea. Uniquest, Siltrontech Electronics and Edom Technology are our primary distributors in Hong Kong and Taiwan, and All American Semiconductor is our exclusive distributor in North America. Inno Micro Corporation and Shinden Hightex Corporation have been added as distributors for Japan. Our distributors are restricted from selling to certain OEMs and major notebook manufacturers and have provisions in their agreements specifying inventory levels, price protection policies and rights of return policies for non end-of-life products. As needed, we will continue to add representation to our current sales and distribution network.

      In addition, we have field applications engineers who work directly with our customers. We have opened offices in Taiwan and Japan to provide sales and customer support. We work with our potential customers to select, integrate and tune hardware and software system components that make up the final computer system. We also provide potential customers with reference platform designs, which we believe will enable our customers to achieve easier and faster transitions from the initial prototype designs through final production releases. We believe these reference platform designs also will enhance our targeted customers’ confidence that our products will meet their market requirements and product introduction schedules.

Manufacturing

      We use third-party manufacturers for wafer fabrication. By subcontracting our manufacturing, we focus our resources on product design and eliminate the high cost of owning and operating a semiconductor fabrication facility. This fabless business model also allows us to take advantage of the research and development efforts of manufacturers, and permits us to work with those manufacturers that offer the most advanced manufacturing processes and competitive prices.

      We currently use Taiwan Semiconductor Manufacturing Co., or TSMC, to fabricate wafers for our microprocessors. We place orders with TSMC on a purchase order basis. We do not have a manufacturing agreement with TSMC or a guaranteed level of production capacity or long term contractual wafer pricing with TSMC. TSMC may allocate capacity to other companies and reduce deliveries to us on short notice.

      Our designs are compatible with industry-standard CMOS manufacturing processes. Substantially all of our products are now fabricated using 0.13 micron process technologies. We continuously evaluate the benefits, on a product-by-product basis, of migrating to a smaller geometry process technology to reduce costs and increase the performance of our microprocessors. Difficulties in shifting to smaller geometry process technologies or new manufacturing processes have and may continue to lead to delays in product deliveries or may lead to reductions in manufacturing yields.

      We currently contract with Advance Semiconductor Engineering, or ASE, to perform the initial testing of the silicon wafers that contain our microprocessors. After initial testing, the silicon wafers are cut into individual semiconductors and assembled into packages. All testing is performed on standard test equipment using proprietary test programs developed by our test engineering group. We periodically inspect our test facilities to ensure that their procedures remain consistent with those required for the assembly of our products. We rely upon ASE to assemble and test substantially all of our products. This reliance on ASE could result in product shortages or delays in the future. If these shortages or delays were significant, our customers might seek alternative sources of supply, which could harm our operating results and reputation.

      We participate in quality and reliability monitoring through each stage of the production cycle by reviewing data from our wafer fabrication plants and assembly subcontractor. We closely monitor wafer fabrication plant production to enhance product quality and reliability and yield levels.

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Competition

      The market for microprocessors is intensely competitive, rapidly evolving and subject to rapid technological change. We believe that competition will become more intense in the future and may cause price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenue and increase our losses. Significant competitors that offer microprocessors for the notebook computer market include Intel, Advanced Micro Devices and VIA Technologies. Intel currently manufactures lower power versions of its microprocessors targeting applications in the ultra-light notebook computer market.

      We compete on the basis of a variety of factors, including:

	•	technical innovation;
	•	performance of our products, including their power usage, product system compatibility, speed, reliability and density;
	•	product price;
	•	product availability;
	•	reputation and branding; and
	•	technical support.

      Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition and larger customer bases than we do. Many of our competitors also have significant influence in the industry. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage.

Intellectual Property

      Our success depends in part upon our ability to maintain the proprietary aspects of our technology and to operate without infringing the proprietary rights of others. We rely on a combination of patents, copyrights, trademarks, trade secret laws and contractual restrictions on disclosure to protect our intellectual property rights. Our current patents principally cover microprocessors, software, components for microprocessors and systems including microprocessors. It is possible that no patents will issue from additional patent applications that we have filed. Even if additional patents are issued, taken together with our existing patents, they may not provide sufficiently broad protection to protect our proprietary rights. We hold a number of trademarks, including Transmeta, Crusoe, LongRun and Code Morphing.

      Legal protections afford only limited protection for our technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, leading companies in the semiconductor industry have extensive intellectual property portfolios relating to semiconductor technology. From time to time, third parties, including these leading companies, may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies and related methods that are important to us. We have received, and may in the future receive, communications from third parties asserting patent or other intellectual property rights covering our products. There are currently no such third party claims that we believe to be material. In the future, however, litigation may be necessary to defend against claims of infringement or invalidity, to determine the validity and scope of the proprietary rights of others, to enforce our intellectual property rights, or to protect our trade secrets.

Employees

      At December 31, 2002, we employed 289 people in the United States, Japan, Taiwan and Europe. Of these employees, 216 were engaged in research and development, 28 were engaged in sales and marketing and 45 were engaged in general and administrative functions. None of our employees is subject to any collective bargaining agreements. We believe that our employee relations are good.

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Available Information

      We make available free of charge on or through our Internet address located at www.transmeta.com our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file that material with, or furnish it to, the Securities and Exchange Commission.

      We lease a total of approximately 131,225 square feet of office space in four buildings in a business park complex located in Santa Clara, California. We lease space in these buildings under four separate leases all of which expire in June 2008. During fiscal 2002, we subleased approximately 8,280 square feet of office space in Santa Clara to a single subtenant. The sublease agreement expired in July 2002 and the subtenant vacated the subleased office space. We also lease approximately 5,000 square feet of office space in a two-story office building located in Acton, Massachusetts under a separate lease agreement, which expires in February 2004. We also lease office space in Taiwan, Japan and Europe to support our sales and marketing personnel worldwide. As a result of our workforce reduction completed in the third quarter of fiscal 2002, we vacated a total of approximately 72,730 square feet of office space in Santa Clara, California and Acton, Massachusetts as of September 30, 2002. We have listed the excess office space with a real estate broker in an effort to secure one or more subtenants, and in early fiscal 2003, we subleased 8,600 square feet of our vacant facilities. We believe the facilities we currently occupy are adequate to meet our needs for the foreseeable future.

      Beginning in June 2001, Transmeta, its directors, and certain of its officers were named as defendants in several putative shareholder class actions filed in the United States District Court for the Northern District of California.(1) The Court consolidated those complaints into a single action entitled In re Transmeta Corporation Securities Litigation, Case No. C 01-02450 WHA. In December 2001, plaintiffs filed their consolidated amended complaint. The consolidated amended complaints purported to allege a class action on behalf of all persons, other than the individual defendants and the other officers of Transmeta, who purchased or acquired common stock of Transmeta during the period from November 7, 2000 to July 19, 2001. The consolidated amended complaints alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, and Sections 11 and 15 of the Securities Act of 1933, as amended. In March 2002, the Court granted in part and denied in part defendants’ motions to dismiss the consolidated amended complaint. In May 2002, the Court granted in part and denied in part defendants’ motion to dismiss the second amended complaint, and denied plaintiffs’ motion for leave to file a third amended complaint. In June 2002, defendants answered the second amended complaint as to the only surviving claim. In July 2002, defendants filed a motion for summary judgment relating to that claim. Plaintiffs moved for class certification, and the Court was scheduled to hear defendants’ motion for summary judgment and plaintiffs’ motion for class certification in December 2002. We believe that the allegations in the second amended complaint and the antecedent complaints are without merit and have defended the consolidated action vigorously. Notwithstanding this belief, and in order to avoid any additional waste of management time and expense, the Company and the individual defendants entered into an agreement with plaintiffs’ counsel to settle this action for approximately $5.5 million, all of which monies have been paid by

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      Beginning in June 2001, the directors and certain officers of Transmeta were sued in four purported shareholder derivative actions.(2) In October 2001, those cases were consolidated in and by the Superior Court for Santa Clara County in a single action entitled In re Transmeta Corporation Derivative Litigation, Master File No. CV 799491. In April 2002, plaintiffs filed a consolidated amended complaint. Like its antecedents, the consolidated amended complaint is based upon the same general allegations set out in the purported shareholder class actions described above. In May and June 2002, Transmeta and the individual defendants filed two demurrers to the second amended complaint. In July 2002, the Court sustained Transmeta’s demurrer based on plaintiffs’ lack of standing, gave plaintiffs 90 days to file an amended complaint, and deferred consideration of the individual defendants’ demurrer as moot. We believe that the allegations in the second amended complaint and its antecedents are without merit and we have defended the action vigorously. Notwithstanding this belief, and in order to avoid any additional waste of management time and expense, the Company and the individual defendants agreed to settle this action for a sum of money to be paid entirely by defendants’ D&O liability insurance, similar to the proposed agreement to settle all of the claims in the federal class action. In December 2002, the parties executed a memorandum of understanding dated October 3, 2002 (the “MOU”). The MOU provides for a settlement of the consolidated derivative action pursuant to a definitive agreement and subject to judicial approval. The proposed settlement includes a dismissal with prejudice of all asserted claims, a release in favor of all defendants, and a payment to fees to counsel for the derivative plaintiffs in an amount to be approved by the Court but not to exceed $300,000. The court has scheduled a hearing on the proposed settlement for April 29, 2003.

      Beginning in June 2001, the Company, certain of its directors and officers, and certain of the underwriters for its initial public offering were named as defendants in three putative shareholder class actions filed in the United States District Court for the Southern District of New York. In January 2002, the Court ordered that all matters in the Southern District of New York be consolidated under In re Transmeta Corporation Initial Public Offering Securities Litigation, No. 01 CV 6492. On April 19, 2002, plaintiffs filed a consolidated amended complaint. The consolidated amended complaint alleges that the prospectus from Transmeta’s November 7, 2000 initial public offering failed to disclose certain alleged actions by the underwriters for the offering. The consolidated amended complaint alleges claims against Transmeta and several of its officers and directors under Sections 11 and 15 of the Securities Act of 1933, as amended, and under Sections 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended. Other actions have been filed making similar allegations regarding the initial public offerings of more than 300 other companies. All of these consolidated cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS). We believe that the allegations in the consolidated amended complaint and its antecedents are without merit and intend to defend the action vigorously. In November 2002, Transmeta joined a coordinated motion to dismiss filed on behalf of all issuers and individual defendants. In March 2003, the Court granted in part and denied in part that coordinated motion to dismiss, and issued an order regarding pleading of amended complaints.

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      Not applicable.

PART II

Market Information for Common Stock

      Transmeta’s common stock began trading on the Nasdaq National Market on November 6, 2000 under the symbol “TMTA”. The following table shows the high and low sale prices reported on the Nasdaq National Market for the periods indicated. The market price of our common stock has been volatile. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risks That Could Affect Future Results.” On March 21, 2003, the closing price of our common stock was $1.24.

Stockholders

      As of March 21, 2003, we had approximately 603 holders of record of our common stock. This does not include the number of persons whose stock is in nominee or “streetname” accounts through brokers.

Dividends

      Transmeta has never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings to fund the development and growth of our business and do not anticipate declaring or paying any cash dividends on our common stock in the foreseeable future.

Securities Authorized For Issuance Under Equity Compensation Plans

      The information required by this item is incorporated by reference to the caption “Equity Compensation Plan Information” in our Proxy Statement for our May 2003 Annual Meeting.

Recent Sales of Unregistered Securities

      During the year ended December 31, 2002, we issued and sold the following unregistered securities:

      In February 2002, we issued 340,483 shares of common stock, valued at $1.0 million, to an intellectual property owner as partial consideration for certain intellectual property and related assets that we acquired in February 2001.

      The sales and issuance of securities listed above were determined to be exempt from registration under Section 4(2) of the Securities Act or Regulation D promulgated under the Securities Act as transactions by an issuer not involving a public offering.

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Use of Proceeds From Sales of Registered Securities

      Our Registration Statement on Form S-1 (File No. 333-44030) related to our initial public offering was declared effective by the Securities and Exchange Commission on November 6, 2000. A total of 14,950,000 shares of our common stock were registered with the Securities and Exchange Commission with an aggregate offering price of approximately $314 million. Net offering proceeds to us (after deducting underwriting discounts and offering expenses) were approximately $289.4 million.

      As of December 31, 2002, we paid $14.5 million of the net proceeds to IBM under the terms of our amended license agreement, approximately $13.2 million in property and equipment purchases and $20.5 million for the purchase of intellectual property and related assets from Seiko Epson and other intellectual property owners. We have also paid approximately $190.6 million to fund ordinary operating expenses. The remaining net proceeds have been invested in short-term interest bearing, investment-grade securities.

      The following table reflects selected unaudited consolidated financial information for Transmeta for the past five fiscal years. We have prepared this information using the historical audited consolidated financial statements of Transmeta Corporation for the five years ended December 31, 2002.

      It is important that you read this selected historical financial data with the historical consolidated financial statements and related notes contained in this Report as well as the section of this Report titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These historical results are not necessarily indicative of results to be expected in any future period.

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(1)	Cost of revenue includes a charge of $28.1 million related to an inventory charge taken in the second quarter of 2001, which was partially offset by the sale of such previously written off inventory and reversal of previously accrued inventory charges of $1.9 million and $2.5 million in fiscal 2002 and 2001, respectively.
(2)	Restructuring charges primarily includes $8.9 million for excess facilities, $1.6 million for property and equipment and prepaid software maintenance write-offs and $4.1 million related to a reduction in workforce.
(3)	During the fourth quarter of 2001, we wrote-off $16.6 million of long-lived asset balances related to deferred charges under licensing agreements.
(4)	Stock compensation in fiscal 2001 includes variable stock compensation charges of $2.5 million, $16.6 million of deferred stock compensation as a result of options granted prior to November 2000 and $1.7 million in forgiveness of interest on notes receivables associated with option exercises.

      NOTE: For a more complete understanding of our financial condition and results of operations, and some of the risks that could affect future results, see “Risks That Could Affect Future Results.” This section should also be read in conjunction with the Consolidated Financial Statements and related Notes, which immediately follow this section.

Overview

      We develop and sell software-based microprocessors and develop additional hardware, software, and system technologies that enable manufacturers to build highly efficient computing systems characterized by low power consumption, reduced heat dissipation and the high performance required to run standard x86 compatible programs. We originally developed our family of Crusoe microprocessors for lightweight notebook computers and other mobile computing devices, but we have developed and are continuing to develop microprocessors suitable for a variety of existing and emerging end markets in which energy and thermal efficiency along with x86 software compatibility are desirable. We rely on independent, third party contractors to perform manufacturing, assembly and test functions. Our fabless approach allows us to focus on designing, developing and marketing our products and to significantly reduce the amount of capital needed to invest in manufacturing infrastructure.

      From our inception in March 1995 through January 2000, we were engaged primarily in research and development. In 1999, we began focusing on achieving design wins with original equipment manufacturers, or OEMs, in addition to our ongoing development activities. In January 2000, we introduced our Crusoe family of microprocessors and began recognizing product revenue from sales of these microprocessors in the first half of 2000. Through June 30, 2000, product shipments consisted of development systems and prototypes. We expect to be dependent on sales of Crusoe microprocessors and successive generations of these products for the foreseeable future.

      We sell our products directly to OEMs and, to a lesser extent, through distributors, stocking representatives and manufacturers’ representatives. We have added manufacturers’ representatives and distributors in

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      The majority of our sales have been to a limited number of customers and sales are highly concentrated. Additionally, we derive a significant portion of our revenue from customers located in Asia. Sales to two customers, each of which is located in Japan, accounted for 37% and 26%, respectively, of our net product revenue in fiscal 2002. The same two customers accounted for 30% and 12%, respectively, of our net product revenue in fiscal 2001 and 60% and 28%, respectively, of our net product revenue in fiscal 2000. Sales to two additional customers, each of which is located in Japan, accounted for 18% and 11%, respectively, of our net product revenue in fiscal 2001. The loss of a major customer, or the delay of significant orders from these customers could reduce or delay our recognition of revenue. Three customers accounted for 78% of our accounts receivable balance as of December 31, 2002, and four different customers accounted for 92% of our accounts receivable balance as of December 31, 2001.

      All of our product sales to date have been denominated in U.S. dollars and we expect that most of our sales in the future will be denominated in U.S. dollars. We have not engaged in any foreign currency hedging activities, although we may do so in the future. Our product sales in 2002, 2001 and 2000 were primarily made to the notebook computer market. If our Crusoe products fail to achieve widespread acceptance in the notebook computer market we may not achieve revenue sufficient to sustain our business.

      Cost of revenue consists primarily of the costs of manufacturing, assembly and test of our silicon chips, and compensation and associated costs related to manufacturing support, logistics and quality assurance personnel. Gross margin is the percentage derived from dividing gross profit by revenue. Our gross margin each quarter is affected by a number of factors, including competitive pricing, mix, foundry pricing, yields, production flow costs and speed distribution of our products. Research and development expenses consist primarily of salaries and related overhead costs associated with employees engaged in research, design and development activities, as well as the cost of masks, wafers and other materials and related test services and equipment used in the development process. Selling, general and administrative expenses consist of salaries and related overhead costs for sales, marketing and administrative personnel and legal and accounting services.

      We previously recorded deferred stock compensation representing the difference between the deemed fair value of our common stock at the date of grant for accounting purposes and the exercise price of these options. Deferred stock compensation is presented as a reduction of stockholders’ equity and is amortized on the graded vesting method. As of December 31, 2002, approximately $3.0 million was recorded on our balance sheet, which will be amortized through 2004 using an accelerated graded method.

      Historically we have incurred significant losses. As of December 31, 2002, we had an accumulated deficit of $454.9 million. We expect to incur substantial losses for the foreseeable future. We also expect to incur significant research and development and selling, general and administrative expenses. As a result, if our revenue does not increase substantially, our operating results will be adversely affected, and we will not achieve profitability. During the fourth quarter of fiscal 2001 and into the first quarter of fiscal 2002 our revenue was primarily impacted by production difficulties. Additionally, beginning in the second quarter of fiscal 2001 and continuing through the fourth quarter of fiscal 2002 our net product revenues have been adversely affected by the slow worldwide and particularly, Japanese economies. If we experience additional production constraints or if economic conditions do not improve, or worsen, we would continue to experience adverse impacts on our revenue and operating results.

      For ease of presentation, the accompanying financial information has been shown as of December 31 and calendar quarter ends for all annual and quarterly financial statement captions. Fiscal years 2002, 2001 and 2000 each consisted of 52 weeks and ended on December 27, December 28 and December 29, respectively.

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Critical Accounting Policies

      We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements:

	•	Estimation of inventory valuations;
	•	Valuation of long-lived and intangible assets;
	•	Restructuring charges; and
	•	Revenue reserves.

      Estimation of Inventory Valuations. In accordance with several accounting pronouncements, including Accounting Research Bulletin 43, our inventory valuation policy stipulates that at the end of each reporting period we write-down or write-off our inventory for estimated obsolescence or unmarketable inventory. The amount of the write-down or write-off is equal to the difference between the cost of the inventory and the estimated market value of the inventory based upon reasonable assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs or write-offs may be required. Additionally, as we introduce product enhancements and new products, and improve our manufacturing processes, demand for our existing products in inventory may decrease. Inventory on hand in excess of forecasted demand, which is generally twelve months or less, is not valued. At the end of the second quarter of 2001, consistent with this policy, we recorded a charge of $28.1 million primarily to write-off certain older inventory products as a result of an actual decrease of future demand for these older products. In the future, we may find that similar assessments may warrant another significant write-down or write-off of inventory.

      Valuation of Long-Lived and Intangible Assets. Our accounting policy related to the valuation and impairment of long-lived assets is in accordance with the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards (SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived Assets. In accordance with our policy, at the end of each accounting period we evaluate our long-lived and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable. Recoverability of assets to be held and used is determined by comparing the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds the future undiscounted cash flows the asset is considered to be impaired and the impairment charge recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. During the fourth quarter of 2001, consistent with this policy, we recorded an impairment write-off charge of $16.6 million related to deferred charges under certain license agreements with IBM and Toshiba. Although we do not now believe that our existing long-lived assets will be impaired in the future, we continue to periodically evaluate our long-lived assets for impairment in accordance with SFAS 144 and acknowledge it is at least reasonably possible that such evaluation might result in future adjustments for impairment. Such an impairment might adversely affect our operating results.

      Restructuring Charges. In fiscal 2002, in accordance with EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”, we accrued for restructuring costs when we made a commitment to a firm exit plan that specifically identified all significant actions to be taken in conjunction with our response to a change in our strategic plan, product demand, increased costs or other environmental factors. Our assumptions used in determining the estimation of restructuring expenses include the determination of the period that it will take to sublet our vacated premises, the market price that we will be able to command for the subleased space and the discounted interest rate that we are using to determine the present value of our future lease obligations. Any significant variation in these estimates compared to actual results may have a material impact on our restructuring expenses and our operating results. We reassess the prior restructuring accruals on a quarterly basis to reflect changes in the costs of the restructuring activities, and we record new restructuring accruals as commitments are incurred. During the second quarter of fiscal 2002, we recorded restructuring charges of $10.6 million primarily related to lease costs and equipment write-offs. We recorded restructuring charges of

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      Revenue Reserves. We record a provision for estimated sales returns and allowances on product sales in the same period as the related revenues are recorded. We base these estimates on actual historical sales returns, allowances and other known factors. Actual returns and allowances could be different from our estimates and current provisions, resulting in future adjustments to our operating results.

Results of Operations

      Fiscal 2002 Compared to Fiscal 2001. Total net product revenue for fiscal 2002 was $24.2 million, compared to $35.6 million in fiscal 2001. The decrease of $11.4 million is due to several factors, including production difficulties at the beginning of fiscal 2002, decreases in average selling prices during fiscal 2002, as well as unfavorable global economic conditions and reduced information technology spending, particularly in Japan. During fiscal 2002 and 2001, demand for our products continued to depend primarily on sales by our OEM customers of notebook computers that incorporate our products.

      Fiscal 2001 Compared to Fiscal 2000. Total net product revenue for fiscal 2001 was $35.6 million, compared to $16.2 million in fiscal 2000. The increase of $19.4 million is a result of a full year of volume shipments of products during 2001 compared to volume shipments in the last two quarters of fiscal 2000.

      Fiscal 2002 Compared to Fiscal 2001. For fiscal 2002, gross margin was 29.4%, compared to (36.8)% for fiscal 2001. Gross margin for fiscal 2001 included an inventory charge of $28.1 million to cost of revenue in the second quarter primarily related to the write-off of excess inventory. In fiscal 2002 and 2001, we recognized 100% gross profit of $0.7 million and $1.7 million, respectively, related to the sale of previously written-off inventory. In fiscal 2002 and 2001, we recognized 100% gross profit of $1.2 million and $0.8 million, respectively, related to the reversal of previously accrued inventory related purchase commitments due to favorable settlements of such purchase commitments.

      Fiscal 2001 Compared to Fiscal 2000. For fiscal 2001, gross margin was (36.8)%, compared to 41.5% in 2000. Gross margin for fiscal 2001 included an inventory charge of $28.1 million to cost of revenue in the second quarter of fiscal 2001 primarily related to the write-off of excess inventory. Inventory purchases and commitments are based upon product demand forecasts. We built inventory levels for certain components with long lead times and entered into commitments for certain components. Due to a sudden and significant decrease in demand for our products in fiscal 2001, inventory levels and purchase commitments exceeded our estimated requirements based on demand forecasts. We believe the decrease in demand was primarily due to unfavorable economic conditions and reduced information technology spending, particularly in Japan. The inventory charge was calculated based on inventory levels in excess of forecasted demand for each specific product. Subsequently, we recognized 100% gross profit of $1.7 million in fiscal 2001 related to the sale of previously written-off inventory and $0.8 million related to the reversal of previously accrued inventory related purchase commitments due to favorable settlements of such purchase commitments. During each of the third, and particularly the fourth quarters of 2001, our gross margin also decreased due in part to lower than expected product revenue, which did not allow for adequate overhead absorption and the scrapping of older inventory.

      Fiscal 2002 Compared to Fiscal 2001. Research and development expenses were $63.6 million in fiscal 2002 compared to $67.6 million in fiscal 2001. The decrease is primarily due to lower employee compensation

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      Fiscal 2001 Compared to Fiscal 2000. Research and development expenses were $67.6 million in fiscal 2001, compared to $61.4 million in fiscal 2000. The increase is primarily due to increased employee compensation and benefit costs and consultant fees, as well as increased software maintenance costs associated with product development. These increases were partially offset by a decrease in prototype expenditures compared to fiscal 2000.

      In April 2001, we licensed certain computing technologies and intellectual property from Advanced Micro Devices, Inc. (AMD), including AMD’s HyperTransport interconnect technology for our future products and technology initiatives. As initial consideration for the patents and patent rights licensed under the agreement, we issued 1,000,000 unregistered shares of our common stock valued at $15.0 million based upon the average closing price of our stock prior to issuance. For accounting purposes, however, the value of the shares was determined using the closing price of the stock at the date of issuance, or $13.60, resulting in a recorded value of $13.6 million. The entire $13.6 million was expensed as purchased in-process research and development during the second quarter of 2001 because the HyperTransport technology is designed for use in products that are currently in research and development.

      Fiscal 2002 Compared to Fiscal 2001. Selling, general and administrative expenses were $29.9 million in fiscal 2002, compared to $35.5 million in fiscal 2001. The decrease is primarily due to lower employee compensation and benefit costs and consultant fees related to our reduction in workforce in the third quarter of fiscal 2002. Additionally, our efforts to reduce overall operating expenses resulted in decreases in travel, trade show and advertising costs during the third and fourth quarters of fiscal 2002. These decreases were partially offset by increases in our insurance renewal premiums for our various corporate insurance policies.

      Fiscal 2001 Compared to Fiscal 2000. Selling, general and administrative expenses were $35.5 million in fiscal 2001, compared to $27.0 million in fiscal 2000. The increase was primarily due to increased employee compensation and benefit costs, consultant fees and recruiting costs.

      During fiscal 2002, we recorded restructuring charges of $14.7 million. We recorded charges of $10.6 million in the second quarter of fiscal 2002 consisting primarily of lease costs, equipment write-offs and other costs as we identified a number of leased facilities and leased equipment that were no longer required. We recorded severance and termination charges of $4.1 million in the third quarter of fiscal 2002 related to the reduction in workforce. Approximately 195 employees and contractors were terminated on July 18, 2002. Other than future lease payments for our vacated facilities, the majority of our restructuring activities have been completed. We evaluated the restructuring reserve balance as of December 31, 2002 and determined no adjustments were needed.

      Amortization charges for fiscal 2002 and fiscal 2001 relate to various patents and patent rights acquired from Seiko Epson and others during fiscal 2001. Amortization charges for fiscal 2001 and fiscal 2000 also include charges related to our IBM and Toshiba technology license agreements, as amended, which were originally entered into during fiscal 1997 and 1998, respectively. See Note 4 and Note 5 in the “Notes to Consolidated Financial Statements” for further discussion of our technology license agreements and patents and patent rights.

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      Fiscal 2002 Compared to Fiscal 2001. We recorded amortization charges of $11.4 million, compared to $17.6 million in fiscal 2001. The decrease is due to the impairment charge recorded during the fourth quarter of fiscal 2001 to adjust the IBM and Toshiba license agreements to their respective fair values, resulting in no additional amortization expenses being recorded in fiscal 2002 related to these deferred charges.

      Fiscal 2001 Compared to Fiscal 2000. We recorded amortization charges of $17.6 million in fiscal 2001, compared to $10.4 million in fiscal 2000. The increase is due to the capitalization and subsequent amortization related to the patents acquired from Seiko Epson and others in fiscal 2001.

      Deferred charges related to IBM and Toshiba technology license agreements were being amortized on a straight-line basis through December 2003, which was the remaining license term during which the reacquired rights were originally in effect. See Note 4 in the “Notes to Consolidated Financial Statements” for further discussion of our technology license agreements. During the fourth quarter of 2001, due to the emergence of indicators of impairment, we performed an assessment of the carrying value our long-lived assets to be held and used. The assessment was performed in connection with our internal policies and pursuant to SFAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” because of the significant negative industry and economic trends affecting both our current operations and expected future operating cash flows. The conclusion of that assessment was that the anticipated future undiscounted cash flows was less than the carrying value for all long-lived assets, including the deferred charges. As a result, during the fourth quarter of 2001, we recorded a charge of $16.6 million to reduce the carrying amount of the deferred charges under license agreements based on the amount by which the carrying amount of these assets exceeded their fair value. Although these assets were impaired and written off, the associated remaining payments due to IBM of $23.0 million are still required and will continue to accrete interest until the final payment is made.

      Fiscal 2002 Compared to Fiscal 2001. Amortization of deferred stock compensation associated with options granted prior to November 2000, net of cancellation, was $3.6 million in fiscal 2002, compared to $16.6 million in 2001. The decrease is primarily a result of amortizing the deferred charge on an accelerated graded method, as well as a credit recorded to stock compensation expense of $1.7 million in the third quarter of fiscal 2002 related to our workforce reduction. The total credit to deferred compensation expense for cancellations was $3.4 million and $3.1 million for fiscal 2002 and 2001, respectively. In connection with stock options grants through November 2000, we expect to record $2.6 million in 2003 and $0.4 million in 2004.

      We apply variable accounting for certain stock option grants, which is included in deferred stock compensation, because during the fourth quarter of fiscal 2001, we did not enforce the recourse provisions of certain employee notes associated with option exercises. Therefore, we account for all outstanding notes as if they had terms equivalent to non-recourse notes, even though the terms of these notes were not in fact changed from recourse to non-recourse. As a result, we have and will continue to record variable stock compensation expense on the associated stock awards until the notes are paid. This variable stock compensation charge is based on the excess, if any, of the current market price of our stock as of period-end over the purchase price of the stock award, adjusted for vesting and prior stock compensation expense recognized on the stock award. Stock compensation for fiscal 2002 included a credit of $1.8 million recorded to stock compensation expense due to a lower market price of our stock at the end of fiscal 2002 compared the end of fiscal 2001. Stock compensation expense in fiscal 2001 included $2.5 million in variable stock compensation and $1.7 million in forgiveness of interest related to officer resignations.

      In the future, if the price of our stock increases $1 per share it will result in approximately $1.5 million of additional stock compensation expense, or if the stock price decreases $1 per share it will result in a benefit (reduction) in stock compensation expense of approximately the same amount. Because variable stock compensation expense is calculated based on the current market value of our common stock at the end of each accounting period, future stock compensation expense for these variable stock awards could increase

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      Fiscal 2001 Compared to Fiscal 2000. Deferred stock compensation expense, net of cancellation, was $16.6 million in fiscal 2001, compared to $13.1 million in fiscal 2000. Additionally, stock compensation expense in fiscal 2001 included 2.5 million in variable stock compensation and $1.7 million in forgiveness of interest related to officer resignations, compared to zero in fiscal 2000. The increase is a result of a full year of amortization of the total deferred stock compensation expense of $46.0 million recorded in connection with our initial public offering in November 2000. The total credit to deferred compensation expense for cancellations was $3.1 million for fiscal 2001.

      Fiscal 2002 Compared to Fiscal 2001. Interest and other income was $5.0 million in fiscal 2002, compared to $14.7 million in fiscal 2001. The decrease is due to a decrease in the average invested cash balances during 2002 as we continue to use cash to fund operations, as well as a significant decrease in interest rates earned on investments during the period. As we continue to use cash to fund operations, our investment balances will decrease and as a result our interest income is expected to decrease over time. Interest expense was $0.6 million in fiscal 2002, compared to $1.1 million in fiscal 2001. The decrease year over year is the result of lower average debt balances due to several lease-financing arrangements expiring during 2002.

      Fiscal 2001 Compared to Fiscal 2000. Interest and other income was $14.7 million in fiscal 2001, compared to $9.2 million in fiscal 2000. The increase year over year is primarily due to larger average invested cash balances resulting from the closing of an equity offering in April 2000 and our initial public offering in November 2000. Interest expense was $1.1 million in fiscal 2001, compared to $1.7 million in fiscal 2000. The decrease year over year is due to lower average debt balances due to several lease-financing arrangements expiring during 2001.

Liquidity and Capital Resources

      Since our inception, we have financed our operations primarily through sales of equity securities and, to a lesser extent, from product revenue and lease financing. At December 31, 2002, we had $129.5 million in cash, cash equivalents and short-term investments compared to $241.7 million at December 31, 2001.

      Net cash used in operating activities was $93.9 million for the year ended December 31, 2002. This was primarily the result of the net loss of $110.0 million, as well as increases in inventories of $9.5 million and accounts receivable of $2.4 million, and a decrease in accounts payable and accrued liabilities of $3.4 million. The net loss and changes in operating assets and liabilities were partially offset by non-cash charges related to amortization of patents and patent rights of $11.4 million, $6.1 million of depreciation and amortization, $1.8 million in amortization of deferred compensation and $1.6 million of non cash restructuring charges. The net loss was further offset by a decrease in prepaid expenses and other current assets of $2.3 million.

      Net cash provided by investing activities was $49.7 million for the year ended December 31, 2002, and consisted primarily of $70.5 million net proceeds from the maturity of available-for-sale investments. These proceeds were partially offset by the $15.0 million partial settlement of long-term payable obligations for licensing agreements and patents and patent rights, as well as purchases of property and equipment of $5.6 million in fiscal 2002.

      Net cash provided by financing activities was $3.1 million for the year ended December 31, 2002, and consisted primarily of net proceeds from option exercises and employee stock purchase plan purchases of $4.6 million and proceeds from capital lease obligations of $1.1 million, partially offset by repayment of debt and capital leases obligations of $2.7 million.

      At December 31, 2002, we had $16.6 million in cash and cash equivalents and $112.8 million in short-term investments. We lease our facilities under non-cancelable operating leases expiring in 2008, and we lease

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      We believe that existing cash and cash equivalents and short-term investments balances will be sufficient to fund our operations for the next twelve months. After this period, capital requirements will depend on many factors, including general economic conditions, the rate of sales growth, market acceptance of our products, costs of securing access to adequate manufacturing capacity, the timing and extent of research and development projects, increases in our operating expenses, and ultimately our ability to generate profits from operations. To the extent that existing cash and cash equivalents and short-term investments balances and any cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. Although we are currently not a party to any agreement or letter of intent with respect to a potential acquisition or business combination, we may enter into acquisitions or business combinations in the future, which also could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

Recent Accounting Pronouncements

      In July 2002, the FASB issued SFAS 146 “Accounting for Costs Associated with Exit or Disposal Activities”, which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. The principal difference between SFAS 146 and EITF 94-3 relates to the timing of the recognition of a liability for a cost associated with an exit or disposal activity. SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. A liability for an exit cost as generally defined in EITF 94-3 is to be recognized at the date of an entity’s commitment to an exit plan. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We accounted for our restructuring activity during fiscal 2002 under EITF 94-3. We do not expect the adoption of SFAS 146 to have a material impact on our financial position or results of operations.

      In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantee’s of Indebtedness of Others.” FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Our adoption of FIN 45 did not have a material impact on our financial position or results of operations.

      In December 2002, the FASB issued SFAS 148 “Accounting for Stock-Based Compensation — Transition and Disclosure”, which amends SFAS 123 “Accounting for Stock-Based Compensation” and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reporting results. The transition guidance and annual disclosures provisions of SFAS 148 are effective for fiscal years ending

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      In January 2003, the FASB issued FIN No. 46 “Consolidation of Variable Interest Entities.” FIN 46 requires a variable interest to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to a receive a majority of the entity’s residual returns or both. A variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A variable interest entity often holds financial assets, including loans or receivables, real estate or other property. A variable interest entity may be essentially passive or it may engage in research and development or other activities on behalf of another company. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. We do not expect that the adoption of this standard will have a material impact on our financial position or results of operations.

Risks that Could Affect Future Results

      The factors discussed below are cautionary statements that identify important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements in this Form 10-K. If any of the following risks actually occurs, our business, financial condition and results of operations would suffer. In this case, the trading price of our common stock could decline and investors might lose all or part of their investment in our common stock.

      We have a history of substantial losses and expect to incur further significant losses. We incurred net losses of $110.0 million in 2002, $171.3 million in 2001 and $97.7 million in 2000. As of December 31, 2002, we had an accumulated deficit of $454.9 million. Historically, we have increased our research and development, sales and marketing, and administrative expenses over time. Although we have recently taken steps to reduce operating expenses, we cannot assure you that our operating expenses will not increase in future periods. We also expect to incur substantial non-cash charges relating to the amortization of deferred charges, patents and patent rights and deferred stock and variable stock compensation, which will serve to increase our net losses further. Our revenue must increase if we are to achieve profitability under our current business model. We cannot assure you that our revenue will increase, so we may never achieve profitability. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or an annual basis.

      We introduced our first Crusoe microprocessors in January 2000 and recognized our first product revenue from these products in the first half of 2000. Through June 30, 2000, we had manufactured only limited quantities of our products. In September 2000, we began volume shipments. Thus, we have only a very limited operating history with our products. This limited history makes it difficult to forecast our business. Until 2000, we derived substantially all of our revenue from license fees, but we do not expect any significant license fee revenue in the foreseeable future. We need to generate substantial future revenue from product sales, but our ability to manufacture our products in production quantities and the revenue and income potential of our

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      We expect to derive virtually all of our revenue for the foreseeable future from the sale of our Crusoe microprocessors, which we only began to ship in volume in September 2000. Since September 2000 we have recognized substantially all of our revenue from sales of our Crusoe microprocessors. Therefore, our future operating results will depend on the demand for Crusoe products by existing and future customers. If our Crusoe microprocessors are not widely accepted by the market due to performance, price, compatibility or any other reason, or if, following acceptance, we fail to enhance our Crusoe products in a timely manner, demand for our products may fail to increase, or may diminish. If demand for our Crusoe products does not increase, our revenue will not increase and the value of an investment in our common stock would likely decline further.

      Our business is subject to the effects of general economic conditions in the United States and worldwide, and, in particular, market conditions in the semiconductor and notebook computer industries. In fiscal 2001 and 2002, our operating results were adversely affected by unfavorable global economic conditions and reduced information technology spending, particularly in Japan, where we currently generate the majority of our revenue. These adverse conditions resulted in decreased demand for notebook computers and, as a result, our products, which are components of notebook computers. Further, demand for our products decreases as computer manufacturers seek to manage their component and finished product inventory levels. If the economic conditions in Japan and worldwide do not improve, or worsen, we may continue to experience material adverse effects on our business, operating results, and financial condition.

      Transitioning to new manufacturing technologies involves extensive redesigning of products and modifying the manufacturing processes for the products. Difficulties in shifting to smaller geometry process technologies and other new manufacturing processes have led to delays in product deliveries and increased expenses. In particular, during the third and fourth quarters of fiscal 2001 and to a lesser extent the first quarter of fiscal 2002, we experienced difficulties in bringing our products into volume production and distribution. As a result, in part, of these delays, our net product revenue in 2001 declined from $10.5 million in the second quarter to $5.0 million in the third quarter and then to $1.5 million in the fourth quarter. In addition, if we experience continued delays in product deliveries, our target customers could design a competitor’s microprocessor into their product, which would lead to lost sales and impede our ability to increase our revenue. Further, problems associated with manufacturing processes divert engineering personnel from product development and other tasks.

      Our success depends upon our ability to sell our Crusoe microprocessors in volume to the small number of OEMs that manufacture notebook computers. Due to our software-based approach to microprocessor design, we have been required, and expect to continue to be required, to devote substantial resources to educate prospective customers in the notebook computer market about the benefits of our Crusoe products and to assist potential customers with their designs. In addition, since computer products generally are designed to incorporate a specific microprocessor, OEMs must design new products to utilize different microprocessors such as our Crusoe products. Given the complexity of these computer products and their many components, designing new products requires significant investments. For instance, OEMs may need to design new computer casings, basic input/output system software and motherboards. Our target customers

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      The growth of our business depends in part on acceptance and use of our products in new markets such as the high-density server market and new embedded processor applications. We depend on the ability of our target customers to develop new products and enhance existing products for these markets that incorporate our products and to introduce and promote their products successfully. These new markets often rely on newly developed technologies, which will require extensive development and marketing before widespread acceptance is achieved, so the new markets may grow slowly, if at all. If the new markets do not grow as we anticipate, our target customers do not incorporate our products into theirs, or our products are not widely accepted by end users, our growth would be impeded and we will not be able to factor the related revenues into our growth in the future. In addition, manufacturers within emerging markets may have widely varying requirements. To meet the requirements of different manufacturers and markets, we may be required to change our product design or features, sales methods or pricing policies. The costs of addressing these requirements could be substantial and could delay or prevent any improvement in our operating results.

      The semiconductor industry has historically been cyclical, and characterized by wide fluctuations in product supply and demand. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Industry downturns have been characterized by diminished product demand, production overcapacity and accelerated decline of average selling prices, and in some cases have lasted for more than a year. The industry experienced a downturn of this type in 1997 and 1998, and has been experiencing a downturn again since 2001. Our net product revenue has decreased in response to industry-wide fluctuations, and could decrease further. In addition, we may determine to lower our prices of our products to increase or maintain market share, which would likely decrease our operating results.

      Our operating results fluctuate significantly from quarter to quarter and we expect our results to fluctuate in the future. You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. Our stock price declined substantially since our stock began trading publicly in November of 2000. If our future operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price would likely decline further in the future.

      Our results could fluctuate because of the amount of revenue we recognize or the amount of cash we spend in a particular period. For example, our results could fluctuate due to the following factors:

	•	the gain or loss of significant customers, or significant changes in their purchasing volume;
	•	the amount and timing of our operating expenses and capital expenditures;
	•	pricing concessions that we might grant on volume sales;
	•	the effectiveness of our product cost reduction efforts and those of our suppliers;
	•	changes in the average selling prices of our microprocessors or the products that incorporate them;
	•	charges to earnings for workforce reductions;

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	•	our ability to specify, develop, complete, introduce and market new products and technologies, and bring them to volume production in a timely manner; and
	•	changes in the mix of products that we sell.

      Our reliance on third parties for wafer fabrication, assembly, test and warehouse services also could contribute to fluctuations in our quarterly results, based upon factors such as the following:

	•	fluctuations in manufacturing yields;
	•	cancellations, changes or delays of deliveries to us by our manufacturer;
	•	the cost and availability of manufacturing, assembly and test capacity;
	•	delays in deliveries to customers of our products; and
	•	problems or delays resulting from shifting our products to smaller geometry process technologies or from designing our products to achieve higher levels of design integration.

      In addition, our results could fluctuate from quarter to quarter due to factors in our industry that are outside of our control, including the following factors:

	•	the timing, rescheduling or cancellation of customer orders;
	•	the varying length of our sales cycles;
	•	the availability and pricing of competing products and technologies, and the resulting effect on sales and pricing of our products;
	•	the availability and pricing of products that compete with products that incorporate our microprocessors;
	•	fluctuations in the cost and availability of complementary components that our customers require to build systems that incorporate our products;
	•	fluctuations in the cost and availability of raw materials, such as wafers, chip packages and chip capacitors;
	•	the rate of adoption and acceptance of new industry standards in our target markets;
	•	seasonality in some of our target markets;
	•	changes in demand by the end users of our customers’ products;
	•	variability of our customers’ product life cycles; and
	•	economic and market conditions in the semiconductor industry and in the industries served by our customers.

      A large portion of our expenses, including rent, salaries and capital leases, is fixed and difficult to reduce. Our expenses are based in part on expectations for our revenue. If our revenue does not meet our expectations, the adverse effect of the revenue shortfall upon our operating results may be acute in light of the fixed nature of our expenses. We make many shipments of our products at or near the end of the fiscal quarter, which makes it difficult to estimate or adjust our operating activities quickly in response to a shortfall in expected revenue.

      In July 2002, as part of our effort to reduce operating expenses, we announced a restructuring and related reduction in our workforce. Our restructuring plan included the termination of approximately 195 employees and contractors, which constituted approximately 40 percent of our workforce. As a result of the recent workforce reduction, we have incurred substantial costs related to severance and other employee-related costs.

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      Our success depends heavily upon the contributions of our key management and technical personnel, whose knowledge, leadership and technical expertise would be difficult to replace. Many of these individuals have been with us for several years and have developed specialized knowledge and skills relating to our technology and business. Others, including our president and chief executive officer, have joined us in senior management roles only recently. During 2002, we had significant changes in senior management. In April 2002, Matthew R. Perry joined us as chief executive officer and president, replacing Murray A. Goldman and R. Hugh Barnes, who served in positions of chief executive officer and president and chief operating officer, respectively, from October 2001 to April 2002. In June 2002 Svend-Olav Carlsen, our vice president of finance and corporate controller, began serving as acting chief financial officer. In August 2002, Ray Holzworth joined us as vice president of operations. In March 2003, Arthur L. Swift joined us as senior vice president of marketing. Our success will depend in part upon the ability of these new executives to work effectively together and with the rest of our employees to continue to develop our technology and manage the operation and growth of our business. All of our executive officers and key personnel are employees at will. We have no employment contracts and do not maintain key person insurance on any of our personnel. We might not be able to execute on our business plan if we were to lose the services of any of our key personnel. If any of these individuals were to leave Transmeta unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor develops the necessary training and experience.

      The market price of our common stock has been volatile and is likely to remain to be subject to wide fluctuations in the future. Many factors could cause the market price of our common stock to fluctuate, including:

	•	variations in our quarterly results;
	•	market conditions in our industry, the industries of our customers and the economy as a whole;
	•	announcements of technological innovations by us or by our competitors;
	•	introductions of new products or new pricing policies by us or by our competitors;
	•	acquisitions or strategic alliances by us or by our competitors;
	•	recruitment or departure of key personnel;
	•	the gain or loss of significant orders;
	•	the gain or loss of significant customers; and
	•	changes in the estimates of our operating performance or changes in recommendations by securities analysts.

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      In addition, the stock market generally and the market for semiconductor and other technology-related stocks in particular has experienced a decline during 2000, 2001 and through the third quarter of 2002, and could decline further, which could cause the market price of our common stock to fall for reasons not necessarily related to our business, results of operations or financial condition. The market price of our stock also might decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. Accordingly, you may not be able to resell your shares of common stock at or above the price you paid. Securities class action litigation is often brought against a company following a period of volatility in the market price of its securities, and we are defending several purported securities class action lawsuits. Further, certain of our management and directors have also been sued in purported shareholder derivative actions. Although we believe that the lawsuits lack merit, an adverse determination could have a significant effect upon our business and materially affect the price of our stock. Moreover, regardless of the ultimate result, it is likely that the lawsuits will divert management’s attention and resources from other matters, which could also adversely affect our business and the price of our stock.

      The market for microprocessors is dominated by established firms and subject to rapid technological change. We face particularly strong competitive pressure in the United States and we believe that such pressure is increasing on a worldwide basis. Competition may cause price reductions, reduced gross margins and loss of market share, any one of which could significantly reduce our future revenue and increase our losses. For example, we may determine to lower the prices of our products in order to increase or maintain market share, which would likely increase our losses. Significant competitors include Intel, Advanced Micro Devices, VIA Technologies and licensees of technology from ARM Holdings and MIPS Technologies.

      Our current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition and significantly larger customer bases than we do. Our competitors may be able to develop products comparable or superior to those we offer, adapt more quickly than we do to new technologies, evolving industry trends and customer requirements, and devote greater resources to the development, promotion and sale of their products than we can. Many of our competitors also have well-established relationships with our existing and prospective customers and suppliers. As a result of these factors, many of our competitors, either alone or with other companies, have significant influence in our target markets that could outweigh any advantage that we may possess. For example, negotiating and maintaining favorable customer and strategic relationships are and will continue to be critical to our business. If our competitors use their influence to negotiate strategic relationships on more favorable terms than we are able to negotiate, or if they structure relationships that impair our ability to form strategic relationships, our competitive position and our business would be substantially damaged.

      Furthermore, our competitors may merge or form strategic relationships that might enable them to offer, or bring to market earlier, products that are superior to ours in terms of features, quality, pricing or other factors. We expect additional competition from other established and emerging companies and technologies. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage.

      Highly complex products such as our microprocessors may contain hardware or software defects or bugs for many reasons, including design issues or defective materials or manufacturing processes. Often, these defects and bugs are not detected until after the products have been shipped. If any of our products contain defects, or has reliability, quality or compatibility problems, our reputation might be damaged significantly and customers might be reluctant to buy our products, which could result in the loss of or failure to attract customers. In addition, these defects could interrupt or delay sales. We may have to invest significant capital and other resources to correct these problems. If any of these problems are not found until after we have commenced commercial production of a new product, we might incur substantial additional development

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      Sales to two customers in the aggregate accounted for 63% of net product revenue in 2002. These customers are located in Japan, which subjects us to economic cycles in that country. We expect that a small number of OEM customers and distributors will continue to account for a significant portion of our revenue. Our future success will depend upon the timing and size of future purchase orders, if any, from these customers and new customers and, in particular:

	•	the success of our customers in marketing products that incorporate our products;
	•	the product requirements of our customers; and
	•	the financial and operational success of our customers.

      We have entered into distributor agreements and rely in part on distributors and stocking representatives for sales of our products in large territories, including Japan, Taiwan, Hong Kong, Europe, China, Korea and North America. These agreements do not contain minimum purchase commitments. Additionally, we have entered into agreements with manufacturers’ representatives in North America and Europe. Any distributor, stocking representative or manufacturers’ representative that fails to emphasize sales of our products, chooses to emphasize alternative products or devices to promote products of our competitors might not sell a significant amount or any of our products. We expect that our sales to OEM customers will continue to be made on the basis of purchase orders rather than long-term commitments. In addition, customers can delay, modify or cancel orders without penalty. Many of our customers and potential customers are significantly larger than we are and have sufficient bargaining power to demand reduced prices and favorable nonstandard terms. The loss of any major customer, or the delay of significant orders from these customers, could reduce or delay our recognition of revenue.

      The cost, quality and availability of third-party manufacturing operations are essential elements to the successful production of our products. We currently rely exclusively on TSMC to fabricate our wafers. We do not have a manufacturing agreement with TSMC that guarantees any particular production capacity or any particular price from TSMC. We place orders on a purchase order basis and TSMC may allocate capacity to other companies’ products while reducing deliveries to us on short notice. The absence of dedicated capacity means that, with little or no notice, TSMC could refuse to continue to fabricate all or some of the wafers that we require or change the terms under which it fabricates wafers. If TSMC were to stop manufacturing for us, we would likely be unable to replace the lost capacity in a timely manner. Transferring to another manufacturer would require a significant amount of time and money, and a smooth and timely transition would be unlikely. As a result, we could lose potential sales and fail to meet existing obligations to our customers. In addition, if TSMC were to change the terms under which it manufactures for us, our manufacturing costs could increase.

      Our reliance on third-party manufacturers exposes us to the following risks outside our control:

	•	unpredictability of manufacturing yields and production costs;
	•	interruptions in shipments;

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	•	potential lack of adequate capacity to fill all or part of the services we require;
	•	inability to control quality of finished products;
	•	inability to control product delivery schedules; and
	•	potential lack of access to key fabrication process technologies.

      Because we only introduced our products in January 2000 and did not start volume shipments of commercial products until September 2000, we have little historical information about demand for our products. Many shipments of our products are made near the end of the fiscal quarter, which also makes it difficult to estimate demand for our products. The demand for our products depends upon many factors and is difficult to forecast. We expect that it will become more difficult to forecast demand as we introduce a larger number of products and as competition in the markets for our products intensifies. Significant unanticipated fluctuations in demand have caused, and in the future could cause, problems in our operations.

      The lead-time required to fabricate large volumes of wafers is often longer than the lead-time our customers provide to us for delivery of their product requirements. Therefore, we often must place our orders in advance of expected purchase orders from our customers. As a result, we have only a limited ability to react to fluctuations in demand for our products, which could cause us to have either too much or too little inventory of a particular product. If demand does not develop as we expect, we could have excess production. Excess production would result in excess inventories of finished products, which would use cash and could result in inventory write-downs and write-offs. We have limited capability to reduce ongoing production once wafer fabrication has commenced. For example, due to the sudden and significant decrease in actual and forecasted demand for our products during the second and third quarters of 2001, we recorded a net charge of $25.6 million to cost of revenue related to excess inventory and related purchase commitments. Further, as we introduce product enhancements and new products, and improve our manufacturing processes, demand for our existing products decreases. Conversely, if demand exceeds our expectations, TSMC, might not be able to fabricate wafers as quickly as we need them. Also, ASE, which provides our assembly and test services, might not be able to increase assembly functions in a timely manner. In that event, we would need to increase production and assembly rapidly at TSMC and ASE or find, qualify and begin production and assembly at additional manufacturers, which may not be possible within a time frame acceptable to our customers. The inability of TSMC and ASE to increase production rapidly enough could cause us to fail to meet customer demand. In addition, rapid increases in production levels to meet unanticipated demand could result in higher costs for manufacturing and other expenses. These higher costs could lower our gross margins.

      The fabrication of wafers for our microprocessors is a highly complex and precise process that requires production in a tightly controlled, clean room environment. Minute impurities, difficulties in the fabrication process, defects in the masks used to print circuits on a wafer or other factors can cause numerous die on each wafer to be nonfunctional. The proportion of functional die expressed as a percentage of total die on a wafer is referred to as product “yield.” Semiconductor companies frequently encounter difficulties in achieving expected product yields. During 2001, we experienced yield problems as we migrated our manufacturing processes to smaller geometries, which caused increases in our product costs, delays in product availability and diversion of engineering personnel. Even with functional die, normal variations in wafer fabrication can cause some die to run faster than others. Variations in speed yield could lead to excess inventory, a resulting unfavorable impact on gross margins and insufficient inventory of faster products, depending upon customer demand. Yield problems may not be identified and resolved until a product has been manufactured and can be analyzed and tested, if ever. As a result, yield problems are often difficult, time consuming and expensive to correct. Yield problems have in the past and could in the future hamper our ability to deliver our products to our customers in a timely manner.

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      We rely on ASE for substantially all of our assembly and test services. As a result, we do not directly control our product delivery schedules. This lack of control could result in product shortages, which could increase our costs or delay delivery of our products. We do not have a contract with ASE for test and assembly services, and we typically procure these services from ASE on a per order basis. ASE could cease to perform all of the services that we require, or could change the terms upon which it performs services for us. Therefore, we may not be able to obtain assembly and testing services for our products on acceptable terms, or at all. If we are required to find and qualify alternative assembly or testing services, we could experience delays in product shipments, increased product costs or a decline in product quality.

      Our California facilities, including our principal executive offices, are located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, our business could be materially and adversely affected. In addition, TSMC, upon which we currently rely to fabricate our wafers, and ASE, upon which we currently rely for substantially all of our assembly and test services, are located in Taiwan. Taiwan has experienced significant earthquakes and could be subject to additional earthquakes in the future. Any earthquake or other natural disaster in Taiwan could materially disrupt TSMC’s production capabilities and ASE’s assembly and test capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of wafers and possibly in higher wafer prices.

      In addition to our customers, we will need to establish and maintain relationships with companies that develop technologies that work in conjunction with our microprocessors. These technologies include operating systems, basic input/output systems, graphics chips, dynamic random access memory, or DRAM, and other hardware components and software that are used in computers. If we fail to establish and maintain these relationships, it would be more difficult for us to develop and market products with features that address emerging market trends.

      Our products are designed to function as components of a system. Our customers use our products in systems that have differing specifications and that require various other components, such as dynamic random access memory, or DRAM, and other semiconductor devices. If our customers’ systems are to function properly, all of the components must be compatible with each other. If our customers experience system-level incompatibilities between our products and the other components in their systems, we could be required to modify our products to overcome the incompatibilities or delay shipment of our products until the manufacturers of other components modify their products or until our customers select other components. These events would delay purchases of our products, cause orders for our products to be cancelled or result in product returns. System-level incompatibilities that are significant, or are perceived to be significant could also result in negative publicity and could significantly damage our business.

      Suppliers of other components incorporated into our customers’ systems may experience shortages, which could reduce the demand for our products. For example, from time to time, the computer and semiconductor

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      Software applications, games or operating systems with machine-specific routines programmed into them can result in specific incompatibilities. If a particular software application, game or operating system is programmed in a manner that makes it unable to respond correctly to our microprocessor, it will appear to users of that software that our microprocessor is not compatible with PC software. We might encounter incompatibilities in the future. If any incompatibilities are significant or are perceived to be significant, our products might never achieve market acceptance and we might not receive significant revenue from product sales.

      Our ability to implement our business plan in a rapidly evolving market requires effective planning and management process. Changes in our business plans could place significant strain on our management systems, infrastructure and other resources. In addition, we expect that we will continue to improve our financial and managerial controls and procedures. We will also need to expand, train and manage our workforce worldwide. Furthermore, we expect that we will be required to manage an increasing number of relationships with suppliers, manufacturers, customers and other third parties. If we fail to manage change effectively, our employee-related costs and employee turnover could increase and our business may not succeed.

      We depend upon other companies designing our microprocessors into their products, which we refer to as design wins. Many of our targeted customers consider the choice of a microprocessor to be a strategic decision. Thus our targeted customers may take a long time to evaluate our products, and many individuals may be involved in the evaluation process. We anticipate that the length of time between our initial contact with a customer and the time when we recognize revenue from that customer will vary. We expect our sales cycles to range from six to twelve months from the time we achieve a design win to the time the customer begins volume production of products that incorporate our microprocessors. We do not have historical experience selling our products that is sufficient for us to determine how our sales cycles will affect the timing of our revenue. Variations in the length of our sales cycles could cause our revenue to fluctuate widely from period to period. While potential customers are evaluating our products and before they place an order with us, we may incur sales and marketing expenses and expend significant management and engineering resources without any assurance of success. The value of any design win depends upon the commercial success of our customers’ products. If our customers cancel projects or change product plans, we could lose anticipated sales. We can offer no assurance that we will achieve further design wins or that the products for which we achieve design wins will ultimately be introduced or will, if introduced, be commercially successful.

      The semiconductor industry is characterized by rapid technological change, frequent new product introductions and enhancements, and ongoing customer demands for greater performance. In addition, the average selling price of any particular microprocessor product has historically decreased substantially over its life, and we expect that trend to continue. As a result, our products may not be competitive if we fail to

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	•	accurately define and design new products to meet market needs;
	•	design features that continue to differentiate our products from those of our competitors;
	•	transition our products to new manufacturing process technologies;
	•	identify emerging technological trends in our target markets;
	•	anticipate changes in end-user preferences with respect to our customers’ products;
	•	bring products to market on a timely basis at competitive prices; and
	•	respond effectively to technological changes or product announcements by others.

      We believe that we will need to continue to enhance our products and develop new products to keep pace with competitive and technological developments and to achieve market acceptance for our products.

      Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot be certain that our products do not and will not infringe issued patents, patents that may be issued in the future, or other intellectual property rights of others. In addition, leading companies in the semiconductor industry have extensive intellectual property portfolios with respect to semiconductor technology. From time to time, third parties, including these leading companies, may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies and related methods that are important to us. We expect that we may become subject to infringement claims as the number of products and competitors in our target markets grows and the functionality of products overlaps. We have received, and may in the future receive, communications from third parties asserting patent or other intellectual property rights covering our products. Litigation may be necessary in the future to defend against claims of infringement or invalidity, to determine the validity and scope of the proprietary rights of others, to enforce our intellectual property rights, or to protect our trade secrets. We may also be subject to claims from customers for indemnification. Any resulting litigation, regardless of its resolution, could result in substantial costs and diversion of resources.

      If it were determined that our products infringe the intellectual property rights of others, we would need to obtain licenses from these parties or substantially reengineer our products in order to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms, or at all, or to reengineer our products successfully. Moreover, if we are sued for infringement and lose the suit, we could be required to pay substantial damages or be enjoined from licensing or using the infringing products or technology. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products.

      We believe that our success will depend in part upon our proprietary technology. We rely on a combination of patents, copyrights, trademarks, trade secret laws and contractual obligations with employees and third parties to protect our proprietary rights. These legal protections provide only limited protection and may be time consuming and expensive to obtain and enforce. If we fail to protect our proprietary rights

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      Our pending patent and trademark applications may not be approved. Our patents, including any patents which may result from our patent applications may not provide us with any competitive advantage or may be challenged by third parties. If challenged, our patents might not be upheld or their claims could be narrowed. Any litigation surrounding our rights could force us to divert important financial and other resources from our business operations.

      To grow our business successfully and maintain a high level of quality, we will need to recruit, train, retain and motivate highly skilled sales, marketing, engineering and finance personnel. We will need to develop our sales and marketing organizations in order to increase market awareness of our products and to increase revenue. In addition, as a company focused on the development of complex products, we will need to hire skilled engineering staff of various experience levels in order to meet our product roadmap. We may not be able to hire on a timely basis a sufficient number of skilled employees, which could lead to delays in product deliveries or the development of new products. Competition for skilled employees, particularly in the San Francisco Bay Area, is intense. We may have difficulty recruiting potential employees and retaining our key personnel if prospective or current employees perceive the equity component of our compensation package to be less valuable than that of other employers.

      Our common stock is listed on the Nasdaq National Market. The Nasdaq Stock Market’s Marketplace Rules impose requirements for companies listed on the Nasdaq National Market to maintain their listing status. One of these requirements is that we must maintain a minimum closing bid price of $1.00 per share for our common stock. If we fail to meet this requirement for 30 consecutive business days, we will receive a “deficiency notice” from Nasdaq. Upon receipt of this notice, we would then have 90 calendar days to comply, and during this period the minimum closing bid price per share must be above $1.00 per share for 10 consecutive business days during this period to comply. Following this period, we could appeal to Nasdaq for a hearing regarding the determination to delist our common stock from the Nasdaq National Market. On March 21, 2003, the closing bid price of our common stock was $1.24 per share. Delisting could reduce the ability of holders of our common stock to purchase or sell shares as quickly and as inexpensively as they have done historically. For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our common stock. Not maintaining a listing on a major stock market may result in a decrease in the trading price of our common stock due to a decrease in liquidity, reduced analyst coverage and less interest by institutions and individuals in investing in our common stock.

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      We may acquire companies and technology to expand our business and for other strategic reasons. Integrating newly acquired organizations and technologies into our company could put a strain on our resources and be expensive and time consuming. We may not be successful in integrating acquired businesses or technologies and may not achieve anticipated revenue and cost benefits. In addition, future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or incurrence of charges related to goodwill and other intangible assets, any of which could adversely affect our balance sheet and operating results. Moreover, we may not be able to identify future suitable acquisition candidates or, if we are able to identify suitable candidates, we may not be able to make these acquisitions on commercially reasonable terms or at all.

      We believe that we must expand our international sales and distribution operations to be successful. We have sold, and in the future we expect to sell a significant portion of our products to customers in Asia. As part of our international expansion, we have personnel in Taiwan, Japan and Europe who provide sales and customer support. In addition, we have appointed distributors, stocking representatives and manufacturers’ representatives to sell products in Japan, Taiwan, Hong Kong, Europe, China, Korea and North America. In attempting to conduct and expand business internationally, we are exposed to various risks that could adversely affect our international operations and, consequently, our operating results, including:

	•	difficulties and costs of staffing and managing international operations;
	•	fluctuations in currency exchange rates;
	•	unexpected changes in regulatory requirements, including imposition of currency exchange controls;
	•	longer accounts receivable collection cycles;
	•	import or export licensing requirements;
	•	potentially adverse tax consequences;
	•	political and economic instability; and
	•	potentially reduced protection for intellectual property rights.

      In addition, because we have suppliers that are located outside of the United States, we are subject to risks generally associated with contracting with foreign suppliers and may experience problems in the timeliness and the adequacy or quality of product deliveries.

      Provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions include:

	•	establishing a classified board of directors so that not all members of our board may be elected at one time;
	•	providing that directors may be removed only “for cause” and only with the vote of 66 2/3% of our outstanding shares;
	•	requiring super-majority voting to amend some provisions in our certificate of incorporation and bylaws;

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	•	authorizing the issuance of “blank check” preferred stock that our board could issue to increase the number of outstanding shares and to discourage a takeover attempt;
	•	limiting the ability of our stockholders to call special meetings of stockholders;
	•	prohibiting stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
	•	eliminating cumulative voting in the election of directors; and
	•	establishing advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

      In addition, the stockholder rights, which we implemented in 2002, and Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control.

      We believe that our available cash resources are sufficient to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months. We might need to raise additional funds, however, to respond to business contingencies, which could include the need to:

	•	fund expansion;
	•	fund marketing expenditures;
	•	develop new products or enhance existing products;
	•	enhance our operating infrastructure;
	•	fund working capital if our revenue does not increase, or declines;
	•	hire additional personnel;
	•	respond to competitive pressures; or
	•	acquire complementary businesses or technologies.

      If we were to raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced, and these newly issued securities might have rights, preferences or privileges senior to those of our then-existing stockholders. Additional financing might not be available on terms favorable to us, or at all. If adequate funds were not available or were not available on acceptable terms, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our products or otherwise respond to competitive pressures would be significantly limited.

      The Sarbanes-Oxley Act of 2002 that became law in July 2002 requires changes in some of our corporate governance, public disclosure and compliance practices. The Act also requires the SEC to promulgate new rules on a variety of subjects. In addition to final rules and rule proposals already made by the SEC, the National Association of Securities Dealers has proposed revisions to its requirements for companies, such as us, that are Nasdaq-listed. We expect these developments to increase our legal and financial compliance costs, and to make some activities, such as SEC reporting requirements, more difficult. Additionally, we expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments could make it more difficult for us to attract qualified executive officers and attract and retain qualified members of our board of directors, particularly to serve on our audit committee. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.

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      Interest Rate Risk. Our cash equivalents and short-term investments are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. As of December 31, 2002, our cash equivalents and short-term investments included money market funds and short and medium term corporate bonds and earned interest at an average rate of 2.2%. Due to the relative short-term nature of our investment portfolio, our interest income is extremely vulnerable to sudden changes in market interest rates. We do not use our investment portfolio for trading or other speculative purposes.

      The table below presents principle amounts and related weighted average interest rates by year of maturity for our investment portfolio as of December 31, 2002 (in thousands):

      Foreign Currency Exchange Risk. All of our sales and substantially all of our expenses are denominated in U.S. dollars. As a result, we have relatively little exposure to foreign currency exchange risk. We do not currently enter into forward exchange contracts to hedge exposures denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. However, in the event our exposure to foreign currency risk increases, we may choose to hedge those exposures.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

      The following financial statements are filed as part of this Report:

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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

      We have audited the accompanying consolidated balance sheets of Transmeta Corporation as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transmeta Corporation at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.

	/s/ ERNST & YOUNG LLP

San Jose, California

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TRANSMETA CORPORATION

(See accompanying notes)

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TRANSMETA CORPORATION

(1)	Excludes $4,364, $8,292 and $5,557 in amortization of deferred stock compensation for the year ended December 31, 2002, 2001 and 2000, respectively.
(2)	Excludes $(408) and $2,006 in variable stock compensation for the year ended December 31, 2002 and 2001, respectively.
(3)	Excludes $950, $8,460 and $7,499 in amortization of deferred stock compensation for the year ended December 31, 2002, 2001 and 2000, respectively.
(4)	Excludes $(1,360) and $2,196 in variable stock compensation for the year ended December 31, 2002 and 2001, respectively.
(5)	Excludes $(1,737) in amortization of deferred stock compensation related to employee terminations for year ended December 31, 2002.

(See accompanying notes)

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TRANSMETA CORPORATION