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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended September 30, 2003

OR

For the Transition Period from          to                        

Commission File Number 000-31803

TRANSMETA CORPORATION

3990 Freedom Circle, Santa Clara, CA 95054
(Address of principal executive offices, including zip code)

(408) 919-3000
(Registrant’s telephone number, including area code)

     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 [X] No [ ]

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

     There were 141,306,529 shares of the Company’s common stock, par value $0.00001 per share, outstanding on October 20, 2003.

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TRANSMETA CORPORATION

FORM 10-Q
Quarterly Period Ended September 30, 2003

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PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

TRANSMETA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)

(See accompanying notes)

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TRANSMETA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

(See accompanying notes)

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TRANSMETA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

(See accompanying notes)

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TRANSMETA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and accounting principles generally accepted in the United States for interim financial information. However, certain information or footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed, or omitted, pursuant to such rules and regulations. The preparation of financial statements in accordance with accounting principles generally accepted in the United Sates requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates. Significant estimates made in preparing the financial statements include inventory valuations, long-lived and intangible asset valuations, restructuring charges and revenue reserves. In the opinion of management, the statements include all adjustments (which are of a normal and recurring nature) necessary for the fair presentation of the results of the interim periods presented. These financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto included in the Company’s Form 10-K for the year ended December 31, 2002. The results of operations for the three months and nine months ended September 30, 2003 are not necessarily indicative of the operating results for the full fiscal year or any future period.

     The financial statements of the Company have been presented based on the assumption that the Company will continue as a going concern. The Company, however, has a history of substantial losses, and expects to incur future losses. Demonstrating the effects of these losses on its cash balances, during the past twelve months the Company’s cash and cash equivalents and short-term investments balances have decreased $81.3 million, from $155.7 million at September 30, 2002 to $74.4 million at September 30, 2003. As the Company shifts its product mix to its next generation processor, the Efficeon TM8000, and as it continues to develop new or enhance existing products or services in line with its business model, the Company expects that, as a result of an increased level of operations, it will need to increase its working capital, and accordingly, the net cash used to fund operating activities will increase, exceeding its current cash and cash equivalents and short-term investments balances, and that it will need to raise additional funds during the next twelve months to fund its operations and satisfy its current debt obligations. If it is unable to raise additional funds, the Company is positioned to modify its current business model to leverage its intellectual property assets to permit the Company to continue operating on a modified business model for a period that extends at least twelve months beyond September 30, 2003.

     The Company’s fiscal year ends on the last Friday in December, and each fiscal quarter ends on the last Friday of each calendar quarter. 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. The three-month periods ended September 26, 2003 and September 27, 2002 each consisted of 13 weeks. The first nine months of fiscal 2003 and 2002 each consisted of 39 weeks.

2. Stock Based Compensation

     In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment of FASB Statement No. 123” (SFAS 148). SFAS 148 amends the disclosure requirements of FASB’s SFAS 123, “Accounting for Stock-Based Compensation” to require more prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

     The Company accounts for its stock options and equity awards in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and related interpretations and has elected to follow the “disclosure only” alternative prescribed by SFAS 123. Expense associated with stock-based compensation is amortized on an accelerated basis over the vesting period of the individual award consistent with the method described in FASB Interpretation 28. Accordingly, approximately 59% of the unearned deferred compensation is amortized in the first year, 25% in the second year, 12% in the third year, and 4% in the fourth year following the date of grant. Pursuant to SFAS 123, Transmeta discloses the pro forma effect of using the fair value method of accounting for its stock-based compensation arrangements.

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     For purposes of pro forma disclosures, the estimated fair value of options is amortized to pro forma expense over the option’s vesting period using an accelerated graded method. Pro forma information follows:

     The fair value for the Company’s stock-based awards is estimated at the date of grant using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes option-pricing model requires the input of highly subjective assumptions, including expected stock price volatility. Because the Company’s stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards. The fair value of options granted was determined based on estimated stock price volatility. The weighted average assumptions used to determine fair value were as follows:

3. Net Loss per Share

     Basic and diluted net loss per share is presented in conformity with FASB’s SFAS 128, “Earnings Per Share”, for all periods presented. Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during each period, less weighted-average shares subject to repurchase.

     The following table presents the computation of basic and diluted net loss per share:

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     The Company has excluded all outstanding stock options from the calculation of basic and diluted net loss per share because these securities are antidilutive for all periods presented. Options and warrants to purchase 35,532,096 and 28,758,358 shares of common stock at September 30, 2003 and 2002, respectively, were not included in the computation of diluted net loss per share. These securities, had they been dilutive, would have been included in the computation of diluted net loss per share using the treasury stock method. Outstanding shares subject to repurchase have also been excluded from the calculation of net loss per share.

4. Net Comprehensive Loss

     Net comprehensive loss includes the Company’s net loss, as well as changes to the accumulated other comprehensive loss on available-for-sale investments. Net comprehensive loss for the three and nine month periods ended September 30, 2003 and 2002, respectively, is as follows (in thousands):

5. Inventories

     Inventories are stated at the lower of cost (first-in, first-out) or market. The components of inventories consist of the following (in thousands):

     During the three and nine months ended September 30, 2003, the Company made adjustments of $868,000 and $1.1 million, respectively, compared to $937,000 and $2.6 million for the same periods in the prior year, to decrease the value of its inventory in response to lower demand and lower average selling prices expected in future periods for some of its products. The adjustments resulted in writing down these materials to a lower of cost or market value of $4.7 million as of September 30, 2002. Accordingly, gross margin may benefit from future sales of these parts to the extent that the associated revenue exceeds their currently adjusted values. During the first nine months of fiscal 2003 the Company has seen a minimal effect on gross margins resulting from the sale of previously reserved inventory, whereas during the third quarter of fiscal 2002 the Company recognized $700,000 in gross margin related to the sale of inventory for which the value had been written down in previous periods.

6. Revenue Recognition

     The Company recognizes revenue from products sold when persuasive evidence of an arrangement exists, the price is fixed or determinable, shipment is made and collectibility is reasonably assured. The Company accrues for estimated sales returns, and other allowances at the time of shipment. Certain of the Company’s product sales are made to distributors under agreements allowing for price protection and/ or right of return on unsold products. The Company defers recognition of revenue on these sales until the distributors sell the products. The Company may also sell certain products with “End of Life” status to its distributors under special arrangements without price protection or return privileges for which revenue is recognized upon transfer of title, typically shipment.

     The Company recognizes license revenue from technology license agreements when earned, which generally occurs when agreed-upon deliverables are provided, or milestones are met and confirmed by licensees. Additionally, license revenues are recognized only if payments received are non-refundable and not subject to any future performance obligation by the Company. Licensing revenue was $323,000 and $850,000 for the three and nine month periods ended September 30, 2003, respectively. The corresponding periods in fiscal 2002 did not include any licensing revenues.

7. Product Warranty

     Transmeta typically provides a warranty that includes factory repair services or replacement as needed for replacement parts on its

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products for a period of one year from shipment. Transmeta records a provision for estimated warranty costs when the revenue on product sales is recognized. Actual warranty costs have been within management’s expectations to date and have not been material.

     The Company generally sells products with a limited indemnification of customers against intellectual property infringement claims related to the Company’s products. The Company’s policy is to accrue for known indemnification issues if a loss is probable and can be reasonably estimated, and accrues for estimated incurred but unidentified issues based on historical activity. To date, there are no such accruals or related expenses.

8. Restructuring Charges

     In the second quarter of fiscal 2002, Transmeta recorded a $10.6 million restructuring charge as a result of the Company’s decision to cease development and productization of the TM6000 microprocessor. The restructuring charge consisted primarily of lease costs, equipment write-offs and other costs as the Company identified a number of leased facilities as well as leased and owned equipment that were no longer required.

     On July 18, 2002, in connection with Transmeta’s decision to cease the development and productization of the TM6000 microprocessor, the Company terminated 195 employees and contractors. As a result, the Company recorded severance and termination charges of $4.1 million in the third quarter of fiscal 2002, which excludes a credit of $1.7 million to deferred compensation expense related to stock option cancellations for terminated employees. Additionally, the Company paid approximately $531,000 for previously accrued compensation in the third quarter of fiscal 2002 in connection with the employee terminations. Of the 195 employees and contractors that were terminated on July 18, 2002, 44 were sales, marketing, and administrative employees and 151 were research and development personnel. The Company’s workforce reduction was completed in the third quarter of fiscal 2002. Additionally, the Company vacated all excess facilities as of September 30, 2002.

     Accrued restructuring charges consist of the following at September 30, 2003 (in thousands):

9. Legal Proceedings

     Beginning in June 2001, Transmeta, its directors, and certain of its officers were named as defendants in several putative shareholder class actions that were consolidated in and by the United States District Court for the Northern District of California as In re Transmeta Corporation Securities Litigation, Case No. C 01-02450 WHA. The complaints purported to allege a class action on behalf of persons who purchased Transmeta common stock between November 7, 2000 and July 19, 2001, and 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 sole surviving claim. In July 2002, defendants filed a motion for summary judgment relating to that claim. In July 2002, plaintiffs moved for class certification and initiated discussion of a proposed settlement. The Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they entered into an agreement in October 2002 to settle all claims that might have been brought in this action for approximately $5.5 million, all of which monies have been fully funded by defendants’ director and officer liability insurance. In March 2003, after proper class notice and hearings, the Court approved the settlement and entered judgment for defendants, dismissing the action. In April 2003, a plaintiff’s law firm that was not selected by the Court to serve as class counsel filed a notice of appeal relating to certain Court orders addressing that firm’s applications to the Court for attorney’s fees. In August 2003, on appellant’s own motion, the Court of Appeals dismissed the appeal.

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     Beginning in June 2001, the directors and certain officers of Transmeta were named as defendants in four purported shareholder derivative actions that were consolidated in and by the Superior Court for Santa Clara County in In re Transmeta Corporation Derivative Litigation, Master File No. CV 799491. The complaints were based upon the same matters alleged in the shareholder class action described above. In July 2002, the Court sustained the Company’s demurrer with leave to amend based on plaintiffs’ lack of standing, and deferred consideration of the individual defendants’ demurrer on the merits. The Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they entered into an agreement to settle all claims that might have been brought in this action. The settlement includes a payment of approximately $300,000 in fees to counsel for the derivative plaintiffs and shall be fully funded by defendants’ director and officer liability insurance. In October 2003, upon motion and after a hearing, the Court approved the settlement and entered an order dismissing the consolidated derivative action as to all defendants.

     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 that were consolidated in and by the United States District Court for the Southern District of New York in In re Transmeta Corporation Initial Public Offering Securities Litigation, Case No. 01 CV 6492. The complaints allege that the prospectus issued in connection with the Company’s initial public offering on November 7, 2000 failed to disclose certain alleged actions by the underwriters for that offering, and alleges claims against the Company 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. Similar actions have been filed against more than 300 other companies that issued stock in connection with other initial public offerings during 1999-2000. Those cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS). In July 2002, the Company joined in a coordinated motion to dismiss filed on behalf of multiple issuers and other defendants. In February 2003, the Court granted in part and denied in part the coordinated motion to dismiss, and issued an order regarding the pleading of amended complaints. Plaintiffs subsequently proposed a settlement offer to all issuer defendants, which settlement would provide for payments by issuers’ insurance carriers if plaintiffs fail to recover a certain amount from underwriter defendants. Although the Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they accepted plaintiffs’ proposal to settle all claims that might have been brought in this action. The Company and the individual Transmeta defendants expect that their share of the global settlement will be fully funded by their director and officer liability insurance. Although the Company and the Transmeta defendants have approved the settlement in principle, it remains subject to several procedural conditions, as well as formal approval by the Court. It is possible that the parties may not reach a final written settlement agreement or that the Court may decline to approve the settlement in whole or part. In the event that the parties do not reach agreement on the final settlement, the Company and the Transmeta defendants believe that they have meritorious defenses and intend to defend any remaining action vigorously.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Caution Regarding Forward-Looking Statements

     The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the related notes contained in this report and with the information included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002 and subsequent reports filed with the Securities and Exchange Commission (SEC). The information contained in this report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed regularly with the SEC, some of which reports discuss our business in greater detail.

     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.

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     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.

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 and additional technologies 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 and have continued to do so to date. Through June 30, 2000, product shipments consisted of development systems and prototypes. In October 2003, we introduced the Efficeon TM8000 family of microprocessors, which are our next generation x-86 compatible processors. We are seeing interest in Efficeon processors for designs beginning in 2004 in the mainstream consumer notebook segment. These microprocessors are targeted for use in notebook computers characterized by the need for fast responsiveness, long battery life, small form factors and rich multimedia experience. These microprocessors are also targeted for use in new classes of devices, such as tablet PCs, ultra-personal computers, high density servers and new embedded processor applications. Our initial releases of Efficeon will be manufactured by TSMC using its 130 nanometer manufacturing technology. We expect that a future version of Efficeon will be manufactured by Fujitsu Microelectronics using its 90 nanometer manufacturing technology. We expect to be dependent on sales of our current and successive generation microprocessors 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 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 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.

     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. In the first nine months of fiscal 2003, sales to three customers, each of whom is located in Asia, accounted for 23%, 23% and 18%, respectively, of our net revenue. For the same period in the prior year, those customers accounted for less than 10%, less than 10%, and 30%, respectively. In addition, a customer that had accounted for less than 10% of our net revenue for the first nine months of fiscal 2003 accounted for 41% of our net revenue for the same period last year. The loss of a major customer or the delay of significant orders from these customers could reduce or delay our recognition of revenue. Five of our customers accounted for 91% of our accounts receivable balance as of September 30, 2003. Two of these customers accounted for 52% and 15%, respectively, of our accounts receivable balance as of December 31, 2002. Each of the other three customers represented less than 10% of our accounts receivable at December 31, 2002.

     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 the first nine months of fiscal years 2003 and 2002 were primarily made to the lightweight and other mobile personal computer (PC) markets. If our products fail to achieve widespread acceptance in these markets we may not achieve revenue sufficient to sustain our business.

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     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. On occasion, cost of revenue may additionally include a component for adjustments to the valuation of certain inventories based on lower demand and average selling prices expected in future periods. 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 an accelerated method. As of September 30, 2003, approximately $1.0 million was recorded on our balance sheet, which will be amortized through 2004.

     Historically we have incurred significant losses. As of September 30, 2003, we had an accumulated deficit of $520.6 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 negatively impacted by production difficulties. Additionally, beginning in the second quarter of fiscal 2001 and continuing through the first nine months of fiscal 2003 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. The three-month periods ended September 30, 2003 and 2002 each consisted of 13 weeks and ended on September 26 and 27, respectively. The first nine months of fiscal 2003 and 2002 each consisted of 39 weeks.

Critical Accounting Policies

     The process of preparing financial statements requires the use of estimates on the part of our management. The estimates used by management are based on our historical experiences combined with management’s understanding of current facts and circumstances. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial condition and results and require significant or complex judgment on the part of management. For a description of what we believe to be our most critical accounting policies and estimates, refer to our Annual Report on Form 10-K for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 27, 2003. There have been no changes in any of our critical accounting policies since December 31, 2002.

Results of Operations

Net Revenue

     Net revenue of $2.7 million for the third quarter of fiscal 2003 represented a decrease of 58.3% from $6.4 million for the same period last year. This decrease can be primarily attributed to a decline in demand for our TM5800 processor from notebook manufacturers, as the processor has nearly reached the end of its cycle in the notebook computing segment. To a lesser extent, as this product has matured, the decrease in average selling prices also contributed to the decrease in revenue. For the third quarter of fiscal 2003, our unit shipments decreased 44.3% while our average selling prices have decreased 24.1% from the same period in the prior year, excluding the effects of a $905,000 one-time sale of previously reserved inventory in the third quarter of fiscal 2002. Net revenue of $13.8 million for the first nine months of fiscal 2003 represented a decrease of 24.1% from $18.1 million for the same period last year. This year to date decrease from the same period in the prior year can be attributed to a decrease in the average selling prices. For the nine months ended September 30, 2003, our unit shipments increased 22.1% as we increased sales into the tablet PC market, and as we expanded our international sales into Europe and China. During the same period, our average selling prices decreased 39.2% from the corresponding period in the prior year, excluding the effects of a one-time sale of previously reserved inventory in the third quarter of fiscal 2002. Pricing pressure on the TM5800 has increased and may continue to increase as the product has matured and as the processor transitions into geographies and market segments that traditionally demand lower average selling prices. We will continue to manufacture the TM5800 as we plan to sell the processor into market segments such as the embedded and ultra personal computer markets, from which we expect the processor to derive the majority of its future revenue. We expect to experience higher average selling prices as we shift our product mix to our next-generation processor, the Efficeon TM8000.

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     We currently derive our product revenue primarily from microprocessors used in mobile computing devices and, to a lesser extent, the embedded processor applications. Net revenue recognized in the first nine months of fiscal 2003 also included license revenue, which was earned in connection with a technology license agreement executed during the first half of the year. This licensing revenue was $323,000 and $850,000 for the three and nine month periods ended September 30, 2003, respectively. The remaining $100,000 of license revenue from this agreement is expected to be recognized in the fourth quarter of fiscal 2003. The corresponding periods in fiscal 2002 did not include any license revenues.

Gross Margin

     Gross margin was negative 14.3% for the third quarter of fiscal 2003, compared to 38.0% in the same period last year. For the first nine months of fiscal 2003, gross margin was 9.0% compared to 31.3% in the same period last year. Excluding the effects of a one-time sale of previously reserved inventory in the third quarter of 2002, which contributed 10.3% to our gross margin during that period, the decline in gross margin is primarily due to lower average selling prices of our products. For the three and nine months ended September 30, 2003, average selling prices decreased 24.1% and 39.2% from the same periods in the prior year. The lower average selling prices resulted from pricing pressures on our TM5800 product as it has nearly reached the end of its cycle in the notebook computing segment this year. One factor offsetting the decline in gross margin was the lower average costs of products sold, which decreased 9.3% and 16.8%, respectively, for the three and nine months ended September 30, 2003 from the same periods in the prior year. Another factor offsetting the general decrease in gross margin was the 100% margin recognized on licensing revenues of $323,000 and $850,000, respectively, for the three and nine months ended September 30, 2003. Additionally, we recorded a benefit of $571,000 and $1.2 million, respectively, for the three and nine month periods in fiscal 2002 related to the reversal of previously accrued inventory-related purchase commitments due to favorable settlements of such purchase commitments.

     During the first nine months of both fiscal 2003 and 2002, our gross margin was adversely affected by adjustments to our inventory valuation in response to lower demand and lower average selling prices expected in future periods for some of our products. For the three and nine months ended September 30, 2003, these adjustments totaled $868,000 and $1.1 million, respectively, compared to $937,000 and $2.6 million for the same periods in the prior year. The adjustments resulted in writing down these materials to a lower of cost or market value of $4.7 million. Accordingly, gross margin may benefit from future sales of these parts to the extent that the associated revenue exceeds their currently adjusted values. Gross margin was also adversely affected during the first nine months of fiscal 2002 and 2003 by unabsorbed overhead costs as our production related infrastructure exceeded our needs. For the three and nine months ended September 30, 2003, these costs were $465,000 and $1.6 million, respectively, compared to $419,000 and $1.3 million for the same periods in the prior year. As we shift our product mix to the new Efficeon TM8000 processor, we expect overall gross margins to benefit from increased utilization of our manufacturing overhead.

Research and Development

     Research and development (R&D) costs for the third quarter of fiscal 2003 decreased 9.2% to $12.5 million from $13.7 million for the same period last year. The decrease in the quarter to quarter comparison is primarily due to decreased headcount and expenditures resulting from our workforce reduction in the third quarter of fiscal 2002. R&D costs for the first nine months of fiscal 2003 decreased 27.2% to $37.1 million from $51.0 million for the same period last year. The majority of the decrease for the nine month period can be attributed to our workforce reduction in the third quarter of fiscal 2002, which resulted in lower compensation and benefit costs, consultant fees, recruiting costs and certain equipment related expenses. We also recognized in the second quarter of 2002 a charge of $1.6 million for engineering related silicon and mask sets for products for which the Company ceased development. The majority of R&D spending in the first nine months of fiscal 2003 was for our next-generation microprocessor, the Efficeon TM8000. We additionally devoted research and development resources towards our recently announced LongRun2 power management technology. The remaining portion was for sustaining engineering efforts on our TM5800 microprocessor.

Selling, General and Administrative

     Selling, general and administrative (SG&A) costs for the third quarter of fiscal 2003 decreased 4.4% to $6.0 million from $6.3 million for the same period last year. The decrease in the quarter to quarter comparison is primarily due to decreased headcount and expenditures resulting from our workforce reduction in the third quarter of fiscal 2002. SG&A costs for the first nine months of fiscal 2003 decreased 17.3% to $19.0 million from $22.9 million for the same period last year. The majority of this decrease is due to lower compensation and benefit costs, consultant fees and recruiting costs related to our reduction in workforce in the third quarter of fiscal 2002. As a result of our 2002 restructuring

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charge, we also recorded lower facilities-related charges, including rent and building maintenance costs. During the first nine months of fiscal 2003, we had lower travel and conference related costs as we implemented a restricted travel policy within that period in response to the outbreak of SARS in the Asia-Pacific region. As the restricted travel policy has now been lifted, we expect travel costs to return to historic levels. These decreases were partly offset by increases in other areas, including higher corporate insurance costs and expenditures for patent protection of our inventions.

Restructuring Charges

     In the first nine months of fiscal 2002, we recorded restructuring charges of $14.7 million as a result of the Company’s decision to cease development and productization of the TM6000 microprocessor. The restructuring charges consisted 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. Other than future lease payments for our vacated facilities, the majority of our restructuring activities were completed in 2002. We evaluated the restructuring reserve balance as of September 30, 2003 and determined no adjustments were needed.

Amortization of Deferred Charges, Patents and Patent Rights

     Amortization charges for the first nine months of fiscal 2003 and 2002 primarily relate to various patents and patent rights acquired from Seiko Epson and others during fiscal 2001. Additionally, we accreted interest payable in relation to amounts due for certain technology license agreements. The amortization and accretion charges for these license agreements, patents and patent rights in the third quarter of fiscal 2003 were $2.6 million, compared to $2.8 million in the same period last year. For the first nine months of fiscal 2003, the amortization and accretion charges were $7.9 million, compared to $8.5 million in the same period last year.

Stock Compensation

     Total stock compensation charges during the third quarter of fiscal 2003 were $2.3 million, compared to a $1.7 million credit in the same period last year. For the first nine months of fiscal 2003, stock compensation charges were $3.8 million, compared to $0.6 million in the same period last year. There were two components to stock compensation expense during these periods.

     The first component is the amortization of deferred stock compensation associated with options granted prior to November 2000, net of cancellations, which amounted to $305,000 during the third quarter of fiscal 2003, compared to $422,000 in the same period last year. Net amortization for the first nine months of fiscal 2003 was $1.5 million, compared to $2.6 million in the same period last year. On a year-to-date basis, the decrease is primarily a result of amortizing the deferred charge on an accelerated method in accordance with our accounting policy, as well as a decrease in the number of outstanding options affecting the compensation charge as a result of cancellations in connection with our reduction in workforce in the third quarter of fiscal 2002.

     The second component is the application of variable accounting for certain stock option grants, the effect of which is included in deferred stock compensation. 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 other 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 adjustments related to variable stock option accounting 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 the period-end over the purchase price of the stock award, adjusted for vesting and prior stock compensation expense recognized on the stock award. Variable stock compensation for the third quarter of fiscal 2003 amounted to $2.0 million, compared to a credit of $2.1 million for the same period last year. For the first nine months of fiscal 2003 variable stock compensation was $2.3 million, compared to a credit of $2.0 million for the same period last year.

Interest and Other Income and Interest Expense

     Interest and other income in the third quarter of fiscal 2003 was $203,000, compared to $1.1 million in the same period last year. Interest and other income for the first nine months of fiscal 2003 was $1.2 million, compared to $4.4 million in the same period last year. The decreases are due to lower average invested cash balances during fiscal 2003 as we continue to use cash to fund operations, as well as a 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 in the third quarter of fiscal 2003 was $116,000, compared to $88,000 in the same period last year. Interest expense for the first nine months of fiscal 2003 was $363,000, compared to $557,000 for the same period last year. This decrease is primarily the result of lower average debt balances due to several lease-financing arrangements expiring during 2002.

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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 and license revenue and lease financing. At September 30, 2003 we had $74.4 million in cash, cash equivalents and short-term investments compared to $129.5 million at December 31, 2002.

     Net cash used in operating activities was $48.2 million for the first nine months of fiscal 2003. This was primarily the result of the net loss of $65.7 million, as well a decrease in accounts payable and accrued liabilities during the period. This was partially offset by decreases in accounts receivable and inventory.

     Net cash provided by investing activities was $64.0 million for the first nine months of fiscal 2003, and consisted primarily of $73.9 million net proceeds from the maturity of available-for-sale investments. These proceeds were partially offset by a $9.0 million partial settlement of long-term payable obligations for purchased patents and patent rights, as well as $834,000 in purchases of capital equipment.

     Net cash provided by financing activities was $3.3 million for the first nine months of fiscal 2003, and consisted primarily of $3.9 million net proceeds from option exercises and employee stock purchase plan purchases. These proceeds were partially offset by payments of $584,000 for debt and capital lease obligations.

     At September 30, 2003, we had $35.6 million in cash and cash equivalents and $38.8 million in short-term investments. We lease our facilities under non-cancelable operating leases expiring in 2008, and we lease equipment and software under non-cancelable leases with terms ranging from 12 to 48 months. At September 30, 2003, we had the following contractual obligations:

     During the past twelve months, our cash and cash equivalents and short-term investments balances have decreased $81.3 million, from $155.7 million at September 30, 2002 to $74.4 million at September 30, 2003. This decrease includes payments of $15.0 million that were made in satisfaction of long term debt obligations. As we shift our product mix to our next generation processor, the Efficeon TM8000, and as we continue to develop new or enhance existing products or services in line with our business model, we expect that, as a result of an increased level of operations, we will need to increase our working capital, and accordingly, the net cash which we will use in our operating activities will increase, exceeding our current cash and cash equivalents and short-term investments balances, and that we will need to raise additional funds during the next twelve months to fund our operations and satisfy our current debt obligations. If we are unable to raise additional funds, the Company is positioned to modify its current business model to leverage its intellectual property assets to permit the Company to continue operating on a modified business model for a period that extends at least twelve months beyond September 30, 2003.

     Our capital requirements will depend on many factors, including but not limited to 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 and increases in our operating expenses. Although we are currently not a party to any agreement or letter of intent for 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 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. On July 17, 2003, we filed a Form S-3 shelf registration statement with the Securities and Exchange Commission. The shelf registration statement became effective on July 29, 2003. The shelf registration statement provides for the possible future offer and sale by us of up to $100,000,000 in common stock, preferred stock, secured or unsecured debt securities and warrants, from time to time.

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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-Q. 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 Losses, Expect to Incur Further Significant Losses and May Never Achieve or Maintain Profitability.

     We have a history of substantial losses and expect to incur further significant losses. We incurred net losses of $65.7 million in the first nine months of fiscal 2003, $110.0 million in fiscal 2002, $171.3 million in fiscal 2001 and $97.7 million in fiscal 2000. As of September 30, 2003, we had an accumulated deficit of $520.6 million. 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.

Our Business Is Difficult to Forecast.

     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. In addition, we do not expect that our new product, the Efficeon TM8000 microprocessor, will be available for shipment in volume production until the first half of 2004. 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. Although we expect licensing opportunities to be an increasing source of revenue for us in the future, we need to generate substantial future revenue from product sales under our current business model. Our ability to manufacture our products in production quantities and the revenue and income potential of our products and business are unproven. You should consider our chances of financial and operational success in light of the risks, uncertainties, expenses, delays and difficulties associated with new businesses in highly competitive technology fields, many of which may be beyond our control. If we fail to address these risks, uncertainties, expenses, delays and difficulties, the value of an investment in our common stock would decline further.

Our Future Operating Results will Depend Significantly on Sales of our New Efficeon TM8000 Products.

     Our future revenue and gross margins will be influenced in large part by the level of sales of our new Efficeon TM8000 products. Therefore, our future operating results will depend on the demand for these products from future customers. If we experience 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 generate market interest in our new microprocessor. If these products are not widely accepted by the market due to performance, price, compatibility or any other reason, or if, following acceptance, we fail to enhance these products in a timely manner, significant demand for our new products may fail to materialize.

We Also Depend Upon Increasing Demand for Our Crusoe Microprocessors.

     We have historically derived the majority of our revenue from the sale of our Crusoe microprocessors, which we only began to ship in volume in September 2000. Therefore, our future operating results might continue to depend on the demand for our 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 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.

We Are Subject to General Economic and Market Conditions.

     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, 2002 and through parts of fiscal 2003, our operating

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results were adversely affected by unfavorable global economic conditions and reduced information technology spending, particularly in Japan, where we currently generate a substantial portion 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.

If We Experience Continued Difficulties in Transitioning to New Manufacturing Technologies, We Could Experience Reduced Manufacturing Yields, Delays in Product Deliveries and Increased Expenses.

     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.

     We intend to use Fujitsu Microelectronics to manufacture our initial 90 nanometer Efficeon TM8000 microprocessors. We have not worked with Fujitsu in the past, and therefore, could experience difficulties in bringing these products to volume production. If we experience 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 Future Revenue Depends In Part Upon Our Ability to Penetrate the Notebook Computer Market.

     Our success depends in part upon our ability to sell our 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 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 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 may not choose our products for technical, performance, packaging, novelty, design cost or other reasons. If our products fail to achieve widespread acceptance in the notebook computer market, we would likely never achieve revenue sufficient to sustain our business and the value of an investment in our common stock would likely decline significantly.

The Growth of Our Business Depends in Part upon the Development of Emerging Markets and Our Ability to Meet the Needs of These Markets.

     The growth of our business depends in part on acceptance and use of our products in new classes of devices such as tablet PCs, ultra-personal computers, high density servers 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 Cyclical Nature of the Semiconductor Industry Could Create Fluctuations 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.

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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 Are Difficult to Predict and Fluctuate Significantly, and a Failure to Meet the Expectations of Securities Analysts or Investors Has Resulted in a Substantial Decline in Our Stock Price.

     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;
	•		the availability of new products for volume shipment and customer demand for those products;
	•		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;
	•		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 as well as the amount of license revenues for a period.

     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 to a new manufacturer, 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

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			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.

We Might Not Experience Growth in Our Licensing Revenues.

     Although licensing revenues constituted approximately 12% of our total revenues for the three months ended September 30, 2003, these revenues have not accounted for more than 10% of our total revenues in recent periods subsequent to September 2000. License transactions often have a long sales cycle and can result in additional liability, such as indemnification obligations. In addition, the amount of revenue we recognize under our license transactions can depend significantly upon product sales by the licensees, over which we will have no control. While we anticipate that we will continue to license our technology to licensees, we cannot predict the timing or the extent of any future licensing revenue, and recent levels of license revenues may not be indicative of future periods.

We Might Not Be Able to Execute on Our Business Plan if We Lose Key Management or Technical Personnel, on Whose Knowledge, Leadership and Technical Expertise We Rely, or if We Fail to Work Effectively With New Members of Our Management Team.

     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 have joined us in senior management roles only recently. In March 2003, Arthur L. Swift joined us as senior vice president of marketing. Our success will depend in part upon the ability of 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 Price of our Common Stock Has Been Volatile and is Subject to Wide Fluctuations.

     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;

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	•		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.

     In addition, the stock market generally and the market for semiconductor and other technology-related stocks in particular experienced a decline during 2000, 2001 and through 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 have settled or are defending several purported shareholder class action or derivative lawsuits. Although we believe that those lawsuits lack merit, 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.

We Face Intense Competition in the Semiconductor Market; Our Competitors Are Much Larger Than We Are and Have Significantly Greater Resources; We May Not Be Able to Compete Effectively.

     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.

Our Products May Have Defects, Which Could Damage Our Reputation, Decrease Market Acceptance of Our Products, Cause Us to Lose Customers and Revenue, and Result in Liability to Us.

     Highly complex products such as our microprocessors may contain hardware or software defects or bugs for many reasons,

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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 costs. If we fail to provide solutions to the problems, such as software upgrades or patches, we could also incur product recall, repair or replacement costs. These problems might also result in claims against us by our customers or others. In addition, these problems might divert our technical and other resources from other development efforts. Moreover, we would likely lose, or experience a delay in, market acceptance of the affected product or products, and we could lose credibility with our current and prospective customers. This is particularly significant as we are a new entrant to a market dominated by large well-established companies.

We Derive a Substantial Portion of Our Revenue From a Small Number of Customers, and Our Revenue Would Decline Significantly if Any Major Customer Were to Cancel, Reduce or Delay a Purchase of Our Products.

     Sales to three customers in the aggregate accounted for 64% of net product revenue in the first nine months of fiscal 2003. These customers are located in Asia, which subjects us to economic cycles in that area as well as the geographic areas in which they sell their products containing our microprocessors. We expect that a small number of 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.

Our Dependence on TSMC and, in the future, Fujitsu Microelectronics to Fabricate Wafers Limits Our Control Over the Production, Supply and Delivery of Our Products.

     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 for all of our current products. We currently intend to rely on Fujitsu Microelectronics to manufacture our initial 90 nanometer TM8000 products. We do not have a manufacturing agreement with TSMC that guarantees any particular production capacity or any particular price from TSMC. We may not have guaranteed production capacity with Fujitsu Microelectronics, although we have yet to enter into a definitive manufacturing agreement with them. 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 and we expect that this will also be the case with respect to Fujitsu. The absence of dedicated capacity means that, with little or no notice, our manufacturers could refuse to continue to fabricate all or some of the wafers that we require or change the terms under which they fabricate wafers. If our manufacturers 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 would be subject to all risks incident to relying on third parties for wafer fabrication. As a result, we could lose potential sales and fail to meet existing obligations to our customers. In addition, if our manufacturers were to change the terms under which they manufacture for us, our manufacturing costs could increase.

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

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

If We Fail to Forecast Demand for Our Products Accurately, We Could Lose Sales and Incur Inventory Losses.

     The demand for our products depends upon many factors and is difficult to forecast. Many shipments of our products may be made near the end of the fiscal quarter, which makes it difficult to estimate demand for our products. We expect that it will become more difficult to forecast demand as we introduce new 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 product, 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. 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 or Fujitsu might not be able to fabricate wafers as quickly as we need them. Also, ASE, which provides the majority of 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 our product manufacturer 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 our product manufacturer 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.

We May Experience Manufacturing Difficulties That Could Increase the Cost and Reduce the Supply of Our Products.

     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.

Our Dependence on ASE to Provide Assembly and Test Services Limits Our Control Over Production Costs and Product Supply.

     We rely on ASE for the majority 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

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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 and the Facilities of Third Parties Upon Which We Rely to Provide Us Critical Services are Located in Regions that are Subject to Earthquakes and Other Natural Disasters.

     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 the majority of our assembly and test services, are located in Taiwan. Fujitsu, which we expect will fabricate a significant amount of our wafers in the future, is located in Japan. Taiwan and Japan have experienced significant earthquakes and could be subject to additional earthquakes in the future. Any earthquake or other natural disaster in these areas could materially disrupt our manufacturer’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.

An Outbreak of SARS in the Asia-Pacific Region and Its Continued Spread Could Harm Our Business.

     Another outbreak of severe acute respiratory syndrome, or SARS, may have a negative impact on our business. We have employees located in Taiwan, and we have our products manufactured and assembled in Taiwan. Our business may be impacted by a variety of SARS-related factors, including but not limited to disruptions in the operations of our offices, our partners, our customers, and their partners; reduced sales in certain end-markets; and increased costs to conduct our business abroad. Although the magnitude of probable SARS cases has been controlled, our business could be harmed if the number of cases of SARS increases or spreads to other areas, including the United States.

If We Fail to Establish and Maintain Relationships With Key Participants in Our Target Markets, We May Have Difficulty Selling Our Products.

     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.

If Our Products Are Not Compatible With the Other Components That Our Customers Design Into Their Systems, Sales of Our Products Could Be Delayed or Cancelled and a Substantial Portion of Our Products Could Be Returned.

     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.

If Our Customers Are Not Able to Obtain the Other Components Necessary to Build Their Systems, Sales of Our Products Could Be Delayed or Cancelled.

     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 industries have experienced shortages of some materials and devices, such as memory components, displays, and storage devices. Our customers could defer or cancel purchases of our products if they are not able to obtain the other components necessary to build their systems.

There May Be Software Applications or Operating Systems That Are Not Compatible With Our Products, Which May Prevent Our Products from Achieving Market Acceptance and Prevent Us From Receiving Significant Revenue.

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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. Software incompatibilities that are significant or are perceived to be significant could hinder our products from market acceptance and we might not receive significant revenue from product sales.

The Evolution of Our Business Could Place Significant Strain on Our Management Systems, Infrastructure and Other Resources, and Our Business May Not Succeed if We Fail to Manage Effectively.

     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.

Our Lengthy and Variable Sales Cycles Make It Difficult for Us to Predict When and if a Design Win Will Result in Volume Shipments.

     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, or more, 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.

If We Do Not Keep Pace With Technological Change, Our Products May Not Be Competitive and Our Revenue and Operating Results May Suffer.

     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 introduce new products or product enhancements that meet evolving customer demands. It may be difficult or costly for us or we may not be able to enhance existing products to fully meet customer demands. For instance, in order to meet the demands of our customers for enhancement of our existing products, we may incur manufacturing or other costs that would harm our operating margins and financial condition. Further, we may not achieve further design wins with current customers unless we continue to meet their evolving needs by developing new products. The development of new products is complex, and we may not be able to complete development in a timely manner, or at all. To introduce and improve products on a timely basis, we must:

	•		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;

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	•		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. We may incur significant research and development manufacturing or other costs that would harm our operating margins and financial conditions in our development efforts. These efforts may not result in enhanced products, or in additional product sales. Accordingly, these investments may not provide us with an acceptable return, or any return at all.

Our Products May Infringe the Intellectual Property Rights of Others, Which May Cause Us to Become Subject to Expensive Litigation, Cause Us to Incur Substantial Damages, Require Us to Pay Significant License Fees or Prevent Us From Selling 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.

If We Are Unable to Protect Our Proprietary Rights Adequately, Our Competitors Might Gain Access to Our Technology and We Might Not Compete Successfully In Our Markets.

     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 adequately, our competitors might gain access to our technology. As a result, our competitors might offer similar products and we might not be able to compete successfully in our market. Moreover, despite our efforts to protect our proprietary rights, unauthorized parties may copy aspects of our products and obtain and use information that we regard as proprietary. Also, our competitors may independently develop similar, but not infringing, technology, duplicate our products, or design around our patents or our other intellectual property. In addition, other parties may breach confidentiality agreements or other protective contracts with us, and we may not be able to enforce our rights in the event of these breaches. Furthermore, we expect that we will increase our international operations in the future, and the laws of many foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. We may be required to spend significant resources to monitor and protect our intellectual property rights.

     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. We may initiate claims or litigation against third parties based on our proprietary rights. Any litigation surrounding our rights could force us to divert important financial and other resources from our business operations.

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We Will Not Be Able to Grow Our Business if We Are Unable to Hire, Train and Retain Sales, Marketing, Operations, Engineering and Finance Personnel.

     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.

We May Make Acquisitions, Which Could Put a Strain on Our Resources, Cause Dilution to Our Stockholders and Adversely Affect Our Financial Results.

     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 Plan to Expand Our International Operations, and the Success of Our International Expansion Is Subject to Significant Uncertainties.

     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;
	•		major health concerns, such as SARS;
	•		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.

Our Certificate of Incorporation and Bylaws, Stockholder Rights Plan and Delaware Law Contain Provisions That Could

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Discourage or Prevent a Takeover, Even if an Acquisition Would Be Beneficial to Our Stockholders.

     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;
	•		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.

If We Need Additional Financing, We May Not Be Able to Raise Further Financing or It May Only Be Available on Terms Unfavorable to Us or Our Stockholders.

     We have a history of substantial losses, and expects to incur future losses. Demonstrating the effects of these losses on our cash balances, during the past twelve months our cash and cash equivalents and short-term investments balances have decreased $81.3 million, from $155.7 million at September 30, 2002 to $74.4 million at September 30, 2003. As we shift our product mix to our next generation processor, the Efficeon TM8000, and as we continue to develop new or enhance existing products or services in line with our business model, we expect that, as a result of an increased level of operations, we will need to increase our working capital, and accordingly, the net cash used to fund operating activities will increase, exceeding our current cash and cash equivalents and short-term investments balances, and that we will need to raise additional funds during the next twelve months to fund our operations and satisfy our current debt obligations. We also might need to raise additional funds to respond to other business contingencies, which could include the need to:

	•		fund expansion;
	•		fund marketing expenditures;
	•		develop new products or enhance existing products;
	•		enhance our operating infrastructure;
	•		hire additional personnel;
	•		respond to customer concerns about our viability;
	•		respond to competitive pressures; or
	•		acquire complementary businesses or technologies.

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     On July 17, 2003, we filed a Form S-3 shelf registration statement with the Securities and Exchange Commission, which provides for the possible future offer and sale by us of up to $100,000,000 in common stock, preferred stock, secured or unsecured debt securities and warrants, from time to time. The shelf registration statement became effective on July 29, 2003. However, if we were to raise additional funds through the issuance of equity or convertible debt securities using this registration statement or otherwise, 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. For example, in order to raise equity financing, we may decide to sell our stock at a discount of our then current trading price, which may have an adverse effect on our future trading price. 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.

Recently Enacted and Proposed Changes in Securities Laws and Regulations are Likely to Increase Our Costs.

     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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Interest Rate Risk. Our cash equivalents and available-for-sale investments are exposed to financial market risk due to fluctuations in interest rates, which may affect our interest income. Over the past few years, we have experienced significant reductions in our interest income due in part to declines in interest rates. These declines have led to interest rates that are low by historical standards and we do not believe that further decreases in interest rates will have a material impact on the interest income earned on our cash equivalents and short-term investments held at September 30, 2003.

     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.

Item 4. Controls and Procedures

     The Securities and Exchange Commission defines the term “disclosure controls and procedures” to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Chief Executive Officer and Chief Financial Officer have concluded, based on the evaluation of the effectiveness of our disclosure controls and procedures by our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, as of the end of the period covered by this report, that our disclosure controls and procedures were effective for this purpose

     During the third quarter of fiscal 2003, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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     Beginning in June 2001, Transmeta, its directors, and certain of its officers were named as defendants in several putative shareholder class actions that were consolidated in and by the United States District Court for the Northern District of California as In re Transmeta Corporation Securities Litigation, Case No. C 01-02450 WHA. The complaints purported to allege a class action on behalf of persons who purchased Transmeta common stock between November 7, 2000 and July 19, 2001, and 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 sole surviving claim. In July 2002, defendants filed a motion for summary judgment relating to that claim. In July 2002, plaintiffs moved for class certification and initiated discussion of a proposed settlement. The Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they entered into an agreement in October 2002 to settle all claims that might have been brought in this action for approximately $5.5 million, all of which monies have been fully funded by defendants’ director and officer liability insurance. In March 2003, after proper class notice and hearings, the Court approved the settlement and entered judgment for defendants, dismissing the action. In April 2003, a plaintiff’s law firm that was not selected by the Court to serve as class counsel filed a notice of appeal relating to certain Court orders addressing that firm’s applications to the Court for attorney’s fees. In August 2003, on appellant’s own motion, the Court of Appeals dismissed the appeal.

     Beginning in June 2001, the directors and certain officers of Transmeta were named as defendants in four purported shareholder derivative actions that were consolidated in and by the Superior Court for Santa Clara County in In re Transmeta Corporation Derivative Litigation, Master File No. CV 799491. The complaints were based upon the same matters alleged in the shareholder class action described above. In July 2002, the Court sustained the Company’s demurrer with leave to amend based on plaintiffs’ lack of standing, and deferred consideration of the individual defendants’ demurrer on the merits. The Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they entered into an agreement to settle all claims that might have been brought in this action. The settlement includes a payment of approximately $300,000 in fees to counsel for the derivative plaintiffs and shall be fully funded by defendants’ director and officer liability insurance. In October 2003, upon motion and after a hearing, the Court approved the settlement and entered an order dismissing the consolidated derivative action as to all defendants.

     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 that were consolidated in and by the United States District Court for the Southern District of New York in In re Transmeta Corporation Initial Public Offering Securities Litigation, Case No. 01 CV 6492. The complaints allege that the prospectus issued in connection with the Company’s initial public offering on November 7, 2000 failed to disclose certain alleged actions by the underwriters for that offering, and alleges claims against the Company 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. Similar actions have been filed against more than 300 other companies that issued stock in connection with other initial public offerings during 1999-2000. Those cases have been coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS). In July 2002, the Company joined in a coordinated motion to dismiss filed on behalf of multiple issuers and other defendants. In February 2003, the Court granted in part and denied in part the coordinated motion to dismiss, and issued an order regarding the pleading of amended complaints. Plaintiffs subsequently proposed a settlement offer to all issuer defendants, which settlement would provide for payments by issuers’ insurance carriers if plaintiffs fail to recover a certain amount from underwriter defendants. Although the Company and the individual defendants believe that the complaints are without merit and deny any liability, but because they also wish to avoid the continuing waste of management time and expense of litigation, they accepted plaintiffs’ proposal to settle all claims that might have been brought in this action. The Company and the individual Transmeta defendants expect that their share of the global settlement will be fully funded by their director and officer liability insurance. Although the Company and the Transmeta defendants have approved the settlement in principle, it remains subject to several procedural conditions, as well as formal approval by the Court. It is possible that the parties may not reach a final written settlement agreement or that the Court may decline to approve the settlement in whole or part. In the event that the parties do not reach agreement on the final settlement, the Company and the Transmeta defendants believe that they have meritorious defenses and intend to defend any remaining action vigorously.

Item 2. Changes in Securities and Use of Proceeds

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Recent Sales of Unregistered Securities

     Not Applicable.

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 September 30, 2003, we paid $14.5 million of the net proceeds to IBM under the terms of our amended license agreement, $1.1 million to Quickturn Design Systems to repay indebtedness incurred in conjunction with equipment purchases in 1998, approximately $14.0 million in property and equipment purchases and $29.5 million for the purchase of intellectual property and related assets from Seiko Epson and other intellectual property owners. We have also paid approximately $230.3 million to fund ordinary operating expenses.

Item 3. Defaults upon Senior Securities

     Not Applicable.

Item 4. Submission of Matters to a Vote of Security Holders

     Not Applicable.

Item 5. Other Information

     Not Applicable.

Item 6. Exhibits and Reports on Form 8-K

     (a)  Exhibits.

     The following exhibits are filed herewith:

     *     As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this quarterly report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are not incorporated by reference in any filing of Transmeta Corporation under the Securities Act of 1933 or the Securities Exchange Act of 1934, including this quarterly report, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

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     (b)  Reports on Form 8-K

     On July 17, 2003, we filed a current report on Form 8-K respecting a press release we issued announcing earnings for the quarter ended June 27, 2003. The information furnished under that Form 8-K was intended to be furnished and not deemed filed with the Securities and Exchange Commission, and is not incorporated by reference in any filing of Transmeta Corporation under the Securities Act of 1933 or the Securities Exchange Act of 1934, including this quarterly report, whether made before or after the date of that Form 8-K and irrespective of any general incorporation language in any filings.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 7, 2003

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EXHIBIT INDEX