UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the Quarterly Period Ended June 30, 2004

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 o

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

     There were 174,227,866 shares of the Company’s common stock, par value $0.00001 per share, outstanding on July 23, 2004.

TRANSMETA CORPORATION

FORM 10-Q
Quarterly Period Ended June 30, 2004

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

TRANSMETA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(See accompanying notes)

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TRANSMETA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(See accompanying notes)

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TRANSMETA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(See accompanying notes)

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TRANSMETA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 States 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 license revenue recognition, inventory valuations, long-lived and intangible asset valuations, restructuring charges and loss contingencies. 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, 2003. The results of operations for the three months and six months ended June 30, 2004 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. To the extent that existing cash and cash equivalents and short-term investments balances and any cash from operations are insufficient to fund its activities during the next 12 months, the Company may need to raise during that time period additional funds through public or private equity or debt financing or by any other means available to the Company at that time. Additional funds may not be available on terms favorable to the Company or at all. In the event that the Company is unable to raise additional funds, it is positioned to modify its current business model, for example, to leverage its intellectual property assets and focus on its strategy of licensing its advanced power management technologies to other companies and, in doing so, to substantially limit its operations and reduce costs related to aspects of the business other than intellectual property and technology licensing to permit it to continue to operate on a modified business model for a period that extends at least twelve months beyond June 30, 2004.

     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 June 25, 2004 and June 27, 2003 each consisted of 13 weeks. The first six months of fiscal 2004 and 2003 each consisted of 26 weeks.

2. Net Loss per Share

     Basic and diluted net loss per share is presented in conformity with the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards (SFAS) No. 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 and shares subject to repurchase 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 35,871,772 and 36,566,532 shares of common stock at June 30, 2004 and 2003, respectively, determined using the treasury stock method, were not included in the computation of diluted net loss per share because the effect would be antidilutive. These securities, had they been dilutive, would have been included in the computation of diluted net loss per share using the treasury stock method.

3. Stock Based Compensation

     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”, and related interpretations and has elected to follow the “disclosure only” alternative prescribed by SFAS 123, “Accounting for Stock-Based Compensation.” 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, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plan.” 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. In December 2002, the FASB issued, and the Company adopted, SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123”. 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.

     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:

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4. Net Comprehensive Loss

     Net comprehensive loss includes the Company’s net loss, as well as accumulated other comprehensive income/(loss) on available-for-sale investments and foreign currency translation adjustments. Net comprehensive loss for the three and six month periods ended June 30, 2004 and 2003, respectively, is as follows (in thousands):

     The components of accumulated other comprehensive income, net of taxes as of June 30, 2004 and December 31, 2003, 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):

     In the second quarter of fiscal 2004, we recorded a $2.7 million inventory-related charge primarily associated with our 1.0 GHz 12 Watt 130 nanometer Efficeon processors as the cost to manufacture these parts exceeded the price at which we expect to be able to sell for these products. Of the $12.0 million and $8.8 million of inventory on hand at June 30, 2004 and December 31, 2003, respectively, $6.9 million and $2.6 million of inventory, respectively, were stated at net realizable value. Accordingly, gross margin may be impacted from future sales of these parts to the extent that the associated revenue exceeds or fails to achieve their currently adjusted values. Benefits to gross margin as a result of products being sold at ASPs in excess of their previously written down values were $0.2 million and $0.2 million for the three and six months ended June 30, 2004, respectively, compared to $0.1 million and $0.8 million for the same periods last year.

6. 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,

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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.

     Accrued restructuring charges consist of the following at June 30, 2004 (in thousands):

7. Legal Proceedings

     The Company is a party in one consolidated lawsuit. 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

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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, 2003 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.

     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 design, develop and sell highly efficient x86-compatible software-based microprocessors. Since the introduction of our first family of microprocessors, the Crusoe series, in January 2000, we have derived the majority of our revenue from the sale of these products. In October 2003, we introduced the Efficeon TM8000 family of microprocessors, which is our next family of x86-compatible processors. In fiscal 2003, and through the first six months of fiscal 2004, we additionally have recognized revenue from technology and intellectual property license agreements. During the first quarter of fiscal 2004, we entered into a licensing agreement with NEC Electronics, or NEC, wherein NEC licensed our LongRun2 technologies for power management and transistor leakage control. The agreement with NEC includes deliverable-based license fees, maintenance service fees, and subsequent royalties payable to us once NEC begins production of products incorporating our technologies, which NEC currently expects to begin in late 2005. Through June 30, 2004, we have collected a total of $0.3 million in maintenance service fees related to our NEC agreement. These funds will be recognized as revenue once certain predetermined milestones are met. We expect in the near term for technology and intellectual property license revenues to contribute to our total revenue, and we will continue to explore additional opportunities for licensing our advanced power management and other technologies to other companies in the integrated circuit industry.

     Our total revenue, including product revenue and license and service revenue, for the three and six months ended June 30, 2004, was $6.0 million and $11.2 million, respectively, compared to $5.1 million and $11.1 million for the corresponding periods last year. These increases were primarily due to increases of 48% and 14% in net units shipped for the three and six months ended June 30, 2004, respectively, compared to the same periods last year. The increases in the net unit volume shipped were offset by a decrease in average selling prices, or ASPs. However, we also had a more favorable product mix in fiscal 2004 and had higher ASPs associated with shipments of our Efficeon products, which began toward the end of the fourth quarter of fiscal 2003. The higher ASPs from Efficeon were offset by a 21% and 31% decrease in the ASPs of the Crusoe TM5800 for the three and six months periods ended June 30, 2004, respectively, compared to the same periods last year. The cost to manufacture our Crusoe products has decreased for the three and six months ended June 30, 2004 compared to the same periods last year. As a result, our Crusoe product line has continued to contribute favorably to our financial results.

     We had total operating expenses of $23.7 million and $46.9 million for the three and six months ended June 30, 2004, respectively, compared to $22.3 million and $44.5 million for the corresponding periods last year. Net loss was $25.5 million and $48.9 million for the three and six months ended June 30, 2004, respectively, compared to $22.0 million and $42.1 million for the corresponding periods last year. Historically we have incurred significant losses, and as of June 30, 2004, we had an accumulated deficit of $591.4 million.

     The majority of our sales have been to a limited number of customers. Additionally, we derive a significant portion of our revenue

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from customers located in Asia. The following table represents our sales to customers, each of which is located in Asia, that accounted for more than 10% of total revenue for the three and six months ended June 30, 2004 and 2003:

We had five customers that accounted for more than 10% of our accounts receivable balance at June 30, 2004, including customers A, B, C and E, referenced above, who represented 30%, 24%, 12% and 11%, respectively, of our accounts receivable balance. An additional customer represented 11% of our accounts receivable balance at June 30, 2004. This compares to two customers that accounted for more than 10% of our accounts receivable balance at December 31, 2003, including customers A and B, who represented 66% and 13%, respectively, of our accounts receivable balance.

     We began shipment in the fourth quarter of 2003 of our initial Efficeon TM8000 microprocessor, manufactured using a 130 nanometer complementary metal oxide semiconductor, or CMOS, process. We believe that we must successfully complete the transition of the manufacturing of our Efficeon TM8000 microprocessors to a 90 nanometer CMOS process in order to be able to achieve broad market acceptance of our Efficeon TM8000 microprocessors. We began sampling our 90 nanometer Efficeon TM8000 processors in early April and we continue to pursue our goal to begin limited production of these products in the third quarter of fiscal 2004.

     In the fiscal quarter ended June 30, 2004, we recorded a $2.7 million inventory-related charge primarily associated with our 1.0 GHz 12 Watt 130 nanometer Efficeon processors, as the cost to manufacture these parts exceeded our currently projected market value for these products. Accordingly, gross margin may benefit from future sales of these parts only to the extent that the associated revenue exceeds their currently adjusted values. Similarly, our gross margins could be adversely affected if the products are sold at a price lower than our currently estimated market value. Our goal is to improve gross margins after we sell through the 130 nanometer Efficeon inventory on hand at June 30, 2004, all of which is currently stated at its estimated market value, and after we shift our product mix to our new 90 nanometer Efficeon processor.

     We have historically reported negative cash flows from operations, and we intend to rely on funds that we have received from financing activities until we are able to generate sufficient revenue and related gross profit to cover operational expenses as well as anticipated increases in our working capital requirements. Our ability to increase sales of our Crusoe TM5800 products into additional market segments, achieve market acceptance of our Efficeon TM8000 microprocessor manufactured using a 130 nanometer process and successfully transition our Efficeon TM8000 microprocessor to a 90 nanometer process will be particularly critical in determining our cash needs.

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, 2003 filed with the Securities and Exchange Commission on March 9, 2004. There have been no changes in any of our critical accounting policies since December 31, 2003.

Results of Operations

Total Revenue

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     We derive revenue from two sources: product revenue, and license and service revenue. Total revenue for the comparative periods is summarized in the following table:

     Our products are targeted at a broad range of computing platforms, particularly battery-operated mobile devices and applications that need high performance, low power consumption and low heat generation. Such platforms include thin clients, notebook computers, embedded computers and blade servers, ultra-personal computers, or UPCs, and tablet PCs. Product revenue derived from each computing market segment as well as license and service revenue is presented as a percentage of total revenue in the following table:

     Total product revenue for the three and six months ended June 30, 2004 was $5.7 million and $10.7 million, respectively, compared to $4.6 million and $10.5 million for the corresponding periods last year. The increase in revenue is primarily due to an overall increase in net product shipped of 48% and 14%, respectively, for the three and six months ended June 30, 2004 compared to the same periods last year. Contributing to this increase were the shipments of our Efficeon product, which began in the fourth quarter of 2003 and represented 32% and 25%, respectively, of total revenue for the three and six months ended June 30, 2004. Partially offsetting this increase was the decrease of ASPs for our Crusoe processors.

     Pricing pressure on the TM5800 has increased and may continue to increase as the product has matured and continues to penetrate into market segments and geographies, such as China and Taiwan, that traditionally demand lower ASPs. We will continue to manufacture the TM5800 as that processor continues to penetrate into market segments such as the embedded and thin client markets, from which we expect the processor to derive the majority of its future revenue. The Efficeon TM8000 product is targeted at the high-volume notebook and other markets that demand low power consumption and low heat generation characteristics, such as the UPC and thin and light notebook markets. We have recently seen that in the short term our potential customers in the mainstream notebook markets plan to limit the number of system designs they will support, and are consolidating their design teams and focusing on what they perceive to be the products with the highest volume potential. This generally means that there are fewer overall design opportunities and there is a stronger focus on mainstream consumer notebooks among Taiwanese and U.S. manufacturers. As we compete in the mainstream consumer notebook segments, we are facing increased competition and are finding that ASPs are much lower than in other market segments such as the thin and light notebook markets, and as a result could have a negative impact on our future revenues.

     For the three and six months ended June 30, 2004, we recognized revenue of $0.3 million and $0.5 million, respectively, related to a license and service agreement that we entered into during fiscal 2003. In the first quarter of fiscal 2004, we licensed our LongRun2 technologies for power management and transistor leakage control to NEC Electronics. Through June 30, 2004, we have not recognized any revenue from the agreement with NEC. However, we expect to recognize revenue associated with this arrangement once specific milestones are achieved. We will continue to explore additional opportunities for licensing our advanced power management technologies to other companies in the integrated circuit industry. For example, we believe our proprietary LongRun2 leakage control technology could be valuable to the semiconductor industry and could generate significant future licensing revenues for us without impairing our microprocessor product business.

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Gross Margin

     Our gross margin is comprised of the components displayed in the following table, shown as a percentage of total revenue:

     Gross margin was negative 33.5% for the second quarter of fiscal 2004 compared to 1.1% for the same period last year. In the second quarter of fiscal 2004, we recorded a $2.7 million inventory-related charge primarily associated with our 1.0 GHz 12 Watt 130 nanometer Efficeon processors as the cost to manufacture these parts exceeded the price at which we expect to be able to sell these products. Accordingly, gross margin may benefit from future sales of these parts to the extent that the associated revenue exceeds their currently adjusted values. Similarly, our gross margins could be adversely affected if the products are sold at a price lower than our currently estimated market value. The 130 nanometer Efficeon product currently has a manufactured cost at or near projected market value. Accordingly, we have made adjustments to the carrying value of inventory on hand as well as inventory not yet received, but for which we have firm purchase commitments, to write this inventory down to its net realizable value. Of the $2.7 million charge noted above, $0.8 million of this charge related to firm purchase commitments. There were no similar charges related to purchase commitments in any other periods. We plan to transition our Efficeon customers to our next generation 90 nanometer TM8000 products as we expect these products to contribute more favorably to our financial results.

     Gross margin was negative 21.6% for the first six months of fiscal 2004 compared to 14.7% for the same period last year. As a percent of total revenue, our product costs increased 18.0 percentage points, from 73.8% to 91.8%, mostly as a result of a decrease in average selling prices. In addition to this decline in average selling prices, we saw an increase in the average dollar cost of products sold in the first six months of fiscal 2004 compared to the same period last year, mostly related to sales of our Efficeon TM8000 processor. The initial product cost for our 130 nanometer Efficeon TM8000 processors was significantly higher than the product cost of a more mature product, as the first quarter of fiscal 2004 was our first full quarter of producing this product. Gross margin was additionally adversely affected in the second quarter of fiscal 2004 as a result of the $2.7 million inventory-related charge noted above.

     Gross margin was adversely affected during both periods by unabsorbed overhead costs as our production-related infrastructure exceeded our needs. For the second quarter of fiscal 2004, these unabsorbed costs were $0.1 million, or 0.9% of total revenue, compared to $0.6 million, or 10.9% of total revenue, for the same period in the prior year. For the first six months of fiscal 2004, these unabsorbed costs were $0.5 million, or 4.8% of total revenue, compared to $1.1 million, or 10.0% of total revenue, for the same period in the prior year. We expect to increase the utilization of our manufacturing overhead in coming periods as the volume of shipments of our Efficeon TM8000 and Crusoe TM5800 products increase.

     Of the $12.0 million and $8.8 million of inventory on hand at June 30, 2004 and December 31, 2003, respectively, $6.9 million and $2.6 million of inventory, respectively, were stated at net realizable value, which was lower than the respective historical cost. Accordingly, gross margin may be impacted from future sales of these parts to the extent that the associated revenue differs from their currently adjusted values. Benefits to gross margin as a result of products being sold at ASPs in excess of their previously written down values were $0.2 million and $0.2 million for the three and six months ended June 30, 2004, respectively, compared to $0.1 million and $0.8 million for the same periods last year.

Research and Development

     Research and development (R&D) expenses were $13.7 million and $26.4 million for the three and six months ended June 30,

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2004, respectively, compared to $12.2 million and $24.7 million for the corresponding periods last year. The increase in R&D expenses for the second quarter of fiscal 2004 compared to the same period last year was due to increases in headcount-related expenses of $0.8 million, engineering charges of $0.8 million and consultant expenses of $0.4 million, partially offset by a decrease in depreciation expenses of $0.3 million. The increase in R&D expenses for the first six months of fiscal 2004 compared to the same period last year was due to increases in headcount-related expenses of $1.0 million, engineering charges of $0.8 million and consultant costs of $0.7 million, partially offset by a decrease in depreciation expenses of $0.7 million. The increases in these areas of R&D expense through the first six months of fiscal 2004 were primarily the result of our increased efforts devoted to the development of the 90 nanometer and 130 nanometer manufacturing technology for our Efficeon TM8000 family of microprocessors, as well as our LongRun2 power management technologies. The decreases in depreciation expenses were primarily due to certain property and equipment being fully depreciated throughout the last fiscal year. In addition to the resources devoted to our Efficeon TM8000 and LongRun2 Technologies, the remaining portion of our fiscal 2004 expenditures was used for sustaining engineering efforts on our TM5800 microprocessors.

Selling, General and Administrative

     Selling, general and administrative (SG&A) expenses were $7.4 million and $14.1 million for the three and six months ended June 30, 2004, respectively, compared to $6.3 million and $13.0 million for the corresponding periods last year. The increase in SG&A expenses for the second quarter of fiscal 2004 compared to the same period last year was due to increases in headcount-related expenses of $0.5 million and travel and tradeshow expenses of $0.5 million. The increase in SG&A expenses for the first six months of fiscal 2004 compared to the same period last year was due to increases in headcount-related expenses of $1.1 million, travel and tradeshow expenses of $0.5 million and sales and advertising expenses of $0.3 million, offset by decreases in depreciation expenses of $0.5 million and legal expenses of $0.4 million. The increases in these areas of SG&A expense through the first six months of fiscal 2004 were primarily the result of our continued efforts to hire additional personnel, to expand our presence in the Asia-Pacific market with new offices and to promote awareness of our Efficeon TM8000 processor. For the remainder of fiscal 2004, we may increase our selling costs as we plan to initiate a marketing alliance program that is specifically designed and structured to promote our customers’ products, to drive awareness, foster market opportunities, and help generate sales.

Amortization of Deferred Charges, Patents and Patent Rights

     Amortization of deferred charges, patents and patent rights were $2.3 million and $4.8 million for the three and six months ended June 30, 2004, respectively, compared to $2.6 million and $5.3 million for the corresponding periods last year. Amortization charges relate to various patents and patent rights acquired from Seiko Epson and others during fiscal 2001. The decreases can be attributed to a reduction in payments due under our patent and patent rights and our technology license agreement with IBM, as amended. Amounts due under the agreements decreased from $30.5 million at June 30, 2003 to $16.0 million at June 30, 2004.

Stock Compensation

     Stock compensation was $0.2 million for the three months ended June 30, 2004 compared to $1.1 million for the same period last year, representing a decrease of $0.9 million. Stock compensation was $1.6 million for the six months ended June 30, 2004 compared to $1.5 million for the same period last year, representing an increase of $0.1 million. The two components of stock compensation were the amortization of deferred stock compensation and variable stock compensation.

     Net amortization of deferred stock compensation for the second quarter of fiscal 2004 was $0.3 million, compared to $0.6 million for the same period last year. For the first six months of fiscal 2004, net amortization was $0.6 million, compared to $1.2 million for the same period last year. The decrease was 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. The amortization of the remaining $0.1 million of deferred stock compensation will continue through the end of fiscal 2004.

     Variable stock compensation 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 second quarter of fiscal 2004 was a credit of $0.1 million, compared to a charge of $0.5 million for the same period last year. This decrease was the result of certain notes receivable from stockholders being fully paid toward the end of fiscal 2003. For the first six months of fiscal 2004, variable stock compensation was $1.0 million, compared to $0.3 million for the same period last year. This increase was the result of adjustments made for certain notes receivable from stockholders that had been fully paid, as well as a higher market price of our stock as of June 30, 2004, compared to the same period in the prior year.

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Interest Income and Other, Net and Interest Expense

     Interest income and other, net was $0.2 million and $0.5 million for the three and six months ended June 30, 2004, respectively, compared to $0.3 million and $1.0 million for the corresponding periods last year. The decreases were due to lower average invested cash balances as we continued to use cash to fund operations, as well as a decrease in interest rates earned on investments during the period. Interest expense was $20,000 and $35,000 for the three and six months ended June 30, 2004, respectively, compared to $123,000 and $247,000 for the corresponding periods last year. The decrease was primarily the result of lower average debt balances due to several lease-financing arrangements expiring during 2003, as well as decreases in certain accretion expenses related to our facilities lease commitments.

Liquidity and Capital Resources

Cash and Cash Flows

     We have historically reported negative cash flows from operations as the gross profit generated, if any, from our product and licensing revenues has not been sufficient to cover our operating cash requirements. We intend to rely on funds that we have received from financing activities until we are able to generate sufficient revenue and gross profit to cover operational expenses as well as anticipated increases in our working capital requirements. We believe that the proceeds received from financing activities will be sufficient to fund our operations, planned capital and R&D expenditures for at least the next twelve months on our current or modified business model, but we cannot be sure that those proceeds will be sufficient to fund our operations for this period because of significant risks and uncertainties as noted below.

     For the period through June 30, 2005 and over the longer term, 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. As we shift our product mix to our new 90 nanometer Efficeon TM8000 microprocessors, 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 non-cash working capital, and accordingly, the net cash which we will use in our operating activities will increase.

     Our ability to increase sales of our Crusoe TM5800 products into additional market segments, decrease manufacturing costs for our Crusoe TM5800 and Efficeon TM8000 products, achieve market acceptance of our initial Efficeon TM8000 microprocessor manufactured using a 130 nanometer process and successfully transition our Efficeon TM8000 microprocessor to a 90 nanometer process will be particularly critical in determining our cash needs. All of these factors are subject to significant risks and uncertainties.

     To the extent that existing cash and cash equivalents and short-term investments balances and any cash from operations are insufficient to fund our activities during the next 12 months, we may need to raise during that time period additional funds through public or private equity or debt financing. Additional funds may not be available on terms favorable to us or at all. In the event that we are unable to raise additional funds, we are positioned to modify our current business model, for example, to leverage our intellectual property assets and focus on our strategy of licensing our advanced power management technologies to other companies and, in doing so, to substantially limit our operations and reduce costs related to aspects of the business other than intellectual property and technology licensing to permit us to continue to operate on a modified business model for a period that extends at least through June 30, 2005.

     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. 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.

     As of June 30, 2004 we had $84.7 million in cash, cash equivalents and short-term investments compared to $120.8 million at December 31, 2003.

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     The following comparison table summarizes our usage of cash and cash equivalents for the six months ended June 30, 2004 and the six months ended June 30, 2003:

     Net cash used in operating activities was $40.6 million for the six months ended June 30, 2004, compared to $31.6 million for the corresponding period in fiscal 2003. Net cash used during the first six months of fiscal 2004 was primarily the result of a net loss of $48.9 million, an increase in inventories of $3.2 million and an increase in accounts receivable of $1.8 million. The net loss and changes in operating assets and liabilities were partially offset by increases in accounts payable and accrued liabilities of $6.6 million, non-cash charges related to amortization of patents and patent rights of $4.8 million, depreciation of $1.9 million and stock compensations of $1.6 million. Subsequent to the end of the second quarter of fiscal 2004, we received $3.0 million as the first installment of fees due to us under our NEC licensing agreement. We expect to receive the remaining portion of our technology transfer fees over the next two fiscal quarters.

     Net cash used in investing activities was $31.2 million for the six months ended June 30, 2004, compared to net cash provided by investing activities of $53.5 million for the corresponding period in fiscal 2003. This change was primarily due to $22.0 million in net purchases of available-for-sale investments for the first six months of fiscal 2004, compared to net proceeds of $63.2 million from the maturity of available-for-sale investments for the same period last year. Additionally, we made scheduled payments for previously acquired patent and patent rights totaling $7.5 million during the first six months of fiscal 2004, compared to $9.0 million in the same period last year. We have a remaining payment of $16.0 million to a development partner that is due prior to December 31, 2004. Additional cash used in investing activities included the purchase of property and equipment, which amounted to $1.7 million and $0.7 million for the first six months in fiscals 2004 and 2003, respectively. We expect that capital equipment purchases may increase over the coming year as we invest in our next generation 90 nanometer manufacturing technology and further develop our LongRun2 power management technologies.

     Net cash provided by financing activities was $14.0 million for the six months ended June 30, 2004, compared to $1.1 million for the corresponding period in fiscal 2003. This increase was primarily the result of our receipt of $10.2 million when our underwriters exercised their over-allotment option to purchase an additional 3.75 million shares of our common stock in relation to our December 2003 common stock offering. We also received $3.1 million in net proceeds from sales of common stock under our employee stock purchase and stock option plans for the first six months of fiscal 2004, compared to $1.5 million for the same period last year. Additionally, we received $0.9 million for the repayment of notes from our stockholders in the first six months of fiscal 2004. Since our inception, we have financed our operations primarily through sales of equity securities and, to a lesser extent, from lease financing. It is reasonably possible that we may continue to seek financing through these sources of capital as well as other types of financing, including, but not limited to, debt financing. Additional financing might not be available on terms favorable to us, or at all.

     At June 30, 2004, we had $25.9 million in cash and cash equivalents and $58.8 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 36 months.

Contractual Obligations

     At June 30, 2004, we had the following contractual obligations:

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(2)

Other obligation represents the final payment to our development partner.

Off-Balance Sheet Arrangements

     As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 30, 2004, we are not involved in SPE transactions.

Risks that Could Affect Future Results

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

We have a history of losses, expect to incur further significant losses and may never achieve or maintain profitability.

     Since our inception, we have incurred cumulative losses aggregating $591.4 million, including net losses of $48.9 million for the first six months of fiscal 2004, $87.6 million in fiscal 2003 and $110.0 million in fiscal 2002, which have reduced stockholders’ equity to $98.1 million at June 30, 2004. We currently expect to continue to incur losses under our current business plan until at least 2005.

     We have financed our operations primarily through sales of equity securities and, to a lesser extent, from product and license revenue and lease financing. We cannot, however, be sure that funds previously received from financing activities will be sufficient to fund our operations until we are able to generate positive cash flows from operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”. However, our ability to continue to operate under our current business model until we achieve profitability may be affected by a variety of factors, which may include our ability to achieve market acceptance for our Efficeon TM8000 products, significant unexpected technical or manufacturing problems we may experience in transitioning our Efficeon TM8000 microprocessor to a 90 nanometer manufacturing process or any significant problems we may face in selling our TM5800 microprocessors in additional market segments. All of these factors are subject to significant risks and uncertainties.

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. We just began shipment in the fourth quarter of 2003 of our initial Efficeon TM8000 microprocessor manufactured using a 130 nanometer complementary metal oxide semiconductor, or CMOS, process. If we experience delays in manufacturing sufficient quantities of microprocessors, 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, significant demand for our new products may fail to materialize.

     We are transitioning the manufacturing of our Efficeon TM8000 microprocessors to a 90 nanometer CMOS process. We believe that successfully completing this transition will be important to our ability to achieve broad market acceptance of our Efficeon TM8000 microprocessors and to our ability to compete, particularly in market segments in which performance is a key competitive factor such as the notebook personal computer and blade server markets. Further, the announcement of our 90 nanometer Efficeon TM8000 microprocessor may reduce demand for our 130 nanometer Efficeon TM8000 microprocessor below our expectations since customers may delay purchases of our Efficeon TM8000 microprocessor until the 90 nanometer version of the product is available. We cannot be sure that we will successfully complete the development of, and introduce, the Efficeon TM8000 microprocessor manufactured using the 90 nanometer process.

We could encounter a variety of technical and manufacturing problems that could delay or prevent the successful introduction of Efficeon TM8000 microprocessors manufactured using a 90 nanometer process.

     Transitioning our TM8000 microprocessors to a 90 nanometer manufacturing process involves a variety of technical and

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manufacturing challenges. We are using Fujitsu Microelectronics to manufacture our initial 90 nanometer Efficeon TM8000 microprocessors. We delivered to Fujitsu Microelectronics the tape-out of our Efficeon TM8000 microprocessors for implementation in its 90 nanometer foundry in November 2003. We received first silicon for testing in January 2004 and sampled these processors to certain customers in April 2004. Although we have anticipated that several revisions will need to be made before production, we cannot be sure that more revisions than anticipated will not be necessary or that we will not encounter more significant problems than expected. If those problems prove to be more serious than expected and cannot be remedied on a timely basis and at a reasonable cost, our stock price would likely be very substantially reduced. Fujitsu Microelectronics has limited experience with the 90 nanometer CMOS process. We cannot be sure that Fujitsu Microelectronics’ 90 nanometer foundry will be qualified for production shipments on our planned schedule. For example, during 2001 we experienced yield problems as we migrated our products to smaller geometries, which caused increases in our product costs, delays in product availability and diversion of engineering personnel. If we encounter problems with the manufacture of the Efficeon TM8000 microprocessors using the 90 nanometer process that are more significant or take longer to resolve than we anticipate, our ability to increase our revenue would suffer and we could incur significant expenses.

Our Crusoe TM5800 microprocessors are experiencing decreasing demand from notebook computer manufacturers and are experiencing declining average selling prices. If we are unable to sell the TM5800 microprocessors into additional market segments or reduce our costs of production, our operating results will suffer.

     As our Crusoe TM5800 microprocessors have matured, demand for the TM5800 microprocessors from notebook computer manufacturers has declined in that market segment. We have begun to sell the TM5800 microprocessors into additional market segments such as the thin client, ultra-personal computer, or UPC, and embedded computer market segments, many of which are only beginning to be developed. We cannot be sure that we will be successful in selling the TM5800 microprocessors into these markets or that these markets will experience significant growth. In addition, the average selling price of the TM5800 microprocessors has decreased, and we expect that pricing pressure on the TM5800 microprocessors will continue to increase as sales of these microprocessors increasingly derive from geographies and market segments that traditionally demand lower average selling prices. If we are unable to achieve sufficient reductions in our costs of products sold, this decline in prices will adversely affect our gross margins.

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, UPCs, 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 ability to increase our revenues would suffer. 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.

Our future revenue depends in part upon our ability to penetrate additional segments of the notebook computer market.

     Historically, our sales in the notebook computer market have primarily been in the market segment consisting of thin and light notebook computers for which low heat generation and power consumption are particularly critical. Our ability to increase our revenues in the future will depend in significant part on our ability to market our new Efficeon TM8000 microprocessors in additional segments of the notebook computer market in which microprocessor performance is a more significant factor. These notebook market segments are intensely competitive and dominated by Intel. We have not succeeded in deriving significant revenues from sales of our microprocessors in these market segments in the past and cannot be sure that we will successfully market and sell our microprocessor products in these market segments in the future.

     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, original equipment manufacturers, or 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

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significant investments. For instance, OEMs may need to design new computer casings, basic input/output system, or BIOS, 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, our ability to increase our revenue would likely be seriously harmed.

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 expect to incur future losses. As we shift our product mix to our next family of microprocessors, 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, our cash expenditures will increase. Although we intend to use the net proceeds from the common stock offering in December 2003 to increase our working capital and fund our operations, which are generating significant losses, we cannot be sure that the net proceeds from that offering will be sufficient for this purpose. If the revenue that we generate falls below our expectations, we could utilize our existing cash resources, including the net proceeds of the offering, faster than we expect. In addition, we may begin to generate positive cash flow from operations later than anticipated or we may never generate positive cash flow from operations. As a result, we may need significant additional funds. A variety of other business contingencies could contribute to our need for funds in the future, including 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.

     If we were to raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced, and these newly issued securities might have rights, preferences or privileges senior to those of our then-existing stockholders. Additional financing might not be available on terms favorable to us, or at all. 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 on acceptable terms or at all, 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.

We face intense competition in the x86-compatible microprocessor market. Many of 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 intensely competitive. We may not be able to compete effectively against current and potential competitors, especially those with significantly greater resources and market leverage. 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 in the x86-compatible microprocessor product market include Intel, Advanced Micro Devices and VIA 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

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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.

     In particular, Intel has dominated the market for x86-compatible microprocessors for many years. We may be adversely affected by Intel’s pricing decisions, product mix and introduction schedules, marketing strategies and influence over industry standards and other market participants and the loyalty of consumers to the Intel brand. We cannot be sure that we can compete effectively against Intel even in the market segments that we intend to target.

     In 2003, Intel introduced a new microprocessor that is focused on the notebook computer market segment and designed to consume less power than its prior microprocessors. We expect that Intel, and potentially other microprocessor companies, will increasingly seek to offer microprocessors specifically targeted at many of the same market segments that we intend to serve, which could adversely affect our ability to compete successfully.

     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 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, particularly when introducing new products. 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. We have experienced yield problems in the past, and we may experience yield problems in the future that impair our ability to deliver our products to our customers, increase our costs, adversely affect our margins and divert the efforts of our engineering personnel. Difficulties in achieving the desired yields often occur in the early stages of production of a new product or in the migration of manufacturing processes to smaller geometries. We could experience difficulties in achieving desired yields or other manufacturing problems in the production of our Efficeon TM8000 products that could delay our ability to further introduce Efficeon TM8000 products in volume, adversely affect our costs and gross margins and harm our reputation. In addition, we could also experience these difficulties as we seek to migrate the Efficeon TM8000 products to a 90 nanometer process technology, which poses significant technical challenges and in which neither we nor Fujitsu Microelectronics, which we intend to use to manufacture these products, has significant experience. 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 of the slower, less valuable die, a resulting unfavorable impact on gross margins and an insufficient inventory of faster products, depending upon customer demand.

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 typically from six to 12 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 accurately 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

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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 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, Taiwan Semiconductor Manufacturing Company, or TSMC, or Fujitsu Microelectronics might not be able to fabricate wafers as quickly as we need them. Also, Advanced Semiconductor Engineering, or ASE, might not be able to increase assembly functions in a timely manner. In that event, we would need to increase production and assembly rapidly or find, qualify and begin production and assembly at additional manufacturers or providers of assembly and test services, which may not be possible within a time frame acceptable to our customers. The inability of our product manufacturer or 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 currently 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 76% of total revenue in the first six months of fiscal 2004. 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 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.

     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 or to promote products of our competitors might not sell a significant amount or any of our products.

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.

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     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.

We rely on an independent foundry that has no obligation to provide us with fixed pricing or production capacity for the fabrication of our wafers, and our business will suffer if we are unable to obtain sufficient production capacity on favorable terms.

     We do not have our own manufacturing facilities and, therefore, must rely on third parties to manufacture our products. We currently rely on TSMC in Taiwan to fabricate the wafers for all of our current products and rely on Fujitsu Microelectronics in Japan to manufacture our initial 90 nanometer Efficeon TM8000 products. As is common in the industry, we do not have a manufacturing contract with TSMC that guarantees any particular production capacity or any particular price, and although we have not yet entered into a definitive manufacturing agreement with Fujitsu Microelectronics, we cannot be assured that we will have any guaranteed production capacity with Fujitsu Microelectronics. The Fujitsu Microelectronics 90 nanometer foundry has relatively limited capacity and we cannot be sure that sufficient capacity will be available at that foundry to enable us to manufacture our initial 90 nanometer Efficeon TM8000 products in the quantities that we would desire if these products were to achieve rapid market acceptance.

     These foundries may allocate capacity to other companies’ products while reducing the capacity available to us on short notice. Foundry customers that are larger than we and have greater economic resources, that have long-term agreements with these foundries or that purchase in significantly larger volumes than we may cause these foundries to reallocate capacity to them, decreasing the capacity available to us. In addition, these foundries could, with little or no notice, refuse to continue to fabricate all or some of the wafers that we require. If these foundries 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. As a result, we could lose potential sales and fail to meet existing obligations to our customers. These foundries could also, with little or no notice, change the terms under which they manufacture for us, which could cause our manufacturing costs to increase substantially.

Our reliance on TSMC and Fujitsu Microelectronics to fabricate our wafers limits our ability to control the production, supply and delivery of our products.

     Our reliance on third-party manufacturers exposes us to a number of risks outside our control, including the following:

	•		unpredictability of manufacturing yields and production costs;
	•		interruptions in shipments;
	•		inability to control quality of finished products;
	•		inability to control product delivery schedules;
	•		potential lack of access to key fabrication process technologies; and
	•		potentially greater exposure to misappropriation of our intellectual property.

We depend on ASE to provide assembly and test services. If ASE were to cease providing services to us in a timely manner and on acceptable terms, our business would suffer.

     We rely on ASE, which is located in Taiwan, for the majority of our assembly and test services. We do not have a contract with ASE for test and assembly services, and we typically procure these services from ASE on a per order basis. ASE could cease to perform all of the services that we require, or could change the terms upon which it performs services for us. If we were 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. In addition, as a result of our reliance on ASE, we do not directly control our product delivery schedules. If ASE were not to provide high quality services in a timely manner, our costs could increase, we could experience delays in the delivery of our products and our product quality could suffer.

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If our products are not compatible with industry standards, hardware that our customers design into their systems or that is used by end-users or software applications or operating systems for x86-compatible microprocessors, market acceptance of our products and our ability to maintain or increase our revenues would suffer.

     Our products are designed to function as components of a system. 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.

     In addition, to gain and maintain market acceptance, our microprocessors must not have significant incompatibilities with software for x86-compatible microprocessors, and in particular, the Windows operating systems, or hardware used by end-users. 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 that software. Software or hardware incompatibilities that are significant or are perceived to be significant could hinder our products from achieving or maintaining market acceptance and impair our ability to increase our revenues.

     In an effort to test and ensure the compatibility of our products with hardware and software for x86-compatible microprocessors, we rely on the cooperation of third-party hardware and software companies, including manufacturers of graphics chips, motherboards, BIOS software and other components. All of these third-party designers and manufacturers produce chipsets, motherboards, BIOS software and other components to support each new generation of Intel’s microprocessors, and Intel has significant leverage over their business opportunities. If these third parties were to cease supporting our microprocessor products, our business would suffer.

Our products may have defects that 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, 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 contains 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 is 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 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 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 computer industries. In 2001, 2002 and through parts of 2003, our operating 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.

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 in 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 began experiencing a downturn again in 2001. Our revenue has decreased, in part due to industry-wide downturns, 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 harm our operating results.

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;
	•		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.

Advances in battery design, cooling systems and power management systems could adversely affect our ability to achieve widespread market acceptance for our products.

     We believe that our ability to achieve widespread market acceptance for our products will depend in large part on whether potential purchasers of our products believe that the low power usage of our products is a substantial benefit. Advances in battery technology, or energy technologies such as fuel cell technologies, that offer increased battery life and enhanced power capacity, as well as the development and introduction of more advanced cooling systems, may make microprocessor power consumption a less important factor to our customers and potential customers. These developments, or developments in power management systems by third parties, may adversely affect our ability to market and sell our products and increase our revenues.

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.

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     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 that 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.

We might not experience growth in our licensing revenues.

     Licensing revenue was $0.5 million for the first six months of fiscal year 2004 and $1.1 million for fiscal year 2003. However, we may not recognize significant licensing revenue in the future. License transactions often have a long sales cycle and can result in additional liability, such as indemnification obligations. A portion of the revenue to which we might be entitled under some of our license transactions depends upon our provision of future deliverables to licensees. If we do not provide those deliverables in a timely and satisfactory manner, then we may not receive that portion of the revenue and we may strain our relationship with the licensee. In addition, the amount of revenue we recognize under some of 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.

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     Our success depends heavily upon the contributions of our key management and technical personnel, whose knowledge, leadership and technical expertise would be difficult to replace. Many of these individuals have been with us for several years and have developed specialized knowledge and skills relating to our technology and business. For instance, Svend-Olav Carlsen, who had joined Transmeta in October 2000 and was promoted to be our Chief Financial Officer in June 2002, resigned in June 2004. Others have joined us in senior management roles only recently. 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 our company 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.

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, operations, 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.

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 it 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.

We have significant international operations and plan to expand our international operations, which exposes us to risk and 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, most of our products to customers in Asia. In addition, TSMC and ASE are located in Taiwan, and the Fujitsu Microelectronics foundry we use for our initial 90 nanometer product is located in Japan. As part of our international expansion, we have personnel in Japan, Taiwan, China, Korea and Europe who provide sales and customer support. We have appointed distributors, stocking representatives and manufacturers’ representatives to sell products in Japan, Taiwan, Hong Kong, Europe, China, Korea and North America. In addition, we generally ship our products from a third-party warehouse facility located in Hong Kong. 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;
	•		problems in the timeliness or quality of product deliveries;

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	•		potentially adverse tax consequences;
	•		major health concerns, such as SARS;
	•		political and economic instability, for example as a result of tensions between Taiwan and the People’s Republic of China; and
	•		potentially reduced protection for intellectual property rights.

Our operating results are difficult to predict and fluctuate significantly. A failure to meet the expectations of securities analysts or investors could result in a substantial decline in our stock price.

     Our operating results fluctuate significantly from quarter to quarter, and we expect that our operating results will fluctuate significantly in the future as a result of one or more of the risks described in this section or as a result of numerous other factors. You should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance. Our stock price has declined substantially since our stock began trading publicly. If our future operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price would likely decline from current levels.

     A large portion of our expenses, including rent and salaries, 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 often 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.

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 subject to wide fluctuations in the future. Many factors could cause the market price of our common stock to fluctuate, including:

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

     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 from current levels, 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 litigation is often brought against a company following a period of volatility in the market price of its securities, and we have been subject to such litigation in the past. Any such lawsuits in the future will divert management’s attention and resources from other matters, which could also adversely affect our business and the price of our stock.

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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 Microelectronics, 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.

Our certificate of incorporation and bylaws, stockholder rights plan and Delaware law contain provisions that could 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; 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 plan, which we implemented in 2002, and Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control.

Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.

     Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants, the Securities and Exchange Commission (SEC) and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, we currently are not required to record stock-based compensation charges if an employee’s stock option exercise price is equal to or exceeds the deemed fair value of our common stock at the date of grant. However, several companies have recently elected to change their accounting policies and begun to record the fair value of stock options as an expense. Although the standards have not been finalized and the timing of a final statement has not been established, FASB published in March 2004 an exposure draft that would require us to record expense for the fair value of stock options granted. Our reported earnings and/or loss would be harmed if we were required to change our current accounting policy

Changes in securities laws and regulations have increased our costs.

     The Sarbanes-Oxley Act of 2002 has required and will require changes in some of our corporate governance, public disclosure and

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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 adopted revisions to its requirements for companies, such as us, that are listed on the Nasdaq National Market. These developments have increased our legal and financial compliance costs and have made 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 June 30, 2004.

     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 first six months of fiscal 2004, 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

     The Company is a party in one consolidated lawsuit. 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

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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, Use of Proceeds and Issuer Purchases of Equity Securities

     Not Applicable.

Item 3. Defaults upon Senior Securities

     Not Applicable.

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

	(a)		The Annual Meeting of Stockholders of Transmeta was held on May 26, 2004.
	(c)		At the Annual Meeting, our stockholders elected each of the following nominees as Class I directors, each for a term of three years and until his successor has been elected and qualified or until his earlier resignation, death or removal. The vote for each director was as follows:

     Further, at the Annual Meeting, our stockholders adopted the following resolution by the vote indicated:

     To ratify the selection of Ernst & Young LLP as our independent auditors for 2004.

Item 5. Other Information

     Not Applicable.

Item 6. Exhibits and Reports on Form 8-K

     (a) Exhibits.

     The following exhibits are filed herewith:

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     * 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.

     (b) Reports on Form 8-K

     On April 15, 2004, we filed a current report on Form 8-K respecting a press release we issued announcing earnings for the quarter ended March 26, 2004. 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 the Form 8-K and irrespective of any general incorporation language in any filings.

     On May 18, 2004, we filed a current report on Form 8-K under item 5 announcing that Svend-Olav Carlsen planned to resign as the company’s chief financial officer in June 2004.

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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.

	TRANSMETA CORPORATION
	By:	/s/ JOHN O’HARA HORSLEY
		John O’Hara Horsley
		Chief Financial Officer, Vice President, General Counsel and Secretary (Principal Financial Officer and Duly Authorized Officer)

Date: August 4, 2004

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EXHIBIT INDEX

     * 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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