UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2005

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 þ No o

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

     There were 189,847,966 shares of the Company’s common stock, par value $0.00001 per share, outstanding on May 3, 2005.

TRANSMETA CORPORATION

FORM 10-Q
Quarterly Period Ended March 31, 2005

TABLE OF CONTENTS

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 financial 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 the audited consolidated financial statements and the notes thereto included in the Company’s Form 10-K for the year ended December 31, 2004. The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the operating results for the full fiscal year or any future period.

     The Company has historically reported negative cash flows from its operations. From its inception in 1995 through the first quarter of fiscal 2005, the Company incurred a cumulative loss aggregating $670.4 million, which losses have reduced stockholders’ equity to $38.5 million at March 31, 2005.

     The Company believes that its existing cash and cash equivalents and short-term investment balances and cash from operations will be sufficient to fund its operations, planned capital and research and development (R&D) expenditures for the next twelve months under the modified business model and related restructuring plan announced by the Company on March 31, 2005. The Company plans to further leverage its intellectual property rights and to increase its business focus on licensing its advanced power management and other proprietary technologies to other companies. By increasing its focus on its licensing and service business, the Company hopes to increase revenue from its licensing and service activities in 2005 and beyond. During the first quarter of 2005, the Company also took action to reduce its operating expenses by discontinuing certain of its products, increasing prices for its products, and changing its terms and conditions of sale. On March 31, 2005, the Company announced a strategic restructuring plan that included a reduction of the Company’s workforce. Although the Company believes that its restructuring plan will improve the negative gross margins and further reduce the operating expenses associated with its product business, the Company also anticipates that its modified business model will further reduce its historic business focus on product sales.

     The financial statements of the Company have been presented based on the assumption that the Company will operate as a going concern for at least the next twelve months through March 31, 2006. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result should the Company be unable to continue as a going concern.

     On February 25, 2005, the Company’s Board of Directors resolved to change the fiscal year from one ending on the last Friday in December to a fiscal year ending the last calendar day in December. This change is not deemed a change in fiscal year for purposes of reporting subject to Rule 13a-10 or 15d-10 because the Company’s fiscal year 2005 commenced with the end of its fiscal year 2004. The Company’s fiscal year 2004 ended on December 31, 2004. The first quarter of fiscal 2005 ended on March 31, 2005 and the first quarter of fiscal 2004 ended on March 26, 2004. The three-month periods ended March 31, 2005 and March 26, 2004 each consisted of 13 weeks. 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.

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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:

     The Company has excluded all outstanding stock options and warrants 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 36,846,902 and 32,912,286 shares of common stock at March 31, 2005 and 2004, 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. Revenue Recognition

     The Company recognizes revenue from products sold when persuasive evidence of an arrangement exists, the price is fixed or determinable, delivery has occurred and collectibility is reasonably assured. The Company recognizes revenue for product sales upon transfer of title. Transfer of title for the majority of the Company’s customers occurs upon shipment, as those customers have terms of FOB: shipping point. For those customers that have terms other than FOB: shipping point, transfer of title generally occurs once products have been delivered to the customer or the customer’s freight forwarder. The Company accrues for estimated sales returns, and other allowances at the time of shipment. Certain of the Company’s product sales are made to distributors under agreements allowing for price protection and/or right of return on unsold products. The Company defers recognition of revenue on these sales until the distributors sell the products. The Company may also sell certain products with “End of Life” status to its distributors under special arrangements without price protection or return privileges for which revenue is recognized upon transfer of title, typically upon shipment.

     The Company enters into license agreements, some of which may contain multiple elements, including technology license and support services, or non-standard terms and conditions. As a result, in accordance with Emerging Issues Task Force (EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, “Revenue Recognition,” significant interpretation of these agreements is sometimes required to determine the appropriate accounting, including whether deliverables specified in a multiple element arrangement should be treated as separate units of accounting for revenue recognition purposes, and if so, how the price should be allocated among the deliverable elements and when to recognize revenue for each element. The Company recognizes revenue from license agreements when earned, which generally occurs when agreed-upon deliverables are provided, or milestones are met and confirmed by licensees and relative fair values of multiple elements can be determined. Additionally, license revenues and maintenance and service revenues are recognized if collectibility is reasonably assured and if the Company is not subject to any future performance obligation. The Company recognizes revenue from maintenance agreements based on the fair value of such agreements ratably over the period in which such services are rendered. Royalty revenue is recognized upon receipt of royalty payments from customers.

     License and service revenue were $0.4 million and $0.2 million for the three months ended March 31, 2005 and March 31, 2004, respectively. License and service revenue included revenue recognized in connection with a trademark and technology licensing agreement entered during fiscal 2003, which service revenue amounted to $198,000 and $195,000 for the three months ended March 31, 2005 and March 31, 2004, respectively. The remaining license and service revenue of $250,000 for the three months ended March 31, 2005 was related to service revenue for a technology and professional services agreement entered in March 2004. Additionally, the Company received a total of $14.5 million for the three months ended March 31, 2005 for technology transfer service fees related

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to two agreements with its LongRun2 licensing partners. The Company has not recognized revenue on these amounts, which amounts are included in deferred revenue, as the Company had not completed the delivery of all the required deliverables.

4. Stock Based Compensation

     The Company has elected to use the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employee,” as permitted by Statement of Financial Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation,” subsequently amended by SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” to account for stock options issued to its employees under its stock option plans, and amortizes deferred compensation, if any, ratably over the vesting period of the options. 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.

     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:

5. 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 month periods ended March 31, 2005 and 2004, respectively, is as follows (in thousands):

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     The components of accumulated other comprehensive income/(loss), net of taxes as of March 31, 2005 and December 31, 2004, respectively, is as follows (in thousands):

6. 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 first quarter of fiscal 2005, the Company recorded a charge of approximately $0.2 million to cost of revenue related to the valuation of inventory on hand, which resulted in a reduction of the carrying value of that inventory. As a component of this charge and in computing inventory valuation adjustments as a result of lower of cost or market considerations, the Company reviews the inventory on hand and inventory on order. In estimating the net realizable value of the inventory on hand and in determining whether the inventory on hand was in excess of anticipated demand, the Company took into consideration current assumptions regarding the Company’s future plans on its products and the related potential impact on customer demand and average selling prices. Inventories written down to net realizable value at the close of a fiscal period are not marked up in subsequent periods. Of the $3.2 million and $5.4 million of net inventory on hand at March 31, 2005 and December 31, 2004, respectively, $1.1 million and $2.4 million of net inventory, respectively, were adjusted to their net realizable value. For the first quarter of fiscal 2005 and 2004, the Company recorded a benefit to gross margin from the sale of previously written down inventory of $1.2 million and $34,000, respectively. In the first quarter of fiscal 2005, the Company experienced an unexpected increase in demand for this previously written down inventory from customers who received notice of the Company’s intention to discontinue certain products and to substantially raise the ASPs on other products, which increased demand and ASPs resulted in approximately $0.6 million of the $1.2 million benefit noted above. Also included in the benefit of $1.2 million noted above was $0.6 million associated with the sale in the first quarter of fiscal 2005 of inventory that was improperly written down in the fourth quarter of fiscal 2004. The Company expects to realize additional gross margin benefit in future periods from the sale of such improperly written down inventory but does not expect such benefit to be material to any future period. Gross margin may be impacted from future sales of other previously written down inventory to the extent that the associated revenue exceeds or fails to achieve the currently adjusted value of that inventory.

7. Deferred Revenue

     The Company received a total of $14.5 million for the three months ended March 31, 2005 for technology transfer service fees related two agreements with its LongRun2 licensing partners. The Company has not recognized revenue on these amounts, as the Company had not completed the delivery of all the required deliverables.

8. Restructuring Charges

     In the first quarter of fiscal 2005, Transmeta recorded a $1.3 million restructuring charge as a result of the Company’s strategic restructuring plan to focus its ongoing efforts on licensing its advanced technologies and intellectual property, engaging in synergistic engineering services opportunities and continuing its product business on a modified basis. The restructuring charge recorded in connection with this March 2005 restructuring consisted primarily of workforce reduction costs for termination benefits. The Company expects to pay this charge in the second quarter of fiscal 2005 for the approximately 51 employees that were terminated on March 31, 2005. Additionally, the Company anticipates recording a workforce reduction charge of between $0.4 million and $0.6 million in future periods, primarily for severance and fringe benefits related to the 14 employees that are on transition. The Company will accrue for these charges as the related liabilities are incurred. Of this amount, the Company expects to pay between $0.3 million and $0.5 million during the second quarter of fiscal 2005 and $0.1 million in the third quarter of fiscal 2005 as the employees terminate during these periods.

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

     During the fourth quarter of fiscal 2003, the Company reassessed the adequacy of the remaining accrual and adjusted the accrued restructuring costs as a result of an update in certain underlying assumptions.

     During the third quarter of fiscal 2004, the Company reassessed the adequacy of the remaining accrual and adjusted the accrued restructuring costs as a result of an update in certain underlying assumptions. In view of current market conditions, the Company has no assumptions of subleasing previously vacated space that remains unused as of September 30, 2004. As a result of this update in assumptions, the Company adjusted the accrued restructuring costs and recorded a charge of $0.9 million in restructuring charges.

     Accrued restructuring charges consist of the following at March 31, 2005 (in thousands):

9. Related Party Transaction

     Transmeta entered into a trademark and technology licensing agreement during fiscal 2003 with Chinese 2 Linux (Holdings) Limited, whereby the Company became a 16.6% beneficial owner of Chinese 2 Linux (Holdings) Limited. In relation to this agreement, the Company recognized license revenue of $198,000 and $195,000 for the three months ended March 31, 2005 and March 31, 2004, respectively.

10. Geographic and Customer Concentration Information

     The following table presents our sales to customers, each of which is located in Asia, that accounted for more than 10% of total revenue for the three months ended March 31, 2005 and 2004:

     The following table presents balances from our customers that accounted for more than 10% of our accounts receivable balance at March 31, 2005 and December 31, 2004:

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11. Recent Accounting Pronouncements

     In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 123(R), “Share-Based Payment.” SFAS 123(R); requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25 and allowed under the original provisions of SFAS 123. SFAS 123(R) requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. In April 2005, the SEC announced the adoption of a new rule which amends the effective date for SFAS 123(R). The requirements of SFAS 123(R) are effective for annual fiscal periods beginning after June 15, 2005. SFAS 123(R) allows for either prospective recognition of compensation expense or retrospective recognition, which may be back to the original issuance of SFAS 123 or only to interim periods in the year of adoption. The Company is currently evaluating the impact of the adoption of SFAS 123(R).

12. 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. Our insurance carriers are part of the proposed settlement, and 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.

13. Subsequent Events

     On May 12, 2005, Transmeta Corporation, a Delaware corporation, and Microsoft Corporation, a Washington corporation, entered into a series of related definitive development services agreements (collectively, the “Microsoft Agreement”). Under the Microsoft Agreement, Transmeta will provide development services to Microsoft relating to a proprietary Microsoft project.

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

Caution Regarding Forward-Looking Statements

     The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the related notes contained in this report and with the information included in our Annual Report on Form 10-K for the year ended December 31, 2004 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

     From Transmeta’s inception in 1995 through our fiscal year ended December 31, 2004, our business model was focused primarily on designing, developing and selling highly efficient x86-compatible software-based microprocessors. Since introducing our first family of microprocessor products in January 2000, we have derived the majority of our revenue from selling our microprocessor products. Although we believe that our products deliver a compelling balance of low power consumption, high performance, low cost and small size, we have had negative cash flows and had incurred a cumulative loss aggregating $649.4 million as of December 31, 2004. Accordingly, we have diversified our business model to establish a revenue stream based upon the licensing of certain of our intellectual property and advanced computing and semiconductor technologies developed in the course of Transmeta’s research and development programs. Since March 2004, we have entered into and announced agreements granting licenses to NEC Electronics, Fujitsu Limited and Sony Corporation to use Transmeta’s proprietary LongRun2 technologies for power management and transistor leakage control. Those licensing agreements include deliverable-based technology transfer fees, maintenance and service fees, and subsequent royalties on products incorporating the licensed technologies.

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     In January 2005, we announced that we were critically evaluating the economics of our microprocessor product business; that we intended to modify our business model during the first quarter of 2005 to increase our efforts to license our intellectual property and advanced technologies; and that we would announce a modified business model and related restructuring plan on or about March 31, 2005. During the first quarter of 2005, we began modifying our business model to further leverage our intellectual property rights and to increase our business focus on licensing our advanced power management and other proprietary technologies to other companies. By increasing our focus on our licensing and service business, we expect to increase revenue from our licensing and service activities in 2005 and beyond. During the first quarter of 2005, we also took action to reduce our operating expenses by discontinuing certain of our products, increasing prices for our products, and changing our terms and conditions of sale. On March 31, 2005, we announced a strategic restructuring plan that included a reduction of our workforce. Although we anticipate that our restructuring plan will improve the negative gross margins and further reduce our operating expenses associated with our product business, we also anticipate that our modified business model will further reduce our historic business focus on product sales.

     Our restructuring plan included a reorganization of our management team and some changes in our executive officers. Arthur L. Swift, formerly our Senior Vice President of Marketing, was promoted and appointed as President and Chief Executive Officer of the Company on March 31, 2005. Matthew R. Perry, our President and Chief Executive Officer since April 2002, and Fred Brown, our Senior Vice President of Worldwide Sales since October 2001, both left the Company on March 31, 2005.

     In addition, as part of our modified business model, we have continued our efforts to develop strategic alliances with other companies that could enable us to leverage our microprocessor design and development capabilities in order to raise operating capital and to improve or enhance our business in other ways. For example, on March 31, 2005, we entered into a design services agreement with Sony Computer Entertainment Inc. and Sony Corporation (collectively, the “Sony Group”). Under that agreement, which has a term of two years unless terminated earlier, Transmeta will provide the design and engineering services of more than one hundred Transmeta engineers to work on advanced projects for Sony Group. We believe that our March 2005 agreement with Sony Group will make a positive contribution to our operations, consistent with our modified business model, beginning in the second quarter of 2005. We are currently engaged in discussions with other companies regarding potential strategic alliance and engineering services agreements that would enable us to leverage our microprocessor design and development capabilities in order to raise operating capital and to improve or enhance our business in other ways.

     Our total revenue for the first three months in fiscal 2005 was $6.9 million, compared to $5.2 million in the corresponding period last year. Our total revenue increased primarily due to an increase in units shipped for our Efficeon products and an increase in customer demand for the products for which we had issued end-of-life notices. As a percent of product revenue, our product gross margin was 25.8% for the first three months in fiscal 2005, compared to negative 7.3% for the corresponding period last year. The increase in our gross margin was primarily attributed to the positive gross margin from sales of inventory that had been written down in prior periods in anticipation of reduced customer demand for certain products. In addition and to a lesser extent, lower manufacturing costs due to reduced average unit cost to manufacture our products contributed to the increase in gross margin in the first quarter of fiscal 2005. To a lesser extent, the higher ASPs associated with the sales of our Efficeon products also contributed to our increased product gross margins.

     We have historically reported negative cash flows from operations because the gross profit, if any, generated from our product and licensing revenues has not been sufficient to cover our operational cash requirements. Our total operating expenses were $23.2 million for the first three months in fiscal 2005, compared to $23.2 million for the corresponding period last year. Our net loss was $21.1 million for the first three months in fiscal 2005, compared to $23.4 million for the corresponding period last year. Historically we have incurred significant losses, and as of March 31, 2005, we had an accumulated deficit of $670.4 million. We expect to improve our results of operations by increasing our focus on our licensing and service business and to improve the gross margins associated with the sales of our 90 nanometer Efficeon microprocessors with an increase in product prices and favorable changes to our terms and conditions of sale. We expect to reduce our overall operating expenses in 2005 based on our modified business model.

     We believe that our existing cash and cash equivalents and short-term investment balances and cash from operations will be sufficient to fund our operations, planned capital and R&D expenditures for the next twelve months on the modified business model and related restructuring plan that we announced on March 31, 2005.

     On February 25, 2005, the Company’s Board of Directors resolved to change the fiscal year from one ending on the last Friday in December to a fiscal year ending the last calendar day in December. This change is not deemed a change in fiscal year for purposes of reporting subject to Rule 13a-10 or 15d-10 because the Company’s fiscal year 2005 commenced with the end of its fiscal year 2004. The Company’s fiscal year 2004 ended on December 31, 2004. The first quarter of fiscal 2005 ended on March 31, 2005 and the first quarter of fiscal 2004 ended on March 26, 2004.

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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.

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, 2004 filed with the SEC on March 29, 2005. There have been no changes in any of our critical accounting policies since December 31, 2004.

Results of Operations

Total Revenue

     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 notebook computers, ultra-personal computers, or UPCs, tablet PCs, thin clients, blade servers and embedded computers. Total revenue, which includes product and license and service revenue, for each computing market, is presented as a percentage of total revenue in the following table:

     With the introduction of our TM8000 Efficeon products for the embedded and server computing market segment, we saw an increase in revenue for this market segment. Although our products continue to be used in the thin client desktops and notebook computers, our revenue from these market segments, as a percentage of total product revenue, decreased for the three months ended March 31, 2005 compared to the corresponding period last year. Tablet PCs revenues declined as a result of a product line transition within a major customer account. UPCs revenue reflects the launch of that platform in late 2004.

     We have derived the majority of our revenue from a limited number of customers. Additionally, we derive a significant portion of our revenue from customers located in Asia, which subjects us to economic cycles in that region, as well as the geographic areas in which they sell their products containing our microprocessors. The following table presents our sales to customers, each of which is located in Asia, that accounted for more than 10% of total revenue for the three months ended March 31, 2005 and 2004:

     The following table presents balances from our customers that accounted for more than 10% of our accounts receivable balance at March 31, 2005 and December 31, 2004:

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     Total revenue for the comparative periods is summarized in the following table:

     Total revenue was $6.9 million for the three months ended March 31, 2005, compared to $5.2 million for the corresponding period last year, representing an increase of $1.7 million, or 32.7%.

     Product revenue increased $1.4 million, from $5.0 million for the three months ended March 31, 2004 to $6.4 million for the three months ended March 31, 2005. The increase was due to increased revenue from our Efficeon products, which had their first full year of sales in fiscal 2004. Revenue from Efficeon represented 29% of total revenue for the three months ended March 31, 2005, compared to 17% of total revenue for the corresponding period in the prior year. Additionally, we saw an increase in units shipped for our Crusoe product line, as a result of an increase in customer demand for Crusoe products for which we had issued end-of-life notices.

     License and service revenue included revenue recognized in connection with a trademark and technology licensing agreement entered during fiscal 2003, which service revenue amounted to $198,000 and $195,000 for the three months ended March 31, 2005 and March 31, 2004, respectively. The remaining license and service revenue of $250,000 for the three months ended March 31, 2005 was related to service revenue for a technology and professional services agreement entered in March 2004.

     In addition, we received a total of $14.5 million during the three months ended March 31, 2005 for technology transfer fees and maintenance service fees related to two agreements with two licensees of our proprietary LongRun2 advanced power management and transistor leakage control technologies. We have not recognized revenue on these amounts, which are instead included in deferred revenue, because we had not completed the delivery of all the required deliverables.

Product Gross Margin

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

     Product gross margin was 25.8% for the three months ended March 31, 2005, compared to negative 7.3% for the corresponding period last year. As a percent of product revenue, our product costs decreased 12.5 percentage points, to 85.8% for the three months

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ended March 31, 2005, from 98.3% for the corresponding period last year. Gross margin was adversely affected during both periods by unabsorbed overhead costs as our production-related infrastructure exceeded our needs. For the three months ended March 31, 2005, these unabsorbed costs were $0.3 million, or 4.4% of product revenue, compared to $0.5 million, or 9.7% of product revenue, for the same period in the prior year. The decrease in our product costs was primarily the result of lower manufacturing costs associated with the Efficeon TM8000 processors, which had higher costs in the first quarter of fiscal 2004 when the product was new to the market. Additionally, the activities from which manufacturing costs are allocated to overhead has decreased from the comparable period in the prior year.

     For the three months ended March 31, 2005, we recorded inventory-related charges of $0.2 million consisting of charges related to excess quantities and net realizable value of inventory on hand. These charges primarily related to our Crusoe and 130 nanometer Efficeon processors.

     Of the $3.2 million and $5.4 million net inventory on hand at March 31, 2005 and December 31, 2004, respectively, $1.1 million and $2.4 million of net inventory, respectively, were adjusted to their net realizable value, which was lower than cost. Inventories written down to net realizable value at the close of a fiscal period are not marked up in subsequent periods. The benefit to gross margin from the sale of previously written down inventory was $1.2 million and $34,000 for the three months ended March 31, 2005 and 2004, respectively. The write down of inventory in prior periods was based on historical sales trends which suggested that the carrying value of the related inventory exceeded its anticipated realizable value. However, in the first quarter of fiscal 2005, we experienced an unexpected increase in demand for this previously written down inventory from customers who received notice of our intention to discontinue certain products and to substantially raise the ASPs on other products, which increased demand and ASPs resulted in approximately $0.6 million of the $1.2 million benefit noted above.

     Also included in the benefit of $1.2 million discussed above was $0.6 million associated with the sale in the first quarter of fiscal 2005 of inventory that was improperly written down in the fourth quarter of fiscal 2004. We expect to realize additional gross margin benefit in future periods from the sale of such inventory, but we do not expect such benefit to be material to any future period.

     In addition, future gross margin benefit is expected to be realized as a result of sales order activity and pricing levels higher than those previously anticipated at the time the related inventory was written down.

Research and Development

     Research and development (R&D) expenses were $12.2 million for the three months ended March 31, 2005, compared to $12.7 million for the corresponding period in the prior year, representing an increase of $0.5 million, or 3.9%. The decrease in R&D expenses was due to decreased non-recurring engineering charges of $1.7 million and depreciation and software maintenance expenses of $1.0 million, partially offset by increased compensation-related expenses of $2.1 million. The decrease in non-recurring engineering charges was primarily due to our decision to modify our product business by providing customers with our Crusoe and 130nm Efficeon processors on an end-of-life basis only, and by continuing to manufacture select models of our 90nm Efficeon processor for critical customers under modified terms and conditions. The decrease in depreciation expenses was primarily due to certain property and equipment being written off when we performed an impairment assessment of long-lived assets during the fourth quarter of fiscal 2004. The increase in compensation-related expenses was primarily the result of a program that we had put in place to retain employees until we had announced our strategic restructuring plan on March 31, 2005. We anticipate that our research and development spending in future periods will be invested to further develop our advanced power management and other computing technologies.

Selling, General and Administrative

     Selling, general and administrative (SG&A) expenses were $8.0 million for the three months ended March 31, 2005, compared to $6.7 million for the corresponding periods last year, representing an increase of $1.3 million, or 19.4%. The increase in SG&A expenses was due to increases in consultant and accounting expenses of $1.4 million and compensation-related expenses of $0.8 million, partially offset by decreases in advertising expenses of $0.3 million and travel and tradeshow expense of $0.2 million. The increased consultant and accounting expenses were primarily due to costs incurred in relation to efforts to comply with Section 404 “Management’s Internal Controls and Procedures for Financial Reporting” of the Sarbanes-Oxley Act of 2002 as well as increased costs for financial advisory services. The increase in compensation-related expenses was primarily the result of a program that we had put in place to retain employees until we had announced our strategic restructuring plan on March 31, 2005. Advertising and travel and tradeshow expenses had decreased primarily due to decreased activities to promote awareness of our product line of business in connection with our decision to focus our ongoing efforts on licensing advanced technologies and intellectual property, engaging in synergistic engineering services opportunities and continuing our product business on a modified basis.

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Restructuring Charges

     In the three month period ended March 31, 2005, we recorded restructuring charges of $1.3 million, primarily comprised of severance and termination charges related to the reduction in workforce in connection with our strategic restructuring plan. We expect to pay this charge in the second quarter of fiscal 2005 for the approximately 51 employees that were terminated on March 31, 2005. Additionally, we anticipate recording a workforce reduction charge of between $0.4 million and $0.6 million in future periods, primarily for severance and fringe benefits related to the 14 employees that are on transition. Of this amount, we expect to pay between $0.3 million and $0.5 million during the second quarter of fiscal 2005 and $0.1 million in the third quarter of fiscal 2005.

Amortization of Deferred Charges, Patents and Patent Rights

     Amortization of deferred charges, patents and patent rights were $1.7 million for the three months ended March 31, 2005, compared to $2.4 million for the corresponding period last year. Amortization charges relate to various patents and patent rights acquired from Seiko Epson and others during fiscal 2001. Also included in the amortization charges are accretion expenses associated with the liability recorded from the acquisition of these patents and patent rights. The decreases can be attributed to a decrease in accretion expenses, as the liabilities associated with the patents and patent rights have been either paid in full or accreted to its future value as of December 31, 2004.

Stock Compensation

     Stock compensation was a credit of $34,000 for the three months ended March 31, 2005 compared to a charge of $1.4 million for the same period last year.

     As we had completed the amortization of deferred stock compensation during the fourth quarter of fiscal 2004, no additional amortization expenses were recorded for the three months ended March 31, 2005. Net amortization of deferred stock compensation for the three months ended March 31, 2004 was $0.2 million.

     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 three months ended March 31, 2005 was a credit of $34,000, primarily as a result of the lower market value of our common stock at March 31, 2005 compared to December 31, 2004, the previously valued date. This compares to a charge of $1.1 million in variable stock compensation for the same period last year, which was comprised of $0.5 million in expenses related to adjustments made for certain notes receivable from stockholders that had been fully paid and $0.6 million in expenses related to the higher market price of our common stock at the time of repayment of notes from stockholders compared to fiscal year end 2003.

Interest Income and Other, Net and Interest Expense

     Interest income and other, net was $0.2 million for the three months ended March 31, 2005, compared to $0.2 million for the corresponding period last year. Interest expense was $0.1 million for the three months ended March 31, 2005, compared to $15,000 for the corresponding period last year. The increase in interest expense was primarily the result of interest expense related to the $5.0 million in long-term payables for a technology license agreement.

Liquidity and Capital Resources

     We have historically reported negative cash flows from our operations because the gross profit, if any, generated from our product revenues and our license and service revenues has not been sufficient to cover our operating cash requirements. From our inception in 1995 through the first quarter of fiscal year 2005, we incurred a cumulative loss aggregating $670.4 million, which included net losses of $21.1 million in the first quarter of fiscal 2005, $106.8 million in fiscal 2004, $87.6 million in fiscal 2003 and $110.0 million in fiscal 2002, which losses have reduced stockholders’ equity to $38.5 million at March 31, 2005.

     As of March 31, 2005 we had $42.0 million in cash, cash equivalents and short-term investments compared to $53.7 million at December 31, 2004.

     We believe that our existing cash and cash equivalents and short-term investment balances and cash from operations will be sufficient to fund our operations, planned capital and R&D expenditures for the next twelve months under the modified business model and related restructuring plan that we announced on March 31, 2005. During the first quarter of 2005, we began modifying our business model to further leverage our intellectual property rights and to increase our business focus on licensing our advanced power

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management and other proprietary technologies to other companies. By increasing our focus on our licensing and service business, we expect to increase revenue from our licensing and service activities in 2005 and beyond. During the first quarter of 2005, we also took action to reduce our operating expenses by discontinuing certain of our products, increasing prices for our products, and changing our terms and conditions of sale. On March 31, 2005, we announced a strategic restructuring plan that included a reduction of our workforce. Although we anticipate that our restructuring plan will improve the negative gross margins and further reduce our operating expenses associated with our product business, we also anticipate that our modified business model will further reduce our historic business focus on product sales.

     In addition, as part of our modified business model, we have continued our efforts to develop strategic alliances with other companies that could enable us to leverage our microprocessor design and development capabilities in order to raise operating capital and to improve or enhance our business in other ways. For example, on March 31, 2005, we entered into and announced a design services agreement with Sony Computer Entertainment Inc. and Sony Corporation (collectively, the “Sony Group”). Under that agreement, which has a term of two years unless terminated earlier, Transmeta will provide the design and engineering services of more than one hundred Transmeta engineers to work on advanced projects for Sony Group. We believe that our March 2005 agreement with Sony Group will make a positive contribution to our operations, consistent with our modified business model, beginning in the second quarter of 2005. We are currently engaged in discussions with other companies regarding potential strategic alliance and engineering services agreements that would enable us to leverage our microprocessor design and development capabilities in order to raise operating capital and to improve or enhance our business in other ways. Although it is possible that we might raise additional operating capital or create new prospects by means of one or more strategic alliances with other companies, we have no assurance that we will achieve any such strategic alliance or that any such strategic alliance, if achieved, will prove favorable for us or our business.

     The accompanying financial statements have been prepared assuming that we will continue as a going concern under our modified business model, and we believe that, despite the many risks and contingencies relating to our modified business model and related restructuring plan, our recent changes to our business model and our implementation of that restructuring plan have eliminated any substantial doubt about our ability to continue as a going concern until at least March 31, 2006.

     To date, we have financed our operational expenses and working capital requirements primarily with funds that we raised from the sale of our common stock. Although it is possible that we might raise additional capital by means of one or more strategic alliances, or through public or private equity or debt financing, we have no assurance that any additional funds will be available on terms favorable to us or at all.

     The following comparison table summarizes our usage of cash and cash equivalents for the three months ended March 31, 2005 and the three months ended March 31, 2004:

     Net cash used in operating activities was $13.3 million for the three months ended March 31, 2005, compared to $20.2 million for the corresponding period in fiscal 2004. Net cash used during the first three months of fiscal 2005 was primarily the result of a net loss of $21.1 million and an increase in accounts receivable of $2.3 million. The net loss and changes in operating assets and liabilities were partially offset by an increase in accounts payable and other accrued liabilities of $4.7 million, a decrease in inventory of $2.2 million, non-cash charges related to amortization of patents and patent rights of $1.7 million and non-cash restructuring charges of $1.3 million. The increase in the accounts receivable balance was primarily attributed to increased product sales for the three months ended March 31, 2005 compared to the corresponding period last year. The increase in accounts payable and other accrued liabilities was primarily attributed to increased deferred revenue from licensees of our proprietary LongRun2 technologies for power management and transistor leakage control, offset by decreases in accounts payable and accrued inventory-related charges.

     Net cash provided by investing activities was $8.5 million for the three months ended March 31, 2005, compared to net cash used in investing activities of $22.6 million for the corresponding period in fiscal 2004. This change was primarily due to $8.6 million in net proceeds from the maturity of available-for-sale investments for the first three months of fiscal 2005, compared to $21.9 million in net purchases of available-for-sale investments for the same period last year.

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     Net cash provided by financing activities was $1.8 million for the three months ended March 31, 2005, compared to $13.2 million for the corresponding period in fiscal 2004. For the three months ended March 31, 2005, we received $1.8 million in net proceeds from sales of common stock under our employee stock purchase and stock options plans, compared to $2.3 million for the same period last year. Additionally, we received $10.2 million in 2004 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.

     At March 31, 2005, we had $14.3 million in cash and cash equivalents and $27.7 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 March 31, 2005, we had the following contractual obligations:

Recent Accounting Pronouncements

     In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 123(R), “Share-Based Payment.” SFAS 123(R) requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25, and allowed under the original provisions of SFAS 123. SFAS 123(R) requires the use of an option pricing model for estimating fair value, which is amortized to expense over the service periods. In April 2005, the SEC announced the adoption of a new rule which amends the effective date for SFAS 123(R). The requirements of SFAS 123(R) are effective for annual fiscal periods beginning after June 15, 2005. SFAS 123(R) allows for either prospective recognition of compensation expense or retrospective recognition, which may be back to the original issuance of SFAS 123 or only to interim periods in the year of adoption. We are currently evaluating the impact of the adoption of SFAS 123(R).

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 Quarterly Report on Form 10-Q. If any of the following risks actually occurs, our business, financial condition and results of operations would suffer. In this case, the trading price of our common stock could decline and investors might lose all or part of their investment in our common stock.

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We have a history of losses, expect to incur further significant losses and must develop and successfully execute on a modified business model and restructuring plan if we are to sustain our operations.

     We have historically reported negative cash flows from operations because the gross profit, if any, generated from our product revenue and our licensing and service revenue has not been sufficient to cover our operating cash requirements. Since our inception, we have incurred a cumulative loss aggregating $670.4 million, which includes net losses of $21.1 million during the first three months of fiscal 2005, $106.8 million in fiscal 2004, $87.6 million in fiscal 2003 and $110.0 million in fiscal 2002, which losses have reduced stockholders’ equity to $38.5 million at March 31, 2005.

     At the end of 2004, we determined that our existing cash and cash equivalents and short-term investment balances and cash from operations would not be sufficient to fund our operations, planned capital and R&D expenditures for the next twelve months under the business model that we pursued during and through the end of 2004, which business model was primarily focused on designing, developing and selling software-based x86-compatible microprocessor products. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” Accordingly, we undertook a critical evaluation of our customers’ requirements for our products and of the economics and competitive conditions in the market for x86-compatible microprocessors, and we announced a modified business model and a related restructuring plan based in part on that evaluation in March 2005. We must execute successfully on our modified business model and related restructuring plan in order to continue to operate for a period that extends at least through March 31, 2006.

We might fail to execute our restructuring plan or to operate successfully under our modified business model.

     In March 2005, we announced a modified business model and related restructuring plan. As part of this modified business model, we have decided to focus our ongoing efforts on licensing our advanced technologies and intellectual property, engaging in synergistic engineering services opportunities and continuing our product business on a modified basis to focus on those customer opportunities and product models that are economically advantageous for the company. The modification of our business model entails significant risks and costs, and we might not succeed in operating within this model or under our restructuring plan for many reasons. These reasons include the risks that we might not be able to develop viable products or technologies, achieve market acceptance for our products or technologies, earn adequate revenues from the sale of our products or from our licensing and services business, or achieve profitability. Employee concern about changes in our business model or the effect of such changes on their workloads or continued employment might cause our employees to seek or accept other employment, depriving us of the human and intellectual capital that we need in order to succeed. Because we necessarily lack historical operating and financial results for our modified business model, it will be difficult for us, as well as for investors, to predict or evaluate our business prospects and performance. Our business prospects would need to be considered in light of the uncertainties and difficulties frequently encountered by companies undergoing a business transition or in the early stages of development. The modification of our business model might also create uncertainties and cause our stock price to fall and impair our ability to raise additional capital.

Our restructuring plan and related reductions in our workforce may adversely affect the morale and performance of our personnel, the rate of attrition among our personnel, our ability to hire new personnel and our ability to conduct our business operations.

     As part of our effort to reduce operating expenses under our modified business model, we announced a financial restructuring and related reduction in our workforce on March 31, 2005. Our restructuring plan includes the termination of employment of some of our employees and contractors, and included a reorganization of our management team and some changes in our executive officers. Our restructuring plan and related workforce reduction will cause us to incur substantial costs related to severance and other employee-related costs. Our workforce reduction may also subject us to litigation risks and expenses. In addition, our restructuring plan may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce. As a result of these reductions, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities. In addition, some of the employees who were terminated had specific and valuable knowledge or expertise, the loss of which may adversely affect our operations. Further, the reduction in force may reduce employee morale and may create concern among existing employees about job security, which may lead to increased attrition or turnover. As a result of these factors, our remaining personnel may decide to seek other employment, including opportunities with more established companies or with smaller, private companies, and we may have difficulty attracting new personnel that we might wish to hire in the future.

We might not be able to execute on our modified business model and restructuring plan if we lose key management or technical personnel, on whose knowledge, leadership and technical expertise we rely.

     Our success under our modified business model and restructuring plan will depend 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 lines of business. We have recently lost some of our executive management. For instance, Matthew R. Perry, our President and Chief

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Executive Officer since April 2002, and Fred Brown, our Senior Vice President of Worldwide Sales since October 2001, both left the Company in March 2005, and Ray Holzworth, our Vice President of Operations since August 2002, left the Company in February 2005. Others have joined us in key management roles only recently. In March 2005, Arthur L. Swift, formerly our Senior Vice President of Marketing, became our President and Chief Executive Officer, and in September 2004, Mark R. Kent joined us as our Chief Financial Officer. 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 modified business model or restructuring 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 may not be able to raise any more financing, or financing may only be available on terms unfavorable to us or our stockholders.

     Although we believe that our existing cash and cash equivalents and short-term investment balances and cash from operations will be sufficient to fund our operations, planned capital and R&D expenditures for the next twelve months under our modified business model and related restructuring plan, it is possible that we may need to raise significant additional funds through public or private equity or debt financing in order to continue operations under our modified business model. Further, as we continue to develop new technologies or to enhance our products or service competencies in accordance with our modified business model, we might require more cash to fund our operations. 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. 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. For example, in order to raise equity financing, we may decide to sell our stock at a discount to our then current trading price, which may have an adverse effect on our future trading price. Additional financing might not be available on terms favorable to us, or at all. If we are unable to raise additional funds or to sustain our operations on a modified business model in the future, then substantial doubt may develop as to our ability to continue to operate our business as a going concern, with substantial adverse effects on the value of our common stock and our ability to raise additional capital. This uncertainty may also create concerns among our current and future customers, vendors and licensees as to whether we will be able to fulfill our obligations or, in the case of customers, fulfill their future product or service needs. As a result, our current and prospective customers, licensees and strategic partners might decide not to do business with us, or only do so on less favorable terms and conditions. Employee concern about the future of the business and their continued prospects for employment may cause employees to seek employment elsewhere, depriving us of the human and intellectual capital we need to be successful.

We may fail to meet the continued listing requirements of the Nasdaq Stock Market, which may cause our stock to be delisted and result in reduced liquidity of our stock, reduce the trading price of our stock, and impair our ability to raise financing.

     We have recently received notices of potential delisting of our stock from the Nasdaq National Market based on our failure to satisfy certain continued listing requirements of the Nasdaq National Market, and we may be unable to satisfy those requirements in the future. To maintain our listing on the Nasdaq National Market, we are required, among other things, both to make timely regular filings of periodic reports with the SEC and to maintain a minimum bid price per share of at least $1.00. On May 18, 2005, we received notice from the Nasdaq Listing Qualifications staff indicating that because the Nasdaq Stock Market had not as of that date received this report on Form 10-Q for the period ended March 31, 2005, our securities are subject to potential delisting from the Nasdaq Stock Market and, as a result of our filing delinquency, a fifth character, “E,” was appended to our trading symbol, changing it from TMTA to TMTAE. On May 19, 2005, we received notice from the Nasdaq National Market that the daily minimum bid price of our common stock had fallen, and remained below, $1.00 for 30 consecutive business days. As a result, we were as of that date out of compliance with the $1.00 minimum bid price for continued inclusion of our common stock in the Nasdaq National Market and have, under Nasdaq rules, until November 15, 2005 to achieve compliance with the minimum bid price rule. We might not be able to regain compliance with that rule. If we are unable to regain compliance, our common stock may be delisted from the Nasdaq National Market. Delisting from the Nasdaq National Market would adversely affect the trading price and limit the liquidity of our common stock and therefore cause the value of an investment in our company to substantially decrease. If our common stock were to be delisted, holders of our common stock would be less able to purchase or sell shares as quickly and as inexpensively as they have done historically. For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our common stock. The loss or discontinuation of our Nasdaq National Market listing may result in a decrease in the trading price of our common stock due to a decrease in liquidity, reduced analyst coverage and less interest by institutions and individuals in investing in our common stock.

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If we fail to constitute an independent Board of Directors by the time of our next annual stockholders meeting, our common stock could be delisted, which would reduce the liquidity of our stock and would likely result in a further decrease in the trading price of our stock.

     In order to maintain our Nasdaq continued listing requirements, we also must satisfy the specific requirement that a majority of the members of our Board of Directors are independent, within the meaning of Nasdaq rules, by the time of our next annual meeting of stockholders. We expect that our meeting of stockholders for 2005 will be held in May or June 2005. Our Board of Directors, as currently constituted, would not satisfy this requirement, and we must adjust the membership of our Board of Directors in order to achieve that requirement by the time of our annual meeting of stockholders. If we are unable to meet the Board independence requirement for any reason, our common stock may be delisted. If our common stock were to be delisted, holders of our common stock would be less able to purchase or sell shares as quickly and as inexpensively as they have done historically. For instance, failure to obtain listing on another market or exchange may make it more difficult for traders to sell our securities. Broker-dealers may be less willing or able to sell or make a market in our common stock. Not maintaining a listing on a major stock market may result in a decrease in the trading price of our common stock due to a decrease in liquidity, reduced analyst coverage and less interest by institutions and individuals in investing in our common stock.

Our product revenue and our product business may be negatively impacted by modifications to our business model that we have recently implemented or are contemplating.

     During the first quarter of 2005, as part of our transition to a modified business model, we began taking action to reduce our operating expenses by discontinuing certain of our products, increasing prices for our products, and changing our terms and conditions of sale, which actions we anticipate will improve the negative gross margins historically associated with our product business. Accordingly, we have advised our customers that we plan to discontinue production of our Crusoe products during 2005. We have provided our Crusoe customers an End-of-Life notice and we will continue to work closely with our customers during this transition period. Based upon our review of critical customer needs, we have also decided to narrow our Efficeon product line and announced to our customers that certain versions of the Efficeon products will be discontinued. Our modified business model will further reduce our historic business focus on product sales, and we will further reduce operating expenses associated with our product business as part of our restructuring plan, including the reduction of our workforce. The actions that we have taken or contemplate taking likely will result in lost sales as target customers design a competitor’s microprocessor into their product, to replace our own microprocessors. We expect to continue evaluating the business of designing, developing and selling our Efficeon processors, and we may decide to discontinue some or all of our remaining Efficeon products in 2005 as we refine our modified business model.

The success of our licensing and service business depends on maintaining and increasing our LongRun2 licensing revenue.

     Our licensing and service revenue was $0.4 million during the first three months of 2005, $10.7 million in fiscal year 2004 and $1.1 million in fiscal year 2003. In 2005, our licensing and service revenue will depend upon revenue that we receive from existing licensing agreements and our entering into new licensing agreements. Our ability to enter into new LongRun2 licensing agreements depends in part upon the adoption of our LongRun2 technology by our licensees and potential licensees and the success of the products incorporating our technology sold by licensees. While we anticipate that we will continue our efforts 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 have limited visibility regarding when and to what extent our licensees will use our LongRun2 or other licensed technologies.

     We have not yet earned or received any royalties under any of our LongRun2 licensees. Our receipt of royalties from our LongRun2 licenses depends on our licensees incorporating our technology into their manufacturing and products, their bringing their products to market, and the success of their products. Our licensees are not contractually obligated to manufacture, distribute or sell products using our licensed technologies. Thus, our entry into and our full performance of our obligations under our LongRun2 licensing agreements do not necessarily assure us of any future royalty revenue. Any royalties that we are eligible to receive are based upon our licensees’ use of our licensed technologies and, as a result, we do not have direct access to information that would enable us to forecast the timing and amount of any future royalties. Factors that negatively affect our licensees and their customers could adversely affect our future royalties. The success of our licensees is subject to a number of factors, including:

	•	the competition these companies face and the market acceptance of their products;
	•	the pricing policies of our licensees for their products incorporating our technology and whether those products are competitively priced;
	•	the engineering, marketing and management capabilities of these companies and technical challenges unrelated to our technology that they face in developing their products; and
	•	the financial and other resources of our licensees.

Because we do not control the business practices of our licensees and their customers, we have little influence on the degree to which our licensees promote our technology.

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Our licensing and services revenue cycle is long and unpredictable, which makes it difficult to predict future revenues, which may cause us to miss analysts’ estimates and may result in unexpected changes in our stock price.

     It is difficult to predict accurately our future revenues from either the granting of new licenses or the generation of royalties by our licensees under our existing licenses. In addition, engineering services are dependent upon the varying level of assistance desired by licensees and, therefore, revenue from these services is also difficult to predict. There can be no assurance that we can accurately estimate the amount of resources required to complete projects, or that we will have, or be able to expend, sufficient resources required to complete a project. Furthermore, there can be no assurance that the development schedules of our licensees will not be changed or delayed. Our licensees are not obligated to continue using our licensed technology or to use future generations of our technologies in future manufacturing processes, and therefore our past contract revenue may not be indicative of the amount of such revenue in any future period. All of these factors make it difficult to predict future licensing and service revenue, which may result in us missing analysts’ estimates and may cause unexpected changes in our stock price.

We could encounter a variety of technical and manufacturing problems that could delay or prevent us from satisfying customer demand for Efficeon TM8000 series microprocessors manufactured using a 90 nanometer process.

     We are using Fujitsu Limited to manufacture our 90 nanometer Efficeon TM8000 series microprocessors. Manufacturing on an advanced 90 nanometer CMOS process involves a variety of technical and manufacturing challenges. Fujitsu Limited has limited experience with the 90 nanometer CMOS process and, although we have achieved production of our Efficeon TM8800 product on the Fujitsu Limited 90 nanometer CMOS process, we cannot be sure that Fujitsu Limited’s 90 nanometer foundry will achieve production shipments on our planned schedule or that other manufacturing challenges might later arise. For example, during 2001 and again in 2004, 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 series microprocessors using the 90 nanometer process that are more significant or take longer to resolve than we anticipate, our ability to fulfill our customer demand would suffer and we could incur significant expenses.

Our restructuring plan will very likely reduce our resources and ability to pursue opportunities and support customers in emerging markets for our microprocessor products.

     The modification of our business model will further reduce our historical business focus on product sales, and we will further reduce operating expenses associated with our product business as part of our restructuring plan, including the reduction of our workforce. Our restructuring plan will likely substantially limit our resources and ability to pursue opportunities in emerging markets for which our products are suited, including new classes of computing devices such as UPCs and other unique PC form factors, which require newly developed technologies, extensive development time, and marketing support.

We face intense competition in the x86-compatible microprocessor and power management markets. 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 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.

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     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 have served and 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 also expect to face substantial competition in our licensing and services business, in which we have focused primarily on licensing our advanced power management and transistor leakage control technologies. The development of such technologies is an emerging field subject to rapid technological change, and our competition is unknown and could increase. Our LongRun2 technologies are highly proprietary and, though the subject of patents and patents pending, are marketed primarily as trade secrets subject to strict confidentiality protocols. Although we are not aware of any other company having developed, offered or demonstrated any comparable power management or leakage control technologies, we note that most semiconductor companies have internal efforts to reduce transistor leakage and power consumption in current and future semiconductor products. Indeed, all of our current and prospective licensees are larger, technologically sophisticated companies, which generally have significant resources and internal efforts to develop their own technological solutions.

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 series products that could delay our ability to deliver Efficeon TM8000 series products, adversely affect our costs and gross margins and harm our reputation. 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 product 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’

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products. If our customers cancel projects or change product plans, we could lose anticipated sales. We can offer no assurance that we will achieve further design wins or that the products for which we achieve design wins will ultimately be introduced or will, if introduced, be commercially successful.

If we 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. 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. 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. For example, we recorded a $6.8 million inventory-related charge for the third quarter of fiscal 2004. We have limited capability to reduce ongoing production once wafer fabrication has commenced. Conversely, if demand exceeds our expectations, Taiwan Semiconductor Manufacturing Company, or TSMC, or Fujitsu Limited 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 product 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.

     Our customer base for product sales is highly concentrated. For example, sales to four customers in the aggregate accounted for 71% of total revenue during the first three months of fiscal 2005. We expect that a small number of customers will continue to account for a significant portion of our revenue. Our future revenue will depend upon the timing and size of future purchase orders, if any, from these customers and new customers and, among other things, 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. Many of our customers and potential customers are significantly larger than we are and have sufficient bargaining power to demand changes in terms and conditions of sale. The loss of any major customer, or the delay of significant orders from these customers, could reduce or delay our recognition of revenue.

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If our customers are not able to obtain the other components necessary to build their systems, sales of our products could be delayed or cancelled.

     Suppliers of other components incorporated into our customers’ systems may experience shortages, which could reduce the demand for our products. For example, from time to time, the computer and semiconductor industries have experienced shortages of some materials and devices, such as memory components, displays, and storage devices. Our customers could defer or cancel purchases of our products if they are not able to obtain the other components necessary to build their systems.

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 our current 130 nanometer products, and we rely on Fujitsu Limited in Japan to manufacture our 90 nanometer Efficeon TM8000 series products. We do not have manufacturing contracts with TSMC or Fujitsu Limited, and therefore we cannot be assured that we will have any guaranteed production capacity. 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 Limited 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.

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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.

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, particularly in view of our restructuring plan.

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.

Our products and technologies may infringe the intellectual property rights of others, which may cause us to become subject to expensive litigation, cause us to incur substantial damages, require us to pay significant license fees or prevent us from selling our products.

     Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot be certain that our products and technologies 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 and technologies 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 and technologies 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.

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Any dispute regarding our intellectual property may require us to indemnify certain licensees, the cost of which could severely hamper our business operations and financial condition.

     In any potential dispute involving our patents or other intellectual property, our licensees could also become the target of litigation. Our LongRun2 license agreements provide limited indemnities. Our indemnification obligations could result in substantial expenses. In addition to the time and expense required for us to supply such indemnification to our licensees, a licensee’s development, marketing and sales of licensed products incorporating our LongRun2 technology could be severely disrupted or shut down as a result of litigation, which in turn could severely hamper our business operations and financial condition.

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, 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.

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.

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We have significant international operations, which exposes us to risk and uncertainties.

     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 Limited foundry we use for our 90 nanometer product is located in Japan. 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;
	•	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 or 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.

We might experience payment disputes for amounts owed to us under our LongRun2 licensing agreements, and this may harm our results of operations.

     The standard terms of our LongRun2 license agreements require our licensees to document the royalties owed to us from the sale of products that incorporate our technology and report this data to us on a quarterly basis. While standard license terms give us the right to audit books and records of our licensees to verify this information, audits can be expensive, time consuming, and potentially detrimental to our ongoing business relationship with our licensees. Our failure to audit our licensees’ books and records may result in us receiving more or less royalty revenues than we are entitled to under the terms of our license agreements. The result of such royalty audits could result in an increase, as a result of a licensee’s underpayment, or decrease, as a result of a licensee’s overpayment, to previously reported royalty revenues. Such adjustments would be recorded in the period they are determined. Any adverse material adjustments resulting from royalty audits or dispute resolutions may result in us missing analyst estimates and causing our stock price to decline. Royalty audits may also trigger disagreements over contract terms with our licensees and such disagreements could hamper customer relations, divert the efforts and attention of our management from normal operations and impact our business operations and financial condition.

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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.

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 Limited, 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;

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	•	authorizing the issuance of “blank check” preferred stock that our board could issue to increase the number of outstanding shares and to discourage a takeover attempt;
	•	limiting the ability of our stockholders to call special meetings of stockholders;
	•	prohibiting stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; 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. The FASB published a pronouncement in December 2004 that would require us to record expense for the fair value of stock options granted. The effective date of the proposed standard is for periods beginning after June 15, 2005. Our future operating expenses may be adversely affected in connection with the issuance of stock options.

We have identified material weaknesses in our internal control over financial reporting, which contributed to our need to amend our financial statements for the second quarter of fiscal 2004.

     In the course of preparing our financial statements for the third quarter of fiscal 2004, material weaknesses, as defined in Public Company Accounting Oversight Board Standard No. 2, were identified in our internal control over financial reporting. Specifically, material weaknesses were identified with respect to our financial statement close process and our contract administration. These material weaknesses contributed to post-closing adjustments and the resulting need to amend our financial statements for the second quarter of fiscal 2004. Our amendment of our previously released financial statements could diminish public confidence in the reliability of our financial statements, which could harm our business and our stock price. In addition, we cannot assure you that we will not in the future identify further material weaknesses or significant deficiencies in our internal control over financial reporting.

     In compliance with the Sarbanes-Oxley Act of 2002, we recently completed our system and financial process evaluation and testing required for our management to assess the effectiveness of our system of internal control over financial reporting as of December 31, 2004 and March 31, 2005. In our evaluation, we identified certain material weaknesses as set out in Item 9A “Controls and Procedures” of our reports on Form 10-K and Form 10-K/A for the year ended December 31, 2004, and below in Part I, Item 4 “Controls and Procedures” of this report on Form 10-Q. We have taken and are taking steps to remediate the material weaknesses in our system of internal control over financial reporting, but we have not completed our remediation effort, and there can be no assurance that we will completely remediate our material weaknesses such that we will be able to conclude that our internal control over financial reporting is effective and that our independent registered public accounting firm will be able to express an opinion on the effectiveness of our internal control over financial reporting in the future.

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 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

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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. As of March 31, 2005, we had cash equivalents and available-for-sale investments of $42.0 million. 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 March 31, 2005.

     Foreign Currency Exchange Risk. To date, 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. Although we will continue to monitor our exposure to currency fluctuations and, when appropriate, may use financial hedging techniques to minimize the effect of these fluctuations, we cannot assure that exchange rate fluctuations will not adversely affect our financial results in the future.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

     Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2005. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

     As described below, we have identified and reported to our audit committee of our board of directors and Ernst & Young LLP, our independent registered public accounting firm, material weaknesses in our internal control over financial reporting. As a result of these material weaknesses, our chief executive officer and chief financial officer have concluded that, as of March 31, 2005, our disclosure controls and procedures were not effective.

Internal Control Over Financial Reporting

     Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, our CEO and CFO, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

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     A material weakness is a control deficiency, or a combination of control deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management assessed our internal control over financial reporting as of December 31, 2004, the end of our fiscal year. Based on this assessment, management identified material weaknesses in internal control over financial reporting in the following six areas:

	•	Period-end close and financial reporting;
	•	Contract administration;
	•	Inventory and cost accounting;
	•	Inadequate technical accounting staff;
	•	Fixed asset accounting; and
	•	Segregation of duties in Accounts Payable function.

For information relating to the insufficient controls that resulted in the material weaknesses noted above, please see the discussion under “Item 9A. Controls and Procedures—Management Report on Internal Control Over Financial Reporting” contained in our report on Form 10-K/A for the year ended December 31, 2004.

Remediation Actions to Address Material Weaknesses in Internal Control over Financial Reporting

     During the first quarter of 2005, we focused our efforts on assessing our accounting and finance staff requirements and began to interview qualified accounting and finance staff in order to augment the expertise of our finance department, and to more effectively and efficiently address the material weaknesses noted above. We also continue to work closely with our financial advisors to assist us in addressing our control deficiencies and to improve our internal control infrastructure.

     We anticipate that our remediation will continue throughout fiscal 2005, during which we expect to continue pursuing appropriate corrective actions. Our management and audit committee will monitor closely the implementation of our remediation plan. The effectiveness of the steps we have taken to date and the steps we are still in the process of completing is subject to continued management review, as well as audit committee oversight, and we are endeavoring to complete the remediation of all material weaknesses by the end of the fourth quarter of fiscal 2005. Currently, we are not aware of any material weaknesses in our internal control over financial reporting other than as described above.

Inherent Limitations on Effectiveness of Controls

     Our management, including our chief executive officer and our chief financial officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. Any control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Changes in Internal Control over Financial Reporting

     There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter ended March 31, 2005 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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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. Our insurance carriers are part of the proposed settlement, and 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. Unregistered Sales of Equity Securities and Use of Proceeds

     Not Applicable.

Item 3. Defaults Upon Senior Securities

     Not Applicable.

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

     Not Applicable.

Item 5. Other Information

     Not Applicable.

Item 6. Exhibits

     (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.

     ** Management contract or compensatory agreement.

     + Confidential treatment has been requested for portions of this exhibit. These portions have been omitted from this Report and have been filed separately with the Securities and Exchange Commission.

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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/ MARK R. KENT
		Mark R. Kent
		Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)

Date: May 25, 2005

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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.

     ** Management contract or compensatory agreement.

     + Confidential treatment has been requested for portions of this exhibit. These portions have been omitted from this Report and have been filed separately with the Securities and Exchange Commission.