##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




---

Form 10-K



---

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the year ended December 31,
    2003                                                    
|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

(Exact name of registrant as specified in its
charter)


|                         |  |                                  
|------------------------ |  | ---------------------------------
|Delaware                 |  | 77-0402448                       
|(State of Incorporation) |  | (IRS Employer Identification No.)

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)


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

None


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

Common Stock, $0.00001 par value per
share


Stock Purchase Rights


Indicate by check
mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.     Yes þ          No o

Indicate by check
mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this
Form 10-K.     þ

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

As of June 27,
2003, the aggregate market value of the shares of common stock
held by non-affiliates of the Registrant (based on the closing
price of $1.42 for the common stock as quoted by the Nasdaq
National Market on that date) was approximately $161,938,596.

As of
February 27, 2004, there were 173,505,306 shares of
the Registrants common stock, $0.00001 par value per
share, outstanding. This is the only outstanding class of common
stock of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
Registrants definitive Proxy Statement for its Annual
Meeting of Stockholders to be held in 2004 are incorporated by
reference into Parts II and III of this report on
Form 10-K.



---






---










TRANSMETA CORPORATION

FISCAL YEAR 2003 FORM 10-K


INDEX

|              |  |                                                                                                        |  |      |    | 
|------------- |  | ------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|Item          |  |                                                                                                        |  | Page
|              |  |                                                                                                        |  |     
|PART I       
|Item 1        |  | Business                                                                                               |  |      | 2  | 
|Item 2        |  | Properties                                                                                             |  |      | 9  | 
|Item 3        |  | Legal Proceedings                                                                                      |  |      | 9  | 
|Item 4        |  | Submission of Matters to a
    Vote of Security Holders                                                |  |      | 11 | 
|PART II      
|Item 5        |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |  |      | 11 | 
|Item 6        |  | Selected Financial Data                                                                                |  |      | 12 | 
|Item 7        |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |  |      | 14 | 
|Item 7A       |  | Quantitative and Qualitative
    Disclosures About Market Risk                                         |  |      | 41 | 
|Item 8        |  | Financial Statements and
    Supplementary Data                                                        |  |      | 42 | 
|Item 9        |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure               |  |      | 72 | 
|Item 9A       |  | Controls and Procedures                                                                                |  |      | 72 | 
|PART III     
|Item 10       |  | Directors and Executive
    Officers of the Registrant                                                 |  |      | 72 | 
|Item 11       |  | Executive Compensation                                                                                 |  |      | 72 | 
|Item 12       |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |  |      | 72 | 
|Item 13       |  | Certain Relationships and
    Related Transactions                                                     |  |      | 72 | 
|Item 14       |  | Principal Accountant Fees
    and Services                                                             |  |      | 72 | 
|PART IV      
|Item 15       |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                                    |  |      | 73 | 
|              |  | Signatures                                                                                             |  |      | 76 | 
|EXHIBIT 23.01
|EXHIBIT 31.01
|EXHIBIT 31.02
|EXHIBIT 32.01
|EXHIBIT 32.02



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

1



---



##### Table of Contents



CAUTION REGARDING FORWARD-LOOKING
STATEMENTS

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

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




PART I




Item 1.     Business

Transmeta designs, develops and sells highly
efficient x86-compatible software-based microprocessors. We
believe that our microprocessors deliver a compelling balance of
low power consumption, high performance, low cost and small
size. These advantages are valuable to a broad range of
computing platforms, especially 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. Some of
these platforms provide types of computer configurations that
may reduce the total cost of ownership by reducing maintenance
and support costs or the total number of computing platforms
that must be supported in an enterprise. We currently sell our
products to a number of the computing industrys leaders,
such as Fujitsu, Hewlett-Packard, NEC and Sharp.

Unlike traditional microprocessors that are built
entirely with silicon hardware, our microprocessor products
utilize our innovative combination of software and hardware
technology. A portion of the functionality of our
microprocessors is implemented with software that allows the
remaining functionality to be implemented with only a fraction
of the number of logic transistors required in a conventional
microprocessor. Because of this reduction in the number of logic
transistors, our microprocessors consume less power and generate
less heat.

In October 2003, we introduced our second family
of microprocessors, the Efficeon TM8000 series. To date we
have shipped limited quantities of the initial
130 nanometer Efficeon product. We have been shipping our
first family of microprocessors, the Crusoe series, since 2000.
We believe that the increased capabilities of the Efficeon
family will enable us to address a substantially larger target
market, particularly mainstream notebook computers. We believe
our new Efficeon family delivers performance comparable to that
of conventional x86-compatible mobile microprocessors, while
providing the advantages of lower power consumption, lower cost
and smaller size while maintaining compatibility with standard
PC software.

The Efficeon family is currently being
manufactured at Taiwan Semiconductor Manufacturing Company, or
TSMC, one of the leading semiconductor foundries in the world,
using TSMCs established 130 nanometer semiconductor
manufacturing process that continues to be used for our Crusoe
product family. We intend to

2



---



##### Table of Contents



use Fujitsu Microelectronics to manufacture our
initial 90 nanometer Efficeon TM8000 microprocessors. We
delivered to Fujitsu Microelectronics the design and
specifications, or tape-out, of our Efficeon
TM8000 microprocessor for implementation in its
90 nanometer foundry in November 2003. We have received our
first prototype units, or first silicon, from this tape-out in
January 2004, and we plan to begin volume shipments from this
process in the second half of 2004.


The Broadening Market for Energy Efficient
x86-Compatible Microprocessors

The personal computer market is dominated by
x86-compatible microprocessors, which have become the most
common type of microprocessor in desktop PCs, notebook
computers, servers, enterprise computing, and many other
computing platforms. Manufacturers are increasingly adopting
x86-compatible microprocessors in order to access the rich and
broad range of software available for PC-compatible computing
devices. As the x86 architecture migrates into these
additional market segments, the requirements to reduce cost,
size and power consumption for a given level of performance are
becoming more acute.

Originally, x86-compatible microprocessors were
designed for desktop computers. However, trends towards mobile
computing, coupled with increased affordability, have resulted
in dynamic growth of the notebook computer market. In addition
to traditional notebook computers, new categories of mobile PCs
are emerging, including tablet PCs, UPCs and thin and light
notebooks. These product categories demand long battery life,
small form factors, quiet fanless designs, and lower cost.

The trend towards distributed computing and
related cost of ownership issues for traditional personal
computers in enterprise environments has resulted in the
creation of several new types of PC platforms. Thin client
computers coupled with centralized blade servers can deliver
full PC functionality to large numbers of desks, while
centralizing all of the computers and facilitating
administration and maintenance. Blade servers consolidate
distributed computing resources into easy-to-manage rack mounted
environments. UPCs consolidate multiple form factors into a
single device that is more easily managed. Here again, these
categories demand compact form factors, low heat generation and
low cost.

Embedded processor applications also comprise an
emerging market for x86-compatible microprocessors. Embedded
processors are general purpose devices that perform dedicated
applications with limited or no user interface and end-user
programmability, and have often been addressed by
non-x86-compatible microprocessor architectures. As the cost of
software increases, it becomes more cost effective to migrate to
processors compatible with the large available base of
x86-compatible software. Markets for embedded processors include
industrial automation, scientific instrumentation, retail
kiosks, point-of-sale terminals, process control and other
applications. These categories demand compelling performance at
low cost and in small form factors with low heat generation.

Power Consumption and Heat Generation Problems
Are Intensifying

Advances in semiconductor technology have doubled
the number of transistors that can be placed on the same size
chip approximately every eighteen months, which is commonly
known as Moores Law. Each transistor consumes power and
generates heat. As a result, microprocessor power consumption
and heat generation have increased significantly as the number
of transistors has increased.

In order to manage the problem of increased heat
across successive generations of microprocessors, computer
manufacturers have increasingly needed higher capacity cooling
techniques, such as larger heat sinks, higher capacity fans, or
even liquid cooling. Such cooling requirements and power loads
cannot be effectively accommodated in most small mobile
computing devices. Furthermore, these issues are becoming
increasingly important in stationary computers, especially where
silent operation and small or enclosed form factors are desired.

A looming new issue related to power consumption
and heat generation, known as transistor leakage,
has recently emerged in the microprocessor industry and in the
broader semiconductor industry as well. As transistors decrease
in size, they become increasingly unable to completely turn off
the flow of current. When transistors leak current, they consume
additional power and generate more heat. As the industry
transitions to

3



---



##### Table of Contents



the 90 nanometer and 65 nanometer
technology nodes over the next several years, integrated
circuits are expected to consume a substantial fraction of their
total power consumption through leakage. Leakage power could
dominate total chip power consumption and prevent low power
standby operation if not controlled. Most major semiconductor
companies are seeking to solve the leakage problem. If the
leakage problem is not solved, it could threaten the ability of
the semiconductor industry to continue to scale to smaller
geometries in accordance with Moores Law.


Our Software-Based Microprocessor
Technology

Our microprocessors are unique because, unlike
traditional microprocessors that are built entirely with silicon
hardware, they are composed of both software and hardware
components. When combined, these two components form a
microprocessor solution that is compatible with software
programs designed for x86-compatible computers, operates using
less power than most other x86 microprocessors and runs
standard PC software and Internet applications. Implementing a
portion of the functionality in software greatly reduces the
number of logic transistors, saving power and cost.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Code Morphing Software.The software component of our
    microprocessors is called Code Morphing Software, because it
    dynamically translates, or morphs, x86 instructions into
    instructions for our Very Long Instruction Word, or VLIW,
    processors. Code Morphing Software dynamically translates from
    the ones and zeros of the x86 software instructions into a
    functionally equivalent but simpler set of ones and zeros for
    our hardware chip to decode and execute. The technology involved
    in Code Morphing Software is similar to that used in advanced
    compilers, but with the input being binary programs rather than
    high-level language source code. Code Morphing Software
    translates small groups of instructions incrementally, on an
    as-needed basis. Once a group of instructions is translated,
    those translated instructions are cached for successive
    executions to reduce the need for further translation. Since
    instructions in an application often execute millions of times
    or more, performance costs associated with translation are
    quickly amortized. Code Morphing Software constantly monitors
    the programs a user is running in order to re-optimize the
    operation of those programs so as to maximize the energy
    efficiency and performance of our microprocessors.
|
| |  | Very Long Instruction Word
    (VLIW) Processor Hardware.The
    hardware component of our microprocessors is a VLIW processor
    chip. Our VLIW chip is responsible for basic arithmetic
    computation, input/output functions and the control and caching
    functions. Our Efficeon product can execute up to eight internal
    instructions per clock cycle using a 256-bit VLIW instruction.
    Our Crusoe product can execute up to four internal instructions
    per clock cycle using a 128-bit VLIW instruction. Each of these
    wide VLIW instructions can control multiple functional units in
    parallel for high performance under software control. For
    example, a single 256-bit VLIW instruction might simultaneously
    control multiple integer additions, floating point operations,
    memory loads and branches.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

Our Dynamic Power Management
Technology

In addition to power reduction as a result of
reducing the number of logic transistors, we also achieve
additional power efficiency benefits with our proprietary
LongRun power management technology. Our proprietary LongRun
technology is enabled by the monitoring and optimization
capabilities of our Code Morphing Software. LongRun monitors the
levels of user activity to determine how much performance is
actually needed at any particular instant. Our chip has special
purpose hardware that allows LongRun to adjust rapidly the clock
speed and voltage of the chip to match closely the needed level
of performance. Reducing clock speed and voltage can
substantially reduce the power consumed by our microprocessors,
which in turn leads to longer battery life.

Our first generation LongRun power management
technology was introduced in January 2000, and was the first
technology in the industry to dynamically adjust clock speed and
voltage hundreds of times per second, to reduce power
consumption. In October 2003, we announced our LongRun2
technology, which provides for software controlled leakage
management. Our LongRun2 technology is designed to control
transistor leakage through software by dynamically adjusting
transistor threshold voltages. Software control is

4



---



##### Table of Contents



important in order to adjust leakage due to
changes in runtime conditions, such as voltage and temperature,
that are not predetermined when the chip is manufactured. For
example, in standby mode, which accounts for a large portion of
a microprocessors usage, LongRun2 is designed to raise the
threshold voltage and reduce the supply voltage so that leakage
is significantly reduced. Conversely, when a transistor is
processing at peak rates, LongRun2 will be able to dynamically
lower its threshold voltage and increase supply voltage so that
it can perform high speed processing, while taking into account
changes in temperature and voltage.


Our Strategy

Our objective is to penetrate a broad range of
computing markets by delivering energy-efficient x86-compatible
microprocessors at a variety of compelling cost and performance
points. Key elements of our strategy include:

Further develop and exploit the fundamental
advantages of our software-based microprocessor technology.We believe that our software-based
microprocessor architecture has fundamental advantages over
traditional microprocessors and that those comparative
advantages are likely to increase in the future as computing
technologies evolve. We plan to continue to extend our expertise
in software-based microprocessor technology in order to develop
and bring to market microprocessor products with a superior
balance of performance, power consumption, size and cost. We
have developed and intend to continue to develop successive
generations of hardware architectures and Code Morphing Software
optimizations to further enhance power management and
performance, while maintaining x86 software compatibility. We
also intend to continue to exploit the unique characteristics of
our software to migrate additional functions from hardware into
software, and to develop and implement attractive features, such
as robust security and enhanced power management. We plan to
further extend the ability of our Code Morphing Software to
learn about the characteristics of an application
program while it is running in order to further optimize
performance.

Become the leading vendor of microprocessors
in market segments where our balance of product features gives
us a comparative advantage.We target
mobile computing market segments where energy efficiency, low
heat and x86 software compatibility are paramount. These
segments include thin and light weight notebook computers,
tablet PCs and UPCs. We believe our Efficeon family of
microprocessors delivers the performance needed to penetrate
broader segments of the notebook market than our previous family
of Crusoe microprocessors. In addition, we target stationary
market segments where cool and quiet operation, small form
factors and low costs are needed. These include thin client
desktop computers, high density blade servers and embedded
systems. Potential markets include next generation set top
boxes, digital television, Internet platforms and other emerging
categories of digital consumer products. To facilitate
widespread adoption of our products, we work with strategic OEMs
and original design manufacturers, or ODMs, to optimize
system-level solutions and to develop reference designs for
their requirements.

Maintain compatibility with leading edge
industry standards.We intend to
maintain compatibility with x86 software in order to address our
target markets. Our microprocessors interoperate with leading
edge chips from prominent vendors of graphics processors and
chipsets. Our microprocessors incorporate leading edge bus
interfaces and high-speed memory controllers. We enter into
alliances with other vendors in order to provide compact,
cost-effective system-level solutions, such as complete
motherboard reference designs. We seek to provide our customers
with flexible choices of best-of-breed cost-effective chipsets
for their particular application.

Maintain a leadership position in low-power
semiconductor technologies.We are
developing additional advanced low-power solutions applicable
not only to microprocessors, but also to integrated circuits
generally. We believe that our approach to power management in
microprocessors through a combination of innovative hardware and
software technology may have more general application to
integrated circuits. An example is our LongRun2 technology,
which combines both hardware and software technology to
dynamically control the leakage power of each transistor. Our
approach has led to what we believe is a breakthrough in solving
the vexing and growing problem of leakage in advanced small
geometry chips.

Commercially exploit our power management
technologies, such as LongRun and LongRun2 technologies, through
licensing to the semiconductor industry.We are exploring opportunities for
licensing our

5



---



##### Table of Contents



advanced power management technologies to other
companies in the integrated circuit industry. We expect that our
licensing strategy will focus on promoting and enabling the use
of our power management technologies by leading semiconductor
manufacturers and suppliers without compromising our competitive
position in the microprocessor market. For example, we believe
our proprietary LongRun2 leakage control technology could be
valuable to the semiconductor industry and generate significant
future licensing revenues for us without impairing our
microprocessor product business.


Products

In October 2003, we introduced the Efficeon
TM8000 family of microprocessors. Our other current products
include the TM5000 family of Crusoe microprocessors. Our
products are designed to provide our customers with a balance of
the following key benefits:



| |   |                                
| | - | -------------------------------
| |  | low power consumption;         
|
| |  | low heat generation;           
|
| |  | high performance;              
|
| |  | leading edge system interfaces;
|
| |  | small size; and                
|
| |  | lower cost.                    

Our microprocessors employ a number of advanced
memory features and have relatively large level 1 instruction
and data caches. Our level 2 caches improve performance by
reducing the average time to access data from memory, and also
help reduce power by decreasing the number of power-consuming
memory accesses to dynamic random access memory, or DRAM.



| |         
| | --------
| | Efficeon

In October 2003, we introduced our second family
of microprocessors, the Efficeon TM8000 series. The Efficeon
family is currently being manufactured at TSMC, one of the
leading semiconductor foundries in the world, using TSMCs
established 130 nanometer semiconductor manufacturing
process that continues to be used for our Crusoe product family.
To date we have shipped limited quantities of the initial
130 nanometer Efficeon product. We delivered to Fujitsu
Microelectronics the tape-out of the 90 nanometer version
of the Efficeon chip for manufacture in its 90 nanometer
foundry in November 2003. We received first silicon from this
tape-out in January 2004, and we plan to begin volume shipments
from this process in the second half of 2004.

The Efficeon family of microprocessors is
designed to run at maximum speeds ranging from 1.0 GHz to
up to 2.0 GHz. In addition to our Code Morphing Software
and LongRun technologies, these microprocessors include three
new high performance bus interfaces. They have an on-chip
HyperTransport bus interface, for increased input/output
efficiency. The new processors also include an on-chip Double
Data Rate SDRAM memory interface. These microprocessors also
have an on-chip AGP graphics interface for industry standard,
high performance graphics solutions. All three of these new
interfaces allow Efficeon microprocessors to achieve more work
per clock, which results in greater energy efficiency and longer
battery life for mobile computer users. We designed our Efficeon
microprocessors to later incorporate, without significant
modification, our LongRun2 technology, which is designed to
significantly reduce leakage current. Our goal is to deliver
volume shipments of Efficeon microprocessors incorporating
LongRun2 technology in the second half of 2004.



| |       
| | ------
| | Crusoe

The TM5800 Crusoe processors are manufactured in
a 130 nanometer CMOS technology at TSMC. The TM5800 has a
512 KByte level 2 cache. It also has a 64 KByte
level 1 data cache and 64 KByte level 1
instruction cache as well as an integrated
northbridge, which consists of a PCI bus controller,
a SDR

6



---



##### Table of Contents



DRAM controller, and a DDR DRAM controller. This
product currently features maximum operating frequencies of up
to 1.0 GHz. We introduced the TM5800 in 2001.


Customers

We currently sell our products to a number of the
computing industrys leaders. Based on product revenue for
the year ended December 31, 2003, our top four customers
were Sharp, Fujitsu, Hewlett-Packard and one of our
distributors, Uniquest, acting as the distributor of our product
for the Hewlett Packard Tablet PC program.

Sales and Marketing

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

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

Manufacturing

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

We currently use TSMC to fabricate wafers for our
Crusoe microprocessors, and intend to continue to rely
exclusively on it to manufacture our 130 nanometer Efficeon
TM8600 product. We place orders with TSMC on a purchase order
basis. We do not have a manufacturing agreement with TSMC that
guarantees any particular production capacity or any particular
price from TSMC. TSMC may allocate capacity to other companies
and reduce deliveries to us on short notice.

We currently intend to use Fujitsu
Microelectronics in Japan to manufacture our initial
90 nanometer Efficeon TM8000 products. In November, we
delivered to Fujitsu Microelectronics the tape-out of the
90 nanometer version of the Efficeon chip for manufacture
in its 90 nanometer foundry. We received first silicon from
this tape-out in January 2004, and we plan to begin volume
shipments from this process in the second half of 2004. We have
yet to enter into a definitive manufacturing agreement with
them, and any agreement we may enter into may not provide us
with guaranteed production capacity.

Advanced Semiconductor Engineering, or ASE,
performs the initial testing of the silicon wafers that contain
our microprocessors. After initial testing, ASE cuts the silicon
wafers into individual semiconductors and assembles them into
packages. All testing is performed on standard test equipment
using proprietary test

7



---



##### Table of Contents



programs developed by our test engineering group.
We periodically inspect the test facilities to ensure that their
procedures remain consistent with those required for the
assembly of our products. We generally ship our products from a
third party fulfillment center in Hong Kong.


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

Competition

The market for microprocessors is intensely
competitive, is subject to rapid technological change and is
currently, and has been for many years, dominated by Intel. We
face intense and direct competition from Intel, and we face
additional competition from AMD and VIA Technologies, in the
market for microprocessors. We expect to continue to face
intense competition from these and other competitors in the
various microprocessor markets that we target, such as notebook
computers, UPCs, tablet PCs, thin clients, blade servers and
embedded computers. We believe that competition will be intense
in the future in all of the markets in which we compete and may
cause price reductions, reduced gross margins and loss of market
share, any one of which could significantly reduce our future
revenue and increase our losses.

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



| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | technical innovation;                                                                                                       
|
| |  | performance of our products, including their
    speed, power usage, product system compatibility, reliability
    and size;
|
| |  | product price;                                                                                                              
|
| |  | product availability;                                                                                                       
|
| |  | reputation and branding;                                                                                                    
|
| |  | product marketing and merchandising; and                                                                                    
|
| |  | technical support.                                                                                                          

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

In marketing our microprocessors to OEMs, ODMs
and distributors, we depend on third-party companies for the
design and manufacture of core-logic chipsets, 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.

Intellectual Property

Our success depends in part upon our ability to
secure and maintain legal protection for the proprietary aspects
of our technology and to operate without infringing the
proprietary rights of others. We rely on a combination of
patents, copyrights, trademarks, trade secret laws and
contractual restrictions on disclosure to protect our
intellectual property rights. Our intellectual property rights
include numerous issued U.S. patents, with expiration dates
ranging from 2012 to 2020. We also have a number of patent
applications pending in the United States and in other
countries. It is possible that no more patents will issue from
patent applications that we have filed. Our existing patents and
any additional patents that may issue may not provide
sufficiently broad protection to protect our proprietary rights.
We hold a number of trademarks, including Transmeta, Crusoe,
Efficeon, LongRun and Code Morphing.

8



---



##### Table of Contents



Legal protections afford only limited protection
for our technology. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy
aspects of our products or to obtain and use information that we
regard as proprietary. In addition, the laws of some foreign
countries do not protect our proprietary rights to the same
extent as do the laws of the United States. Attempts may be made
to copy or reverse engineer aspects of our products or to obtain
and use information that we regard as proprietary. Accordingly,
we may not be able to prevent misappropriation of our technology
or deter others from developing similar technology. Furthermore,
policing the unauthorized use of our products or technology is
difficult. Leading companies in the semiconductor industry have
extensive intellectual property portfolios relating to
semiconductor technology. From time to time, third parties,
including these leading companies, may assert exclusive patent,
copyright, trademark and other intellectual property rights to
technologies and related methods that are important to us. We
have received, and may in the future receive, communications
from third parties asserting patent or other intellectual
property rights covering our products. There are currently no
such third party claims that we believe to be material. In the
future, however, litigation may be necessary to defend against
claims of infringement or invalidity, to determine the validity
and scope of the proprietary rights of others, to enforce our
intellectual property rights, or to protect our trade secrets.

Employees

At December 31, 2003, we employed 296 people
in the United States, Japan, Taiwan and Europe. Of these
employees, 214 were engaged in research and development, 34 were
engaged in sales and marketing and 48 were engaged in general
and administrative functions. None of our employees is subject
to any collective bargaining agreements. We believe that our
employee relations are good.

Available Information

We make available free of charge on or through
our Internet address located at www.transmeta.comour
annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments
to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, as soon as reasonably practicable after we
electronically file that material with, or furnish it to, the
Securities and Exchange Commission. Materials we file with the
SEC may be read and copied at the SECs Public Reference
Room at 450 Fifth Street, NW, Washington, D.C. 20549.
This information may also be obtained by calling the SEC at
1-800-SEC-0330. The SEC also maintains an internet website that
contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the
SEC at www.sec.gov. We will provide a copy of any of the
foregoing documents to stockholders upon request.






|        |           
|------- | ----------
|Item 2. | Properties

We lease a total of approximately
126,225 square feet of office space in Santa Clara,
California, under leases expiring in June 2008. We also
lease office space in Taiwan and Japan to support our sales and
marketing personnel worldwide. As a result of our workforce
reduction in the third quarter of fiscal 2002, we vacated
approximately 67,730 square feet of office space in Santa
Clara, California and we have listed this excess office space
with a real estate broker in an effort to secure subtenants.
During the fourth quarter of fiscal 2003, we reassessed our
needs for office space and determined that we will begin to use
approximately 20,000 square feet of previously vacated
space in 2004.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Beginning in June 2001, Transmeta, its
directors, and certain of its officers were named as defendants
in several putative shareholder class actions that were
consolidated in and by the United States District Court for the
Northern District of California as In re Transmeta
Corporation Securities Litigation,Case
No. C 01-02450 WHA. The complaints purported to
allege a class action on behalf of persons who purchased
Transmeta common stock between November 7, 2000 and
July 19, 2001, and alleged violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, as amended, and Rule 10b-5 promulgated thereunder,
and Sections 11 and 15 of the Securities Act of 1933, as
amended. In March 2002, the Court

9



---



##### Table of Contents



granted in part and denied in part
defendants motions to dismiss the consolidated amended
complaint. In May 2002, the Court granted in part and
denied in part defendants motion to dismiss the second
amended complaint, and denied plaintiffs motion for leave
to file a third amended complaint. In June 2002, defendants
answered the second amended complaint as to the sole surviving
claim. In July 2002, defendants filed a motion for summary
judgment relating to that claim. In July 2002, plaintiffs
moved for class certification and initiated discussion of a
proposed settlement. The Company and the individual defendants
believe that the complaints are without merit and deny any
liability, but because they also wish to avoid the continuing
waste of management time and expense of litigation, they entered
into an agreement in October 2002 to settle all claims that
might have been brought in this action for approximately
$5.5 million, all of which monies have been fully funded by
defendants director and officer liability insurance. In
March 2003, after proper class notice and hearings, the
Court approved the settlement and entered judgment for
defendants, dismissing the action. In April 2003, a
plaintiffs law firm that was not selected by the Court to
serve as class counsel filed a notice of appeal relating to
certain Court orders addressing that firms applications to
the Court for attorneys fees. In August 2003, on
appellants own motion, the Court of Appeals dismissed the
appeal.


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

Beginning in June 2001, the Company, certain
of its directors and officers, and certain of the underwriters
for its initial public offering were named as defendants in
three putative shareholder class actions that were consolidated
in and by the United States District Court for the Southern
District of New York in In re Transmeta Corporation Initial
Public Offering Securities Litigation, Case
No. 01 CV 6492. The complaints allege that the
prospectus issued in connection with the Companys initial
public offering on November 7, 2000 failed to disclose
certain alleged actions by the underwriters for that offering,
and alleges claims against the Company and several of its
officers and directors under Sections 11 and 15 of the
Securities Act of 1933, as amended, and under
Sections 10(b) and Section 20(a) of the Securities
Exchange Act of 1934, as amended. Similar actions have been
filed against more than 300 other companies that issued stock in
connection with other initial public offerings during 1999-2000.
Those cases have been coordinated for pretrial purposes as In
re Initial Public Offering Securities Litigation, Master
File No. 21 MC 92 (SAS). In July 2002, the
Company joined in a coordinated motion to dismiss filed on
behalf of multiple issuers and other defendants. In
February 2003, the Court granted in part and denied in part
the coordinated motion to dismiss, and issued an order regarding
the pleading of amended complaints. Plaintiffs subsequently
proposed a settlement offer to all issuer defendants, which
settlement would provide for payments by issuers insurance
carriers if plaintiffs fail to recover a certain amount from
underwriter defendants. Although the Company and the individual
defendants believe that the complaints are without merit and
deny any liability, but because they also wish to avoid the
continuing waste of management time and expense of litigation,
they accepted plaintiffs proposal to settle all claims
that might have been brought in this action. The Company and the
individual Transmeta defendants expect that their share of the
global settlement will be fully funded by their director and
officer liability insurance. Although the Company and the
Transmeta defendants have approved the settlement in principle,
it remains subject to several procedural conditions, as well as
formal approval by the Court. It is possible that the parties
may not reach a final written settlement agreement or that the
Court may decline to approve the settlement in whole or part. In
the event that the parties do not reach agreement on the final
settlement, the Company and the Transmeta defendants believe
that they have meritorious defenses and intend to defend any
remaining action vigorously.

10



---



##### Table of Contents








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

Not applicable.



PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Market Information for Common Stock

Our common stock began trading on the Nasdaq
National Market on November 6, 2000 under the symbol
TMTA. The following table shows the high and low
sale prices reported on the Nasdaq National Market for the
periods indicated. The market price of our common stock has been
volatile. See Managements Discussion and Analysis of
Financial Condition and Results of Operations  Risks
That Could Affect Future Results. On February 27,
2004, the closing price of our common stock was $3.62.

|                                    |                |      |   |      |  |  |   |      | 
|----------------------------------- | -------------- | ---- | - | ---- |  |  | - | ---- | 
|                                    |                | High |   | Low 
|                                    |                |      |   |     
|Fiscal year ended December 31, 2002 |                |      |   |      |  |  |   |     
|                                    | First quarter  |      | $ | 4.47 |  |  | $ | 2.15 | 
|                                    | Second quarter |      |   | 3.87 |  |  |   | 1.79 | 
|                                    | Third quarter  |      |   | 2.34 |  |  |   | 0.85 | 
|                                    | Fourth quarter |      |   | 1.64 |  |  |   | 0.74 | 
|Fiscal year ended December 31, 2003 |                |      |   |      |  |  |   |     
|                                    | First quarter  |      | $ | 1.62 |  |  | $ | 1.05 | 
|                                    | Second quarter |      |   | 1.90 |  |  |   | 0.91 | 
|                                    | Third quarter  |      |   | 3.59 |  |  |   | 1.41 | 
|                                    | Fourth quarter |      |   | 5.51 |  |  |   | 2.75 | 

Stockholders

As of February 27, 2004, we had
approximately 595 holders of record of our common stock. This
does not include the number of persons whose stock is in nominee
or streetname accounts through brokers.

Dividends

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

Securities Authorized For Issuance Under
Equity Compensation Plans

The information required by this item is
incorporated by reference to the caption Equity
Compensation Plan Information in our Proxy Statement for
our 2004 Annual Meeting.

Recent Sales of Unregistered
Securities

During the year ended December 31, 2003, we
issued and sold the following unregistered securities:



| |                                                                                                                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In February 2003, we issued
    796,178 shares of common stock, valued at
    $1.0 million, to an intellectual property owner as partial
    consideration for certain intellectual property and related
    assets that we acquired in February 2001.                                                                  
|
| | In October 2003, we issued
    222,960 shares of common stock to VLLI Holdings LLC and
    VLLI Holdings II LLC upon exercise of a warrant that was
    granted in April 1998. The exercise price of $1.25 was paid
    by a net exercise of the warrant through the surrender of shares
    issuable under the warrant.

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

11



---



##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The following table reflects selected unaudited
consolidated financial information for Transmeta for the past
five fiscal years. We have prepared this information using the
historical audited consolidated financial statements of our
company for the five years ended December 31, 2003.

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

|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |        |        | 
|----------------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------- | ------- | ------ | ------ | ---- | -------- | ------ | ------- | ---- | -------- | ------ | ------- | - | -------- | ------ | ------- | - | ------- | ------ | ------ | 
|                                                            |                                                                 |                                      
|                                                            |                                                                 | Years Ended December 31,             
|                                                            |                                                                 |                                      
|                                                            |                                                                 | 2003                                  |         | 2002   |        | 2001 |          | 2000   |         | 1999
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |     
|                                                            |                                                                 |                                      
|                                                            |                                                                 | (In thousands, except per share data)
|Consolidated Statement of
    Operations Data:              |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Revenue:                                                    |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            | Product                                                         |                                       | $       | 16,225 |        |      | $        | 24,247 |         |      | $        | 35,590 |         |   | $        | 16,180 |         |   | $       | 76     |       
|                                                            | License                                                         |                                       |         | 1,090  |        |      |          |       |         |      |          |       |         |   |          |       |         |   |         | 5,000  |       
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            |                                                                 | Total revenue                         |         |        | 17,315 |      |          |        | 24,247  |      |          |        | 35,590  |   |          |        | 16,180  |   |         |        | 5,076  | 
|Cost of revenue:                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            | Product                                                         |                                       |         | 16,184 |        |      |          | 17,127 |         |      |          | 48,694 |         |   |          | 9,461  |         |   |         | 18     |       
|                                                            | License                                                         |                                       |         | 140    |        |      |          |       |         |      |          |       |         |   |          |       |         |   |         |       |       
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            |                                                                 | Total cost of revenue(1)              |         |        | 16,324 |      |          |        | 17,127  |      |          |        | 48,694  |   |          |        | 9,461   |   |         |        | 18     | 
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Gross profit (loss)                                         |                                                                 |                                       | 991     |        |        |      | 7,120    |        |         |      | (13,104  | )      |         |   | 6,719    |        |         |   | 5,058   |       
|Operating expenses:                                         |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            | Research and development                                        |                                       |         | 48,525 |        |      |          | 63,603 |         |      |          | 67,639 |         |   |          | 61,415 |         |   |         | 33,122 |       
|                                                            | Purchased in-process research and development                   |                                       |         |       |        |      |          |       |         |      |          | 13,600 |         |   |          |       |         |   |         |       |       
|                                                            | Selling, general and administrative                             |                                       |         | 26,199 |        |      |          | 29,917 |         |      |          | 35,460 |         |   |          | 27,045 |         |   |         | 12,811 |       
|                                                            | Restructuring charges (recovery)(2)                             |                                       |         | (244   | )      |      |          | 14,726 |         |      |          |       |         |   |          |       |         |   |         |       |       
|                                                            | Amortization of deferred charges, patents and
    patent rights |                                       |         | 10,530 |        |      |          | 11,392 |         |      |          | 17,556 |         |   |          | 10,416 |         |   |         | 218    |       
|                                                            | Impairment write-off of deferred charges(3)                     |                                       |         |       |        |      |          |       |         |      |          | 16,564 |         |   |          |       |         |   |         |       |       
|                                                            | Stock compensation(4)                                           |                                       |         | 4,529  |        |      |          | 1,809  |         |      |          | 20,954 |         |   |          | 13,056 |         |   |         |       |       
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|                                                            |                                                                 | Total operating expenses              |         |        | 89,539 |      |          |        | 121,447 |      |          |        | 171,773 |   |          |        | 111,932 |   |         |        | 46,151 | 
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Operating loss                                              |                                                                 |                                       | (88,548 | )      |        |      | (114,327 | )      |         |      | (184,877 | )      |         |   | (105,213 | )      |         |   | (41,093 | )     
|                                                            | Interest income and other, net                                  |                                       |         | 1,389  |        |      |          | 4,962  |         |      |          | 14,686 |         |   |          | 9,174  |         |   |         | 2,456  |       
|                                                            | Interest expense                                                |                                       |         | (477   | )      |      |          | (601   | )       |      |          | (1,060 | )       |   |          | (1,666 | )       |   |         | (1,952 | )     
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Loss before income taxes                                    |                                                                 |                                       | (87,636 | )      |        |      | (109,966 | )      |         |      | (171,251 | )      |         |   | (97,705  | )      |         |   | (40,589 | )     
|                                                            | Provision for income taxes                                      |                                       |         |       |        |      |          |       |         |      |          |       |         |   |          |       |         |   |         | 500    |       
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Net loss                                                    |                                                                 | $                                     | (87,636 | )      |        | $    | (109,966 | )      |         | $    | (171,251 | )      |         | $ | (97,705  | )      |         | $ | (41,089 | )     
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Net loss per share  basic and diluted                      |                                                                 | $                                     | (0.63   | )      |        | $    | (0.82    | )      |         | $    | (1.33    | )      |         | $ | (2.18    | )      |         | $ | (1.51   | )     
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       
|Weighted average shares outstanding 
    basic and diluted |                                                                 |                                       | 139,692 |        |        |      | 134,719  |        |         |      | 129,002  |        |         |   | 44,741   |        |         |   | 27,236  |       
|                                                            |                                                                 |                                       |         |        |        |      |          |        |         |      |          |        |         |   |          |        |         |   |         |       

12



---



##### Table of Contents



|                                              |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        | 
|--------------------------------------------- |  | -------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------ | 
|                                              |  |               
|                                              |  | December 31,  
|                                              |  |               
|                                              |  | 2003           |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                              |  |                |         |      |  |      |         |      |  |     
|                                              |  |               
|                                              |  | (In thousands)
|Consolidated Balance Sheet Data:              |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        | 
|Cash and cash equivalents                     |  | $              | 83,765  |      |  | $    | 16,613  |      |  | $    | 57,747  |  |  | $ | 259,744 |  |  | $ | 46,645 | 
|Short-term investments                        |  |                | 37,000  |      |  |      | 112,837 |      |  |      | 183,941 |  |  |   | 83,358  |  |  |   | 19,799 | 
|Working capital                               |  |                | 99,290  |      |  |      | 116,033 |      |  |      | 217,152 |  |  |   | 343,004 |  |  |   | 58,912 | 
|Total assets                                  |  |                | 171,590 |      |  |      | 197,555 |      |  |      | 309,024 |  |  |   | 412,536 |  |  |   | 99,443 | 
|Long-term obligations, net of current portion |  |                | 356     |      |  |      | 18,116  |      |  |      | 29,295  |  |  |   | 20,950  |  |  |   | 27,020 | 
|Total stockholders equity                    |  |                | 131,418 |      |  |      | 140,847 |      |  |      | 244,965 |  |  |   | 364,916 |  |  |   | 63,083 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Cost of revenue includes $1.5 million,
    $2.6 million and $28.1 million, respectively, related
    to charges taken to decrease the value of our inventory to its
    fair market value in fiscal 2003, 2002 and 2001, respectively,
    which was partially offset by the sale of previously written
    down inventory and the reversal of previously accrued inventory
    charges of $0.5 million, $1.9 million and
    $2.5 million, respectively. There were no similar charges
    in fiscal 2000 and 1999.
|   
|(2) | Restructuring recovery in fiscal 2003 primarily
    relates to adjustments in the costs related to excess
    facilities. Restructuring charges recorded in fiscal 2002
    primarily consist of $8.9 million for excess facilities,
    $1.6 million for equipment and prepaid software maintenance
    write-offs and $4.1 million related to a reduction in
    workforce.                                                                                                                                       
|   
|(3) | During the fourth quarter of 2001, we wrote-off
    $16.6 million of long-lived asset balances related to
    deferred charges under licensing agreements.                                                                                                                                                                                                                                                                                                                                                          
|   
|(4) | Stock compensation includes $1.8 million,
    $3.6 million, $16.8 million and $13.1 million in
    amortization of deferred stock compensation for the years ended
    December 31, 2003, 2002, 2001 and 2000, respectively. Stock
    compensation also includes $2.7 million, $(1.8) million and
    $4.2 million in variable stock compensation for the years
    ended December 31, 2003, 2002 and 2001, respectively.                                                                                          

13



---



##### Table of Contents








| |         |                                                                                          
| | ------- | -----------------------------------------------------------------------------------------
| | Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

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

Overview

We design, develop and sell highly efficient
x86-compatible software-based microprocessors. Since the
introduction of our first family of microprocessors in January
2000, the Crusoe series, we have derived the majority of our
revenue from the sale of these products. In October 2003, we
introduced the Efficeon TM8000 family of microprocessors,
which is our next family of x86-compatible processors, and as of
December 31, 2003 have not recognized substantial revenue
from these products. In fiscal 2003, we recognized a limited
amount of revenue from technology and trademark license
agreements. We will continue to explore additional opportunities
for licensing our advanced power management technologies to
other companies in the integrated circuit industry.

During fiscal 2002, and to a lesser extent during
the first half of fiscal 2003, our performance, and that of the
industry as a whole, was impacted negatively by the global
economic downturn and cautious IT spending. While the economic
environment remains challenging, IT spending showed signs of
improvement and there were indications of an improving economic
outlook as we exited fiscal 2003.

Our total revenue in fiscal 2003 was
$17.3 million, compared to $24.2 million in fiscal 2002.
Our total revenue decreased even though unit volume increased by
8%. This trend in revenue is primarily due to a decrease in
average selling prices as our Crusoe line of products has nearly
reached the end of its cycle in the notebook computing segment.
We had total operating expenses of $89.5 million and
$121.4 million in fiscal 2003 and fiscal 2002,
respectively. The fiscal 2002 operating expenses included a
restructuring charge of $14.7 million mostly related to the
cost of facilities and leased equipment. Net loss for fiscal
2003 was $87.6 million, while net loss for fiscal 2002 was
$110.0 million. Historically we have incurred significant
losses, and as of December 31, 2003, we had an accumulated
deficit of $542.6 million.

Pricing pressure on our TM5800 product has
increased and may continue to increase as the product has
matured and transitions into geographies and market segments,
such as the embedded and thin client markets, that traditionally
demand lower ASPs. However, we expect overall gross margins to
increase as we shift our product mix to the new
Efficeon TM8000 processor, which is targeted at the
high-volume notebook market, for which we receive higher ASPs
than those of the TM5800. We began shipment in the fourth
quarter of 2003 of our initial Efficeon TM8000
microprocessor, manufactured using a 130 nanometer CMOS
process. Our ability to generate revenues from that product
would be harmed if we were to experience delays in manufacturing
sufficient quantities of that product or if the product were not
widely accepted by the market. Further, we believe that we must
successfully complete the transition of the manufacturing of our
Efficeon TM8000 microprocessors to a 90 nanometer CMOS
process in order to achieve broad market acceptance of our
Efficeon TM8000 microprocessors and to compete in the
microprocessor market. We do not expect to begin volume shipment
of 90 nanometer Efficeon TM8000 microprocessors until
the second half of 2004.

In December of 2003, we received net proceeds,
before expenses, of $68.2 million related to an issuance of
25.0 million shares of our common stock. In January of
2004, we received additional net proceeds of $10.2 million,
before expenses, when our underwriters exercised their
over-allotment option to purchase an additional
3.75 million shares of our common stock. We have
historically reported negative cash flows from operations, and
we intend to rely on funds that we have received from financing
activities until we are able to generate sufficient revenue and
related gross profit to cover operational expenses as well as
anticipated increases in our working capital other than cash.
Our ability to increase sales of our Crusoe TM5800 products
into additional market segments, achieve wide market acceptance
of our initial Efficeon TM8000 microprocessor manufactured
using a 130 nanometer process and successfully transition
our Efficeon TM8000 microprocessor to a 90 nanometer
process will be particularly critical in determining our cash
needs.

14



---



##### Table of Contents



For ease of presentation, the accompanying
financial information has been shown as of December 31 for
all annual financial statement captions. Fiscal years 2003, 2002
and 2001 each consisted of 52 weeks and ended on
December 26, December 27 and December 28,
respectively.

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 judgments on the part of management.

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



| |   |                                               
| | - | ----------------------------------------------
| |  | License revenue recognition;                  
|
| |  | Estimation of inventory valuations;           
|
| |  | Valuation of long-lived and intangible assets;
|
| |  | Restructuring charges; and                    
|
| |  | Loss contingencies                            

License Revenue Recognition.We enter into technology and trademark
license agreements, some of which may contain multiple elements,
including technology licenses and support services, or
non-standard terms and conditions. As a result, interpretation
on these agreements, 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. 101, Revenue Recognition in Financial
Statements, is 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. We recognize revenue
from license agreements when earned, which generally occurs when
agreed-upon deliverables are provided, customer acceptance
criteria has been met, or milestones are met and accepted by
licensees and relative fair values of multiple elements can be
determined. Additionally, license revenues are recognized only
if payments received are non-refundable and not subject to any
future performance obligation by the Company.

Estimation of Inventory Valuations.Our inventory valuation policy
stipulates that we write-down or write-off our inventory for
estimated obsolescence or unmarketable inventory at the end of
each reporting period. The amount of the write-down or write-off
is equal to the difference between the cost of the inventory and
the estimated market value of the inventory based upon
reasonable assumptions about future demand and market
conditions. If actual market conditions are less favorable than
those projected by management, additional inventory write-downs
or write-offs may be required. Conversely, if demand for
estimated excess or obsolete materials exceeds our original
estimates, or the sales prices for previously reserved materials
are higher than anticipated, our gross margins would benefit to
the extent that the associated revenue exceeds the
materials adjusted value. Additionally, as we introduce
product enhancements and new products, and improve our
manufacturing processes, demand for our existing products in
inventory may decrease. Inventory on hand in excess of
forecasted demand, which is generally twelve months or less, is
not valued. At the end of the second quarter of 2001, consistent
with this policy, we recorded a charge of $28.1 million
primarily to write-off certain older inventory products as a
result of an actual decrease of future demand for these older
products. Additionally, we made adjustments of $1.5 million
and $2.6 million for fiscal 2003 and 2002, respectively, to
decrease the value of our inventory in response to lower demand
and lower average selling prices expected in future periods for
some of our products. For fiscal 2003, the Companys gross
margins included a benefit of $0.5 million resulting from
the sale of previously reserved inventory. For fiscal 2002, the
Company recognized $0.7 million in gross margin related to
the sale of inventory for which the value had been written down
in previous periods.

15



---



##### Table of Contents



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

Restructuring Charges.In fiscal 2002, in accordance with
EITF Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring), we accrued for restructuring costs when we
made a commitment to a firm exit plan that specifically
identified all significant actions to be taken in conjunction
with our response to a change in our strategic plan, product
demand, increased costs or other environmental factors. As part
of the 2002 restructuring plan, we recorded restructuring
charges of $10.6 million primarily related to lease costs
and equipment write-offs. We recorded restructuring charges of
$4.1 million related to a reduction in workforce during the
third quarter of fiscal 2002. Our assumptions used in
determining the estimation of restructuring expenses include the
determination of the period that it will take to sublet our
vacated premises, the market price that we would be able to
command for the subleased space and the interest rate used to
determine the present value of our future lease obligations. Any
significant variation in these estimates compared to actual
results may have a material impact on our restructuring expenses
and our operating results. We reassess the restructuring
accruals on a quarterly basis to reflect changes in the costs of
the restructuring activities. The most significant variables of
our accrued restructuring costs are the period that it will take
to sublet our vacated premises and the market price at which we
believe that we will be able to sublet our vacated facilities.
For example, if it is determined that the rate for which we are
able to sublease our vacated space is less than our assumed
rate, our restructuring charges could significantly increase as
a result. Additionally, if it takes longer than expected to
sublease our vacated space, additional restructuring charges may
be incurred. When reassessing our estimates, we incorporate the
most recently available industry data regarding relevant
occupancy and lease cost rates. We have found that these
variables are often difficult to predict as there are many
uncertainties related to the commercial real estate market in
which we are attempting to sublet our vacated facilities. During
the fourth quarter of fiscal 2003, we adjusted the balance in
our accrued restructuring costs and recorded a benefit of
$244,000 to restructuring charges. This adjustment was the
result of an update in assumptions regarding the Companys
internal use of previously vacated office space, as well as the
anticipated length of time before our vacated facilities are
sublet to others.

Loss Contingencies.We are subject to the possibility of
various loss contingencies arising in the normal course of
business. In accordance with SFAS No. 5,
Accounting for Contingencies, we accrue for a loss
contingency when it is probable that a liability has been
incurred and we can reasonably estimate the amount of loss. We
regularly assess current information available to determine
whether changes in such accruals are required.

Description of Operating Accounts

Total Revenue.Total
revenue currently consists primarily from product sales, net of
returns and allowances and, to a lesser extent, from licensing.

Gross Margin.Cost
of revenue consists primarily of the costs of manufacturing,
assembly and testing of our silicon chips, and compensation and
associated costs related to manufacturing support, logistics and
quality assurance personnel. On occasion, cost of revenue may
additionally include a component for adjustments to the
valuation of certain inventories based on lower demand and
average selling prices expected

16



---



##### Table of Contents



in future periods. Gross margin is the percentage
derived from dividing gross profit by revenue. Our gross margin
each quarter is affected by a number of factors, including
competitive pricing, mix, foundry pricing, yields, production
flow costs and speed distribution of our products.


Research and Development.Research and development expenses
consist primarily of salaries and related overhead costs
associated with employees engaged in research, design and
development activities, as well as the cost of masks, wafers and
other materials and related test services and equipment used in
the development process.

Purchased In-Process Research and Development.Purchased in-process research and
development resulted from our licensing of certain computing
technologies and intellectual property from Advanced Micro
Devices, or AMD, in April 2001.

Selling, General & Administrative.Selling, general and administrative
expenses consist of salaries and related overhead costs for
sales, marketing and administrative personnel and legal and
accounting services.

Restructuring Charges.Restructuring charges resulted from
our decision in 2002 to cease development and productization of
a previous generation of microprocessors. The restructuring
charges consisted primarily of lease costs, employee severance
and termination costs, equipment write-offs and other costs.

Amortization of Deferred Charges, Patents and
Patent Rights.These charges primarily
relate to various patents and patent rights acquired from Seiko
Epson and others during fiscal 2001.

Impairment Write-off of Deferred Charges.The impairment of deferred charges was
recorded in fiscal 2001 after the emergence of indicators of
impairment related to technology license agreements with IBM and
Toshiba prompted an assessment of the carrying value of these
deferred charges. This led to a write-off of the entire carrying
value of these deferred charges.

Stock Compensation.There were two components to stock
compensation expense during these periods. The first component
is the amortization of deferred stock compensation associated
with options granted prior to November 2000, net of
cancellations. The second component is the application of
variable accounting for certain stock option grants. During the
fourth quarter of fiscal 2001, we did not enforce the recourse
provisions of certain employee notes associated with option
exercises. Therefore, we account for all other outstanding notes
as if they had terms equivalent to non-recourse notes, even
though the terms of these notes were not in fact changed from
recourse to non-recourse. As a result, we have and will continue
to record adjustments related to variable stock option
accounting on the associated stock awards until the notes are
paid. This variable stock compensation charge is based on the
excess, if any, of the current market price of our stock as of
the period-end over the purchase price of the stock award,
adjusted for vesting and prior stock compensation expense
recognized on the stock award.

Interest Income and Other, Net and Interest
Expense.Interest income and other,
net consist of the interest income on our average cash balances
over a given period of time. Interest expense is primarily based
on the accretion of long-term property lease obligations related
to office space that was vacated as part of our 2002
restructuring.

17



---



##### Table of Contents





| |                      
| | ---------------------
| | Results of Operations

Changes to
Previously Announced Fiscal 2003 Fourth Quarter and Annual
Results

On January 15, 2004, we announced our fiscal
2003 fourth quarter and annual results. In conjunction with the
filing of this annual report, we are required to reassess all
significant estimates and judgments made in the financial
statements for the period, considering any additional
information that is available as of the filing date. This
updated analysis includes information that was not available at
the time we announced our fiscal 2003 results. In light of newly
available information and after considering all available
evidence, we concluded that recording additional operating
expenses of $0.3 million in the fourth quarter of fiscal
2003 was appropriate.

The adjustment relates to an update to our
estimates for bad debt exposure as well as expenditures recorded
by us subsequent to the January 15, 2004 earnings release,
but related to the fourth fiscal quarter of 2003. Both of these
charges were partly offset by an update to our estimates related
to our restructuring accrual, to reflect an update in
assumptions regarding our internal use of previously vacated
office space, as well as to reflect our success, subsequent to
the balance sheet date, in subleasing a portion of vacated
facilities earlier than previously anticipated and at a rate
that differed from previous estimates.

As a result of the $0.3 million adjustment,
our fiscal fourth quarter 2003 net loss was $21.9 million,
or a loss of $0.15 per share, compared to $21.6 million, or
a loss of $0.15 per share, as previously announced. For the
full fiscal year, the net loss was $87.6 million, or a loss
of $0.63 per share, compared to $87.3 million, or a loss of
$0.62 per share, as previously announced.



| |              
| | -------------
| | 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 revenue, for each
computing market segment, is presented as a percentage of total
revenue in the following table:

|         |                     |              |    |      |  |      |     |     |  |  |     |     | 
|-------- | ------------------- | ------------ | -- | ---- |  | ---- | --- | --- |  |  | --- | --- | 
|         |                     |             
|         |                     | Years Ended 
|         |                     | December 31,
|         |                     |             
|         |                     | 2003         |    | 2002 |  | 2001
|         |                     |              |    |      |  |     
|Product: |                     |              |    |      |  |      |     |     |  |  |     |    
|         | Notebook computers  |              |    | 42%  |  |      |     | 82% |  |  |     | 76% | 
|         | Tablet PCs         |              |    | 27%  |  |      |     | 6%  |  |  |     | 2%  | 
|         | Thin client desktop |              |    | 17%  |  |      |     | 6%  |  |  |     | n/a | 
|         | Embedded/ servers   |              |    | 6%   |  |      |     | 5%  |  |  |     | 20% | 
|         | UPCs                |              |    | 2%   |  |      |     | 1%  |  |  |     | 2%  | 
|License: |                     |              | 6% |      |  |      | n/a |     |  |  | n/a |    

During fiscal 2003, we recognized
$1.1 million of technology and trademark license revenue
related to certain license agreements that we entered into
during the year. We continue to explore additional opportunities
for licensing our advanced power management technologies to
other companies in the integrated circuit industry. For example,
we believe our proprietary LongRun2 leakage control technology
could be valuable to the semiconductor industry and could
generate significant future licensing revenues for us without
impairing our microprocessor product business.

18



---



##### Table of Contents



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

|        |               |                          |        |        |  |      |        |        |  |   |        |        | 
|------- | ------------- | ------------------------ | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|        |               |                         
|        |               | Years Ended December 31,
|        |               |                         
|        |               | 2003                     |        | 2002   |  | 2001
|        |               |                          |        |        |  |     
|        |               |                         
|        |               | (In thousands)          
|Product |               | $                        | 16,225 |        |  | $    | 24,247 |        |  | $ | 35,590 |       
|License |               |                          | 1,090  |        |  |      |       |        |  |   |       |       
|        |               |                          |        |        |  |      |        |        |  |   |        |       
|        | Total revenue |                          | $      | 17,315 |  |      | $      | 24,247 |  |   | $      | 35,590 | 
|        |               |                          |        |        |  |      |        |        |  |   |        |       

Fiscal 2003 Compared to Fiscal 2002.Total revenue was $17.3 million
for fiscal 2003 compared to $24.2 million for fiscal 2002,
representing a decrease of $6.9 million, or 28.5%.
Excluding the effects of a sale of previously written down
inventory in the third quarter of fiscal 2002, this decline can
be attributed to a decrease in average selling prices, or ASPs,
of 36.0% from fiscal 2002 to fiscal 2003, partially offset by an
increase in unit volume of 8%. The increase in volume primarily
resulted from an increase of our products into the tablet PC and
thin client markets and an expansion of our international sales,
particularly into China, Hong Kong and Taiwan. See Gross
Margin section below for further discussion on the effects
of decreases in ASPs and increases in volume.

Pricing pressure on the TM5800 has increased and
may continue to increase as the product has matured and
transitions into geographies and market segments that
traditionally demand lower ASPs. We will continue to manufacture
the TM5800 as we have begun to migrate the processor into market
segments such as the embedded, thin client, and ultra personal
computer markets, from which we expect the processor to derive
the majority of its future revenue. The Efficeon product is
targeted at the high-volume notebook market, which traditionally
demands higher ASPs. We started shipping the Efficeon product in
the fourth quarter of fiscal 2003. Revenue recognized from sales
of this product represented less than 5% of total fiscal 2003
revenue.

Revenue recognized in fiscal 2003 also included
license revenue, which was earned in connection with technology
and trademark license agreements during the year. Total
licensing revenue was $1.1 million for fiscal 2003. Fiscal
2002 did not include any license revenues.

Fiscal 2002 Compared to Fiscal 2001.Revenue for fiscal 2002 was $24.2
million compared to $35.6 million for fiscal 2001,
representing a decrease of $11.4 million, or 32.0%. This
decrease was due to several factors, including production
difficulties at the beginning of fiscal 2002, decreases in
average selling prices during fiscal 2002, as well as
unfavorable global economic conditions and reduced information
technology spending, particularly in Japan. During fiscal 2002
and 2001, demand for our products continued to depend primarily
on sales by our OEM customers of notebook computers that
incorporate our products. We did not have any licensing revenue
in fiscal 2002 or 2001.

19



---



##### Table of Contents





| |             
| | ------------
| | Gross Margin

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

|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |       |       |       |  
|---------------- | -------------------------------------------------------------------------------------------- | ------------------------ | --------------------- | ---- | ----- | ---- | - | ----- | ----- | ---- | - | ----- | ----- | ----- | -
|                 |                                                                                              |                         
|                 |                                                                                              | Years Ended December 31,
|                 |                                                                                              |                         
|                 |                                                                                              | 2003                     |                       | 2002 |       | 2001
|                 |                                                                                              |                          |                       |      |       |     
|Revenue:         |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 | Product                                                                                      |                          |                       | 93.7 | %     |      |   | 100.0 | %     |      |   | 100.0 | %    
|                 | License                                                                                      |                          |                       | 6.3  | %     |      |   |      | %     |      |   |      | %    
|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 |                                                                                              | Total revenue            |                       |      | 100.0 | %    |   |       | 100.0 | %    |   |       | 100.0 | %    
|Cost of revenue: |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 | Product Cost                                                                                 |                          |                       | 75.7 | %     |      |   | 60.3  | %     |      |   | 62.0  | %    
|                 | Underabsorbed overhead                                                                       |                          |                       | 12.0 | %     |      |   | 7.3   | %     |      |   | 3.0   | %    
|                 | Charges for inventory adjustments                                                            |                          |                       | 8.5  | %     |      |   | 10.8  | %     |      |   | 70.4  | %    
|                 | Charges for inventory purchase commitments                                                   |                          |                       |     | %     |      |   |      | %     |      |   | 8.5   | %    
|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 |                                                                                              | Cost of product revenue  |                       |      | 96.2  | %    |   |       | 78.4  | %    |   |       | 143.9 | %    
|                 |                                                                                              | Cost of license revenue  |                       |      | 0.8   | %    |   |       |      | %    |   |       |      | %    
|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 |                                                                                              |                          | Total cost of revenue |      |       | 97.0 | % |       |       | 78.4 | % |       |       | 143.9 | %
|                 | Benefits to gross margin from the favorable
    settlement of inventory purchase commitments |                          |                       |     | %     |      |   | 4.8   | %     |      |   | 2.3   | %    
|                 | Benefits to gross margin from the sale of
    previously reserved inventory                  |                          |                       | 2.7  | %     |      |   | 3.0   | %     |      |   | 4.8   | %    
|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      
|                 |                                                                                              | Gross margin             |                       |      | 5.7   | %    |   |       | 29.4  | %    |   |       | (36.8 | )%   
|                 |                                                                                              |                          |                       |      |       |      |   |       |       |      |   |      

Fiscal 2003 Compared to Fiscal 2002.Gross margin was 5.7% for fiscal 2003
compared to 29.4% for fiscal 2002, representing a decrease of
23.7 percentage points. Before the benefits from the sale
of previously written down inventory and the settlement of
previously recorded inventory purchase commitments, our cost of
product revenue was 97.0% of total revenue for fiscal 2003, and
78.4% of total revenue for fiscal 2002. As a percent of total
revenue, our product costs increased 15.4 percentage points,
from 60.3% to 75.7%, mostly as a result of a decrease in average
selling prices, which is used as a component of the denominator
in this calculation. Partially offsetting this decline in
average selling prices was a reduced average dollar cost of
products sold in fiscal 2003 as compared to fiscal 2002. The
reduced average product cost is attributed to reduced costs to
manufacture our Crusoe TM5800 product. Additionally, we
experienced production difficulties in fiscal 2002 which
increased our costs to manufacture product during that period.

Gross margin was adversely affected during both
years by unabsorbed overhead costs as our production-related
infrastructure exceeded our needs. For fiscal 2003, these
unabsorbed costs were $2.1 million, or 12.0% of total
revenue, compared to $1.8 million, or 7.3% of total
revenue, for the same period in the prior year. We expect to
increase the utilization of our manufacturing overhead in coming
periods as we shift our product mix to the Efficeon TM8000, and
as the volume of shipments of our Crusoe TM5800 product
increases.

In fiscal 2003 and fiscal 2002 our gross margin
was adversely affected by adjustments to our inventory valuation
in response to lower demand and lower average selling prices
expected in future periods for some of our products. For the
year ended December 31, 2003, these adjustments totaled
$1.5 million, or 8.5% of total revenue compared to
$2.6 million, or 10.8% of total revenue for the same period
in the prior year. Of the $8.8 million and
$10.9 million of inventory on hand at December 31,
2003 and 2002, respectively, $2.6 million and
$2.8 million of inventory, respectively, was stated at net
realizable value. Accordingly, gross margin may benefit from
future sales of these parts to the extent that the associated
revenue exceeds their currently adjusted values. In fiscal 2003,
the Companys gross margin included a benefit of
$0.5 million resulting from the sale of previously reserved
inventory. In fiscal 2002 the Company recognized
$0.7 million in gross margin

20



---



##### Table of Contents



related to the sale of inventory for which the
value had been written down in previous periods at amounts in
excess of the average selling prices used to record their lower
of cost or market valuation. In fiscal 2002 we additionally
recorded a benefit to gross margin sold in the amount of
$1.2 million related to the reversal of previously accrued
inventory-related purchase commitments due to favorable
settlements of such purchase commitments.


We recorded licensing revenues of
$1.1 million in fiscal 2003, for which we recorded gross
profit of $1.0 million, or 5.8% of total revenue. We
continue to explore additional opportunities for licensing our
advanced power management technologies to other companies in the
integrated circuit industry, which could have a favorable impact
on our future gross margins.

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



| |                         
| | ------------------------
| | Research and Development

Fiscal 2003 Compared to Fiscal 2002.Research and development was
$48.5 million for fiscal 2003 compared to
$63.6 million for fiscal 2002, representing a decrease of
$15.1 million, or 23.7%. The majority of the decrease for
the year can be attributed to our workforce reduction in the
third quarter of fiscal 2002, which resulted in lower
compensation and benefit costs and consultant fees. We
additionally incurred less non-recurring engineering charges in
fiscal 2003, in part due to a $1.6 million charge in the
second quarter of 2002 for engineering related silicon and mask
sets for products that the Company ceased development. The
majority of research and development spending in fiscal 2003 was
for our next family of microprocessors, the Efficeon TM8000. We
also devoted additional research and development resources
towards our next generation 90 nanometer manufacturing
technology as well as our recently announced LongRun2 power
management technology. The remaining portion of the fiscal 2003
research and development expenditure was used for sustaining
engineering efforts on our TM5800 microprocessor. We anticipate
that we may increase our research and development spending in
the future in order to properly invest in our next generation
90 nanometer manufacturing technology, as well as further
develop our LongRun2 power management technology.

Fiscal 2002 Compared to Fiscal 2001.Research and development was
$63.6 million in fiscal 2002 compared to $67.6 million
in fiscal 2001, representing a decrease of $4.0 million, or
5.9%. This decrease was primarily due to lower employee
compensation and benefit costs and consultant fees related to
our reduction in workforce in the third quarter of fiscal 2002.
Additionally, depreciation expense decreased in fiscal 2002 as a
result of the write-off of certain fixed assets related to our
restructuring activities in the second quarter of fiscal 2002.
These decreases were partially offset by an increase in
prototype expenditures related to updates of our existing
microprocessors, as well as our next family of microprocessors.



| |                                                  
| | -------------------------------------------------
| | Purchased In-Process Research and
    Development

Purchased in-process research and development was
$13.6 million in fiscal 2001. We did not have a similar
expense in fiscal 2003 or fiscal 2002. In April 2001, we
licensed certain computing technologies and intellectual
property from AMD, including AMDs HyperTransport
interconnect technology for our products and technology
initiatives, for which we must pay royalties to AMD based upon
shipments of our products that incorporate such technologies,
beginning with our Efficeon TM8000 microprocessor. As initial
consideration for the patents and patent rights licensed under
the agreement, we issued 1,000,000 unregistered shares of our
common stock valued at $15.0 million based upon the average
closing price of our stock prior to issuance. For accounting
purposes, however, the value of the shares was determined using
the closing price of the stock at the date of issuance, or
$13.60, resulting in a recorded value of $13.6 million. The
entire $13.6 million was

21



---



##### Table of Contents



expensed as purchased in-process research and
development during the second quarter of 2001 because the
HyperTransport technology is designed for use in products that
had been in research and development at that time.




| |                                        
| | ---------------------------------------
| | Selling, General and
    Administrative

Fiscal 2003 Compared to Fiscal 2002.Selling, general and administrative
was $26.2 million for fiscal 2003 compared to
$29.9 million for fiscal 2002, representing a decrease of
$3.7 million, or 12.4%. A significant portion of this
decrease was due to lower compensation and benefit costs,
consultant fees and recruiting costs related to our reduction in
workforce in the third quarter of fiscal 2002. Additionally, as
a result of our 2002 restructuring charge, for fiscal 2003 we
recorded lower facilities-related charges, including rent and
building maintenance costs. These decreases were partly offset
by increases in other areas, including higher corporate
insurance costs and expenditures for patent protection of our
inventions. In fiscal 2003 the primary focus of our marketing
expenses was to promote the awareness of our new Efficeon TM8000
processor. We may increase our selling costs as we plan to
initiate a marketing alliance program that is specifically
designed and structured to promote our customers products,
to drive awareness, foster market opportunities, and help
generate sales.

Fiscal 2002 Compared to Fiscal 2001.Selling, general and administrative
was $29.9 million in fiscal 2002 compared to
$35.5 million in fiscal 2001, representing a decrease of
$5.6 million, or 15.8%. This decrease was primarily due to
lower employee compensation and benefit costs and consultant
fees related to our reduction in workforce in the third quarter
of fiscal 2002. Additionally, our efforts to reduce overall
operating expenses resulted in decreases in travel, trade show
and advertising costs during the third and fourth quarters of
fiscal 2002. These decreases were partially offset by increases
in insurance renewal premiums for our various corporate
insurance policies.



| |                      
| | ---------------------
| | Restructuring Charges

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

As a result of our workforce reduction completed
in the third quarter of fiscal 2002, we vacated a total of
approximately 67,730 square feet of office space in Santa
Clara, California. As part of our quarterly reassessment of
restructuring accruals, during the fourth quarter of fiscal
2003, we adjusted the restructuring reserve balance as a result
of an update in assumptions regarding our internal use of
previously vacated office space, as well as the anticipated
length of time before vacated facilities are sublet to others.
As a result of this update, we adjusted the balance in accrued
restructuring costs and recorded a benefit of $244,000 to
restructuring charges. We may need to adjust our restructuring
accruals in the future as circumstances change and as we make
our quarterly reassessment.

Amortization
of Deferred Charges, Patents and Patent Rights

Amortization charges for fiscal 2003, 2002 and
fiscal 2001 relate to various patents and patent rights acquired
from Seiko Epson and others during fiscal 2001. Amortization
charges for fiscal 2001 also include charges related to our IBM
and Toshiba technology license agreements, as amended, which
were originally entered into during fiscal 1997 and 1998,
respectively. See Note 4 and Note 5 in the Notes
to Consolidated Financial Statements for further
discussion of our technology license agreements and patents and
patent rights.

Fiscal 2003 Compared to Fiscal
2002.Amortization of deferred
charges, patents and patent rights was $10.5 million for
fiscal 2003 compared to $11.4 million for fiscal 2002,
representing a decrease of $0.9 million, or 7.9%. This
decrease can be attributed to a reduction in payments due under
our patent and patent rights and

22



---



##### Table of Contents



our technology license agreement with IBM, as
amended. Amounts due under the agreements decreased
$16.0 million, from $39.5 million at December 31,
2002 to $23.5 million at December 31, 2003.


Fiscal 2002 Compared to Fiscal
2001.We recorded amortization of
deferred charges, patents and patent rights of
$11.4 million in fiscal 2002 compared to $17.6 million
in fiscal 2001, representing a decrease of $6.2 million, or
35.2%. Amortization of deferred charges, patents and patent
rights relate to various patents and patent rights acquired from
Seiko Epson and others during fiscal 2001. Amortization charges
for fiscal 2001 also include charges related to our IBM and
Toshiba technology license agreements, as amended, which were
originally entered into during fiscal 1997 and 1998,
respectively. The decrease was due to the impairment charge
recorded during the fourth quarter of fiscal 2001 to adjust the
IBM and Toshiba license agreements to their respective fair
values, resulting in no additional amortization expenses being
recorded in fiscal 2002 related to these deferred charges.



| |                                             
| | --------------------------------------------
| | Impairment Write-off of Deferred
    Charges

Impairment write-off of deferred charges was
$16.6 million in fiscal 2001. We did not have an impairment
write-off of deferred charges in fiscal 2003 or 2002. Although
these deferred charges were impaired and written off, the
associated remaining payments due to IBM are still required and
will continue to accrete interest until the final payment of
$16.0 million is made in December 2004. See Note 4 in
the Notes to Consolidated Financial Statements for
further discussion of the impairment writeoff.



| |                   
| | ------------------
| | Stock Compensation

Fiscal 2003 Compared to Fiscal
2002.Stock compensation was
$4.5 million for fiscal 2003 compared to $1.8 million
for fiscal 2002, representing an increase of $2.7 million.
The two components of stock compensation were the amortization
of deferred stock compensation and variable stock compensation.
Net amortization of deferred stock compensation for fiscal 2003
was $1.8 million compared to $3.6 million for fiscal
2002. This decrease was primarily a result of amortizing the
deferred charge on an accelerated method in accordance with our
accounting policy, as well as a decrease in the number of
outstanding options affecting the compensation charge as a
result of cancellations in connection with our reduction in
workforce in the third quarter of fiscal 2002. In connection
with stock options granted prior to November 2000, we expect to
record amortization of deferred stock compensation of
$0.7 million in 2004. Variable stock compensation for
fiscal 2003 was $2.7 million, compared to a credit of
$1.8 million for the same period last year. This charge is
based on the excess, if any, of the current market price of our
stock as of the period-end over the purchase price of the stock
award, adjusted for vesting and prior stock compensation expense
recognized on the stock award. The increase in the variable
stock compensation component primarily resulted from a higher
market price of our stock as of December 31, 2003, compared
to the same period in the prior year.

Fiscal 2002 Compared to Fiscal
2001.Stock compensation was
$1.8 million for fiscal 2002 compared to $21.0 million
for fiscal 2001, representing a decrease of $19.2 million,
or 91.4%. Amortization of deferred stock compensation associated
with options granted prior to November 2000, net of
cancellation, was $3.6 million in fiscal 2002, compared to
$16.8 million in fiscal 2001. The decrease was primarily a
result of amortizing the deferred charge on an accelerated
graded method, as well as a credit recorded to stock
compensation expense of $1.7 million in the third quarter
of fiscal 2002 related to our workforce reduction. In addition,
the credit to deferred compensation expense for cancellations
was $3.4 million and $3.1 million for fiscal 2002 and
2001, respectively. Variable stock compensation for fiscal 2002
was a credit of $1.8 million. Stock compensation expense in
fiscal 2001 included $2.5 million in variable stock
compensation as well as a charge of $1.7 million for the
forgiveness of interest related to officer resignations



| |                                                        
| | -------------------------------------------------------
| | Interest Income and Other, Net and Interest
    Expense

Fiscal 2003 Compared to Fiscal
2002.Interest income and other, net
for fiscal 2003 was $1.4 million compared to
$5.0 million for fiscal 2002, representing a decrease of
$3.6 million, or 72.0%. This decrease was due to lower
average invested cash balances during fiscal 2003 as we
continued to use cash to fund operations, as well as a decrease
in interest rates earned on investments during the period.
Interest expense for fiscal 2003

23



---



##### Table of Contents



was $0.5 million compared to
$0.6 million for fiscal 2002, representing a decrease of
$0.1 million, or 16.7%. This decrease was primarily the
result of lower average debt balances due to several
lease-financing arrangements expiring during 2002, offset by
increases in certain accretion expenses related to our
facilities lease commitments.


Fiscal 2002 Compared to Fiscal 2001.Interest income and other, net was
$5.0 million in fiscal 2002 compared to $14.7 million
in fiscal 2001, representing a decrease of $9.7 million, or
66.0%. This decrease was due to a decrease in the average
invested cash balances during 2002 as we continue to use cash to
fund operations, as well as a significant decrease in interest
rates earned on investments during the period. Interest expense
was $0.6 million in fiscal 2002 compared to
$1.1 million in fiscal 2001, representing a decrease of
$0.5 million, or 45.5%. This decrease was the result of
lower average debt balances due to several lease-financing
arrangements expiring during 2002.



| |                           
| | --------------------------
| | Provision for Income Taxes

We recorded an income tax provision of $32,000
for fiscal 2003, which represented foreign income taxes, and is
included in interest income and other, net. Our provision for
income taxes in fiscal 2003 differed from the tax benefit that
would be derived from applying the federal statutory rate to the
loss before taxes primarily due to foreign income taxes and an
increase in valuation allowance for deferred tax assets. For
fiscal 2002, we recorded an income tax provision of $21,000,
which represented foreign income taxes. No provision was
recorded for income taxes in fiscal 2001.

As of December 31, 2003, we had deferred tax
assets of approximately $182.0 million. Based upon the
weight of available evidence, which includes our historical
operating performance, we have provided a full valuation
allowance against our net deferred tax assets as it is more
likely than not that the deferred tax assets will not be
realized. The valuation allowance increased by approximately
$29.0 million, $40.8 million and $53.5 million
for fiscal 2003, 2002, and 2001, respectively.

As of December 31, 2003, we had federal net
operating loss and research and development credit carryforwards
of approximately $386.7 million and $9.0 million,
respectively. The federal net operating loss and tax credit
carryforwards will expire beginning in 2010, if not utilized. We
also had state net operating loss and tax credits carryforwards
of approximately $109.0 million and $10.1 million,
respectively. The state net operating loss will expire beginning
in 2005, if not utilized. The state research and development tax
credits carry forward indefinitely.

Utilization of the net operating loss
carryforwards and tax credit carryforwards may be subject to a
substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as
amended, and similar state provisions. The annual limitation may
result in the expiration of net operating loss carryforwards and
tax credit carryforwards before utilization.

Liquidity and Capital Resources

|                                                        |  |                          |         |      |  |      |         |   |  |   |          |  
|------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | -------- | -
|                                                        |  |                         
|                                                        |  | Years Ended December 31,
|                                                        |  |                         
|                                                        |  | 2003                     |         | 2002 |  | 2001
|                                                        |  |                          |         |      |  |     
|                                                        |  |                         
|                                                        |  | (In thousands)          
|Net cash used in operating activities                   |  | $                        | (64,467 | )    |  | $    | (93,918 | ) |  | $ | (80,621  | )
|Net cash provided by/(used in) investing
    activities |  |                          | 58,556  |      |  |      | 49,679  |   |  |   | (118,205 | )
|Net cash provided by/(used in) financing
    activities |  |                          | 73,063  |      |  |      | 3,105   |   |  |   | (3,171   | )
|                                                        |  |                          |         |      |  |      |         |   |  |   |          |  
|Increase/(Decrease) in cash and cash equivalents        |  | $                        | 67,152  |      |  | $    | (41,134 | ) |  | $ | (201,997 | )
|                                                        |  |                          |         |      |  |      |         |   |  |   |          |  



| |                    
| | -------------------
| | Cash and Cash Flows

We have historically reported negative cash flows
from operations as the gross profit generated from our product
and licensing revenues have not been sufficient to cover our
operating cash requirements. We intend to rely on funds that we
have received from financing activities until we are able to
generate sufficient revenue

24



---



##### Table of Contents



and related gross profit to cover operational
expenses as well as anticipated increases in our working capital
other than cash. We believe that the proceeds received from
financing activities will be sufficient to fund our operations
for at least the next twelve months. However, our ability to do
so may be affected by a number of variables as noted below and
is subject to significant risks and uncertainties.


In the period through December 31, 2004 and
over the longer term, our capital requirements will depend on
many factors, including but not limited to general economic
conditions, the rate of sales growth, market acceptance of our
products, costs of securing access to adequate manufacturing
capacity, the timing and extent of research and development
projects and increases in our operating expenses. As we shift
our product mix to our next family of microprocessors, the
Efficeon TM8000, and as we continue to develop new or enhance
existing products or services in line with our business model,
we expect that, as a result of an increased level of operations,
we will need to increase our non-cash working capital, and
accordingly, the net cash which we will use in our operating
activities will increase.

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

Although we are currently not a party to any
agreement or letter of intent for a potential acquisition or
business combination, we may enter into acquisitions or business
combinations in the future, which also could require us to seek
additional equity or debt financing. If adequate funds were not
available or were not available on acceptable terms, our ability
to fund our operations, take advantage of unanticipated
opportunities, develop or enhance our products or otherwise
respond to competitive pressures would be significantly limited.

As of December 31, 2003 we had
$120.8 million in cash, cash equivalents and short-term
investments compared to $129.5 million and
$241.7 million as of December 31, 2002 and
December 31, 2001, respectively.

Net cash used in operating activities was
$64.5 million for the year ended December 31, 2003,
compared to $93.9 million for the year ended
December 31, 2002 and $80.6 million for the year ended
December 31, 2001. The cash usage during fiscal 2003 was
primarily the result of a net loss of $87.6 million, as
well as a $2.5 million net cash drawdown of accrued
restructuring charges related to building leasehold costs during
the period. This usage in cash was partially offset by the
$2.2 million decrease in accounts receivable and the
$2.1 million decrease in inventory as a result of improved
inventory management. The net loss and changes in operating
assets and liabilities were partially offset by non-cash charges
related to amortization of patents and patent rights of
$10.5 million, depreciation and amortization of
$6.0 million, and amortization of deferred compensation of
$4.5 million.

Net cash provided by investing activities was
$58.6 million for the year ended December 31, 2003,
compared to a provision of $49.7 million for the year ended
December 31, 2002 and a usage of $118.2 million for
the year ended December 31, 2001. This increase was
primarily due to $75.7 million in net proceeds from the
maturity of available-for-sale investments for fiscal 2003,
compared to net proceeds of $70.5 million for fiscal 2002
and net purchases of $100.0 million for fiscal 2001.
Offsetting this cash provided by investing activities were
payments related to the purchase of patents and patent rights
and payments to our development partner, which totaled
$16.0 million, $15.0 million, and $15.5 million,
for fiscals 2003, 2002 and 2001, respectively. The remaining
payments for these items total $23.5 million and are due
prior to December 31, 2004. Additional cash used in
investing activities included the purchase of property and
equipment, which amounted to $1.1 million,
$5.6 million, and $7.6 million for fiscals 2003, 2002
and 2001, respectively. We expect that capital equipment
purchases may increase over the coming year as we invest in our
next generation 90 nanometer manufacturing technology and
further develop our LongRun2 power management technology.

Net cash provided by financing activities was
$73.1 million for the year ended December 31, 2003,
compared to a provision of $3.1 million for the year ended
December 31, 2002 and a usage of $3.2 million for the
year ended December 31, 2001. This increase was primarily
the result of our receipt of $67.5 million in net

25



---



##### Table of Contents



proceeds related to the issuance of
25.0 million shares of our common stock in December 2003.
Additionally, we received $6.1 million in net proceeds from
sales of common stock under our employee stock purchase and
stock option plans for fiscal 2003, compared to
$4.2 million for fiscal 2002 and $2.4 million for
fiscal 2001. These proceeds from stock issuances were partially
offset by payments for debt and capital lease obligations of
$0.7 million for fiscal 2003, compared to $2.7 million
for fiscal 2002 and $5.3 million for fiscal 2001. The
decrease in payments for debt and capital lease obligations was
primarily the result of the expiration of these leases in
fiscals 2002 and 2003. Since our inception, we have financed our
operations primarily through sales of equity securities and, to
a lesser extent, from lease financing. It is reasonably possible
that we may continue to seek financing through these sources of
capital as well as other types of financing, including but not
limited to debt financing. Additional financing might not be
available on terms favorable to us, or at all. In January 2004,
we received an additional $10.2 million when our
underwriters exercised their over-allotment option to purchase
an additional 3.75 million shares of our common stock.


At December 31, 2003, we had
$83.8 million in cash and cash equivalents and
$37.0 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.



| |              
| | -------------
| | Restructuring

As part of our 2002 restructuring plan, we
recorded charges primarily for excess facilities costs for which
we expect cash expenditures of approximately $7.7 million
through June 2008. Of this amount, $6.1 million was
recorded on our consolidated balance sheets at December 31,
2003 and $1.6 million will be expensed as interest expense
in future periods as the costs are incurred or the requirements
to record the costs as a liability are met.



| |                        
| | -----------------------
| | Contractual Obligations

At December 31, 2003, we had the following
contractual obligations:

|                                      |  |                        |        |           |  |       |        |         |  |   |        |  |  |   |       | 
|------------------------------------- |  | ---------------------- | ------ | --------- |  | ----- | ------ | ------- |  | - | ------ |  |  | - | ----- | 
|                                      |  |                       
|                                      |  | Payments Due by Period
|                                      |  |                       
|                                      |  |                        |        | Less Than |  | 1-3   |        | After  
|Contractual Obligations               |  | Total                  |        | 1 Year    |  | Years |        | 4 Years
|                                      |  |                        |        |           |  |       |        |        
|                                      |  |                       
|                                      |  | (In thousands)        
|Capital Lease Obligations             |  | $                      | 778    |           |  | $     | 407    |         |  | $ | 371    |  |  |   |      | 
|Operating Leases                      |  | $                      | 20,356 |           |  | $     | 4,338  |         |  | $ | 13,633 |  |  | $ | 2,385 | 
|Unconditional Purchase Obligations(1) |  | $                      | 2,982  |           |  | $     | 2,982  |         |  |   |       |  |  |   |      | 
|Other Obligations(2)                  |  | $                      | 23,500 |           |  | $     | 23,500 |         |  |   |       |  |  |   |      | 
|                                      |  |                        |        |           |  |       |        |         |  |   |        |  |  |   |       | 
|Total                                 |  | $                      | 47,616 |           |  | $     | 31,227 |         |  | $ | 14,004 |  |  | $ | 2,385 | 



---



|    |                                                                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Purchase obligations include agreements to
    purchase goods or services that are enforceable and legally
    binding on Transmeta and that specify all significant terms,
    including: fixed or minimum quantities to be purchased; fixed,
    minimum or variable price provisions; and the approximate timing
    of the transaction.
|   
|(2) | Other obligations include payments for patent and
    patent rights and payments to our development partner.                                                                                                                                                                                                                               



| |                                   
| | ----------------------------------
| | Off-Balance Sheet
    Arrangements

As part of our ongoing business, we do not
participate in transactions that generate relationships with
unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special
purpose entities (SPEs), which would have been
established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes.
As of December 31, 2003, we are not involved in SPE
transactions.

26



---



##### Table of Contents



Recent Accounting Pronouncements

In January 2003, the FASB issued FASB
Interpretation No. 46 (FIN 46) Consolidation of
Variable Interest Entities. FIN 46 requires a variable
interest to be consolidated by a company if that company is
subject to a majority of the risk of loss from the variable
interest entitys activities, entitled to receive a
majority of the entitys residual returns or both. A
variable interest entity (VIE) is a corporation,
partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the
entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables,
real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development
or other activities on behalf of another company. In December
2003, the FASB completed deliberations of proposed modifications
to FIN 46 (Revised Interpretations) resulting
in multiple effective dates based on the nature as well as the
creation date of the VIE. FIN 46 became effective for financial
statements issued for the first reporting period ending after
December 15, 2003. The adoption of this standard did not
have a material impact on the Companys financial position
or results of operations.

Risks that Could Affect Future
Results

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

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

Since our inception, we have incurred cumulative
losses aggregating $542.6 million, including net losses of
$87.6 million in 2003, $110.0 million in 2002 and
$171.3 million in 2001, which have reduced
stockholders equity to $131.4 million at
December 31, 2003. We currently expect to continue to incur
losses under our current business plan until at least 2005.

We have financed our operations primarily through
sales of equity securities and, to a lesser extent, from product
and license revenue and lease financing. As a result of our use
of cash in the course of our business operations, our cash, cash
equivalents and short-term investments have declined from a
quarter-end high of $343.1 million as of December 31,
2000 to $120.8 million as of December 31, 2003. We cannot,
however, be sure that funds previously received from financing
activities will be sufficient to fund our operations until we
are able to generate positive cash flows from operations. See
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and Capital
Resources. However, whether we will be able to continue to
operate under our current business model until we achieve
profitability may be affected by a variety of factors, which may
include our ability to achieve market acceptance for our
Efficeon TM8000 products, significant unexpected technical or
manufacturing problems we may experience in transitioning our
Efficeon TM8000 microprocessor to a 90 nanometer
manufacturing process or any significant problems we may face in
selling our TM5800 microprocessors in additional market
segments. All of these factors are subject to significant risks
and uncertainties.



| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | Our future operating results will depend
    significantly on sales of our new Efficeon TM8000
    products.

Our future revenue and gross margins will be
influenced in large part by the level of sales of our new
Efficeon TM8000 products. Therefore, our future operating
results will depend on the demand for these products from future
customers. We have generated only limited revenue from the sale
of our Efficeon TM8000 products, the revenue from which
accounted for less than 5% of our total revenue in 2003. We just
began shipment in the fourth quarter of 2003 of our initial
Efficeon TM8000 microprocessor manufactured using a
130 nanometer complementary metal oxide semiconductor, or
CMOS, process. If we experience delays in manufacturing
sufficient quantities of microprocessors, our target customers
could design a

27



---



##### Table of Contents



competitors microprocessor into their
product, which would lead to lost sales and impede our ability
to generate market interest in our new microprocessor. If these
products are not widely accepted by the market due to
performance, price, compatibility or any other reason,
significant demand for our new products may fail to materialize.


We are seeking to transition the manufacturing of
our Efficeon TM8000 microprocessors to a 90 nanometer CMOS
process. We believe that successfully completing this transition
will be important to our ability to achieve broad market
acceptance of our Efficeon TM8000 microprocessors and to our
ability to compete, particularly in market segments in which
performance is a key competitive factor such as the notebook
personal computer and blade server markets. We cannot be sure
that we will successfully complete the development of, and
introduce, the Efficeon TM8000 microprocessor manufactured using
the 90 nanometer process. We do not expect to begin volume
shipment of 90 nanometer Efficeon TM8000 microprocessors until
the second half of 2004.



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

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



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

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

28



---



##### Table of Contents





| |                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------
| | The growth of our business depends in part
    upon the development of emerging markets and our ability to meet
    the needs of these markets.

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



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

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

Due to our software-based approach to
microprocessor design, we have been required, and expect to
continue to be required, to devote substantial resources to
educate prospective customers in the notebook computer market
about the benefits of our products and to assist potential
customers with their designs. In addition, since computer
products generally are designed to incorporate a specific
microprocessor, original equipment manufacturers, or OEMs, must
design new products to utilize different microprocessors such as
our products. Given the complexity of these computer products
and their many components, designing new products requires
significant investments. For instance, OEMs may need to design
new computer casings, basic input/output system, or BIOS,
software and motherboards. Our target customers may not choose
our products for technical, performance, packaging, novelty,
design cost or other reasons. If our products fail to achieve
widespread acceptance in the notebook computer market, our
ability to increase our revenue would likely be seriously harmed.



| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we need additional financing, we may not be
    able to raise further financing or it may only be available on
    terms unfavorable to us or our stockholders.

We have a history of substantial losses, and
expect to incur future losses. As we shift our product mix to
our next family of microprocessors, the Efficeon TM8000, and as
we continue to develop new or enhance existing products or
services in line with our business model, we expect that, as a
result of an increased level of operations, our cash
expenditures will increase. Although we intend to use the net
proceeds from the common stock offering in December 2003 to
increase our working capital and fund our operations, which are
generating significant losses, we cannot be sure that the net
proceeds from that offering will be sufficient for this purpose.
If the revenue that we generate falls below our expectations, we
could utilize our existing cash resources, including the net
proceeds of the offering, faster than we expect. In addition, we
may begin to generate positive cash flow from operations later
than anticipated or we may never generate positive cash flow
from operations.

29



---



##### Table of Contents



As a result, we may need significant additional
funds. A variety of other business contingencies could
contribute to our need for funds in the future, including the
need to:




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

If we were to raise additional funds through the
issuance of equity or convertible debt securities, the
percentage ownership of our stockholders would be reduced, and
these newly issued securities might have rights, preferences or
privileges senior to those of our then-existing stockholders.
Additional financing might not be available on terms favorable
to us, or at all. For example, in order to raise equity
financing, we may decide to sell our stock at a discount of our
then current trading price, which may have an adverse effect on
our future trading price. If adequate funds were not available
on acceptable terms or at all, our ability to fund our
operations, take advantage of unanticipated opportunities,
develop or enhance our products or otherwise respond to
competitive pressures would be significantly limited.



| |                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face intense competition in the
    x86-compatible microprocessor market. Many of our competitors
    are much larger than we are and have significantly greater
    resources. We may not be able to compete effectively.

The market for microprocessors is intensely
competitive. We may not be able to compete effectively against
current and potential competitors, especially those with
significantly greater resources and market leverage. Competition
may cause price reductions, reduced gross margins and loss of
market share, any one of which could significantly reduce our
future revenue and increase our losses. For example, we may
determine to lower the prices of our products in order to
increase or maintain market share, which would likely increase
our losses.

Significant competitors in the x86-compatible
microprocessor product market include Intel, Advanced Micro
Devices and VIA Technologies. Our current and potential
competitors have longer operating histories, significantly
greater financial, technical, product development and marketing
resources, greater name recognition and significantly larger
customer bases than we do. Our competitors may be able to
develop products comparable or superior to those we offer, adapt
more quickly than we do to new technologies, evolving industry
trends and customer requirements, and devote greater resources
to the development, promotion and sale of their products than we
can. Many of our competitors also have well-established
relationships with our existing and prospective customers and
suppliers. As a result of these factors, many of our
competitors, either alone or with other companies, have
significant influence in our target markets that could outweigh
any advantage that we may possess. For example, negotiating and
maintaining favorable customer and strategic relationships are
and will continue to be critical to our business. If our
competitors use their influence to negotiate strategic
relationships on more favorable terms than we are able to
negotiate, or if they structure relationships that impair our
ability to form strategic relationships, our competitive
position and our business would be substantially damaged.

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

30



---



##### Table of Contents



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

Furthermore, our competitors may merge or form
strategic relationships that might enable them to offer, or
bring to market earlier, products that are superior to ours in
terms of features, quality, pricing or other factors. We expect
additional competition from other established and emerging
companies and technologies.



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| | We may experience manufacturing difficulties
    that could increase the cost and reduce the supply of our
    products.

The fabrication of wafers for our microprocessors
is a highly complex and precise process that requires production
in a tightly controlled, clean room environment. Minute
impurities, difficulties in the fabrication process, defects in
the masks used to print circuits on a wafer or other factors can
cause numerous die on each wafer to be nonfunctional. The
proportion of functional die expressed as a percentage of total
die on a wafer is referred to as product yield.
Semiconductor companies frequently encounter difficulties in
achieving expected product yields, particularly when introducing
new products. Yield problems may not be identified and resolved
until a product has been manufactured and can be analyzed and
tested, if ever. As a result, yield problems are often
difficult, time-consuming and expensive to correct. We have
experienced yield problems in the past, and we may experience
yield problems in the future that impair our ability to deliver
our products to our customers, increase our costs, adversely
affect our margins and divert the efforts of our engineering
personnel. Difficulties in achieving the desired yields often
occur in the early stages of production of a new product or in
the migration of manufacturing processes to smaller geometries.
We could experience difficulties in achieving desired yields or
other manufacturing problems in the production of our initial
Efficeon TM8000 products that could delay our ability to further
introduce Efficeon TM8000 products in volume, adversely affect
our costs and gross margins and harm our reputation. In
addition, we could also experience these difficulties as we seek
to migrate the Efficeon TM8000 products to a 90 nanometer
process technology, which poses significant technical challenges
and in which neither we nor Fujitsu Microelectronics, which we
intend to use to manufacture these products, has significant
experience. Even with functional die, normal variations in wafer
fabrication can cause some die to run faster than others.
Variations in speed yield could lead to excess inventory of the
slower, less valuable die, a resulting unfavorable impact on
gross margins and an insufficient inventory of faster products,
depending upon customer demand.



| |                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------
| | Our lengthy and variable sales cycles make it
    difficult for us to predict when and if a design win will result
    in volume shipments.

We depend upon other companies designing our
microprocessors into their products, which we refer to as design
wins. Many of our targeted customers consider the choice of a
microprocessor to be a strategic decision. Thus our targeted
customers may take a long time to evaluate our products, and
many individuals may be involved in the evaluation process. We
anticipate that the length of time between our initial contact
with a customer and the time when we recognize revenue from that
customer will vary. We expect our sales cycles to range
typically from six to 12 months, or more, from the time we
achieve a design win to the time the customer begins volume
production of products that incorporate our microprocessors. We
do not have historical experience selling our products that is
sufficient for us to determine accurately how our sales cycles
will affect the timing of our revenue. Variations in the length
of our sales cycles could cause our revenue to fluctuate widely
from period to period. While potential customers are evaluating
our products and before they place an order with us, we may
incur sales and marketing expenses and expend significant
management and engineering resources without any assurance of
success. The value of any design win depends upon the commercial
success of our customers products. If our customers cancel
projects or change product plans, we could lose anticipated
sales. We can offer no assurance that we 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.

31



---



##### Table of Contents





| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | If we fail to forecast demand for our products
    accurately, we could lose sales and incur inventory
    losses.

The demand for our products depends upon many
factors and is difficult to forecast. Many shipments of our
products may be made near the end of the fiscal quarter, which
makes it difficult to estimate demand for our products. We
expect that it will become more difficult to forecast demand as
we introduce new products and as competition in the markets for
our products intensifies. Significant unanticipated fluctuations
in demand have caused, and in the future could cause, problems
in our operations.

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

We currently derive a substantial portion of
our revenue from a small number of customers, and our revenue
would decline significantly if any major customer were to
cancel, reduce or delay a purchase of our products.

Sales to four customers in the aggregate
accounted for 71% of net revenue in 2003. These customers are
located in Asia, which subjects us to economic cycles in that
area as well as the geographic areas in which they sell their
products containing our microprocessors. We expect that a small
number of customers and distributors will continue to account
for a significant portion of our revenue. Our future success
will depend upon the timing and size of future purchase orders,
if any, from these customers and new customers and, in
particular:



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

We expect that our sales to OEM customers will
continue to be made on the basis of purchase orders rather than
long-term commitments. In addition, customers can delay, modify
or cancel orders without penalty. Many of our customers and
potential customers are significantly larger than we are and
have sufficient bargaining power to demand reduced prices and
favorable nonstandard terms. The loss of any major customer, or
the delay of significant orders from these customers, could
reduce or delay our recognition of revenue.

We have entered into distributor agreements and
rely in part on distributors and stocking representatives for
sales of our products in large territories, including Japan,
Taiwan, Hong Kong, Europe, China, Korea and North America. These
agreements do not contain minimum purchase commitments.

Additionally, we have entered into agreements
with manufacturers representatives in North America and
Europe. Any distributor, stocking representative or
manufacturers representative that fails to emphasize sales

32



---



##### Table of Contents



of our products, chooses to emphasize alternative
products or devices or to promote products of our competitors
might not sell a significant amount or any of our products.


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

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

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

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

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

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

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



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

33



---



##### Table of Contents



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.

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

34



---



##### Table of Contents



others. In addition, these problems might divert
our technical and other resources from other development
efforts. Moreover, we would likely lose, or experience a delay
in, market acceptance of the affected product or products, and
we could lose credibility with our current and prospective
customers. This is particularly significant as we are a new
entrant to a market dominated by large well-established
companies.


We are subject to general economic and market
conditions.

Our business is subject to the effects of general
economic conditions in the United States and worldwide and, in
particular, market conditions in the semiconductor and computer
industries. In 2001, 2002 and through parts of 2003, our
operating results were adversely affected by unfavorable global
economic conditions and reduced information technology spending,
particularly in Japan, where we currently generate a substantial
portion of our revenue. These adverse conditions resulted in
decreased demand for notebook computers and, as a result, our
products, which are components of notebook computers. Further,
demand for our products decreases as computer manufacturers seek
to manage their component and finished product inventory levels.
If the economic conditions in Japan and worldwide do not
improve, or worsen, we may continue to experience material
adverse effects on our business, operating results and financial
condition.

The cyclical nature of the semiconductor
industry could create fluctuations in our operating
results.

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

If we do not keep pace with technological
change, our products may not be competitive and our revenue and
operating results may suffer.

The semiconductor industry is characterized by
rapid technological change, frequent new product introductions
and enhancements, and ongoing customer demands for greater
performance. In addition, the average selling price of any
particular microprocessor product has historically decreased
substantially over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we
fail to introduce new products or product enhancements that meet
evolving customer demands. It may be difficult or costly for us,
or we may not be able, to enhance existing products to fully
meet customer demands. For instance, in order to meet the
demands of our customers for enhancement of our existing
products, we may incur manufacturing or other costs that would
harm our operating margins and financial condition. Further, we
may not achieve further design wins with current customers
unless we continue to meet their evolving needs by developing
new products. The development of new products is complex, and we
may not be able to complete development in a timely manner, or
at all. To introduce and improve products on a timely basis, we
must:



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

35



---



##### Table of Contents



We believe that we will need to continue to
enhance our products and develop new products to keep pace with
competitive and technological developments and to achieve market
acceptance for our products. We may incur significant research
and development, manufacturing or other costs that would harm
our operating margins and financial conditions, in our
development efforts. These efforts may not result in enhanced
products, or in additional product sales. Accordingly, these
investments may not provide us with an acceptable return, or any
return at all.

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

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

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

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

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

If we are unable to protect our proprietary
rights adequately, our competitors might gain access to our
technology and we might not compete successfully in our
markets.

We believe that our success will depend in part
upon our proprietary technology. We rely on a combination of
patents, copyrights, trademarks, trade secret laws and
contractual obligations with employees and third parties to
protect our proprietary rights. These legal protections provide
only limited protection and may be time consuming and expensive
to obtain and enforce. If we fail to protect our proprietary
rights adequately, our competitors might gain access to our
technology. As a result, our competitors might offer similar
products and we might not be able to compete successfully in our
market. Moreover, despite our efforts to protect our proprietary
rights, unauthorized parties may copy aspects of our products
and obtain and use information that we regard as proprietary.
Also, our competitors may independently develop similar, but not

36



---



##### Table of Contents



infringing, technology, duplicate our products,
or design around our patents or our other intellectual property.
In addition, other parties may breach confidentiality agreements
or other protective contracts with us, and we may not be able to
enforce our rights in the event of these breaches. Furthermore,
we expect that we will increase our international operations in
the future, and the laws of many foreign countries do not
protect our intellectual property rights to the same extent as
the laws of the United States. We may be required to spend
significant resources to monitor and protect our intellectual
property rights.


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

We might not experience growth in our
licensing revenues.

Although licensing revenue for fiscal 2003 was
$1.1 million, the corresponding period in 2002 did not
include any licensing revenue, and we may not recognize
significant licensing revenue in the future. License
transactions often have a long sales cycle and can result in
additional liability, such as indemnification obligations. In
addition, the amount of revenue we recognize under some of our
license transactions can depend significantly upon product sales
by the licensees, over which we will have no control. While we
anticipate that we will continue to license our technology to
licensees, we cannot predict the timing or the extent of any
future licensing revenue, and recent levels of license revenues
may not be indicative of future periods.

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

Our success depends heavily upon the
contributions of our key management and technical personnel,
whose knowledge, leadership and technical expertise would be
difficult to replace. Many of these individuals have been with
us for several years and have developed specialized knowledge
and skills relating to our technology and business. Others have
joined us in senior management roles only recently. All of our
executive officers and key personnel are employees at will. We
have no employment contracts and do not maintain key person
insurance on any of our personnel. We might not be able to
execute on our business plan if we were to lose the services of
any of our key personnel. If any of these individuals were to
leave our company unexpectedly, we could face substantial
difficulty in hiring qualified successors and could experience a
loss in productivity while any such successor develops the
necessary training and experience.

We will not be able to grow our business if we
are unable to hire, train and retain sales, marketing,
operations, engineering and finance personnel.

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

37



---



##### Table of Contents



The evolution of our business could place
significant strain on our management systems, infrastructure and
other resources, and our business may not succeed if we fail to
manage it effectively.

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

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

We believe that we must expand our international
sales and distribution operations to be successful. We have
sold, and in the future we expect to sell, most of our products
to customers in Asia. In addition, TSMC and ASE are located in
Taiwan, and the Fujitsu Microelectronics foundry we intend to
use for our initial 90 nanometer product is located in Japan. As
part of our international expansion, we have personnel in
Taiwan, Japan and Europe who provide sales and customer support.
We have appointed distributors, stocking representatives and
manufacturers representatives to sell products in Japan,
Taiwan, Hong Kong, Europe, China, Korea and North America. In
addition, we generally ship our products from a third-party
warehouse facility located in Hong Kong. In attempting to
conduct and expand business internationally, we are exposed to
various risks that could adversely affect our international
operations and, consequently, our operating results, including:



| |   |                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties and costs of staffing and managing
    international operations;                                                         
|
| |  | fluctuations in currency exchange rates;                                                                                              
|
| |  | unexpected changes in regulatory requirements,
    including imposition of currency exchange controls;                                
|
| |  | longer accounts receivable collection cycles;                                                                                         
|
| |  | import or export licensing requirements;                                                                                              
|
| |  | problems in the timeliness or quality of product
    deliveries;                                                                      
|
| |  | potentially adverse tax consequences;                                                                                                 
|
| |  | major health concerns, such as SARS;                                                                                                  
|
| |  | political and economic instability, for example
    as a result of tensions between Taiwan and the Peoples
    Republic of China; and
|
| |  | potentially reduced protection for intellectual
    property rights.                                                                  

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

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

A large portion of our expenses, including rent
and salaries, is fixed and difficult to reduce. Our expenses are
based in part on expectations for our revenue. If our revenue
does not meet our expectations, the adverse effect of the
revenue shortfall upon our operating results may be acute in
light of the fixed nature of our

38



---



##### Table of Contents



expenses. We often make many shipments of our
products at or near the end of the fiscal quarter, which makes
it difficult to estimate or adjust our operating activities
quickly in response to a shortfall in expected revenue.


The price of our common stock has been
volatile and is subject to wide fluctuations.

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



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

In addition, the stock market generally and the
market for semiconductor and other technology-related stocks in
particular experienced a decline during 2000, 2001 and through
2002, and could decline from current levels, which could cause
the market price of our common stock to fall for reasons not
necessarily related to our business, results of operations or
financial condition. The market price of our stock also might
decline in reaction to events that affect other companies in our
industry even if these events do not directly affect us.
Accordingly, you may not be able to resell your shares of common
stock at or above the price you paid. Securities litigation is
often brought against a company following a period of volatility
in the market price of its securities, and we have been subject
to such litigation in the past. Any such lawsuits in the future
will divert managements attention and resources from other
matters, which could also adversely affect our business and the
price of our stock.

Our California facilities and the facilities
of third parties upon which we rely to provide us critical
services are located in regions that are subject to earthquakes
and other natural disasters.

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

39



---



##### Table of Contents



Our certificate of incorporation and bylaws,
stockholder rights plan and Delaware law contain provisions that
could discourage or prevent a takeover, even if an acquisition
would be beneficial to our stockholders.

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



| |   |                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | establishing a classified board of directors so
    that not all members of our board may be elected at one time;                                                                  
|
| |  | providing that directors may be removed only
    for cause and only with the vote of 66 2/3% of
    our outstanding shares;                                                      
|
| |  | requiring super-majority voting to amend some
    provisions in our certificate of incorporation and bylaws;                                                                       
|
| |  | authorizing the issuance of blank
    check preferred stock that our board could issue to
    increase the number of outstanding shares and to discourage a
    takeover attempt;
|
| |  | limiting the ability of our stockholders to call
    special meetings of stockholders;                                                                                             
|
| |  | prohibiting stockholder action by written
    consent, which requires all stockholder actions to be taken at a
    meeting of our stockholders; and                                
|
| |  | establishing advance notice requirements for
    nominations for election to our board or for proposing matters
    that can be acted upon by stockholders at stockholder meetings.

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

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

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

Recently enacted and proposed changes in
securities laws and regulations are likely to increase 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. We expect these
developments to increase our legal and financial compliance
costs, and to make some activities, such as SEC reporting
requirements, more difficult. Additionally, we expect these
developments to make it more difficult and more expensive for us
to obtain

40



---



##### Table of Contents



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 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Interest Rate Risk.Our cash equivalents and short-term
investments are exposed to financial market risk due to
fluctuations in interest rates, which may affect our interest
income. As of December 31, 2003, our cash equivalents and
short-term investments included money market funds and short and
medium term corporate bonds and earned interest at an average
rate of 1.2%. Due to the relative short-term nature of our
investment portfolio, our interest income is extremely
vulnerable to sudden changes in market interest rates. We do not
use our investment portfolio for trading or other speculative
purposes.

The table below presents principle amounts and
related weighted average interest rates by year of maturity for
our investment portfolio as of December 31, 2003 (in
thousands):

|                       |              |      |        |      |   |            |        |       |   |            |   |   |  |   |        |     |   |   |        |  | 
|---------------------- | ------------ | ---- | ------ | ---- | - | ---------- | ------ | ----- | - | ---------- | - | - |  | - | ------ | --- | - | - | ------ |  | 
|                       |              | 2004 |        | 2005 |   | Thereafter |        | Total |   | Fair Value
|                       |              |      |        |      |   |            |        |       |   |           
|Cash equivalents       |              | $    | 83,765 |      |   |            |       |       |   |            |  |   |  | $ | 83,765 |     |   | $ | 83,765 | 
|                       | Average rate |      |        | 1.0  | % |            |        |      |   |            |   |  |  |   |        | 1.0 | % |   |        |  | 
|Short term investments |              | $    | 15,000 |      |   | $          | 22,000 |       |   |            |  |   |  | $ | 37,000 |     |   | $ | 37,000 | 
|                       | Average rate |      |        | 1.1  | % |            |        | 2.0   | % |            |   |  |  |   |        | 1.6 | % |   |        |  | 

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

41



---



##### Table of Contents








|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

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

|                                                      |  |      |    | 
|----------------------------------------------------- |  | ---- | -- | 
|                                                      |  | Page
|                                                      |  |     
|Report of Ernst & Young LLP, Independent
    Auditors |  |      | 43 | 
|Consolidated Balance Sheets                           |  |      | 44 | 
|Consolidated Statements of Operations                 |  |      | 45 | 
|Consolidated Statements of Stockholders
    Equity   |  |      | 46 | 
|Consolidated Statements of Cash Flows                 |  |      | 48 | 
|Notes to Consolidated Financial Statements            |  |      | 49 | 

42



---



##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS

The Board of Directors and Stockholders

Transmeta Corporation


We have audited the accompanying consolidated
balance sheets of Transmeta Corporation as of December 31,
2003 and 2002, and the related consolidated statements of
operations, stockholders equity and cash flows for each of
the three years in the period ended December 31, 2003.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.

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

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Transmeta Corporation at
December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

San Jose, California

March 3, 2004


43



---



##### Table of Contents



TRANSMETA CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |         |         | 
|------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | -------- | ------- | ------- |  | -------- | ------- | ------- | 
|                                                                         |                                                                                                                                                                                  |                                           
|                                                                         |                                                                                                                                                                                  | December 31,                              
|                                                                         |                                                                                                                                                                                  |                                           
|                                                                         |                                                                                                                                                                                  | 2003                                       |          | 2002   
|                                                                         |                                                                                                                                                                                  |                                            |          |        
|                                                                         |                                                                                                                                                                                  |                                           
|                                                                         |                                                                                                                                                                                  | (In thousands, except for                 
|                                                                         |                                                                                                                                                                                  | share and per share data)                 
|ASSETS                                                                  
|Current assets:                                                          |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         | Cash and cash equivalents                                                                                                                                                        |                                            | $        | 83,765  |         |  | $        | 16,613  |        
|                                                                         | Short-term investments                                                                                                                                                           |                                            |          | 37,000  |         |  |          | 112,837 |        
|                                                                         | Accounts receivable, net of allowances for
    doubtful accounts of $215 and $90, in 2003 and 2002, respectively                                                                 |                                            |          | 1,719   |         |  |          | 4,060   |        
|                                                                         | Inventories                                                                                                                                                                      |                                            |          | 8,796   |         |  |          | 10,937  |        
|                                                                         | Prepaid expenses and other current assets                                                                                                                                        |                                            |          | 3,671   |         |  |          | 4,722   |        
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         |                                                                                                                                                                                  | Total current assets                       |          |         | 134,951 |  |          |         | 149,169 | 
|Property and equipment, net                                              |                                                                                                                                                                                  |                                            | 5,305    |         |         |  | 9,574    |        
|Patents and patent rights, net                                           |                                                                                                                                                                                  |                                            | 29,771   |         |         |  | 36,623   |        
|Other assets                                                             |                                                                                                                                                                                  |                                            | 1,563    |         |         |  | 2,189    |        
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         |                                                                                                                                                                                  | Total assets                               |          | $       | 171,590 |  |          | $       | 197,555 | 
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                
|Current liabilities:                                                     |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         | Accounts payable                                                                                                                                                                 |                                            | $        | 1,900   |         |  | $        | 2,311   |        
|                                                                         | Accrued compensation and related compensation
    liabilities                                                                                                                    |                                            |          | 4,986   |         |  |          | 3,195   |        
|                                                                         | Other accrued liabilities                                                                                                                                                        |                                            |          | 5,360   |         |  |          | 8,216   |        
|                                                                         | Current portion of accrued restructuring costs                                                                                                                                   |                                            |          | 1,916   |         |  |          | 2,549   |        
|                                                                         | Current portion of long-term payables                                                                                                                                            |                                            |          | 21,129  |         |  |          | 16,000  |        
|                                                                         | Current portion of long-term debt and capital
    lease obligations                                                                                                              |                                            |          | 370     |         |  |          | 865     |        
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         |                                                                                                                                                                                  | Total current liabilities                  |          |         | 35,661  |  |          |         | 33,136  | 
|Long-term accrued restructuring costs, net of
    current portion        |                                                                                                                                                                                  |                                            | 4,155    |         |         |  | 5,456    |        
|Long-term payables, net of current portion                               |                                                                                                                                                                                  |                                            |         |         |         |  | 17,449   |        
|Long-term debt and capital lease obligations, net
    of current portion |                                                                                                                                                                                  |                                            | 356      |         |         |  | 667      |        
|Commitments and contingencies                                            |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|Stockholders equity:                                                    |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         | Convertible preferred stock, $0.00001 par value,
    at amounts paid in; Authorized shares  5,000,000.
    None issued in 2003 and 2002                                         |                                            |          |        |         |  |          |        |        
|                                                                         | Common stock, $0.00001 par value, at amounts paid
    in; Authorized shares  1,000,000,000. Issued and
    outstanding shares  167,528,493 in 2003 and
    136,086,142 in 2002 |                                            |          | 677,093 |         |  |          | 601,119 |        
|Treasury stock  796,875 shares in 2003
    and 2002                     |                                                                                                                                                                                  |                                            | (2,439   | )       |         |  | (2,439   | )      
|Deferred stock compensation                                              |                                                                                                                                                                                  |                                            | (696     | )       |         |  | (3,039   | )      
|Accumulated other comprehensive income                                   |                                                                                                                                                                                  |                                            | 24       |         |         |  | 134      |        
|Accumulated deficit                                                      |                                                                                                                                                                                  |                                            | (542,564 | )       |         |  | (454,928 | )      
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         |                                                                                                                                                                                  | Total stockholders equity                 |          |         | 131,418 |  |          |         | 140,847 | 
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        
|                                                                         |                                                                                                                                                                                  | Total liabilities and stockholders equity |          | $       | 171,590 |  |          | $       | 197,555 | 
|                                                                         |                                                                                                                                                                                  |                                            |          |         |         |  |          |        

(See accompanying notes)

44



---



##### Table of Contents



TRANSMETA CORPORATION

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |        |         | 
|----------------------------------------------------------- | --------------------------------------------------------------- | ----------------------------------------- | ------- | ------ | ------ | ---- | -------- | ------ | ------- | - | -------- | ------ | ------- | 
|                                                            |                                                                 |                                          
|                                                            |                                                                 | Years Ended December 31,                 
|                                                            |                                                                 |                                          
|                                                            |                                                                 | 2003                                      |         | 2002   |        | 2001
|                                                            |                                                                 |                                           |         |        |        |     
|                                                            |                                                                 |                                          
|                                                            |                                                                 | (In thousands, except for per share data)
|Revenue:                                                    |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            | Product                                                         |                                           | $       | 16,225 |        |      | $        | 24,247 |         |   | $        | 35,590 |        
|                                                            | License                                                         |                                           |         | 1,090  |        |      |          |       |         |   |          |       |        
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            |                                                                 | Total revenue                             |         |        | 17,315 |      |          |        | 24,247  |   |          |        | 35,590  | 
|Cost of revenue:                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            | Product                                                         |                                           |         | 16,184 |        |      |          | 17,127 |         |   |          | 48,694 |        
|                                                            | License                                                         |                                           |         | 140    |        |      |          |       |         |   |          |       |        
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            |                                                                 | Total cost of revenue                     |         |        | 16,324 |      |          |        | 17,127  |   |          |        | 48,694  | 
|Gross profit (loss)                                         |                                                                 |                                           | 991     |        |        |      | 7,120    |        |         |   | (13,104  | )     
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|Operating expenses:                                         |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            | Research and development(1)(2)                                  |                                           |         | 48,525 |        |      |          | 63,603 |         |   |          | 67,639 |        
|                                                            | In-process research and development                             |                                           |         |       |        |      |          |       |         |   |          | 13,600 |        
|                                                            | Selling, general and administrative(3)(4)                       |                                           |         | 26,199 |        |      |          | 29,917 |         |   |          | 35,460 |        
|                                                            | Restructuring charges (recovery)(5)                             |                                           |         | (244   | )      |      |          | 14,726 |         |   |          |       |        
|                                                            | Amortization of deferred charges, patents and
    patent rights |                                           |         | 10,530 |        |      |          | 11,392 |         |   |          | 17,556 |        
|                                                            | Impairment write-off of deferred charges                        |                                           |         |       |        |      |          |       |         |   |          | 16,564 |        
|                                                            | Stock compensation                                              |                                           |         | 4,529  |        |      |          | 1,809  |         |   |          | 20,954 |        
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|                                                            |                                                                 | Total operating expenses                  |         |        | 89,539 |      |          |        | 121,447 |   |          |        | 171,773 | 
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|Operating loss                                              |                                                                 |                                           | (88,548 | )      |        |      | (114,327 | )      |         |   | (184,877 | )     
|                                                            | Interest income and other, net                                  |                                           |         | 1,389  |        |      |          | 4,962  |         |   |          | 14,686 |        
|                                                            | Interest expense                                                |                                           |         | (477   | )      |      |          | (601   | )       |   |          | (1,060 | )      
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|Net loss                                                    |                                                                 | $                                         | (87,636 | )      |        | $    | (109,966 | )      |         | $ | (171,251 | )     
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|Net loss per share  basic and diluted                      |                                                                 | $                                         | (0.63   | )      |        | $    | (0.82    | )      |         | $ | (1.33    | )     
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       
|Weighted average shares outstanding  basic
    and diluted |                                                                 |                                           | 139,692 |        |        |      | 134,719  |        |         |   | 129,002  |       
|                                                            |                                                                 |                                           |         |        |        |      |          |        |         |   |          |       



---



|    |                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes $1,118, $4,364 and $8,292 in
    amortization of deferred stock compensation for the year ended
    December 31, 2003, 2002 and 2001, respectively.     
|   
|(2) | Excludes $128, $(408) and $2,006 in variable
    stock compensation for the year ended December 31, 2003,
    2002 and 2001, respectively.                       
|   
|(3) | Excludes $657, $950 and $8,460 in amortization of
    deferred stock compensation for the year ended December 31,
    2003, 2002 and 2001 and 2000, respectively.
|   
|(4) | Excludes $2,626, $(1,360) and $2,196 in variable
    stock compensation for the year ended December 31, 2003,
    2002 and 2001, respectively.                   
|   
|(5) | Excludes $(1,737) of deferred stock compensation
    related to employee terminations for the year ended
    December 31, 2002.                                  

(See accompanying notes)

45



---



##### Table of Contents



TRANSMETA CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |         |             |  |               |         |   |  |  |     |  |  |  |          |   |  |  |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------- | ------- | -------- |  | ------------ | ------ | ------------ |  | ------------- | ------- | ----------- |  | ------------- | ------- | - |  |  | --- |  |  |  | -------- | - |  |  | -------- | -
|                                                                                                                                              |  |                                                     |         |          |  | Notes        |        |              |  | Accumulated   |         |             |  |              
|                                                                                                                                              |  |                                                     |         |          |  | Receivable   |        | Deferred     |  | Other         |         |             |  | Total        
|                                                                                                                                              |  | Common                                              |         | Treasury |  | from         |        | Stock        |  | Comprehensive |         | Accumulated |  | Stockholders
|                                                                                                                                              |  | Stock                                               |         | Stock    |  | Stockholders |        | Compensation |  | Income/(Loss) |         | Deficit     |  | Equity       
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |         |             |  |              
|                                                                                                                                              |  |                                                    
|                                                                                                                                              |  | (In thousands, except for share and per share data)
|Balance at December 31, 2000                                                                                                                  |  |                                                     | 589,220 |          |  |              |       |              |  |               | (17,752 | )           |  |               | (32,988 | ) |  |  | 147 |  |  |  | (173,711 | ) |  |  | 364,916  |  
|Issuance costs related to issuance of shares of
    common stock in initial public offering                                                   |  |                                                     | (256    | )        |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | (256     | )
|Issuance of 1,948,164 shares of common stock to
    employees under option exercises and employee stock purchase
    plan, net of repurchases |  |                                                     | 2,371   |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | 2,371    |  
|Issuance of 798,649 shares of common stock in
    connection with the purchase of patents and patent rights                                   |  |                                                     | 13,813  |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | 13,813   |  
|Issuance of 618,817 shares of common stock in
    connection with net warrant exercises                                                       |  |                                                     | 170     |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | 170      |  
|Stock compensation in connection with employee
    severance arrangement                                                                      |  |                                                     | 75      |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | 75       |  
|Issuance of 1,000,000 shares in connection with
    the purchase of in-process research and development                                       |  |                                                     | 13,600  |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | 13,600   |  
|Stock compensation                                                                                                                            |  |                                                     | (1,960  | )        |  |              |       |              |  |               | 1,744   |             |  |               | 21,170  |   |  |  |    |  |  |  |         |   |  |  | 20,954   |  
|Purchase of 796,875 shares of treasury stock in
    exchange for cancellation of shareholder notes                                            |  |                                                     |        |          |  |              | (2,439 | )            |  |               | 2,439   |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  |         |  
|Purchase of 1,753,125 shares of unvested treasury
    stock in exchange for cancellation of shareholder notes                                 |  |                                                     |        |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  |         |  
|Reduction of shareholder notes relating to
    termination of officers and application of non- recourse
    accounting to remaining notes     |  |                                                     | (13,569 | )        |  |              |       |              |  |               | 13,569  |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  |         |  
|Other comprehensive income                                                                                                                    |  |                                                     |        |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  | 573 |  |  |  |         |   |  |  | 573      |  
|Net loss                                                                                                                                      |  |                                                     |        |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  | (171,251 | ) |  |  | (171,251 | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |         |             |  |               |         |   |  |  |     |  |  |  |          |   |  |  |          |  
|Comprehensive loss                                                                                                                            |  |                                                     |        |          |  |              |       |              |  |               |        |             |  |               |        |   |  |  |    |  |  |  |         |   |  |  | (170,678 | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |         |             |  |               |         |   |  |  |     |  |  |  |          |   |  |  |          |  
|Balance at December 31, 2001                                                                                                                  |  |                                                     | 603,464 |          |  |              | (2,439 | )            |  |               |        |             |  |               | (11,818 | ) |  |  | 720 |  |  |  | (344,962 | ) |  |  | 244,965  |  

46



---



##### Table of Contents



TRANSMETA CORPORATION


CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY  (Continued)

|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------- | ------- | -------- |  | ------------ | ------ | ------------ |  | ------------- | - | ----------- |  | ------------- | ------ | - |  | - | ---- | - |  | - | -------- | - |  | - | -------- | -
|                                                                                                                                              |  |                                                     |         |          |  | Notes        |        |              |  | Accumulated   |   |             |  |              
|                                                                                                                                              |  |                                                     |         |          |  | Receivable   |        | Deferred     |  | Other         |   |             |  | Total        
|                                                                                                                                              |  | Common                                              |         | Treasury |  | from         |        | Stock        |  | Comprehensive |   | Accumulated |  | Stockholders
|                                                                                                                                              |  | Stock                                               |         | Stock    |  | Stockholders |        | Compensation |  | Income/(Loss) |   | Deficit     |  | Equity       
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |              
|                                                                                                                                              |  |                                                    
|                                                                                                                                              |  | (In thousands, except for share and per share data)
|Issuance of 3,511,101 shares of common stock to
    employees under option exercises and employee stock purchase
    plan, net of repurchases |  |                                                     | 4,168   |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 4,168    |  
|Issuance of 340,483 shares of common stock in
    connection with the purchase of patents and patent rights                                   |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   |         |  
|Stock compensation                                                                                                                            |  |                                                     | (5,201  | )        |  |              |       |              |  |               |  |             |  |               | 8,779  |   |  |   |     |   |  |   |         |   |  |   | 3,578    |  
|Repayment of notes from stockholders                                                                                                          |  |                                                     | 456     |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 456      |  
|Variable stock compensation                                                                                                                   |  |                                                     | (1,768  | )        |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | (1,768   | )
|Other comprehensive income                                                                                                                    |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   | (586 | ) |  |   |         |   |  |   | (586     | )
|Net loss                                                                                                                                      |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   | (109,966 | ) |  |   | (109,966 | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|Comprehensive loss                                                                                                                            |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | (110,552 | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|Balance at December 31, 2002                                                                                                                  |  |                                                     | 601,119 |          |  |              | (2,439 | )            |  |               |  |             |  |               | (3,039 | ) |  |   | 134  |   |  |   | (454,928 | ) |  |   | 140,847  |  
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|Issuance of 25,000,000 shares of common stock, in
    public offering, net of issuance costs of $5.1 million                                  |  |                                                     | 67,450  |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 67,450   |  
|Issuance of 5,423,213 shares of common stock to
    employees under option exercises and employee stock purchase
    plan, net of repurchases |  |                                                     | 6,136   |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 6,136    |  
|Issuance of 796,178 shares of common stock in
    connection with the purchase of patents and patent rights                                   |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   |         |  
|Issuance of 222,960 shares of common stock in
    connection with net warrant exercises                                                       |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   |         |  
|Stock compensation                                                                                                                            |  |                                                     | (568    | )        |  |              |       |              |  |               |  |             |  |               | 2,343  |   |  |   |     |   |  |   |         |   |  |   | 1,775    |  
|Repayment of notes from stockholders                                                                                                          |  |                                                     | 202     |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 202      |  
|Variable stock compensation                                                                                                                   |  |                                                     | 2,754   |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | 2,754    |  
|Other comprehensive income                                                                                                                    |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   | (110 | ) |  |   |         |   |  |   | (110     | )
|Net loss                                                                                                                                      |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   | (87,636  | ) |  |   | (87,636  | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|Comprehensive income/(loss)                                                                                                                   |  |                                                     |        |          |  |              |       |              |  |               |  |             |  |               |       |   |  |   |     |   |  |   |         |   |  |   | (87,746  | )
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  
|Balance at December 31, 2003                                                                                                                  |  | $                                                   | 677,093 |          |  | $            | (2,439 | )            |  | $             |  |             |  | $             | (696   | ) |  | $ | 24   |   |  | $ | (542,564 | ) |  | $ | 131,418  |  
|                                                                                                                                              |  |                                                     |         |          |  |              |        |              |  |               |   |             |  |               |        |   |  |   |      |   |  |   |          |   |  |   |          |  

(See accompanying notes)

47



---



##### Table of Contents



TRANSMETA CORPORATION

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |          |        |  
|--------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------------- | ------- | ------- | ------ | ---- | ------- | -------- | ------ | - | -------- | -------- | ------ | -
|                                                                            |                                                                                               |                                                                
|                                                                            |                                                                                               | Years Ended December 31,                                       
|                                                                            |                                                                                               |                                                                
|                                                                            |                                                                                               | 2003                                                            |         | 2002    |        | 2001
|                                                                            |                                                                                               |                                                                 |         |         |        |     
|                                                                            |                                                                                               |                                                                
|                                                                            |                                                                                               | (In thousands)                                                 
|Cash flows from operating activities:                                       |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|                                                                            | Net loss                                                                                      |                                                                 | $       | (87,636 | )      |      | $       | (109,966 | )      |   | $        | (171,251 | )     
|                                                                            | Adjustments to reconcile net loss to net cash
    used in operating activities:               |                                                                 |         |         |        |      |         |          |        |   |          |          |       
|                                                                            |                                                                                               | Stock compensation                                              |         |         | 4,529  |      |         |          | 1,809  |   |          |          | 20,954 |  
|                                                                            |                                                                                               | Depreciation                                                    |         |         | 5,586  |      |         |          | 5,888  |   |          |          | 6,494  |  
|                                                                            |                                                                                               | Loss on disposal of fixed assets, net                           |         |         | 138    |      |         |          | 148    |   |          |          |       |  
|                                                                            |                                                                                               | Allowance for doubtful accounts                                 |         |         | 125    |      |         |          | 90     |   |          |          |       |  
|                                                                            |                                                                                               | Amortization of other assets                                    |         |         | 413    |      |         |          | 201    |   |          |          | 190    |  
|                                                                            |                                                                                               | Fair value of equity instruments issued for
    services        |         |         |       |      |         |          |       |   |          |          | 170    |  
|                                                                            |                                                                                               | Stock compensation in connection with severance
    agreement   |         |         |       |      |         |          |       |   |          |          | 75     |  
|                                                                            |                                                                                               | Amortization of deferred charges, patents and
    patent rights |         |         | 10,530 |      |         |          | 11,392 |   |          |          | 17,556 |  
|                                                                            |                                                                                               | Impairment write-off of deferred charges                        |         |         |       |      |         |          |       |   |          |          | 16,564 |  
|                                                                            |                                                                                               | Write-off of purchased in-process research and
    development  |         |         |       |      |         |          |       |   |          |          | 13,600 |  
|                                                                            |                                                                                               | Non cash restructuring charges                                  |         |         | (244   | )    |         |          | 1,629  |   |          |          |       |  
|                                                                            | Changes in operating assets and liabilities:                                                  |                                                                 |         |         |        |      |         |          |        |   |          |          |       
|                                                                            |                                                                                               | Accounts receivable                                             |         |         | 2,216  |      |         |          | (2,401 | ) |          |          | 1,549  |  
|                                                                            |                                                                                               | Inventories                                                     |         |         | 2,141  |      |         |          | (9,549 | ) |          |          | 14,065 |  
|                                                                            |                                                                                               | Prepaid expenses and other current assets                       |         |         | 1,122  |      |         |          | 2,320  |   |          |          | 730    |  
|                                                                            |                                                                                               | Other non-current assets                                        |         |         | 101    |      |         |          | (103   | ) |          |          | (904   | )
|                                                                            |                                                                                               | Accounts payable and accrued liabilities                        |         |         | (1,015 | )    |         |          | (3,381 | ) |          |          | (275   | )
|                                                                            |                                                                                               | Accrued restructuring charges                                   |         |         | (2,473 | )    |         |          | 8,005  |   |          |          |       |  
|                                                                            |                                                                                               | Deposits received under subleasing agreements                   |         |         |       |      |         |          |       |   |          |          | (138   | )
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Net cash used in operating activities                                       |                                                                                               |                                                                 | (64,467 | )       |        |      | (93,918 | )        |        |   | (80,621  | )       
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Cash flows from investing activities:                                       |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|                                                                            | Purchase of available-for-sale investments                                                    |                                                                 |         | (93,775 | )      |      |         | (178,596 | )      |   |          | (255,610 | )     
|                                                                            | Proceeds from sale or maturity of
    available-for-sale investments                          |                                                                 |         | 169,502 |        |      |         | 249,114  |        |   |          | 155,600  |       
|                                                                            | Purchase of property and equipment                                                            |                                                                 |         | (1,112  | )      |      |         | (5,581   | )      |   |          | (7,634   | )     
|                                                                            | Loans to founders                                                                             |                                                                 |         |        |        |      |         |         |        |   |          | 5,446    |       
|                                                                            | Payment to development partner                                                                |                                                                 |         | (7,000  | )      |      |         | (6,000   | )      |   |          | (3,500   | )     
|                                                                            | Payment of patents and patent rights                                                          |                                                                 |         | (9,000  | )      |      |         | (9,000   | )      |   |          | (12,041  | )     
|                                                                            | Other assets                                                                                  |                                                                 |         | (59     | )      |      |         | (258     | )      |   |          | (466     | )     
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Net cash provided by/(used in) investing
    activities                     |                                                                                               |                                                                 | 58,556  |         |        |      | 49,679  |          |        |   | (118,205 | )       
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Cash flows from financing activities:                                       |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|                                                                            | Net proceeds from public offering of common stock                                             |                                                                 |         | 67,450  |        |      |         |         |        |   |          | (256     | )     
|                                                                            | Common stock issued under stock option plans and
    employee stock purchase programs         |                                                                 |         | 6,136   |        |      |         | 4,168    |        |   |          | 2,371    |       
|                                                                            | Repayment of notes from stockholders                                                          |                                                                 |         | 202     |        |      |         | 456      |        |   |          |         |       
|                                                                            | Proceeds from debt and capital lease obligations                                              |                                                                 |         |        |        |      |         | 1,140    |        |   |          |         |       
|                                                                            | Repayment of debt and capital lease obligations                                               |                                                                 |         | (725    | )      |      |         | (2,659   | )      |   |          | (5,286   | )     
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Net cash provided by/(used in) financing
    activities                     |                                                                                               |                                                                 | 73,063  |         |        |      | 3,105   |          |        |   | (3,171   | )       
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Change in cash and cash equivalents                                         |                                                                                               |                                                                 | 67,152  |         |        |      | (41,134 | )        |        |   | (201,997 | )       
|Cash and cash equivalents at beginning of period                            |                                                                                               |                                                                 | 16,613  |         |        |      | 57,747  |          |        |   | 259,744  |         
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Cash and cash equivalents at end of period                                  |                                                                                               | $                                                               | 83,765  |         |        | $    | 16,613  |          |        | $ | 57,747   |         
|                                                                            |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|Supplemental disclosure of cash paid during the
    period:                 |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|                                                                            | Cash paid for interest                                                                        |                                                                 | $       | 75      |        |      | $       | 639      |        |   | $        | 908      |       
|Supplemental disclosure of non-cash financing and
    investing activities: |                                                                                               |                                                                 |         |         |        |      |         |          |        |   |          |         
|                                                                            | Issuance of common stock in connection with net
    exercise of warrants                      |                                                                 |         | 919     |        |      |         |         |        |   |          | 170      |       
|                                                                            | Issuance of common stock to employees for notes
    receivable                                |                                                                 |         |        |        |      |         |         |        |   |          | 40       |       
|                                                                            | Issuance of common stock in connection with
    purchase of patent and patent rights          |                                                                 |         |        |        |      |         |         |        |   |          | 13,813   |       
|                                                                            | Issuance of common stock in connection with
    purchased in-process research and development |                                                                 |         |        |        |      |         |         |        |   |          | 13,600   |       
|                                                                            | Purchase of treasury stock in exchange for
    cancellation of shareholder notes              |                                                                 |         |        |        |      |         |         |        |   |          | 2,439    |       

(See accompanying notes)

48



---



##### Table of Contents



TRANSMETA CORPORATION

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |         
|-- | --------
|1. | Overview



| |            
| | -----------
| | The Company

Transmeta designs, develops and sells highly
efficient x86-compatible software-based microprocessors. We
believe that our microprocessors deliver a compelling balance of
low power consumption, high performance, low cost and small
size. These advantages are valuable to a broad range of
computing platforms, especially 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. Some of
these platforms provide types of computer configurations that
may reduce the total cost of ownership by reducing maintenance
and support costs or the total number of computing platforms
that must be supported in an enterprise.

Transmeta was incorporated in California as
Transmeta Corporation on March 3, 1995. Effective
October 26, 2000, Transmeta reincorporated as a Delaware
corporation.



| |            
| | -----------
| | Fiscal Year

Transmetas fiscal year ends on the last
Friday in December. For ease of presentation, the accompanying
financial statements have been shown as ending on
December 31 and calendar quarter ends for all annual and
quarterly financial statement captions. Fiscal years 2003, 2002
and 2001 consisted of 52 weeks each and ended on
December 26, December 27 and December 28,
respectively.



|   |                                               
|-- | ----------------------------------------------
|2. | Summary of Significant Accounting
    Policies



| |                            
| | ---------------------------
| | Principles of Consolidation

The accompanying consolidated financial
statements include the financial statements of Transmeta and its
wholly owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.



| |                 
| | ----------------
| | Use of Estimates

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.
The critical accounting policies that require management
judgment and estimates include license revenue recognition,
inventory valuations, long-lived and intangible asset
valuations, restructuring charges and loss contingencies.



| |                              
| | -----------------------------
| | Concentrations of Credit Risk

Financial instruments that potentially subject
the Company to credit risk consist primarily of cash
equivalents, short-term investments and accounts receivable.
Substantially all of the Companys cash equivalents are
invested in highly liquid money market funds and commercial
securities with high-quality financial institutions in the
United States. Short-term investments consist of
U.S. government and commercial bonds and notes. The Company
performs ongoing credit evaluations of its customers, maintains
an allowance for potential credit losses and does not generally
require collateral.



| |                        
| | -----------------------
| | Supplier Concentrations

The Company depends on a single or limited number
of outside contractors to fabricate, assemble and test its
semiconductor devices. While the Company seeks to maintain a
sufficient level of supply and endeavors to maintain ongoing
communications with suppliers to guard against interruptions or
cessation of supply, business and results of operations could be
adversely affected by a stoppage or delay of supply from these
vendors.

49



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | Revenue Recognition

The Company recognizes revenue from products sold
when persuasive evidence of an arrangement exists, the price is
fixed or determinable, shipment is made and collectibility is
reasonably assured. The Company accrues for estimated sales
returns, and other allowances at the time of shipment. Certain
of the Companys product sales are made to distributors
under agreements allowing for price protection and/or right of
return on unsold products. The Company defers recognition of
revenue on these sales until the distributors sell the products.
The Company may also sell certain products with End of
Life status to its distributors under special arrangements
without price protection or return privileges for which revenue
is recognized upon transfer of title, typically 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. 101, Revenue Recognition in Financial
Statements, significant interpretation on 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 are recognized only if payments received are
non-refundable and not subject to any future performance
obligation by the Company.



| |                            
| | ---------------------------
| | Shipping and Handling Costs

Shipping and handling costs are expensed as
incurred and included in cost of revenue in the Companys
results of operations.



| |                   
| | ------------------
| | Comprehensive Loss

Net comprehensive loss includes the
Companys net loss, as well as accumulated comprehensive
income/(loss) on available-for-sale investments and foreign
currency translation adjustments. Net comprehensive loss for the
years ended December 31, 2003, 2002 and 2001, respectively,
is as follows:

|                                                           |  |                          |         |      |  |      |          |   |  |   |          |  
|---------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                                           |  |                         
|                                                           |  | Years Ended December 31,
|                                                           |  |                         
|                                                           |  | 2003                     |         | 2002 |  | 2001
|                                                           |  |                          |         |      |  |     
|                                                           |  |                         
|                                                           |  | (In thousands)          
|Net loss                                                   |  | $                        | (87,636 | )    |  | $    | (109,966 | ) |  | $ | (171,251 | )
|Net change in unrealized gain/(loss) on
    investments    |  |                          |        |      |  |      | (586     | ) |  |   | 573      |  
|Net change in foreign currency translation
    adjustments |  |                          | (110    | )    |  |      |         |   |  |   |         |  
|                                                           |  |                          |         |      |  |      |          |   |  |   |          |  
|Net comprehensive loss                                     |  | $                        | (87,746 | )    |  | $    | (110,552 | ) |  | $ | (170,678 | )
|                                                           |  |                          |         |      |  |      |          |   |  |   |          |  



| |                                                
| | -----------------------------------------------
| | Cash Equivalents and Short-term
    Investments

Highly liquid debt securities with insignificant
interest rate risk and original maturities of three months or
less are classified as cash equivalents. Debt securities with
maturities greater than three months and remaining maturities
less than one year are available-for-sale and are classified as
short-term investments. Securities with maturity dates greater
than one year are also classified as short-term investments as
they are considered to be available-for-sale securities.

All of Transmetas short-term investments
were classified as available-for-sale as of the balance sheet
dates presented and, accordingly, are reported at fair value
with unrealized gains and losses recorded as a component of
accumulated other comprehensive income/(loss) in
stockholders equity. Fair values of cash

50



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

equivalents approximated original cost due to the
short period of time to maturity. The cost of securities sold is
based on the specific identification method. Realized gains or
losses and declines in value, if any, judged to be other than
temporary on available-for-sale securities are reported in
interest income or expense.



| |                                         
| | ----------------------------------------
| | Fair Values of Financial
    Instruments

The fair values of Transmetas cash
equivalents, short-term investments, accounts receivable,
prepaid expenses and other current assets, and accounts payable
and accrued liabilities approximate their carrying values due to
the short-term nature of those instruments.

The fair values of short-term and long-term
capital lease obligations are based on interest rates inherent
on leasing contracts. The carrying values of these obligations
approximate their respective fair values.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost
(first-in, first-out) or market. Write-downs to reduce the
carrying value of excess and obsolete, slow moving and
non-usable inventory to net realizable value are charged to cost
of revenue.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are recorded at cost.
Depreciation and amortization have been provided on the
straight-line method over the related assets estimated
useful life ranging from three to five years. Leasehold
improvements and assets recorded under capital leases are
amortized on a straight-line basis over the lesser of the
related assets estimated useful life or the remaining
lease term.



| |                                                  
| | -------------------------------------------------
| | Valuation of Long-Lived and Intangible
    Assets

Transmetas accounting policy related to the
valuation and impairment of long-lived assets is in accordance
with the Financial Accounting Standards Boards
(FASB) Statement of Financial Accounting Standards
(SFAS) 144, Accounting for the Impairment or Disposal
of Long-Lived Assets. In accordance with our policy, at
the end of each accounting period we evaluate our long-lived and
intangible assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of long-lived
assets may not be recoverable. Recoverability of assets to be
held and used is determined by comparing the carrying amount of
an asset to the future undiscounted cash flows expected to be
generated by the asset. If the carrying amount of an asset
exceeds the future undiscounted cash flows the asset is
considered to be impaired and the impairment charge recognized
is measured by the amount by which the carrying amount of the
asset exceeds the fair value of the asset.



| |                         
| | ------------------------
| | Research and Development

Costs to develop Transmetas products are
expensed as incurred in accordance with the FASBs SFAS 2,
Accounting for Research and Development Costs, which
establishes accounting and reporting standards for research and
development costs.



| |             
| | ------------
| | Income Taxes

Transmeta accounts for income taxes in accordance
with the FASBs SFAS 109, Accounting for Income
Taxes, which requires the use of the liability method in
accounting for income taxes. Under SFAS 109, deferred tax
assets and liabilities are measured based on differences between
the financial reporting and tax bases of assets and liabilities
using enacted tax rates and laws that will be in effect when
differences are expected to reverse.



| |                 
| | ----------------
| | Product Warranty

Transmeta typically provides a warranty that
includes factory repair services or replacement as needed for
replacement parts on its products for a period of one year from
shipment. Transmeta records a provision for

51



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

estimated warranty costs upon shipment of its
products. Warranty costs have been within managements
expectations to date and have not been material.

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



| |                     
| | --------------------
| | Advertising Expenses

All advertising costs are expensed as incurred.
To date, advertising costs have not been material.



| |                   
| | ------------------
| | Net Loss Per Share

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

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

|                                       |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |          |  
|-------------------------------------- | ---------------------------------------------------------------------------------- | ---------------------------------------- | ----- | ------- | - | ---- | ----- | -------- | - | - | ----- | -------- | -
|                                       |                                                                                    |                                         
|                                       |                                                                                    | Years Ended December 31,                
|                                       |                                                                                    |                                         
|                                       |                                                                                    | 2003                                     |       | 2002    |   | 2001
|                                       |                                                                                    |                                          |       |         |   |     
|                                       |                                                                                    |                                         
|                                       |                                                                                    | (In thousands, except per share amounts)
|Basic and diluted:                     |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         
|                                       | Net loss                                                                           |                                          | $     | (87,636 | ) |      | $     | (109,966 | ) |   | $     | (171,251 | )
|                                       |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         
|Basic and diluted:                     |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         
|                                       | Weighted average shares outstanding                                                |                                          |       | 139,698 |   |      |       | 134,902  |   |   |       | 132,779  |  
|                                       | Less: Weighted average shares subject to
    repurchase                            |                                          |       | (6      | ) |      |       | (183     | ) |   |       | (3,777   | )
|                                       |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         
|                                       | Weighted average shares used in computing basic
    and diluted net loss per share |                                          |       | 139,692 |   |      |       | 134,719  |   |   |       | 129,002  |  
|                                       |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         
|Net loss per share  basic and diluted |                                                                                    | $                                        | (0.63 | )       |   | $    | (0.82 | )        |   | $ | (1.33 | )       
|                                       |                                                                                    |                                          |       |         |   |      |       |          |   |   |       |         

The Company has excluded all outstanding stock
options and shares subject to repurchase from the calculation of
basic and diluted net loss per share because these securities
are antidilutive for all periods presented. Options and warrants
to purchase 33,706,226, 32,917,730 and 22,885,437 shares of
common stock in 2003, 2002 and 2001, 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.

In relation to the Companys December 2003
common stock offering, on January 12, 2004, the
Companys underwriters exercised their over-allotment
option and purchased 3.75 million shares.



| |                         
| | ------------------------
| | Stock-Based Compensation

In December 2002, the FASB issued, and the
Company adopted, SFAS 148, Accounting for Stock-Based
Compensation  Transition and Disclosure 
an Amendment of FASB Statement No. 123. SFAS 148
amends the disclosure requirements of FASBs SFAS 123,
Accounting for Stock-Based Compensation, to require
more prominent disclosures in both annual and interim financial
statements regarding the method of accounting for stock-based
employee compensation and the effect of the method used on
reported results.

52



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Transmeta has employee stock plans that are
described more fully in Note 11. The Company accounts for its
stock options and equity awards in accordance with the
provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and
related interpretations and has elected to follow the
disclosure only alternative prescribed by SFAS 123.
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:

|                                                                                                                                       |  |                                       |          |      |  |      |          |   |  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | -------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                                                                                                                       |  |                                      
|                                                                                                                                       |  | Years Ended December 31,             
|                                                                                                                                       |  |                                      
|                                                                                                                                       |  | 2003                                  |          | 2002 |  | 2001
|                                                                                                                                       |  |                                       |          |      |  |     
|                                                                                                                                       |  |                                      
|                                                                                                                                       |  | (In thousands, except per share data)
|Net loss, as reported                                                                                                                  |  | $                                     | (87,636  | )    |  | $    | (109,966 | ) |  | $ | (171,251 | )
|Add: Stock-based employee compensation expense
    included in reported net loss, net of related tax effects                           |  | $                                     | 4,529    |      |  | $    | 1,809    |   |  | $ | 20,954   |  
|Less: Total stock-based employee compensation
    expense under fair value based method for all awards, net of
    related tax effects |  | $                                     | (46,462  | )    |  | $    | (41,377  | ) |  | $ | (39,648  | )
|Pro forma net loss                                                                                                                     |  | $                                     | (129,569 | )    |  | $    | (149,534 | ) |  | $ | (189,945 | )
|Basic and diluted net loss per share 
    as reported                                                                                 |  | $                                     | (0.63    | )    |  | $    | (0.82    | ) |  | $ | (1.33    | )
|Basic and diluted net loss per share 
    pro forma                                                                                   |  | $                                     | (0.93    | )    |  | $    | (1.11    | ) |  | $ | (1.47    | )

See Note 11 for a discussion of the
assumptions used in the option pricing model and estimated fair
value of employee stock options.

Options and warrants granted to consultants and
vendors are accounted for at fair value determined by using the
Black-Scholes method in accordance with Emerging Issues Task
Force (EITF) Issue No. 96-18. The assumptions used to
value stock-based awards to consultants and vendors are similar
to those used for employees except that the respective
contractual life of the warrant or option was used instead of
the estimated life. (See Note 11).

Due to the resignation in fiscal 2001 of certain
officers and the treatment of the notes they issued to the
Company in order to early exercise their options, the Company is
accounting for all remaining stockholder notes that were issued
to purchase shares of the Companys common stock as if such
notes had terms equivalent to non-recourse notes. As a result,
in fiscal 2001 the Company recorded additional stock
compensation expense to write-off all accrued interest related
to its remaining stockholder notes and recorded an adjustment to
its balance sheet to reduce common stock and reduce notes
receivable from stockholders by the remaining amounts owed under
the stockholder notes. This entry did not have a material impact
on stockholders equity.

In addition, under the terms of the outstanding
stockholder notes, interest continues to accrue until the notes
are paid. In assessing these notes as non-recourse, the
underlying purchase price for the shares is not deemed to be
fixed until the notes have been paid or otherwise settled.
Accordingly, the Company determined that variable accounting is
to be applied to these note arrangements as long as the notes
remain outstanding. Under variable accounting, the Company
records compensation expense for the vested shares for the
excess, if any, of the current market value of the shares over
the then current principle amount of the notes and accrued
interest, determined separately for each outstanding stockholder
note. This variable accounting resulted in the Company recording
a stock compensation expense of $2.7 million in fiscal 2003
resulting from a higher share

53



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

price of the Companys common stock at the
end of fiscal 2003 compared to the end of fiscal 2002. Stock
compensation expense related to variable accounting was a
benefit of $1.8 million in fiscal 2002 and expenses of
$2.5 million in fiscal 2001. The market value of the
Companys common stock was $3.24, $1.21 and $2.22 per share
at the end of fiscal 2003, 2002 and 2001, respectively. During
the remaining life of these outstanding stockholder notes, the
Companys reported stock compensation will be adjusted
upward (expense) or downward (benefit) at each period
end, based on the above stated formula.



| |                      
| | ---------------------
| | Restructuring Charges

The Company accounted for its restructuring
activity during fiscal 2002 under EITF Issue No. 94-3,
Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain
Cots Incurred in a Restructuring) for recognition of
liabilities and expenses associated with exit and disposal costs
when the Company made a commitment to a firm exit plan. In July
2002, the FASB issued SFAS 146 Accounting for Costs
Associated with Exit or Disposal Activities, which
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF
Issue No. 94-3. SFAS 146 is effective for exit or
disposal activities that are initiated after December 31,
2002. Any future restructuring activities, if any, will be
recorded in accordance with SFAS 146, which requires that a
liability for costs associated with an exit or disposal activity
be recognized when the liability is incurred.



| |                  
| | -----------------
| | Reclassifications

Certain reclassifications have been made to prior
year balances in order to conform to the current year
presentation.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

In January 2003, the FASB issued FIN No. 46
Consolidation of Variable Interest Entities. FIN 46
requires a variable interest to be consolidated by a company if
that company is subject to a majority of the risk of loss from
the variable interest entitys activities, entitled to
receive a majority of the entitys residual returns or
both. A variable interest entity (VIE) is a corporation,
partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the
entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables,
real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development
or other activities on behalf of another company. In December
2003, the FASB completed deliberations of proposed modifications
to FIN 46 (Revised Interpretations) resulting in
multiple effective dates based on the nature as well as the
creation date of the VIE. FIN 46 became effective for
financial statements issued for the first reporting period
ending after December 15, 2003. The adoption of this
standard did not have a material impact on the Companys
financial position or results of operations.

54



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                               
|-- | ------------------------------
|3. | Financial Statement Components



| |                                                
| | -----------------------------------------------
| | Cash Equivalents and Short-Term
    Investments

All cash equivalents and short-term investments
as of December 31, 2003 and 2002 were classified as
available-for-sale securities and consisted of the following:

|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |         |  
|------------------------ | ------------------------------------------- | -------------- | - | ---------- |  | ---------- | - | ---------- |  |  | - | -- |  |  | - | ------- | -
|                         |                                             |                |   | Gross      |  | Gross      |   |           
|                         |                                             | Amortized      |   | Unrealized |  | Unrealized |   |           
|                         |                                             | Cost           |   | Gains      |  | Losses     |   | Fair Value
|                         |                                             |                |   |            |  |            |   |           
|                         |                                             |               
|                         |                                             | (In thousands)
|As of December 31, 2003: |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Money market funds                          |                | $ | 72,766     |  |            | $ |           |  |  | $ |   |  |  | $ | 72,766  |  
|                         | Federal agency discount notes               |                |   | 22,000     |  |            |   | 21         |  |  |   | 21 |  |  |   | 22,000  |  
|                         | Commercial paper                            |                |   | 25,999     |  |            |   |           |  |  |   |   |  |  |   | 25,999  |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Total available-for-sale securities         |                | $ | 120,765    |  |            | $ | 21         |  |  | $ | 21 |  |  | $ | 120,765 |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Less amounts classified as cash equivalents |                |   |            |  |            |   |            |  |  |   |    |  |  |   | (83,765 | )
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Total short-term investments                |                |   |            |  |            |   |            |  |  |   |    |  |  | $ | 37,000  |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|As of December 31, 2002: |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Money market funds                          |                | $ | 16,613     |  |            | $ |           |  |  | $ |   |  |  | $ | 16,613  |  
|                         | Municipal obligations                       |                |   | 10,000     |  |            |   |           |  |  |   |   |  |  |   | 10,000  |  
|                         | Federal agency discount notes               |                |   | 33,000     |  |            |   | 82         |  |  |   |   |  |  |   | 33,082  |  
|                         | Commercial paper                            |                |   | 69,703     |  |            |   | 52         |  |  |   |   |  |  |   | 69,755  |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Total available-for-sale securities         |                | $ | 129,316    |  |            | $ | 134        |  |  | $ |   |  |  | $ | 129,450 |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Less amounts classified as cash equivalents |                |   |            |  |            |   |            |  |  |   |    |  |  |   | (16,613 | )
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        
|                         | Total short-term investments                |                |   |            |  |            |   |            |  |  |   |    |  |  | $ | 112,837 |  
|                         |                                             |                |   |            |  |            |   |            |  |  |   |    |  |  |   |        

The following is a summary of amortized costs and
estimated fair values of debt securities by contractual maturity.

|                         |                                                    |                |   |        |  |  |   |        | 
|------------------------ | -------------------------------------------------- | -------------- | - | ------ |  |  | - | ------ | 
|                         |                                                    | Amortized      |   | Fair  
|                         |                                                    | Cost           |   | Value 
|                         |                                                    |                |   |       
|                         |                                                    |               
|                         |                                                    | (In thousands)
|As of December 31, 2003: |                                                    |                |   |        |  |  |   |       
|                         | Amounts maturing within one year                   |                | $ | 15,000 |  |  | $ | 15,000 | 
|                         | Amounts maturing after one year, within five years |                | $ | 22,000 |  |  | $ | 22,000 | 

55



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | Accounts Receivable

Customers who accounted for more than 10% of
Transmetas accounts receivable balance at
December 31, 2003 and 2002 are as follows:

|          |                                        |              |  |      |   |  |  |    |  
|--------- | -------------------------------------- | ------------ |  | ---- | - |  |  | -- | -
|          |                                        |             
|          |                                        | December 31,
|          |                                        |             
|          |                                        | 2003         |  | 2002
|          |                                        |              |  |     
|Customer: |                                        |              |  |      |   |  |  |   
|          | Hewlett Packard International Pte Ltd. |              |  | 66   | % |  |  | *  | %
|          | Antelope Technologies                  |              |  | 13   | % |  |  | *  | %
|          | Sharp Trading Corporation              |              |  | 13   | % |  |  | 15 | %
|          | Uniquest Hong Kong                     |              |  | *    | % |  |  | 52 | %
|          | Mitac Technology Corp.                 |              |  | *    | % |  |  | 11 | %



---



|  |                                                            
|- | -----------------------------------------------------------
|* | represents less than 10% of accounts receivable
    balance

The Company maintains an allowance for doubtful
accounts receivable based upon the expected collectibility of
accounts receivable. During fiscal 2002 the Company increased
the allowance for doubtful accounts from $0 at December 31,
2001 to $90,000 at December 31, 2002, which resulted in a
charge to bad debt expense of $90,000. During fiscal 2003, the
Company increased the allowance for doubtful accounts from
$90,000 at December 31, 2002 to $215,000 at
December 31, 2003, which resulted in a charge to bad debt
expense of $125,000. There were no other adjustments to the
allowance for bad doubtful accounts during fiscal 2003 and 2002.
Net accounts receivable at December 31, 2003 and 2002
included a revenue reserve of $23,000 and $65,000, respectively.



| |            
| | -----------
| | Inventories

The components of inventories as of
December 31, 2003 and 2002 are as follows:

|                 |  |                |       |      |  |   |        | 
|---------------- |  | -------------- | ----- | ---- |  | - | ------ | 
|                 |  |               
|                 |  | December 31,  
|                 |  |               
|                 |  | 2003           |       | 2002
|                 |  |                |       |     
|                 |  |               
|                 |  | (In thousands)
|Work in progress |  | $              | 6,136 |      |  | $ | 8,545  | 
|Finished goods   |  |                | 2,660 |      |  |   | 2,392  | 
|                 |  |                |       |      |  |   |        | 
|                 |  | $              | 8,796 |      |  | $ | 10,937 | 
|                 |  |                |       |      |  |   |        | 

The Company made adjustments of $1.5 million
and $2.6 million for fiscal 2003 and 2002, respectively, to
decrease the value of its inventory in response to lower demand
and lower average selling prices expected in future periods for
some of its products. Of the $8.8 million and
$10.9 million of inventory on hand at December 31,
2003 and 2002, respectively, $2.6 million and
$2.8 million of inventory, respectively, was stated at net
realizable value. Accordingly, gross margin may benefit from
future sales of these parts to the extent that the associated
revenue exceeds their currently adjusted values. For fiscal
2003, the Companys gross margins included a benefit of
$0.5 million resulting from the sale of previously reserved
inventory. For fiscal 2002, the Company recognized
$0.7 million in gross margin related to the sale of
inventory for which the value had been written down in previous
periods. Additionally, the Company recognized 100% gross profit
of $1.2 million in fiscal 2002, respectively, related to
the reversal of previously accrued inventory related to purchase
commitments due to favorable settlements of such purchase
commitments.

56



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment, net, consisted of the
following:

|                                                |                             |                |         |       |  |   |         |       | 
|----------------------------------------------- | --------------------------- | -------------- | ------- | ----- |  | - | ------- | ----- | 
|                                                |                             |               
|                                                |                             | December 31,  
|                                                |                             |               
|                                                |                             | 2003           |         | 2002 
|                                                |                             |                |         |      
|                                                |                             |               
|                                                |                             | (In thousands)
|Furniture and fixtures                          |                             | $              | 2,018   |       |  | $ | 2,018   |      
|Computer equipment                              |                             |                | 21,643  |       |  |   | 20,510  |      
|Computer software                               |                             |                | 11,181  |       |  |   | 11,153  |      
|Leasehold improvements                          |                             |                | 2,730   |       |  |   | 2,657   |      
|                                                |                             |                |         |       |  |   |         |      
|                                                |                             |                | 37,572  |       |  |   | 36,338  |      
|Less: Accumulated depreciation and amortization |                             |                | (32,267 | )     |  |   | (26,764 | )    
|                                                |                             |                |         |       |  |   |         |      
|                                                | Property and equipment, net |                | $       | 5,305 |  |   | $       | 9,574 | 
|                                                |                             |                |         |       |  |   |         |      

The original cost of equipment recorded under
capital lease arrangements included in property and equipment
aggregated $1.9 million at 2003 and $1.0 million at 2002.
Related accumulated depreciation was $0.6 million and $1.0
million in 2003 and 2002, respectively. Amortization expense
related to assets under capital leases is included with
depreciation expense.



| |                          
| | -------------------------
| | Patents and Patent Rights

Patents and patent rights, net consisted of the
following:

|                               |                                |                |         |        |  |   |         |        | 
|------------------------------ | ------------------------------ | -------------- | ------- | ------ |  | - | ------- | ------ | 
|                               |                                |               
|                               |                                | December 31,  
|                               |                                |               
|                               |                                | 2003           |         | 2002  
|                               |                                |                |         |       
|                               |                                |               
|                               |                                | (In thousands)
|Patents and patent rights      |                                | $              | 47,920  |        |  | $ | 47,920  |       
|Less: Accumulated amortization |                                |                | (18,149 | )      |  |   | (11,297 | )     
|                               |                                |                |         |        |  |   |         |       
|                               | Patents and patent rights, net |                | $       | 29,771 |  |   | $       | 36,623 | 
|                               |                                |                |         |        |  |   |         |       

Patent and patent rights are amortized on a
straight-line basis over their expected life of seven years.
Amortization expense of $6.8 million was recorded in fiscal
2003 and 2002 related to patents and patent rights. Future
amortization expense related to patents and patent rights is as
follows:

|                          |      |                           |   |       |        | 
|------------------------- | ---- | ------------------------- | - | ----- | ------ | 
|                          |      | (In thousands)           
|Years ending December 31, |      |                           |   |      
|                          | 2004 |                           | $ | 6,846 |       
|                          | 2005 |                           |   | 6,846 |       
|                          | 2006 |                           |   | 6,846 |       
|                          | 2007 |                           |   | 6,846 |       
|                          | 2008 |                           |   | 2,387 |       
|                          |      |                           |   |      
|                          |      | Total future amortization |   | $     | 29,771 | 
|                          |      |                           |   |      



|   |                              
|-- | -----------------------------
|4. | Technology License Agreements

In December 1997, Transmeta entered into a
technology license agreement with IBM Corporation (IBM), which
was amended in 1999 and again in 2000. The term of the original
agreement was five years. In the first amendment, in November
1999, IBM relinquished certain of the worldwide license rights
previously obtained in exchange for commitments by Transmeta.
These commitments included payments of $33.0 million to IBM
in various installments beginning in fiscal 2001 through fiscal
2004.

57



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The then net present value of the
$33.0 million commitment (approximately $18.9 million)
was recorded on the balance sheet as an element of deferred
charges under license agreements with a corresponding liability.
The liability is being accreted to its future value using the
effective interest method at a rate of approximately 15% per
annum and the accretion expense is being recorded as part of
amortization of deferred charges, patents and patent rights.
Accretion expense for these payments for fiscal 2003, 2002 and
2001 was $2.7 million, $3.2 million, and
$3.0 million, respectively. During 2001, Transmeta
fulfilled its obligation to pay IBM the $4.0 million
payment due on or before December 15, 2001 by negotiating a
$3.5 million payment in June 2001. A scheduled payment of
$7.0 million and $6.0 million was made to IBM in
December 2003 and 2002, respectively, in accordance with the
terms of the agreement. The future cash commitment to IBM at
December 31, 2003 was as follows:

|                                               |                             |                |        |        |  
|---------------------------------------------- | --------------------------- | -------------- | ------ | ------ | -
|                                               |                             | (In thousands)
|Year ended December 31,                        |                             |                |        |       
|                                               | 2004                        |                | $      | 16,000 |  
|                                               | Less: Unamortized discounts |                |        | (2,087 | )
|                                               |                             |                |        |       
|Present value as recorded on the balance sheet |                             | $              | 13,913 |       
|                                               |                             |                |        |       

The convertibility of IBMs convertible
promissory note, issued with the original agreement entered into
in December 1997, was fixed at 1,200,000 shares of
Transmetas common stock as part of the amended agreement.
The fair value of the embedded beneficial conversion feature of
the amended convertible promissory note was estimated to be
$3.2 million based on the Black-Scholes method using a
dividend yield of 0%, a risk-free interest rate of 6.35%, an
expected life of four years and a volatility factor of 0.8. The
fair value was recorded as a deferred charge under license
agreements and was credited to common stock.

On September 28, 2000, Transmeta and IBM
agreed to a further amendment to the technology license
agreement. IBM relinquished the right to receive certain
contingent payments in exchange for a fixed commitment to pay
$5.0 million, which was paid in two installments during the
fourth quarter of 2000. This charge was recorded as a deferred
charge under license agreements.

In February 1998, Transmeta also entered into a
similar technology license agreement with Toshiba Corporation
(Toshiba). In February 2000, Transmeta and Toshiba amended their
technology license agreement and Toshiba relinquished certain of
their worldwide license rights previously obtained from
Transmeta in exchange for 1,200,000 shares of Transmeta
common stock. The then current value of the common stock,
$6.8 million, was recorded on the balance sheet as a
deferred charge under license agreements.

Through the fourth quarter of 2001, the deferred
charges under the IBM and Toshiba license agreements had been
amortized on a straight-line basis over the remaining period of
the original license agreements. During the fourth quarter of
2001, as part of the Companys routine procedures and due
to the emergence of indicators of impairment, Transmeta
performed an assessment of the carrying value its long-lived
assets to be held and used. The assessment was performed in
connection with the Companys internal policies and
pursuant to SFAS 121 because of the significant negative
industry and economic trends and particularly because of the
Companys delayed shipments due to difficulties in bringing
new products into high volume distribution, which significantly
affected the Companys operations and expected future
operating cash flows. The conclusion of that assessment was that
future cash flows did not exceed the carrying value of all
long-lived assets. As a result, during the fourth quarter of
2001, the Company recorded a charge of $16.6 million to
write-off such deferred charges under license agreements based
on the amount by which the carrying amount of these assets
exceeded their fair value. Fair value was determined to be zero,
and was based on future cash flows for the company as a whole.
The assumptions supporting the estimated future cash flows
reflect managements best estimates. Although the asset was
impaired, the associated liability is in effect and will
continue to accrete interest until the final payment is made,
which is due in 2004.

58



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                          
|-- | -------------------------
|5. | Patents and Patent Rights

Patents and patent rights for microprocessor
technology were acquired from Seiko Epson (Epson) in May 2001.
Under the patent and patent rights agreement with Epson,
Transmeta agreed to pay Epson a combination of
$30.0 million cash and shares of the Companys common
stock valued at $10.0 million based upon the average of the
closing stock price over a defined period. The Company recorded
total consideration of $38.1 million consisting of
$10.8 million of Transmeta common stock, $26.8 million
as the net present value of cash payments and $0.5 million
of acquisition costs on the balance sheet as an element of
patents and patent rights. The Company paid Epson
$7.5 million in cash and 766,930 shares of the
Companys unregistered common stock in May 2001. The number
of shares issued to Epson was calculated in accordance with the
agreement; however for accounting purposes the value of the
shares was determined using the closing price on the issuance
date, or $14.10, resulting in a recorded value of
$10.8 million. The Company paid Epson $7.5 million in
cash in May 2003 and $7.5 million in cash in May 2002 in
accordance with the terms of the agreement.

Additional patent and patents rights for
microprocessor technology were acquired from another third party
in February 2001. In exchange for the acquired patent and patent
rights, Transmeta agreed to pay a combination of
$7.0 million cash and shares of the Companys common
stock valued at $3.0 million over a three year period. The
Company recorded total consideration of $9.7 million
consisting of the net present value of cash payments of
$6.7 million and $3.0 million of Transmeta common
stock. The Company paid $1.5 million, $1.5 million and
$4.0 million in cash in February 2003, 2002 and 2001,
respectively. The Company issued 796,178 shares, 340,483
shares and 31,719 shares of the Companys unregistered
common stock in February 2003, 2002 and 2001, respectively. Each
issuance had a market value of $1.0 million calculated in
accordance with the terms of the agreement.

The present value of future cash payments due
Epson and others in 2004 accretes interest using the effective
interest method at a rate of 10% per annum. Total commitments
for patents and patent rights to Epson as follows:

|                                               |                             |                |       |       |  
|---------------------------------------------- | --------------------------- | -------------- | ----- | ----- | -
|                                               |                             | (In thousands)
|Year ended December 31,                        |                             |                |       |      
|                                               | 2004                        |                | $     | 7,500 |  
|                                               | Less: Unamortized discounts |                |       | (284  | )
|                                               |                             |                |       |      
|Present value as recorded on the balance sheet |                             | $              | 7,216 |      
|                                               |                             |                |       |      



|   |                                                  
|-- | -------------------------------------------------
|6. | Purchased In-process Research and
    Development

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



|   |                      
|-- | ---------------------
|7. | Restructuring Charges

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

59



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

During the fourth quarter of fiscal 2003,
Transmeta reassessed the adequacy of the remaining accrual and
adjusted the restructuring reserve balance as a result of an
update in certain underlying assumptions. The Company
anticipates using portions of previously vacated space primarily
to expand research and development activities. Also, the Company
was able to sublease other previously vacated space earlier than
originally anticipated at a lower rate than originally
estimated. As a result of this update in assumptions, the
Company adjusted the balance in accrued restructuring costs and
recorded a credit of $244,000 in restructuring charges. Net
non-cash drawdowns in fiscal 2003 primarily consist of interest
accretion related to building commitments, write-offs of certain
property and equipment and reclassification of drawdowns between
anticipated workforce reduction and anticipated building
leasehold cost.

Accrued restructuring charges consist of the
following at December 31, 2003 (in thousands):

|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|------------------------------------------------------------- |  | ------------- | ------ | --------- |  | ------------ | ----- | ------------- |  | --------- | ----- | ------------ |  | -------- | ----- | ---- |  | - | ---- | - |  | - | ----- |  |  | - | ---- | - |  | - | ----- | 
|                                                              |  |               |        |           |  | Provision    |       |               |  |           |       | Provision   
|                                                              |  |               |        | Drawdowns |  | Balance at   |       |               |  | Drawdowns |       | Balance at  
|                                                              |  | Restructuring |        |           |  | December 31, |       | Restructuring |  |           |       | December 31,
|                                                              |  | Charges       |        | Cash      |  | Non-cash     |       | 2002          |  | Recovery  |       | Cash         |  | Non-Cash |       | 2003
|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |     
|Charges recorded in the quarter ended
    June 30, 2002:      |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|Building leasehold costs                                      |  | $             | 8,854  |           |  | $            | 667   |               |  | $         | 284   |              |  | $        | 7,903 |      |  | $ | (244 | ) |  | $ | 2,473 |  |  | $ | (885 | ) |  | $ | 6,071 | 
|Property and equipment and software costs                     |  |               | 1,629  |           |  |              | 187   |               |  |           | 1,442 |              |  |          |      |      |  |   |     |   |  |   |      |  |  |   |     |   |  |   |      | 
|Other                                                         |  |               | 141    |           |  |              | 141   |               |  |           |      |              |  |          |      |      |  |   |     |   |  |   |      |  |  |   |     |   |  |   |      | 
|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|                                                              |  |               | 10,624 |           |  |              | 995   |               |  |           | 1,726 |              |  |          | 7,903 |      |  |   | (244 | ) |  |   | 2,473 |  |  |   | (885 | ) |  |   | 6,071 | 
|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|Charges recorded in the quarter ended
    September 30, 2002: |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|Workforce reduction                                           |  |               | 4,102  |           |  |              | 4,000 |               |  |           |      |              |  |          | 102   |      |  |   |     |   |  |   |      |  |  |   | 102  |   |  |   |      | 
|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 
|                                                              |  | $             | 14,726 |           |  | $            | 4,995 |               |  | $         | 1,726 |              |  | $        | 8,005 |      |  |   | (244 | ) |  |   | 2,473 |  |  |   | (783 | ) |  | $ | 6,071 | 
|                                                              |  |               |        |           |  |              |       |               |  |           |       |              |  |          |       |      |  |   |      |   |  |   |       |  |  |   |      |   |  |   |       | 



|   |                              
|-- | -----------------------------
|8. | Commitments and Contingencies

Transmeta leases its facilities and certain
equipment under noncancelable operating leases expiring through
2008. Gross operating lease and rental expenses were
$2.2 million in 2003, $3.7 million in 2002 and
$4.3 million in 2001. The facility leases provide for a 4%
annual base rent increase. During fiscal 2002 and 2001,
Transmeta subleased a portion of its facilities. Sublease income
was $122,000 in 2002 and $547,000 in 2001. Of the total
operating lease commitments of $19.9 million included in
the table below, the Company has accrued $6.1 million of
the liabilities as a component of accrued restructuring costs
(See Note 7). During fiscal 2003, Transmeta entered into an
agreement that expires in 2007 to sublease a portion of its
facilities that was vacated as part of the 2002 restructuring
plan. Accordingly, sublease income of $128,000 in fiscal 2003
derived from this agreement was charged to the accrued
restructuring charge balance.

The Company finances certain equipment and
software under noncancelable lease agreements that are accounted
for as capital leases.

60



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

At December 31, 2003, future minimum
payments for capital and operating lease obligations are as
follows:

|                                           |                       |                              |     |           |     |  |   |       |        | 
|------------------------------------------ | --------------------- | ---------------------------- | --- | --------- | --- |  | - | ----- | ------ | 
|                                           |                       | Capital                      |     | Operating
|                                           |                       | Leases                       |     | Leases   
|                                           |                       |                              |     |          
|                                           |                       |                             
|                                           |                       | (In thousands)              
|Years ending December 31,                  |                       |                              |     |           |     |  |   |      
|                                           | 2004                  |                              | $   | 407       |     |  | $ | 4,338 |       
|                                           | 2005                  |                              |     | 371       |     |  |   | 4,393 |       
|                                           | 2006                  |                              |     |          |     |  |   | 4,544 |       
|                                           | 2007                  |                              |     |          |     |  |   | 4,696 |       
|                                           | 2008                  |                              |     |          |     |  |   | 2,385 |       
|                                           | Income from subleases |                              |     |          |     |  |   | (451  | )     
|                                           |                       |                              |     |           |     |  |   |      
|                                           |                       | Total minimum lease payments |     |           | 778 |  |   | $     | 19,905 | 
|                                           |                       |                              |     |           |     |  |   |      
|Less amount representing interest          |                       |                              | (52 | )         |     |  |   |      
|                                           |                       |                              |     |           |     |  |   |      
|Present value of capital lease obligations |                       |                              | 726 |           |     |  |   |      
|Less current portion                       |                       |                              | 370 |           |     |  |   |      
|                                           |                       |                              |     |           |     |  |   |      
|Non-current portion                        |                       | $                            | 356 |           |     |  |   |      
|                                           |                       |                              |     |           |     |  |   |      

Transmetas foundry relationship with TSMC
allows the Company to cancel all outstanding purchase orders,
but requires Transmeta to pay the foundry for expenses it has
incurred in connection with the purchase orders through the date
of cancellation. As of December 31, 2003, TSMC had incurred
approximately $1.9 million of manufacturing expenses on the
Companys outstanding purchase orders.

Transmeta outsources certain production and
non-production related services to a third-party supplier. Under
the terms of an agreement with the supplier, Transmeta has a
non-cancelable $1.4 million purchase commitment for certain
services, of which $0.5 million have been purchased and an
additional $0.6 million have been pre-paid as of
December 31, 2003. Under the terms of the agreement,
Transmeta must fulfill its purchase obligation before July 2004,
or risk losing the prepaid funds if the Company is unable to
extend the purchase commitment deadline. As of December 31,
2003, management feels that the Company will be able to satisfy
its purchase commitment before the agreements expiration
date.



|   |     
|-- | ----
|9. | Debt

Transmeta issued promissory notes to financing
companies in the principal amounts of $1.4 million in 1999,
which mature through January 2003. As of December 31, 2003,
these notes have been fully paid. No additional notes were
issued after 1999. In connection with the notes, Transmeta
issued to the note holders warrants to purchase
735,032 shares of common stock. Warrants to purchase
685,032 shares of common stock were issued with an exercise
price of $1.25 and expire between March 2004 and April 2008.
Warrants to purchase 50,000 shares of common stock were
issued with an exercise price of $3.00 and expire in May 2005.
These warrants were assigned an aggregate value of $78,000 on
the basis of Black-Scholes valuation models using the
contractual lives ranging from six to ten years and a volatility
of 0.80. The value of the warrants was recorded as a discount
against the respective borrowings. The amount of discount
accreted and recorded as interest expense for the years ended
December 31, 2003, 2002 and 2001 was $0, $0 and $7,000,
respectively. In October 2003, one of the note holders, who was
issued a warrant to purchase 320,000 shares of common
stock, exercised the warrant and paid the $1.25 per share
exercise price by a net exercise of the warrant through the
surrender of shares issuable under the warrant. The note holder
was issued 222,960 shares of common stock from this net
exercise. See Note 11 for warrants outstanding to purchase
common stock at December 31, 2003.

61



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                     
|--- | --------------------
|10. | Stockholders Equity

In December 2003, the Company completed a public
offering of 25,000,000 shares of common stock at a price of
$2.90 per share. Total net proceeds, after $4.4 million of
underwriter discounts and commissions and $0.7 million of
expenses, were $67.5 million.



| |                                       
| | --------------------------------------
| | Common Stock Reserved for
    Issuance

Shares reserved for future issuance are as
follows:

|                             |  |              |            |      |  |  |            | 
|---------------------------- |  | ------------ | ---------- | ---- |  |  | ---------- | 
|                             |  |             
|                             |  | December 31,
|                             |  |             
|                             |  | 2003         |            | 2002
|                             |  |              |            |     
|Warrants outstanding         |  |              | 566,228    |      |  |  | 1,046,228  | 
|Options outstanding          |  |              | 33,139,998 |      |  |  | 31,871,502 | 
|Employee Stock Purchase Plan |  |              | 4,067,421  |      |  |  | 5,972,977  | 
|Future option grants         |  |              | 4,229,540  |      |  |  | 1,100,358  | 
|                             |  |              |            |      |  |  |            | 
|                             |  |              | 42,003,187 |      |  |  | 39,991,065 | 
|                             |  |              |            |      |  |  |            | 
|Shares subject to repurchase |  |              |           |      |  |  | 590,507    | 
|                             |  |              |            |      |  |  |            | 



| |                      
| | ---------------------
| | Common Stock Warrants

Transmeta has periodically granted warrants in
connection with certain lease and bank agreements and consulting
services. The Company had the following warrants outstanding to
purchase common stock at December 31, 2003:

|              |                        |           |         |           |  |                 |      |  |  |  |               |  | 
|------------- | ---------------------- | --------- | ------- | --------- |  | --------------- | ---- |  |  |  | ------------- |  | 
|              |                        |           |         | Exercise  |  |                
|              |                        | Number of |         | Price per |  |                
|Issuance Date |                        | Shares    |         | Share     |  | Expiration Date
|              |                        |           |         |           |  |                
|October 1995  |                        |           | 60,196  |           |  | $               | 0.41 |  |  |  | October 2005  | 
|January 1998  |                        |           | 125,032 |           |  | $               | 1.25 |  |  |  | December 2007 | 
|April 1998    |                        |           | 240,000 |           |  | $               | 1.25 |  |  |  | April 2008    | 
|May 1998      |                        |           | 50,000  |           |  | $               | 3.00 |  |  |  | May 2005      | 
|March 1999    |                        |           | 68,000  |           |  | $               | 3.00 |  |  |  | March 2004    | 
|February 2000 |                        |           | 8,000   |           |  | $               | 5.00 |  |  |  | February 2005 | 
|March 2001    |                        |           | 15,000  |           |  | $               | 5.00 |  |  |  | March 2005    | 
|              |                        |           |         |           |  |                 |      |  |  |  |               | 
|              | Total number of shares |           |         | 566,228   |  |                 |      |  |  |  |               |  | 
|              |                        |           |         |           |  |                 |      |  |  |  |               | 

All warrants have been valued using the
Black-Scholes valuation model based on the assumptions used for
stock-based awards to employees (see Note 11) except that a
volatility of 0.80 was used was used through fiscal 2000.
Assigned values of $30,000 and $17,000 associated with these
warrant issuances were recorded as common stock in 2000 and
1999, respectively, and were amortized as interest expense over
the term of the agreement or the period the services were
rendered. Costs associated with warrants issued during 2001 were
immaterial.



| |               
| | --------------
| | Treasury Stock

In connection with the resignation of two
officers in the fourth quarter of fiscal 2001, the Company
purchased 796,875 mature vested shares with a market value of
approximately $2.4 million held by the two officers in
exchange for cancellations of a portion of shareholder notes
held by the officers (see Note 11). Mature vested shares
are shares that have been both vested and outstanding for over
six months. As a result of this transaction, the Company has
recorded $2.4 million as a contra-equity balance
representing the market value of the treasury stock at the date
the shares were acquired and the notes were cancelled.

62



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                
| | ---------------
| | Preferred Stock

The Company is authorized, subject to limitations
imposed by Delaware law, to issue up to a total of
5,000,000 shares of preferred stock in one or more series,
without stockholder approval. The Board of Directors is
authorized to establish from time to time the number of shares
to be included in each series, and to fix the rights,
preferences and privileges of the shares of each wholly unissued
series and any of its qualifications, limitations or
restrictions. The Board of Directors can also increase or
decrease the number of shares of a series, but not below the
number of shares of that series then outstanding, without any
further vote or action by the stockholders.

The Board of Directors may authorize the issuance
of preferred stock with voting or conversion rights that could
harm the voting power or other rights of the holders of the
common stock. The issuance of preferred stock, while providing
flexibility in connection with possible acquisitions and other
corporate purposes, could, among other things, have the effect
of delaying, deferring or preventing a change in control of
Transmeta and might harm the market price of its common stock
and the voting and other rights of the holders of common stock.
As of December 31, 2003 and 2002, there were no shares of
preferred stock outstanding.



| |                                   
| | ----------------------------------
| | Stockholders Rights
    Agreement

On January 10, 2002, the Company entered
into a Rights Agreement, pursuant to which the Companys
Board of Directors declared a dividend of one stock purchase
right (a Right) for each outstanding share of the
Companys common stock. The dividend was issued to
stockholders of record on January 18, 2002. In addition,
one Right shall be issued with each share of the Companys
common stock that becomes outstanding (i) between the
record date and the earliest of the Distribution Date, the
Redemption Date and the Final Expiration Date (as such terms are
defined in the Rights Agreement) or (ii) following the
Distribution Date and prior to the Redemption Date or Final
Expiration Date, pursuant to the exercise of stock options or
under any employee plan or arrangement or upon the exercise,
conversion or exchange of other securities of the Company, which
options or securities were outstanding prior to the Distribution
Date. The Rights will become exercisable only upon the
occurrence of certain events specified in the Rights Agreement,
including the acquisition of 15% of the Companys
outstanding common stock by a person or group. Each Right
entitles the registered holder, other than an acquiring
person, under specified circumstances, to purchase from
the Company one one-hundredth of a share of Series A Junior
Participating Preferred Stock, par value $0.00001 per share, of
the Company, at a price of $21.00 per one one-hundredth of a
share of that preferred stock, subject to adjustment. In
addition, each Right entitles the registered holder, other than
an acquiring person, under specified circumstances,
to purchase from the Company that number of shares of the
Companys Common Stock having a market value of two times
the exercise price of the Right.



|    |                         
|--- | ------------------------
|11. | Stock-Based Compensation



| |                           
| | --------------------------
| | 2000 Equity Incentive Plan

The 2000 Equity Incentive Plan (the
Plan) was adopted in September 2000 and became effective
November 6, 2000. The Plan serves as the successor to the
1997 Equity Incentive Plan, and authorizes the award of options,
restricted stock and stock bonuses and provides for the grant of
both incentive stock options (ISOs) that
qualify under Section 422 of the Internal Revenue Code to
employees and nonqualified stock options to employees, directors
and consultants. The exercise price of the incentive stock
options must be at least equal to the fair market value of the
common stock on the date of grant. The exercise price of
incentive stock options granted to 10% stockholders must be at
least equal to 110% of the fair market value of the common stock
on the date of grant. The maximum term of the options granted is
ten years. During any calendar year, no person will be eligible
to receive more than 4,000,000 shares, or
6,000,000 shares in the case of a new employee.

Transmeta initially reserved
7,000,000 shares of common stock under the Plan. The
aggregate number of shares reserved for issuance under the Plan
is increased automatically on January 1 of each year
starting on

63



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

January 1, 2001 by an amount equal to 5% of
the total outstanding shares of the Company on the immediately
preceding December 31. As a result of this provision,
6,804,307, 6,611,728 and 6,520,946 shares were added to the Plan
in 2003, 2002 and 2001, respectively. In addition, the Plan
allows for canceled shares from the 1995 and 1997 Equity
Incentive Plans to be transferred into the 2000 Plan. As a
result of this provision, 728,479, 3,116,323 and 1,508,882
shares were also added to the Plan in 2003, 2002 and 2001,
respectively.



| |                             
| | ----------------------------
| | Non-Plan Stock Option Grants

Transmeta has from time to time granted options
outside of its plans (non-plan stock options).
Non-plan stock options to purchase shares of common stock
authorized and granted were 7,046,000 in 2000 and 2,500,000 in
1999. No non-plan stock options were granted in 2003, 2002 and
2001.



| |                             
| | ----------------------------
| | Prior Equity Incentive Plans

The 1995 Equity Incentive Plan and the 1997
Equity Incentive Plan (the Prior Plans) provided for
the grant of ISOs to employees and the grant of nonstatutory
stock options to employees, directors and consultants. Options
granted under the Prior Plans were designated as
ISO, or nonstatutory stock options at
the discretion of Transmeta, with exercise prices not less than
the fair market value at the date of grant. Options granted
under the Prior Plans generally vest 25% on the first
anniversary of the vesting start date and then monthly over the
next three years and expire ten years from the grant date.



| |                     
| | --------------------
| | Stock Option Summary

The following is a summary of the Companys
stock option activity under the Plan, the Prior Plans and
outside the plans, and related information:

|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |      | 
|---------------------------- | -------------------------- | ------------- | --------- | ------------------- | - | -------- | ---------- | ----------- | - | - | ---- | ---- |  |  | - | ---- | 
|                             |                            |               |           |                    
|                             |                            |               |           | Options Outstanding
|                             |                            |               |           |                    
|                             |                            |               |           |                     |   | Weighted |            | Weighted   
|                             |                            | Shares        |           |                     |   | Average  |            | Average    
|                             |                            | Available for |           | Number of           |   | Exercise |            | Grant Date 
|                             |                            | Grant         |           | Shares              |   | Price    |            | Fair Value 
|                             |                            |               |           |                     |   |          |            |            
|Balance at December 31, 2000 |                            |               | 6,974,000 |                     |   |          | 16,586,546 |             |   | $ | 4.72 |      |  |  |   |     
|                             | Additional shares reserved |               |           | 8,029,828           |   |          |            |            |   |   |      |      |  |  |   |      | 
|                             | Options granted            |               |           | (8,791,821          | ) |          |            | 8,791,821   |   |   | $    | 3.62 |  |  | $ | 2.70 | 
|                             | Options exercised          |               |           |                    |   |          |            | (1,670,589  | ) |   | $    | 0.94 |  |  |   |      | 
|                             | Options canceled           |               |           | 484,834             |   |          |            | (1,868,569  | ) |   | $    | 5.15 |  |  |   |      | 
|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |     
|Balance at December 31, 2001 |                            |               | 6,696,841 |                     |   |          | 21,839,209 |             |   | $ | 4.53 |      |  |  |   |     
|                             | Additional shares reserved |               |           | 9,728,051           |   |          |            |            |   |   |      |      |  |  |   |      | 
|                             | Options granted            |               |           | (22,278,100         | ) |          |            | 22,278,100  |   |   | $    | 1.94 |  |  | $ | 1.59 | 
|                             | Options exercised          |               |           |                    |   |          |            | (1,187,191  | ) |   | $    | 0.68 |  |  |   |      | 
|                             | Options canceled           |               |           | 6,953,566           |   |          |            | (11,058,616 | ) |   | $    | 4.35 |  |  |   |      | 
|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |     
|Balance at December 31, 2002 |                            |               | 1,100,358 |                     |   |          | 31,871,502 |             |   | $ | 2.93 |      |  |  |   |     
|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |     
|                             | Additional shares reserved |               |           | 7,532,786           |   |          |            |            |   |   |      |      |  |  |   |      | 
|                             | Options granted            |               |           | (6,889,750          | ) |          |            | 6,889,750   |   |   | $    | 1.65 |  |  | $ | 1.04 | 
|                             | Options exercised          |               |           |                    |   |          |            | (2,336,796  | ) |   | $    | 1.53 |  |  |   |      | 
|                             | Options canceled           |               |           | 2,486,146           |   |          |            | (3,284,458  | ) |   | $    | 3.27 |  |  |   |      | 
|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |     
|Balance at December 31, 2003 |                            |               | 4,229,540 |                     |   |          | 33,139,998 |             |   | $ | 2.73 |      |  |  |   |     
|                             |                            |               |           |                     |   |          |            |             |   |   |      |      |  |  |   |     

64



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                       |  |           |            |                  |  |   |      | 
|---------------------- |  | --------- | ---------- | ---------------- |  | - | ---- | 
|                       |  | Number of |            | Weighted Average
|Shares exercisable at: |  | Shares    |            | Exercise Price  
|                       |  |           |            |                 
|December 31, 2001      |  |           | 6,067,480  |                  |  | $ | 4.15 | 
|December 31, 2002      |  |           | 8,493,708  |                  |  | $ | 3.92 | 
|December 31, 2003      |  |           | 14,876,266 |                  |  | $ | 3.36 | 

The exercise prices for options outstanding and
exercisable as of December 31, 2003 and their weighted
average remaining contractual lives were as follows:

|                         |              |             |  |             |  |          |  |             |  |          |   |      |  |  |  |            |  |  |   |      | 
|------------------------ | ------------ | ----------- |  | ----------- |  | -------- |  | ----------- |  | -------- | - | ---- |  |  |  | ---------- |  |  | - | ---- | 
|                         |              |             |  |             |  |         
|                         |              | Outstanding |  |            
|                         |              |             |  | Exercisable
|                         |              |             |  | Weighted    |  |          |  |            
|                         |              |             |  | Average     |  | Weighted |  |             |  | Weighted
|                         |              |             |  | Remaining   |  | Average  |  |             |  | Average 
|                         |              | Shares      |  | Contractual |  | Exercise |  | Shares      |  | Exercise
|Range of Exercise Prices |              | Outstanding |  | Life Years  |  | Price    |  | Exercisable |  | Price   
|                         |              |             |  |             |  |          |  |             |  |         
|As of December 31, 2003: |              |             |  |             |  |          |  |             |  |          |   |      |  |  |  |            |  |  |   |     
|                         | $0.19-$0.95  |             |  | 4,910,009   |  |          |  | 8.1         |  |          | $ | 0.88 |  |  |  | 2,631,163  |  |  | $ | 0.82 | 
|                         | $0.96-$1.27  |             |  | 5,053,250   |  |          |  | 8.6         |  |          | $ | 1.14 |  |  |  | 1,722,841  |  |  | $ | 1.15 | 
|                         | $1.30-$1.57  |             |  | 5,106,373   |  |          |  | 9.4         |  |          | $ | 1.55 |  |  |  | 753,718    |  |  | $ | 1.56 | 
|                         | $1.58-$2.38  |             |  | 4,032,487   |  |          |  | 8.1         |  |          | $ | 2.31 |  |  |  | 1,993,846  |  |  | $ | 2.35 | 
|                         | $2.40-$2.60  |             |  | 5,181,085   |  |          |  | 8.3         |  |          | $ | 2.52 |  |  |  | 1,560,144  |  |  | $ | 2.55 | 
|                         | $2.66-$5.25  |             |  | 5,099,041   |  |          |  | 7.3         |  |          | $ | 3.77 |  |  |  | 3,426,876  |  |  | $ | 3.91 | 
|                         | $5.30-$27.88 |             |  | 3,757,753   |  |          |  | 6.7         |  |          | $ | 8.18 |  |  |  | 2,787,678  |  |  | $ | 8.13 | 
|                         |              |             |  |             |  |          |  |             |  |          |   |      |  |  |  |            |  |  |   |     
|                         | $0.19-$27.88 |             |  | 33,139,998  |  |          |  | 8.1         |  |          | $ | 2.73 |  |  |  | 14,876,266 |  |  | $ | 3.36 | 
|                         |              |             |  |             |  |          |  |             |  |          |   |      |  |  |  |            |  |  |   |     



| |                                      
| | -------------------------------------
| | 2000 Employee Stock Purchase
    Plan

Transmeta effected the 2000 Employee Stock
Purchase Plan (the Purchase Plan) in November 2000.
The Purchase Plan allows employees to designate up to 15% of
their total compensation to purchase shares of the
Companys common stock at 85% of fair market value. Upon
effectiveness of the Purchase Plan, the Company reserved
2,000,000 shares of common stock under the Purchase Plan.
In addition, the aggregate number of shares reserved for
issuance under the Purchase Plan will be increased automatically
on January 1 of each year starting on January 1, 2001
by an amount equal to 1% of the total outstanding shares of the
Company on the immediately preceding December 31. As a
result of this provision, 1,360,861, 1,322,346 and
1,304,189 shares were added to the Purchase Plan in 2003,
2002 and 2001, respectively. In May 2002, the Companys
stockholders authorized an additional 4,000,000 shares to
be available under the Purchase Plan. As of December 31,
2003, 5,919,975 shares had been issued under the Purchase
Plan.



| |                            
| | ---------------------------
| | Deferred Stock Compensation

Transmeta recorded deferred stock compensation of
$46.0 million during 2000, representing the aggregate
difference between the exercise prices of certain options and
the deemed fair values of common stock subject to the options as
of the respective measurement dates. This amount is being
amortized by charges to operations, using the accelerated graded
method, over the four year vesting periods of the individual
stock options. During 2003, 2002 and 2001, the Company recorded
$1.8 million, $3.6 million and $16.8 million,
respectively, of net amortization expense related to deferred
stock compensation. The net amortization expense recorded during
fiscal 2002 included a credit of $1.7 million for stock
option cancellations resulting from the Companys workforce
reduction in the third quarter.



| |                                            
| | -------------------------------------------
| | Accounting for Stock-Based
    Compensation

The Company has elected to follow
APB Opinion 25 and related interpretations in
accounting for its employee and director stock-based awards
because, as discussed below, the alternative fair value
accounting

65



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

provided for under SFAS 123 requires use of
option valuation models that were not developed for use in
valuing employee stock-based awards. Under
APB Opinion 25, the Company recognizes no compensation
expense with respect to awards if the exercise price equals or
exceeds the fair value of the underlying security on the date of
grant and other terms are fixed.

Notes Receivable from Stockholders.Transmetas equity incentive
plans permit, subject to approval by the Board of Directors,
holders of options granted prior to March 1999 and certain
holders of non-plan grants to exercise stock options before they
are vested. Shares of common stock issued in connection with
these exercises are subject to repurchase at the exercise price.
At December 31, 2003, the outstanding notes issued by
employees to exercise stock options bear interest at rates
ranging from 4.77% to 6.60% and have original terms of five
years. Prior to the fourth quarter of fiscal 2001, all notes
were full recourse and were recorded as a reduction of
stockholders equity when issued.

Officer notes.In
the fourth quarter of fiscal 2001, the employment of two
officers terminated. In connection with the termination of their
employment, the Company repurchased a total of 796,875 vested
shares and 1,753,125 unvested shares held by these officers.
These shares were originally issued in return for an aggregate
of $8.0 million in recourse notes. As a result of the
repurchase of these shares and the cancellation of the
outstanding recourse notes and accrued interest, Transmeta
recorded additional stock compensation expense of
$1.2 million primarily to write-off accrued interest on the
notes and an offsetting entry of $1.9 million to reverse
stock compensation expense previously recognized on the unvested
shares.

Recourse notes held by other officers and
employees.At the time the above two
officer notes were cancelled, other recourse notes for a total
of $8.2 million, including $0.7 million of accrued
interest, were outstanding. Because the Company did not enforce
the recourse provisions of the notes for the officers that
resigned, which would have recouped all principal and interest,
in the fourth quarter of 2001, the Company began to account for
these remaining notes as if they had terms equivalent to
non-recourse notes, even though the terms of these notes were
not in fact changed from recourse to non-recourse.

Transmeta will continue to record stock
compensation expense on these stock awards until the notes are
paid based on the current market value of its stock at the end
of each accounting period. This variable stock compensation will
be based on the excess, if any, of the current market price of
its stock as of period-end over the purchase price of the stock
award, adjusted for vesting and prior stock compensation expense
recognized on the stock award. At December 31, 2003, the
Company had 1,108,000 shares that are subject to variable stock
compensation at prices ranging from $0.19 to $0.65 per share.
During fiscal 2003, the Company recorded $2.7 million of
variable stock compensation expense relating to these stock
awards. During fiscal 2002, stock compensation included a credit
of $1.8 million recorded to stock compensation expense due
to a lower market price of our common stock at the end of fiscal
2002 compared to the end of fiscal 2001. During fiscal 2001,
Transmeta recorded $2.5 million of variable stock
compensation expense relating to these stock awards. In
addition, the Company recorded additional stock compensation
expense of $0.7 million to write-off all interest that had
accrued under the other recourse notes. In the future, if the
price of the Companys stock increases $1 per share it
will result in approximately $1.1 million of additional
stock compensation expense, or if the stock decreases $1 per
share it will result in a benefit (reduction) in stock
compensation expense of approximately the same amount. Because
variable stock compensation expense is calculated based on the
current market value of the Companys common stock at the
end of each accounting period, future stock compensation expense
for these variable stock awards could increase significantly in
periods when the Companys stock price rises, and could
reverse and become a benefit in periods when the Companys
stock price falls. The Company also has an additional
1,100,000 shares that are subject to variable accounting if
its stock price increases above approximately $11.50 per share.
However, the Company has a call option on these shares that it
intends to exercise before the stock price exceeds $11.50 per
share and does not believe it will incur variable stock
compensation on these shares.

66



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Fair value accounting for stock-based awards.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 in 2000 was determined based on
estimated stock price volatility. The weighted average
assumptions used to determine fair value were as follows:

|                        |  |              |      |              |  |      |     |      |  |      |     |      |  |  |     |   |  |  |     |   |  |  |     |  
|----------------------- |  | ------------ | ---- | ------------ |  | ---- | --- | ---- |  | ---- | --- | ---- |  |  | --- | - |  |  | --- | - |  |  | --- | -
|                        |  |              |      |             
|                        |  | Options      |      | ESPP        
|                        |  |              |      |             
|                        |  |              |      |             
|                        |  | Years Ended  |      | Years Ended 
|                        |  | December 31, |      | December 31,
|                        |  |              |      |             
|                        |  | 2003         |      | 2002         |  | 2001 |     | 2003 |  | 2002 |     | 2001
|                        |  |              |      |              |  |      |     |      |  |      |     |     
|Expected volatility     |  |              | 0.86 |              |  |      | 1.3 |      |  |      | 1.1 |      |  |  | 1.1 |   |  |  | 1.2 |   |  |  | 1.3 |  
|Expected life in years  |  |              | 4    |              |  |      | 4   |      |  |      | 4   |      |  |  | .5  |   |  |  | .5  |   |  |  | .5  |  
|Risk-free interest rate |  |              | 2.3  | %            |  |      | 3.7 | %    |  |      | 4.4 | %    |  |  | 2.0 | % |  |  | 2.5 | % |  |  | 4.0 | %
|Expected dividend yield |  |              | 0    |              |  |      | 0   |      |  |      | 0   |      |  |  | 0   |   |  |  | 0   |   |  |  | 0   |  



|    |                      
|--- | ---------------------
|12. | Employee Benefit Plan

Transmeta has an Employee Savings and Retirement
Plan (the Benefit Plan) under Section 401(k) of
the Internal Revenue Code for its eligible employees. The
Benefit Plan is available to all of Transmetas employees
who meet minimum age requirements, and provides employees with
tax deferred salary deductions and alternative investment
options. Employees may contribute up to 15% of their eligible
earnings, subject to certain limitations. There have been no
matching contributions by the Company under the Benefit Plan.



|    |                          
|--- | -------------------------
|13. | Related Party Transaction

Transmeta entered into a trademark and technology
licensing agreement during fiscal 2003 with Chinese 2 Linux
(Holdings) Limited. In relation to this agreement, the Company
became a 16.6% beneficial owner of the party with which the
agreement was entered. The agreement resulted in recognition of
license revenue of $140,000 during fiscal 2003.



|    |             
|--- | ------------
|14. | Income Taxes

Transmeta recorded a provision for foreign income
taxes of $32,000 and $21,000 for fiscal 2003 and 2002,
respectively, in interest income and other, net. No provision
was recorded for income taxes in fiscal 2001.

The provision for income taxes differs from the
amount computed by applying the statutory federal income tax
rate to income (loss) before income taxes. The sources and tax
effects of the differences are as follows (in thousands):

|                                                        |  |                          |         |      |  |      |         |   |  |   |         |  
|------------------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                        |  |                         
|                                                        |  | Years Ended December 31,
|                                                        |  |                         
|                                                        |  | 2003                     |         | 2002 |  | 2001
|                                                        |  |                          |         |      |  |     
|                                                        |  |                         
|                                                        |  | (In thousands)          
|Income tax expense (benefit) at U.S. statutory
    rate |  | $                        | (29,689 | )    |  | $    | (37,381 | ) |  | $ | (58,225 | )
|Foreign income taxes                                    |  |                          | 32      |      |  |      | 21      |   |  |   |        |  
|Valuation Allowance                                     |  |                          | 29,689  |      |  |      | 37,381  |   |  |   | 58,225  |  
|                                                        |  |                          |         |      |  |      |         |   |  |   |         |  
|Provision for income taxes                              |  | $                        | 32      |      |  | $    | 21      |   |  | $ |        |  
|                                                        |  |                          |         |      |  |      |         |   |  |   |         |  

Deferred income taxes reflect the net tax effects
of operating losses and tax credit carryforwards and temporary
differences between the carrying amount of assets and
liabilities for financial reporting purposes and

67



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the amounts used for income tax purposes.
Significant components of the Companys deferred tax assets
are as follows:

|                                                 |  |                          |          |      |  |      |          |   |  |   |          |  
|------------------------------------------------ |  | ------------------------ | -------- | ---- |  | ---- | -------- | - |  | - | -------- | -
|                                                 |  |                         
|                                                 |  | Years Ended December 31,
|                                                 |  |                         
|                                                 |  | 2003                     |          | 2002 |  | 2001
|                                                 |  |                          |          |      |  |     
|                                                 |  |                         
|                                                 |  | (In thousands)          
|Federal operating loss carryforwards             |  | $                        | 131,500  |      |  | $    | 99,000   |   |  | $ | 67,400   |  
|State operating loss carryforwards               |  |                          | 6,500    |      |  |      | 5,000    |   |  |   | 5,400    |  
|Federal tax credit carryforwards                 |  |                          | 9,000    |      |  |      | 8,000    |   |  |   | 6,500    |  
|State tax credit carryforwards                   |  |                          | 7,000    |      |  |      | 6,000    |   |  |   | 3,300    |  
|Non-deductible reserves and capitalized expenses |  |                          | 28,000   |      |  |      | 35,000   |   |  |   | 29,600   |  
|                                                 |  |                          |          |      |  |      |          |   |  |   |          |  
|                                                 |  |                          | 182,000  |      |  |      | 153,000  |   |  |   | 112,200  |  
|Less: Valuation allowance                        |  |                          | (182,000 | )    |  |      | (153,000 | ) |  |   | (112,200 | )
|                                                 |  |                          |          |      |  |      |          |   |  |   |          |  
|Net deferred taxes                               |  | $                        |         |      |  | $    |         |   |  | $ |         |  
|                                                 |  |                          |          |      |  |      |          |   |  |   |          |  

Based upon the weight of available evidence,
which includes the Companys historical operating
performance, the Company has always provided a full valuation
allowance against its net deferred tax assets as it is more
likely than not that the deferred tax assets will not be
realized. The valuation allowance increased by
$29.0 million in 2003, $40.8 million in 2002 and
$53.5 million in 2001.

The federal operating loss and tax credit
carryforwards listed above will expire between 2010 and 2023, if
not previously utilized. The state operating loss and tax credit
carryforwards will expire beginning in 2005, if not previously
utilized. Utilization of the Companys net operating loss
may be subject to substantial annual limitations due to the
ownership change limitations provided by the Internal Revenue
Code and similar state provisions. Such annual limitation could
result in the expiration of the net operating loss being
utilized.

The Company incurred pre-tax income from foreign
operations of $0.5 million in fiscal 2003. During fiscal 2002
and 2001, pre-tax losses from foreign operations totaled
$20.7 million and $14.0 million, respectively.



|    |                    
|--- | -------------------
|15. | Segment Information

Transmeta has adopted the FASBs
SFAS 131, Disclosure About Segments of an Enterprise
and Related Information. Transmeta operates and is
evaluated by management on a single segment basis; the
development, marketing and sale of hardware and software
technologies for the mobile computing market. Sales by
geographic area are categorized based on the customers billing
address. The following is a summary of the Companys net
revenue by major geographic area:

|                 |  |              |    |      |  |      |    |   |  |  |    |  
|---------------- |  | ------------ | -- | ---- |  | ---- | -- | - |  |  | -- | -
|                 |  |             
|                 |  | Years Ended 
|                 |  | December 31,
|                 |  |             
|                 |  | 2003         |    | 2002 |  | 2001
|                 |  |              |    |      |  |     
|Japan            |  |              | 44 | %    |  |      | 79 | % |  |  | 67 | %
|China/ Hong Kong |  |              | 39 | %    |  |      | 6  | % |  |  | *  | %
|Taiwan           |  |              | 13 | %    |  |      | 14 | % |  |  | 24 | %
|North America    |  |              | 4  | %    |  |      | 1  | % |  |  | 9  | %

68



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following customers accounted for more than
10% of total revenue:

|          |                                        |              |  |      |   |      |  |    |   |  |  |    |  
|--------- | -------------------------------------- | ------------ |  | ---- | - | ---- |  | -- | - |  |  | -- | -
|          |                                        |             
|          |                                        | Years Ended 
|          |                                        | December 31,
|          |                                        |             
|          |                                        | 2003         |  | 2002 |   | 2001
|          |                                        |              |  |      |   |     
|Customer: |                                        |              |  |      |   |      |  |    |   |  |  |   
|          | Uniquest Hong Kong**                   |              |  | 21   | % |      |  | *  | % |  |  | *  | %
|          | Sharp Trading Corporation              |              |  | 20   | % |      |  | *  | % |  |  | *  | %
|          | Fujitsu America Inc.                   |              |  | 16   | % |      |  | 26 | % |  |  | 12 | %
|          | Hewlett Packard International Pte Inc. |              |  | 14   | % |      |  | *  | % |  |  | *  | %
|          | Sony Trading International Corp.       |              |  | *    | % |      |  | 37 | % |  |  | 30 | %
|          | Toshiba America Inc.                   |              |  | *    | % |      |  | *  | % |  |  | 18 | %
|          | Siltrontech Electronics Corporation    |              |  | *    | % |      |  | *  | % |  |  | 11 | %



---



|  |                                          
|- | -----------------------------------------
|* | represents less than 10% of total revenue



|   |                                                                                                                                    
|-- | -----------------------------------------------------------------------------------------------------------------------------------
|** | Uniquest Hong Kong made these purchases acting as
    the distributor of our product for the Hewlett Packard Tablet PC
    program.



|    |                  
|--- | -----------------
|16. | Legal Proceedings

Beginning in June 2001, Transmeta, its directors,
and certain of its officers were named as defendants in several
putative shareholder class actions that were consolidated in and
by the United States District Court for the Northern District of
California as In re Transmeta Corporation Securities
Litigation, Case No. C 01-02450 WHA. The
complaints purported to allege a class action on behalf of
persons who purchased Transmeta common stock between
November 7, 2000 and July 19, 2001, and alleged
violations of Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, as amended, and Rule 10b-5
promulgated thereunder, and Sections 11 and 15 of the
Securities Act of 1933, as amended. In March 2002, the Court
granted in part and denied in part defendants motions to
dismiss the consolidated amended complaint. In May 2002, the
Court granted in part and denied in part defendants motion
to dismiss the second amended complaint, and denied
plaintiffs motion for leave to file a third amended
complaint. In June 2002, defendants answered the second amended
complaint as to the sole surviving claim. In July 2002,
defendants filed a motion for summary judgment relating to that
claim. In July 2002, plaintiffs moved for class certification
and initiated discussion of a proposed settlement. The Company
and the individual defendants believe that the complaints are
without merit and deny any liability, but because they also wish
to avoid the continuing waste of management time and expense of
litigation, they entered into an agreement in October 2002 to
settle all claims that might have been brought in this action
for approximately $5.5 million, all of which monies have
been fully funded by defendants director and officer
liability insurance. In March 2003, after proper class notice
and hearings, the Court approved the settlement and entered
judgment for defendants, dismissing the action. In April 2003, a
plaintiffs law firm that was not selected by the Court to
serve as class counsel filed a notice of appeal relating to
certain Court orders addressing that firms applications to
the Court for attorneys fees. In August 2003, on
appellants own motion, the Court of Appeals dismissed the
appeal.

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

69



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

approximately $300,000 in fees to counsel for the
derivative plaintiffs and shall be fully funded by
defendants director and officer liability insurance. In
October 2003, upon motion and after a hearing, the Court
approved the settlement and entered an order dismissing the
consolidated derivative action as to all defendants.

Beginning in June 2001, the Company, certain of
its directors and officers, and certain of the underwriters for
its initial public offering were named as defendants in three
putative shareholder class actions that were consolidated in and
by the United States District Court for the Southern District of
New York in In re Transmeta Corporation Initial Public
Offering Securities Litigation, Case No. 01 CV 6492.
The complaints allege that the prospectus issued in connection
with the Companys initial public offering on
November 7, 2000 failed to disclose certain alleged actions
by the underwriters for that offering, and alleges claims
against the Company and several of its officers and directors
under Sections 11 and 15 of the Securities Act of 1933, as
amended, and under Sections 10(b) and Section 20(a) of
the Securities Exchange Act of 1934, as amended. Similar actions
have been filed against more than 300 other companies that
issued stock in connection with other initial public offerings
during 1999-2000. Those cases have been coordinated for pretrial
purposes as In re Initial Public Offering Securities
Litigation, Master File No. 21 MC 92 (SAS).
In July 2002, the Company joined in a coordinated motion to
dismiss filed on behalf of multiple issuers and other
defendants. In February 2003, the Court granted in part and
denied in part the coordinated motion to dismiss, and issued an
order regarding the pleading of amended complaints. Plaintiffs
subsequently proposed a settlement offer to all issuer
defendants, which settlement would provide for payments by
issuers insurance carriers if plaintiffs fail to recover a
certain amount from underwriter defendants. Although the Company
and the individual defendants believe that the complaints are
without merit and deny any liability, but because they also wish
to avoid the continuing waste of management time and expense of
litigation, they accepted plaintiffs proposal to settle
all claims that might have been brought in this action. The
Company and the individual Transmeta defendants expect that
their share of the global settlement will be fully funded by
their director and officer liability insurance. Although the
Company and the Transmeta defendants have approved the
settlement in principle, it remains subject to several
procedural conditions, as well as formal approval by the Court.
It is possible that the parties may not reach a final written
settlement agreement or that the Court may decline to approve
the settlement in whole or part. In the event that the parties
do not reach agreement on the final settlement, the Company and
the Transmeta defendants believe that they have meritorious
defenses and intend to defend any remaining action vigorously.



|    |                 
|--- | ----------------
|17. | Subsequent Event

In relation to the Companys
December 2003 common stock offering, on January 12,
2004, the Companys underwriters exercised their
over-allotment option and purchased 3.75 million shares,
resulting in net proceeds to the company, before expenses, of
$10.2 million. The shares were offered under the shelf S-3
registration statement that was filed by Transmeta with the
Securities and Exchange Commission (the SEC) and
declared effective on July 29, 2003 by the SEC.

70



---



##### Table of Contents



TRANSMETA CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

18.     Quarterly
Results of Operations (Unaudited)

The following table presents Transmetas
unaudited quarterly statement of operations data for the four
quarters of fiscal 2003 and fiscal 2002, each of which consists
of 13 weeks. For ease of presentation, the quarterly
financial statements are shown as ending on calendar quarters.
The Company believes that this information has been prepared on
the same basis as its audited consolidated financial statements
and that all necessary adjustments, consisting only of normal
recurring adjustments, have been included to present fairly the
selected quarterly information. Transmetas quarterly
results of operations for these periods are not necessarily
indicative of future results of operations.

|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |       |        | 
|----------------------------------------------------------- | -------------------------------------------------------------- | ----------------------------------------- | ------- | --------- | ------ | -------- | ------- | -------- | ------ | -------- | ------- | --------- | ------ | -------- | ------- | -------- | ------ | - | ------- | ----- | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ----- | ------ | 
|                                                            |                                                                |                                          
|                                                            |                                                                | Quarters Ended                           
|                                                            |                                                                |                                          
|                                                            |                                                                | Dec. 31,                                  |         | Sept. 30, |        | Jun. 30, |         | Mar. 31, |        | Dec. 31, |         | Sept. 30, |        | Jun. 30, |         | Mar. 31,
|                                                            |                                                                | 2003                                      |         | 2003      |        | 2003     |         | 2003     |        | 2002     |         | 2002      |        | 2002     |         | 2002    
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |         
|                                                            |                                                                |                                          
|                                                            |                                                                | (In thousands, except for per share data)
|Revenue:                                                    |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|                                                            | Product                                                        |                                           | $       | 3,316     |        |          | $       | 2,365    |        |          | $       | 4,601     |        |          | $       | 5,943    |        |   | $       | 6,118 |        |   | $       | 6,443  |        |   | $       | 7,539  |        |   | $       | 4,147 |       
|                                                            | License                                                        |                                           |         | 240       |        |          |         | 323      |        |          |         | 453       |        |          |         | 74       |        |   |         |      |        |   |         |       |        |   |         |       |        |   |         |      |       
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|                                                            |                                                                | Total revenue                             |         |           | 3,556  |          |         |          | 2,688  |          |         |           | 5,054  |          |         |          | 6,017  |   |         |       | 6,118  |   |         |        | 6,443  |   |         |        | 7,539  |   |         |       | 4,147  | 
|Cost of revenue:                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|                                                            | Product                                                        |                                           |         | 3,661     |        |          |         | 3,073    |        |          |         | 4,998     |        |          |         | 4,452    |        |   |         | 4,680 |        |   |         | 3,994  |        |   |         | 5,617  |        |   |         | 2,836 |       
|                                                            | License                                                        |                                           |         | 140       |        |          |         |         |        |          |         |          |        |          |         |         |        |   |         |      |        |   |         |       |        |   |         |       |        |   |         |      |       
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|                                                            |                                                                | Total cost of revenue                     |         |           | 3,801  |          |         |          | 3,073  |          |         |           | 4,998  |          |         |          | 4,452  |   |         |       | 4,680  |   |         |        | 3,994  |   |         |        | 5,617  |   |         |       | 2,836  | 
|Gross profit (loss)                                         |                                                                |                                           | (245    | )         |        |          | (385    | )        |        |          | 56      |           |        |          | 1,565   |          |        |   | 1,438   |       |        |   | 2,449   |        |        |   | 1,922   |        |        |   | 1,311   |      
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|Operating expenses Research and development                 |                                                                |                                           | 11,404  |           |        |          | 12,452  |          |        |          | 12,190  |           |        |          | 12,479  |          |        |   | 12,632  |       |        |   | 13,707  |        |        |   | 19,184  |        |        |   | 18,080  |      
|                                                            | Selling, general and administrative                            |                                           |         | 7,240     |        |          |         | 5,978    |        |          |         | 6,347     |        |          |         | 6,634    |        |   |         | 6,991 |        |   |         | 6,255  |        |   |         | 8,737  |        |   |         | 7,934 |       
|                                                            | Restructuring charges                                          |                                           |         | (244      | )      |          |         |         |        |          |         |          |        |          |         |         |        |   |         |      |        |   |         | 4,102  |        |   |         | 10,624 |        |   |         |      |       
|                                                            | Amortization of deferred charges, patent and
    patent rights |                                           |         | 2,628     |        |          |         | 2,628    |        |          |         | 2,634     |        |          |         | 2,640    |        |   |         | 2,848 |        |   |         | 2,848  |        |   |         | 2,848  |        |   |         | 2,848 |       
|                                                            | Stock compensation                                             |                                           |         | 696       |        |          |         | 2,302    |        |          |         | 1,095     |        |          |         | 436      |        |   |         | 1,214 |        |   |         | (1,651 | )      |   |         | (2,558 | )      |   |         | 4,804 |       
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|                                                            |                                                                | Total operating expenses                  |         |           | 21,724 |          |         |          | 23,360 |          |         |           | 22,266 |          |         |          | 22,189 |   |         |       | 23,685 |   |         |        | 25,261 |   |         |        | 38,835 |   |         |       | 33,666 | 
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|Operating loss                                              |                                                                |                                           | (21,969 | )         |        |          | (23,745 | )        |        |          | (22,210 | )         |        |          | (20,624 | )        |        |   | (22,247 | )     |        |   | (22,812 | )      |        |   | (36,913 | )      |        |   | (32,355 | )    
|                                                            | Interest income and other, net                                 |                                           |         | 167       |        |          |         | 203      |        |          |         | 312       |        |          |         | 707      |        |   |         | 628   |        |   |         | 1,137  |        |   |         | 1,425  |        |   |         | 1,772 |       
|                                                            | Interest expense                                               |                                           |         | (114      | )      |          |         | (116     | )      |          |         | (123      | )      |          |         | (124     | )      |   |         | (67   | )      |   |         | (90    | )      |   |         | (140   | )      |   |         | (304  | )     
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|Net loss                                                    |                                                                | $                                         | (21,916 | )         |        | $        | (23,658 | )        |        | $        | (22,021 | )         |        | $        | (20,041 | )        |        | $ | (21,686 | )     |        | $ | (21,765 | )      |        | $ | (35,628 | )      |        | $ | (30,887 | )    
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|Net loss per share  basic and diluted                      |                                                                | $                                         | (0.15   | )         |        | $        | (0.17   | )        |        | $        | (0.16   | )         |        | $        | (0.15   | )        |        | $ | (0.16   | )     |        | $ | (0.16   | )      |        | $ | (0.27   | )      |        | $ | (0.23   | )    
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      
|Weighted average shares outstanding 
    basic and diluted |                                                                |                                           | 142,747 |           |        |          | 139,844 |          |        |          | 138,678 |           |        |          | 137,551 |          |        |   | 136,850 |       |        |   | 135,561 |        |        |   | 133,868 |        |        |   | 132,997 |      
|                                                            |                                                                |                                           |         |           |        |          |         |          |        |          |         |           |        |          |         |          |        |   |         |       |        |   |         |        |        |   |         |        |        |   |         |      

71



---



##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

Not applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and
Procedures.The Securities and
Exchange Commission defines the term disclosure controls
and procedures to mean a companys controls and other
procedures that are designed to ensure that information required
to be disclosed in the reports that it files or submits under
the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported, within the time periods specified in
the Commissions rules and forms. Our chief executive
officer and chief financial officer have concluded, based on the
evaluation of the effectiveness of the disclosure controls and
procedures by our management, with the participation of our
chief executive officer and chief financial officer, as of the
end of the period covered by this report, that our disclosure
controls and procedures were effective for this purpose.

Changes in Internal
Controls.During the fourth quarter of
fiscal year 2003, there were no changes in our internal control
over financial reporting that have materially affected or are
reasonably likely to materially affect our internal control over
financial reporting.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required by this item is
incorporated by reference to our definitive proxy statement for
our 2004 Annual Meeting of Stockholders.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this item is
incorporated by reference to our definitive proxy statement for
our 2004 Annual Meeting of Stockholders.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information required by this item is
incorporated by reference to our definitive proxy statement for
our 2004 Annual Meeting of Stockholders.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this item is
incorporated by reference to our definitive proxy statement for
our 2004 Annual Meeting of Stockholders.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required by this item is
incorporated by reference to our definitive proxy statement for
our 2004 Annual Meeting of Stockholders.

72



---



##### Table of Contents






PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a)The following documents are filed as
part of this report:



| |                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. Financial Statements 
    See Index to Consolidated Financial Statements in Part II,
    Item 8.                                                                                                                            
|
| | 2. Financial Statement
    Schedules  All financial statement schedules have
    been omitted because the information required is not applicable
    or is shown in the Consolidated Financial Statements or notes
    thereto.
|
| | 3. Exhibits                                                                                                                                                                                                                     

The following exhibits are filed herewith or
incorporated by reference herein:

|        |    |               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------- | -- | ------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |              
|Number  |    | Exhibit Title
|        |    |              
|        | 3  | .01           |  | Second Amended and Restated Certificate of
    Incorporation. Incorporated by reference to Exhibit 3.01 to
    Transmetas Form 10-K for the year ended
    December 31, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|        | 3  | .02           |  | Restated Bylaws. Incorporated by reference to
    Exhibit 3.06 to Transmetas Form S-1 Registration
    Statement (File No. 333-44030) (the
    IPO S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        | 3  | .03           |  | Certificate of Designations specifying the terms
    of the Series A Junior Participating Preferred Stock of
    Transmeta as filed with the Secretary of State of the State of
    Delaware on January 15, 2002. Incorporated by reference to
    Exhibit 3.02 to Transmetas Form 8-A Registration
    Statement filed on January 16, 2002.                                                                                                                                                                                                                                                                                 
|        | 4  | .01           |  | Specimen common stock certificate. Incorporated
    by reference to Exhibit 4.01 to the IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        | 4  | .02           |  | Fifth Restated Investors Rights Agreement
    dated March 31, 2000, between Transmeta, certain
    stockholders of Transmeta and a convertible note holder named
    therein. Incorporated by reference to Exhibit 4.02 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                  
|        | 4  | .03           |  | Form of Piggyback Registration Rights Agreement.
    Incorporated by reference to Exhibit 4.03 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 4  | .04           |  | Rights Agreement dated January 15, 2002
    between Transmeta and Mellon Investor Services LLC as Rights
    Agent, which includes as Exhibit A the form of Certificate
    of Designations of Series A Junior Participating Preferred
    Stock, as Exhibit B the Summary of Stock Purchase Rights
    and as Exhibit C the Form of Rights Certificate.
    Incorporated by reference to Exhibit 4.01 to
    Transmetas Form 8-A Registration Statement filed on
    January 16, 2002.                                                                                                                                      
|        | 10 | .01           |  | Form of Indemnity Agreement. Incorporated by
    reference to Exhibit 10.01 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 10 | .02           |  | 1995 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.02 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10 | .03           |  | 1997 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.03 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10 | .04           |  | 2000 Equity Incentive Plan. Incorporated by
    reference to Exhibit 4.06 to Transmetas Form S-8
    Registration Statement filed January 18, 2002.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        | 10 | .05           |  | 2000 Employee Stock Purchase Plan. Incorporated
    by reference to Exhibit 4.08 to Transmetas
    Form S-8 Registration Statement filed May 28, 2002.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        | 10 | .06           |  | Lease Agreement, dated November 1, 1995,
    between John Arrillaga, as trustee of John Arrillaga Family
    Trust, Richard T. Peery, as trustee of Richard T. Peery Separate
    Property Trust, and Transmeta, as amended by Amendment
    No. 1, dated January 29, 1997, and Amendment
    No. 2, dated April 2, 1998, between John Arrillaga, as
    trustee of John Arrillaga Survivors Trust (successor in
    interest to the Arrillaga Family Trust), Richard T. Peery, as
    trustee of Richard T. Peery Separate Property Trust, and
    Transmeta. Incorporated by reference to Exhibit 10.08 to
    the IPO S-1.

73



---



##### Table of Contents



|        |    |               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|------- | -- | ------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |              
|Number  |    | Exhibit Title
|        |    |              
|        | 10 | .07           |  | Lease Agreement, dated January 29, 1997,
    between John Arrillaga, as trustee of John Arrillaga Family
    Trust, Richard T. Peery, as trustee of Richard T. Peery Separate
    Property Trust, and Transmeta, as amended by Amendment
    No. 1, dated April 2, 1998, between John Arrillaga, as
    trustee of John Arrillaga Survivors Trust (successor in
    interest to the Arrillaga Family Trust), Richard T. Peery, as
    trustee of Richard T. Peery Separate Property Trust, and
    Transmeta. Incorporated by reference to Exhibit 10.09 to
    the IPO S-1.
|        | 10 | .08           |  | Lease Agreement, dated April 2, 1998,
    between John Arrillaga, as trustee of John Arrillaga
    Survivors Trust, Richard T. Peery, as trustee of Richard
    T. Peery Separate Property Trust, and Transmeta. Incorporated by
    reference to Exhibit 10.10 to the IPO S-1.                                                                                                                                                                                                                                                                                             
|        | 10 | .09           |  | Lease Agreement, dated April 2, 1998,
    between John Arrillaga, as trustee of John Arrillaga
    Survivors Trust, Richard T. Peery, as trustee of Richard
    T. Peery Separate Property Trust, and Transmeta. Incorporated by
    reference to Exhibit 10.11 to the IPO S-1.                                                                                                                                                                                                                                                                                             
|        | 10 | .10           |  | Sublease Agreement, dated as of April 28,
    1999, between Transmeta and Xuan Nguyen dba World Marketing
    Alliance. Incorporated by reference to Exhibit 10.13 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                       
|        | 10 | .11           |  | Form of Stock Option Agreement under
    Transmetas 2000 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.17 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 10 | .12           |  | Form of Stock Option Agreement (for Non-Employee
    Directors) under Transmetas 2000 Equity Incentive Plan.
    Incorporated by reference to Exhibit 10.18 to the
    IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                           
|        | 10 | .13           |  | Form of Stock Option Agreement. Incorporated by
    reference to Exhibit 10.18 to Transmetas
    Form 10-K for the year ended December 31, 2000.**                                                                                                                                                                                                                                                                                                                                                                                                                          
|        | 10 | .14           |  | Authorized Exclusive Distributor Agreement, dated
    September 12, 2000, between Transmeta and Siltrontech
    Electronics Corporation. Incorporated by reference to
    Exhibit 10.15 to Transmetas Form 10-K for the
    year ended December 31, 2001 (the
    2001 10-K).                                                                                                                                                                                                                                                                                             
|        | 10 | .15           |  | Option Amendment and Termination Agreement, dated
    November 16, 2001, between Transmeta and Merle McClendon.
    Incorporated by reference to Exhibit 10.17 to the
    2001 10-K.**                                                                                                                                                                                                                                                                                                                                                                                       
|        | 10 | .16           |  | Offer of Employment from Transmeta Corporation to
    Matthew R. Perry dated March 21, 2002. Incorporated by
    reference to Exhibit 10.22 to Transmetas
    Form 10-Q for the quarterly period ended June 30,
    2002.**                                                                                                                                                                                                                                                                                                                                                 
|        | 21 | .01           |  | Subsidiaries. Incorporated by reference to
    Exhibit 21.01 to the IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 23 | .01*          |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|        | 24 | .01*          |  | Power of Attorney. See Signature Page.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|        | 31 | .01*          |  | Certification by Matthew R. Perry pursuant to
    Rule 13a-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 31 | .02*          |  | Certification by Svend-Olav Carlsen pursuant to
    Rule 13a-14(a).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|        | 32 | .01*          |  | Certification by Matthew R. Perry pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                          
|        | 32 | .02*          |  | Certification by Svend-Olav Carlsen pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                        



---



| |   |                
| | - | ---------------
| | * | Filed herewith.



|   |                                                 
|-- | ------------------------------------------------
|** | Management contract or compensatory arrangement.

(b) Reports on Form 8-K

On November 25, 2003, we filed a current
report on Form 8-K under items 5 and 7 respecting a
press release we issued announcing that we intended to offer
shares of our common stock in a public offering.

On December 4, 2003, we filed a current
report on Form 8-K under item 5 announcing that David
R. Ditzel made a previously and regularly scheduled sale of
100,000 shares of stock pursuant to a preexisting sales
plan.

74



---



##### Table of Contents



On December 17, 2003, we filed a current
report on Form 8-K under item 5 announcing that we had
included certain disclosures in the preliminary prospectus
supplement filed with the Securities and Exchange Commission on
November 25, 2003.

On December 18, 2003, we filed a current
report on Form 8-K under items 5 and 7 respecting a
press release we issued announcing that we had priced the
offering of shares of our common stock in a public offering.

On December 18, 2003, we filed a current
report on Form 8-K under item 5 announcing that
R. Hugh Barnes had made a scheduled and limited sale of
48,690 shares of common stock consistent with a lock-up
agreement that he entered into in connection with the offering
of shares of our common stock in a public offering.

(c)Exhibits

See Item 15(a)(3) above.

(d) Financial Statement Schedules

See Item 15(a)(2) above.

75



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) 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/ SVEND-OLAV CARLSEN

| |                                 
| | --------------------------------
| |                                 
| | Svend-Olav Carlsen              
| | Chief Financial Officer         
| | (Principal Financial Officer and
| | Duly Authorized Officer)        

Dated: March 5, 2004

POWER OF ATTORNEY

By signing this Form 10-K below, I hereby
appoint each of Matthew R. Perry and Svend-Olav Carlsen, as my
attorney-in-fact to sign all amendments to this Form 10-K
on my behalf, and to file this Form 10-K (including all
exhibits and other documents related to the Form 10-K) with
the Securities and Exchange Commission. I authorize each of my
attorneys-in-fact to (1) appoint a substitute
attorney-in-fact for himself and (2) perform any actions
that he or she believes are necessary or appropriate to carry
out the intention and purpose of this Power of Attorney. I
ratify and confirm all lawful actions taken directly or
indirectly by my attorneys-in-fact and by any properly appointed
substitute attorneys-in-fact.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|                                         |  |                                                                                           |  |               |  | 
|---------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                         |  |                                                                                           |  |              
|Signature                                |  | Title                                                                                     |  | Date         
|                                         |  |                                                                                           |  |              
|                                        
|/s/ MATTHEW R. PERRYMatthew R. Perry     |  | Chief Executive Officer
    [Principal Executive Officer]                                 |  | March 5, 2004
|                                        
|/s/ SVEND-OLAV CARLSENSvend-Olav Carlsen |  | Chief Financial Officer
    [Principal Financial Officer and
    Duly Authorized Officer] |  | March 5, 2004
|                                        
|/s/ MURRAY A. GOLDMANMurray A. Goldman   |  | Director                                                                                  |  | March 5, 2004
|                                        
|/s/ R. HUGH BARNESR. Hugh Barnes         |  | Director                                                                                  |  | March 5, 2004
|                                        
|/s/ DAVID R. DITZELDavid R. Ditzel       |  | Director                                                                                  |  | March 5, 2004
|                                        
|/s/ WILLIAM P. TAIWilliam P. Tai         |  | Director                                                                                  |  | March 5, 2004

76



---



##### Table of Contents



|                                   |  |          |  |               |  | 
|---------------------------------- |  | -------- |  | ------------- |  | 
|                                   |  |          |  |              
|Signature                          |  | Title    |  | Date         
|                                   |  |          |  |              
|                                  
|/s/ T. PETER THOMAST. Peter Thomas |  | Director |  | March 5, 2004
|                                  
|/s/ RICK TIMMINSRick Timmins       |  | Director |  | March 8, 2004

77



---



##### Table of Contents



EXHIBIT INDEX

|        |       |               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------- | ----- | ------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 3.01  |               |  | Second Amended and Restated Certificate of
    Incorporation. Incorporated by reference to Exhibit 3.01 to
    Transmetas Form 10-K for the year ended
    December 31, 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                                
|        | 3.02  |               |  | Restated Bylaws. Incorporated by reference to
    Exhibit 3.06 to Transmetas Form S-1 Registration
    Statement (File No. 333-44030) (the
    IPO S-1).                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|        | 3.03  |               |  | Certificate of Designations specifying the terms
    of the Series A Junior Participating Preferred Stock of
    Transmeta as filed with the Secretary of State of the State of
    Delaware on January 15, 2002. Incorporated by reference to
    Exhibit 3.02 to Transmetas Form 8-A Registration
    Statement filed on January 16, 2002.                                                                                                                                                                                                                                                                                 
|        | 4.01  |               |  | Specimen common stock certificate. Incorporated
    by reference to Exhibit 4.01 to the IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        | 4.02  |               |  | Fifth Restated Investors Rights Agreement
    dated March 31, 2000, between Transmeta, certain
    stockholders of Transmeta and a convertible note holder named
    therein. Incorporated by reference to Exhibit 4.02 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                  
|        | 4.03  |               |  | Form of Piggyback Registration Rights Agreement.
    Incorporated by reference to Exhibit 4.03 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|        | 4.04  |               |  | Rights Agreement dated January 15, 2002
    between Transmeta and Mellon Investor Services LLC as Rights
    Agent, which includes as Exhibit A the form of Certificate
    of Designations of Series A Junior Participating Preferred
    Stock, as Exhibit B the Summary of Stock Purchase Rights
    and as Exhibit C the Form of Rights Certificate.
    Incorporated by reference to Exhibit 4.01 to
    Transmetas Form 8-A Registration Statement filed on
    January 16, 2002.                                                                                                                                      
|        | 10.01 |               |  | Form of Indemnity Agreement. Incorporated by
    reference to Exhibit 10.01 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        | 10.02 |               |  | 1995 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.02 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10.03 |               |  | 1997 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.03 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        | 10.04 |               |  | 2000 Equity Incentive Plan. Incorporated by
    reference to Exhibit 4.06 to Transmetas Form S-8
    Registration Statement filed January 18, 2002.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        | 10.05 |               |  | 2000 Employee Stock Purchase Plan. Incorporated
    by reference to Exhibit 4.08 to Transmetas
    Form S-8 Registration Statement filed May 28, 2002.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|        | 10.06 |               |  | Lease Agreement, dated November 1, 1995,
    between John Arrillaga, as trustee of John Arrillaga Family
    Trust, Richard T. Peery, as trustee of Richard T. Peery Separate
    Property Trust, and Transmeta, as amended by Amendment
    No. 1, dated January 29, 1997, and Amendment
    No. 2, dated April 2, 1998, between John Arrillaga, as
    trustee of John Arrillaga Survivors Trust (successor in
    interest to the Arrillaga Family Trust), Richard T. Peery, as
    trustee of Richard T. Peery Separate Property Trust, and
    Transmeta. Incorporated by reference to Exhibit 10.08 to
    the IPO S-1.
|        | 10.07 |               |  | Lease Agreement, dated January 29, 1997,
    between John Arrillaga, as trustee of John Arrillaga Family
    Trust, Richard T. Peery, as trustee of Richard T. Peery Separate
    Property Trust, and Transmeta, as amended by Amendment
    No. 1, dated April 2, 1998, between John Arrillaga, as
    trustee of John Arrillaga Survivors Trust (successor in
    interest to the Arrillaga Family Trust), Richard T. Peery, as
    trustee of Richard T. Peery Separate Property Trust, and
    Transmeta. Incorporated by reference to Exhibit 10.09 to
    the IPO S-1.                                                 
|        | 10.08 |               |  | Lease Agreement, dated April 2, 1998,
    between John Arrillaga, as trustee of John Arrillaga
    Survivors Trust, Richard T. Peery, as trustee of Richard
    T. Peery Separate Property Trust, and Transmeta. Incorporated by
    reference to Exhibit 10.10 to the IPO S-1.                                                                                                                                                                                                                                                                                                                                              
|        | 10.09 |               |  | Lease Agreement, dated April 2, 1998,
    between John Arrillaga, as trustee of John Arrillaga
    Survivors Trust, Richard T. Peery, as trustee of Richard
    T. Peery Separate Property Trust, and Transmeta. Incorporated by
    reference to Exhibit 10.11 to the IPO S-1.                                                                                                                                                                                                                                                                                                                                              
|        | 10.10 |               |  | Sublease Agreement, dated as of April 28,
    1999, between Transmeta and Xuan Nguyen dba World Marketing
    Alliance. Incorporated by reference to Exhibit 10.13 to the
    IPO S-1.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|        | 10.11 |               |  | Form of Stock Option Agreement under
    Transmetas 2000 Equity Incentive Plan. Incorporated by
    reference to Exhibit 10.17 to the IPO S-1.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                             



---



##### Table of Contents



|        |        |               |  |                                                                                                                                                                                                                                                                             
|------- | ------ | ------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |              
|Number  |        | Exhibit Title
|        |        |              
|        | 10.12  |               |  | Form of Stock Option Agreement (for Non-Employee
    Directors) under Transmetas 2000 Equity Incentive Plan.
    Incorporated by reference to Exhibit 10.18 to the
    IPO S-1.**                                                                                          
|        | 10.13  |               |  | Form of Stock Option Agreement. Incorporated by
    reference to Exhibit 10.18 to Transmetas
    Form 10-K for the year ended December 31, 2000.**                                                                                                                         
|        | 10.14  |               |  | Authorized Exclusive Distributor Agreement, dated
    September 12, 2000, between Transmeta and Siltrontech
    Electronics Corporation. Incorporated by reference to
    Exhibit 10.15 to Transmetas Form 10-K for the
    year ended December 31, 2001 (the 2001 10-K).
|        | 10.15  |               |  | Option Amendment and Termination Agreement, dated
    November 16, 2001, between Transmeta and Merle McClendon.
    Incorporated by reference to Exhibit 10.17 to the 2001
    10-K.**                                                                                      
|        | 10.16  |               |  | Offer of Employment from Transmeta Corporation to
    Matthew R. Perry dated March 21, 2002. Incorporated by
    reference to Exhibit 10.22 to Transmetas
    Form 10-Q for the quarterly period ended June 30,
    2002.**                                                
|        | 21.01  |               |  | Subsidiaries. Incorporated by reference to
    Exhibit 21.01 to the IPO S-1.                                                                                                                                                                                                
|        | 23.01* |               |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                                                                                                                                                                                     
|        | 24.01* |               |  | Power of Attorney. See Signature Page.                                                                                                                                                                                                                                      
|        | 31.01* |               |  | Certification by Matthew R. Perry pursuant to
    Rule 13a-14(a).                                                                                                                                                                                                           
|        | 31.02* |               |  | Certification by Svend-Olav Carlsen pursuant to
    Rule 13a-14(a).                                                                                                                                                                                                         
|        | 32.01* |               |  | Certification by Matthew R. Perry pursuant to 18
    U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                         
|        | 32.02* |               |  | Certification by Svend-Olav Carlsen pursuant to
    18 U.S.C. Section 1350, as adopted pursuant to Section 906
    of the Sarbanes-Oxley Act of 2002.                                                                                                                       



---



|  |                
|- | ---------------
|* | Filed herewith.



|   |                                                 
|-- | ------------------------------------------------
|** | Management contract or compensatory arrangement.