##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D. C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended March 31, 2006
 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
(State or other jurisdiction of
incorporation or organization)
    
    77-0402448
(I.R.S. 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)
 
 þ o
 o þ o
 o þ




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##### 



TRANSMETA CORPORATION
 FORM 10-Q
Quarterly Period Ended March 31, 2006
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATIONItem 1. Condensed Consolidated Financial Statements
    
    
    3Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and, 2005
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    27Item 4. Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    29Item 1A. Risk Factors
    
    
    29Item 6. Exhibits
    
    
    42Signatures
    
    
    43EXHIBIT 10.26EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01EXHIBIT 32.02
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 TRANSMETA CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share and per share amounts)
 March 31,
    
    
    December 31,2006
    
    
    2005 (1)(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    27,522
    
    
    $
    27,659Short-term investments
    
    
    29,859
    
    
    
    28,811Accounts receivable
    
    
    216
    
    
    
    1,686Inventories
    
    
    177
    
    
    
    265Prepaid expenses and other current assets
    
    
    2,241
    
    
    
    2,279Total current assets
    
    
    60,015
    
    
    
    60,700Property and equipment, net
    
    
    1,436
    
    
    
    1,623Patents and patent rights, net
    
    
    14,369
    
    
    
    16,080Other assets
    
    
    920
    
    
    
    911Total assets
    
    $
    76,740
    
    
    $
    79,314LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    733
    
    
    $
    1,521Accrued compensation and related compensation liabilities
    
    
    2,951
    
    
    
    3,279Deferred income, net
    
    
    5,847
    
    
    
    5,937Other accrued liabilities
    
    
    1,992
    
    
    
    2,109Advances from customers
    
    
    3,586
    
    
    
    7,260Current portion of accrued restructuring costs
    
    
    1,792
    
    
    
    1,803Total current liabilities
    
    
    16,901
    
    
    
    21,909Long-term accrued restructuring costs, net of current portion
    
    
    2,054
    
    
    
    2,453Total liabilities
    
    
    18,955
    
    
    
    24,362Commitments and contingenciesStockholders equity:Preferred stock, $0.00001 par value, at amounts paid in; Authorized shares 
5,000,000. None issued
and outstanding
    
    
    
    
    
    
    Common stock, $0.00001 par value, at amounts paid in; Authorized shares 
1,000,000,000. Issued and outstanding shares  195,285,839 and 191,710,620,
respectively
    
    
    717,562
    
    
    
    713,129Treasury stock shares  796,875 and 796,875, respectively
    
    
    (2,439
    )
    
    
    (2,439
    )Accumulated other comprehensive loss
    
    
    (148
    )
    
    
    (195
    )Accumulated deficit
    
    
    (657,190
    )
    
    
    (655,543
    )Total stockholders equity
    
    
    57,785
    
    
    
    54,952Total liabilities and stockholders equity
    
    $
    76,740
    
    
    $
    79,314
 
 (1)
    
    Derived from the Companys audited financial statements as of December 31, 2005, but does not
include all disclosures required by accounting principles generally accepted in the United
States of America.  3




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TRANSMETA CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except per share amounts)
 (Unaudited)
 Three Months EndedMarch 31,
    
    
    March 31,2006
    
    
    2005Revenue:Product
    
    $
    589
    
    
    $
    6,406License
    
    
    
    
    
    
    Service
    
    
    18,920
    
    
    
    448Total revenue
    
    
    19,509
    
    
    
    6,854Cost of revenue:Product (2)
    
    
    162
    
    
    
    4,752License
    
    
    
    
    
    
    Service (2)
    
    
    10,881
    
    
    
    161Total cost of revenue
    
    
    11,043
    
    
    
    4,913Gross profit
    
    
    8,466
    
    
    
    1,941Operating expenses:Research and
development (1) (2)
    
    
    3,252
    
    
    
    12,222Selling, general and administrative (2)
    
    
    5,544
    
    
    
    7,956Restructuring charges, net
    
    
    74
    
    
    
    1,309Amortization of patents and patent rights
    
    
    1,711
    
    
    
    1,711Stock compensation
    
    
    
    
    
    
    (34
    )Total operating expenses
    
    
    10,581
    
    
    
    23,164Operating loss
    
    
    (2,115
    )
    
    
    (21,223
    )Interest income and other, net
    
    
    503
    
    
    
    246Interest expense
    
    
    (35
    )
    
    
    (108
    )Net loss
    
    $
    (1,647
    )
    
    $
    (21,085
    )Net loss per share  basic and diluted
    
    $
    (0.01
    )
    
    $
    (0.11
    )Weighted average shares outstanding  basic and diluted
    
    
    193,365
    
    
    
    189,151
 
 (1)
    
    Excludes $0 and $(34) in variable stock compensation for the three months ended March 31,
2006 and 2005, respectively.(2)
    
    Includes stock based compensation charges as follows: Cost of product revenue
    
    $
    4
    
    
    $
    Cost of service revenue
    
    
    601
    
    
    
    Research and development
    
    
    258
    
    
    
    Selling, general and administrative
    
    
    454
    
    
    
    Total stock-based compensation
    
    $
    1,317
    
    
    $
    
  4




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TRANSMETA CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Three Months EndedMarch 31,
    
    
    March 31,2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (1,647
    )
    
    $
    (21,085
    )Adjustments to reconcile net loss to net cash used in operating activities:Stock compensation expense
    
    
    1,317
    
    
    
    (34
    )Depreciation
    
    
    301
    
    
    
    331Amortization of patents and patent rights
    
    
    1,711
    
    
    
    1,711Non cash restructuring charges
    
    
    74
    
    
    
    1,309Changes in operating assets and liabilities:Accounts receivable
    
    
    1,470
    
    
    
    (2,317
    )Inventories
    
    
    97
    
    
    
    2,230Prepaid expenses and other current assets
    
    
    124
    
    
    
    284Other assets
    
    
    (9
    )
    
    
    Accounts payable and accrued liabilities
    
    
    (1,233
    )
    
    
    4,749Deferred income
    
    
    (86
    )
    
    
    Advances from customers
    
    
    (3,674
    )
    
    
    Accrued restructuring charges
    
    
    (484
    )
    
    
    (433
    )Net cash used in operating activities
    
    
    (2,039
    )
    
    
    (13,255
    )Cash flows from investing activities:Purchase of available-for-sale investments
    
    
    (4,000
    )
    
    
    (5,000
    )Proceeds from sale or maturity of available-for-sale investments
    
    
    2,999
    
    
    
    13,558Purchase of property and equipment
    
    
    (114
    )
    
    
    (78
    )Net cash
provided by (used in) investing activities
    
    
    (1,115
    )
    
    
    8,480Cash flows from financing activities:Proceeds from sales of common stock under employee stock purchase and incentive option plans
    
    
    3,017
    
    
    
    1,847Repayment of debt and capital lease obligations
    
    
    
    
    
    
    (87
    )Net cash provided by financing activities
    
    
    3,017
    
    
    
    1,760Change in cash and cash equivalents
    
    
    (137
    )
    
    
    (3,015
    )Cash and cash equivalents at beginning of period
    
    
    27,659
    
    
    
    17,273Cash and cash equivalents at end of period
    
    $
    27,522
    
    
    $
    14,258
  5




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TRANSMETA CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 1. Description of Business
  2. Basis of Presentation
  6




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3. Balance Sheet Details
 March 31,
    
    
    December 31,2006
    
    
    2005InventoriesRaw materials
    
    $
    
    
    
    $
    Work in progress
    
    
    
    
    
    
    Finished goods
    
    
    177
    
    
    
    265Total
    
    $
    177
    
    
    $
    265Property and equipment, netLeasehold improvements
    
    $
    2,419
    
    
    $
    2,410Computer equipment
    
    
    6,016
    
    
    
    5,911Furniture and fixtures
    
    
    1,635
    
    
    
    1,635Computer software
    
    
    1,825
    
    
    
    1,825Less accumulated depreciation and amortization
    
    
    11,895
    
    
    
    11,781Total
    
    
    (10,459
    )
    
    
    (10,158
    )$
    1,436
    
    
    $
    1,623Other accrued liabilitiesAccrued audit
    
    $
    414
    
    
    $
    885Deferred rent
    
    
    345
    
    
    
    408Other
    
    
    1,233
    
    
    
    816Total
    
    $
    1,992
    
    
    $
    2,109
 7




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4. Short-Term Investments
   Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Aggregatecost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueAs of March 31, 2006Federal agency discount notes
    
    $
    24,000
    
    
    $
    
    
    
    $
    141
    
    
    $
    23,859Commercial paper
    
    
    6,000
    
    
    
    
    
    
    
    
    
    
    
    6,000Total
    
    $
    30,000
    
    
    $
    
    
    
    $
    141
    
    
    $
    29,859As of December 31, 2005Federal agency discount notes
    
    $
    25,000
    
    
    $
    
    
    
    $
    189
    
    
    $
    24,811Commercial paper
    
    
    4,000
    
    
    
    
    
    
    
    
    
    
    
    4,000Total
    
    $
    29,000
    
    
    $
    
    
    
    $
    189
    
    
    $
    28,811
  Amortized
    
    
    AggregateCost
    
    
    Fair Value(In thousands)As of March 31, 2006:Amounts maturing within one year
    
    $
    21,000
    
    
    $
    20,924Amounts maturing after one year, within five years
    
    
    9,000
    
    
    
    8,935Total
    
    $
    30,000
    
    
    $
    29,859
     8




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In Loss Position
    
    
    In Loss Position< 12 Months
    
    
    > 12 Months
    
    
    Total in Loss PositionGross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    GrossFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedValue
    
    
    (Loss)
    
    
    Value
    
    
    (Loss)
    
    
    Value
    
    
    (Loss)Short-term investments:Federal agency discount notes
    
    $
    14,925
    
    
    $
    (75
    )
    
    $
    8,935
    
    
    $
    (66
    )
    
    $
    23,859
    
    
    $
    (141
    )Commercial paper
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,000
    
    
    
    Total in loss position
    
    $
    14,925
    
    
    $
    (75
    )
    
    $
    8,935
    
    
    $
    (66
    )
    
    $
    29,859
    
    
    $
    (141
    )
 5. Commitments and Contingencies
 Purchase Obligations
  Operating Leases
   Operating Leases(In thousands)Years ending December 31,
2006 (remaining nine months)
    
    $
    3,4922007
    
    
    4,7112008
    
    
    2,4012009
    
    
    20Income from subleases
    
    
    (642
    )Total minimum operating lease payments
    
    $
    9,982
 Litigation
 In
re Transmeta Corporation Initial Public Offering Securities Litigation, In re
Initial Public Offering Securities Litigation,
  9




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##### Table of Contents



6. Net Comprehensive Loss
  Three Months EndedMarch 31,
    
    
    March 31,2006
    
    
    2005Net loss
    
    $
    (1,647
    )
    
    $
    (21,085
    )Net change in unrealized gain (loss) on investments
    
    
    48
    
    
    
    (106
    )Net change in foreign currency translation adjustments
    
    
    (1
    )
    
    
    (11
    )Net comprehensive loss
    
    $
    (1,600
    )
    
    $
    (21,202
    )
  March 31,
    
    
    December 31,2006
    
    
    2005Net unrealized loss on investments
    
    $
    (141
    )
    
    $
    (189
    )Cumulative foreign currency translation adjustments
    
    
    (7
    )
    
    
    (6
    )Accumulated other comprehensive loss
    
    $
    (148
    )
    
    $
    (195
    )
 10




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##### Table of Contents



7. Stock Based Compensation
        Prior to the Adoption of SFAS No. 123(R)
   Three MonthsEndedMarch 31, 2005Net loss as reported
    
    $
    (21,085
    )Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects
    
    
    (34
    )Less: Pro forma stock compensation expense computed under the fair value method for all awards, net of
related tax effects
    
    
    (2,938
    )Pro forma net loss
    
    $
    (24,057
    )Basic and diluted net loss per share, as reported
    
    $
    (0.11
    )Pro forma basic and diluted net loss per share
    
    $
    (0.13
    )
 Impact of the Adoption of SFAS No. 123(R)
  Three MonthsEndedMarch 31, 2006Stock-based compensation expense by type of award:Employee stock options
    
    $
    1,012Employee stock purchase plan
    
    
    318Amounts capitalized as inventory
    
    
    (9
    )Amounts capitalized as deferred costs
    
    
    (4
    )Total stock-based compensation
    
    
    1,317Tax effect on stock-based compensation
    
    
    Net effect on net loss
    
    $
    1,317
   11




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##### Table of Contents



Valuation Assumptions
  Three Months Ended March 31,Equity Incentive
Plans
    
    2006
    
    2005Risk-free interest rate
    
    
    4.6
    %
    
    
    3.6
    %Expected life of option
    
    
    3 to 4 years
    
    
    
    3.4 yearsExpected dividend yield
    
    
    0
    
    
    
    0Volatility
    
    
    100
    %
    
    
    99
    %
 Three Months Ended March 31,Employee Stock
Purchase Plan
    
    2006
    
    2005Risk-free interest rate
    
    
    4.7
    %
    
    
    2.9
    %Expected life of option
    
    
    0.5 years
    
    
    
    0.5 yearsExpected dividend yield
    
    
    0
    
    
    
    0Volatility
    
    
    100
    %
    
    
    99
    %
   Equity Incentive Plans
    WeightedShares
    
    
    
    
    
    
    Average
    
    
    Weighted Average
    
    
    Weighted Average
    
    
    AggregateAvailable for
    
    
    Number of
    
    
    Exercise
    
    
    Grant Date
    
    
    Remaining
    
    
    IntrinsicGrant
    
    
    Shares
    
    
    Price
    
    
    Fair Value
    
    

Contractual
Term
    
    

ValueBalance at December 31, 2005
    
    
    16,847,775
    
    
    
    39,124,784
    
    
    $
    1.90Additional shares reserved
    
    
    9,585,531
    
    
    
    Options granted
    
    
    (435,000
    )
    
    
    435,000
    
    
    $
    1.24
    
    
    $0.88Options exercised
    
    
    
    
    
    
    (1,818,564
    )
    
    $
    0.98Options canceled
    
    
    792,228
    
    
    
    (792,228
    )
    
    $
    1.62Balance at March 31, 2006
    
    
    26,790,534
    
    
    
    36,948,992
    
    
    $
    1.95
    
    
    
    
    
    

    7.5
years
    
    
    $
    2,703Shares
Exercisable at:March 31, 2006
    
    
    
    
    
    
    22,658,652
    
    
    $
    2.59
    
    
    
    
    
    

    6.7
years
    
    
    $
    9,202
  12




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##### Table of Contents



Outstanding
    
    
    ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    
    WeightedRemaining
    
    
    Average
    
    
    
    
    
    
    AverageShares
    
    
    Contractual
    
    
    Exercise
    
    
    Shares
    
    
    ExerciseRange of Exercise Prices
    
    Outstanding
    
    
    Life Years
    
    
    Price
    
    
    Exercisable
    
    
    PriceAs of March 31, 2006:$0.19-$0.71
    
    
    823,168
    
    
    
    6.2
    
    
    $
    0.66
    
    
    
    388,168
    
    
    $
    0.63$0.72-$0.75
    
    
    10,874,622
    
    
    
    9.1
    
    
    $
    0.75
    
    
    
    2,402,005
    
    
    $
    0.75$0.77-$1.15
    
    
    4,387,750
    
    
    
    7.6
    
    
    $
    0.97
    
    
    
    2,782,475
    
    
    $
    1.00$1.19-$1.23
    
    
    3,739,726
    
    
    
    8.6
    
    
    $
    1.21
    
    
    
    1,999,066
    
    
    $
    1.21$1.24-$1.57
    
    
    3,975,947
    
    
    
    7.8
    
    
    $
    1.49
    
    
    
    2,209,908
    
    
    $
    1.52$1.60-$2.38
    
    
    4,916,879
    
    
    
    7.1
    
    
    $
    2.21
    
    
    
    4,670,610
    
    
    $
    2.23$2.40-$3.11
    
    
    4,073,278
    
    
    
    5.8
    
    
    $
    2.70
    
    
    
    4,058,173
    
    
    $
    2.70$3.15-$9.50
    
    
    3,988,951
    
    
    
    4.8
    
    
    $
    6.13
    
    
    
    3,979,576
    
    
    $
    6.14$11.17-$13.62
    
    
    150,671
    
    
    
    5.1
    
    
    $
    12.72
    
    
    
    150,671
    
    
    $
    12.72$14.49-$14.49
    
    
    18,000
    
    
    
    5.2
    
    
    $
    14.49
    
    
    
    18,000
    
    
    $
    14.49Total
    
    
    36,948,992
    
    
    
    7.5
    
    
    $
    1.95
    
    
    
    22,658,652
    
    
    $
    2.59
 2000 Employee Stock Purchase Plan
  8. Geographic and Customer Concentration Information
  Three Months EndedMarch 31,
    
    March 31,2006
    
    2005Sony Corporation
    
    
    50
    %
    
    
    *
    %Microsoft Corporation
    
    
    47
    %
    
    
    *
    %Hewlett-Packard
    
    
    *
    %
    
    
    28
    %Siltrontech
    
    
    *
    %
    
    
    15
    %Fujitsu
    
    
    *
    %
    
    
    15
    %All American
    
    
    *
    %
    
    
    13
    %
 
 *
    
    represents less than 10% of total revenue 13




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##### Table of Contents



March 31,
    
    December 31,2006
    
    2005Microsoft Corporation
    
    
    63
    %
    
    
    12
    %All American
    
    
    18
    %
    
    
    12
    %3COM Corporation
    
    
    *
    %
    
    
    27
    %OQO, Inc.
    
    
    *
    %
    
    
    14
    %ASEM S.p.A.
    
    
    *
    %
    
    
    11
    %Sony Corporation
    
    
    *
    %
    
    
    11
    %
 
 *
    
    represents less than 10% of net accounts receivable 14




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##### Table of Contents



9. Net Loss per Share
  15




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##### Table of Contents



Three Months EndedMarch 31, 2006
    
    
    March 31, 2005(in thousands, except for per share amounts)Basic and diluted:Net loss, as reported
    
    $
    (1,647
    )
    
    $
    (21,085
    )Shares used to compute basic net loss per share
    
    
    193,365
    
    
    
    189,151Effect of dilutive securities:Common stock equivalents
    
    
    
    
    
    
    Shares used to compute diluted net loss per share
    
    
    193,365
    
    
    
    189,151Basic and diluted net loss per share
    
    $
    (0.01
    )
    
    $
    (0.11
    )
 10. Advances from Customers
  11. Deferred Income
  March 31,
    
    
    December 31,2006
    
    
    2005Deferred revenue:Product
    
    $
    715
    
    
    $
    619License
    
    
    5,000
    
    
    
    Service
    
    
    575
    
    
    
    8,934Total
    
    
    6,290
    
    
    
    9,553Deferred costs:Product
    
    
    60
    
    
    
    54License
    
    
    
    
    
    
    Service
    
    
    383
    
    
    
    3,562Total
    
    
    443
    
    
    
    3,616Deferred income
    
    $
    5,847
    
    
    $
    5,937
 12. Restructuring Charges
   Excess
    
    
    WorkforceFacilities
    
    
    Reduction
    
    
    TotalBalance as of December 31, 2004
    
    $
    5,245
    
    
    $
    
    
    
    $
    5,245Restructuring charges
    
    
    1,841
    
    
    
    1,502
    
    
    
    3,343Adjustments and reversals
    
    
    (1,278
    )
    
    
    (56
    )
    
    
    (1,334
    )Cash drawdowns
    
    
    (1,552
    )
    
    
    (1,446
    )
    
    
    (2,998
    )Balance as of December 31, 2005
    
    
    4,256
    
    
    
    
    
    
    
    4,256Restructuring charges
    
    
    74
    
    
    
    
    
    
    
    74Cash drawdowns
    
    
    (484
    )
    
    
    
    
    
    
    (484
    )Balance as of March 31, 2006
    
    $
    3,846
    
    
    $
    
    
    
    $
    3,846
 16




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##### Table of Contents



13. Related Party Transactions
 Sales to Investee
  Indemnification Agreements
  14. Asset Purchase and License Agreements
   15. Recent Accounting Pronouncements
   17




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Caution Regarding Forward-Looking Statements
    Overview
   
    
    On March 31, 2005, we entered into a design and engineering services agreement with Sony
Computer Entertainment Inc. and Sony Corporation (collectively, the Sony Group). The term
of this design services agreement extends to March 31, 2007; however, the services we
provide are agreed upon pursuant to specific project agreements with terms of one year or
less. Our prior project agreements expired by their terms on March 31, 2006, corresponding
to Sony Groups fiscal year end. In April 2006, we entered into a series of new project
agreements for us to continue to provide design and engineering services to the Sony Group
during the second year of the two-year design and engineering services agreement. The new
project agreements provide for us to perform a variety of design and engineering services
for the Sony Group over project periods ranging from three months to one year, ending March
31, 2007. Under the new project agreements, we initially will provide the services of more
than 100 engineers in the second quarter of fiscal 2006 to work on advanced projects for the
Sony Group. We and the Sony Group are currently discussing additional potential engineering
projects for us to perform for the Sony Group under the
 18




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##### Table of Contents



design and engineering services agreement, but we cannot assure you that the parties will
enter into any additional project agreements. In light of both the
reduction in the Sony Groups requirements for our engineering services as reflected in the current project agreements and
our current expectations regarding further decisions by the Sony Group about prospective new engineering
service engagements in 2006, we now anticipate reduced demand by the Sony Group for our engineering
services in fiscal 2006.
    
    On May 12, 2005, we entered into a series of related definitive engineering and
development services agreements with Microsoft Corporation. We have substantially completed
the services to be provided under these engineering and development services agreements. We
generally have deferred the recognition of revenue and the associated costs until the
project has been completed and we have met all of our obligations in connection with the
engineering and development services and have obtained customer acceptance for such
completed deliverables. However, since we have substantially completed the project, we have
elected to segment our fixed fee revenue and related costs into a recognized portion (for
the amount accepted by the customer) and a deferred portion (for the remaining amount).
Accordingly, in the three months ended March 31, 2006, we recognized $9.1 million and $4.6
million of fixed fee revenue and the related fixed fee development costs of services,
respectively. Furthermore, at March 31, 2006, the deferred portion of the fixed fee revenue
and related fixed fee development costs of services were $0.6 million and $0.4 million,
respectively. We currently are in negotiations with Microsoft regarding the provision of
additional engineering and development services, and, although we expect to continue to
provide such services to Microsoft in 2006, we do not necessarily expect that we will
continue to supply engineering and development services at the same level as we provided in
2005.
      Critical Accounting Policies
  19




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##### Table of Contents



Accounting for Stock-Based Compensation
  Results of Operations
  Three Months EndedMarch 31,
    
    March 31,2006
    
    2005Product
    
    
    3
    %
    
    
    93
    %License
    
    
    0
    %
    
    
    0
    %Service
    
    
    97
    %
    
    
    7
    %Total
    
    
    100
    %
    
    
    100
    %Costs of product
    
    
    1
    %
    
    
    69
    %Costs of license
    
    
    0
    %
    
    
    0
    %Costs of service
    
    
    56
    %
    
    
    3
    %Total cost of revenue
    
    
    57
    %
    
    
    72
    %Gross profit
    
    
    43
    %
    
    
    28
    %Operating expenses:Research and development
    
    
    17
    %
    
    
    178
    %Selling, general and administrative
    
    
    28
    %
    
    
    116
    %Restructuring charges
    
    
    0
    %
    
    
    19
    %Amortization of patents and patent rights
    
    
    9
    %
    
    
    25
    %Stock compensation
    
    
    0
    %
    
    
    0
    %Total operating expenses
    
    
    54
    %
    
    
    338
    %Operating loss
    
    
    (11
    %)
    
    
    (310
    %)Interest income and other, net
    
    
    3
    %
    
    
    4
    %Interest expense
    
    
    0
    %
    
    
    (2
    %)Net loss
    
    
    (8
    %)
    
    
    (308
    %)
 Total Revenue
  Three Months EndedMarch 31,
    
    
    March 31,2006
    
    
    2005Product
    
    $
    589
    
    
    $
    6,406License
    
    
    
    
    
    
    Service
    
    
    18,920
    
    
    
    448Total revenue
    
    $
    19,509
    
    
    $
    6,854
  20




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##### Table of Contents



Product Revenues.
  License Revenue.
 Service Revenue.
  Services Revenue
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Time & Materials Based Contracts
    
    $
    9,829
    
    
    $
    198Fixed Fee Development Service
    
    
    9,091
    
    
    
    Maintenance & Technical Support Services for License
    
    
    
    
    
    
    250Total Services Revenue
    
    $
    18,920
    
    
    $
    448
 Maintenance and Technical Support Services Revenue.
 Fixed Fee Development Service Revenue and Cost of Services
 Time and Materials Based Design Service Revenue.
 21




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##### Table of Contents



Three Months EndedMarch 31,
    
    March 31,2006
    
    2005Sony Corporation
    
    
    50
    %
    
    
    *
    %Microsoft Corporation
    
    
    47
    %
    
    
    *
    %Hewlett-Packard
    
    
    *
    %
    
    
    28
    %Siltrontech
    
    
    *
    %
    
    
    15
    %Fujitsu
    
    
    *
    %
    
    
    15
    %All American
    
    
    *
    %
    
    
    13
    %
 
 *
    
    represents less than 10% of total revenue  March 31,
    
    December 31,2006
    
    2005Microsoft Corporation
    
    
    63
    %
    
    
    12
    %All American
    
    
    18
    %
    
    
    12
    %3COM Corporation
    
    
    *
    %
    
    
    27
    %OQO, Inc.
    
    
    *
    %
    
    
    14
    %ASEM S.p.A.
    
    
    *
    %
    
    
    11
    %Sony Corporation
    
    
    *
    %
    
    
    11
    %
 
 *
    
    represents less than 10% of net accounts receivable Costs of Revenues
  Products:
  Three Months EndedMarch 31,
    
    
    March 31,2006
    
    
    2005Product revenue
    
    
    100
    %
    
    
    100
    %Cost of product revenue
    
    
    28
    %
    
    
    74
    %Product gross margin
    
    
    72
    %
    
    
    26
    %
   22




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##### Table of Contents



Licenses:
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Cost of License
    
    $
    
    
    
    $
    
  Services:
   Costs of Services Revenue
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Time & Materials Based Contract
    
    $
    6,220
    
    
    $
    161Fixed Fee Development Service
    
    
    4,661
    
    
    
    License Related Maintenance and Support Services
    
    
    
    
    
    
    Total Cost of Services
    
    $
    10,881
    
    
    $
    161
 Research and Development
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Research and development expenses
    
    $
    3,252
    
    
    $
    12,222Amount classified to costs of service and deferred costs (1)
    
    $
    6,196
    
    
    $
    
 
 (1)
    
    In fiscal 2006, we classified costs directly attributable to the design and development
services agreements to costs of service revenues. In the prior years, such costs were included in
the R&D activities as the employees involved with such activities were performing R&D related
activities.   Selling, General and Administrative
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Selling, general and administrative expenses
    
    $
    5,544
    
    
    $
    7,956
 23




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##### Table of Contents



Restructuring Charges, net
  Amortization of Patents and Patent Rights
  Stock Compensation
 Three Months Ended(in thousands)
    
    March 31, 2006
    
    
    March 31, 2005Stock compensation expense
    
    $
    1,317
    
    
    $
    (34
    )
   Interest Income and Other, Net
  Interest Expense
  24




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##### Table of Contents



Liquidity and Capital Resources
   Three months EndedMarch 31,
    
    March 31,2006
    
    2005(in thousands)Net cash used in operating activities
    
    $
    (2,039
    )
    
    $
    (13,255
    )Net cash provided by (used in) investing activities
    
    
    (1,115
    )
    
    
    8,480Net cash provided by financing activities
    
    
    3,017
    
    
    
    1,760Decrease in cash and cash equivalents
    
    $
    (137
    )
    
    $
    (3,015
    )
        25




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##### Table of Contents



Restructuring
   Excess
    
    
    WorkforceFacilities
    
    
    Reduction
    
    
    TotalBalance as of December 31, 2004
    
    $
    5,245
    
    
    $
    
    
    
    $
    5,245Restructuring charges
    
    
    1,841
    
    
    
    1,502
    
    
    
    3,343Adjustments and reversals
    
    
    (1,278
    )
    
    
    (56
    )
    
    
    (1,334
    )Cash drawdowns
    
    
    (1,552
    )
    
    
    (1,446
    )
    
    
    (2,998
    )Balance as of December 31, 2005
    
    
    4,256
    
    
    
    
    
    
    
    4,256Restructuring charges
    
    
    74
    
    
    
    
    
    
    
    74Cash drawdowns
    
    
    (484
    )
    
    
    
    
    
    
    (484
    )Balance as of March 31, 2006
    
    $
    3,846
    
    
    $
    
    
    
    $
    3,846
 Contractual Obligations
  Payments Due by PeriodRemainder
    
    
    2007 to
    
    
    AfterContractual Obligations
    
    Total
    
    
    of 2006
    
    
    2009
    
    
    2009(In thousands)Operating Leases(1)
    
    $
    10,624
    
    
    $
    3,492
    
    
    $
    7,128
    
    
    $
    4Unconditional Purchase Obligations(2)
    
    
    3,319
    
    
    
    3,319
    
    
    
    
    
    
    
    Total
    
    $
    13,943
    
    
    $
    6,811
    
    
    $
    7,128
    
    
    $
    4
 
 (1)
    
    Operating leases include agreements for building facilities.(2)
    
    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. Purchase obligations also include agreements for design
tools and software for use in product development. Off-Balance Sheet Arrangements
  26




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##### Table of Contents



Recent Accounting Pronouncements
   
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
 Interest Rate Risk.
 Foreign Currency Exchange Risk.
 
 Item 4. Controls and Procedures
 Disclosure Controls and Procedures
  Inherent Limitations on Effectiveness of Controls
  27




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Changes in Internal Control over Financial Reporting
  28




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 In
re Transmeta Corporation Initial Public Offering Securities Litigation In re
Initial Public Offering Securities Litigation
 
 Item 1A. Risk Factors
 The factors discussed below are cautionary statements that identify important risk factors
that could cause actual results to differ materially from those anticipated in the forward-looking
statements in this Quarterly Report on Form 10-Q . If any of the following risks actually occurs,
our business, financial condition and results of operations would suffer. In this case, the trading
price of our common stock could decline and investors might lose all or part of their investment in
our common stock.
 We have a history of losses, and we must successfully execute on our modified business model if we
are to sustain our operations.
   29




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##### Table of Contents



We might fail to operate successfully under our modified business model.
  We might not be able to execute on our modified business model if we lose key management or
technical personnel, on whose knowledge, leadership and technical expertise we rely.
  We may not be able to raise any more financing, or financing may only be available on terms
unfavorable to us or our stockholders.
  
    
    fund expansion;
    
    fund marketing expenditures;
    
    develop or enhance our products or technologies;
    
    enhance our operating infrastructure;
    
    hire additional personnel;
 30




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##### Table of Contents




    
    respond to customer concerns about our viability;
    
    respond to competitive pressures; or
    
    acquire complementary businesses or technologies.
  We may fail to meet the continued listing requirements of the Nasdaq Stock Market, which may cause
our stock to be delisted and result in reduced liquidity of our stock, reduce the trading price of
our stock, and impair our ability to raise financing.
  The success of our licensing business depends on maintaining and increasing our LongRun2 licensing
revenue.
  31




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##### Table of Contents



We have limited visibility regarding when and to what extent our licensees will use our LongRun2 or
other licensed technologies.
  
    
    the competition these companies face and the market acceptance of their products;
    
    the pricing policies of our licensees for their products incorporating our technology and
whether those products are competitively priced;
    
    the engineering, marketing and management capabilities of these companies and technical
challenges unrelated to our technology that they face in developing their products; and
    
    the financial and other resources of our licensees.
  Our licensing and services revenue cycle is long and unpredictable, which makes it difficult to
predict future revenues, which may cause us to miss analysts estimates and may result in
unexpected changes in our stock price.
  We have only recently entered the engineering services business, and our ability to succeed in that
line of business is uncertain and subject to many risks.
  32




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##### Table of Contents



We could encounter a variety of technical and manufacturing problems that could delay or prevent us
from satisfying customer demand for Efficeon TM8000 series microprocessors manufactured using a 90
nanometer process.
  Our restructuring plan has reduced our resources and ability to pursue opportunities and support
customers in emerging markets for our microprocessor products.
  We currently derive a substantial portion of our revenue from a small number of customers and
licensees, and our revenue would decline significantly if any major customer were to cancel, reduce
or delay a transaction relating to our products, licenses and services.
   We face intense competition in the power management, engineering services and x86-compatible
microprocessor markets. Many of our competitors are much larger than we are and have significantly
greater resources. We may not be able to compete effectively.
  33




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##### Table of Contents



We may experience manufacturing difficulties that could increase the cost and reduce the supply of
our products.
  Our lengthy and variable product sales cycles make it difficult for us to predict when and if a
design win will result in volume shipments.
  34




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##### Table of Contents



If we fail to forecast demand for our products accurately, we could lose sales and incur inventory
losses.
  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.
  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.
  Our reliance on Fujitsu to fabricate our wafers limits our ability to control the production,
supply and delivery of our products.
  
    
    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
 35




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##### Table of Contents




    
    potentially greater exposure to misappropriation of our intellectual property.
 We depend on ASE to provide assembly and test services. If ASE were to cease providing services to
us in a timely manner and on acceptable terms, our business would suffer.
  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 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.
  36




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##### Table of Contents



We are subject to general economic and market conditions.
  If we do not keep pace with technological change, our products may not be competitive and our
revenue and operating results may suffer.
  Advances in battery design, cooling systems and power management systems could adversely affect our
ability to achieve widespread market acceptance for our products and technologies.
  Our products and technologies may infringe the intellectual property rights of others, which may
cause us to become subject to expensive litigation, cause us to incur substantial damages, require
us to pay significant license fees or prevent us from selling our products.
   37




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##### Table of Contents



Any dispute regarding our intellectual property may require us to indemnify certain licensees or
third parties, the cost of which could severely hamper our business operations and financial
condition.
  If we are unable to protect our proprietary rights adequately, our competitors might gain access to
our technology and we might not compete successfully in our markets.
   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.
  We have significant international operations, which exposes us to risk and uncertainties.
  
    
    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;
 38




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##### Table of Contents




    
    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 reported financial results may be adversely affected by changes in accounting principles
generally accepted in the United States.
  We might experience payment disputes for amounts owed to us under our LongRun2 licensing
agreements, and this may harm our results of operations.
  39




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##### Table of Contents



The price of our common stock has been volatile and is subject to wide fluctuations.
  
    
    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.
  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 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.
  
    
    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 shares and to outstanding discourage a takeover attempt;
    
    limiting the ability of our stockholders to call special meetings of stockholders;
 40




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##### Table of Contents




    
    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.
  We may identify material weaknesses in our internal control over financial reporting.
  Changes in securities laws and regulations have increased our costs.
  41




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##### Table of Contents



Item 6. Exhibits
 Exhibits.
  Exhibit Number
    
    Exhibit Title10.26+
    
    LongRun2 Technology License Agreement, dated February 22, 2006, between Transmeta and Toshiba Corporation.31.01
    
    Certification by Arthur L. Swift pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of
1934.31.02
    
    Certification by Mark R. Kent pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934.32.01*
    
    Certification by Arthur L. Swift 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 Mark R. Kent pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this quarterly
report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and
are not incorporated by reference in any filing of Transmeta Corporation under the Securities
Act of 1933 or the Securities Exchange Act of 1934, including this quarterly report, whether
made before or after the date hereof and irrespective of any general incorporation language in
any filings.+
    
    Confidential treatment has been requested for portions of this exhibit. These portions have
been omitted from this Report and have been filed separately with the Securities and Exchange
Commission. 42




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##### Table of Contents



SIGNATURES
  TRANSMETA CORPORATIONBy
    
    /s/ MARK R. KENT

Mark R. KentChief Financial Officer(Principal Financial Officer and Duly AuthorizedDate: May 10, 2006
    
    
    
    Officer)
 43




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##### Table of Contents



EXHIBIT INDEX
 Exhibit Number
    
    Exhibit Title10.26+
    
    LongRun2 Technology License Agreement, dated February 22, 2006, between Transmeta and Toshiba Corporation.31.01
    
    Certification by Arthur L. Swift pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of
1934.31.02
    
    Certification by Mark R. Kent pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934.32.01*
    
    Certification by Arthur L. Swift 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 Mark R. Kent pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this quarterly
report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are
not incorporated by reference in any filing of Transmeta Corporation under the Securities Act of
1933 or the Securities Exchange Act of 1934, including this quarterly report, whether made before
or after the date hereof and irrespective of any general incorporation language in any filings.+
    
    Confidential treatment has been requested for portions of this exhibit. These portions have
been omitted from this Report and have been filed separately with the Securities and Exchange
Commission.