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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549
 FORM 10-Q/A Amendment No. 1
 (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended June 30, 2004 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)  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o There were 174,227,866 shares of the Companys common stock, par value
$0.00001 per share, outstanding on July 23, 2004.




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##### Table of Contents



TRANSMETA CORPORATION Explanatory Note We
are filing this Amendment No. 1 to our Quarterly Report on Form 10-Q
for the period ended June 30, 2004 to amend and restate portions of our Form
10-Q for the same period initially filed with the Securities and
Exchange Commission on August 4, 2004 (the Initially Filed Form 10-Q). This
Amendment No. 1 amends and restates the following items of the Initially Filed
Form 10-Q: (i) Part I, Item 1  Unaudited Condensed Consolidated Financial
Statements, (ii) Part I, Item 2  Managements Discussion and Analysis of
Financial Condition and Results of Operations, (iii) Part I, Item 4  Controls
and Procedures, and (iv) Part II, Item 6  Exhibits and Reports on Form 8-K.
The disclosures set forth in those items in the Initially Filed Form 10-Q that
are amended by this Amendment No. 1 include, without limitation:  
    
    our financial results for three and six months ended June 30,
2004 are amended by this Amendment No. 1 to reflect an additional $1.3 million
adjustment to our product cost of revenue relating to previously
unidentified excess package substrate materials on hand and on order
within that period and capitalized manufacturing costs that were in
excess of our standard costs, and which had stated certain
inventories in excess of their net realizable values;
    
    Note 8 to the Notes to Condensed Consolidated Financial
Statement, Related Party Transaction, which had been previously
omitted, is updated by this Amendment No. 1;
    
    the contractual obligations table in Item 2, Managements
Discussion and Analysis of Financial Condition and Results of
Operations, is updated by this Amendment No. 1 to include certain
operating leases and unconditional purchase obligations that had
been previously omitted; and
    
    Item 4, Controls and Disclosures, is updated by this
Amendment No. 1 to discuss material weaknesses in our internal
control over financial reporting identified in the
course of preparing our financial statements for the third quarter
of fiscal 2004 and that had an impact on the reporting of our second
quarter financial results. The restatement has no impact on our net cash used in operating activities
or on our cash and cash equivalents and short term investments in the unaudited
condensed consolidated statements of cash flows for the periods restated. Please see Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations and Note 9 to the Notes to Condensed
Consolidated Financial Statements contained in this Amendment No. 1 for further
information regarding the revisions to our financial results. All information in the Initially Filed Form 10-Q, as amended by this
Amendment No. 1, speaks as of the date of the original filing of the Initially
Filed Form 10-Q and does not reflect any subsequent information or events,
except as presented in this Amendment No. 1 and except for Exhibits 31.01,
31.02, 32.01 and 32.02. References to Annual Report and Form 10-K in this
Amendment No. 1 refer to our Annual Report on Form 10-K for the fiscal year
ended December 31, 2003. References to Amendment No. 1, Quarterly Report
and Form 10-Q in this Amendment No. 1, refer to our quarterly report on Form
10-Q for the three months and six months ended June 30, 2004, as amended. All information contained in this Amendment No. 1 is subject to updating
and supplementing as provided in our reports filed with the Securities and
Exchange Commission subsequent to the date of the filing of the Initially Filed
Form 10-Q. 2




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FORM 10-Q/A
Quarterly Period Ended June 30, 2004  
 TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1. Unaudited Condensed Consolidated Financial Statements
    
    4Unaudited Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31,
2003
    
    4Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 2004 and June 30, 2003
    
    5Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2004 and June 30, 2003
    
    6Notes to Unaudited Condensed Consolidated Financial Statements
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    13Item 4. Controls and Procedures
    
    33PART II. OTHER INFORMATIONItem 6. Exhibits and Reports on Form 8-K
    
    35Signatures
    
    36EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01EXHIBIT 32.02
  3




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PART I. FINANCIAL INFORMATION 
 Item 1.Condensed Consolidated Financial Statements TRANSMETA CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share amounts)
 June 30,
    
    December 31,2004
    
    2003(1)(unaudited)(As restated)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    25,913
    
    
    $
    83,765Short-term investments
    
    
    58,776
    
    
    
    37,000Accounts receivable, net
    
    
    3,492
    
    
    
    1,719Inventories
    
    
    11,346
    
    
    
    8,796Prepaid expenses and other current assets
    
    
    3,888
    
    
    
    3,671Total current assets
    
    
    103,415
    
    
    
    134,951Property and equipment, net
    
    
    5,119
    
    
    
    5,305Patents and patent rights, net
    
    
    26,349
    
    
    
    29,771Other assets
    
    
    1,973
    
    
    
    1,563Total assets
    
    $
    136,856
    
    
    $
    171,590LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    7,283
    
    
    $
    1,900Accrued compensation and related compensation liabilities
    
    
    5,261
    
    
    
    4,986Other accrued liabilities
    
    
    6,852
    
    
    
    5,360Current portion of accrued restructuring charges
    
    
    1,668
    
    
    
    1,916Current portion of long-term payables
    
    
    14,957
    
    
    
    21,129Current portion of long-term debt and capital lease obligations
    
    
    346
    
    
    
    370Total current liabilities
    
    
    36,367
    
    
    
    35,661Long-term accrued restructuring costs, net of current portion
    
    
    3,496
    
    
    
    4,155Long-term debt and capital lease obligations, net of current portion
    
    
    181
    
    
    
    356Commitments and contingenciesStockholders Equity:Preferred stock, $0.00001 par value Authorized shares - 5,000,000. None issued
    
    
    
    
    
    
    Common stock, $0.00001 par value, at amounts paid in; Authorized shares -
1,000,000,000. Issued and outstanding shares  174,219,034 at June 30, 2004
and 167,528,493 at December 31, 2003
    
    
    692,287
    
    
    
    677,093Treasury stock
    
    
    (2,439
    )
    
    
    (2,439
    )Deferred stock compensation
    
    
    (116
    )
    
    
    (696
    )Accumulated other comprehensive income (loss)
    
    
    (228
    )
    
    
    24Accumulated deficit
    
    
    (592,692
    )
    
    
    (542,564
    )Total stockholders equity
    
    
    96,812
    
    
    
    131,418Total liabilities and stockholders equity
    
    $
    136,856
    
    
    $
    171,590
 (1)
    
    Derived from the Companys audited financial statements as of December
31, 2003, included in the Companys Form 10-K filed with the Securities
and Exchange Commission.
 (See accompanying notes) 4




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

(Unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(As restated)
    
    
    
    
    
    (As restated)Revenue:Product
    
    $
    5,673
    
    
    $
    4,601
    
    
    $
    10,680
    
    
    $
    10,544License and service
    
    
    327
    
    
    
    453
    
    
    
    522
    
    
    
    527Total revenue
    
    
    6,000
    
    
    
    5,054
    
    
    
    11,202
    
    
    
    11,071Cost of revenue:Product
    
    
    9,162
    
    
    
    4,998
    
    
    
    14,534
    
    
    
    9,450License and service
    
    
    102
    
    
    
    
    
    
    
    344
    
    
    
    Total cost of revenue
    
    
    9,264
    
    
    
    4,998
    
    
    
    14,878
    
    
    
    9,450Gross profit (loss)
    
    
    (3,264
    )
    
    
    56
    
    
    
    (3,676
    )
    
    
    1,621Operating expenses:Research and development(1)(2)
    
    
    13,719
    
    
    
    12,190
    
    
    
    26,436
    
    
    
    24,669Selling, general and administrative(3)(4)
    
    
    7,418
    
    
    
    6,347
    
    
    
    14,139
    
    
    
    12,981Amortization of deferred charges, patents and patent rights
    
    
    2,347
    
    
    
    2,634
    
    
    
    4,751
    
    
    
    5,274Stock compensation
    
    
    230
    
    
    
    1,095
    
    
    
    1,580
    
    
    
    1,531Total operating expenses
    
    
    23,714
    
    
    
    22,266
    
    
    
    46,906
    
    
    
    44,455Operating loss
    
    
    (26,978
    )
    
    
    (22,210
    )
    
    
    (50,582
    )
    
    
    (42,834
    )Interest income and other, net
    
    
    243
    
    
    
    312
    
    
    
    489
    
    
    
    1,019Interest expense
    
    
    (20
    )
    
    
    (123
    )
    
    
    (35
    )
    
    
    (247
    )Net loss
    
    $
    (26,755
    )
    
    $
    (22,021
    )
    
    $
    (50,128
    )
    
    $
    (42,062
    )Net loss per share  basic and diluted
    
    $
    (0.15
    )
    
    $
    (0.16
    )
    
    $
    (0.29
    )
    
    $
    (0.30
    )Weighted average shares outstanding  basic and diluted
    
    
    174,006
    
    
    
    138,678
    
    
    
    172,938
    
    
    
    138,089
 (1)
    
    Excludes $228 and $316 in amortization of deferred stock compensation for
the three months ended June 30, 2004 and June 30, 2003, respectively, and
$355 and $735 for the six months ended June 30, 2004 and June 30, 2003,
respectively.(2)
    
    Excludes $(109) and $59 in variable stock compensation for the three
months ended June 30, 2004 and June 30, 2003, respectively, and $362 and
$35 for the six months ended June 30, 2004 and June 30, 2003,
respectively.(3)
    
    Excludes $126 and $269 in amortization of deferred stock compensation for
the three months ended June 30, 2004 and June 30, 2003, respectively, and
$205 and $506 for the six months ended June 30, 2004 and June 30, 2003,
respectively.(4)
    
    Excludes $(15) and $451 in variable stock compensation for the three
months ended June 30, 2004 and June 30, 2003, respectively, and $658 and
$255 for the six months ended June 30, 2004 and June 30, 2003,
respectively.
 (See accompanying notes) 5




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TRANSMETA CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) Six Months EndedJune 30,
    
    June 30,2004
    
    2003(As restated)Cash flows from operating activities:Net loss
    
    $
    (50,128
    )
    
    $
    (42,062
    )Adjustments to reconcile net loss to net cash used in operating activities:Stock compensation
    
    
    1,580
    
    
    
    1,531Depreciation
    
    
    1,878
    
    
    
    3,036Amortization of other assets
    
    
    
    
    
    
    324Amortization of deferred charges, patents and patent rights
    
    
    4,751
    
    
    
    5,274Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,773
    )
    
    
    1,236Inventories
    
    
    (2,550
    )
    
    
    3,360Prepaid expenses and other current assets
    
    
    (627
    )
    
    
    (286
    )Accounts payable and accrued liabilities
    
    
    7,150
    
    
    
    (2,707
    )Accrued restructuring charges
    
    
    (907
    )
    
    
    (1,272
    )Net cash used in operating activities
    
    
    (40,626
    )
    
    
    (31,566
    )Cash flows from investing activities:Purchase of available-for-sale investments
    
    
    (66,754
    )
    
    
    (61,507
    )Proceeds from sale or maturity of available-for-sale investments
    
    
    44,726
    
    
    
    124,729Purchase of property and equipment
    
    
    (1,692
    )
    
    
    (659
    )Payment of patent and patent rights
    
    
    (7,500
    )
    
    
    (9,000
    )Other assets
    
    
    
    
    
    
    (59
    )Net cash provided by / (used in) investing activities
    
    
    (31,220
    )
    
    
    53,504Cash flows from financing activities:Net proceeds from public offering of common stock
    
    
    10,223
    
    
    
    Proceeds from sales of common stock under ESPP and stock option plans
    
    
    3,113
    
    
    
    1,486Repayment of notes from stockholders
    
    
    857
    
    
    
    Repayment of debt and capital lease obligations
    
    
    (199
    )
    
    
    (423
    )Net cash provided by financing activities
    
    
    13,994
    
    
    
    1,063Change in cash and cash equivalents
    
    
    (57,852
    )
    
    
    23,001Cash and cash equivalents at beginning of period
    
    
    83,765
    
    
    
    16,613Cash and cash equivalents at end of period
    
    $
    25,913
    
    
    $
    39,614
 (See accompanying notes) 6




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TRANSMETA CORPORATION 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission and accounting principles generally accepted in the United
States for interim financial information. However, certain information or
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed, or omitted, pursuant to such rules and regulations. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements.
Actual results could differ from those estimates. Significant estimates made in
preparing the financial statements include license revenue recognition,
inventory valuations, long-lived and intangible asset valuations, restructuring
charges and loss contingencies. In the opinion of management, the statements
include all adjustments (which are of a normal and recurring nature) necessary
for the fair presentation of the results of the interim periods presented.
These financial statements should be read in conjunction with our audited
consolidated financial statements and the notes thereto included in the
Companys Form 10-K for the year ended December 31, 2003. The results of
operations for the three months and six months ended June 30, 2004 are not
necessarily indicative of the operating results for the full fiscal year or any
future period. The financial statements of the Company have been presented based on the
assumption that the Company will continue as a going concern. The Company,
however, has a history of substantial losses, and expects to incur future
losses. To the extent that existing cash and cash equivalents and short-term
investments balances and any cash from operations are insufficient to fund its
activities during the next 12 months, the Company may need to raise during that
time period additional funds through public or private equity or debt financing
or by any other means available to the Company at that time. Additional funds
may not be available on terms favorable to the Company or at all. In the event
that the Company is unable to raise additional funds, it is positioned to
modify its current business model, for example, to leverage its intellectual
property assets and focus on its strategy of licensing its advanced power
management technologies to other companies and, in doing so, to substantially
limit its operations and reduce costs related to aspects of the business other
than intellectual property and technology licensing to permit it to continue to
operate on a modified business model for a period that extends at least twelve
months beyond June 30, 2004. The Companys fiscal year ends on the last Friday in December, and each
fiscal quarter ends on the last Friday of each calendar quarter. For ease of
presentation, the accompanying financial information has been shown as of
December 31 and calendar quarter ends for all annual and quarterly financial
statement captions. The three-month periods ended June 25, 2004 and June 27,
2003 each consisted of 13 weeks. The first six months of fiscal 2004 and 2003
each consisted of 26 weeks. 2. Net Loss per Share Basic and diluted net loss per share is presented in conformity with the
Financial Accounting Standards Boards (FASB) Statement of Financial Accounting
Standards (SFAS) No. 128, Earnings Per Share, for all periods presented.
Basic and diluted net loss per share has been computed using the
weighted-average number of shares of common stock outstanding during each
period, less weighted-average shares subject to repurchase. 7




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The following table presents the computation of basic and diluted net loss
per share: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(As restated)
    
    
    
    
    
    (As restated)(in thousands, except for per share amounts)Basic and diluted:Net loss, as reported
    
    $
    (26,755
    )
    
    $
    (22,021
    )
    
    $
    (50,128
    )
    
    $
    (42,062
    )Basic and diluted:Weighted average shares outstanding
    
    
    174,006
    
    
    
    138,679
    
    
    
    172,938
    
    
    
    138,100Less: Weighted average shares subject to repurchase
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    (11
    )Weighted average shares used in computing basic
and diluted net loss per share
    
    
    174,006
    
    
    
    138,678
    
    
    
    172,938
    
    
    
    138,089Net loss per share  basic and diluted
    
    $
    (0.15
    )
    
    $
    (0.16
    )
    
    $
    (0.29
    )
    
    $
    (0.30
    )
 The Company has excluded all outstanding stock options and shares subject
to repurchase from the calculation of basic and diluted net loss per share
because these securities are antidilutive for all periods presented. Options
and warrants to purchase 35,871,772 and 36,566,532 shares of common stock at
June 30, 2004 and 2003, respectively, determined using the treasury stock
method, were not included in the computation of diluted net loss per share
because the effect would be antidilutive. These securities, had they been
dilutive, would have been included in the computation of diluted net loss per
share using the treasury stock method. 3. Stock Based Compensation The Company accounts for its stock options and equity awards in accordance
with the provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations and has elected to
follow the disclosure only alternative prescribed by SFAS 123, Accounting
for Stock-Based Compensation. Expense associated with stock-based compensation
is amortized on an accelerated basis over the vesting period of the individual
award consistent with the method described in FASB Interpretation 28,
Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plan. Accordingly, approximately 59% of the unearned deferred
compensation is amortized in the first year, 25% in the second year, 12% in the
third year, and 4% in the fourth year following the date of grant. Pursuant to
SFAS 123, Transmeta discloses the pro forma effect of using the fair value
method of accounting for its stock-based compensation arrangements. In December
2002, the FASB issued, and the Company adopted, SFAS 148, Accounting for
Stock-Based Compensation  Transition and Disclosure  an Amendment of FASB
Statement No. 123. SFAS 148 amends the disclosure requirements of FASBs SFAS
123, Accounting for Stock-Based Compensation, to require more prominent
disclosures in both annual and interim financial statements regarding the
method of accounting for stock-based employee compensation and the effect of
the method used on reported results. For purposes of pro forma disclosures, the estimated fair value of options
is amortized to pro forma expense over the options vesting period using an
accelerated graded method. Pro forma information follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(As restated)
    
    
    
    
    
    (As restated)(in thousands, except for per share amounts)Net loss, as reported
    
    $
    (26,755
    )
    
    $
    (22,021
    )
    
    $
    (50,128
    )
    
    $
    (42,062
    )Add: Stock-based employee compensation expense
included in reported net loss, net of related tax
effects
    
    
    230
    
    
    
    1,095
    
    
    
    1,580
    
    
    
    1,531Less: Total stock-based employee compensation
expense under fair value based method for all
awards, net of related tax effects
    
    
    (9,196
    )
    
    
    (12,879
    )
    
    
    (20,113
    )
    
    
    (23,069
    )Pro forma net loss
    
    $
    (35,721
    )
    
    $
    (33,805
    )
    
    $
    (68,661
    )
    
    $
    (63,600
    )Basic and diluted net loss per share  as reported
    
    $
    (0.15
    )
    
    $
    (0.16
    )
    
    $
    (0.29
    )
    
    $
    (0.30
    )Basic and diluted net loss per share  pro forma
    
    $
    (0.21
    )
    
    $
    (0.24
    )
    
    $
    (0.40
    )
    
    $
    (0.46
    )
 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 8




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estimate, in managements opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its stock-based awards.
The fair value of options granted was determined based on estimated stock price
volatility. The weighted average assumptions used to determine fair value were
as follows: Options
    
    ESPPThree Months
    
    Six Months
    
    Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,
    
    Ended June 30,
    
    Ended June 30,2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003
    
    2004
    
    2003Expected volatility
    
    
    0.64
    
    
    
    0.88
    
    
    
    0.65
    
    
    
    0.85
    
    
    
    0.90
    
    
    
    0.81
    
    
    
    0.95
    
    
    
    0.93Expected life in
years
    
    
    4.0
    
    
    
    4.0
    
    
    
    4.0
    
    
    
    4.0
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    0.5
    
    
    
    0.5Risk-free interest
rate
    
    
    3.7
    %
    
    
    2.2
    %
    
    
    3.6
    %
    
    
    2.3
    %
    
    
    2.3
    %
    
    
    1.4
    %
    
    
    1.7
    %
    
    
    1.4
    %Expected dividend
yield
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
 4. Net Comprehensive Loss Net comprehensive loss includes the Companys net loss, as well as
accumulated other comprehensive income/(loss) on available-for-sale investments
and foreign currency translation adjustments. Net comprehensive loss for the
three and six month periods ended June 30, 2004 and 2003, respectively, is as
follows (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(As restated)
    
    
    
    
    
    (As restated)Net loss
    
    $
    (26,755
    )
    
    $
    (22,021
    )
    
    $
    (50,128
    )
    
    $
    (42,062
    )Net change in unrealized loss on investments
    
    
    (238
    )
    
    
    (21
    )
    
    
    (240
    )
    
    
    (117
    )Net change in foreign currency translation adjustments
    
    
    (17
    )
    
    
    8
    
    
    
    (12
    )
    
    
    8Net comprehensive loss
    
    $
    (27,010
    )
    
    $
    (22,034
    )
    
    $
    (50,380
    )
    
    $
    (42,171
    )
 The components of accumulated other comprehensive income, net of taxes as
of June 30, 2004 and December 31, 2003, respectively, is as follows (in
thousands): June 30,
    
    December 31,2004
    
    2003Net unrealized loss on investments
    
    $
    (240
    )
    
    $
    (1
    )Cumulative foreign currency translation adjustments
    
    
    12
    
    
    
    25Accumulated other comprehensive income
    
    $
    (228
    )
    
    $
    24
 5. Inventories Inventories are stated at the lower of cost (first-in, first-out) or
market. The components of inventories consist of the following (in thousands): June 30,
    
    December 31,2004
    
    2003(As restated)Work in progress
    
    $
    8,038
    
    
    $
    6,136Finished goods
    
    
    3,308
    
    
    
    2,660$
    11,346
    
    
    $
    8,796
 In the second quarter of fiscal 2004, the Company recorded a $3.9 million
inventory-related charge to product cost of revenue, which partly consisted of
a $2.6 million adjustment to inventory on hand. The remaining $1.3 million of
charges related to non-cancelable commitments for package substrate materials
and wafers on order with our third-party suppliers, as such
contractual commitments were in excess of that inventorys net
realizable value. The Company became aware of the commitment for
package substrate materials during the third quarter of fiscal 2004. The charge for materials on hand and on order
was primarily associated with our 1.0 GHz 12 9




---



##### Table of Contents



Watt 130 nanometer Efficeon processors because the cost to manufacture
these parts exceeded the price at which we expect to be able to sell these
products. To a lesser extent, a portion of the inventory-related charge relates
to package substrate materials for the 130 nanometer Efficeon product that are
in excess of our anticipated requirements for these materials. Typically, the
Company places its orders for materials with third-party suppliers in advance
of expected product purchase orders from its customers and, as a result, the
Company may have too much material for a particular product on hand or on
order. Of the $11.3 million and $8.8 million of net inventory on hand at June 30,
2004 and December 31, 2003, respectively, $6.2 million and $2.6 million of
net inventory, respectively, were stated at net realizable value. Accordingly,
gross margin may be impacted from future sales of these parts to the extent
that the associated revenue exceeds or fails to achieve their currently
adjusted values. Benefits to gross margin as a result of products being sold at
ASPs in excess of their previously written down values were $0.2 million and
$0.2 million for the three and six months ended June 30, 2004, respectively,
compared to $0.1 million and $0.4 million for the same periods last year. 6. Restructuring Charges In the second quarter of fiscal 2002, Transmeta recorded a $10.6 million
restructuring charge as a result of the Companys decision to cease development
and productization of the TM6000 microprocessor. The restructuring charge
consisted primarily of lease costs, equipment write-offs and other costs as the
Company identified a number of leased facilities as well as leased and owned
equipment that were no longer required. Accrued restructuring charges consist of the following at June 30, 2004
(in thousands): Provision
    
    
    
    
    
    
    
    
    
    Provision
    
    
    
    
    
    
    
    
    
    ProvisionBalance at
    
    
    
    
    
    
    
    
    
    Balance at
    
    
    
    
    
    
    
    
    
    Balance atDecember 31,
    
    Drawdowns
    
    March 31,
    
    Drawdowns
    
    June 30,2003
    
    Cash
    
    Non-Cash
    
    2004
    
    Cash
    
    Non-Cash
    
    2004Building leasehold
Costs
    
    $
    6,071
    
    
    $
    408
    
    
    
    
    
    
    $
    5,663
    
    
    $
    499
    
    
    
    
    
    
    $
    5,164
 7. Legal Proceedings The Company is a party in one consolidated lawsuit. Beginning in June
2001, the Company, certain of its directors and officers, and certain of the
underwriters for its initial public offering were named as defendants in three
putative shareholder class actions that were consolidated in and by the United
States District Court for the Southern District of New York in In re Transmeta
Corporation Initial Public Offering Securities Litigation, Case No. 01 CV 6492.
The complaints allege that the prospectus issued in connection with the
Companys initial public offering on November 7, 2000 failed to disclose
certain alleged actions by the underwriters for that offering, and alleges
claims against the Company and several of its officers and directors under
Sections 11 and 15 of the Securities Act of 1933, as amended, and under
Sections 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as
amended. Similar actions have been filed against more than 300 other companies
that issued stock in connection with other initial public offerings during
1999-2000. Those cases have been coordinated for pretrial purposes as In re
Initial Public Offering Securities Litigation, Master File No. 21 MC 92 (SAS).
In July 2002, the Company joined in a coordinated motion to dismiss filed on
behalf of multiple issuers and other defendants. In February 2003, the Court
granted in part and denied in part the coordinated motion to dismiss, and
issued an order regarding the pleading of amended complaints. Plaintiffs
subsequently proposed a settlement offer to all issuer defendants, which
settlement would provide for payments by issuers insurance carriers if
plaintiffs fail to recover a certain amount from underwriter defendants.
Although the Company and the individual defendants believe that the complaints
are without merit and deny any liability, but because they also wish to avoid
the continuing waste of management time and expense of litigation, they
accepted plaintiffs proposal to settle all claims that might have been brought
in this action. The Company and the individual Transmeta defendants expect that
their share of the global settlement will be fully funded by their director and
officer liability insurance. Although the Company and the Transmeta defendants
have approved the settlement in principle, it remains subject to several
procedural conditions, as well as formal approval by the Court. It is possible
that the parties may not reach a final written settlement agreement or that the
Court may decline to approve the settlement in whole or part. In the event that
the parties do not reach agreement on the final settlement, the Company and the
Transmeta defendants believe that they have meritorious defenses and intend to
defend any remaining action vigorously. 8. 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 10




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##### Table of Contents



entered. In relation to this agreement, the Company recognized license
revenue of $327,000 and $522,000 for the three and six months ended June 30,
2004, respectively. 9. Restatement of Financial Statements: Presented below are the unaudited condensed consolidated financial
statements of the Company at the date or for the periods specified below (1) as
originally reported in our Form 10-Q for the period ended June 30, 2004 that we
initially filed with the Securities and Exchange Commission on August 4, 2004,
and (2) as restated. June 30, 2004(unaudited)(As originallyreported)
    
    (As restated)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    25,913
    
    
    $
    25,913Short-term investments
    
    
    58,776
    
    
    
    58,776Accounts receivable, net
    
    
    3,492
    
    
    
    3,492Inventories
    
    
    12,025
    
    
    
    11,346Prepaid expenses and other current assets
    
    
    3,888
    
    
    
    3,888Total current assets
    
    
    104,094
    
    
    
    103,415Property and equipment, net
    
    
    5,119
    
    
    
    5,119Patents and patent rights, net
    
    
    26,349
    
    
    
    26,349Other assets
    
    
    1,973
    
    
    
    1,973Total assets
    
    $
    137,535
    
    
    $
    136,856LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    7,283
    
    
    $
    7,283Accrued compensation and related compensation liabilities
    
    
    5,261
    
    
    
    5,261Other accrued liabilities
    
    
    6,278
    
    
    
    6,852Current portion of accrued restructuring charges
    
    
    1,668
    
    
    
    1,668Current portion of long-term payables
    
    
    14,957
    
    
    
    14,957Current portion of long-term debt and capital lease obligations
    
    
    346
    
    
    
    346Total current liabilities
    
    
    35,793
    
    
    
    36,367Long-term accrued restructuring costs, net of current portion
    
    
    3,496
    
    
    
    3,496Long-term debt and capital lease obligations, net of current portion
    
    
    181
    
    
    
    181Commitments and contingenciesStockholders Equity:Preferred stock, $0.00001 par value Authorized shares - 5,000,000. None issued
    
    
    
    
    
    
    Common
stock, $0.00001 par value, at amounts paid in; Authorized shares - 1,000,000,000. Issued and outstanding shares 
174,219,034 at June 30, 2004 and 167,528,493 at December 31, 2003
    
    
    692,287
    
    
    
    692,287Treasury stock
    
    
    (2,439
    )
    
    
    (2,439
    )Deferred stock compensation
    
    
    (116
    )
    
    
    (116
    )Accumulated other comprehensive income (loss)
    
    
    (228
    )
    
    
    (228
    )Accumulated deficit
    
    
    (591,439
    )
    
    
    (592,692
    )Total stockholders equity
    
    
    98,065
    
    
    
    96,812Total liabilities and stockholders equity
    
    $
    137,535
    
    
    $
    136,856
 11




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##### Table of Contents



Three Months EndedJune 30,
    
    June 30,2004
    
    2004(unaudited)(As originallyreported)
    
    (As restated)Revenue:Product
    
    $
    5,673
    
    
    $
    5,673License and service
    
    
    327
    
    
    
    327Total revenue
    
    
    6,000
    
    
    
    6,000Cost of revenue:Product
    
    
    7,909
    
    
    
    9,162License and service
    
    
    102
    
    
    
    102Total cost of revenue
    
    
    8,011
    
    
    
    9,264Gross profit (loss)
    
    
    (2,011
    )
    
    
    (3,264
    )Operating expenses:Research and development(1)(2)
    
    
    13,719
    
    
    
    13,719Selling, general and administrative(3)(4)
    
    
    7,418
    
    
    
    7,418Amortization of deferred charges, patents and patent rights
    
    
    2,347
    
    
    
    2,347Stock compensation
    
    
    230
    
    
    
    230Total operating expenses
    
    
    23,714
    
    
    
    23,714Operating loss
    
    
    (25,725
    )
    
    
    (26,978
    )Interest income and other, net
    
    
    243
    
    
    
    243Interest expense
    
    
    (20
    )
    
    
    (20
    )Net loss
    
    $
    (25,502
    )
    
    $
    (26,755
    )Net loss per share  basic and diluted
    
    $
    (0.15
    )
    
    $
    (0.15
    )Weighted average shares outstanding  basic and diluted
    
    
    174,006
    
    
    
    174,006
   (1)
    
    Excludes $228 in amortization of deferred stock compensation for the
three months ended June 30, 2004.(2)
    
    Excludes $(109) in variable stock compensation for the three months ended
June 30, 2004.(3)
    
    Excludes $126 in amortization of deferred stock compensation for the
three months ended June 30, 2004.(4)
    
    Excludes $(15) in variable stock compensation for the three months ended
June 30, 2004. Six Months EndedJune 30,
    
    June 30,2004
    
    2004(unaudited)(As originallyreported)
    
    (As restated)Revenue:Product
    
    $
    10,680
    
    
    $
    10,680License and service
    
    
    522
    
    
    
    522Total revenue
    
    
    11,202
    
    
    
    11,202Cost of revenue:Product
    
    
    13,281
    
    
    
    14,534License and service
    
    
    344
    
    
    
    344Total cost of revenue
    
    
    13,625
    
    
    
    14,878Gross profit (loss)
    
    
    (2,423
    )
    
    
    (3,676
    )Operating expenses:Research and development(1)(2)
    
    
    26,436
    
    
    
    26,436Selling, general and administrative(3)(4)
    
    
    14,139
    
    
    
    14,139Amortization of deferred charges, patents and patent rights
    
    
    4,751
    
    
    
    4,751Stock compensation
    
    
    1,580
    
    
    
    1,580Total operating expenses
    
    
    46,906
    
    
    
    46,906Operating loss
    
    
    (49,329
    )
    
    
    (50,582
    )Interest income and other, net
    
    
    489
    
    
    
    489Interest expense
    
    
    (35
    )
    
    
    (35
    )Net loss
    
    $
    (48,875
    )
    
    $
    (50,128
    )Net loss per share  basic and diluted
    
    $
    (0.28
    )
    
    $
    (0.29
    )Weighted average shares outstanding  basic and diluted
    
    
    172,938
    
    
    
    172,938
 12




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##### Table of Contents



(1)
    
    Excludes $355 in amortization of deferred stock compensation for the six
months ended June 30, 2004.(2)
    
    Excludes $362 in variable stock compensation for the six months ended
June 30, 2004.(3)
    
    Excludes $205 in amortization of deferred stock compensation for the six
months ended June 30, 2004.(4)
    
    Excludes $658 in variable stock compensation for the six months ended
June 30, 2004. 
 Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations Caution Regarding Forward-Looking Statements The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and the related notes contained
in this report and with the information included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2003 and subsequent reports filed
with the Securities and Exchange Commission (SEC). The information contained in
this report is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this report and in
our other reports filed regularly with the SEC, some of which reports discuss
our business in greater detail. 13




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##### Table of Contents



This report contains forward-looking statements that are based upon our
current expectations, estimates and projections about our industry, and that
reflect our beliefs and certain assumptions based upon information made
available to us at the time of this report. Words such as anticipates,
expects, intends, plans, believes, seeks, estimates, may,
could, will and variations of these words or similar expressions are
intended to identify forward-looking statements. Such statements include, but
are not limited to, statements concerning anticipated trends or developments in
our business and the markets in which we operate, the competitive nature and
anticipated growth of those markets, our expectations for our future
performance and the market acceptance of our products, our ability to migrate
our products to smaller process geometries, and our future gross margins,
operating expenses and need for additional capital. Investors are cautioned that such forward-looking statements are only
predictions, which may differ materially from actual results or future events.
These statements are not guarantees of future performance and are subject to
risks, uncertainties and assumptions that are difficult to predict. Some of the
important risk factors that may affect our business, results of operations and
financial condition are set out and discussed below in the section entitled
Risks That Could Affect Future Results. You should carefully consider those
risks, in addition to the other information in this report and in our other
filings with the SEC, before deciding to invest in our company or to maintain
or change your investment. Investors are cautioned not to place reliance on
these forward-looking statements, which reflect managements analysis only as
of the date of this report. We undertake no obligation to revise or update any
forward-looking statement for any reason. Overview We design, develop and sell highly efficient x86-compatible software-based
microprocessors. Since the introduction of our first family of microprocessors,
the Crusoe series, in January 2000, we have derived the majority of our revenue
from the sale of these products. In October 2003, we introduced the Efficeon
TM8000 family of microprocessors, which is our next family of x86-compatible
processors. In fiscal 2003, and through the first six months of fiscal 2004, we
additionally have recognized revenue from technology and intellectual property
license agreements. During the first quarter of fiscal 2004, we entered into a
licensing agreement with NEC Electronics, or NEC, wherein NEC licensed our
LongRun2 technologies for power management and transistor leakage control. The
agreement with NEC includes deliverable-based license fees, maintenance service
fees, and subsequent royalties payable to us once NEC begins production of
products incorporating our technologies, which NEC currently expects to begin
in late 2005. Through June 30, 2004, we have collected a total of $0.3 million
in maintenance service fees related to our NEC agreement. These funds will be
recognized as revenue once certain predetermined milestones are met. We expect
in the near term for technology and intellectual property license revenues to
contribute to our total revenue, and we will continue to explore additional
opportunities for licensing our advanced power management and other
technologies to other companies in the integrated circuit industry. Our total revenue, including product revenue and license and service
revenue, for the three and six months ended June 30, 2004, was $6.0 million and
$11.2 million, respectively, compared to $5.1 million and $11.1 million for the
corresponding periods last year. These increases were primarily due to
increases of 48% and 14% in net units shipped for the three and six months
ended June 30, 2004, respectively, compared to the same periods last year. The
increases in the net unit volume shipped were offset by a decrease in average
selling prices, or ASPs. However, we also had a more favorable product mix in
fiscal 2004 and had higher ASPs associated with shipments of our Efficeon
products, which began toward the end of the fourth quarter of fiscal 2003. The
higher ASPs from Efficeon were offset by a 21% and 31% decrease in the ASPs of
the Crusoe TM5800 for the three and six months periods ended June 30, 2004,
respectively, compared to the same periods last year. The cost to manufacture
our Crusoe products has decreased for the three and six months ended June 30,
2004 compared to the same periods last year. As a result, for the
three and six months ended June 30, 2004, our Crusoe product
line contributed favorably to our gross margin. We had total operating expenses of $23.7 million and $46.9 million for the
three and six months ended June 30, 2004, respectively, compared to $22.3
million and $44.5 million for the corresponding periods last year. Net loss was
$26.8 million and $50.1 million for the three and six months ended June 30,
2004, respectively, compared to $22.0 million and $42.1 million for the
corresponding periods last year. Historically we have incurred significant
losses, and as of June 30, 2004, we had an accumulated deficit of $592.7
million. The majority of our sales have been to a limited number of customers.
Additionally, we derive a significant portion of our revenue 14




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##### Table of Contents



from customers located in Asia. The following table represents our sales to
customers, each of which is located in Asia, that accounted for more than 10%
of total revenue for the three and six months ended June 30, 2004 and 2003: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Customer A
    
    
    39
    %
    
    
    *
    %
    
    
    46
    %
    
    
    *
    %Customer B
    
    
    21
    %
    
    
    24
    %
    
    
    19
    %
    
    
    21
    %Customer C
    
    
    *
    %
    
    
    *
    %
    
    
    11
    %
    
    
    *
    %Customer D
    
    
    *
    %
    
    
    13
    %
    
    
    *
    %
    
    
    23
    %Customer E
    
    
    *
    %
    
    
    13
    %
    
    
    *
    %
    
    
    19
    %
   *
    
    represents less than 10% of total revenue We had five customers that accounted for more than 10% of our accounts
receivable balance at June 30, 2004, including customers A, B, C and E,
referenced above, who represented 30%, 24%, 12% and 11%, respectively, of our
accounts receivable balance. An additional customer represented 11% of our
accounts receivable balance at June 30, 2004. This compares to two customers
that accounted for more than 10% of our accounts receivable balance at December
31, 2003, including customers A and B, who represented 66% and 13%,
respectively, of our accounts receivable balance. We began shipment in the fourth quarter of 2003 of our initial Efficeon
TM8000 microprocessor, manufactured using a 130 nanometer complementary metal
oxide semiconductor, or CMOS, process. We believe that we must successfully
complete the transition of the manufacturing of our Efficeon TM8000
microprocessors to a 90 nanometer CMOS process in order to be able to achieve
broad market acceptance of our Efficeon TM8000 microprocessors. We began
sampling our 90 nanometer Efficeon TM8000 processors in early April and we
continue to pursue our goal to begin limited production of these products in
the third quarter of fiscal 2004. In the fiscal quarter ended June 30, 2004, we recorded a $3.9 million
charge to product cost of revenue, which partly consisted of a $2.6 million
adjustment to inventory on hand. The remaining $1.3 million of charges related
to non-cancelable commitments for package substrate materials and wafers on
order with our third-party suppliers. The majority of the charge for inventory
on hand and on order was primarily associated with our 1.0 GHz 12 Watt 130
nanometer Efficeon processors because the cost to manufacture these parts
exceeded the price at which we expect to sell these products. Accordingly,
gross margin may benefit from future sales of these parts only to the extent
that the associated revenue exceeds their currently adjusted values. Similarly,
our gross margins could be adversely affected if the products are sold at a
price lower than our currently estimated market value. Our goal is to improve
gross margins after we sell through the 130 nanometer Efficeon inventory on
hand at June 30, 2004, all of which is currently stated at its estimated market
value, and after we shift our product mix to our new 90 nanometer Efficeon
processor. We have historically reported negative cash flows from operations, and we
intend to rely on funds that we have received from financing activities until
we are able to generate sufficient revenue and related gross profit to cover
operational expenses as well as anticipated increases in our working capital
requirements. Our ability to increase sales of our Crusoe TM5800 products into
additional market segments, achieve market acceptance of our Efficeon TM8000
microprocessor manufactured using a 130 nanometer process and successfully
transition our Efficeon TM8000 microprocessor to a 90 nanometer process will be
particularly critical in determining our cash needs. Critical Accounting Policies The process of preparing financial statements requires the use of
estimates on the part of our management. The estimates used by management are
based on our historical experiences combined with managements understanding of
current facts and circumstances. Certain of our accounting policies are
considered critical as they are both important to the portrayal of our
financial condition and results and require significant or complex judgment on
the part of management. For a description of what we believe to be our most
critical accounting policies and estimates, refer to our Annual Report on Form
10-K for the year ended December 31, 2003 filed with the Securities and
Exchange Commission on March 9, 2004. There have been no changes in any of our
critical accounting policies since December 31, 2003. 15




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##### Table of Contents



Results of Operations Total Revenue We derive revenue from two sources: product revenue, and license and
service revenue. Total revenue for the comparative periods is summarized in the
following table: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Product
    
    $
    5,673
    
    
    $
    4,601
    
    
    $
    10,680
    
    
    $
    10,544License and service
    
    
    327
    
    
    
    453
    
    
    
    522
    
    
    
    527Total revenue
    
    $
    6,000
    
    
    $
    5,054
    
    
    $
    11,202
    
    
    $
    11,071
 Our products are targeted at a broad range of computing platforms,
particularly battery-operated mobile devices and applications that need high
performance, low power consumption and low heat generation. Such platforms
include thin clients, notebook computers, embedded computers and blade servers,
ultra-personal computers, or UPCs, and tablet PCs. Product revenue derived from
each computing market segment as well as license and service revenue is
presented as a percentage of total revenue in the following table: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Product revenue:Thin client desktop
    
    
    46
    %
    
    
    13
    %
    
    
    51
    %
    
    
    8
    %Notebook computers
    
    
    20
    %
    
    
    44
    %
    
    
    24
    %
    
    
    46
    %Embedded/servers
    
    
    16
    %
    
    
    5
    %
    
    
    10
    %
    
    
    7
    %UPCs
    
    
    8
    %
    
    
    1
    %
    
    
    4
    %
    
    
    1
    %Tablet PCs
    
    
    4
    %
    
    
    28
    %
    
    
    6
    %
    
    
    33
    %License and service
revenue:
    
    
    6
    %
    
    
    9
    %
    
    
    5
    %
    
    
    5
    %
 Total product revenue for the three and six months ended June 30, 2004 was
$5.7 million and $10.7 million, respectively, compared to $4.6 million and
$10.5 million for the corresponding periods last year. The increase in revenue
is primarily due to an overall increase in net product shipped of 48% and 14%,
respectively, for the three and six months ended June 30, 2004 compared to the
same periods last year. Contributing to this increase were the shipments of our
Efficeon product, which began in the fourth quarter of 2003 and represented 32%
and 25%, respectively, of total revenue for the three and six months ended June
30, 2004. Partially offsetting this increase was the decrease of ASPs for our
Crusoe processors. Pricing pressure on the TM5800 has increased and may continue to increase
as the product has matured and continues to penetrate into market segments and
geographies, such as China and Taiwan, that traditionally demand lower ASPs. We
will continue to manufacture the TM5800 as that processor continues to
penetrate into market segments such as the embedded and thin client markets,
from which we expect the processor to derive the majority of its future
revenue. The Efficeon TM8000 product is targeted at the high-volume notebook
and other markets that demand low power consumption and low heat generation
characteristics, such as the UPC and thin and light notebook markets. We have
recently seen that in the short term our potential customers in the mainstream
notebook markets plan to limit the number of system designs they will support,
and are consolidating their design teams and focusing on what they perceive to
be the products with the highest volume potential. This generally means that
there are fewer overall design opportunities and there is a stronger focus on
mainstream consumer notebooks among Taiwanese and U.S. manufacturers. As we
compete in the mainstream consumer notebook segments, we are facing increased
competition and are finding that ASPs are much lower than in other market
segments such as the thin and light notebook markets, and as a result could
have a negative impact on our future revenues. For the three and six months ended June 30, 2004, we recognized revenue of
$0.3 million and $0.5 million, respectively, related to a license and service
agreement that we entered into during fiscal 2003. In the first quarter of
fiscal 2004, we licensed our LongRun2 technologies for power management and
transistor leakage control to NEC Electronics. Through June 30, 2004, we have
not recognized any revenue from the agreement with NEC. However, we expect to
recognize revenue associated with this arrangement 16




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##### Table of Contents



once specific milestones are achieved. We will continue to explore
additional opportunities for licensing our advanced power management
technologies to other companies in the integrated circuit industry. For
example, we believe our proprietary LongRun2 leakage control technology could
be valuable to the semiconductor industry and could generate significant future
licensing revenues for us without impairing our microprocessor product
business. Gross Margin Our gross margin is comprised of the components displayed in the following
table, shown as a percentage of total revenue: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,
    
    June 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(As restated)
    
    
    
    
    
    (As restated)Revenue:Product
    
    
    94.5
    %
    
    
    91.0
    %
    
    
    95.3
    %
    
    
    95.2
    %License and service
    
    
    5.5
    %
    
    
    9.0
    %
    
    
    4.7
    %
    
    
    4.8
    %Total revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenue:Product
    
    
    89.3
    %
    
    
    84.6
    %
    
    
    91.8
    %
    
    
    73.9
    %Underabsorbed overhead
    
    
    0.9
    %
    
    
    10.9
    %
    
    
    4.8
    %
    
    
    10.0
    %Charges for inventory adjustments
    
    
    65.8
    %
    
    
    5.5
    %
    
    
    35.2
    %
    
    
    4.7
    %Cost of product revenue
    
    
    156.0
    %
    
    
    101.0
    %
    
    
    131.8
    %
    
    
    88.6
    %Cost of license and service
revenue
    
    
    1.7
    %
    
    
    
    %
    
    
    3.1
    %
    
    
    
    %Total cost of revenue
    
    
    157.7
    %
    
    
    101.0
    %
    
    
    134.9
    %
    
    
    88.6
    %Benefits to gross margin from
the sale of previously written down
inventory
    
    
    3.3
    %
    
    
    2.1
    %
    
    
    2.1
    %
    
    
    3.3
    %Gross margin
    
    
    (54.4
    )%
    
    
    1.1
    %
    
    
    (32.8
    )%
    
    
    14.7
    %
 Gross margin was negative 54.4% for the second quarter of fiscal 2004
compared to 1.1% for the same period last year. In the second quarter of fiscal
2004, we recorded a $3.9 million charge to product cost of revenue, which
partly consisted of a $2.6 million adjustment to the value of inventory on hand. The
remaining $1.3 million of charges related to non-cancelable commitments for
package substrate materials and wafers on order with our third-party
suppliers, as such contractual commitments were in excess of that
inventorys net realizable value. We became aware of the commitment for package
substrate materials during the third quarter of fiscal 2004.
The charge for inventory on hand has resulted in a decrease in the carrying
value of our inventory, while the charge for inventory on order has resulted in
an increase of our recorded liabilities. The majority of the charge for
inventory on hand and on order was primarily associated with our 1.0 GHz 12
Watt 130 nanometer Efficeon processors, as the cost to manufacture these parts
exceeded the price at which we expect to sell these products. Accordingly, we
have made adjustments to the carrying value of 130 nanometer Efficeon inventory
on hand to write this inventory down to its net realizable value. Gross margin
may benefit from future sales of these parts to the extent that the associated
revenue exceeds their currently adjusted values. Similarly, our gross margins
could be adversely affected if the products are sold at a price lower than our
currently estimated market value. We plan to transition our Efficeon customers
to our next generation 90 nanometer TM8000 products as we expect these products
to contribute more favorably to our financial results. Gross margin was negative 32.8% for the first six months of fiscal 2004
compared to 14.7% for the same period last year. As a percent of total revenue,
our product costs increased 17.9 percentage points, from 73.9% to 91.8%, mostly
as a result of a decrease in average selling prices. In addition to this
decline in average selling prices, we saw an increase in the average dollar
cost of products sold in the first six months of fiscal 2004 compared to the
same period last year, mostly related to sales of our Efficeon TM8000
processor. The initial product cost for our 130 nanometer Efficeon TM8000
processors was significantly higher than the product cost of a more mature
product, as the first quarter of fiscal 2004 was our first full quarter of
producing this product. Gross margin was additionally adversely affected in the
second quarter of fiscal 2004 as a result of the $3.9 million of
inventory-related charges noted above. Gross margin was adversely affected during both periods by unabsorbed
overhead costs as our production-related infrastructure exceeded our needs. For
the second quarter of fiscal 2004, these unabsorbed costs were $0.1 million, or
0.9% of total revenue, compared to $0.6 million, or 10.9% of total revenue, for
the same period in the prior year. For the first six months of fiscal 2004,
these unabsorbed costs were $0.5 million, or 4.8% of total revenue, compared to
$1.1 million, or 10.0% of total revenue, for the same period 17




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in the prior year. We expect to increase the utilization of our
manufacturing overhead in coming periods as the volume of shipments of our
Efficeon TM8000 and Crusoe TM5800 products increase. Of
the $11.3 million and $8.8 million of net inventory on hand at June 30,
2004 and December 31, 2003, respectively, $6.2 million and $2.6 million of
net inventory, respectively, were stated at net realizable value, which was lower
than the respective historical cost. Accordingly, gross margin may be impacted
from future sales of these parts to the extent that the associated revenue
differs from their currently adjusted values. Benefits to gross margin as a
result of products being sold at ASPs in excess of their previously written
down values were $0.2 million and $0.2 million for the three and six months
ended June 30, 2004, respectively, compared to $0.1 million
and $0.4 million
for the same periods last year. Research and Development Research and development (R&D) expenses were $13.7 million and $26.4
million for the three and six months ended June 30, 2004, respectively,
compared to $12.2 million and $24.7 million for the corresponding periods last
year. The increase in R&D expenses for the second quarter of fiscal 2004
compared to the same period last year was due to increases in headcount-related
expenses of $0.8 million, engineering charges of $0.8 million and consultant
expenses of $0.4 million, partially offset by a decrease in depreciation
expenses of $0.3 million. The increase in R&D expenses for the first six months
of fiscal 2004 compared to the same period last year was due to increases in
headcount-related expenses of $1.0 million, engineering charges of $0.8 million
and consultant costs of $0.7 million, partially offset by a decrease in
depreciation expenses of $0.7 million. The increases in these areas of R&D
expense through the first six months of fiscal 2004 were primarily the result
of our increased efforts devoted to the development of the 90 nanometer and 130
nanometer manufacturing technology for our Efficeon TM8000 family of
microprocessors, as well as our LongRun2 power management technologies. The
decreases in depreciation expenses were primarily due to certain property and
equipment being fully depreciated throughout the last fiscal year. In addition
to the resources devoted to our Efficeon TM8000 and LongRun2 Technologies, the
remaining portion of our fiscal 2004 expenditures was used for sustaining
engineering efforts on our TM5800 microprocessors. Selling, General and Administrative Selling, general and administrative (SG&A) expenses were $7.4 million and
$14.1 million for the three and six months ended June 30, 2004, respectively,
compared to $6.3 million and $13.0 million for the corresponding periods last
year. The increase in SG&A expenses for the second quarter of fiscal 2004
compared to the same period last year was due to increases in headcount-related
expenses of $0.5 million and travel and tradeshow expenses of $0.5 million. The
increase in SG&A expenses for the first six months of fiscal 2004 compared to
the same period last year was due to increases in headcount-related expenses of
$1.1 million, travel and tradeshow expenses of $0.5 million and sales and
advertising expenses of $0.3 million, offset by decreases in depreciation
expenses of $0.5 million and legal expenses of $0.4 million. The increases in
these areas of SG&A expense through the first six months of fiscal 2004 were
primarily the result of our continued efforts to hire additional personnel, to
expand our presence in the Asia-Pacific market with new offices and to promote
awareness of our Efficeon TM8000 processor. For the remainder of fiscal 2004,
we may increase our selling costs as we plan to initiate a marketing alliance
program that is specifically designed and structured to promote our customers
products, to drive awareness, foster market opportunities, and help generate
sales. Amortization of Deferred Charges, Patents and Patent Rights Amortization of deferred charges, patents and patent rights were $2.3
million and $4.8 million for the three and six months ended June 30, 2004,
respectively, compared to $2.6 million and $5.3 million for the corresponding
periods last year. Amortization charges relate to various patents and patent
rights acquired from Seiko Epson and others during fiscal 2001. The decreases
can be attributed to a reduction in payments due under our patent and patent
rights and our technology license agreement with IBM, as amended. Amounts due
under the agreements decreased from $30.5 million at June 30, 2003 to $16.0
million at June 30, 2004. Stock Compensation Stock compensation was $0.2 million for the three months ended June 30,
2004 compared to $1.1 million for the same period last year, representing a
decrease of $0.9 million. Stock compensation was $1.6 million for the six
months ended June 30, 2004 compared to $1.5 million for the same period last
year, representing an increase of $0.1 million. The two components of stock
compensation were the amortization of deferred stock compensation and variable
stock compensation. 18




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Net amortization of deferred stock compensation for the second quarter of
fiscal 2004 was $0.3 million, compared to $0.6 million for the same period last
year. For the first six months of fiscal 2004, net amortization was $0.6
million, compared to $1.2 million for the same period last year. The decrease
was primarily a result of amortizing the deferred charge on an accelerated
method in accordance with our accounting policy, as well as a decrease in the
number of outstanding options affecting the compensation charge as a result of
cancellations. The amortization of the remaining $0.1 million of deferred stock
compensation will continue through the end of fiscal 2004. Variable stock compensation is based on the excess, if any, of the current
market price of our stock as of the period-end over the purchase price of the
stock award, adjusted for vesting and prior stock compensation expense
recognized on the stock award. Variable stock compensation for the second
quarter of fiscal 2004 was a credit of $0.1 million, compared to a charge of
$0.5 million for the same period last year. This decrease was the result of
certain notes receivable from stockholders being fully paid toward the end of
fiscal 2003. For the first six months of fiscal 2004, variable stock
compensation was $1.0 million, compared to $0.3 million for the same period
last year. This increase was the result of adjustments made for certain notes
receivable from stockholders that had been fully paid, as well as a higher
market price of our stock as of June 30, 2004, compared to the same period in
the prior year. Interest Income and Other, Net and Interest Expense Interest income and other, net was $0.2 million and $0.5 million for the
three and six months ended June 30, 2004, respectively, compared to $0.3
million and $1.0 million for the corresponding periods last year. The decreases
were due to lower average invested cash balances as we continued to use cash to
fund operations, as well as a decrease in interest rates earned on investments
during the period. Interest expense was $20,000 and $35,000 for the three and
six months ended June 30, 2004, respectively, compared to $123,000 and $247,000
for the corresponding periods last year. The decrease was primarily the result
of lower average debt balances due to several lease-financing arrangements
expiring during 2003, as well as decreases in certain accretion expenses
related to our facilities lease commitments. Liquidity and Capital Resources Cash and Cash Flows We have historically reported negative cash flows from operations as the
gross profit generated, if any, from our product and licensing revenues has not
been sufficient to cover our operating cash requirements. We intend to rely on
funds that we have received from financing activities until we are able to
generate sufficient revenue and gross profit to cover operational expenses as
well as anticipated increases in our working capital requirements. We believe
that the proceeds received from financing activities will be sufficient to fund
our operations, planned capital and R&D expenditures for at least the next
twelve months on our current or modified business model, but we cannot be sure
that those proceeds will be sufficient to fund our operations for this period
because of significant risks and uncertainties as noted below. For the period through June 30, 2005 and over the longer term, our capital
requirements will depend on many factors, including but not limited to general
economic conditions, the rate of sales growth, market acceptance of our
products, costs of securing access to adequate manufacturing capacity, the
timing and extent of research and development projects and increases in our
operating expenses. As we shift our product mix to our new 90 nanometer
Efficeon TM8000 microprocessors, and as we continue to develop new or enhance
existing products or services in line with our business model, we expect that,
as a result of an increased level of operations, we will need to increase our
non-cash working capital, and accordingly, the net cash which we will use in
our operating activities will increase. Our ability to increase sales of our Crusoe TM5800 products into
additional market segments, decrease manufacturing costs for our Crusoe TM5800
and Efficeon TM8000 products, achieve market acceptance of our initial Efficeon
TM8000 microprocessor manufactured using a 130 nanometer process and
successfully transition our Efficeon TM8000 microprocessor to a 90 nanometer
process will be particularly critical in determining our cash needs. All of
these factors are subject to significant risks and uncertainties. To the extent that existing cash and cash equivalents and short-term
investments balances and any cash from operations are insufficient to fund our
activities during the next 12 months, we may need to raise during that time
period additional funds through public or private equity or debt financing.
Additional funds may not be available on terms favorable to us or at all. In
the event that we are unable to raise additional funds, we are positioned to
modify our current business model, for example, to leverage our intellectual
property assets and focus on our strategy of licensing our advanced power
management technologies to other companies and, in doing so, to substantially
limit our operations and reduce costs related to aspects of the business other
than intellectual property and 19




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##### Table of Contents



technology licensing to permit us to continue to operate on a modified
business model for a period that extends at least through June 30, 2005. Although we are currently not a party to any agreement or letter of intent
for a potential acquisition or business combination, we may enter into
acquisitions or business combinations in the future, which also could require
us to seek additional equity or debt financing. If adequate funds were not
available or were not available on acceptable terms, our ability to fund our
operations, take advantage of unanticipated opportunities, develop or enhance
our products or otherwise respond to competitive pressures would be
significantly limited. As of June 30, 2004 we had $84.7 million in cash, cash equivalents and
short-term investments compared to $120.8 million at December 31, 2003. The following comparison table summarizes our usage of cash and cash
equivalents for the six months ended June 30, 2004 and the six months ended
June 30, 2003: Six Months EndedJune 30,
    
    June 30,2004
    
    2003(in thousands)Net cash used in operating activities
    
    $
    (40,626
    )
    
    $
    (31,566
    )Net cash provided by/(used in) investing activities
    
    
    (31,220
    )
    
    
    53,504Net cash provided by financing activities
    
    
    13,994
    
    
    
    1,063Increase/(Decrease) in cash and cash equivalents
    
    $
    (57,852
    )
    
    $
    23,001
 Net cash used in operating activities was $40.6 million for the six months
ended June 30, 2004, compared to $31.6 million for the corresponding period in
fiscal 2003. Net cash used during the first six months of fiscal 2004 was
primarily the result of a net loss of $50.1 million, an increase in inventories
of $2.6 million and an increase in accounts receivable of $1.8 million. The net
loss and changes in operating assets and liabilities were partially offset by
increases in accounts payable and accrued liabilities of $7.2 million, non-cash
charges related to amortization of patents and patent rights of $4.8 million,
depreciation of $1.9 million and stock compensations of $1.6 million.
Subsequent to the end of the second quarter of fiscal 2004, we received $3.0
million as the first installment of fees due to us under our NEC licensing
agreement. We expect to receive the remaining portion of our technology
transfer fees over the next two fiscal quarters. Net cash used in investing activities was $31.2 million for the six months
ended June 30, 2004, compared to net cash provided by investing activities of
$53.5 million for the corresponding period in fiscal 2003. This change was
primarily due to $22.0 million in net purchases of available-for-sale
investments for the first six months of fiscal 2004, compared to net proceeds
of $63.2 million from the maturity of available-for-sale investments for the
same period last year. Additionally, we made scheduled payments for previously
acquired patent and patent rights totaling $7.5 million during the first six
months of fiscal 2004, compared to $9.0 million in the same period last year.
We have a remaining payment of $16.0 million to a development partner that is
due prior to December 31, 2004. Additional cash used in investing activities
included the purchase of property and equipment, which amounted to $1.7 million
and $0.7 million for the first six months in fiscals 2004 and 2003,
respectively. We expect that capital equipment purchases may increase over the
coming year as we invest in our next generation 90 nanometer manufacturing
technology and further develop our LongRun2 power management technologies. Net cash provided by financing activities was $14.0 million for the six
months ended June 30, 2004, compared to $1.1 million for the corresponding
period in fiscal 2003. This increase was primarily the result of our receipt of
$10.2 million when our underwriters exercised their over-allotment option to
purchase an additional 3.75 million shares of our common stock in relation to
our December 2003 common stock offering. We also received $3.1 million in net
proceeds from sales of common stock under our employee stock purchase and stock
option plans for the first six months of fiscal 2004, compared to $1.5 million
for the same period last year. Additionally, we received $0.9 million for the
repayment of notes from our stockholders in the first six months of fiscal
2004. Since our inception, we have financed our operations primarily through
sales of equity securities and, to a lesser extent, from lease financing. It is
reasonably possible that we may continue to seek financing through these
sources of capital as well as other types of financing, including, but not
limited to, debt financing. Additional financing might not be available on
terms favorable to us, or at all. At June 30, 2004, we had $25.9 million in cash and cash equivalents and
$58.8 million in short-term investments. We lease our facilities under
non-cancelable operating leases expiring in 2008, and we lease equipment and
software under non-cancelable leases with terms ranging from 12 to 36 months. 20




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##### Table of Contents



Contractual Obligations At June 30, 2004, we had the following contractual obligations: Payments Due by PeriodLess Than
    
    1-3
    
    AfterContractual Obligations
    
    Total
    
    1 Year
    
    Years
    
    4 Years(In thousands)Capital Lease Obligations
    
    $
    557
    
    
    $
    371
    
    
    $
    186
    
    
    
    Operating Leases(1)
    
    $
    18,338
    
    
    $
    4,440
    
    
    $
    13,898
    
    
    
    Unconditional Purchase Obligations(2)
    
    $
    11,109
    
    
    $
    9,002
    
    
    $
    2,107
    
    
    
    Other Obligation(3)
    
    $
    16,000
    
    
    $
    16,000
    
    
    
    
    
    
    
    Total
    
    $
    46,004
    
    
    $
    29,813
    
    
    $
    16,191
    
    
    $
    
   (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.(3)
    
    Other obligation represents the final payment to our development partner. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions
that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities (SPEs), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of June 30, 2004, we are not involved in SPE
transactions. Risks that Could Affect Future Results The factors discussed below are cautionary statements that identify
important factors that could cause actual results to differ materially from
those anticipated in the forward-looking statements in thisForm 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 $592.7
million, including net losses of $50.1 million for the first six months of
fiscal 2004, $87.6 million in fiscal 2003 and $110.0 million in fiscal 2002,
which have reduced stockholders equity to $96.8 million at June 30, 2004. We
currently expect to continue to incur losses under our current business plan
until at least 2005. We have financed our operations primarily through sales of equity
securities and, to a lesser extent, from product and license revenue and lease
financing. We cannot, however, be sure that funds previously received from
financing activities will be sufficient to fund our operations until we are
able to generate positive cash flows from operations. See Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources. However, our ability to continue to operate
under our current business model until we achieve profitability may be affected
by a variety of factors, which may include our ability to achieve market
acceptance for our Efficeon TM8000 products, significant unexpected technical
or manufacturing problems we may experience in transitioning our Efficeon
TM8000 microprocessor to a 90 nanometer manufacturing process or any
significant problems we may face in selling our TM5800 microprocessors in
additional market segments. All of these factors are subject to significant
risks and uncertainties. Our future operating results will depend significantly on sales of our new
Efficeon TM8000 products. 21




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Our future revenue and gross margins will be influenced in large part by
the level of sales of our new Efficeon TM8000 products. Therefore, our future
operating results will depend on the demand for these products from future
customers. We just began shipment in the fourth quarter of 2003 of our initial
Efficeon TM8000 microprocessor manufactured using a 130 nanometer complementary
metal oxide semiconductor, or CMOS, process. If we experience delays in
manufacturing sufficient quantities of microprocessors, our target customers
could design a competitors microprocessor into their product, which would lead
to lost sales and impede our ability to generate market interest in our new
microprocessor. If these products are not widely accepted by the market due to
performance, price, compatibility or any other reason, significant demand for
our new products may fail to materialize. We are transitioning the manufacturing of our Efficeon TM8000
microprocessors to a 90 nanometer CMOS process. We believe that successfully
completing this transition will be important to our ability to achieve broad
market acceptance of our Efficeon TM8000 microprocessors and to our ability to
compete, particularly in market segments in which performance is a key
competitive factor such as the notebook personal computer and blade server
markets. Further, the announcement of our 90 nanometer Efficeon TM8000
microprocessor may reduce demand for our 130 nanometer Efficeon TM8000
microprocessor below our expectations since customers may delay purchases of
our Efficeon TM8000 microprocessor until the 90 nanometer version of the
product is available. We cannot be sure that we will successfully complete the
development of, and introduce, the Efficeon TM8000 microprocessor manufactured
using the 90 nanometer process. We could encounter a variety of technical and manufacturing problems that could
delay or prevent the successful introduction of Efficeon TM8000 microprocessors
manufactured using a 90 nanometer process. Transitioning our TM8000 microprocessors to a 90 nanometer manufacturing
process involves a variety of technical and manufacturing challenges. We are
using Fujitsu Microelectronics to manufacture our initial 90 nanometer Efficeon
TM8000 microprocessors. We delivered to Fujitsu Microelectronics the tape-out
of our Efficeon TM8000 microprocessors for implementation in its 90 nanometer
foundry in November 2003. We received first silicon for testing in January 2004
and sampled these processors to certain customers in April 2004. Although we
have anticipated that several revisions will need to be made before production,
we cannot be sure that more revisions than anticipated will not be necessary or
that we will not encounter more significant problems than expected. If those
problems prove to be more serious than expected and cannot be remedied on a
timely basis and at a reasonable cost, our stock price would likely be very
substantially reduced. Fujitsu Microelectronics has limited experience with the
90 nanometer CMOS process. We cannot be sure that Fujitsu Microelectronics 90
nanometer foundry will be qualified for production shipments on our planned
schedule. For example, during 2001 we experienced yield problems as we migrated
our products to smaller geometries, which caused increases in our product
costs, delays in product availability and diversion of engineering personnel.
If we encounter problems with the manufacture of the Efficeon TM8000
microprocessors using the 90 nanometer process that are more significant or
take longer to resolve than we anticipate, our ability to increase our revenue
would suffer and we could incur significant expenses. Our Crusoe TM5800 microprocessors are experiencing decreasing demand from
notebook computer manufacturers and are experiencing declining average selling
prices. If we are unable to sell the TM5800 microprocessors into additional
market segments or reduce our costs of production, our operating results will
suffer. As our Crusoe TM5800 microprocessors have matured, demand for the TM5800
microprocessors from notebook computer manufacturers has declined in that
market segment. We have begun to sell the TM5800 microprocessors into
additional market segments such as the thin client, ultra-personal computer, or
UPC, and embedded computer market segments, many of which are only beginning to
be developed. We cannot be sure that we will be successful in selling the
TM5800 microprocessors into these markets or that these markets will experience
significant growth. In addition, the average selling price of the TM5800
microprocessors has decreased, and we expect that pricing pressure on the
TM5800 microprocessors will continue to increase as sales of these
microprocessors increasingly derive from geographies and market segments that
traditionally demand lower average selling prices. If we are unable to achieve
sufficient reductions in our costs of products sold, this decline in prices
will adversely affect our gross margins. The growth of our business depends in part upon the development of emerging
markets and our ability to meet the needs of these markets. The growth of our business depends in part on acceptance and use of our
products in new classes of devices such as tablet PCs, UPCs, high density
servers and new embedded processor applications. We depend on the ability of
our target customers to develop new products and enhance existing products for
these markets that incorporate our products and to introduce and promote their
products successfully. These new markets often rely on newly developed
technologies, which will require extensive development and 22




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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. 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. 23




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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. In 2003, Intel introduced a new microprocessor that is focused on the
notebook computer market segment and designed to consume less power than its
prior microprocessors. We expect that Intel, and potentially other
microprocessor companies, will increasingly seek to offer microprocessors
specifically targeted at many of the same market segments that we intend to
serve, which could adversely affect our ability to compete successfully. Furthermore, our competitors may merge or form strategic relationships
that might enable them to offer, or bring to market earlier, products that are
superior to ours in terms of features, quality, pricing or other factors. We
expect additional competition from other established and emerging companies and
technologies. We may experience manufacturing difficulties that could increase the cost and
reduce the supply of our products. The fabrication of wafers for our microprocessors is a highly complex and
precise process that requires production in a tightly controlled, clean room
environment. Minute impurities, difficulties in the fabrication process,
defects in the masks used to print circuits on a wafer or other factors can
cause numerous die on each wafer to be nonfunctional. The proportion of
functional die expressed as a percentage of total die on a wafer is referred to
as product yield. Semiconductor companies frequently encounter difficulties
in achieving expected product yields, particularly when introducing new
products. Yield problems may not be identified and resolved until a product has
been manufactured and can be analyzed and tested, if ever. As a result, yield
problems are often difficult, time-consuming and expensive to correct. We have
experienced yield problems in the past, and we may experience yield problems in
the future that impair our ability to deliver our products to our customers,
increase our costs, adversely affect our margins and divert the efforts of our
engineering personnel. Difficulties in achieving the desired yields often occur
in the early stages of production of a new product or in the migration of
manufacturing processes to smaller geometries. We could experience difficulties
in achieving desired yields or other manufacturing problems in the production
of our Efficeon TM8000 products that could delay our 24




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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. If we fail to forecast demand for our products accurately, we could lose sales
and incur inventory losses. The demand for our products depends upon many factors and is difficult to
forecast. Many shipments of our products may be made near the end of the fiscal
quarter, which makes it difficult to estimate demand for our products. We
expect that it will become more difficult to forecast demand as we introduce
new products and as competition in the markets for our products intensifies.
Significant unanticipated fluctuations in demand have caused, and in the future
could cause, problems in our operations. The lead-time required to fabricate
large volumes of wafers is often longer than the lead-time our customers
provide to us for delivery of their product requirements. Therefore, we often
must place our orders in advance of expected purchase orders from our
customers. As a result, we have only a limited ability to react to fluctuations
in demand for our products, which could cause us to have either too much or too
little inventory of a particular product. If demand does not develop as we
expect, we could have excess production. Excess production would result in
excess inventories of product, which would use cash and could result in
inventory write-downs and write-offs. We have limited capability to reduce
ongoing production once wafer fabrication has commenced. Further, as we
introduce product enhancements and new products, and improve our manufacturing
processes, demand for our existing products decreases. Conversely, if demand
exceeds our expectations, Taiwan Semiconductor Manufacturing Company, or TSMC,
or Fujitsu Microelectronics might not be able to fabricate wafers as quickly as
we need them. Also, Advanced Semiconductor Engineering, or ASE, might not be
able to increase assembly functions in a timely manner. In that event, we would
need to increase production and assembly rapidly or find, qualify and begin
production and assembly at additional manufacturers or providers of assembly
and test services, which may not be possible within a time frame acceptable to
our customers. The inability of our product manufacturer or ASE to increase
production rapidly enough could cause us to fail to meet customer demand. In
addition, rapid increases in production levels to meet unanticipated demand
could result in higher costs for manufacturing and other expenses. These higher
costs could lower our gross margins. We currently derive a substantial portion of our revenue from a small number of
customers, and our revenue would decline significantly if any major customer
were to cancel, reduce or delay a purchase of our products. Sales to three customers in the aggregate accounted for 76% of total
revenue in the first six months of fiscal 2004. These customers are located in
Asia, which subjects us to economic cycles in that area as well as the
geographic areas in which they sell their products containing our
microprocessors. We expect that a small number of customers and distributors
will continue to account for a significant portion of our revenue. Our future
success will depend upon the timing and size of future purchase orders, if any,
from these customers and new customers and, in particular:  
    
    the success of our customers in marketing products that incorporate our products; 25




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
    
    the product requirements of our customers; and  
    
    the financial and operational success of our customers. We expect that our sales to OEM customers will continue to be made on the
basis of purchase orders rather than long-term commitments. In addition,
customers can delay, modify or cancel orders without penalty. Many of our
customers and potential customers are significantly larger than we are and have
sufficient bargaining power to demand reduced prices and favorable nonstandard
terms. The loss of any major customer, or the delay of significant orders from
these customers, could reduce or delay our recognition of revenue. We have entered into distributor agreements and rely in part on
distributors and stocking representatives for sales of our products in large
territories, including Japan, Taiwan, Hong Kong, Europe, China, Korea and North
America. These agreements do not contain minimum purchase commitments. Additionally, we have entered into agreements with manufacturers
representatives in North America and Europe. Any distributor, stocking
representative or manufacturers representative that fails to emphasize sales
of our products, chooses to emphasize alternative products or devices or to
promote products of our competitors might not sell a significant amount or any
of our products. If our customers are not able to obtain the other components necessary to build
their systems, sales of our products could be delayed or cancelled. Suppliers of other components incorporated into our customers systems may
experience shortages, which could reduce the demand for our products. For
example, from time to time, the computer and semiconductor industries have
experienced shortages of some materials and devices, such as memory components,
displays, and storage devices. Our customers could defer or cancel purchases of
our products if they are not able to obtain the other components necessary to
build their systems. We rely on an independent foundry that has no obligation to provide us with
fixed pricing or production capacity for the fabrication of our wafers, and our
business will suffer if we are unable to obtain sufficient production capacity
on favorable terms. We do not have our own manufacturing facilities and, therefore, must rely
on third parties to manufacture our products. We currently rely on TSMC in
Taiwan to fabricate the wafers for all of our current products and rely on
Fujitsu Microelectronics in Japan to manufacture our initial 90 nanometer
Efficeon TM8000 products. As is common in the industry, we do not have a
manufacturing contract with TSMC that guarantees any particular production
capacity or any particular price, and although we have not yet entered into a
definitive manufacturing agreement with Fujitsu Microelectronics, we cannot be
assured that we will have any guaranteed production capacity with Fujitsu
Microelectronics. The Fujitsu Microelectronics 90 nanometer foundry has
relatively limited capacity and we cannot be sure that sufficient capacity will
be available at that foundry to enable us to manufacture our initial 90
nanometer Efficeon TM8000 products in the quantities that we would desire if
these products were to achieve rapid market acceptance. These foundries may allocate capacity to other companies products while
reducing the capacity available to us on short notice. Foundry customers that
are larger than we and have greater economic resources, that have long-term
agreements with these foundries or that purchase in significantly larger
volumes than we may cause these foundries to reallocate capacity to them,
decreasing the capacity available to us. In addition, these foundries could,
with little or no notice, refuse to continue to fabricate all or some of the
wafers that we require. If these foundries were to stop manufacturing for us,
we would likely be unable to replace the lost capacity in a timely manner.
Transferring to another manufacturer would require a significant amount of time
and money. As a result, we could lose potential sales and fail to meet existing
obligations to our customers. These foundries could also, with little or no
notice, change the terms under which they manufacture for us, which could cause
our manufacturing costs to increase substantially. Our reliance on TSMC and Fujitsu Microelectronics to fabricate our wafers
limits our ability to control the production, supply and delivery of our
products. Our reliance on third-party manufacturers exposes us to a number of risks
outside our control, including the following:  
    
    unpredictability of manufacturing yields and production costs; 26




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
    
    interruptions in shipments;  
    
    inability to control quality of finished products;  
    
    inability to control product delivery schedules;  
    
    potential lack of access to key fabrication process technologies; and  
    
    potentially greater exposure to misappropriation of our intellectual property. We depend on ASE to provide assembly and test services. If ASE were to cease
providing services to us in a timely manner and on acceptable terms, our
business would suffer. We rely on ASE, which is located in Taiwan, for the majority of our
assembly and test services. We do not have a contract with ASE for test and
assembly services, and we typically procure these services from ASE on a per
order basis. ASE could cease to perform all of the services that we require, or
could change the terms upon which it performs services for us. If we were
required to find and qualify alternative assembly or testing services, we could
experience delays in product shipments, increased product costs or a decline in
product quality. In addition, as a result of our reliance on ASE, we do not
directly control our product delivery schedules. If ASE were not to provide
high quality services in a timely manner, our costs could increase, we could
experience delays in the delivery of our products and our product quality could
suffer. 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 27




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against us by our customers or others. In addition, these problems might
divert our technical and other resources from other development efforts.
Moreover, we would likely lose, or experience a delay in, market acceptance of
the affected product or products, and we could lose credibility with our
current and prospective customers. This is particularly significant as we are a
new entrant to a market dominated by large well-established companies. We are subject to general economic and market conditions. Our business is subject to the effects of general economic conditions in
the United States and worldwide and, in particular, market conditions in the
semiconductor and computer industries. In 2001, 2002 and through parts of 2003,
our operating results were adversely affected by unfavorable global economic
conditions and reduced information technology spending, particularly in Japan,
where we currently generate a substantial portion of our revenue. These adverse
conditions resulted in decreased demand for notebook computers and, as a
result, our products, which are components of notebook computers. Further,
demand for our products decreases as computer manufacturers seek to manage
their component and finished product inventory levels. If the economic
conditions in Japan and worldwide do not improve, or worsen, we may continue to
experience material adverse effects on our business, operating results and
financial condition. The cyclical nature of the semiconductor industry could create fluctuations in
our operating results. The semiconductor industry has historically been cyclical and
characterized by wide fluctuations in product supply and demand. From time to
time, the industry has also experienced significant downturns, often in
connection with, or in anticipation of, maturing product cycles and declines in
general economic conditions. Industry downturns have been characterized by
diminished product demand, production overcapacity and accelerated decline in
average selling prices, and in some cases have lasted for more than a year. The
industry experienced a downturn of this type in 1997 and 1998, and began
experiencing a downturn again in 2001. Our revenue has decreased, in part due
to industry-wide downturns, and could decrease further. In addition, we may
determine to lower our prices of our products to increase or maintain market
share, which would likely harm our operating results. If we do not keep pace with technological change, our products may not be
competitive and our revenue and operating results may suffer. The semiconductor industry is characterized by rapid technological change,
frequent new product introductions and enhancements, and ongoing customer
demands for greater performance. In addition, the average selling price of any
particular microprocessor product has historically decreased substantially over
its life, and we expect that trend to continue. As a result, our products may
not be competitive if we fail to introduce new products or product enhancements
that meet evolving customer demands. It may be difficult or costly for us, or
we may not be able, to enhance existing products to fully meet customer
demands. For instance, in order to meet the demands of our customers for
enhancement of our existing products, we may incur manufacturing or other costs
that would harm our operating margins and financial condition. Further, we may
not achieve further design wins with current customers unless we continue to
meet their evolving needs by developing new products. The development of new
products is complex, and we may not be able to complete development in a timely
manner, or at all. To introduce and improve products on a timely basis, we
must:  
    
    accurately define and design new products to meet market needs;  
    
    design features that continue to differentiate our products from those of our competitors;  
    
    transition our products to new manufacturing process technologies;  
    
    identify emerging technological trends in our target markets;  
    
    anticipate changes in end-user preferences with respect to our customers products;  
    
    bring products to market on a timely basis at competitive prices; and  
    
    respond effectively to technological changes or product announcements by others. We believe that we will need to continue to enhance our products and
develop new products to keep pace with competitive and technological
developments and to achieve market acceptance for our products. We may incur
significant research and development, manufacturing or other costs that would
harm our operating margins and financial conditions, in our development
efforts. These 28




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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 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 29




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proprietary rights. Any litigation surrounding our rights could force us
to divert important financial and other resources from our business operations. We might not experience growth in our licensing revenues. Licensing revenue was $0.5 million for the first six months of fiscal year
2004 and $1.1 million for fiscal year 2003. However, we may not recognize
significant licensing revenue in the future. License transactions often have a
long sales cycle and can result in additional liability, such as
indemnification obligations. A portion of the revenue to which we might be
entitled under some of our license transactions depends upon our provision of
future deliverables to licensees. If we do not provide those deliverables in a
timely and satisfactory manner, then we may not receive that portion of the
revenue and we may strain our relationship with the licensee. In addition, the
amount of revenue we recognize under some of our license transactions can
depend significantly upon product sales by the licensees, over which we will
have no control. While we anticipate that we will continue to license our
technology to licensees, we cannot predict the timing or the extent of any
future licensing revenue, and recent levels of license revenues may not be
indicative of future periods. We might not be able to execute on our business plan if we lose key management
or technical personnel, on whose knowledge, leadership and technical expertise
we rely. Our success depends heavily upon the contributions of our key management
and technical personnel, whose knowledge, leadership and technical expertise
would be difficult to replace. Many of these individuals have been with us for
several years and have developed specialized knowledge and skills relating to
our technology and business. For instance, Svend-Olav Carlsen, who had joined
Transmeta in October 2000 and was promoted to be our Chief Financial Officer in
June 2002, resigned in June 2004. Others have joined us in senior management
roles only recently. All of our executive officers and key personnel are
employees at will. We have no employment contracts and do not maintain key
person insurance on any of our personnel. We might not be able to execute on
our business plan if we were to lose the services of any of our key personnel.
If any of these individuals were to leave our company unexpectedly, we could
face substantial difficulty in hiring qualified successors and could experience
a loss in productivity while any such successor develops the necessary training
and experience. We will not be able to grow our business if we are unable to hire, train and
retain sales, marketing, operations, engineering and finance personnel. To grow our business successfully and maintain a high level of quality, we will
need to recruit, train, retain and motivate highly skilled sales, marketing,
operations, engineering and finance personnel. We will need to develop our
sales and marketing organizations in order to increase market awareness of our
products and to increase revenue. In addition, as a company focused on the
development of complex products, we will need to hire skilled engineering staff
of various experience levels in order to meet our product roadmap. We may not
be able to hire on a timely basis a sufficient number of skilled employees,
which could lead to delays in product deliveries or the development of new
products. Competition for skilled employees, particularly in the San Francisco
Bay Area, is intense. We may have difficulty recruiting potential employees and
retaining our key personnel if prospective or current employees perceive the
equity component of our compensation package to be less valuable than that of
other employers. The evolution of our business could place significant strain on our management
systems, infrastructure and other resources, and our business may not succeed
if we fail to manage it effectively. Our ability to implement our business plan in a rapidly evolving market
requires effective planning and management process. Changes in our business
plans could place significant strain on our management systems, infrastructure
and other resources. In addition, we expect that we will continue to improve
our financial and managerial controls and procedures. We will also need to
expand, train and manage our workforce worldwide. Furthermore, we expect that
we will be required to manage an increasing number of relationships with
suppliers, manufacturers, customers and other third parties. If we fail to
manage change effectively, our employee-related costs and employee turnover
could increase and our business may not succeed. We have significant international operations and plan to expand our
international operations, which exposes us to risk and uncertainties. We believe that we must expand our international sales and distribution
operations to be successful. We have sold, and in the future we expect to sell,
most of our products to customers in Asia. In addition, TSMC and ASE are
located in Taiwan, and the Fujitsu Microelectronics foundry we use for our
initial 90 nanometer product is located in Japan. As part of our international
expansion, we 30




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have personnel in Japan, Taiwan, China, Korea and Europe who provide sales
and customer support. We have appointed distributors, stocking representatives
and manufacturers representatives to sell products in Japan, Taiwan, Hong
Kong, Europe, China, Korea and North America. In addition, we generally ship
our products from a third-party warehouse facility located in Hong Kong. In
attempting to conduct and expand business internationally, we are exposed to
various risks that could adversely affect our international operations and,
consequently, our operating results, including:  
    
    difficulties and costs of staffing and managing international operations;  
    
    fluctuations in currency exchange rates;  
    
    unexpected changes in regulatory requirements, including imposition of currency exchange controls;  
    
    longer accounts receivable collection cycles;  
    
    import or export licensing requirements;  
    
    problems in the timeliness or quality of product deliveries;  
    
    potentially adverse tax consequences;  
    
    major health concerns, such as SARS;  
    
    political and economic instability, for example as a result of tensions
between Taiwan and the Peoples Republic of China; and  
    
    potentially reduced protection for intellectual property rights. Our operating results are difficult to predict and fluctuate significantly. A
failure to meet the expectations of securities analysts or investors could
result in a substantial decline in our stock price. Our operating results fluctuate significantly from quarter to quarter, and
we expect that our operating results will fluctuate significantly in the future
as a result of one or more of the risks described in this section or as a
result of numerous other factors. You should not rely on quarter-to-quarter
comparisons of our results of operations as an indication of our future
performance. Our stock price has declined substantially since our stock began
trading publicly. If our future operating results fail to meet or exceed the
expectations of securities analysts or investors, our stock price would likely
decline from current levels. A large portion of our expenses, including rent and salaries, is fixed and
difficult to reduce. Our expenses are based in part on expectations for our
revenue. If our revenue does not meet our expectations, the adverse effect of
the revenue shortfall upon our operating results may be acute in light of the
fixed nature of our expenses. We often make many shipments of our products at
or near the end of the fiscal quarter, which makes it difficult to estimate or
adjust our operating activities quickly in response to a shortfall in expected
revenue. The price of our common stock has been volatile and is subject to wide
fluctuations. The market price of our common stock has been volatile and is likely to
remain subject to wide fluctuations in the future. Many factors could cause the
market price of our common stock to fluctuate, including:  
    
    variations in our quarterly results;  
    
    market conditions in our industry, the industries of our customers and the economy as a whole;  
    
    announcements of technological innovations by us or by our competitors;  
    
    introductions of new products or new pricing policies by us or by our competitors;  
    
    acquisitions or strategic alliances by us or by our competitors; 31




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
    
    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. 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. 32




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Our reported financial results may be adversely affected by changes in
accounting principles generally accepted in the United States. Generally accepted accounting principles in the United States are subject
to interpretation by the Financial Accounting Standards Board (FASB), the
American Institute of Certified Public Accountants, the Securities and Exchange
Commission (SEC) and various bodies formed to promulgate and interpret
appropriate accounting principles. A change in these principles or
interpretations could have a significant effect on our reported financial
results, and could affect the reporting of transactions completed before the
announcement of a change. For example, we currently are not required to record
stock-based compensation charges if an employees stock option exercise price
is equal to or exceeds the deemed fair value of our common stock at the date of
grant. However, several companies have recently elected to change their
accounting policies and begun to record the fair value of stock options as an
expense. Although the standards have not been finalized and the timing of a
final statement has not been established, FASB published in March 2004 an
exposure draft that would require us to record expense for the fair value of
stock options granted. Our reported earnings and/or loss would be harmed if we
were required to change our current accounting policy Changes in securities laws and regulations have increased our costs. The Sarbanes-Oxley Act of 2002 has required and will require changes in
some of our corporate governance, public disclosure and compliance practices.
The Act also requires the SEC to promulgate new rules on a variety of subjects.
In addition to final rules and rule proposals already made by the SEC, the
National Association of Securities Dealers has adopted revisions to its
requirements for companies, such as us, that are listed on the Nasdaq National
Market. These developments have increased our legal and financial compliance
costs and have made some activities, such as SEC reporting requirements, more
difficult. Additionally, we expect these developments to make it more difficult
and more expensive for us to obtain director and officer liability insurance,
and we may be required to accept reduced coverage or incur substantially higher
costs to obtain coverage. These developments could make it more difficult for
us to attract qualified executive officers and attract and retain qualified
members of our board of directors, particularly to serve on our audit
committee. We are presently evaluating and monitoring regulatory developments
and cannot estimate the timing or magnitude of additional costs we may incur as
a result. 
 Item 4.Controls and Procedures We maintain a set of disclosure controls and procedures designed to ensure
that information required to be disclosed by us in the reports filed under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified by the rules and forms of the Securities and
Exchange Commission. Disclosure controls and procedures are also designed with
the objective of ensuring that this information is accumulated and communicated
to our management, including our chief executive officer and chief financial
officer, as appropriate to allow timely decisions regarding required
disclosure. Prior to the initial filing of our quarterly report on Form 10-Q for the
quarterly period ended June 30, 2004 (the Initially Filed Form 10-Q), our
management evaluated, with the participation of our chief executive officer and
our chief financial officer, the effectiveness of our disclosure controls and
procedures as of June 30, 2004, the end of the period covered by that report,
and, based on that evaluation, our chief executive officer and chief financial
officer had concluded, as of the end of the period covered by that report, that
our disclosure controls and procedures were effective for this purpose. In the course of preparing our financial statements for the third quarter
of fiscal 2004, material weaknesses, as defined in Public Company Accounting
Oversight Board, or PCAOB, Standard No. 2, were identified in our internal
control over financial reporting. As used by the PCAOB, a material weakness is
a significant deficiency, or a combination of significant deficiencies, that
results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or detected.
Specifically, material weaknesses were identified with respect to our financial
statement close process and our contract administration. The material weakness with respect to our financial statement close process
affected our inventory for the second and third quarters of fiscal 2004 and our
accrued restructuring costs for the third quarter of fiscal 2004. In respect
of our financial statements for the second quarter of fiscal 2004, we did not
properly record an inventory charge because we had not identified our
contractual obligation to purchase materials from a third-party supplier. We
identified that contractual obligation after we filed the Initially Filed Form
10-Q, and a charge for those materials in excess of our anticipated needs as of
June 30, 2004 is now reflected in our amended financial statements included in
this Amendment No. 1. In respect of our financial statements for the third
quarter of fiscal 2004, we initially made inappropriate and inconsistent
assumptions with respect to certain inventory valuations and accrued restructuring
costs and initially misapplied accounting principles with respect to the impairment
of certain manufacturing related equipment. Management and Ernst & 33




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Young LLP, our independent auditors, identified these inaccuracies, and
the correct charges will be reflected in the financial statements included in
the quarterly report for the third quarter of fiscal 2004. The material weakness with respect to our contract administration contributed
to our failure to identify our contractual obligation to purchase materials
from a third-party supplier described above. We also recently experienced transitions in the oversight of our finance
and accounting personnel. In June 2004, Svend-Olav Carlsen, who had served as
our chief financial officer since June 2002, resigned. In September 2004, we
hired Mark R. Kent as our new chief financial officer. During a portion of the
interim period, our general counsel served as our chief financial officer. Since the filing of the Initially Filed Form 10-Q, our management
has further evaluated, with the participation of our chief executive officer
and our chief financial officer, the effectiveness of our disclosure controls
and procedures as of June 30, 2004, the end of the period covered by this
amended report. In light of these matters, as a consequence of the material
weaknesses described above that existed at June 30, 2004, our chief executive
officer and chief financial officer now conclude that our disclosure controls
and procedures were not effective as of June 30, 2004. Our management and audit committee have assigned a high priority to the
short-term and long-term improvement of our internal control over financial
reporting. Specific initiatives with respect to our disclosure controls and
procedures and actions to address the material weaknesses described above that
we have undertaken through the end of the fiscal year ended December 31, 2004
include the revision and implementation of our policies regarding:  
    
    who at the company is authorized to sign contracts;
    
    confirmation that only authorized company employees have signed contracts;
    
    provision of appropriate signed contracts to our finance group; and
    
    determination of our assumptions used to calculate inventory
valuation by
the finance group integrating in a more comprehensive manner the sales
and inventory forecasting processes. Our management and audit committee intend to closely monitor the
implementation of our remediation plan. Although we have undertaken the
foregoing initiatives, the existence of a material weakness is an indication
that there is more than a remote likelihood that a material misstatement of our
financial statements will not be prevented or detected in a future period. In
addition, we cannot assure you that we will not in the future identify further
material weaknesses or significant deficiencies in our internal control over
financial reporting that we have not discovered to date. We are taking steps to
address the material weaknesses that have been identified and to refine our
internal controls and procedures to meet the internal control reporting
requirements of Section 404 of the Sarbanes-Oxley Act and the rules adopted
thereunder. The effectiveness of the steps we have taken to date and the steps
we are still in the process of completing is subject to continued management
review, as well as audit committee oversight, and we may make additional
changes to our internal control over financial reporting. Other
than the applicable foregoing initiatives, during the second quarter of fiscal 2004, 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. 34




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PART II. OTHER INFORMATION 
 Item 6.Exhibits and Reports on Form 8-K (a) Exhibits. The following exhibits are filed herewith: Exhibit Number
    
    Exhibit Title31.01
    
    Certification by Matthew R. Perry 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 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 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/A and are not deemed filed with the
Securities and Exchange Commission and are not incorporated by reference in any
filing of Transmeta Corporation under the Securities Act of 1933 or the
Securities Exchange Act of 1934, including this quarterly report, whether made
before or after the date hereof and irrespective of any general incorporation
language in any filings. (b) Reports on Form 8-K On April 15, 2004, we filed a current report on Form 8-K respecting a
press release we issued announcing earnings for the quarter ended March 26,
2004. The information furnished under that Form 8-K was intended to be
furnished and not deemed filed with the Securities and Exchange Commission, and
is not incorporated by reference in any filing of Transmeta Corporation under
the Securities Act of 1933 or the Securities Exchange Act of 1934, including
this quarterly report, whether made before or after the date of the Form 8-K
and irrespective of any general incorporation language in any filings. On May 18, 2004, we filed a current report on Form 8-K under item 5
announcing that Svend-Olav Carlsen planned to resign as the companys chief
financial officer in June 2004. 35




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. TRANSMETA CORPORATIONBy:
    
    /s/ MARK R. KENTMark R. KentChief Financial Officer(Principal Financial Officer andDuly Authorized Officer)
 Date: November 8, 2004 36




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EXHIBIT INDEX Exhibit Number
    
    Exhibit Title31.01
    
    Certification by Matthew R. Perry 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 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 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/A 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. 37