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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549
 FORM 10-Q (Mark One)x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934For the Quarterly Period Ended March 31, 2004ORo
    
    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 173,978,629 shares of the Companys common stock, par value
$0.00001 per share, outstanding on April 23, 2004.




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TRANSMETA CORPORATION FORM 10-Q
Quarterly Period Ended March 31, 2004 TABLE OF CONTENTS PagePART I.  FINANCIAL INFORMATIONItem 1.
    
    Unaudited Condensed Consolidated Financial Statements
    
    
    
    3Unaudited Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003
    
    
    
    3Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and March 31, 2003
    
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and March 31, 2003
    
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    
    6Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    
    27Item 4.
    
    Controls and Procedures
    
    
    
    28PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    
    28Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    
    28Item 3.
    
    Defaults Upon Senior Securities
    
    
    
    29Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    
    29Item 5.
    
    Other Information
    
    
    
    29Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    
    29Signatures
    
    
    
    30EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01EXHIBIT 32.02
  2




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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) March 31,
    
    December 31,2004
    
    2003(1)(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    54,133
    
    
    $
    83,765Short-term investments
    
    
    58,900
    
    
    
    37,000Accounts receivable, net
    
    
    3,145
    
    
    
    1,719Inventories
    
    
    7,757
    
    
    
    8,796Prepaid expenses and other current assets
    
    
    4,671
    
    
    
    3,671Total current assets
    
    
    128,606
    
    
    
    134,951Property and equipment, net
    
    
    5,042
    
    
    
    5,305Patents and patent rights, net
    
    
    28,060
    
    
    
    29,771Other assets
    
    
    1,766
    
    
    
    1,563Total assets
    
    $
    163,474
    
    
    $
    171,590LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,460
    
    
    $
    1,900Accrued compensation and related compensation liabilities
    
    
    4,238
    
    
    
    4,986Other accrued liabilities
    
    
    4,991
    
    
    
    5,360Current portion of accrued restructuring charges
    
    
    1,845
    
    
    
    1,916Current portion of long-term payables
    
    
    21,821
    
    
    
    21,129Current portion of long-term debt and capital lease obligations
    
    
    341
    
    
    
    370Total current liabilities
    
    
    36,696
    
    
    
    35,661Long-term accrued restructuring costs, net of current portion
    
    
    3,818
    
    
    
    4,155Long-term debt and capital lease obligations, net of current portion
    
    
    269
    
    
    
    356Commitments and contingencies
Stockholders 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 -
173,615,836 at March 31, 2004 and 167,528,493 at December 31, 2003
    
    
    691,528
    
    
    
    677,093Treasury stock
    
    
    (2,439
    )
    
    
    (2,439
    )Deferred stock compensation
    
    
    (488
    )
    
    
    (696
    )Accumulated other comprehensive income
    
    
    27
    
    
    
    24Accumulated deficit
    
    
    (565,937
    )
    
    
    (542,564
    )Total stockholders equity
    
    
    122,691
    
    
    
    131,418Total liabilities and stockholders equity
    
    $
    163,474
    
    
    $
    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) 3




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TRANSMETA CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited) Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Revenue:Product
    
    $
    5,007
    
    
    $
    5,943License
    
    
    195
    
    
    
    74Total revenue
    
    
    5,202
    
    
    
    6,017Cost of revenue:Product
    
    
    5,372
    
    
    
    4,452License
    
    
    242
    
    
    
    Total cost of revenue
    
    
    5,614
    
    
    
    4,452Gross profit (loss)
    
    
    (412
    )
    
    
    1,565Operating expenses:Research and development(1)(2)
    
    
    12,717
    
    
    
    12,479Selling, general and administrative(3)(4)
    
    
    6,721
    
    
    
    6,634Amortization of deferred charges, patents and patent rights
    
    
    2,404
    
    
    
    2,640Stock compensation
    
    
    1,350
    
    
    
    436Total operating expenses
    
    
    23,192
    
    
    
    22,189Operating loss
    
    
    (23,604
    )
    
    
    (20,624
    )Interest income and other, net
    
    
    246
    
    
    
    707Interest expense
    
    
    (15
    )
    
    
    (124
    )Net loss
    
    $
    (23,373
    )
    
    $
    (20,041
    )Net loss per share  basic and diluted
    
    $
    (0.14
    )
    
    $
    (0.15
    )Weighted average shares outstanding  basic and diluted
    
    
    171,869
    
    
    
    137,551
   (1)
    
    Excludes $127 and $418 in amortization of deferred stock compensation for
the three months ended March 31, 2004 and 2003, respectively.(2)
    
    Excludes $471 and $(24) in variable stock compensation for the three
months ended March 31, 2004 and 2003, respectively.(3)
    
    Excludes $79 and $237 in amortization of deferred stock compensation for
the three months ended March 31, 2004 and 2003, respectively.(4)
    
    Excludes $673 and $(195) in variable stock compensation for the three
months ended March 31, 2004 and 2003, respectively. (See accompanying notes) 4




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TRANSMETA CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited) Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Cash flows from operating activities:Net loss
    
    $
    (23,373
    )
    
    $
    (20,041
    )Adjustments to reconcile net loss to net cash used in operating activities:Stock compensation
    
    
    1,350
    
    
    
    436Depreciation
    
    
    958
    
    
    
    1,540Amortization of other assets
    
    
    
    
    
    
    88Amortization of deferred charges, patents and patent rights
    
    
    2,404
    
    
    
    2,640Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,426
    )
    
    
    1,418Inventories
    
    
    1,039
    
    
    
    970Prepaid expenses and other current assets
    
    
    (1,204
    )
    
    
    (1,079
    )Accounts payable and accrued liabilities
    
    
    35
    
    
    
    (2,638
    )Net cash used in operating activities
    
    
    (20,217
    )
    
    
    (16,666
    )Cash flows from investing activities:Purchase of available-for-sale investments
    
    
    (45,754
    )
    
    
    (47,507
    )Proceeds from sale or maturity of available-for-sale investments
    
    
    23,857
    
    
    
    108,698Purchase of property and equipment
    
    
    (695
    )
    
    
    (528
    )Payment of patent and patent rights
    
    
    
    
    
    
    (1,500
    )Other assets
    
    
    
    
    
    
    (59
    )Net cash provided by / (used in) investing activities
    
    
    (22,592
    )
    
    
    59,104Cash 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
    
    
    2,253
    
    
    
    1,341Repayment of notes from stockholders
    
    
    817
    
    
    
    Repayment of debt and capital lease obligations
    
    
    (116
    )
    
    
    (159
    )Net cash provided by financing activities
    
    
    13,177
    
    
    
    1,182Change in cash and cash equivalents
    
    
    (29,632
    )
    
    
    43,620Cash and cash equivalents at beginning of period
    
    
    83,765
    
    
    
    16,613Cash and cash equivalents at end of period
    
    $
    54,133
    
    
    $
    60,233
 (See accompanying notes) 5




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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 ended March 31, 2004 are not necessarily
indicative of the operating results for the full fiscal year or any future
period. 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 March 26, 2004 and March 28,
2003 each consisted of 13 weeks. 2. Net Loss per Share Basic and diluted net loss per share is presented in conformity with the
Financial Accounting Standards Boards (FASB) Statement of Financial Accounting
Standards (SFAS) No. 128, Earnings Per Share, for all periods presented.
Basic and diluted net loss per share has been computed using the
weighted-average number of shares of common stock outstanding during each
period, less weighted-average shares subject to repurchase. The following table presents the computation of basic and diluted net loss
per share: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003(in thousands, exceptper share amounts)Basic and diluted:Net loss
    
    $
    (23,373
    )
    
    $
    (20,041
    )Basic and diluted:Weighted average shares outstanding
    
    
    171,869
    
    
    
    137,572Less: Weighted average shares subject to
repurchase
    
    
    
    
    
    
    (21
    )Weighted average shares used in
computing basic and diluted net loss per
share
    
    
    171,869
    
    
    
    137,551Net loss per share  basic and diluted
    
    $
    (0.14
    )
    
    $
    (0.15
    )
 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 32,912,286 and 32,920,990 shares of common stock at
March 31, 2004 and 2003, respectively, determined using the treasury stock
method, were not 6




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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 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. The Company accounts for its stock options and equity awards in accordance
with the provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations and has elected to
follow the disclosure only alternative prescribed by SFAS 123. Expense
associated with stock-based compensation is amortized on an accelerated basis
over the vesting period of the individual award consistent with the method
described in FASB Interpretation 28, Accounting for Stock Appreciation Rights
and Other Variable Stock Option or Award Plan. Accordingly, approximately 59%
of the unearned deferred compensation is amortized in the first year, 25% in
the second year, 12% in the third year, and 4% in the fourth year following the
date of grant. Pursuant to SFAS 123, Transmeta discloses the pro forma effect
of using the fair value method of accounting for its stock-based compensation
arrangements. For purposes of pro forma disclosures, the estimated fair value of options
is amortized to pro forma expense over the options vesting period using an
accelerated graded method. Pro forma information follows: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net loss, as reported
    
    $
    (23,373
    )
    
    $
    (20,041
    )Add: Stock-based employee compensation expense
included in reported net loss, net of related tax
effects
    
    
    1,350
    
    
    
    436Less: Total stock-based employee compensation
expense under fair value based method for all
awards, net of related tax effects
    
    
    (10,917
    )
    
    
    (10,190
    )Pro forma net loss
    
    $
    (32,940
    )
    
    $
    (29,795
    )Basic and diluted net loss per share  as reported
    
    $
    (0.14
    )
    
    $
    (0.15
    )Basic and diluted net loss per share  pro forma
    
    $
    (0.19
    )
    
    $
    (0.22
    )
 The fair value for the Companys stock-based awards is estimated at the
date of grant using a Black-Scholes option-pricing model. The Black-Scholes
option-pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In
addition, the Black-Scholes option-pricing model requires the input of highly
subjective assumptions, including expected stock price volatility. Because the
Companys stock-based awards have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in managements opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its stock-based awards. The fair value of options granted was
determined based on estimated stock price volatility. The weighted average
assumptions used to determine fair value were as follows: Options
    
    ESPPThree Months Ended
    
    Three Months EndedMarch 31,
    
    March 31,2004
    
    2003
    
    2004
    
    2003Expected volatility
    
    
    0.79
    
    
    
    0.75
    
    
    
    1.01
    
    
    
    1.03Expected life in years
    
    
    4.0
    
    
    
    4.0
    
    
    
    0.5
    
    
    
    0.5Risk-free interest rate
    
    
    2.7
    %
    
    
    2.6
    %
    
    
    1.1
    %
    
    
    1.4
    %Expected dividend yield
    
    
    0
    
    
    
    0
    
    
    
    0
    
    
    
    0
 7




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4. Net Comprehensive Loss Net comprehensive loss includes the Companys net loss, as well as
accumulated other comprehensive income/(loss) on available-for-sale investments
and foreign currency translation adjustments. Net comprehensive loss for the
three-month periods ended March 31, 2004 and 2003, respectively, is as follows
(in thousands): Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net loss
    
    $
    (23,373
    )
    
    $
    (20,041
    )Net change in unrealized loss on investments
    
    
    (2
    )
    
    
    (96
    )Net change in foreign currency translation adjustments
    
    
    5
    
    
    
    Net comprehensive loss
    
    $
    (23,370
    )
    
    $
    (20,137
    )
 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): March 31,
    
    December 31,2004
    
    2003Work in progress
    
    $
    5,743
    
    
    $
    6,136Finished goods
    
    
    2,014
    
    
    
    2,660$
    7,757
    
    
    $
    8,796
 Of the $7.8 million and $8.8 million of inventory on hand at March 31,
2004 and December 31, 2003, respectively, $4.2 million and $2.6 million of
inventory, respectively, were stated at net realizable value. Accordingly,
gross margin may benefit from future sales of these parts to the extent that
the associated revenue exceeds their currently adjusted values. During the
first quarters of fiscals 2004 and 2003, previously written down products were
sold at or near their previously estimated values. 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. On July 18, 2002 and in connection with Transmetas decision to cease the
development and productization of the TM6000 microprocessor, the Company
terminated approximately 195 employees and contractors. As a result, the
Company recorded severance and termination charges of $4.1 million in the third
quarter of fiscal 2002, which excludes a credit of $1.7 million to deferred
compensation expense related to stock option cancellations for terminated
employees. Additionally, the Company paid approximately $531,000 for previously
accrued compensation in the third quarter of fiscal 2002 in connection with the
employee terminations. Of the approximately 195 employees and contractors that
were terminated on July 18, 2002, approximately 44 were sales, marketing, and
administrative employees and approximately 151 were research and development
personnel. The Companys workforce reduction was completed in the third quarter
of fiscal 2002. Additionally, the Company vacated all excess facilities as of
September 30, 2002. During the fourth quarter of fiscal 2003, Transmeta reassessed the
adequacy of the remaining accrual and adjusted the restructuring reserve
balance as a result of an update in certain underlying assumptions. The Company
determined that it will use portions of previously vacated space primarily to
expand research and development activities. Also, the Company was able to
sublease other previously vacated space earlier than anticipated and at a lower
rate than originally estimated.. No adjustments in the accrued restructuring
charges were made for the quarter ended March 31, 2004. Accrued restructuring charges consist of the following at March 31, 2004
(in thousands): 8




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Provision
    
    
    
    
    
    
    
    
    
    
    
    
    
    ProvisionBalance at
    
    Drawdowns
    
    Balance atDecember 31,
    
    
    
    
    
    
    
    
    
    
    
    
    
    March 31,2003
    
    Cash
    
    Non-Cash
    
    2004Building leasehold costs
    
    $
    6,071
    
    
    $
    408
    
    
    $
    
    
    
    
    
    
    
    $
    5,663
 7. Legal Proceedings The Company is a party in one consolidated lawsuit. Beginning in June 2001, the Company, certain of its directors and
officers, and certain of the underwriters for its initial public offering were
named as defendants in three putative shareholder class actions that were
consolidated in and by the United States District Court for the Southern
District of New York in In re Transmeta Corporation Initial Public Offering
Securities Litigation, Case No. 01 CV 6492. The complaints allege that the
prospectus issued in connection with the Companys initial public offering on
November 7, 2000 failed to disclose certain alleged actions by the underwriters
for that offering, and alleges claims against the Company and several of its
officers and directors under Sections 11 and 15 of the Securities Act of 1933,
as amended, and under Sections 10(b) and Section 20(a) of the Securities
Exchange Act of 1934, as amended. Similar actions have been filed against more
than 300 other companies that issued stock in connection with other initial
public offerings during 1999-2000. Those cases have been coordinated for
pretrial purposes as In re Initial Public Offering Securities Litigation,
Master File No. 21 MC 92 (SAS). In July 2002, the Company joined in a
coordinated motion to dismiss filed on behalf of multiple issuers and other
defendants. In February 2003, the Court granted in part and denied in part the
coordinated motion to dismiss, and issued an order regarding the pleading of
amended complaints. Plaintiffs subsequently proposed a settlement offer to all
issuer defendants, which settlement would provide for payments by issuers
insurance carriers if plaintiffs fail to recover a certain amount from
underwriter defendants. Although the Company and the individual defendants
believe that the complaints are without merit and deny any liability, but
because they also wish to avoid the continuing waste of management time and
expense of litigation, they accepted plaintiffs proposal to settle all claims
that might have been brought in this action. The Company and the individual
Transmeta defendants expect that their share of the global settlement will be
fully funded by their director and officer liability insurance. Although the
Company and the Transmeta defendants have approved the settlement in principle,
it remains subject to several procedural conditions, as well as formal approval
by the Court. It is possible that the parties may not reach a final written
settlement agreement or that the Court may decline to approve the settlement in
whole or part. In the event that the parties do not reach agreement on the
final settlement, the Company and the Transmeta defendants believe that they
have meritorious defenses and intend to defend any remaining action vigorously. 
 Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations Caution Regarding Forward-Looking Statements The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and the related notes contained
in this report and with the information included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2003 and subsequent reports filed
with the Securities and Exchange Commission (SEC). The information contained in
this report is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this report and in
our other reports filed regularly with the SEC, some of which reports discuss
our business in greater detail. This report contains forward-looking statements that are based upon our
current expectations, estimates and projections about our industry, and that
reflect our beliefs and certain assumptions based upon information made
available to us at the time of this report. Words such as anticipates,
expects, intends, plans, believes, seeks, estimates, may,
could, will and variations of these words or similar expressions are
intended to identify forward-looking statements. Such statements include, but
are not limited to, statements concerning anticipated trends or developments in
our business and the markets in which we operate, the competitive nature and
anticipated growth of those markets, our expectations for our future
performance and the market acceptance of our products, our 9




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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
in January 2000, the Crusoe series, we have derived the majority of our revenue
from the sale of these products. In October 2003, we introduced the Efficeon
TM8000 family of microprocessors, which is our next family of x86-compatible
processors. In fiscal 2003, and through the first quarter of fiscal 2004, we
recognized a limited amount of revenue from technology and trademark license
agreements. During the first quarter of fiscal 2004, we entered into a
licensing agreement with NEC Electronics, or NEC, wherein they licensed our
LongRun2 technologies for power management and transistor leakage
control. The
agreement with NEC includes deliverable-based license fees as well as subsequent
royalties payable to us once NEC begins production of products incorporating
our technologies, which NEC currently expects to begin in late 2005. We will
continue to explore additional opportunities for licensing our advanced power
management technologies to other companies in the integrated circuit industry. Our total revenue for the first three months of fiscal 2004 was $5.2
million, compared to $6.0 million for the corresponding period in fiscal 2003.
This change in revenue is primarily due to a decrease in unit volume shipped and
a decrease in Crusoe TM5800 average selling prices, or ASPs, as a result of
these products nearly reaching the end of their cycle in the notebook computing
segment and as we transition the product into segments such as the embedded and
thin client markets, which traditionally have lower ASPs. We had total
operating expenses of $23.2 million and $22.2 million for the first three
months in fiscal 2004 and fiscal 2003, respectively. Net loss for the first
three months of fiscal 2004 was $23.4 million, while net loss for the same
period last year was $20.0 million. Historically we have incurred significant
losses, and as of March 31, 2004, we had an accumulated deficit of $565.9
million. The majority of our sales have been to a limited number of customers.
Additionally, we derive a significant portion of our revenue 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 first three
months of fiscals 2004 and 2003: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Customer A
    
    
    55
    %
    
    
    *
    %Customer B
    
    
    15
    %
    
    
    19
    %Customer C
    
    
    13
    %
    
    
    *
    %Customer D
    
    
    *
    %
    
    
    31
    %Customer E
    
    
    *
    %
    
    
    23
    %
   *
    
    represents less than 10% of total revenue Three of our
customers accounted for 89% of our accounts receivable balance as of March 31,
2004. This compares to three of our customers representing 92% of our accounts
receivable at December 31, 2003. Pricing pressure on our TM5800 product has increased and may continue to
increase as the product has matured and transitions into geographies and market
segments, such as the embedded and thin client markets, that traditionally
demand lower average selling prices. However, we expect overall gross margins
to increase in the long term as we shift our product mix to the new Efficeon
TM8000 processor, which is targeted at the high-volume notebook market, for
which we receive higher ASPs than those of the TM5800. Additionally,
our goal is to improve gross margins once we are able to satisfactorily decrease
manufacturing costs of our new Efficeon TM8000 processors, which generally
occurs after the product starts to mature. 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 achieve broad market acceptance of our Efficeon TM8000
microprocessors and to compete in the microprocessor market. In early April,
we began sampling these processors and now expect to begin limited production
in mid 2004. In relation to our December 2003 common stock offering, the underwriters
exercised their over-allotment option to purchase an additional 3.75 million
shares of our common stock in January of 2004, resulting in net proceeds to us,
before expenses, of $10.2 million. We have historically reported negative cash
flows from operations, and we intend to rely on funds that we have received
from financing activities until we are able to generate sufficient revenue and
related gross profit to cover operational expenses as well as anticipated
increases in our working capital other than cash. Our ability to increase sales
of our Crusoe TM5800 products into 10




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additional market segments, 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. 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 March 31, 2004 and
2003 each consisted of 13 weeks and ended on March 26 and 28, respectively. Critical Accounting Policies The process of preparing financial statements requires the use of
estimates on the part of our management. The estimates used by management are
based on our historical experiences combined with managements understanding of
current facts and circumstances. Certain of our accounting policies are
considered critical as they are both important to the portrayal of our
financial condition and results and require significant or complex judgment on
the part of management. For a description of what we believe to be our most
critical accounting policies and estimates, refer to our Annual Report on Form
10-K for the year ended December 31, 2003 filed with the Securities and
Exchange Commission on March 9, 2004. There have been no changes in any of our
critical accounting policies since December 31, 2003. Results of Operations Total Revenue 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,
tablet PCs, and ultra-personal computers, or UPCs. Total revenue, which
includes product and license revenue, for each computing market segment, is
presented as a percentage of total revenue in the following table: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Product:Thin client desktop
    
    
    55
    %
    
    
    4
    %Notebook computers
    
    
    28
    %
    
    
    48
    %Tablet PCs
    
    
    9
    %
    
    
    36
    %Embedded/servers
    
    
    4
    %
    
    
    9
    %UPCs
    
    
    
    
    
    
    2
    %License:
    
    
    4
    %
    
    
    1
    %
 During the first quarter of fiscal 2004, ended March 31, 2004, we
recognized $0.2 million of revenue 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 March 31, 2004, we have not recognized
any revenue from the licensing agreement with NEC. 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. Total revenue for the comparative periods is summarized in the following table: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003(in thousands)Product
    
    $
    5,007
    
    
    $
    5,943License
    
    
    195
    
    
    
    74Total revenue
    
    $
    5,202
    
    
    $
    6,017
 11




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Total revenue was $5.2 million for the first quarter of fiscal 2004,
compared to $6.0 million for the same period last year. The decrease in revenue
is attributed to a 12% decrease in net product shipped during the most recent
quarter, as well as a 4% decrease in ASPs. While the ASPs of our Crusoe
processors in the most recent quarter have decreased compared to the same
period last year, the higher ASPs of our recently introduced Efficeon
processors have partly offset this decrease. Pricing pressure on the TM5800 has increased and may continue to increase
as the product has matured and transitions into geographies and market segments
that traditionally demand lower ASPs. We will continue to manufacture the
TM5800 as we have migrated the processor 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
product is targeted at the high-volume notebook and other markets with
requirements for low power and low heat generation characteristics,
such as the UPC and the tablet PC markets,
which traditionally demand higher ASPs and with which our goal is to generate
improved gross margin. We started shipping the Efficeon product in the fourth
quarter of fiscal 2003. Revenue recognized from sales of this product
represented less than 20% of total revenue for the first quarter of fiscal
2004. Gross Margin Our gross margin is comprised of the components displayed in the following
table, shown as a percentage of total revenue: Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Revenue:Product
    
    
    96.3
    %
    
    
    98.8
    %License
    
    
    3.7
    %
    
    
    1.2
    %Total revenue
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenue:Product Cost
    
    
    93.9
    %
    
    
    64.8
    %Underabsorbed overhead
    
    
    9.3
    %
    
    
    9.2
    %Cost of product revenue
    
    
    103.2
    %
    
    
    74.0
    %Cost of license revenue
    
    
    4.7
    %
    
    
    
    %Total cost of revenue
    
    
    107.9
    %
    
    
    74.0
    %Gross margin
    
    
    (7.9
    )%
    
    
    26.0
    %
 Gross margin was negative 7.9% for the first quarter of fiscal 2004
compared to 26.0% for the same period last year, representing a decrease of
33.9 percentage points. As a percent of total revenue, our product costs
increased 29.1 percentage points, from 64.8% to 93.9%, mostly as a result of a
decrease in average selling prices, which is used as a component of the
denominator in this calculation. In addition to this decline in average selling
prices, mostly contributed by our Crusoe line of products, we saw an increase
in the average dollar cost of products sold in the first quarter 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 Efficeon TM8000 processors
was significantly higher than product sold in the same period last year as the
first quarter of fiscal 2004 was our first full quarter of producing this
product, and accordingly, our product cost was higher than what we would expect
for a mature product. Our product cost for the first quarter of fiscal 2004 included a charge of
$0.3 million related to certain prepaid manufacturing charges for which we do
not expect to receive a future economic benefit. This charge was partly offset
by a credit of $0.1 million related to a previously unanticipated refund for
manufacturing tools that had already been expensed in previous periods as part
of cost of product revenue. The net effect of these two items represents 3.7%
of our gross margin for the first quarter of fiscal 2004. Gross margin was adversely affected during both periods by unabsorbed
overhead costs as our production-related infrastructure exceeded our needs. For
the first quarter of fiscal 2004, these unabsorbed costs were $0.5 million, or
9.3% of total revenue, compared to $0.6 million, or 9.2% of total revenue, for
the same period in the prior year. We expect to increase the utilization of our
manufacturing overhead in coming periods as we shift our product mix to the
Efficeon TM8000, and as the volume of shipments of our Crusoe TM5800 product
increases. Of the $7.8 million and $8.8 million of inventory on hand at March 31,
2004 and December 31, 2003, respectively, $4.2 million and $2.6 million of
inventory, respectively, were stated at net realizable value, which was lower
than the respective historical cost. Accordingly, gross margin may be impacted
from future sales of these parts to the extent that the associated revenue
differs from their 12




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currently adjusted values. During the first quarters of fiscals 2004 and
2003, previously written down products were sold at or near their previously
estimated values. We
recorded license and service revenues of $0.2 million in the first quarter of
fiscal 2004, for which we recorded a gross loss of $47,000. As a result of
certain events that occurred in the first quarter of fiscal 2004, we recognized
$134,000 in expenses that had been deferred from previous periods, which
contributed to the loss. We currently do not expect to have negative margins
from license and service revenues in the future. Research and Development Research and development was $12.7 million for the first quarter of fiscal
2004 compared to $12.5 million for the same period last year, representing an
increase of $0.2 million, or 1.6%. The change in research and development
expenses is primarily due to increased spending of $0.6 million in consultant
expenses and software and hardware maintenance costs, resulting from increased
efforts devoted to the development of the 130 nanometer and 90 nanometer
manufacturing technology for our Efficeon TM8000 family of microprocessors, as
well as our LongRun2 power management technologies. This increase is offset by
decreases in depreciation expenses of $0.3 million, 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, 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 was $6.7 million for the first quarter
of fiscal 2004 compared to $6.6 million for the same period last year,
representing an increase of $0.1 million, or 1.5%. The change in selling,
general and administrative is due to increases in compensation costs of $0.9
million and advertising and sales costs of $0.3 million. Increases in these
areas were primarily the result of our continued efforts to hire additional
personnel and to promote awareness of our Efficeon TM8000 processor. These
increases were offset by decreases in legal expenses of $0.6 million, outside
services of $0.3 million and depreciation expense of $0.2 million. 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 was $2.4
million for the first quarter of fiscal 2004 compared to $2.6 million for
the same period last year, representing a decrease of $0.2 million, or 7.7%.
Amortization charges relate to various patents and patent rights acquired from
Seiko Epson and others during fiscal 2001. This decrease 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 $14.5 million, from $38.0 million at March 31, 2003 to
$23.5 million at March 31, 2004. Stock Compensation Stock
compensation was $1.4 million for the first quarter of fiscal
2004 compared to $0.4 million for the same period last year, representing an
increase of $1.0 million. The two components of stock compensation were the
amortization of deferred stock compensation and variable stock compensation.
Net amortization of deferred stock compensation for the first quarter of
fiscal 2004 was $0.2 million, compared to $0.7 million for the same period last
year. This decrease was primarily a result of amortizing the deferred charge on
an accelerated method in accordance with our accounting policy, as well as a
decrease in the number of outstanding options affecting the compensation charge
as a result of cancellations. Variable stock compensation for the
first quarter of fiscal 2004 was $1.1 million, compared to a credit of $0.2 million
for the same period last year. This charge is based on the excess, if any, of
the current market price of our stock as of the period-end over the purchase
price of the stock award, adjusted for vesting and prior stock compensation
expense recognized on the stock award. The increase in the variable stock
compensation component resulted from 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 March 31, 2004, compared to the same period in
the prior year. Interest Income and Other, Net and Interest Expense Interest
income and other, net for the first quarter of fiscal 2004
was $0.2 million, compared to $0.7 million for the same period last year,
representing a decrease of $0.5 million, or 71.4%. This decrease was due to
lower average invested cash balances as 13




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we continued to use cash to fund operations, as well as a decrease in
interest rates earned on investments during the period. Interest expense for
the first quarter of fiscal 2004 was $15,000, compared to $124,000 for
fiscal 2003, representing a decrease of $109,000, or 87.9%. This 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 Three Months EndedMarch 31,
    
    March 31,2004
    
    2003Net cash used in operating activities
    
    $
    (20,217
    )
    
    $
    (16,666
    )Net cash provided by/(used in) investing activities
    
    
    (22,592
    )
    
    
    59,104Net cash provided by financing activities
    
    
    13,177
    
    
    
    1,182Increase/(Decrease) in cash and cash equivalents
    
    $
    (29,632
    )
    
    $
    43,620
 Cash and Cash Flows We have historically reported negative cash flows from operations as the
gross profit generated from our product and licensing revenues have not been
sufficient to cover our operating cash requirements. We intend to rely on funds
that we have received from financing activities until we are able to generate
sufficient revenue and related gross profit to cover operational expenses as
well as anticipated increases in our working capital other than cash. We
believe that the proceeds received from financing activities will be sufficient
to fund our operations for at least the next twelve months. However, our
ability to do so may be affected by a number of variables as noted below and is
subject to significant risks and uncertainties. In the period through March 31, 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 next family of
microprocessors, the Efficeon TM8000, and as we continue to develop new or
enhance existing products or services in line with our business model, we
expect that, as a result of an increased level of operations, we will need to
increase our non-cash working capital, and accordingly, the net cash which we
will use in our operating activities will increase. Our ability to increase sales of our Crusoe TM5800 products into
additional market segments, 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. 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 March 31, 2004 we had $113.0 million in cash, cash equivalents and
short-term investments compared to $120.8 million at December 31, 2003. Net cash used in operating activities was $20.2 million for the three
months ended March 31, 2004, compared to $16.7 million for the corresponding
period in fiscal 2003. Net cash used during the first quarter of fiscal 2004
was primarily the result of a net loss of $23.4 million, an increase in
accounts receivable of $1.4 million and an increase in prepaid and other
current assets of $1.2 million. The net loss and changes in operating assets
and liabilities were partially offset by non-cash charges related to
amortization of patents and patent rights of $2.4 million, adjustments to stock
compensations of $1.4 million and depreciation of $1.0 million. Net
cash used in investing activities was $22.6 million for the three
months ended March 31, 2004, compared to net cash provided by investing
activities of $59.1 million for the corresponding period in fiscal 2003. This
change was primarily due to $21.9 million in net purchases of
available-for-sale investments for the first quarter in fiscal 2004, compared
to net proceeds of $61.2 million from the maturity of available-for-sale
investments for the same period last year. Additionally, while we did not have
any payments for patent 14




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and patent rights in the first quarter of fiscal 2004, a $1.5 million
payment was made in the same period last year. The remaining payments for
these items total $23.5 million and are due prior to December 31, 2004.
Additional cash used in investing activities included the purchase of property
and equipment, which amounted to $0.7 million and $0.5 million for the first
quarter 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 $13.2 million for the three
months ended March 31, 2004, compared to $1.2 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 $2.3 million in net
proceeds from sales of common stock under our employee stock purchase and stock
option plans for the first quarter in fiscal 2004, compared to $1.3 million for
the same period last year. Additionally, we received $0.8 million for the
repayment of notes from our stockholders in the first quarter 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 March 31, 2004, we had $54.1 million in cash and cash equivalents and
$58.9 million in short-term investments. We lease our facilities under
non-cancelable operating leases expiring in 2008, and we lease equipment and
software under non-cancelable leases with terms ranging from 12 to 36 months. Contractual Obligations At March 31, 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
    
    $
    649
    
    
    $
    371
    
    
    $
    278
    
    
    
    Operating Leases
    
    $
    19,350
    
    
    $
    4,411
    
    
    $
    13,746
    
    
    $
    1,193Unconditional Purchase Obligations(1)
    
    $
    7,279
    
    
    $
    7,279
    
    
    
    
    
    
    
    Other Obligations(2)
    
    $
    23,500
    
    
    $
    23,500
    
    
    
    
    
    
    
    Total
    
    $
    50,778
    
    
    $
    35,561
    
    
    $
    14,024
    
    
    $
    1,193
   (1)
    
    Purchase obligations include agreements to purchase goods or services
that are enforceable and legally binding on Transmeta and that specify all
significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum or variable price provisions; and the approximate timing of
the transaction.(2)
    
    Other obligations include payments for patent and patent rights and
payments to our development partner. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions
that generate relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or
special purpose entities (SPEs), which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. As of March 31, 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. 15




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Since our inception, we have incurred cumulative losses aggregating $565.9
million, including net losses of $23.4 million for the first three months of
fiscal 2004, $87.6 million in fiscal 2003 and $110.0 million in fiscal 2002,
which have reduced stockholders equity to $122.7 million at March 31, 2004. We
currently expect to continue to incur losses under our current business plan
until at least 2005. We have financed our operations primarily through sales of equity
securities and, to a lesser extent, from product and license revenue and lease
financing. We cannot, however, be sure that funds previously received from
financing activities will be sufficient to fund our operations until we are
able to generate positive cash flows from operations. See Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Liquidity and Capital Resources. However, our ability to continue to operate
under our current business model until we achieve profitability may be affected
by a variety of factors, which may include our ability to achieve market
acceptance for our Efficeon TM8000 products, significant unexpected technical
or manufacturing problems we may experience in transitioning our Efficeon
TM8000 microprocessor to a 90 nanometer manufacturing process or any
significant problems we may face in selling our TM5800 microprocessors in
additional market segments. All of these factors are subject to significant
risks and uncertainties. Our future operating results will depend significantly on sales of our new
Efficeon TM8000 products. Our future revenue and gross margins will be influenced in large part by
the level of sales of our new Efficeon TM8000 products. Therefore, our future
operating results will depend on the demand for these products from future
customers. We just began shipment in the fourth quarter of 2003 of our initial
Efficeon TM8000 microprocessor manufactured using a 130 nanometer complementary
metal oxide semiconductor, or CMOS, process. If we experience delays in
manufacturing sufficient quantities of microprocessors, our target customers
could design a competitors microprocessor into their product, which would lead
to lost sales and impede our ability to generate market interest in our new
microprocessor. If these products are not widely accepted by the market due to
performance, price, compatibility or any other reason, significant demand for
our new products may fail to materialize. We are seeking to transition the manufacturing of our Efficeon TM8000
microprocessors to a 90 nanometer CMOS process. We believe that successfully
completing this transition will be important to our ability to achieve broad
market acceptance of our Efficeon TM8000 microprocessors and to our ability to
compete, particularly in market segments in which performance is a key
competitive factor such as the notebook personal computer and blade server
markets. 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 intend
to use Fujitsu Microelectronics to manufacture our initial 90 nanometer
Efficeon TM8000 microprocessors. We delivered to Fujitsu Microelectronics the
tape-out of our Efficeon TM8000 microprocessors for implementation in its 90
nanometer foundry in November 2003. We received first silicon for testing in
January 2004 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. 16




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Our Crusoe TM5800 microprocessors are experiencing decreasing demand from
notebook computer manufacturers and are experiencing declining average selling
prices. If we are unable to sell the TM5800 microprocessors into additional
market segments or reduce our costs of production, our operating results will
suffer. As our Crusoe TM5800 microprocessors have matured, demand for the TM5800
microprocessors from notebook computer manufacturers has declined in that
market segment. We have begun to sell the TM5800 microprocessors into
additional market segments such as the thin client, ultra-personal computer, or
UPC, and embedded computer market segments, many of which are only beginning to
be developed. We cannot be sure that we will be successful in selling the
TM5800 microprocessors into these markets or that these markets will experience
significant growth. In addition, the average selling price of the TM5800
microprocessors has decreased, and we expect that pricing pressure on the
TM5800 microprocessors will continue to increase as sales of these
microprocessors increasingly derive from geographies and market segments that
traditionally demand lower average selling prices. If we are unable to achieve
sufficient reductions in our costs of products sold, this decline in prices
will adversely affect our gross margins. The growth of our business depends in part upon the development of emerging
markets and our ability to meet the needs of these markets. The growth of our business depends in part on acceptance and use of our
products in new classes of devices such as tablet PCs, UPCs, high density
servers and new embedded processor applications. We depend on the ability of
our target customers to develop new products and enhance existing products for
these markets that incorporate our products and to introduce and promote their
products successfully. These new markets often rely on newly developed
technologies, which will require extensive development and marketing before
widespread acceptance is achieved, so the new markets may grow slowly, if at
all. If the new markets do not grow as we anticipate, our target customers do
not incorporate our products into theirs, or our products are not widely
accepted by end users, our ability to increase our revenues would suffer. In
addition, manufacturers within emerging markets may have widely varying
requirements. To meet the requirements of different manufacturers and markets,
we may be required to change our product design or features, sales methods or
pricing policies. The costs of addressing these requirements could be
substantial and could delay or prevent any improvement in our operating
results. Our future revenue depends in part upon our ability to penetrate additional
segments of the notebook computer market. Historically, our sales in the notebook computer market have primarily
been in the market segment consisting of thin and light notebook computers for
which low heat generation and power consumption are particularly critical. Our
ability to increase our revenues in the future will depend in significant part
on our ability to market our new Efficeon TM8000 microprocessors in additional
segments of the notebook computer market in which microprocessor performance is
a more significant factor. These notebook market segments are intensely
competitive and dominated by Intel. We have not succeeded in deriving
significant revenues from sales of our microprocessors in these market segments
in the past and cannot be sure that we will successfully market and sell our
microprocessor products in these market segments in the future. Due to our software-based approach to microprocessor design, we have been
required, and expect to continue to be required, to devote substantial
resources to educate prospective customers in the notebook computer market
about the benefits of our products and to assist potential customers with their
designs. In addition, since computer products generally are designed to
incorporate a specific microprocessor, original equipment manufacturers, or
OEMs, must design new products to utilize different microprocessors such as our
products. Given the complexity of these computer products and their many
components, designing new products requires 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 17




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the revenue that we generate falls below our expectations, we could
utilize our existing cash resources, including the net proceeds of the
offering, faster than we expect. In addition, we may begin to generate positive
cash flow from operations later than anticipated or we may never generate
positive cash flow from operations. As a result, we may need significant
additional funds. A variety of other business contingencies could contribute to
our need for funds in the future, including the need to:  
    
    fund expansion;
    
    fund marketing expenditures;
    
    develop new products or enhance existing products;
    
    enhance our operating infrastructure;
    
    hire additional personnel;
    
    respond to customer concerns about our viability;
    
    respond to competitive pressures; or
    
    acquire complementary businesses or technologies. If we were to raise additional funds through the issuance of equity or
convertible debt securities, the percentage ownership of our stockholders would
be reduced, and these newly issued securities might have rights, preferences or
privileges senior to those of our then-existing stockholders. Additional
financing might not be available on terms favorable to us, or at all. For
example, in order to raise equity financing, we may decide to sell our stock at
a discount of our then current trading price, which may have an adverse effect
on our future trading price. If adequate funds were not available on acceptable
terms or at all, our ability to fund our operations, take advantage of
unanticipated opportunities, develop or enhance our products or otherwise
respond to competitive pressures would be significantly limited. We face intense competition in the x86-compatible microprocessor market. Many
of our competitors are much larger than we are and have significantly greater
resources. We may not be able to compete effectively. The market for microprocessors is intensely competitive. We may not be
able to compete effectively against current and potential competitors,
especially those with significantly greater resources and market leverage.
Competition may cause price reductions, reduced gross margins and loss of
market share, any one of which could significantly reduce our future revenue
and increase our losses. For example, we may determine to lower the prices of
our products in order to increase or maintain market share, which would likely
increase our losses. Significant competitors in the x86-compatible microprocessor product
market include Intel, Advanced Micro Devices and VIA Technologies. Our current
and potential competitors have longer operating histories, significantly
greater financial, technical, product development and marketing resources,
greater name recognition and significantly larger customer bases than we do.
Our competitors may be able to develop products comparable or superior to those
we offer, adapt more quickly than we do to new technologies, evolving industry
trends and customer requirements, and devote greater resources to the
development, promotion and sale of their 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. 18




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In 2003, Intel introduced a new microprocessor that is focused on the
notebook computer market segment and designed to consume less power than its
prior microprocessors. We expect that Intel, and potentially other
microprocessor companies, will increasingly seek to offer microprocessors
specifically targeted at many of the same market segments that we intend to
serve, which could adversely affect our ability to compete successfully. Furthermore, our competitors may merge or form strategic relationships
that might enable them to offer, or bring to market earlier, products that are
superior to ours in terms of features, quality, pricing or other factors. We
expect additional competition from other established and emerging companies and
technologies. We may experience manufacturing difficulties that could increase the cost and
reduce the supply of our products. The fabrication of wafers for our microprocessors is a highly complex and
precise process that requires production in a tightly controlled, clean room
environment. Minute impurities, difficulties in the fabrication process,
defects in the masks used to print circuits on a wafer or other factors can
cause numerous die on each wafer to be nonfunctional. The proportion of
functional die expressed as a percentage of total die on a wafer is referred to
as product yield. Semiconductor companies frequently encounter difficulties
in achieving expected product yields, particularly when introducing new
products. Yield problems may not be identified and resolved until a product has
been manufactured and can be analyzed and tested, if ever. As a result, yield
problems are often difficult, time-consuming and expensive to correct. We have
experienced yield problems in the past, and we may experience yield problems in
the future that impair our ability to deliver our products to our customers,
increase our costs, adversely affect our margins and divert the efforts of our
engineering personnel. Difficulties in achieving the desired yields often occur
in the early stages of production of a new product or in the migration of
manufacturing processes to smaller geometries. We could experience difficulties
in achieving desired yields or other manufacturing problems in the production
of our initial Efficeon TM8000 products that could delay our ability to further
introduce Efficeon TM8000 products in volume, adversely affect our costs and
gross margins and harm our reputation. In addition, we could also experience
these difficulties as we seek to migrate the Efficeon TM8000 products to a 90
nanometer process technology, which poses significant technical challenges and
in which neither we nor Fujitsu Microelectronics, which we intend to use to
manufacture these products, has significant experience. Even with functional
die, normal variations in wafer fabrication can cause some die to run faster
than others. Variations in speed yield could lead to excess inventory of the
slower, less valuable die, a resulting unfavorable impact on gross margins and
an insufficient inventory of faster products, depending upon customer demand. Our lengthy and variable sales cycles make it difficult for us to predict when
and if a design win will result in volume shipments. We depend upon other companies designing our microprocessors into their
products, which we refer to as design wins. Many of our targeted customers
consider the choice of a microprocessor to be a strategic decision. Thus our
targeted customers may take a long time to evaluate our products, and many
individuals may be involved in the evaluation process. We anticipate that the
length of time between our initial contact with a customer and the time when we
recognize revenue from that customer will vary. We expect our sales cycles to
range typically from six to 12 months, or more, from the time we achieve a
design win to the time the customer begins volume production of products that
incorporate our microprocessors. We do not have historical experience selling
our products that is sufficient for us to determine accurately how our sales
cycles will affect the timing of our revenue. Variations in the length of our
sales cycles could cause our revenue to fluctuate widely from period to period.
While potential customers are evaluating our products and before they place an
order with us, we may incur sales and marketing expenses and expend significant
management and engineering resources without any assurance of success. The
value of any design win depends upon the commercial success of our customers
products. If our customers cancel projects or change product plans, we could
lose anticipated sales. We can offer no assurance that we will achieve further
design wins or that the products for which we achieve design wins will
ultimately be introduced or will, if introduced, be commercially successful. 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 19




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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 accounted for 55%, 15% and 13% of total
revenue in the first three months of fiscal 2004, respectively. These customers are located in Asia,
which subjects us to economic cycles in that area as well as the geographic
areas in which they sell their products containing our microprocessors. We
expect that a small number of customers and distributors will continue to
account for a significant portion of our revenue. Our future success will
depend upon the timing and size of future purchase orders, if any, from these
customers and new customers and, in particular:  
    
    the success of our customers in marketing products that incorporate our products;
    
    the product requirements of our customers; and
    
    the financial and operational success of our customers. We expect that our sales to OEM customers will continue to be made on the
basis of purchase orders rather than long-term commitments. In addition,
customers can delay, modify or cancel orders without penalty. Many of our
customers and potential customers are significantly larger than we are and have
sufficient bargaining power to demand reduced prices and favorable nonstandard
terms. The loss of any major customer, or the delay of significant orders from
these customers, could reduce or delay our recognition of revenue. We have entered into distributor agreements and rely in part on
distributors and stocking representatives for sales of our products in large
territories, including Japan, Taiwan, Hong Kong, Europe, China, Korea and North
America. These agreements do not contain minimum purchase commitments. Additionally, we have entered into agreements with manufacturers
representatives in North America and Europe. Any distributor, stocking
representative or manufacturers representative that fails to emphasize sales
of our products, chooses to emphasize alternative products or devices or to
promote products of our competitors might not sell a significant amount or any
of our products. If our customers are not able to obtain the other components necessary to build
their systems, sales of our products could be delayed or cancelled. 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. 20




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We do not have our own manufacturing facilities and, therefore, must rely
on third parties to manufacture our products. We currently rely on TSMC in
Taiwan to fabricate the wafers for all of our current products and intend to
rely on Fujitsu Microelectronics in Japan to manufacture our initial 90
nanometer Efficeon TM8000 products. As is common in the industry, we do not
have a manufacturing contract with TSMC that guarantees any particular
production capacity or any particular price, and although we have not yet
entered into a definitive manufacturing agreement with Fujitsu
Microelectronics, we cannot be assured that we will have any guaranteed
production capacity with Fujitsu Microelectronics. The Fujitsu Microelectronics
90 nanometer foundry has relatively limited capacity and we cannot be sure that
sufficient capacity will be available at that foundry to enable us to
manufacture our initial 90 nanometer Efficeon TM8000 products in the quantities
that we would desire if these products were to achieve rapid market acceptance. These foundries may allocate capacity to other companies products while
reducing the capacity available to us on short notice. Foundry customers that
are larger than we and have greater economic resources, that have long-term
agreements with these foundries or that purchase in significantly larger
volumes than we may cause these foundries to reallocate capacity to them,
decreasing the capacity available to us. In addition, these foundries could,
with little or no notice, refuse to continue to fabricate all or some of the
wafers that we require. If these foundries were to stop manufacturing for us,
we would likely be unable to replace the lost capacity in a timely manner.
Transferring to another manufacturer would require a significant amount of time
and money. As a result, we could lose potential sales and fail to meet existing
obligations to our customers. These foundries could also, with little or no
notice, change the terms under which they manufacture for us, which could cause
our manufacturing costs to increase substantially. Our reliance on TSMC and, in the future, Fujitsu Microelectronics to fabricate
our wafers limits our ability to control the production, supply and delivery of
our products. Our reliance on third-party manufacturers exposes us to a number of risks
outside our control, including the following:  
    
    unpredictability of manufacturing yields and production costs;
    
    interruptions in shipments;
    
    inability to control quality of finished products;
    
    inability to control product delivery schedules;
    
    potential lack of access to key fabrication process technologies; and
    
    potentially greater exposure to misappropriation of our intellectual property. 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. 21




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In addition, to gain and maintain market acceptance, our microprocessors
must not have significant incompatibilities with software for x86-compatible
microprocessors, and in particular, the Windows operating systems, or hardware
used by end-users. Software applications, games or operating systems with
machine-specific routines programmed into them can result in specific
incompatibilities. If a particular software application, game or operating
system is programmed in a manner that makes it unable to respond correctly to
our microprocessor, it will appear to users of that software that our
microprocessor is not compatible with that software. Software or hardware
incompatibilities that are significant or are perceived to be significant could
hinder our products from achieving or maintaining market acceptance and impair
our ability to increase our revenues. In an effort to test and ensure the compatibility of our products with
hardware and software for x86-compatible microprocessors, we rely on the
cooperation of third-party hardware and software companies, including
manufacturers of graphics chips, motherboards, BIOS software and other
components. All of these third-party designers and manufacturers produce
chipsets, motherboards, BIOS software and other components to support each new
generation of Intels microprocessors, and Intel has significant leverage over
their business opportunities. If these third parties were to cease supporting
our microprocessor products, our business would suffer. Our products may have defects that could damage our reputation, decrease market
acceptance of our products, cause us to lose customers and revenue and result
in liability to us. Highly complex products such as our microprocessors may contain hardware
or software defects or bugs for many reasons, including design issues or
defective materials or manufacturing processes. Often, these defects and bugs
are not detected until after the products have been shipped. If any of our
products contains defects, or has reliability, quality or compatibility
problems, our reputation might be damaged significantly and customers might be
reluctant to buy our products, which could result in the loss of or failure to
attract customers. In addition, these defects could interrupt or delay sales.
We may have to invest significant capital and other resources to correct these
problems. If any of these problems is not found until after we have commenced
commercial production of a new product, we might incur substantial additional
development costs. If we fail to provide solutions to the problems, such as
software patches, we could also incur product recall, repair or replacement
costs. These problems might also result in claims against us by our customers
or others. In addition, these problems might divert our technical and other
resources from other development efforts. Moreover, we would likely lose, or
experience a delay in, market acceptance of the affected product or products,
and we could lose credibility with our current and prospective customers. This
is particularly significant as we are a new entrant to a market dominated by
large well-established companies. We are subject to general economic and market conditions. Our business is subject to the effects of general economic conditions in
the United States and worldwide and, in particular, market conditions in the
semiconductor and computer industries. In 2001, 2002 and through parts of 2003,
our operating results were adversely affected by unfavorable global economic
conditions and reduced information technology spending, particularly in Japan,
where we currently generate a substantial portion of our revenue. These adverse
conditions resulted in decreased demand for notebook computers and, as a
result, our products, which are components of notebook computers. Further,
demand for our products decreases as computer manufacturers seek to manage
their component and finished product inventory levels. If the economic
conditions in Japan and worldwide do not improve, or worsen, we may continue to
experience material adverse effects on our business, operating results and
financial condition. The cyclical nature of the semiconductor industry could create fluctuations in
our operating results. The semiconductor industry has historically been cyclical and
characterized by wide fluctuations in product supply and demand. From time to
time, the industry has also experienced significant downturns, often in
connection with, or in anticipation of, maturing product cycles and declines in
general economic conditions. Industry downturns have been characterized by
diminished product demand, production overcapacity and accelerated decline in
average selling prices, and in some cases have lasted for more than a year. 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. 22




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The semiconductor industry is characterized by rapid technological change,
frequent new product introductions and enhancements, and ongoing customer
demands for greater performance. In addition, the average selling price of any
particular microprocessor product has historically decreased substantially over
its life, and we expect that trend to continue. As a result, our products may
not be competitive if we fail to introduce new products or product enhancements
that meet evolving customer demands. It may be difficult or costly for us, or
we may not be able, to enhance existing products to fully meet customer
demands. For instance, in order to meet the demands of our customers for
enhancement of our existing products, we may incur manufacturing or other costs
that would harm our operating margins and financial condition. Further, we may
not achieve further design wins with current customers unless we continue to
meet their evolving needs by developing new products. The development of new
products is complex, and we may not be able to complete development in a timely
manner, or at all. To introduce and improve products on a timely basis, we
must:  
    
    accurately define and design new products to meet market needs;
    
    design features that continue to differentiate our products from those of our competitors;
    
    transition our products to new manufacturing process technologies;
    
    identify emerging technological trends in our target markets;
    
    anticipate changes in end-user preferences with respect to our customers products;
    
    bring products to market on a timely basis at competitive prices; and
    
    respond effectively to technological changes or product announcements by others. We believe that we will need to continue to enhance our products and
develop new products to keep pace with competitive and technological
developments and to achieve market acceptance for our products. We may incur
significant research and development, manufacturing or other costs that would
harm our operating margins and financial conditions, in our development
efforts. These efforts may not result in enhanced products, or in additional
product sales. Accordingly, these investments may not provide us with an
acceptable return, or any return at all. Advances in battery design, cooling systems and power management systems could
adversely affect our ability to achieve widespread market acceptance for our
products. We believe that our ability to achieve widespread market acceptance for
our products will depend in large part on whether potential purchasers of our
products believe that the low power usage of our products is a substantial
benefit. Advances in battery technology, or energy technologies such as fuel
cell technologies, that offer increased battery life and enhanced power
capacity, as well as the development and introduction of more advanced cooling
systems, may make microprocessor power consumption a less important factor to
our customers and potential customers. These developments, or developments in
power management systems by third parties, may adversely affect our ability to
market and sell our products and increase our revenues. Our products may infringe the intellectual property rights of others, which may
cause us to become subject to expensive litigation, cause us to incur
substantial damages, require us to pay significant license fees or prevent us
from selling our products. 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. 23




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If it were determined that our products infringe the intellectual property
rights of others, we would need to obtain licenses from these parties or
substantially reengineer our products in order to avoid infringement. We might
not be able to obtain the necessary licenses on acceptable terms, or at all, or
to reengineer our products successfully. Moreover, if we are sued for
infringement and lose the suit, we could be required to pay substantial damages
or be enjoined from licensing or using the infringing products or technology.
Any of the foregoing could cause us to incur significant costs and prevent us
from selling our products. If we are unable to protect our proprietary rights adequately, our competitors
might gain access to our technology and we might not compete successfully in
our markets. We believe that our success will depend in part upon our proprietary
technology. We rely on a combination of patents, copyrights, trademarks, trade
secret laws and contractual obligations with employees and third parties to
protect our proprietary rights. These legal protections provide only limited
protection and may be time consuming and expensive to obtain and enforce. If we
fail to protect our proprietary rights adequately, our competitors might gain
access to our technology. As a result, our competitors might offer similar
products and we might not be able to compete successfully in our market.
Moreover, despite our efforts to protect our proprietary rights, unauthorized
parties may copy aspects of our products and obtain and use information that we
regard as proprietary. Also, our competitors may independently develop similar,
but not infringing, technology, duplicate our products, or design around our
patents or our other intellectual property. In addition, other parties may
breach confidentiality agreements or other protective contracts with us, and we
may not be able to enforce our rights in the event of these breaches.
Furthermore, we expect that we will increase our international operations in
the future, and the laws of many foreign countries do not protect our
intellectual property rights to the same extent as the laws of the United
States. We may be required to spend significant resources to monitor and
protect our intellectual property rights. Our pending patent and trademark applications may not be approved. Our
patents, including any patents that may result from our patent applications,
may not provide us with any competitive advantage or may be challenged by third
parties. If challenged, our patents might not be upheld or their claims could
be narrowed. We may initiate claims or litigation against third parties based
on our proprietary rights. Any litigation surrounding our rights could force us
to divert important financial and other resources from our business operations. We might not experience growth in our licensing revenues. Licensing revenue was $0.2 million for the first quarter 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. 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. 24




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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 intend to use
for our initial 90 nanometer product is located in Japan. As part of our
international expansion, we have personnel in Taiwan, Japan, and Europe who
provide sales and customer support. We have appointed distributors, stocking
representatives and manufacturers representatives to sell products in Japan,
Taiwan, Hong Kong, Europe, China, Korea and North America. In addition, we
generally ship our products from a third-party warehouse facility located in
Hong Kong. In attempting to conduct and expand business internationally, we are
exposed to various risks that could adversely affect our international
operations and, consequently, our operating results, including:  
    
    difficulties and costs of staffing and managing international operations;
    
    fluctuations in currency exchange rates;
    
    unexpected changes in regulatory requirements, including imposition of currency exchange controls;
    
    longer accounts receivable collection cycles;
    
    import or export licensing requirements;
    
    problems in the timeliness or quality of product deliveries;
    
    potentially adverse tax consequences;
    
    major health concerns, such as SARS;
    
    political and economic instability, for example as a result of
tensions between Taiwan and the Peoples Republic of China; and
    
    potentially reduced protection for intellectual property rights. Our operating results are difficult to predict and fluctuate significantly. A
failure to meet the expectations of securities analysts or investors could
result in a substantial decline in our stock price. Our operating results fluctuate significantly from quarter to quarter, and
we expect that our operating results will fluctuate significantly in the future
as a result of one or more of the risks described in this section or as a
result of numerous other factors. You 25




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should not rely on quarter-to-quarter comparisons of our results of
operations as an indication of our future performance. Our stock price has
declined substantially since our stock began trading publicly. If our future
operating results fail to meet or exceed the expectations of securities
analysts or investors, our stock price would likely decline from current
levels. A large portion of our expenses, including rent and salaries, is fixed and
difficult to reduce. Our expenses are based in part on expectations for our
revenue. If our revenue does not meet our expectations, the adverse effect of
the revenue shortfall upon our operating results may be acute in light of the
fixed nature of our expenses. We often make many shipments of our products at
or near the end of the fiscal quarter, which makes it difficult to estimate or
adjust our operating activities quickly in response to a shortfall in expected
revenue. The price of our common stock has been volatile and is subject to wide
fluctuations. The market price of our common stock has been volatile and is likely to
remain subject to wide fluctuations in the future. Many factors could cause the
market price of our common stock to fluctuate, including:  
    
    variations in our quarterly results;
    
    market conditions in our industry, the industries of our customers and the economy as a whole;
    
    announcements of technological innovations by us or by our competitors;
    
    introductions of new products or new pricing policies by us or by our competitors;
    
    acquisitions or strategic alliances by us or by our competitors;
    
    recruitment or departure of key personnel;
    
    the gain or loss of significant orders;
    
    the gain or loss of significant customers; and
    
    changes in the estimates of our operating performance or changes in recommendations by securities analysts. In addition, the stock market generally and the market for semiconductor
and other technology-related stocks in particular experienced a decline during
2000, 2001 and through 2002, and could decline from current levels, which could
cause the market price of our common stock to fall for reasons not necessarily
related to our business, results of operations or financial condition. The
market price of our stock also might decline in reaction to events that affect
other companies in our industry even if these events do not directly affect us.
Accordingly, you may not be able to resell your shares of common stock at or
above the price you paid. Securities litigation is often brought against a
company following a period of volatility in the market price of its securities,
and we have been subject to such litigation in the past. Any such lawsuits in
the future will divert managements attention and resources from other matters,
which could also adversely affect our business and the price of our stock. 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. 26




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Provisions of our certificate of incorporation and bylaws, as well as
provisions of Delaware law, could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. These
provisions include:  
    
    establishing a classified board of directors so that not all members of our board may be elected at one time;
    
    providing that directors may be removed only for cause and only with the vote of 66 2/3% of our outstanding shares;
    
    requiring super-majority voting to amend some provisions in our certificate of incorporation and bylaws;
    
    authorizing the issuance of blank check preferred stock that our
board could issue to increase the number of outstanding shares and to
discourage a takeover attempt;
    
    limiting the ability of our stockholders to call special meetings of
stockholders;
    
    prohibiting stockholder action by written consent, which requires all
stockholder actions to be taken at a meeting of our stockholders; and
    
    establishing advance notice requirements for nominations for election
to our board or for proposing matters that can be acted upon by
stockholders at stockholder meetings. In addition, the stockholder rights plan, which we implemented in 2002,
and Section 203 of the Delaware General Corporation Law may discourage, delay
or prevent a change in control. Our reported financial results may be adversely affected by changes in
accounting principles generally accepted in the United States. Generally accepted accounting principles in the United States are subject
to interpretation by the Financial Accounting Standards Board (FASB), the
American Institute of Certified Public Accountants, the Securities and Exchange
Commission (SEC) and various bodies formed to promulgate and interpret
appropriate accounting principles. A change in these principles or
interpretations could have a significant effect on our reported financial
results, and could affect the reporting of transactions completed before the
announcement of a change. For example, we currently are not required to record
stock-based compensation charges if an employees stock option exercise price
is equal to or exceeds the deemed fair value of our common stock at the date of
grant. However, several companies have recently elected to change their
accounting policies and begun to record the fair value of stock options as an
expense. Although the standards have not been finalized and the timing of a
final statement has not been established, FASB published in March 2004 an
exposure draft that would require us to record expense for the fair value of
stock options granted. Our reported earnings and/or loss would be harmed if we
were required to change our current accounting policy Recently enacted and proposed changes in securities laws and regulations are
likely to increase our costs. The Sarbanes-Oxley Act of 2002 has required and will require changes in
some of our corporate governance, public disclosure and compliance practices.
The Act also requires the SEC to promulgate new rules on a variety of subjects.
In addition to final rules and rule proposals already made by the SEC, the
National Association of Securities Dealers has adopted revisions to its
requirements for companies, such as us, that are listed on the Nasdaq National
Market. We expect these developments to increase our legal and financial
compliance costs, and to make some activities, such as SEC reporting
requirements, more difficult. Additionally, we expect these developments to
make it more difficult and more expensive for us to obtain director and officer
liability insurance, and we may be required to accept reduced coverage or incur
substantially higher costs to obtain coverage. These developments could make it
more difficult for us to attract qualified executive officers and attract and
retain qualified members of our board of directors, particularly to serve on
our audit committee. We are presently evaluating and monitoring regulatory
developments and cannot estimate the timing or magnitude of additional costs we
may incur as a result. 
 Item 3.Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk.Our cash equivalents and available-for-sale
investments are exposed to financial market risk due to fluctuations in
interest rates, which may affect our interest income. Over the past few years,
we have experienced significant reductions in our interest income due in part
to declines in interest rates. These declines have led to interest rates that
are low by historical standards and 27




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we do not believe that further decreases in interest rates will have a
material impact on the interest income earned on our cash equivalents and
short-term investments held at March 31, 2004. Foreign Currency Exchange Risk.All of our sales and substantially all of
our expenses are denominated in U.S. dollars. As a result, we have relatively
little exposure to foreign currency exchange risk. We do not currently enter
into forward exchange contracts to hedge exposures denominated in foreign
currencies or any other derivative financial instruments for trading or
speculative purposes. However, in the event our exposure to foreign currency
risk increases, we may choose to hedge those exposures. 
 Item 4.Controls and Procedures The Securities and Exchange Commission defines the term disclosure
controls and procedures to mean a companys controls and other procedures that
are designed to ensure that information required to be disclosed in the reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commissions rules and forms. Our Chief Executive
Officer and Chief Financial Officer have concluded, based on the evaluation of
the effectiveness of our disclosure controls and procedures by our management,
with the participation of our Chief Executive Officer and our Chief Financial
Officer, as of the end of the period covered by this report, that our
disclosure controls and procedures were effective for this purpose During the first quarter of fiscal 2004, there have been no changes in our
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. 
 PART II. OTHER INFORMATION 
 Item 1.Legal Proceedings The Company is a party in one consolidated lawsuit. Beginning in June 2001, the Company, certain of its directors and
officers, and certain of the underwriters for its initial public offering were
named as defendants in three putative shareholder class actions that were
consolidated in and by the United States District Court for the Southern
District of New York in In re Transmeta Corporation Initial Public Offering
Securities Litigation, Case No. 01 CV 6492. The complaints allege that the
prospectus issued in connection with the Companys initial public offering on
November 7, 2000 failed to disclose certain alleged actions by the underwriters
for that offering, and alleges claims against the Company and several of its
officers and directors under Sections 11 and 15 of the Securities Act of 1933,
as amended, and under Sections 10(b) and Section 20(a) of the Securities
Exchange Act of 1934, as amended. Similar actions have been filed against more
than 300 other companies that issued stock in connection with other initial
public offerings during 1999-2000. Those cases have been coordinated for
pretrial purposes as In re Initial Public Offering Securities Litigation,
Master File No. 21 MC 92 (SAS). In July 2002, the Company joined in a
coordinated motion to dismiss filed on behalf of multiple issuers and other
defendants. In February 2003, the Court granted in part and denied in part the
coordinated motion to dismiss, and issued an order regarding the pleading of
amended complaints. Plaintiffs subsequently proposed a settlement offer to all
issuer defendants, which settlement would provide for payments by issuers
insurance carriers if plaintiffs fail to recover a certain amount from
underwriter defendants. Although the Company and the individual defendants
believe that the complaints are without merit and deny any liability, but
because they also wish to avoid the continuing waste of management time and
expense of litigation, they accepted plaintiffs proposal to settle all claims
that might have been brought in this action. The Company and the individual
Transmeta defendants expect that their share of the global settlement will be
fully funded by their director and officer liability insurance. Although the
Company and the Transmeta defendants have approved the settlement in principle,
it remains subject to several procedural conditions, as well as formal approval
by the Court. It is possible that the parties may not reach a final written
settlement agreement or that the Court may decline to approve the settlement in
whole or part. In the event that the parties do not reach agreement on the
final settlement, the Company and the Transmeta defendants believe that they
have meritorious defenses and intend to defend any remaining action vigorously. 
 Item 2.Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 28




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Not Applicable. 
 Item 3.Defaults upon Senior Securities Not Applicable. 
 Item 4.Submission of Matters to a Vote of Security Holders Not Applicable. 
 Item 5.Other Information Not Applicable. 
 Item 6.Exhibits 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 Svend-Olav Carlsen 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 Svend-Olav Carlsen pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 * As contemplated by SEC Release No. 33-8212, these exhibits are
furnished with this quarterly report on Form 10-Q and are not deemed filed with
the Securities and Exchange Commission and are not incorporated by reference in
any filing of Transmeta Corporation under the Securities Act of 1933 or the
Securities Exchange Act of 1934, including this quarterly report, whether made
before or after the date hereof and irrespective of any general incorporation
language in any filings. (b) Reports on Form 8-K On January 15, 2004, we filed a current report on Form 8-K respecting a
press release we issued announcing earnings for the year ended December 26,
2003. 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 February 27, 2004, we filed a current report on Form 8-K under item 5
announcing that Murray A. Goldman made a scheduled and limited sale of 150,000
shares of common stock consistent with a lock-up agreement that he entered into
in connection with the offering of shares of our common stock in a stock
offering. On March 9, 2004, we filed a current report on Form 8-K respecting a press
release we issued announcing the filing of our annual report on From 10-K for
the year ended December 26, 2003 that incorporated a fiscal fourth quarter
adjustment in operating expenses and reported a revised operating expense. 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. 29




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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/ SVEND-OLAV CARLSENSvend-Olav CarlsenChief Financial Officer and
Vice President of Finance(Principal Financial Officer andDuly Authorized Officer)
 Date: May 4, 2004 30




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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 Svend-Olav Carlsen 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 Svend-Olav Carlsen pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 * As contemplated by SEC Release No. 33-8212, these exhibits are
furnished with this quarterly report on Form 10-Q and are not deemed filed with
the Securities and Exchange Commission and are not incorporated by reference in
any filing of Transmeta Corporation under the Securities Act of 1933 or the
Securities Exchange Act of 1934, including this quarterly report, whether made
before or after the date hereof and irrespective of any general incorporation
language in any filings. 31