Processor licensing, is a license which is needed for each processor installed (not the hard disk) on the computer running SQL Server. The Processor License allows any number of devices to access the server, whether through an Intranet or over the Internet.
Using Processor licensing, SQL Server 2000 can take advantage of each installed processor, and support an unlimited number of client devices. A customer that provides access to SQL Server databases over the Internet, or that has a large number of users, will generally choose the Processor License.
Yes, this is exactly what it means. If you have 2 pentium4(or any other brand) processors you can use processor licensing for 2 processors. However, you can also select 1 processor even though you have 2 physical processors and SQL server will only be able to take advantage of 1.