LM35 in its principle is a Silicon Bandgap Temperature Sensor.

From reading the following 2 articles, you should be able to understand the principle.
http://en.wikipedia.org/wiki/Bandgap_voltage_reference
http://en.wikipedia.org/wiki/Silicon...erature_sensor

The silicon bandgap temperature sensor is an extremely common form of temperature sensor
(thermometer) used in electronic equipment. Its main advantage is that it can be included in a silicon
integrated circuit at very low cost. The principle of the sensor is that the forward voltage of a silicon diode,
which may be the base-emitter junction of a bipolar junction transistor (BJT), is temperature-dependent,
according to the following equation:

where

T = temperature in kelvins,
T0 = reference temperature,
VG0 = bandgap voltage at absolute zero,
VBE0 = junction voltage at temperature T0 and current IC0,
K = Boltzmann's constant,
q = charge on an electron,
n = a device-dependent constant.

Circuit of a Brokaw bandgap reference

By comparing the voltages of two junctions at the same temperature, but at two different currents, IC1 and
IC2, many of the variables in the above equation can be eliminated, resulting in the relationship:

Note that the junction voltage is a function of current density, i.e. current/junction area, and a similar output
voltage can be obtained by operating the two junctions at the same current, if one is of a different area to the
other.

A circuit that forces IC1 and IC2 to have a fixed N:1 ratio,[1] gives the relationship:
An electronic circuit, such as the Brokaw bandgap reference, that measures ΔVBE can therefore be used to
calculate the temperature of the diode. The result remains valid up to about 200 °C to 250 °C, when leakage
currents become large enough to corrupt the measurement. Above these temperatures, materials such as
silicon carbide can be used instead of silicon.

The voltage difference between two p-n junctions (e.g. diodes), operated at different current densities, is
proportional to absolute temperature (PTAT).

PTAT circuits using either BJT or CMOS transistors are widely used in temperature sensors (where we want
the output to vary with temperature), and also in bandgap voltage references and other temperature-
compensating circuits (where we want the same output at every temperature).[1][2][3]

If high precision is not required it is enough to bias a diode with any constant low current and use its −2
mV/˚C thermal coefficient for temperature calculation, however this requires calibration for each diode type.
This method is common in monolithic temperature sensors.

The internal circuit of LM35

There is some description for this circuit that i not really understand, i already copy and paste below.

why is the transistor use for? how it operate?

what is the op amp use for? amplifier or comparator?
Description:

The circuit diagram is shown above. Briefly, there are two transistors in the center of the drawing. One has
ten times the emitter area of the other. This means it has one tenth of the current density, since the same
current is going through both transistors. This causes a voltage across the resistor R1 that is proportional to
the absolute temperature, and is almost linear across the range we care about. The "almost" part is taken care
of by a special circuit that straightens out the slightly curved graph of voltage versus temperature.

The amplifier at the top ensures that the voltage at the base of the left transistor (Q1) is proportional to
absolute temperature (PTAT) by comparing the output of the two transistors.

The amplifer at the right converts absolute temperature (measured in Kelvin) into either Fahrenheit or
Celsius, depending on the part (LM34 or LM35). The little circle with the "i" in it is a constant current
source circuit.

The two resistors are calibrated in the factory to produce a highly accurate temperature sensor.

The integrated circuit has many transistors in it -- two in the middle, some in each amplifier, some in the
constant current source, and some in the curvature compensation circuit. All of that is fit into the tiny
package with three leads.