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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2006

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

Commission File Number: 000-50460



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TESSERA TECHNOLOGIES, INC.

(Exact
Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 16-1620029                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|3099 Orchard Drive, San Jose, California                       |  | 95134                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          

(408) 894-0700

(Registrants Telephone Number, Including Area Code)



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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 ̈.

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act (Check one).



|                           |  |                    |  |                       
|-------------------------- |  | ------------------ |  | ----------------------
|Large accelerated filer  x |  | Accelerated filer ̈ |  | Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act.):    Yes ̈No  x

As of November 6, 2006, 46,943,772 shares of the registrants common stock were outstanding.



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##### Table of Contents

TESSERA TECHNOLOGIES, INC.

FORM 10-Q  QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

TABLE OF CONTENTS



|              |  |                                                                                                                       |  |     
|------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                                       |  | Page
|              |  | PART I                                                                                                                |  |     
|Item 1.       |  | Financial Statements                                                                                                  |  |     
|              |  | Condensed Consolidated Balance Sheets (unaudited)  September 30, 2006 and December 31, 2005                          |  | 3   
|              |  | Condensed Consolidated Statements of Operations (unaudited)  Three and Nine Months Ended September 30, 2006 and 2005 |  | 4   
|              |  | Condensed Consolidated Statements of Cash Flows (unaudited)  Nine Months Ended September 30, 2006 and 2005           |  | 5   
|              |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                      |  | 6   
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 20  
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risks                                                           |  | 27  
|Item 4.       |  | Controls and Procedures                                                                                               |  | 27  
|              |  |                                                                                                                      
|              |  | PART II                                                                                                               |  |     
|Item 1.       |  | Legal Proceedings                                                                                                     |  | 28  
|Item 1A.      |  | Risk Factors                                                                                                          |  | 28  
|Item 2.       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                           |  | 37  
|Item 3.       |  | Defaults Upon Senior Securities                                                                                       |  | 37  
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                                                   |  | 37  
|Item 5.       |  | Other Information                                                                                                     |  | 37  
|Item 6.       |  | Exhibits                                                                                                              |  | 37  
|Signatures    |  | 38                                                                                                                   
|Exhibit Index |  | 39                                                                                                                   



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PART I  FINANCIAL INFORMATION

Item 1. Financial Statements

TESSERA TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except for per share amounts)

(unaudited)



|                                                                                                           |  |                   |         |                  |   |         |  
|---------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | ------- | -
|                                                                                                           |  | September 30,2006 |         | December 31,2005 |  
|ASSETS                                                                                                     |  |                   |         |                  |   |         |  
|Current assets:                                                                                            |  |                   |         |                  |   |         |  
|Cash and cash equivalents                                                                                  |  | $                 | 156,784 |                  | $ | 127,594 |  
|Accounts receivable                                                                                        |  |                   | 9,095   |                  |   | 4,602   |  
|Inventories                                                                                                |  |                   | 2,230   |                  |   |        |  
|Short term deferred tax assets                                                                             |  |                   | 1,190   |                  |   | 1,190   |  
|Other current assets                                                                                       |  |                   | 12,796  |                  |   | 1,039   |  
|                                                                                                           |  |                   |         |                  |   |         |  
|Total current assets                                                                                       |  |                   | 182,095 |                  |   | 134,425 |  
|                                                                                                           |  |                  
|Property and equipment, net                                                                                |  |                   | 25,232  |                  |   | 8,751   |  
|Intangible assets, net                                                                                     |  |                   | 28,422  |                  |   | 12,757  |  
|Goodwill                                                                                                   |  |                   | 36,305  |                  |   | 24,154  |  
|Long term deferred tax assets                                                                              |  |                   | 25,296  |                  |   | 9,982   |  
|Other assets                                                                                               |  |                   | 368     |                  |   | 58      |  
|                                                                                                           |  |                   |         |                  |   |         |  
|Total assets                                                                                               |  | $                 | 297,718 |                  | $ | 190,127 |  
|                                                                                                           |  |                   |         |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                       |  |                   |         |                  |   |         |  
|Current liabilities:                                                                                       |  |                   |         |                  |   |         |  
|Accounts payable                                                                                           |  | $                 | 3,031   |                  | $ | 3,043   |  
|Accrued legal fees                                                                                         |  |                   | 1,788   |                  |   | 2,946   |  
|Accrued liabilities                                                                                        |  |                   | 4,780   |                  |   | 3,497   |  
|Deferred revenue                                                                                           |  |                   | 859     |                  |   | 324     |  
|Income tax payable                                                                                         |  |                   | 31,788  |                  |   | 359     |  
|                                                                                                           |  |                   |         |                  |   |         |  
|Total current liabilities                                                                                  |  |                   | 42,246  |                  |   | 10,169  |  
|                                                                                                           |  |                  
|Long term deferred tax liabilities                                                                         |  |                   | 8,990   |                  |   |        |  
|                                                                                                           |  |                   |         |                  |   |         |  
|Total liabilities                                                                                          |  |                   | 51,236  |                  |   | 10,169  |  
|                                                                                                           |  |                  
|Commitments and contingencies (Note 11)                                                                    |  |                   |         |                  |   |         |  
|                                                                                                           |  |                  
|Stockholders equity:                                                                                      |  |                   |         |                  |   |         |  
|Common stock: $0.001 par value; 150,000 shares authorized; 46,771 and 45,124 shares issued and outstanding |  |                   | 47      |                  |   | 45      |  
|Additional paid-in capital                                                                                 |  |                   | 199,483 |                  |   | 182,720 |  
|Deferred stock-based compensation                                                                          |  |                   |        |                  |   | (2,245  | )
|Retained earnings (accumulated deficit)                                                                    |  |                   | 46,952  |                  |   | (562    | )
|                                                                                                           |  |                   |         |                  |   |         |  
|Total stockholders equity                                                                                 |  |                   | 246,482 |                  |   | 179,958 |  
|                                                                                                           |  |                   |         |                  |   |         |  
|Total liabilities and stockholders equity                                                                 |  | $                 | 297,718 |                  | $ | 190,127 |  
|                                                                                                           |  |                   |         |                  |   |         |  

The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.



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TESSERA TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|------------------------------------------------------------------------- |  | ------------------------------- | ------- | ------------------------------ | - | ------ |  | ---- | ------- |  | - | ------
|                                                                          |  | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30,
|                                                                          |  | 2006                            |         | 2005                           |   | 2006   |  | 2005
|Revenues:                                                                 |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Royalty and license fees                                                  |  | $                               | 25,916  |                                | $ | 14,113 |  | $    | 64,817  |  | $ | 39,238
|Past production payments                                                  |  |                                 | 76,000  |                                |   | 1,161  |  |      | 77,633  |  |   | 18,830
|Product and service revenues                                              |  |                                 | 8,625   |                                |   | 4,470  |  |      | 16,014  |  |   | 12,036
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Total revenues                                                            |  |                                 | 110,541 |                                |   | 19,744 |  |      | 158,464 |  |   | 70,104
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Operating expenses:                                                       |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Cost of revenues                                                          |  |                                 | 6,201   |                                |   | 3,059  |  |      | 13,623  |  |   | 9,309 
|Research, development and other related costs                             |  |                                 | 5,317   |                                |   | 2,074  |  |      | 12,589  |  |   | 5,225 
|Selling, general and administrative                                       |  |                                 | 20,116  |                                |   | 7,744  |  |      | 54,091  |  |   | 19,378
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Total operating expenses                                                  |  |                                 | 31,634  |                                |   | 12,877 |  |      | 80,303  |  |   | 33,912
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Operating income                                                          |  |                                 | 78,907  |                                |   | 6,867  |  |      | 78,161  |  |   | 36,192
|Other income, net                                                         |  |                                 | 1,677   |                                |   | 1,067  |  |      | 4,401   |  |   | 2,427 
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Income before taxes                                                       |  |                                 | 80,584  |                                |   | 7,934  |  |      | 82,562  |  |   | 38,619
|Provision for income taxes                                                |  |                                 | 33,229  |                                |   | 2,904  |  |      | 35,048  |  |   | 13,921
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Net income                                                                |  | $                               | 47,355  |                                | $ | 5,030  |  | $    | 47,514  |  | $ | 24,698
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Basic and diluted net income per share:                                   |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Net income per share; basic                                               |  | $                               | 1.02    |                                | $ | 0.11   |  | $    | 1.04    |  | $ | 0.56  
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Net income per share; diluted                                             |  | $                               | 0.98    |                                | $ | 0.11   |  | $    | 0.99    |  | $ | 0.52  
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Weighted average number of shares used in per share calculations; basic   |  |                                 | 46,252  |                                |   | 44,452 |  |      | 45,892  |  |   | 43,720
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       
|Weighted average number of shares used in per share calculations; diluted |  |                                 | 48,422  |                                |   | 47,632 |  |      | 48,131  |  |   | 47,727
|                                                                          |  |                                 |         |                                |   |        |  |      |         |  |   |       

The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.



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TESSERA TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                              |  |                                |         |   |      |   |         |  
|----------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                              |  | Nine Months EndedSeptember 30, |        
|                                                                              |  | 2006                           |         |   | 2005 |  
|Cash flows from operating activities:                                         |  |                                |         |   |      |   |         |  
|Net income                                                                    |  | $                              | 47,514  |   |      | $ | 24,698  |  
|Adjustments to reconcile income to net cash provided by operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                                 |  |                                | 4,701   |   |      |   | 1,099   |  
|Gain on disposal of fixed assets                                              |  |                                | (8      | ) |      |   | (4      | )
|Stock-based compensation, net                                                 |  |                                | 10,950  |   |      |   | 840     |  
|Gross tax windfall from stock-based compensation                              |  |                                | (423    | ) |      |   |        |  
|Changes in operating assets and liabilities, net of acquisitions:             |  |                                |         |   |      |   |         |  
|Accounts receivable                                                           |  |                                | (1,484  | ) |      |   | (2,531  | )
|Inventories                                                                   |  |                                | 655     |   |      |   |        |  
|Deferred tax assets                                                           |  |                                |        |   |      |   | 10,925  |  
|Other assets                                                                  |  |                                | (11,954 | ) |      |   | (526    | )
|Accounts payable                                                              |  |                                | (577    | ) |      |   | 689     |  
|Accrued legal fees                                                            |  |                                | (1,158  | ) |      |   | 722     |  
|Accrued liabilities                                                           |  |                                | (3,281  | ) |      |   | 90      |  
|Deferred revenue                                                              |  |                                | 529     |   |      |   | 42      |  
|Income tax payable                                                            |  |                                | 31,429  |   |      |   | (3      | )
|                                                                              |  |                                |         |   |      |   |         |  
|Net cash provided by operating activities                                     |  |                                | 76,893  |   |      |   | 36,041  |  
|                                                                              |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                         |  |                                |         |   |      |   |         |  
|Purchases of property and equipment                                           |  |                                | (1,677  | ) |      |   | (2,967  | )
|Purchases of intangible assets                                                |  |                                |        |   |      |   | (6,073  | )
|Proceeds from sale of fixed assets                                            |  |                                | 8       |   |      |   | 4       |  
|Acquisitions, net of cash acquired                                            |  |                                | (54,517 | ) |      |   |        |  
|                                                                              |  |                                |         |   |      |   |         |  
|Net cash used in investing activities                                         |  |                                | (56,186 | ) |      |   | (9,036  | )
|                                                                              |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                         |  |                                |         |   |      |   |         |  
|Excess tax benefit from stock-based compensation                              |  |                                | 423     |   |      |   |        |  
|Proceeds from exercise of stock options and warrants, net                     |  |                                | 6,857   |   |      |   | 9,691   |  
|Proceeds from employee stock purchase program                                 |  |                                | 1,203   |   |      |   | 1,107   |  
|                                                                              |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                     |  |                                | 8,483   |   |      |   | 10,798  |  
|                                                                              |  |                                |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                     |  |                                | 29,190  |   |      |   | 37,803  |  
|Cash and cash equivalents at beginning of period                              |  |                                | 127,594 |   |      |   | 108,339 |  
|                                                                              |  |                                |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                    |  | $                              | 156,784 |   |      | $ | 146,142 |  
|                                                                              |  |                                |         |   |      |   |         |  

The accompanying notes are an integral part of these unaudited condensed consolidated financial
statements.



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TESSERA TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1  THE COMPANY AND BASIS OF
PRESENTATION

Tessera Technologies, Inc. (together with its subsidiaries, referred to as Tessera or the Company), is a provider
of miniaturization technologies for the electronics industry. Tessera enables improvements in miniaturization and performance by applying the Companys expertise in the electrical, thermal, mechanical and optical properties of materials and
interconnect. The Company develops and licenses technologies to the electronics industry. The Companys intellectual property portfolio includes over 950 patents and applications, covering a broad range of advanced semiconductor packaging,
interconnect and micro-optics solutions. The Company licenses their technology to customers, enabling them to produce semiconductor chips that are smaller and faster, and incorporate more features. These semiconductors are utilized in a broad range
of electronics products, including digital audio players, digital cameras, personal computers, personal digital assistants, video game consoles and mobile phones.

The consolidated financial statements include the accounts of Tessera Technologies, Inc. and each of its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying interim unaudited condensed consolidated financial statements as of September 30, 2006 and 2005, and for the three and nine months then ended, have
been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). The amounts as of December 31, 2005 have been derived from the Companys annual audited financial
statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in accordance with
such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial
position of the Company and its results of operations and cash flows as of and for the periods presented. These financial statements should be read in conjunction with the annual audited financial statements and notes thereto as of and for the year
ended December 31, 2005, included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

The results of
operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006 or any future period and the Company makes no representations
related thereto.

The Companys fiscal year ends on December 31. For quarterly reporting, the Company employs a four-week, four-week, five-week
reporting period. The current three-month period ended on Sunday, October 1, 2006. For presentation purposes, the financial statements and notes have been presented as ending on the last day of the nearest calendar month, September 30,
2006.

NOTE 2  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United
States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates and assumptions that require managements most significant,
difficult, and subjective judgment include the recognition and measurement of current and deferred income tax assets and liabilities, and the assessment of recoverability of long-lived assets. Actual results experienced by the company may differ
from managements estimates.

Cash and cash equivalents

All highly liquid investments with original maturities of three months or less from the date of purchase are classified as cash and cash equivalents.

Fair value of financial instruments

The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties. The carrying amounts for cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued liabilities approximate
their respective fair values because of the short-term maturity of these items.

Concentration of credit risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents and accounts receivable.
The Company invests primarily in money market funds and high quality commercial paper instruments. Cash equivalents are maintained with high quality institutions, the composition and maturities of which are regularly monitored by management. The
Company believes that the concentration of credit risk in its trade receivables is substantially mitigated by the Companys evaluation process, relatively short collection terms and the high level of credit worthiness of its customers. The
Company performs ongoing credit evaluations of its customers financial condition and limits the amount of credit extended when deemed necessary, but generally requires no collateral.

The Companys accounts receivable are concentrated with two customers at September 30, 2006, representing 32% and 16% of aggregate gross trade receivables, and
three customers at September 30, 2005, representing 44%, 24% and 19% of aggregate gross trade receivables.

Inventories

Inventories are stated at the lower of cost or market, cost being determined under the first-in-first-out method. Appropriate consideration is given to obsolescence,
excessive levels, determination and other factors in evaluating net realizable value.



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Impairment of long-lived assets

The Company evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. When events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, the Company recognizes impairment if the net book value of such assets exceeds the future undiscounted
cash flows attributed to such assets. The Company assesses the impairment in value to its long-lived assets whenever events or circumstances indicate that their carrying value may not be recoverable. Factors the Company considers important that
could trigger an impairment review include operating losses, significant negative industry trends, significant underutilization of the assets and significant changes in how it uses the assets or its plans for its use. No impairment losses were
incurred in the periods presented.

Goodwill and identified intangible assets

Identified intangible assets consist of acquired patents, existing technology, trade names and customer contracts that are amortized on a straight-line basis over their estimated useful lives, ranging from 5 to 15
years.

The Company evaluates the recoverability of goodwill recorded in connection with acquisitions annually, whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The impairment test is a two-step process. The first step requires comparing the fair value of
each reporting unit with allocated goodwill to its net book value. The Company uses management estimates of future cash flows to perform the first step of the goodwill impairment test. These estimates include assumptions about future conditions such
as future revenues, gross margins and operating expenses. The Company uses discounted cash flow and market multiple methodologies to obtain the fair value for each reporting unit. The second step is only performed if impairment is indicated after
the first step is performed, as it involves measuring the actual impairment to goodwill. No goodwill impairment was recorded for the periods presented.

Revenue recognition

The Company accounts for its revenues under the provisions of Staff Accounting Bulletin (SAB)
No. 104, Revenue Recognition. Under the provisions of SAB No. 104, the Company recognizes revenues when there is persuasive evidence of an arrangement, delivery has occurred, the fee is fixed and determinable, and
collectibility of the resulting receivable is reasonably assured.

Royalty and license fees revenues

Royalty and license fees revenues include revenues from license fees and from royalty payments. Licensees typically pay a non-refundable license fee. Revenues from
license fees are generally recognized at the time the license agreement is executed by both parties. In some instances, the Company provides training to its licensees under the terms of the license agreement. The amount of training provided is
limited and is incidental to the licensed technology. Accordingly, in instances where training is provided under the terms of a license agreement, a portion of the license fee is deferred until such training has been provided. The amount of revenues
deferred is the estimated fair value of the services, which is based on the price the Company charges for similar services when they are sold separately. These revenues are reported as service revenues. Semiconductor manufacturers and assemblers pay
on-going royalties on their shipment of semiconductors incorporating the Companys intellectual property. Royalties under the Companys royalty-based technology licenses are generally based upon either unit volumes of semiconductors
shipped using the Companys technology or a percent of the net sales price. Licensees generally report shipment information 30 to 60 days after the end of the quarter in which such activity takes place. As there is no reliable basis on which
the Company can estimate its royalty revenues prior to obtaining these reports from the licensees, the Company recognizes royalty revenues on a one-quarter lag.

Past production payments revenues

Past production payments revenues are royalty payments received through license negotiations or the
resolution of patent disputes. Such negotiations and resolutions arise when it comes to the Companys attention that a third party is infringing on patents or a current licensee is not paying royalties to which the Company it is entitled. Past
production payments revenues represent the portion of royalty payments received through such license negotiations or resolution of patent disputes that relates to previous periods and are based on historical production volumes.

Revenues are recognized upon execution of the agreement by both parties, provided that the amounts are fixed or determinable, there are no significant Company
obligations and collection is reasonably assured. The Company does not recognize any revenues prior to execution of the agreement as there is no reliable basis on which the Company can estimate the amounts for royalties related to previous periods
or assess collectibility.

Product and Service revenues

The Company utilizes the completed-contract and the percentage-of-completion methods of accounting for commercial and government contracts, dependent upon the type of the contract. The completed-contract method of accounting is used for
fixed-fee contracts with relatively short delivery times. Revenues from fixed-fee and fixed-priced contracts are recognized upon acceptance by the customer or in accordance to the contract specifications, assuming title and risk of loss has
transferred to the customer, prices are fixed and determinable, no significant Company obligations remain, and collection of the related receivable is reasonably assured.

The Company uses the percentage-of-completion method of accounting for cost reimbursement-type contracts, which generally specify the reimbursable costs and a certain billable fee amount. Under the
percentage-of-completion method, revenues recognized are that portion of the total contract price equal to the ratio of costs expended to date to the anticipated final total costs based on current estimates of the costs to complete the projects. If
the total estimated costs to complete a project were to exceed the total contract amount, indicating a loss, the entire anticipated loss would be recognized immediately. Revenues, including estimated earned fees, under cost reimbursement-type
contracts are recognized as costs are incurred, assuming that the fee is fixed or determinable and collection is reasonably assured.

Claims made for
amounts in excess of the agreed contract price are recognized only if it is probable that the claim will result in additional revenue and the amount of additional revenue can be reliably estimated.



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The following table sets forth sales to customers comprising 10% or more of the Companys total revenues for the
periods indicated:



|                        |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|----------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                        |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                        |  | 2006                             |   |  | 2005                            |   |  | 2006 |   |  | 2005 |  
|Customer                |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|Micron Technology, Inc. |  | 27                               | % |  |                                |   |  | 19   | % |  |     |  
|Qimonda AG.             |  | 36                               | % |  |                                |   |  | 25   | % |  |     |  
|Texas Instruments, Inc  |  | *                                |   |  | 19                              | % |  | *    |   |  | 17   | %
|Samsung Electronics     |  | *                                |   |  | 13                              | % |  | *    |   |  | 22   | %



---

* Less than 10%

Indemnification

The Company does not have guarantees required to be disclosed under Financial Accounting Standards Board Interpretation (FIN)
No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. However, some of the Companys technology license agreements provide certain types of
indemnification for customers regarding intellectual property infringement claims. Also, the Company indemnifies its officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to its certificate of
incorporation, bylaws and applicable Delaware law. As of September 30, 2006, no such claims have been filed against the Company and no liability has been accrued.

Research, development and other related costs

Research, development and other related costs consist primarily
of compensation and related costs for personnel, as well as costs related to patent prosecution, materials, supplies and equipment depreciation. All research, development and other related costs are expensed as incurred. Research, development and
other related costs, excluding costs related to patent prosecution for the three and nine months ended September 30, 2006 and 2005 were $4,969,000, $11,252,000, $1,704,000 and $3,978,000, respectively.

Income taxes

The Company accounts for its income taxes under
the liability method. Under this method, deferred tax assets and liabilities are determined on the basis of the difference between income tax bases of assets and liabilities and their respective financial reporting amounts at enacted tax rates in
effect for the periods in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to their realizable value when management cannot conclude based on available objective
evidence that it is more likely than not that the benefit will be realized for the deferred tax assets.

NOTE 3  RECENT ACCOUNTING PRONOUNCEMENTS

In June 2006, the Financial Accounting Standards Board (FASB) issued FIN No. 48, Accounting for Uncertainty in Income
Taxes  An Interpretation of SFAS No. 109. This Interpretation contains two-step process. The first step is evaluating the tax position for recognition by determining whether it is more-likely-than-not a tax position will be
sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is to measure the tax benefit at the largest amount that is greater than 50% likely of
being realized upon ultimate settlement. This Interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently in the process of assessing the adoption of this statement.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108 regarding the process of
quantifying financial statement misstatements. SAB No. 108 states that registrants should use both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement. The interpretations
in SAB No. 108 contain guidance on correcting errors under the dual approach as well as provide transition guidance for correcting errors. This interpretation does not change the requirements within SFAS No. 154, Accounting Changes
and Error Corrections  a replacement of Accounting Principles Board Opinion (APB) No. 20 and SFAS No. 3, for the correction of an error on financial statements. SAB No. 108 is effective for annual financial
statements covering the first fiscal year ending after November 15, 2006. The Company will be required to adopt this interpretation by December 31, 2006. The Company is currently evaluating the requirements of SAB No. 108 and the
impact this interpretation may have on its financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements. This standard defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. This
pronouncement applies under other accounting standards that require or permit fair value measurements. Accordingly, this statement does not require any new fair value measurement. This statement is effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company will be required to adopt SFAS No. 157 in the first quarter of fiscal year 2008. The Company is currently evaluating the requirements of SFAS No. 157 and
has not yet determined the impact on its financial statements.



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NOTE 4  COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

Cash and cash equivalents consists of the following (in thousands):



|                   |  |                   |         |                  |   |        
|------------------ |  | ----------------- | ------- | ---------------- | - | -------
|                   |  | September 30,2006 |         | December 31,2005
|Cash               |  | $                 | 20,160  |                  | $ | 16,143 
|Money market funds |  |                   | 136,624 |                  |   | 111,451
|                   |  |                   |         |                  |   |        
|                   |  | $                 | 156,784 |                  | $ | 127,594
|                   |  |                   |         |                  |   |        

Accounts receivable consists of the following (in thousands):



|      |  |                   |       |                  |   |      
|----- |  | ----------------- | ----- | ---------------- | - | -----
|      |  | September 30,2006 |       | December 31,2005
|Trade |  | $                 | 3,385 |                  | $ | 1,629
|Other |  |                   | 5,710 |                  |   | 2,973
|      |  |                   |       |                  |   |      
|      |  | $                 | 9,095 |                  | $ | 4,602
|      |  |                   |       |                  |   |      

Inventories consists of the following (in thousands):



|                |  |                   |       |                  |   |  
|--------------- |  | ----------------- | ----- | ---------------- | - | -
|                |  | September 30,2006 |       | December 31,2005
|Raw materials   |  | $                 | 241   |                  | $ | 
|Work in process |  |                   | 1,001 |                  |   | 
|Finished goods  |  |                   | 988   |                  |   | 
|                |  |                   |       |                  |   |  
|                |  | $                 | 2,230 |                  | $ | 
|                |  |                   |       |                  |   |  

Other current assets consists of the following (in thousands):



|                                 |  |                   |        |                  |   |      
|-------------------------------- |  | ----------------- | ------ | ---------------- | - | -----
|                                 |  | September 30,2006 |        | December 31,2005
|Foreign taxes withholding refund |  | $                 | 10,550 |                  | $ |     
|Other                            |  |                   | 2,246  |                  |   | 1,039
|                                 |  |                   |        |                  |   |      
|                                 |  | $                 | 12,796 |                  | $ | 1,039
|                                 |  |                   |        |                  |   |      

Property and equipment consists of the following (in thousands):



|                                                |  |                   |         |   |                  |   |         |  
|----------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                |  | September 30,2006 |         |   | December 31,2005 |  
|Furniture and equipment                         |  | $                 | 22,659  |   |                  | $ | 17,434  |  
|Land and building                               |  |                   | 16,607  |   |                  |   | 1,886   |  
|                                                |  |                   |         |   |                  |   |         |  
|                                                |  |                   | 39,266  |   |                  |   | 19,320  |  
|Less: Accumulated depreciation and amortization |  |                   | (14,034 | ) |                  |   | (10,569 | )
|                                                |  |                   |         |   |                  |   |         |  
|                                                |  | $                 | 25,232  |   |                  | $ | 8,751   |  
|                                                |  |                   |         |   |                  |   |         |  

Accrued liabilities consist of the following (in thousands):



|                                   |  |                   |       |                  |   |      
|---------------------------------- |  | ----------------- | ----- | ---------------- | - | -----
|                                   |  | September 30,2006 |       | December 31,2005
|Employee compensation and benefits |  | $                 | 3,523 |                  | $ | 2,723
|Professional services              |  |                   | 443   |                  |   | 571  
|Other                              |  |                   | 814   |                  |   | 203  
|                                   |  |                   |       |                  |   |      
|                                   |  | $                 | 4,780 |                  | $ | 3,497
|                                   |  |                   |       |                  |   |      



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NOTE 5  BUSINESS COMBINATIONS

North Corporation

In May 2005, Tessera entered into a number of new agreements with North Corporation
(North), which included the acquisition of 100% ownership of all United States patents and applications filed by North, joint ownership of patents and applications filed in other jurisdictions and the right to sublicense certain other
patents currently owned by North, for $6,073,000. Tessera has recorded these patents and license rights as intangible assets, and is amortizing them over their respective estimated useful lives, currently estimated at 15 years.

Shellcase, Ltd.

On December 21, 2005, Tessera completed its
purchase of certain intellectual property and related assets of Shellcase, Ltd. (Shellcase), an Israeli company. Shellcase was engaged in developing, manufacturing and marketing advanced packaging technologies for microelectronic
integrated circuits.

Purchase price allocation

In accordance to SFAS No. 141, Business Combination, the purchase price of the acquisition is $34.7 million, which has been determined as follows (in thousands):



|                     |  |   |       
|-------------------- |  | - | ------
|Cash                 |  | $ | 33,590
|Transaction costs    |  |   | 1,109 
|                     |  |   |       
|Total purchase price |  | $ | 34,699
|                     |  |   |       

The purchase price has been allocated as follows (in thousands):



|                              |  |   |       
|----------------------------- |  | - | ------
|Property and equipment        |  | $ | 3,583 
|                              | 
|Identified intangible assets: |  |   |       
|Existing technology           |  |   | 6,700 
|Trade name                    |  |   | 220   
|Goodwill                      |  |   | 24,196
|                              |  |   |       
|Total purchase price          |  | $ | 34,699
|                              |  |   |       

A $6.9 million has been allocated to amortizable intangible assets consisting of existing patented technology and
trade names with estimated useful lives of ten years. Goodwill recognized in the transaction totaled $24.2 million, of which none is deducible for tax purposes. Goodwill represents the excess of the purchase price over the fair value of the
underlying net tangible and identifiable intangible assets. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill will not be amortized but instead will be tested for impairment at least annually (more
frequently if certain indicators are present). In the event that management determined that the value of goodwill has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the
determination is made.

Digital Optics Corporation

On
July 18, 2006, Tessera completed its acquisition of Digital Optics Corporation (Digital Optics), a Delaware corporation, whereby Digital Optics became a wholly owned subsidiary of Tessera in a transaction accounted for using the
purchase accounting method. The preliminary purchase price of $59.8 million includes cash of $58.6 million, for all outstanding shares of capital stock and vested stock options, and transaction costs of $1.2 million. The merger consideration of $8.0
million was held in escrow and is subject to forfeiture to satisfy the indemnification obligations, if any, of the former stockholders of Digital Optics and to serve to as security for the purchase price. Subsequent to the end of the quarter, $0.9
million of the escrow amount has been returned to Tessera, and $1.1 million was returned to former stockholders of Digital Optics. The remaining balance of $6.0 million will expire 18 months following the closing date in July, 2006. All
interest and other income earned from the investment will be allocated and distributed to the former stockholders of Digital Optics.

Preliminary
purchase price allocation

In accordance to SFAS No. 141, Business Combinations, the preliminary purchase price of the acquisition
is approximately $59.8 million, which has been determined as follows (in thousands):



|                                 |  |   |       
|-------------------------------- |  | - | ------
|Cash                             |  | $ | 58,644
|Transaction costs                |  |   | 1,177 
|                                 |  |   |       
|Total preliminary purchase price |  | $ | 59,821
|                                 |  |   |       



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##### Table of Contents

Under the purchase method of accounting, the total purchase price as shown in the table above is allocated to the
tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. Based upon the fair values acquired, the purchase price allocation is as follows (in thousands):



|                                             |  |        |        |   |                      |       
|-------------------------------------------- |  | ------ | ------ | - | -------------------- | ------
|                                             |  | Amount |        |   | EstimatedUseful Life
|                                             |  |        |        |   | (Years)             
|Net tangible assets:                         |  |        |        |   |                      |       
|Current assets                               |  | $      | 8,468  |   |                      | N/A   
|Inventory, net                               |  |        | 2,885  |   |                      | N/A   
|Property and equipment, net                  |  |        | 18,270 |   |                      | N/A   
|Long term assets                             |  |        | 6,324  |   |                      | N/A   
|Current liabilities                          |  |        | (5,123 | ) |                      | N/A   
|Long term debt                               |  |        | (12    | ) |                      | N/A   
|                                             |  |        |        |   |                      |       
|                                             |  |        | 30,812 |   |                      |       
|Identified intangible assets:                |  |        |        |   |                      |       
|Existing technology                          |  |        | 6,700  |   |                      | 5 - 7 
|Patents/core technology                      |  |        | 5,200  |   |                      | 7 - 10
|Customer contracts and related relationships |  |        | 1,900  |   |                      | 4     
|Trade name/trademark                         |  |        | 3,100  |   |                      | 10    
|Goodwill                                     |  |        | 12,109 |   |                      | N/A   
|                                             |  |        |        |   |                      |       
|                                             |  |        | 29,009 |   |                      |       
|                                             |  |        |        |   |                      |       
|Total preliminary purchase price             |  | $      | 59,821 |   |                      |       
|                                             |  |        |        |   |                      |       

$30.8 million has been allocated to acquire net tangible assets consisting of inventory, property and equipment
and various assumed assets and liabilities. Approximately $16.9 million has been allocated to amortizable intangible assets acquired. The depreciation and amortization related to the fair value adjustments to net tangible assets and the amortization
related to the amortizable intangible assets are reflected as pro forma adjustments to the unaudited pro forma condensed combined statements of income.

Identified intangible assets

Existing Technology  $6.7 million has been allocated to Existing Technology which relates to Digital
Optics products across all of their product lines which have reached technological feasibility. The fair value of these assets will be amortized on a straight line basis over estimated useful life ranging from 5 to 7 years.

Patents and core technology  $5.2 million has been allocated to Patents/Core Technology which represent the combination of Digital Optics processes, patents
and trade secrets developed through years of experience in design and development of their products. The fair value of these assets will be amortized on a straight line basis over estimated useful life ranging from 7 to 10 years.

Customer contracts and related relationships  $1.9 million has been allocated to Customer Contacts and Related Relationships which represents existing contracts
that relate primarily to underlying customer relationships. The fair value of these assets will be amortized on a straight-line basis over an estimated useful life of 4 years.

Trade name and trademark  $3.1 million has been allocated to Trade Name/Trademark which relates to the Digital Optics trade name. The fair value of these assets will be amortized on a straight-line basis over an
estimated useful life of 10 years.

Goodwill  Tessera acquired Digital Optics with the intent of furthering the companys core manufactured
business and of extending the companys technology and intellectual property in building a larger technology-licensing business in micro-optics for the consumer electronics industry. These factors primarily contributed to a purchase price in
excess of the fair value of the underlying net tangible and intangible assets. Goodwill recognized in this transaction totaled $12.1 million, of which $12.1 million is expected to be deductible for tax purposes. In accordance with the SFAS No. 142,
Goodwill and Other Intangible Assets, goodwill will not be amortized but instead will be tested for impairment at least annually (more frequently if certain indicators are present). In the event that the management determined that the
value of goodwill has become impaired, the Company will incur an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made.



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##### Table of Contents

Pro forma results

The results of operations of the acquisitions have been included in the Companys consolidated statement of operations since the completion of the acquisition. The following unaudited pro forma information presents a summary of the
results of operations of the Company assuming the acquisitions occurred at the beginning of the periods presented (in thousands, except for per share amounts):



|                             |  |                                 |         |                                |   |        |  |      |         |  |   |       
|---------------------------- |  | ------------------------------- | ------- | ------------------------------ | - | ------ |  | ---- | ------- |  | - | ------
|                             |  | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30,
|                             |  | 2006                            |         | 2005                           |   | 2006   |  | 2005
|Net revenues                 |  | $                               | 110,541 |                                | $ | 24,897 |  | $    | 171,302 |  | $ | 84,257
|Net income                   |  | $                               | 47,355  |                                | $ | 3,394  |  | $    | 49,701  |  | $ | 19,821
|Basic net income per share   |  | $                               | 1.02    |                                | $ | 0.08   |  | $    | 1.08    |  | $ | 0.45  
|Diluted net income per share |  | $                               | 0.98    |                                | $ | 0.07   |  | $    | 1.03    |  | $ | 0.42  

NOTE 6  GOODWILL AND IDENTIFIED INTANGIBLE ASSETS

The allocation of goodwill to segments and the changes to the carrying value for the nine months ended September 30, 2006 was reflected below (in thousands):



|                                                         |  |                      |        |          |   |        |  |   |       
|-------------------------------------------------------- |  | -------------------- | ------ | -------- | - | ------ |  | - | ------
|                                                         |  | IntellectualProperty |        | Services |   | Total 
|January 1, 2006                                          |  | $                    | 24,154 |          | $ |       |  | $ | 24,154
|Goodwill acquired through the Digital Optics acquisition |  |                      |       |          |   | 12,109 |  |   | 12,109
|Goodwill adjustments (a)                                 |  |                      | 42     |          |   |       |  |   | 42    
|                                                         |  |                      |        |          |   |        |  |   |       
|September 30, 2006                                       |  | $                    | 24,196 |          | $ | 12,109 |  | $ | 36,305
|                                                         |  |                      |        |          |   |        |  |   |       

---

|(a) | During the nine months ended September 30, 2006, the Company adjusted the goodwill related to prior acquisitions for individually insignificant amount based on continued
post-closing review.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Identified intangible assets consists of the following (in thousands):



|                    |  |             |  |                    |        |                         |   |        |     |  |             |        |                         |   |        |     |   |      |   |  |   |       
|------------------- |  | ----------- |  | ------------------ | ------ | ----------------------- | - | ------ | --- |  | ----------- | ------ | ----------------------- | - | ------ | --- | - | ---- | - |  | - | ------
|                    |  |             |  | September 30, 2006 |        | December 31, 2005      
|                    |  | AverageLife |  | GrossAssets        |        | AccumulatedAmortization |   |        | Net |  | GrossAssets |        | AccumulatedAmortization |   |        | Net
|                    |  | (Years)     |  |                    |        |                         |   |        |     |  |             |        |                         |   |        |    
|Acquired patents    |  | 7 - 15      |  | $                  | 11,273 |                         | $ | (639   | )   |  | $           | 10,634 |                         | $ | 6,073  |     | $ | (236 | ) |  | $ | 5,837 
|Existing technology |  | 5 - 10      |  |                    | 13,400 |                         |   | (686   | )   |  |             | 12,714 |                         |   | 6,700  |     |   |     |   |  |   | 6,700 
|Trade name          |  | 10          |  |                    | 3,320  |                         |   | (67    | )   |  |             | 3,253  |                         |   | 220    |     |   |     |   |  |   | 220   
|Customer contracts  |  | 4           |  |                    | 1,900  |                         |   | (79    | )   |  |             | 1,821  |                         |   |       |     |   |     |   |  |   |      
|                    |  |             |  |                    |        |                         |   |        |     |  |             |        |                         |   |        |     |   |      |   |  |   |       
|                    |  |             |  | $                  | 29,893 |                         | $ | (1,471 | )   |  | $           | 28,422 |                         | $ | 12,993 |     | $ | (236 | ) |  | $ | 12,757
|                    |  |             |  |                    |        |                         |   |        |     |  |             |        |                         |   |        |     |   |      |   |  |   |       

Amortization expense for the three and nine months ended September 30, 2006 and 2005 amounted to $687,000,
$1,235,000, $102,000 and $134,000, respectively.

As of September 30, 2006, the estimated future amortization expense of purchased intangible assets
is as follows (in thousands):



|                          |  |   |       
|------------------------- |  | - | ------
|2006 (remaining 3 months) |  | $ | 893   
|2007                      |  |   | 3,571 
|2008                      |  |   | 3,571 
|2009                      |  |   | 3,572 
|2010                      |  |   | 3,374 
|Thereafter                |  |   | 13,441
|                          |  |   |       
|                          |  | $ | 28,422
|                          |  |   |       



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NOTE 7  NET INCOME PER SHARE

The Company reports both basic net income per share, which is based upon the weighted average number of common shares outstanding excluding returnable shares, and diluted net income per share, which is based on the
weighted average number of common shares outstanding and dilutive potential common shares outstanding.

The following table sets forth the computation of
basic and diluted net income per share (in thousands, except per share amounts):



|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                    |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                    |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005   |  
|Numerator:                                                          |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income                                                          |  | $                               | 47,355 |   |                                | $ | 5,030  |      |  | $ | 47,514 |   |  | $ | 24,698 |  
|                                                                    |  |                                 |        |  
|Denominator:                                                        |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Weighted average common shares outstanding                          |  |                                 | 46,579 |   |                                |   | 44,554 |      |  |   | 46,219 |   |  |   | 43,771 |  
|Less: Weighted average unvested common shares subject to repurchase |  |                                 | (327   | ) |                                |   | (102   | )    |  |   | (327   | ) |  |   | (51    | )
|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total shares; basic                                                 |  |                                 | 46,252 |   |                                |   | 44,452 |      |  |   | 45,892 |   |  |   | 43,720 |  
|                                                                    |  |                                 |        |  
|Effect of dilutive securities                                       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Stock options, unvested restricted stocks and warrants              |  |                                 | 1,843  |   |                                |   | 3,078  |      |  |   | 1,912  |   |  |   | 3,956  |  
|Unvested common shares subject to repurchase                        |  |                                 | 327    |   |                                |   | 102    |      |  |   | 327    |   |  |   | 51     |  
|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total shares; diluted                                               |  |                                 | 48,422 |   |                                |   | 47,632 |      |  |   | 48,131 |   |  |   | 47,727 |  
|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income per common share; basic                                  |  | $                               | 1.02   |   |                                | $ | 0.11   |      |  | $ | 1.04   |   |  | $ | 0.56   |  
|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income per common share; diluted                                |  | $                               | 0.98   |   |                                | $ | 0.11   |      |  | $ | 0.99   |   |  | $ | 0.52   |  
|                                                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  

For the three and nine months ended September 30, 2006 and 2005, a total of 2,089,000, 1,726,000, 925,000 and
260,000 common stock options were excluded from the computation of diluted net income per share as they were considered to have an antidilutive effect, respectively.

NOTE 8  STOCK-BASED COMPENSATION

On January 1, 2006, the Company adopted SFAS No. 123 (revised
2004), Share-Based Payment, (SFAS No. 123(R)) under which the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and
employee stock purchases under the Companys Employee Stock Purchase Plan based on estimated fair values was required. SFAS No. 123(R) supersedes the Companys previous accounting under APB No. 25, Accounting for Stock
Issued to Employees, for periods beginning in fiscal year 2006. In March 2005, the SEC issued SAB No. 107 relating to SFAS No. 123(R).

SFAS No. 123(R) requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the Companys Condensed Consolidated Statement of Operations.

The Company has applied the provisions of
SAB No. 107 in its adoption of SFAS No. 123(R). Thus, the Company adopted SFAS No. 123(R) in accordance with the modified prospective transition method on January 1, 2006. In accordance with the modified prospective transition
method, the Companys Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include the impact of SFAS No. 123(R). The valuation provisions of SFAS No. 123(R) apply to new awards
and to awards that are outstanding on the effective date and subsequently modified or cancelled. Historically, the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB
No. 25 and only disclosed the impact of SFAS No. 123 within the footnote disclosures of the Companys financial statements. Thus, no stock-based compensation expense had been recognized in the Companys Condensed Consolidated
Statement of Operations as permitted under SFAS No. 123.

In conjunction with the adoption of SFAS No. 123(R), the Company prospectively amended
its method of attributing the value of stock-based compensation to expense. Historically, the Company utilized the provisions of FIN No. 28 to recognize the expense associated with equity awards. This method allows for accelerated amortization
of stock based compensation expense over the vesting period of the award. As permitted by SFAS No. 123(R), the Company elected the straight-line method of expensing all stock based compensation awarded subsequent to the adoption of SFAS
No. 123(R). Thus, compensation expense for all stock-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the accelerated approach under FIN No. 28, while compensation expense for all
stock-based payment awards granted on or after January 1, 2006 will be recognized using the straight-line method.

The Company will continue to use
the Black-Scholes valuation model to determine the estimated fair value of stock-based awards since this model utilizes the following award attributes to determine the estimated fair value of stock-based awards: fair value at date of grant, exercise
price, risk free interest rate, volatility, expected life of the award, forfeiture rate and dividend rate.



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##### Table of Contents

The following table depicts the calculations prior to the adoption of the SFAS No. 123(R)(in
thousands, except per share amounts):



|                                                                                                                                 |  |                                      |        |   |                                     |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | - | ----------------------------------- | - | ------- | -
|                                                                                                                                 |  | Three Months EndedSeptember 30, 2005 |        |   | Nine Months EndedSeptember 30, 2005 |  
|Net income - as reported                                                                                                         |  | $                                    | 5,030  |   |                                     | $ | 24,698  |  
|Plus: Stock-based employee compensation expense determined under APB Opinion No. 25, included in reported net income, net of
tax |  |                                      | 10     |   |                                     |   | 17      |  
|Less: Stock-based employee compensation expense determined under fair value based method, net of tax                             |  |                                      | (5,365 | ) |                                     |   | (11,300 | )
|                                                                                                                                 |  |                                      |        |   |                                     |   |         |  
|Net income - as adjusted                                                                                                         |  | $                                    | (325   | ) |                                     | $ | 13,415  |  
|                                                                                                                                 |  |                                      |        |   |                                     |   |         |  
|Basic net income per share:                                                                                                      |  |                                      |        |   |                                     |   |         |  
|As reported                                                                                                                      |  | $                                    | 0.11   |   |                                     | $ | 0.56    |  
|As adjusted                                                                                                                      |  | $                                    | (0.01  | ) |                                     | $ | 0.31    |  
|Diluted net income per share:                                                                                                    |  |                                      |        |   |                                     |   |         |  
|As reported                                                                                                                      |  | $                                    | 0.11   |   |                                     | $ | 0.52    |  
|As adjusted                                                                                                                      |  | $                                    | (0.01  | ) |                                     | $ | 0.28    |  

Impact of the adoption of SFAS No. 123(R)

The Company elected to adopt the modified prospective application method as provided by SFAS No. 123(R). Accordingly, during the three and nine months ended
September 30, 2006, the Company recorded stock-based compensation cost totaling the amount that would have been recognized had the fair value method been applied since the effective date of SFAS No. 123. Previously reported amounts have
not been restated. The following table summarizes stock-based compensation expense related to various operating activities for the three and nine months ended September 30, 2006 (in thousands, except per share amounts):



|                                            |  |                                      |        |   |                                     |   |        |  
|------------------------------------------- |  | ------------------------------------ | ------ | - | ----------------------------------- | - | ------ | -
|                                            |  | Three Months EndedSeptember 30, 2006 |        |   | Nine Months EndedSeptember 30, 2006 |  
|Cost of revenues                            |  | $                                    | 709    |   |                                     | $ | 2,319  |  
|Research, development & other related costs |  |                                      | 334    |   |                                     |   | 443    |  
|Selling, general & administrative           |  |                                      | 2,798  |   |                                     |   | 8,188  |  
|                                            |  |                                      |        |   |                                     |   |        |  
|Total stock-based compensation              |  |                                      | 3,841  |   |                                     |   | 10,950 |  
|Tax effect on stock-based compensation      |  |                                      | (1,001 | ) |                                     |   | (3,007 | )
|                                            |  |                                      |        |   |                                     |   |        |  
|Net effect on net income                    |  | $                                    | 2,840  |   |                                     | $ | 7,943  |  
|                                            |  |                                      |        |   |                                     |   |        |  
|Effect on earnings per share:               |  |                                      |        |   |                                     |   |        |  
|Basic                                       |  | $                                    | 0.06   |   |                                     | $ | 0.17   |  
|Diluted                                     |  | $                                    | 0.06   |   |                                     | $ | 0.17   |  

The stock-based compensation expense categorized by various equity components is summarized in the table below (in
thousands):



|                               |  |                                      |       |                                     |   |       
|------------------------------ |  | ------------------------------------ | ----- | ----------------------------------- | - | ------
|                               |  | Three Months EndedSeptember 30, 2006 |       | Nine Months EndedSeptember 30, 2006
|Employee stock options         |  | $                                    | 2,878 |                                     | $ | 8,763 
|Restricted stock awards        |  |                                      | 661   |                                     |   | 1,705 
|Employee stock purchase plan   |  |                                      | 302   |                                     |   | 482   
|                               |  |                                      |       |                                     |   |       
|Total stock-based compensation |  | $                                    | 3,841 |                                     | $ | 10,950
|                               |  |                                      |       |                                     |   |       



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During the three and nine months ended September 30, 2006, the Company granted 415,000 and 1,174,000, stock options,
respectively. The three and nine months estimated total grant-date fair value of those grants is $7,200,000 and $18,799,000, respectively, before estimated forfeitures. This includes the 156,000 options that were granted in connection with the
Companys acquisition of Digital Optics Corporation in July, 2006. As of September 30, 2006, the unrecorded deferred stock-based compensation costs related to stock options was $23,371,000 before estimated forfeitures and an additional
$8,926,000 related to restricted stock awards will be recognized over an estimated weighted average amortization period of 4 years.

The following
assumptions have been used to value the options granted:



|                        |  |                                 |   |  |                                |   |  |      |   |  |      |  
|----------------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                        |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|                        |  | 2006                            |   |  | 2005                           |   |  | 2006 |   |  | 2005 |  
|Expected life (years)   |  | 4.0                             |   |  | 3.5                            |   |  | 4.0  |   |  | 3.6  |  
|Risk-free interest rate |  | 5.1                             | % |  | 4.1                            | % |  | 4.9  | % |  | 3.8  | %
|Dividend yield          |  | 0.0                             | % |  | 0.0                            | % |  | 0.0  | % |  | 0.0  | %
|Expected volatility     |  | 40.0                            | % |  | 62.8                           | % |  | 54.2 | % |  | 64.7 | %

Under the Employee Stock Purchase Plan (ESPP), for the three and nine months ended September 30,
2006, the Company estimated a total purchase of 327,000 and 674,000 shares, respectively, with a per share weighted average fair value of $8.54 and $7.70, respectively. For the three and nine months estimated total grant-date fair value of those
shares is $2,795,000 and $5,193,000, respectively. The following assumptions have been used to value the ESPP shares:



|                        |  |                                 |   |  |                                |   |  |      |   |  |      |  
|----------------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                        |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|                        |  | 2006                            |   |  | 2005                           |   |  | 2006 |   |  | 2005 |  
|Expected life (years)   |  | 2.0                             |   |  | 2.0                            |   |  | 2.0  |   |  | 2.0  |  
|Risk-free interest rate |  | 5.1                             | % |  | 3.6                            | % |  | 4.9  | % |  | 3.8  | %
|Dividend yield          |  | 0.0                             | % |  | 0.0                            | % |  | 0.0  | % |  | 0.0  | %
|Expected volatility     |  | 42.3                            | % |  | 33.0                           | % |  | 42.9 | % |  | 39.9 | %

The Company uses third-party analyses to assist in developing the expected life assumption used in its
Black-Scholes model. The Company, however, determines its assumptions regarding its volatility and risk-free interest rate. The Company is currently using estimated forfeitures on a quarterly basis and will, in accordance with SFAS No. 123(R),
be adjusting the stock-based expense for actual forfeitures at the end of the year. The volatility assumption is based on the blended volatility approach consisting of a combination of the Companys historical volatility and the volatility of
its industry peers, as the Company has insufficient historical data concerning the volatility of its common stock. The fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model and the straight-line
attribution approach.

NOTE 9  STOCKHOLDERS EQUITY

Stock Option Plans

The 1991 Plan

In November 1991, the Company adopted the 1991 Stock Option Plan (the 1991 Plan). Under the 1991 Plan, incentive stock options may be granted to the Companys employees at an exercise price of no less than 100% of the fair
value on the date of grant, and nonstatutory stock options may be granted to the Companys employees, non-employee directors and consultants at an exercise price of no less than 85% of the fair value. Options granted under the 1991 Plan
generally have a term of ten years from the date of grant and vest over a four-year period. After December 1996, no further options were granted from the 1991 Plan.

The 1996 Plan

In December 1996, the Company adopted the 1996 Stock Option Plan (the 1996 Plan). Under
the 1996 Plan, incentive stock options may be granted to the Companys employees at an exercise price of no less than 100% of the fair value on the date of grant, and nonstatutory stock options may be granted to the Companys employees,
non-employee directors and consultants at an exercise price of no less than 85% of the fair value. Options granted under the 1996 Plan generally have a term of ten years from the date of grant and vest over a four-year period. After February 1999,
no further options were granted from the 1996 Plan.

The 1999 Plan

In February 1999, the Company adopted the 1999 Stock Option Plan (the 1999 Plan), which was approved by the stockholders in May 1999. The terms of the 1999 Plan are similar to the terms of the 1996 Plan.
After December 2002, no further options were granted under the 1999 Plan.

The 2003 Plan

In February 2003, the Board of Directors adopted, and the Company stockholders approved, the 2003 Equity Incentive Plan (the 2003 Plan). The terms of the 2003
Plan are similar to the terms of the 1999 Plan. The 2003 Plan permits the granting of restricted stock either alone, in addition to, or in tandem with any options granted thereunder. As of September 30, 2006, there were 2,733,000 shares
reserved for grant under the 2003 Plan.



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Options to purchase 415,000 and 1,174,000 of common stock were granted at a weighted average fair value of $17.36 and
$16.01 to employees during the three and nine months ended September 30, 2006 under our 2003 Plan, respectively. As of September 30, 2006, options to purchase 4,516,000 shares of common stock were outstanding.

The activities under all of the Companys stock options plans are summarized below (in thousands, except per share amounts):



|                             |  |                 |   |  |                     |   |  |                              |      
|---------------------------- |  | --------------- | - |  | ------------------- | - |  | ---------------------------- | -----
|                             |  |                 |   |  | Options Outstanding
|                             |  | SharesAvailable |   |  | Numberof Shares     |   |  | WeightedAverageExercisePrice
|Balance at December 31, 2005 |  | 710             |   |  | 4,780               |   |  | $                            | 15.22
|                             |  |                 |   |  |                     |   |  |                              |      
|Additional shares authorized |  | 100             |   |  |                    |   |  |                              |     
|Restricted stocks granted    |  | (148            | ) |  |                    |   |  |                              |     
|Options granted              |  | (251            | ) |  | 251                 |   |  |                              | 32.44
|Options exercised            |  |                |   |  | (625                | ) |  |                              | 5.04 
|Options canceled             |  | 26              |   |  | (26                 | ) |  |                              | 17.09
|                             |  |                 |   |  |                     |   |  |                              |      
|Balance at March 31, 2006    |  | 437             |   |  | 4,380               |   |  |                              | 17.65
|                             |  |                 |   |  |                     |   |  |                              |      
|Additional shares authorized |  | 3,200           |   |  |                    |   |  |                              |     
|Restricted stocks granted    |  | (107            | ) |  |                    |   |  |                              |     
|Restricted stocks canceled   |  | 14              |   |  |                    |   |  |                              |     
|Options granted              |  | (508            | ) |  | 508                 |   |  |                              | 28.23
|Options exercised            |  |                |   |  | (278                | ) |  |                              | 5.22 
|Options canceled             |  | 29              |   |  | (29                 | ) |  |                              | 23.79
|                             |  |                 |   |  |                     |   |  |                              |      
|Balance at June 30, 2006     |  | 3,065           |   |  | 4,581               |   |  |                              | 19.54
|                             |  |                 |   |  |                     |   |  |                              |      
|Restricted stocks granted    |  | (23             | ) |  |                    |   |  |                              |     
|Restricted stocks canceled   |  | 9               |   |  |                    |   |  |                              |     
|Options granted              |  | (415            | ) |  | 415                 |   |  |                              | 19.14
|Options exercised            |  |                |   |  | (383                | ) |  |                              | 5.91 
|Options canceled             |  | 97              |   |  | (97                 | ) |  |                              | 15.12
|                             |  |                 |   |  |                     |   |  |                              |      
|Balance at Sept 30, 2006     |  | 2,733           |   |  | 4,516               |   |  | $                            | 20.76
|                             |  |                 |   |  |                     |   |  |                              |      

The aggregate intrinsic value in the table below represents the total pretax intrinsic value, based on the
Companys closing stock price of $34.78 as of September 30, 2006, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of options exercisable as of
September 30, 2006 was 1,837,000. The following table summarizes the ranges of outstanding and exercisable options as of September 30, 2006 (in thousands, except years, per share amounts and aggregate intrinsic value):



|                          |  |                     |  |                                                    |  |                              |       |                                       |   |                 |  |                                                    |  |                              |  |                                       |       |  |   |      
|------------------------- |  | ------------------- |  | -------------------------------------------------- |  | ---------------------------- | ----- | ------------------------------------- | - | --------------- |  | -------------------------------------------------- |  | ---------------------------- |  | ------------------------------------- | ----- |  | - | -----
|                          |  | Options Outstanding |  | Options Vested and Exercisable                    
|Range of exercise prices: |  | Number ofShares     |  | WeightedAverageRemainingContractualLife (in years) |  | WeightedAverageExercisePrice |       | AggregateIntrinsic Value(in millions) |   | Numberof Shares |  | WeightedAverageRemainingContractualLife (in years) |  | WeightedAverageExercisePrice |  | AggregateIntrinsic Value(in millions)
|$0.85-$2.63               |  | 691                 |  | 5.10                                               |  | $                            | 2.02  |                                       | $ | 22.64           |  | 577                                                |  | 2.87                         |  | $                                     | 2.23  |  | $ | 18.77
|$3.25-$17.30              |  | 810                 |  | 6.64                                               |  |                              | 9.00  |                                       |   | 20.89           |  | 522                                                |  | 5.66                         |  |                                       | 6.98  |  |   | 14.50
|$17.75-$27.5              |  | 992                 |  | 7.99                                               |  |                              | 19.54 |                                       |   | 15.12           |  | 248                                                |  | 8.55                         |  |                                       | 18.43 |  |   | 4.05 
|$27.90-$32.08             |  | 930                 |  | 9.44                                               |  |                              | 29.20 |                                       |   | 5.19            |  | 171                                                |  | 9.21                         |  |                                       | 29.02 |  |   | 0.99 
|$32.36-$40.19             |  | 1,093               |  | 8.70                                               |  |                              | 35.21 |                                       |   |                |  | 319                                                |  | 8.83                         |  |                                       | 35.85 |  |   |     
|                          |  |                     |  |                                                    |  |                              |       |                                       |   |                 |  |                                                    |  |                              |  |                                       |       |  |   |      
|$0.85-$40.19              |  | 4,516               |  | 7.78                                               |  | $                            | 20.76 |                                       | $ | 63.84           |  | 1,837                                              |  | 6.06                         |  | $                                     | 14.11 |  | $ | 38.31
|                          |  |                     |  |                                                    |  |                              |       |                                       |   |                 |  |                                                    |  |                              |  |                                       |       |  |   |      

Employee Stock Purchase Plan

In August 2003, the Company adopted the Companys 2003 ESPP, and the Companys stockholders approved the ESPP in September 2003. The ESPP is designed to allow eligible employees and the eligible employees of
participating subsidiaries to purchase shares of common stock, at semi-annual intervals, with their accumulated payroll deductions.



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The Company initially reserved 200,000 shares of our common stock for issuance under the ESPP. The reserve will
automatically increase on the first day of each fiscal year during the term of the ESPP by an amount equal to the lesser of (1) 200,000 shares, (2) 1.0% of the Companys outstanding shares on such date or (3) a lesser amount
determined by the board of directors.

The ESPP will have a series of consecutive, overlapping 24-month offering periods. The first offering period
commenced February 1, 2004, the effective date of the ESPP, as determined by the board of directors.

Individuals who own less than 5% of the
Companys voting stock and are scheduled to work more than 20 hours per week for more than five calendar months per year may join an offering period on the first day of the offering period or the beginning of any semi-annual purchase period
within that period. Individuals who become eligible employees after the start date of an offering period may join the ESPP at the beginning of any subsequent semi-annual purchase period.

Participants may contribute up to 20% of their cash earnings through payroll deductions, and the accumulated deductions will be applied to the purchase of shares on each semi-annual purchase date. The purchase price
per share will be equal to 85% of the fair market value per share on the participants entry date into the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date.

If the fair market value per share of the Companys common stock on any purchase date is less than the fair market value per share on the start date of the two-year
offering period, then that offering period will automatically terminate, and a new 24-month offering period will begin on the next business day. All participants in the terminated offering will be transferred to the new offering period.

In the event of a proposed sale of all or substantially all of the Companys assets, or merger with or into another company, the outstanding rights under the
ESPP will be assumed or an equivalent right substituted by the successor company or its parent or subsidiary. If the successor company or its parent refuses to assume the outstanding rights or substitute an equivalent right, then all outstanding
purchase rights will automatically be exercised prior to the effective date of the transaction. The purchase price will be equal to 85% of the market value per share on the participants entry date into the offering period in which an
acquisition occurs or, if lower, 85% of the fair market value per share on the date the purchase rights are exercised.

The ESPP will terminate no later
than the tenth anniversary of the initial adoption of the ESPP by the board of directors.

As of September 30, 2006, an aggregate of 425,000 shares
were reserved for grant under the ESPP, and an aggregate of 175,000 common shares had been purchased under the ESPP.

NOTE 10  INCOME TAXES

Income tax provision for the three and nine months ended September 30, 2006 was $33.2 million and $35.0 million, respectively. Income tax
provision for both periods is comprised of domestic income tax and foreign withholding tax. Income tax provision for the three and nine months ended September 30, 2005 was $2.9 million and $13.9 million, respectively. The 2005 income tax
provision included domestic income tax and foreign withholding tax. The increase in the income tax provision for the three and nine months ended September 30, 2006 is primarily attributable to the increase in the pre-tax income.

On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3. SFAS No. 123 (R) requires a company to calculate the pool of excess tax
benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS No. 123 (R) (termed the APIC Pool), as if the company had adopted SFAS No. 123 in 1995. There are two methods to calculate the companys
hypothetical APIC Pool: (1) the long form method as set forth in paragraph 81 of SFAS No. 123(R), and (2) the short form method as set forth in FASB Staff Position 123R-3.

The Company has elected to use the long form method under which the Company tracks each award grant on an employee-by-employee basis and grant-by-grant basis to determine if there is a tax benefit situation or tax
deficiency situation for such award. The Company then compares the fair value expense to the tax deduction received for each grant and aggregates the benefits and deficiencies to determine whether there is a hypothetical APIC pool (net tax benefit
situation).

For the three and nine months ended September 30, 2006, the Company has not recognized a tax benefit to APIC, but will instead make this
determination for our fiscal year ending December 31, 2006.

NOTE 11  COMMITMENTS AND CONTINGENCIES

Litigation

Tessera, Inc. v. Advanced Micro Devices, Inc. et al.,
Civil Action No. 05-04063 (N.D. Cal),

On October 7, 2005, the Company filed a complaint for patent infringement against Advanced Micro
Devices, Inc. (AMD) and Spansion LLC (Spansion) in the United States District Court for the Northern District of California, alleging infringement of the Companys U.S. Patents 5,679,977, 5,852,326, 6,433,419 and
6,465,893 arising from AMDs and Spansions respective manufacture, use, sale, offer to sell and/or importation of certain packaged semiconductor components and assemblies thereof. The Company seeks to recover damages, up to treble the
amount of actual damages, together with attorneys fees, interest and costs. The Company also seeks other relief, including enjoining AMD and Spansion from continuing to infringe these patents.

On December 16, 2005, the Company filed a first amended complaint to add Spansion Inc. and Spansion Technology, Inc. to the lawsuit. Spansion Inc. and Spansion
Technology, Inc. are two new entities who were created by the initial public offering of Spansion in December, 2005.

On January 31, 2006, the Company
filed a second amended complaint to add claims of breach of contract and/or patent infringement against several new defendants, including Advanced Semiconductor Engineering, Inc. ASE (U.S.) Inc., ChipMOS Technologies, Inc., ChipMOS U.S.A., Inc.
Siliconware Precision Industries Co. Ltd., Siliconware U.S.A. Inc., STMicroelectronics N.V., STMicroelectronics, Inc., STATS ChipPAC Ltd., STATS ChipPAC, Inc., and STATS ChipPAC (BVI) Ltd.

The defendants in this action have asserted affirmative defenses to our patent infringement claims, and some of them have brought related counterclaims alleging that the
asserted Tessera patents are not infringed, invalid and unenforceable and/or that Tessera is not the owner of the patents. The Company cannot predict the outcome of this proceeding. Discovery is ongoing, and trial is currently set for
January 28, 2008. An adverse decision in this proceeding could significantly harm its business and financial statements.



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Tessera, Inc. v. Amkor Technology, Inc.

On March 2, 2006, the Company issued a request for arbitration with Amkor Technology, Inc. (Amkor) regarding Amkors failure to pay royalties under its license agreement with Tessera. On
November 1, 2006, the arbitration tribunal issued a provisional timetable specifying a seven-day tribunal hearing starting October 1, 2007. The Company cannot predict the outcome of this proceeding. An adverse decision in this proceeding
could significantly harm its business and financial statements.

Tessera, Inc. v. Micron Technology, Inc. et a, Civil Action No. 02-05cv-94 (E.D.
Tex.)

In July 2006, the Company entered into definitive agreements to settle its lawsuit against Micron Technology, Inc. and its subsidiaries
(collectively Micron) and against Infineon Technologies AG and its subsidiaries including Qimonda AG (collectively Infineon) in the U.S. District Court for the Eastern District of Texas. Initially filed on March 1, 2005,
and subsequently amended, this lawsuit alleged (1) Microns and Infineons infringement of the Companys U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893 and 6,133,627; as well as (2) Microns and Infineons
violations of federal antitrust law, Texas antitrust law, and Texas common law. On July 20, 2006, Tessera and Micron entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding litigation between them. On
July 31, 2006, Tessera, Infineon and Qimonda each entered into a Settlement Agreement and TCC License Agreements that resolved all outstanding litigation between them.

Micron Technology, Inc. et al. v. Tessera, Inc., Civil Action No. 02-05cv-319 (E.D. Tex.)

On July 20,
2006, Tessera and Micron entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding litigation between the companies, including this lawsuit, in which Micron alleged that the Company infringed Microns U.S.
Patent Nos. 5,739,585, 6,013,948, 6,268,649, 6,738,263, 5,107,328, 6,265,766, 4,992,849 and Re. 36,325. On July 20, 2006, Tessera and Micron entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding
litigation between them.

Samsung Electronics Co. Ltd. v. Tessera, Inc., Civil Action No. 02-05837 CW (N.D. Cal.)

During the fiscal year ending December 31, 2004, the Company was involved in a lawsuit with Samsung Electronics Company and its subsidiaries (collectively
Samsung) that was settled in November 2004 and finally dismissed in February 2005. This lawsuit involved several Samsung semiconductor chip packages and the Companys U.S. Patent Nos 5,852,326, 5,679,977, 6,433,419, 6,465,893,
5,950,304 and 6,133,627. The terms of settlement, including a royalty-bearing license going forward, are set forth in a Settlement Agreement and a Restated License Agreement, both of which were executed on January 26, 2005.

NOTE 12  SEGMENT AND GEOGRAPHIC INFORMATION

The Company has
adopted SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information (SFAS No. 131). In 2006, the Companys operating segments include Intellectual Property and Services. Intellectual
Property segment is primarily composed of Licensing Business and Emerging Markets and Technologies, and Services segment is composed primarily of the Product Division. The Product Division incorporates operational functions that are reported in both
Intellectual Property and Services segments. The segments were determined based upon how the chief operating decision maker views and evaluates its operations. In addition to its reportable segments, Corporate Overhead, not a reportable segment,
includes certain operating expenses and credits that are not allocated to the operating segments because these operating expenses and credits are not considered in evaluating the operating performance of its business segments.

The following table sets forth our segments revenue, operating expenses and operating income (loss) (in thousands):



|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|----------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                              |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                              |  | 2006                            |         |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|Revenues:                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  | $                               | 101,846 |   |                                | $ | 15,274 |      |  | $ | 142,475 |   |  | $ | 58,068  |  
|Services Segment              |  |                                 | 8,695   |   |                                |   | 4,470  |      |  |   | 15,989  |   |  |   | 12,036  |  
|Corporate Overhead            |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total revenues                |  |                                 | 110,541 |   |                                |   | 19,744 |      |  |   | 158,464 |   |  |   | 70,104  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating expenses:           |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  |                                 | 15,007  |   |                                |   | 5,454  |      |  |   | 42,604  |   |  |   | 11,752  |  
|Services Segment              |  |                                 | 10,250  |   |                                |   | 3,556  |      |  |   | 18,723  |   |  |   | 10,696  |  
|Corporate Overhead            |  |                                 | 6,377   |   |                                |   | 3,867  |      |  |   | 18,976  |   |  |   | 11,464  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses      |  |                                 | 31,634  |   |                                |   | 12,877 |      |  |   | 80,303  |   |  |   | 33,912  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating income (loss)       |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  |                                 | 86,839  |   |                                |   | 9,820  |      |  |   | 99,871  |   |  |   | 46,316  |  
|Services Segment              |  |                                 | (1,555  | ) |                                |   | 914    |      |  |   | (2,734  | ) |  |   | 1,340   |  
|Corporate Overhead            |  |                                 | (6,377  | ) |                                |   | (3,867 | )    |  |   | (18,976 | ) |  |   | (11,464 | )
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating income        |  | $                               | 78,907  |   |                                | $ | 6,867  |      |  | $ | 78,161  |   |  | $ | 36,192  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  



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The Companys revenues are generated from licensees headquartered in the following geographic regions (in
thousands):



|                         |  |                                 |         |                                |   |        |  |      |         |  |   |       
|------------------------ |  | ------------------------------- | ------- | ------------------------------ | - | ------ |  | ---- | ------- |  | - | ------
|                         |  | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30,
|                         |  | 2006                            |         | 2005                           |   | 2006   |  | 2005
|United States of America |  | $                               | 41,495  |                                | $ | 10,047 |  | $    | 61,708  |  | $ | 29,538
|Japan                    |  |                                 | 7,869   |                                |   | 5,851  |  |      | 21,651  |  |   | 18,613
|Europe                   |  |                                 | 52,238  |                                |   |       |  |      | 52,238  |  |   |      
|Asia Pacific             |  |                                 | 8,696   |                                |   | 3,846  |  |      | 22,624  |  |   | 21,953
|Other                    |  |                                 | 243     |                                |   |       |  |      | 243     |  |   |      
|                         |  |                                 |         |                                |   |        |  |      |         |  |   |       
|                         |  | $                               | 110,541 |                                | $ | 19,744 |  | $    | 158,464 |  | $ | 70,104
|                         |  |                                 |         |                                |   |        |  |      |         |  |   |       

NOTE 13  RELATED PARTY TRANSACTION

In November 2005, the Company engaged in consulting services with a company which is owned 100% by one of the Companys employees. For the three and nine months ended September 30, 2006, the Company
recognized $316,000 and $1,229,000 of consulting expenses, respectively, pursuant to this consulting arrangement.



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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following
discussion should be read in conjunction with the attached condensed unaudited consolidated financial statements and notes thereto, and with our audited financial statements and notes thereto for the fiscal year ended December 31, 2005, found
in our Annual Report on Form 10-K filed on March 16, 2006.

The following Managements Discussion and Analysis of Financial Condition and
Results of Operations, as well as information contained in Risk Factors in Part II, Item IA and elsewhere in this Quarterly Report on Form 10-Q, contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend that these forward-looking statements be subject to the safe harbors created by those provisions. Forward-looking statements are generally written in the
future tense and/or are preceded by words such as will, may, should, would, could, forecast, expect, suggest, believe,
anticipate, intend, plan, or other similar words. Forward-looking statements include statements regarding (1) our revenue levels, (2) our gross profit and factors that affect gross profit, (3) our
level of operating expenses, (4) our research and development efforts, (5) our liquidity, (6) our partners and suppliers and (7) the commercial success of our products.

The forward-looking statements contained in this Quarterly Report involve a number of risks and uncertainties, many of which are outside of our control. Factors that
could cause actual results to differ materially from projected results include, but are not limited to, risks associated with (1) our ability to protect and enforce our intellectual property rights, (2) costly legal proceedings that we may
have to undertake to enforce or protect our intellectual property rights, (3) our inability to control risks that are inherent in a royalty-based business model, (4) our ability to create and implement new designs to expand our licensable
technology portfolio and (5) the other risks set forth under the heading Risk Factors in this report. Although we believe that the assumptions underlying the forward-looking statements contained in this Quarterly Report are
reasonable, any of the assumptions could be, or in the future may prove, inaccurate, and therefore we cannot guarantee the accuracy of such statements. In light of the significant uncertainties inherent in the forward-looking statements included
herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved. Furthermore, past performance in
operations and share price is not necessarily indicative of future performance. Tessera disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

Tessera is a provider of miniaturization
technologies for the electronics industry. We enable improvements in miniaturization and performance by applying our expertise in the electrical, thermal, mechanical and optical properties of materials and interconnect. We develop and license
technologies to the electronics industry. Our intellectual property portfolio includes over 950 patents and applications, covering a broad range of advanced semiconductor packaging, interconnect and micro-optics solutions. We license our technology
to our customers, enabling them to produce semiconductor chips that are smaller and faster, and incorporate more features. These semiconductors are utilized in a broad range of electronics products, including digital audio players, digital cameras,
personal computers, personal digital assistants, video game consoles and mobile phones. By using our technology, we believe that our customers are also able to reduce the time-to-market and development costs of their semiconductors.

Our patented technology enables our customers to assemble semiconductor chips into chip-scale packages (CSPs), that are almost as small as the chip itself.
Our technology also enables multiple chips to be stacked vertically in a single three-dimensional multi-chip package that occupies almost the same circuit board area as a CSP. Our technology allows a plurality of semiconductor chips and passive
components to be densely combined in ultra-compact electronics modules. By reducing the size of the semiconductor package and shortening electrical connections between the chip and the circuit board, our technology allows further miniaturization and
increased performance and functionality of electronic products. We achieve these benefits without sacrificing reliability by allowing movement within the package, thus addressing critical problems associated with thermally-induced stress which can
occur when packages decrease in size. Our technologies also enable our customers to package semiconductor chips and microdevices at the wafer level (wafer level packaging or WLP) and to create high-density interconnections
between electronic components using flexible substrate materials.

From our inception in 1990 through 1995, we engaged principally in research and
development activities related to chip-scale and multi-chip packaging technology. We began generating revenues from licenses of our intellectual property in 1994. We began manufacturing activities in 1997 to support market acceptance of our
technology. We discontinued most of these manufacturing activities in 1999 after many suppliers had developed the manufacturing infrastructure to implement our technology. We continue to develop prototypes and manufacture limited volumes of select
circuits.

We generate revenues from:



| |  |  | royalties and license fees, which represent the majority of our revenues and consist of royalties on semiconductors shipped by our licensees that employ our patented technologies;
and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | products and services, which we believe utilize or further develop our technology offerings.
| | - |  | --------------------------------------------------------------------------------------------

Our licensees pay a non-refundable license fee. Revenues from license fees are generally recognized once the license agreement has been executed by both parties. In some instances, we provide training to our licensees
under the terms of the license agreement. In such instances the amount of training we provide is limited and is incidental to the licensed technology. Accordingly, in instances where training is provided under the terms of a license agreement, a
portion of the license fee is deferred until the training has been provided. The amount of revenues deferred is based on the price we charge for similar services when they are sold separately.

Semiconductor manufacturers and assemblers pay on-going royalties on their production or shipment of semiconductors incorporating our intellectual property. Royalty
payments are primarily based upon the number of electrical connections to the semiconductor chip in a package covered by our technology, although we do have arrangements in which royalties are paid based upon a percent of the net sales price. Our
licensees report royalties quarterly, and most also pay on a quarterly basis. As there is no reliable basis on which to estimate our royalty revenues prior to obtaining these reports from our licensees, we recognize royalty revenues when we receive
a royalty report from our customer. We receive these reports the quarter after the semiconductors that incorporate our technology have been produced or shipped.

From time to time, we receive payments through license negotiations or through the resolution of patent disputes. These license negotiations and dispute resolutions generally include amounts for royalties related to previous periods based
on historical production volumes. These amounts are reported as past production payments revenues in the statement of operations. Past production payments revenues will vary significantly on a quarterly basis.



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Product and service revenues include sales of wafer level and micro-optics products, and engineering product development
services for purposes of servicing strategic customers and seeding new markets and engineering services, including related training services. Revenues from product and other services are recognized on a percentage-of-completion or completed contract
method of accounting depending on the nature of the project. Under the percentage-of-completion method, revenues recognized are that portion of the total contract price equal to the ratio of costs expended to date to the anticipated final total
costs based on current estimates of the total costs to complete the projects. If the total estimated costs to complete a project were to exceed the total contract amount, indicating a loss, the entire anticipated loss would be recognized
immediately. Revenues under the completed contract method are recognized upon acceptance by the customer or in accordance with the contract specifications. Revenues from services related to training are recognized as the services are performed.

We derive a significant portion of our revenues from licensees headquartered outside of the United States, principally in Asia and Europe. For the three
and nine months ended September 30, 2006, these revenues accounted for 62.5% and 61.1% of our total revenues, respectively. For the three and nine months ended September 30, 2005, these revenues accounted for 49.1% and 57.9% of our total
revenues, respectively. We expect that these revenues will continue to account for a significant portion of revenues in future periods. All of our revenues are denominated in U.S. dollars. For the three and nine months ended September 30, 2006,
Micron Technology, Inc. and Qimonda, AG, each accounted for 10% or more of our total revenues. For the three and nine months ended September 30, 2005, Samsung Electronics Co, Ltd. and Texas Instruments, Inc. each accounted for over 10% of total
revenues.

We license most of our CSP and multi-chip packaging technology under a license that we refer to as a TCC license. Our TCC license grants a
worldwide right under the licensed patent claims to assemble, use and sell certain CSPs and multi-chip packages. We generally license semiconductor material suppliers under our TCMT license. Our TCMT license calls for a one-time license fee and,
unlike most of our other licenses, does not require ongoing royalty payments.

Effective as of the beginning of 2006 we organized our business units into
three operating divisions: the Licensing Business, the Product Division and Emerging Markets and Technologies. These divisions are reported into two segments, Intellectual Property, which consists primarily of our Licensing Business, and Emerging
Markets and Technologies and Services, which consists primarily of the Product Division. The Product Division incorporates operational functions that are reported in both our Intellectual Property and Services segments. The segments were determined
based upon how our management views and evaluates our operations. Segment information in this Item 2 Managements Discussion and Analysis of Financial Condition and Results of Operations and in Note 12 of the Notes to
Condensed Consolidated Financial Statements included in this report are presented in accordance with the Statement of Financial Accounting Standards (SFAS) No. 131, Disclosure about Segments of an Enterprise and Related Information.
In addition to our reportable segments, we also have aCorporate Overhead category that is not a reportable segment. This category includes certain operating expenses and credits that are not allocated to our business segments because these
operating expenses and credits are not considered in evaluating the operating performance of our business segments.

Cost of revenues consists primarily of
direct compensation, materials, supplies and equipment depreciation costs. Cost of revenues primarily relates to product and service revenues as the cost of revenues associated with intellectual property revenues is de minimis. Consequently, cost of
revenues as a percentage of total revenues will vary based on the percentage of our revenues that is attributable to product and service revenues.

Research, development and other related costs consist primarily of compensation and related costs for personnel as well as costs related to patent applications and examinations, amortization of intangible assets, materials, supplies and
equipment depreciation. Our research and development is conducted primarily in-house and targets CSP, multi-chip and WLP technology. All research, development and other related costs are expensed as incurred. We believe that a significant level of
research, development and other related costs will be required for us to remain competitive in the future. We have increased our research and development personnel to 161 at September 30, 2006 from 78 at September 30, 2005, and expect to
continue to increase our research and development personnel in the future.

Selling expenses consist primarily of compensation and related costs for sales
and marketing personnel, marketing programs, public relations, promotional materials, travel and related trade show expenses. General and administrative expenses consist primarily of compensation and related costs for: general management,
information technology, finance and accounting personnel; litigation expenses and related fees; facilities costs; and professional services. Our general and administrative expenses are not allocated to other expense line items. We anticipate that
our selling, general and administrative expenses will increase as a result of our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002, related regulations and ongoing revisions to disclosure and governance practices. Excluding
litigation expenses, we expect that as a percentage of revenues, these expenses will decrease over time. However, we expect that litigation expenses will continue to be a material portion of our general and administrative expenses in future periods,
and may increase significantly in some periods, because of our ongoing legal actions, as described below in Part II, Item 1 Legal Proceedings , and because we expect that we will become involved in other litigation from time to
time in the future in order to enforce and protect our intellectual property rights.

Critical Accounting Policies and Estimates

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time
the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements.

On January 1, 2006, we adopted SFAS No. 123(R) under which the measurement and recognition of compensation expense for all stock-based payment awards made to
employees and directors including employee stock options and employee stock purchases under our 2003 ESPP based on estimated fair values was required. SFAS No. 123(R) supersedes our previous accounting under APB No. 25, for periods
beginning in fiscal year 2006. In March 2005, the Securities and Exchange Commission (SEC) issued SAB No. 107 relating to SFAS No. 123(R).

SFAS
No. 123(R) requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over
the requisite service periods in our Condensed Consolidated Statement of Operations.

We have applied the provisions of SAB No. 107 in its adoption of
SFAS No. 123(R). Thus, we have adopted SFAS No. 123(R) in accordance with the modified prospective transition method on January 1, 2006. In accordance with the modified prospective transition method, our Condensed Consolidated
Financial Statements for prior periods have not been restated to reflect, and do not include the impact of SFAS No. 123(R). The valuation provisions of SFAS No. 123(R) apply to new awards and to awards that are outstanding on the effective
date and subsequently modified or cancelled. Historically, we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 and only disclosed the impact of SFAS No. 123 within
the footnote disclosures of our financial statements. Thus, no stock-based compensation expense had been recognized in our Condensed Consolidated Statement of Operations as permitted under SFAS No. 123.



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In conjunction with the adoption of SFAS No. 123(R), we prospectively amended our method of attributing the value of
stock-based compensation to expense. Historically, we utilized the provisions of FIN No. 28 to recognize the expense associated with equity awards. This method allows for accelerated amortization of stock based compensation expense over the
vesting period of the award. As permitted by SFAS No. 123(R), we have elected the straight-line method of expensing all stock based compensation awarded subsequent to the adoption of SFAS No. 123(R). Thus, compensation expense for all
stock-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the accelerated approach under FIN No. 28 while compensation expense for all stock-based payment awards granted on or after
January 1, 2006 will be recognized using the straight-line method.

We will continue to use the Black-Scholes valuation model to determine the
estimated fair value of stock-based awards since this model utilizes the following award attributes to determine the estimated fair value of stock-based awards: fair value at date of grant, exercise price, risk free interest rate, volatility,
expected life of the award, forfeiture rate and dividend rate.

The risk-free interest rate assumption is based upon observed interest rates from the U.S.
Government SecuritiesTreasury Constant Maturities for the term of our employee stock options, which is an average of four years. We currently do not pay out any dividends; therefore the dividend yield assumption is not applicable.

The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding. The expected life of any
stock option cannot be less than the vesting period.

The volatility assumption is based on the blended volatility approach consisting of a combination of
the Companys historical volatility and the volatility of its industry peers, as the Company has insufficient historical data concerning the volatility if its common stock.

SFAS No. 123(R) guidelines also require that estimated forfeitures be excluded from the actual stock compensation expense. In consideration of that, we have estimated the forfeiture rate using historical turnover
data as well as pre-vesting cancellations spread over the vesting periods related to an expected term of four years.

On November 10, 2005, the FASB
issued FASB Staff Position No. FAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. SFAS No. 123(R) requires a company to calculate the pool of excess tax benefits available to
absorb tax deficiencies recognized subsequent to adopting SFAS No. 123(R) (termed the APIC Pool), as if the company had adopted SFAS No. 123 in 1995. There are two methods to calculate the companys hypothetical APIC Pool:
(1) the long form method as set forth in paragraph 81 of SFAS No. 123(R), and (2) the short form method as set forth in FASB Staff Position 123R-3.

We have elected to use the long form method under which we track each award grant on an employee-by-employee basis and on a grant-by-grant basis to determine whether there is a tax benefit situation or tax deficiency situation for such
award. We then compare the fair value expense to the tax deduction received for each grant and aggregates the benefits and deficiencies to determine whether there is a hypothetical APIC Pool (net tax benefit situation).

Inventories are stated at the lower of cost or market, cost being determined under the first-in-first-out method. Appropriate consideration is given to obsolescence,
excessive levels, determination and other factors in evaluating net realizable value.

Management believes there have been no other significant changes in
our critical accounting policies and estimates for the three months ended September 30, 2006 from our disclosure in our Annual Report on Form 10-K for the year ended December 31, 2005. For a discussion of our critical accounting policies,
please see the discussion in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Results of Operations

The following table sets forth our operating results for the periods indicated as a percentage of revenues:



|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|--------------------------------------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ----- | - |  | ----- | -
|                                              |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|                                              |  | 2006                            |   |  | 2005                           |   |  | 2006  |   |  | 2005  |  
|Revenues:                                     |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Royalty and license fees                      |  | 23.4                            | % |  | 71.5                           | % |  | 40.9  | % |  | 56.0  | %
|Past production payments                      |  | 68.8                            |   |  | 5.9                            |   |  | 49.0  |   |  | 26.9  |  
|Product and Service revenues                  |  | 7.8                             |   |  | 22.6                           |   |  | 10.1  |   |  | 17.1  |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Total revenues                                |  | 100.0                           |   |  | 100.0                          |   |  | 100.0 |   |  | 100.0 |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Operating expenses:                           |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Cost of revenues                              |  | 5.6                             |   |  | 15.5                           |   |  | 8.6   |   |  | 13.3  |  
|Research, development and other related costs |  | 4.8                             |   |  | 10.5                           |   |  | 7.9   |   |  | 7.5   |  
|Selling, general and administrative           |  | 18.2                            |   |  | 39.2                           |   |  | 34.1  |   |  | 27.6  |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Total operating expenses                      |  | 28.6                            |   |  | 65.2                           |   |  | 50.6  |   |  | 48.4  |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Operating income                              |  | 71.4                            |   |  | 34.8                           |   |  | 49.4  |   |  | 51.6  |  
|Other income, net                             |  | 1.5                             |   |  | 5.4                            |   |  | 2.8   |   |  | 3.5   |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Income before taxes                           |  | 72.9                            |   |  | 40.2                           |   |  | 52.2  |   |  | 55.1  |  
|Income tax provision                          |  | 30.1                            |   |  | 14.7                           |   |  | 22.1  |   |  | 19.9  |  
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  
|Net income                                    |  | 42.8                            | % |  | 25.5                           | % |  | 30.1  | % |  | 35.2  | %
|                                              |  |                                 |   |  |                                |   |  |       |   |  |       |  



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Three and Nine Months Ended September 30, 2006 and 2005

Revenues

Revenues for the three months ended September 30, 2006
were $110.5 million compared with $19.7 million for the three months ended September 30, 2005, an increase of $90.8 million, or 459.9%. Revenues for the nine months ended September 30, 2006 were $158.5 million compared to $70.1 million for
the nine months ended September 30, 2005, an increase of $88.4 million or 126.0%. The increase in revenues for the three months ended September 30, 2006 is primarily due to an increase in royalty and license fees of $11.8 million, past
production payments of $74.8 million and product and service revenues of $4.2 million. The increase in revenues in the nine months ended September 30, 2006 is primarily due to an increase in royalty and license fees of $25.6 million, past
production payments of $58.8 million and product and service revenues of $4.0 million.

Cost and expenses

Cost of Revenues

Cost of revenues primarily relates to product and
service revenues as the cost of revenues associated with royalty and license fee revenues isde minimis. For the three months and nine months ended September 30, 2006, cost of revenues represented 71.9% and 85.1%, respectively, of
product and service revenues for each associated period. For the three months and nine months ended September 30, 2005, cost of revenues represented 68.4% and 77.3%, respectively, of product and service revenues for each associated period cost
of revenues as a percentage of total revenues varies based on the product and service revenues component of total revenues.

Cost of revenues for the three
months ended September 30, 2006 were $6.2 million as compared to $3.1 million for the three months ended September 30, 2005, an increase of $3.1 million, or 100.0 %. Cost of revenues for the nine months ended September 30, 2006 were
$13.6 million, as compared to $9.3 million for the nine months ended September 30, 2005, and increase of $4.3 million, or 46.3%. The majority of the increase in both the three and the nine month period is primarily attributable to increased
materials, subcontracting costs, the allocation of more personnel to product and service-related projects, an increase in the number of these projects, an inventory adjustment of $905,000 and stock based compensation expense of $709,000 and $2.3
million, respectively. The inventory adjustment of $905,000 was directly related to the purchase accounting treatment of inventory acquired in our recent acquisition of Digital Optics Corporation in which the inventory value was written up to fair
value. Increased material and subcontracting costs related to product and service-related projects also accounted for part of the increase in cost of revenues. For the three and nine months ended September 30, 2006, materials and subcontractor
costs totaled $1.6 million and $3.2 million, respectively, as compared to $759,000 and $2.4 million, respectively, for the three months and nine months ended September 30, 2005, an increase of $841,000 and $800,000, respectively, or 116.7% and
32.4%, respectively.

Research, Development and Other Related Costs

Research, development and other related costs for the three and nine months ended September 30, 2006 were $5.3 million and $12.6 million, respectively as compared to $2.1 million and $5.2 million,
respectively, for the three and nine months ended September 30, 2005, an increase of $3.2 million and $7.4 million, respectively or 152.4% and 142.3%, respectively. The increase is primarily due to an increase in headcount from a total of 78 at
September 30, 2005 to 161 at September 30, 2006, the related compensation expenses, including stock based compensation expense of $334,000 and $443,000, respectively, amortization of intangible assets of $687,000 and $1.2 million,
respectively, and costs for our research and development center in Jerusalem of $1.4 million and $4.1 million, respectively, each for the three and nine months ended September 30, 2006.

We believe that a significant level of research and development expenses will be required for us to remain competitive in the future, therefore we expect research and
development costs to increase in absolute dollars, but to decline as a percentage of revenues.

Selling, General and Administrative

Selling, general and administrative or SG&A expenses for the three and nine months ended September 30, 2006 were $20.1 million and $54.1 million, respectively,
as compared to $7.7 million and $19.4 million, respectively, for the three and nine months ended September 30, 2005, an increase of $12.4 million and $34.7 million, or 161.0% and 178.9%, respectively. The increase is primarily attributable to
litigation expense of $9.5 million and $25.2 million, stock-based compensation of $2.8 million and $8.2 million for the three and nine months ended September 30, 2006, respectively, as well as our 2006 internal reorganization of personnel and
departments to better align our resources to accommodate the needs of our business and our recent acquisition of Digital Optics Corporation. In this effort we have also increased our SG&A headcount by 49 in business development, human resource,
finance and legal. The related compensation expense is included in SG&A expenses. Total litigation expenses for the three and nine months ended September 30, 2005 were $2.7 million and $4.6 million, respectively. The increase in litigation
is due to our ongoing legal actions, described in Part II, Item 1 Legal Proceedings. Stock-based compensation for the three and nine months ended September 30, 2005 were $333,000 and $552,000, respectively. The overall
increase stock-based compensation is primarily related to our adoption of SFAS No. 123(R), an increase in the number of equity award grants due to our increased headcount and an increase in the issuance of restricted stock

Excluding litigation expenses, we expect that, as a percentage of revenues, our SG&A expenses will decrease over time. However, we expect that litigation expenses
will continue to be a material portion of our general and administrative expenses in future periods, and may increase significantly in some periods, because of our ongoing litigation, as described in Part II, Item 1 Legal
Proceedings below, and because we expect that we will become involved in other litigation from time to time in the future in order to enforce and protect our intellectual property rights.

Stock-based Compensation

On January 1, 2006, we adopted SFAS
No. 123(R) under which the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and employee stock purchases under our 2003 ESPP based on
estimated fair values was required. SFAS No. 123(R) supersedes our previous accounting under APB No. 25, Accounting for Stock Issued to Employees for periods beginning in fiscal year 2006. In March 2005, the SEC issued SAB
No. 107 relating to SFAS No. 123(R).

SFAS No. 123(R) requires companies to estimate the fair value of stock-based payment awards on the
date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our Condensed Consolidated Statement of Operations.



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We have applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R). Thus, we have adopted SFAS
No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of the first day of the companys fiscal year 2006. In accordance with the modified prospective transition method,
our Condensed Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R). The valuation provisions of SFAS No. 123(R) apply to new awards and to awards that are
outstanding on the effective date and subsequently modified or cancelled. Historically, we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB No. 25 and only disclosed the impact
of SFAS No. 123 within the footnote disclosures of our financial statements. Thus, previously no stock-based compensation expense had been recognized in our Condensed Consolidated Statement of Operations as permitted under SFAS No. 123.

In connection with our acquisition of Digital Optics Corporation in July 2006, we assumed each outstanding unvested option under the Digital Optics
Corporation Employee Stock Option Plan. Each of the assumed options was converted to options to purchase Tessera common stock at an exchange ratio of 0.353 shares of Tessera common stock for each Digital Optics Corporation option. The conversion
resulted in the grant of 156,000 options for the purchase of Tessera common stock.

Stock-based compensation for the three months ended September 30,
2006 was $3.8 million, of which $2.9 million related to employee stock options, $661,000 related to issuances of shares of restricted stock and $302,000 related to employee stock purchases through our 2003 ESPP. For the nine months ended
September 30, 2006 stock-based compensation was $11.0 million, of which $8.8 million related to employee stock options, $1.7 million related to issuances of shares of restricted stock and $482,000 related to employee stock purchases through our
2003 ESPP. Stock-based compensation for the three and nine months ended September 30, 2005 was $525,000 and $840,000, respectively. The overall increase is primarily related to the application of SFAS No. 123(R), an increase in grants due
to an increase in headcount, an increase in the issuance of restricted stock and an increase in expense related to the ESPP. As of September 30, 2006, the unrecorded deferred stock-based compensation balance related to stock options was $23.4
million before estimated forfeitures and an additional $8.9 million related to restricted stock awards will be recognized over an estimated weighted average amortization period of 4 years.

Other Income, Net

Other income, net for the three and nine months
ended September 30, 2006 was $1.7 million and $4.4 million, respectively as compared to $1.1 million and $2.4 million, for the three and nine months ended September 30, 2005, respectively. The increase is primarily related to income earned
on higher cash balances as a result of positive cash flow generated from operations. Our cash balance at September 30, 2006 was $156.8 million as compared to $127.6 million at December 31, 2005.

Provision for Income Taxes

Income tax provision for the three and
nine months ended September 30, 2006 was $33.2 million and $35.0 million, respectively. Income tax provision for both periods is comprised of domestic income tax and foreign withholding tax. Income tax provision for the three and nine months
ended September 30, 2005 was $2.9 million and $13.9 million, respectively. The 2005 income tax provision included domestic income tax and foreign withholding tax. The increase in the income tax provision for the three and nine months ended
September 30, 2006 is primarily attributable to the increase in the pre-tax income.

On November 10, 2005, the FASB issued FASB Staff Position
No. FAS 123(R)-3. SFAS No. 123 (R) requires a company to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS No. 123 (R) (termed the APIC Pool), as if the
company had adopted SFAS No. 123 in 1995. There are two methods to calculate the companys hypothetical APIC Pool: (1) the long form method as set forth in paragraph 81 of SFAS No. 123(R), and (2) the short form method as
set forth in FASB Staff Position 123R-3.

We have elected to use the long form method under which we track each award grant on an employee-by-employee
basis and grant-by-grant basis to determine if there is a tax benefit situation or tax deficiency situation for such award. We then compare the fair value expense to the tax deduction received for each grant and aggregates the benefits and
deficiencies to determine whether there is a hypothetical APIC pool (net tax benefit situation).

For the three and nine months ended September 30,
2006 we have not recognized a tax benefit to APIC, but will instead make this determination for our fiscal year ending December 31, 2006.

Segment
Operating Results

Our two segments are: Intellectual Property and Services.

Intellectual Property segment is primarily composed of the following:

Licensing Business is focused on licensing
technologies in our core markets, including DRAM, Flash, SRAM, DSP, ASIC, ASSP, micro-controllers, general purpose logic and analog devices and imaging and micro-optics solutions. Key functions of this group include licensing, intellectual property
management and marketing.

Emerging Markets and Technologies is focused on expanding our technology portfolio into areas outside of our core markets
that represent long-term growth opportunities through application of products and technologies; research and development of new technologies for high growth markets and applications such as packaging, imaging, interconnect and materials. This
division also focuses on long-term growth opportunities through new partnerships, ventures and acquisitions of complementary technology.

Our Services
segment is composed of ourProduct Division, which performs key research and development and drives our production development services revenues. This segment also addresses the challenges of electronic products miniaturization from a system
perspective, through the dense interconnection of components, extensive use of three-dimensional packaging technologies, and the use of micro-optics technologies. This segment provides a vehicle for transitioning our research
efforts into fully developed technologies both internally and externally with partners that can be licensed.

The Product Division incorporates operational
functions that are reported in both the Intellectual Property and Services segments.



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The following table sets forth our segments revenues, operating expenses and operating income (loss) (in thousands):



|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|----------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                              |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                              |  | 2006                            |         |   | 2005                           |   |        | 2006 |  |   | 2005    |  
|Revenues:                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  | $                               | 101,846 |   |                                | $ | 15,274 |      |  | $ | 142,475 |   |  | $ | 58,068  |  
|Services Segment              |  |                                 | 8,695   |   |                                |   | 4,470  |      |  |   | 15,989  |   |  |   | 12,036  |  
|Corporate Overhead            |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total revenues                |  |                                 | 110,541 |   |                                |   | 19,744 |      |  |   | 158,464 |   |  |   | 70,104  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating expenses:           |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  |                                 | 15,007  |   |                                |   | 5,454  |      |  |   | 42,604  |   |  |   | 11,752  |  
|Services Segment              |  |                                 | 10,250  |   |                                |   | 3,556  |      |  |   | 18,723  |   |  |   | 10,696  |  
|Corporate Overhead            |  |                                 | 6,377   |   |                                |   | 3,867  |      |  |   | 18,976  |   |  |   | 11,464  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses      |  |                                 | 31,634  |   |                                |   | 12,877 |      |  |   | 80,303  |   |  |   | 33,912  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating income (loss)       |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Intellectual Property Segment |  |                                 | 86,839  |   |                                |   | 9,820  |      |  |   | 99,871  |   |  |   | 46,316  |  
|Services Segment              |  |                                 | (1,555  | ) |                                |   | 914    |      |  |   | (2,734  | ) |  |   | 1,340   |  
|Corporate Overhead            |  |                                 | (6,377  | ) |                                |   | (3,867 | )    |  |   | (18,976 | ) |  |   | (11,464 | )
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating income        |  | $                               | 78,907  |   |                                | $ | 6,867  |      |  | $ | 78,161  |   |  | $ | 36,192  |  
|                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  

The revenues and operating income (loss) amounts in this section have been presented on a basis consistent with
accounting principles generally accepted in the U.S. applied at the segment level. Corporate overhead expenses which have been excluded are primarily support services, human resources, legal, finance, IT, corporate development, procurement
activities, insurance and board fees. For the three and nine months ended September 30, 2006, corporate overhead expenses were $6.4 million and $19.0 million, respectively, compared to $3.9 million and $11.5 million for the three and nine
months ended September 30, 2005, respectively. The increase in 2006 is primarily attributable to stock-based compensation of $1.8 million and $5.3 million, for the three and nine months ended September 30, 2006 respectively, an increase in
headcount of seven and the related compensation expense.

Intellectual Property Segment

Intellectual property revenues for the three months ended September 30, 2006 were $101.8 million as compared to $15.3 million for the three months ended
September 30, 2005, an increase of $86.6 million or 566.8%. The increase of $86.6 million is primarily attributable to an increase in royalty and license fees of $11.8 million and an increase in past production payments of $74.8 million. The
increase in royalty and license fees is attributable to an increase of $7.0 million from existing customers and $4.8 million from new customers. The increase in past production payments is due to resolution of negotiations with three customers
totaling $76.0 million in the three months ended September 30, 2006 compared to resolution of negotiations with one customer totaling $1.2 million for the three months ended September 30, 2005. For the nine months ended September 30,
2006 intellectual property revenues were $142.5 million as compared to $58.1 million for the nine months ended September 30, 2005, an increase of $84.4 million or 145.4%. The increase of $84.4 million consists of an increase of $19.7 million
and $5.9 million in royalty and license fees from existing customers and new customers, respectively, and an increase of $58.8 million in past production payments. The increase of $58.8 million in past production payments revenue is primarily due to
negotiated resolutions with three customers totaling $77.6 million in the nine months ended September 30, 2006 compared to resolution of negotiations with five customers totaling $18.8 million for the nine months ended September 30, 2005.

Operating expenses for the three months ended September 30, 2006 were $15.0 million. These expenses consisted of cost of revenues of $6,000,
research, development and other related costs of $2.7 million and SG&A costs of $12.3 million. Included in the research, development and other related costs were $1.4 million in costs related to our research and development center in Jerusalem.
SG&A costs included $790,000 in stock-based compensation and $9.5 million in litigation expense. For the nine months ended September 30, 2006, operating expenses were $42.6 million. These expenses consisted of $43,000 in cost of revenues,
$9.5 million in research, development and other related costs and $33.1 million in SG&A. Included in research, development and other related costs were $4.1 million in costs related to our research and development center in Jerusalem. SG&A
costs included $2.4 million in stock-based compensation and $25.2 million in litigation expense. Operating expenses for the three months and nine months ended September 30, 2005 were $5.5 million and $11.8 million, respectively. For the three
months ended September 30, 2005, operating expenses of $5.5 million consisted of $13,000 in cost of revenues, $1.8 million in research, development and other related costs and $3.6 million in SG&A. For the nine months ended
September 30, 2005, operating expenses of $11.8 million consisted of $52,000 in cost of revenues, $4.6 million in research, development and other related costs and $7.2 million in SG&A. Included in the SG&A expenses for the three and
nine months ended September, 2005 are litigation costs of $2.7 million and $4.6 million, respectively. The overall increase of $9.5 million and $30.8 million in the three and nine months ended September 30, 2006, respectively, over the three
and nine months ended September 30, 2005, respectively, is primarily due to increased research, development and other related costs of $914,000 and $4.9 million, respectively and increased SG&A of $8.7 million and $25.9 million,
respectively. The increase in SG&A for the three and nine months ended September 30, 2006 was primarily attributable to the increase in litigation costs of $6.8 million and $20.6 million, respectively. We expect that litigation costs will
become a material portion of the Intellectual Property segments SG&A in future periods, and may increase significantly in some periods, because of our ongoing legal actions, as described in Part II, Item 1 Legal
Proceedings below, and because we expect that we will become involved in other litigation from time to time in the future in order to enforce and protect our intellectual property rights.



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Operating income for the three and nine months ended September 30, 2006 was $86.8 million and $99.9 million,
respectively, as compared to $9.8 million and $46.3 million for the three and nine months ended September 30, 2005, respectively, an increase of $77.0 million or 785.7% and $53.6 million or 115.8%, respectively. The overall increase for the
three and nine months ended September 30, 2006 is primarily due to increased royalty and license fees and past production payments of $86.6 million and $84.4 million, respectively.

Services Segment

Product and service revenues for the three and nine months ended September 30, 2006 were $8.7
million and $16.0 million, respectively, as compared to $4.5 million and $12.0 million for the three and nine months ended September 30, 2005, respectively, an increase of $4.2 million or 94.5% and $4.0 million or 32.8%, respectively. The
overall increase in the three and nine months ended September 30, 2006 is primarily due to the increase in commercial related products and services of $4.3 million and $5.4 million, respectively, offset by a decrease in government related
contracts of $110,000 and $757,000, respectively.

Operating expenses for the three months and nine months ended September 30, 2006 were $10.3 million
and $18.7 million, respectively as compared to $3.6 million and $10.7 million, for the three and nine months ended September 30, 2005, respectively, an increase of $6.7 million, or 186.1%, and $8.0 million, or 74.8%, respectively. For the three
and nine months ended September 30, 2006, operating expenses consisted of cost of revenues of $6.2 million and $13.6 million, respectively, research, development and other related costs of $2.6 million and $3.1 million, respectively and
SG&A of $1.4 million and $2.1 million, respectively. Included in these costs were $1.2 and $3.1 million in stock-based compensation costs for the three and nine months ended September 30, 2006, respectively. For the three months ended
September 30, 2005, operating expenses of $3.6 million consisted of $4.1 million in cost of revenues and $257,000 in SG&A, offset by a credit to research, development and other related costs of $772,000. Included in these costs was $196,000
in stock-based compensation costs. For the nine months ended September 30, 2005 operating expenses of $10.7 million consisted of $9.3 million in cost of revenues, $568,000 in research, development and other related costs and $871,000 in
SG&A. These costs included $218,000 in stock-based compensation costs.

Operating loss for the three months and nine months ended September 30,
2006 was $1.6 million and $2.7 million, respectively, as compared to operating income of $914,000 and $1.3 million, for the three and nine months ended September 30, 2005, respectively. The decrease of $2.5 million and $4.0 million,
respectively, in the three and nine months ended September 30, 2006 is primarily due to the increase in stock-based compensation costs of $1.0 million and $2.9 million, respectively and an inventory adjustment of $905,000. The inventory
adjustment of $905,000 was directly related to the purchase accounting treatment of inventory acquired in our recent acquisition of Digital Optics Corporation in which the inventory value was written up to fair value.

Liquidity and Capital Resources

Cash and cash equivalents were
$156.8 million at September 30, 2006, an increase of $29.2 million from $127.6 million at December 31, 2005. The increase was primarily the result of $76.9 million in cash provided by operating activities and $8.5 million in net proceeds
from the issuance of common stock under our stock option and employee stock purchase plans, offset by $56.2 million net cash used in investing activities.

Net cash provided by operating activities for the nine months ended September 30, 2006 of $76.9 million was attributable to net income of $47.5 million, adjusted for non-cash items of depreciation, amortization and stock-based
compensation of $4.7 million and $11.0 million, respectively, a decrease in inventory of $655,000 and an increase in deferred revenue and income taxes payable of $529,000 and $31.4 million, respectively. The increase was partially offset by an
increase in accounts receivable of $1.5 million, an increase in prepaid and other assets of $12.0 million, and a decrease in accounts payable and accrued liabilities of $577,000 and $4.4 million respectively. The increase in depreciation and
amortization of $4.7 million is primarily due to the amortization of certain intangible assets purchased in the prior year from North Corporation, amortization of certain tangible and intangible assets of Shellcase, Ltd. and Digital Optics
Corporation. The increase of $11.0 million in stock-based compensation is attributable to the adoption of SFAS No. 123(R) on January 1, 2006. The decrease in accounts payable and accrued liabilities is primarily due to the timing of cash
disbursements on vendor invoices.

Net cash provided by operating activities for the nine months ended September 30, 2005 of $36.0 million was
attributable to net income of $24.7 million, adjusted for non-cash items of depreciation and amortization of deferred stock-based compensation of $1.9 million, a decrease in deferred tax asset of $10.9 million, an increase in accounts payable of
$689,000, an increase in accrued liabilities of $809,000 and an increase in deferred revenue of $42,000. The increase was partially offset by an increase in accounts receivable of $2.5 million and an increase in prepaid expense and other assets of
$526,000. The decrease of $10.9 million in deferred tax asset was due to the booking of domestic income tax. The increase in accounts payable is attributable to increased purchases of materials and supplies to accommodate our increase in
service-related projects. The increase in accounts receivable of $2.5 million is primarily attributable to the timing or receipt from customers and amounts earned under our license agreements. The increase in accrued liabilities is primarily due to
an increase in litigation expenses.

Net cash used in investing activities for the nine months ended September 30, 2006 was $56.2 million consisting
of $54.5 million net of cash for the acquisition of Digital Optics Corporation and $1.7 million of property and equipment purchases. In July 2006 we completed our acquisition of Digital Optics Corporation in which we acquired $25.5 million and $29.0
million in tangible and intangible assets net of cash, respectively.

Net cash used in investing activities in the nine months ended September 30,
2005 was $9.0 million, and was primarily attributable to the purchase of property and equipment of $3.0 million and intangible assets of $6.1 million, respectively. For the amount of $6.0 million, we entered into a number of new agreements with
North in May 2005, which included the acquisition of 100% ownership of all US patents/applications filed by North, joint ownership of patents/applications filed in other jurisdictions and the right to sublicense certain other patents currently owned
by North.

Net cash provided by financing activities in the nine months ended September 30, 2006 of $8.5 million was primarily due to the net proceeds
from the issuance of common stock under out stock option and employee stock purchase plans.

Net cash provided by financing activities in the nine months
ended September 30, 2005 of $10.8 million, was primarily attributable to net proceeds from the issuance of common stock under our stock option and employee stock purchase plans.

We believe that based on current levels of operations and anticipated growth, our cash from operations, together with cash currently available, will be sufficient to fund our operations for at least the next twelve
months. Poor financial results, unanticipated expenses, unanticipated acquisitions of technologies or businesses or unanticipated strategic investments could give rise to additional financing requirements sooner than we expect. There can be no
assurance that equity or debt financing will be available when needed or, if available, that the financing will be on terms satisfactory to us and not dilutive to our then-current stockholders.



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Contractual Cash Obligations

As of September 30, 2006, the following sets forth our minimum commitments under operating leases, most of which result from a facilities lease:



|                            |  |                                       |       |                 |   |          |  |          |       |              |   |       |  |   |  
|--------------------------- |  | ------------------------------------- | ----- | --------------- | - | -------- |  | -------- | ----- | ------------ | - | ----- |  | - | -
|                            |  | Payments Due by Period (In thousands)
|                            |  | Total                                 |       | Less than1 year |   | 1-3Years |  | 4-5Years |       | After 5Years
|Operating Lease Obligations |  | $                                     | 3,092 |                 | $ | 687      |  | $        | 1,370 |              | $ | 1,035 |  | $ | 

For our facilities lease, rent expense charged to operations differs from rent paid because of scheduled rent
increases. Rent expense is calculated by allocating total rental payments on a straight-line basis over the lease term. We recorded the difference between rent expense and rent paid as deferred rent, in accrued liabilities.

Our principal administrative, sales, marketing and research and development facilities occupy approximately 51,000 square feet in one building in San Jose, California,
under a lease that expires on May 31, 2011. In July 2006 we acquired a research and development and manufacturing facility in Charlotte, North Carolina that occupies approximately 100,000 square feet in one building on approximately 18 acres of
land. We also have a research and development facility in Jerusalem, Israel that occupies approximately 2,400 square feet in one building under a lease that expires on January 31, 2011. We believe our existing facilities are adequate for our
current needs.

Off-Balance Sheet Arrangements

As of
September 30, 2006, we did not have any off-balance sheet arrangements as defined in item 303(a)(4)(ii) of Regulation S-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

The primary objective of our investment activities is
to preserve principal while maximizing the income we receive from our investments without significantly increasing risk of loss. Some of the securities that we may invest in the future may be subject to market risk for changes in interest rates. To
mitigate this risk, we maintain a portfolio of cash equivalents and short-term investments in a variety of securities, which may include commercial paper, money market funds, government and non-government debt securities. Currently, we are exposed
to minimal market risks. We manage the sensitivity of our results of operations to these risks by maintaining a conservative portfolio, which is comprised solely of highly-rated, short-term investments. We do not hold or issue derivative, derivative
commodity instruments or other financial instruments for trading purposes.

The risk associated with fluctuating interest rates is limited to our
investment portfolio. We do not believe that a 10% change in interest rates would have a significant impact on our results of operations or cash flows.

Item 4. Controls and Procedures

Tessera maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in Tesseras Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and that such information
is accumulated and communicated to Tesseras management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Under the supervision and with the participation of our
management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that as of September 30, 2006, our
disclosure controls and procedures were effective such that the information relating to Tessera, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission or SEC reports (i) is recorded,
processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to Tesseras management, including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure.

There has been no change in Tesseras internal controls over financial reporting
during Tesseras most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Tesseras internal controls over financial reporting.



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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Tessera, Inc. v. Advanced Micro Devices, Inc. et al., Civil Action No. 05-04063 (N.D.
Cal),

As reported in previous SEC filings, including our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, on October 7,
2005, we filed a complaint for patent infringement against Advanced Micro Devices, Inc., or AMD, and Spansion LLC, or Spansion, in the United States District Court for the Northern District of California, alleging infringement of Tesseras U.S.
Patents 5,679,977, 5,852,326, 6,433,419 and 6,465,893 arising from AMDs and Spansions respective manufacture, use, sale, offer to sell and/or importation of certain packaged semiconductor components and assemblies thereof. We seek to
recover damages, up to treble the amount of actual damages, together with attorneys fees, interest and costs. We also seek other relief, including enjoining AMD and Spansion from continuing to infringe these patents.

On December 16, 2005, we filed a first amended complaint to add Spansion Inc. and Spansion Technology, Inc. to the lawsuit. Spansion Inc. and Spansion Technology,
Inc. are two new entities who were created by the initial public offering of Spansion in December 2005.

On January 31, 2006, we filed a second
amended complaint to add claims of breach of contract and/or patent infringement against several new defendants, including Advanced Semiconductor Engineering, Inc. ASE (U.S.) Inc., ChipMOS Technologies, Inc., ChipMOS U.S.A., Inc., Siliconware
Precision Industries Co. Ltd, Siliconware USA Inc., STMicroelectronics N.V., STMicroelectronics, Inc., STATS ChipPAC Ltd., STATS ChipPAC, Inc. and STATS ChipPAC Ltd. (BVI).

The defendants in this action have asserted affirmative defenses to our patent infringement claims, and some of them have brought related counterclaims alleging that the Tessera patents at issue are not infringed,
invalid and unenforceable and/or that Tessera is not the owner of the patents. We cannot predict the outcome of this proceeding. Discovery is ongoing, and trial is currently set for January 28, 2008. An adverse decision in this proceeding could
significantly harm our business and financial statements.

Tessera, Inc. v. Amkor Technology, Inc.

As previously reported in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, on March 2, 2006, we issued a request for arbitration with
Amkor Technology, Inc., or Amkor, regarding Amkors failure to pay royalties under its license agreement with Tessera. On November 1, 2006, the arbitration tribunal issued a provisional timetable specifying a seven-day tribunal hearing
starting October 1, 2007. We cannot predict the outcome of this proceeding. An adverse decision in this proceeding could significantly harm our business and financial statements.

Tessera, Inc. v. Micron Technology, Inc. et al, Civil Action No. 02-05cv-94 (E.D. Tex.)

In July 2006, the
Company entered into definitive agreements to settle its lawsuit against Micron Technology, Inc. and its subsidiaries (collectively Micron) and against Infineon Technologies AG and its subsidiaries including Qimonda AG (collectively
Infineon) in the U.S. District Court for the Eastern District of Texas. Initially filed on March 1, 2005, and subsequently amended, this lawsuit alleged (1) Microns and Infineons infringement of the Companys
U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893 and 6,133,627; as well as (2) Microns and Infineons violations of federal antitrust law, Texas antitrust law, and Texas common law. On July 20, 2006, Tessera and Micron
entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding litigation between them. On July 31, 2006, Tessera, Infineon and Qimonda each entered into a Settlement Agreement and TCC License Agreements that
resolved all outstanding litigation between them.

Micron Technology, Inc. et al. v. Tessera, Inc., Civil Action No. 02-05cv-319 (E.D. Tex.)

On July 20, 2006, Tessera and Micron entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding litigation
between the companies, including this lawsuit, in which Micron alleged that the Company infringed Microns U.S. Patent Nos. 5,739,585, 6,013,948, 6,268,649, 6,738,263, 5,107,328, 6,265,766, 4,992,849 and Re. 36,325. On July 20, 2006,
Tessera and Micron entered into a Settlement Agreement and a TCC License Agreement that resolved all outstanding litigation between them.

Item 1A. Risk Factors

We are currently in litigation involving some of our key patents, and any court
invalidation or limitation of our key patents, in any current or future litigation, could significantly harm our business.

Our patent portfolio
contains some patents that are particularly significant to our ongoing revenues and business. If any of these key patents are invalidated, or if a court limits the scope of the claims in any of these key patents, the likelihood that companies will
take new licenses and that current licensees will continue to agree to pay under their existing licenses could be significantly reduced. The resulting loss in license fees and royalties could significantly harm our business. As discussed above in
Part II,Item 1 - Legal Proceedings, the Company is currently involved in legal proceedings involving some of its key patents. Any adverse rulings relating to the infringement, validity or enforceability of these key patents could
significantly harm our business.

We are currently, and may in the future be involved in material litigation with our licensees, potential licensees or
strategic partners, which could harm our business.

Our current legal actions, as described above in Part II, Item 1 Legal
Proceedings, are examples of significant disputes and litigation that impact our business. Any similar dispute in the future could cause an existing licensee or strategic partner to cease making royalty or other payments to us and could
substantially damage our relationship with the licensee or strategic partner on both business and technical levels. Any litigation stemming from such a dispute could be very expensive and may reduce or eliminate our profits. Litigation could also
severely disrupt or shut down the business operations of our licensees or strategic partners, which in turn would significantly harm our ongoing relations with them and cause us to lose royalty revenues. Any such litigation could also harm our
relationships with other licensees or our ability to gain new customers, who may postpone licensing decisions pending the outcome of the litigation. We are not able to predict the outcome of any of our legal actions and an adverse decision in any of
our legal actions could significantly harm our business and financial statements. Moreover, even if we settle our legal actions, significant contingencies will exist to their final resolution, including our receipt of any payments owed and the
dismissal of the legal action by the relevant court, all of which are not completely within our control.



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In addition, many semiconductor and package assembly companies maintain their own internal design groups and have their
own package design and manufacturing capabilities. If we believe these groups have designed technologies that infringe upon our intellectual property, and if they fail to enter into a license agreement with us or pay for licensed technology, then we
may be forced to commence legal proceedings against them.

If we fail to protect and enforce our intellectual property rights, our business will suffer.

We rely primarily on a combination of license, development and nondisclosure agreements and other contractual provisions and patent, trademark, trade
secret and copyright laws to protect our intellectual property rights. If we fail to protect our intellectual property rights, our licensees and others may seek to use our technology without the payment of license fees and royalties, which could
weaken our competitive position, reduce our operating results and increase the likelihood of costly litigation. The growth of our business depends in large part on our ability to convince third parties of the applicability of our intellectual
property to their products, and our ability to enforce our intellectual property rights against them.

In certain instances, we attempt to obtain patent
protection for portions of our intellectual property, and our license agreements typically include both issued patents and pending patent applications. If we fail to obtain patents or if the patents issued to us do not cover all of the claims
included in our patent applications, others could use portions of our intellectual property without the payment of license fees and royalties. We also rely on trade secret laws rather than patent laws to protect other portions of our proprietary
technology. However, trade secrets can be difficult to protect. We protect our proprietary technology and processes, in part, through confidentiality agreements with our employees, consultants and customers. We cannot be certain that these contracts
have not been and will not be breached, that we will have adequate remedies for any breach or that our trade secrets will not otherwise become known or be independently discovered by competitors. If we fail to use these mechanisms to protect our
intellectual property, or if a court fails to enforce our intellectual property rights, our business will suffer. We cannot be certain that these protection mechanisms can be successfully asserted in the future or will not be invalidated or
challenged.

We may not be able to protect our confidential information, and this could adversely affect our business.

We generally enter into contractual relationships with our employees that protect our confidential information. The misappropriation of our trade secrets or other
proprietary information could seriously harm our business. In addition, we may not be able to timely detect unauthorized use or transfer of our intellectual property and take appropriate steps to enforce our rights. In the event we are unable to
enforce these contractual obligations and our intellectual property rights, our business could be adversely affected.

We may be required to continue to
undertake costly legal proceedings to enforce or protect our intellectual property rights and this may harm our business.

In the past we have found it
necessary to litigate to enforce our patents and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. We
currently are involved in litigation regarding our intellectual property rights, as described above in Part II, Item 1 Legal Proceedings, and we expect to be involved in similar litigation in the future. Litigation is inherently
uncertain and any adverse decision could result in a loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from others, limit the value of our licensed technology or otherwise negatively impact our
business. Whether or not determined in our favor or settled by us, litigation is costly and diverts our managerial, technical, legal and financial resources from our business operations.

The costs associated with the legal proceedings in which we are involved can be substantial and specific costs are unpredictable and not completely within our control, and unexpected increases in litigation costs
could adversely affect our operating results.

As described above in Part II, Item 1 Legal Proceedings, we are currently involved in
legal proceedings against a number of different companies. The costs associated with legal proceedings are typically high, relatively unpredictable and not completely within our control. While we do our best to forecast and control such costs, the
costs may be materially more than expected, which could adversely affect our operating results. Moreover, we may become involved in unexpected litigation with additional companies at any time, which would increase our aggregate litigation costs and
could adversely affect our operating results.

Our revenues may suffer if we cannot continue to license or enforce our intellectual property rights or
if third parties assert that we violate their intellectual property rights.

We rely upon patent, copyright, trademark and trade secret laws in the
United States and similar laws in other countries, and agreements with our employees, customers, suppliers and other parties, to establish and maintain our intellectual property rights in our technology. However, any of our direct or indirect
intellectual property rights could be challenged, invalidated or circumvented. Further, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws of the United States. Therefore, in certain jurisdictions
we may be unable to protect our technology adequately against unauthorized third-party use, which could adversely affect our business. Third parties also may claim that we or our customers are infringing upon their intellectual property rights. Even
if we believe that the claims are without merit, the claims can be time-consuming and costly to defend and divert managements attention and resources away from our business. Claims of intellectual property infringement also might require us to
enter into costly settlement or license agreements or pay costly damage awards. Even if we have an agreement that provides for a third party to indemnify us against such costs, the indemnifying party may be unable to uphold its contractual
obligations to us. If we cannot or do not license the infringed intellectual property at all or on reasonable terms, or substitute similar technology from another source, our business could suffer.

If Congress changes the patent laws, we could be adversely impacted.

Tessera relies on the uniform and historically consistent application of United States patent laws and regulations. Congress is currently considering modifying the US patent laws, and the Patent and Trademark Office is considering modifying
certain regulations related to obtaining patent protection. Some of these modifications may not be advantageous for us, and may make it more difficult to obtain adequate patent protection or to enforce our patents against parties using them without
a license or a payment of royalties. These changes could have a deleterious affect on our licensing program and, therefore, the royalties we receive.



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We could experience losses due to product liability claims.

We sell products that may subject us to product liability claims in the future. Although we carry liability insurance in amounts that we believe are
appropriate, product liability claims can be costly and any future product liability claim made against us may exceed the coverage limits of our insurance policies or cause us to record a self-insured loss. A product liability claim in
excess of our insurance policies could have a material adverse effect on our business, financial condition and results of operations. Even if a product liability loss is covered by our insurance policies, such policies
contain substantial retentions and deductibles that we would be required to pay. The payment of retentions or deductibles for a significant amount of claims could have a material adverse effect on our business, financial condition and results
of operations.

A significant amount of our royalty revenues comes from a few market segments and products, and our business could be harmed if these
market segments or products decline.

A significant portion of our royalty revenues comes from the manufacture and sale of packaged semiconductor chips
for DSP, ASSP, ASIC and memory. In addition, we derive substantial revenues from the incorporation of our technology into mobile phones. If demand for semiconductors in any one or a combination of these market segments or products declines, our
royalty revenues may be reduced significantly and our business could be harmed. Moreover, were such a decline to occur, our business could become more cyclical in nature.

Our revenue is concentrated in a few customers and if we lose any of these customers our revenues may decrease substantially.

We receive a significant amount of our revenues from a limited number of customers. For the three months and nine months ended September 30, 2006, revenues from Micron Technology, Inc. accounted for 27% and 19% of total revenues,
respectively, Qimonda, AG accounted for 36% and 25% of total revenues, respectively. In the three months and nine months ended September 30, 2005, revenues from Samsung Electronics accounted for 13% and 22% of total revenue, respectively, and
revenues from Texas Instruments, Inc., accounted for 19% and 17% of total revenue, respectively. We expect that a significant portion of our revenues will continue to come from a limited number of customers for the foreseeable future. If we lose any
of these customers or if our revenues from them decline, our revenues may decrease substantially.

Future changes in financial accounting standards or
practices or existing taxation rules or practices may cause adverse unexpected revenue and expense fluctuations and affect our reported results of operations.

A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is
effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practice have occurred and may occur in the future. Changes to existing rules or the questioning current practices may
adversely affect our reported financial results or the way we conduct our business.

We are subject to laws and regulations governing government
contracts, and failure to address these laws and regulations or comply with government contracts could harm our business by leading to a reduction in revenue associated with these customers.

We have agreements relating to services provided to government entities and, as a result, we are subject to various statutes and regulations that apply to companies doing
business with the government. The laws governing government contracts differ from the laws governing private contracts. For example, many government contracts contain pricing terms and conditions that are not applicable to private contracts. We are
also subject to audits relating to compliance with the regulations governing government contracts. A failure to comply with these regulations might result in suspension of these contracts, debarment from future government contracts, or civil and
criminal penalties. In addition, the government may acquire certain intellectual property rights in data produced or delivered under such contracts and inventions made under such contracts.



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Our financial and operating results may vary which may cause the price of our common stock to decline.

We currently provide guidance on revenue, expenses and cash taxes on a quarterly and annual basis. Our quarterly operating results have fluctuated in the past and are
likely to do so in the future. Because our operating results are difficult to predict, you should not rely on quarterly or annual comparisons of our results of operations as an indication of our future performance. Factors that could cause our
operating results to fluctuate during any period include those listed in this Risk Factors section of this report and the following:



| |  |  | the timing and compliance with license or service agreement and the terms and conditions for payment to us of license or service fees under these agreements;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in our royalties caused by changes in demand for products incorporating semiconductors that use our licensed technology;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | the amount of our service revenues;
| | - |  | -----------------------------------



| |  |  | changes in the level of our operating expenses;
| | - |  | -----------------------------------------------



| |  |  | delays in our introduction of new technologies or market acceptance of these new technologies through new license agreements;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | our failure to protect or enforce our intellectual property rights;
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| |  |  | legal proceedings affecting our patents or patent applications;
| | - |  | ---------------------------------------------------------------



| |  |  | the timing of the introduction by others of competing technologies;
| | - |  | -------------------------------------------------------------------



| |  |  | changes in demand for semiconductor chips in the specific markets in which we concentrateDSP, ASIC, ASSP semiconductors and memory;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in accounting principles or a requirement to treat stock option grants as an operating expense; and
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | cyclical fluctuations in semiconductor markets generally.
| | - |  | ---------------------------------------------------------

It is
difficult to predict when we will enter into license agreements. The time it takes to establish a new licensing arrangement can be lengthy. Delays or deferrals in the execution of license agreements may also increase as we develop new technologies.
Because we generally recognize a significant portion of license fee revenues in the quarter that the license is signed, the timing of signing license agreements may significantly impact our quarterly or annual operating results. Under our typical
license agreements, we also receive ongoing royalty payments, and these payments may fluctuate significantly from period to period based on manufacture or sales of products incorporating our licensed technology. We expect to continue to expand our
business rapidly which will require us to increase our operating expenses. We may not be able to increase revenues in an amount sufficient to offset these increased expenditures, which may lead to a loss for a quarterly period.

Due to fluctuations in our quarterly operating results and other factors, the price at which our common stock will trade is likely to continue to be highly volatile. In
future periods, if our revenues or operating results are below our estimates or the estimates or expectations of public market analysts and investors, our stock price could decline. In the past, securities class action litigation has often been
brought against companies following a decline in the market price of their securities. Technology companies have experienced greater than average stock price volatility than companies in many other industries in recent years and, as a result, have,
on average, been subject to a greater number of securities class action claims. If our stock price is volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of
managements attention and resources that are needed to successfully run our business.

Network outages could disrupt our internal operations,
which could adversely affect our revenues, customers and stock price.

Despite our concerted effort to minimize risk to our corporate information
systems and to reduce the effect of unscheduled interruptions to the Company through implementation of Business Continuity Plans, our Company may still be exposed to interruptions due to natural disasters, terrorism or acts of war which are beyond
our control. Disruptions to these systems could also interrupt operational processes and adversely impact our ability to provide services and support to our customers and fulfill contractual obligations. As a result, our results of our operations,
financial position, cash flows and stock price could be adversely affected.

We recently conducted our yearly evaluation of our internal controls
systems in order to allow management to report on, and our independent registered public accounting firm to attest to, our internal controls, as required by Section 404 of the Sarbanes-Oxley Act of 2002, but we cannot ensure that these
practices will satisfy future audits.

We have performed the system and process evaluation and testing required for compliance with the management
certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404). While we have implemented the requirements relating to internal controls and all other aspects of Section 404 in
a timely fashion, we cannot be certain as to the timing of completion of our future evaluations or as to the results of the evaluations. Additionally, there are no assurances that we will be able to continue to comply with the requirements relating
to internal controls and all other aspects of Section 404 in a timely fashion in any given period.



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We have a royalty-based business model, which is inherently risky.

Our long-term success depends on future royalties paid to us by licensees. Royalty payments under our TCC licenses are primarily based upon the number of electrical
connections to the semiconductor chip in a package covered by our licensed technology, although we do have royalty arrangements in which royalties are paid based upon a percent of the net sales price or in which royalties are paid on a per package
basis. We are dependent upon our ability to structure, negotiate and enforce agreements for the determination and payment of royalties. We face risks inherent in a royalty-based business model, many of which are outside of our control, such as the
following:



| |  |  | the rate of adoption and incorporation of our technology by semiconductor manufacturers and assemblers;
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| |  |  | the extent to which large equipment vendors and materials providers develop and supply tools and materials to enable manufacturing using our packaging technology;
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| |  |  | the demand for products incorporating semiconductors that use our licensed technology; and
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| |  |  | the cyclicality of supply and demand for products using our licensed technology.
| | - |  | --------------------------------------------------------------------------------

It is difficult for us to verify royalty amounts owed to us under our licensing agreements, and this may cause us to lose revenues.

The
standard terms of our license agreements require our licensees to document the manufacture and sale of products that incorporate our technology and report this data to us on a quarterly basis. Although our standard license terms give us the right to
audit books and records of our licensees to verify this information, audits can be expensive, time consuming, flawed and potentially detrimental to our ongoing business relationship with our licensees. Our license compliance program randomly audits
licensees to independently verify the accuracy of the information contained in their royalty reports in an effort to decrease the likelihood that we will not receive the royalty revenues to which we are entitled to under the terms of our license
agreements, but we cannot give assurances that the random audits will be effective to that end.

Failure by our licensees to introduce products using
our technology could limit our royalty revenues growth.

Because we expect a significant portion of our future revenues to be derived from royalties on
semiconductors that use our licensed technology, our future success depends upon our licensees developing and introducing commercially successful products. Any of the following factors could limit our licensees ability to introduce products
that incorporate our technology:



| |  |  | the willingness and ability of materials and equipment suppliers to produce materials and equipment that support our licensed technology, in a quantity sufficient to enable volume
manufacturing;
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| |  |  | the ability of our licensees to purchase such materials and equipment on a cost-effective and timely basis;
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| |  |  | the willingness of our licensees and others to make investments in the manufacturing process that supports our licensed technology, and the amount and timing of those investments;
and
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| |  |  | our licensees ability to design and assemble packages incorporating our technology that are acceptable to their customers.
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Failure by the semiconductor industry to adopt next generation high performance DRAM chips that utilize our packaging technology would significantly harm our
business.

To date, our packaging technology has been used by several companies for high performance DRAM chips. For example, packaging using our
technology is used for Double-Data-Rate two (DDR2) DRAM and we currently have licensees, including Samsung, Electronics, Co., Ltd., Qimonda AG, Hynix Semiconductor Inc. and Micron Technology, Inc., who are paying royalties for DRAM chips
in advanced packages.

DRAM manufacturers are also currently developing next generation high performance DRAM chips, including next generation of DDR
referred to as DDR3 and DDR4, to meet increasing speed and performance requirements of electronic products. We believe that these next generation, high performance DRAM chips will require advanced packaging technologies such as CSP.

We anticipate that royalties from shipments of these next generation, high performance DRAM chips packaged using our technology may account for a significant percentage
of our future revenues. If semiconductor manufacturers do not continue to adopt next generation, high performance DRAM packages using our technology and find an alternate viable packaging technology for use with next generation high performance DRAM
chips, or if we do not receive royalties from next generation, high performance DRAM chips that use our technology, our future revenues could be adversely affected.

Our technology may be too expensive for certain next generation high performance DRAM manufacturers, which could significantly reduce the adoption rate of our packaging technology in next generation high performance
DRAM chips. Even if our package technology is selected for at least some of these next generation high performance DRAM chips, there could be delays in the introduction of products utilizing these chips that could materially affect the amount and
timing of any royalty payments that we receive. Other factors that could affect adoption of our technology for next generation high performance DRAM products include delays or shortages of materials and equipment and the availability of testing
services.

Failure by the semiconductor industry to adopt broadly WLP packaging technology could limit our royalty revenue growth.

To date, wafer level packaging technologies have been adopted for a limited number of semiconductor products. To date, our packaging technology has been used by several
companies for CMOS image sensor chips principally for use in camera-equipped mobile phones. We believe that such WLP packages will be useful for image sensors in other applications such as personal digital assistants and digital cameras, and for
other applications such as MEMS devices.



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We anticipate that royalties from shipments of chips packaged using our WLP technology may account for a small but
increasing percentage of our future revenues. If semiconductor manufacturers do not adopt our WLP technology as quickly as is currently being projected by industry sources or find an alternate viable packaging technology for use with their image
sensor and MEMS chips, or if we do not receive royalties from image sensor and MEMS chips that use our technology, our future revenues could be adversely affected. In addition our technology may be too expensive for certain image sensor
manufacturers, which could significantly reduce the adoption rate of our WLP packaging technology in image sensor applications. Other factors that could affect adoption of our WLP technology for image sensors and MEMS chips include delays or
shortages of materials and equipment.

Competing technologies may harm our business.

We expect that our technologies will continue to compete with technologies of internal design groups of semiconductor manufacturers and assemblers. These internal design groups create their own packaging solutions,
and have direct access to their companys technical information and technology roadmaps, and have capacity, cost and technical advantages over us. If these internal design groups design around our patents, they may not need to license our
technology. These groups may design package technology that is less expensive to implement than ours or provides products with higher performance or additional features. Many of these groups have substantially greater resources, financial or
otherwise, than us and lower cost structures. As a result, they may be able to bring alternative package technologies solutions to market more easily and quickly. For instance, certain flip chip technologies are being used by large semiconductor
manufacturers and assemblers for a variety of semiconductors, including processors and memory. Another example of a competitive technology is the small format lead frame packages that are also gaining popularity. The companies using these
technologies are utilizing their current lead frame infrastructure to achieve cost-effective results. Another example of a competitive technology is the chip-on-board technique to package image sensors.

In the future, our licensed technologies may also compete with other package technologies. These technologies may be less expensive than ours and provide higher or
additional performance. Companies with these competing technologies may also have greater resources than us. Technological change could render our technologies obsolete, and new, competitive technologies could emerge that achieve broad adoption and
adversely affect the use of our intellectual property.

If we do not create and implement new designs to expand our licensable technology portfolio, our
competitive position could be harmed and our operating results adversely affected.

We derive a significant portion of our revenues from licenses and
royalties from a relatively small number of key technologies. We plan to devote significant engineering resources in order to develop new packaging technologies to address the evolving needs of the semiconductor and the consumer and communication
electronics industries. To remain competitive, we must introduce new technologies or designs in a timely manner and the market must adopt them. Developments in packaging technologies are inherently complex, and require long development cycles and a
substantial investment before we can determine their commercial viability. We may not be able to develop and market new technologies in a timely or commercially acceptable fashion. Moreover, our currently issued U.S. patents expire at various times
from January 25, 2009 through November 12, 2024. We need to develop and patent successful innovations before our current patents expire and our failure to do so could significantly harm our business.

If we do not successfully license the technologies we acquire, our competitive position could be harmed and our operating results adversely affected.

We also attempt to expand our licensable technology portfolio and technical expertise by acquiring technology or developing strategic relationships with others. These
strategic relationships may include the right for us to sublicense technology to others. However, we may not be able to acquire or obtain rights to licensable technology in a timely manner or upon commercially reasonable terms. Even if we do acquire
such rights, some of the technologies we are investing in are commercially unproven and may not be adopted or accepted by the industry. Moreover, our research and development efforts, and acquisitions and strategic relationships, may be futile if we
do not accurately predict the future packaging needs of the semiconductor, consumer and communication electronics industries. Our failure to acquire new technologies that are commercially viable in the semiconductor, consumer and communication
electronics industries could significantly harm our business.

Some of our license agreements have fixed terms and, in order to maintain our
relationships with licensees under such agreements, we will need to renegotiate some of our existing license agreements in the future.

Some of our
license agreements have fixed terms. We will need to renegotiate license agreements with fixed terms prior to the expiration of such license agreements and, based on various factors including the technology and business needs of our licensees, we
may not be able to renegotiate such license agreements on similar terms, or at all. In order to maintain existing relationships with some of our licensees, we may be forced to renegotiate license agreements on terms that are more favorable to such
licensees, which could harm our results of operations. If we fail to renegotiate our license agreements we would lose existing licensees and our business would be materially adversely affected.

Some of our license agreements convert to fully paid-up licenses at the expiration of their terms, and we will not receive royalties after that time.

Some of our license agreements convert to fully paid-up licenses at the expiration of their terms, either automatically or if the licensee exercises an option to
extend the term for an additional royalty payment. We will not receive further royalties from licensees for any licensed technology, under fully paid-up licenses and such licensees will be entitled to continue using our technology under the terms of
such license agreements, even if relevant patents are still in effect. A significant conversion of our license agreements to fully paid-up licenses could materially harm our results of operations following such conversion.

Our licensing cycle is lengthy and costly and our marketing and sales efforts may be unsuccessful.

We generally incur significant marketing and sales expenses prior to entering into our license agreements, generating a license fee and establishing a royalty stream from each licensee. The length of time it takes to
establish a new licensing relationship can range from six to 18 months or longer. As such, we may incur significant losses in any particular period before any associated revenues stream begins.

We employ intensive marketing and sales efforts to educate materials suppliers, equipment vendors, licensees, potential licensees and original equipment manufacturers
about the benefits of our technologies. In addition, even if these companies adopt our technologies, they must devote significant resources to integrate fully our technologies into their operations. If our marketing and sales efforts are
unsuccessful, then we will not be able to achieve widespread acceptance of our packaging technology. In addition ongoing litigation can impact our ability to gain new licensees.

Cyclicality in the semiconductor industry may affect our revenues, and as a result, our operating results could be adversely affected.



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The semiconductor industry has historically been cyclical and is characterized by wide fluctuations in product supply and
demand. From time to time, this industry has experienced significant downturns, often in connection with, or in anticipation of, maturing product and technology cycles, excess inventories and declines in general economic conditions. This cyclicality
could cause our operating results to decline dramatically from one period to the next. Our business depends heavily upon the volume of production by our licensees, which, in turn, depends upon the current and anticipated market demand for
semiconductors and products that use semiconductors. Similarly, our services business relies at least in part upon the outsourcing of design and engineering projects by the semiconductor industry. Semiconductor manufacturers and package assembly
companies generally sharply curtail their spending during industry downturns and historically have lowered their spending more than the decline in their revenues. As a result, if we are unable to control our expenses adequately in response to lower
revenues from our licensees and service customers, our operating results will suffer and we might experience operating losses.

The international nature
of our business exposes us to financial and regulatory risks and we may have difficulty protecting our intellectual property in some foreign countries.

We derive a significant portion of our revenues from licensees headquartered outside of the United States, principally in Asia and Europe. For the three and nine months ended September 30, 2006, these revenues accounted for 62.2% and
60.9% of our total revenues, respectively. For the three and nine months ended September 30, 2005, these revenues accounted for 49.1% and 57.9% of our total revenues, respectively. International operations are subject to a number of risks,
including the following:



| |  |  | international terrorism and anti-American sentiment, particularly in the emerging markets;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | laws and business practices favoring local companies;
| | - |  | -----------------------------------------------------



| |  |  | withholding tax obligations on license revenues that we may not be able to offset fully against our U.S. tax obligations, including the further risk that foreign tax authorities may
re-characterize license fees or increase tax rates, which could result in increased tax withholdings and penalties; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | less effective protection of intellectual property than is afforded to us in the United States or other developed countries.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------

Our intellectual property is also used in a large number of foreign countries. There are many countries, such as China, in which we currently have no issued patents. In
addition, effective intellectual property enforcement may be unavailable or limited in some foreign countries. It may be difficult for us to protect our intellectual property from misuse or infringement by other companies in these countries. We
expect this to become a greater problem for us as our licensees increase their manufacturing in countries which provide less protection for intellectual property. Our inability to enforce our intellectual property rights in some countries may harm
our business.

Our services business may subject us to specific costs and risks that we may fail to manage adequately which could harm our business.

We derive a portion of our revenues from engineering services. Among the engineering services that we offer are customized package design and
prototyping, modeling, simulation, failure analysis and reliability testing and related training services. A number of factors, including, among others, the perceived value of our intellectual property portfolio, our ability to convince customers of
the value of our engineering services and our reputation for performance under our service contracts, could cause our revenues from engineering services to decline, which would in turn harm our operating results.

Moreover, most of our service revenues are derived from engineering services we provide to government agencies and their contractors to enable the development of new
packaging technologies. If demand for our services from government agencies declines, due to changes in government policies or otherwise, our service revenues will be adversely affected.

Under our services contracts we are required to perform certain services, including sometimes delivering designs and prototypes. If we fail to deliver as required under our service contracts, we could lose revenues
and become subject to liability for breach of contract.

We provide certain services at below cost in an effort to increase the speed and breadth with
which the semiconductor industry adopts our technologies. For example, we provide modeling, manufacturing process training, equipment and materials characterization and other services to assist licensees in designing, implementing, upgrading and
maintaining their packaging assembly line. We frequently provide these services as a form of training to introduce new licensees to our technology and existing clients to new technologies, with the aim that these services will help us to generate
revenues in the future. We need to monitor these services adequately in order to ensure that we do not incur significant expenses without generating corresponding revenues. Our failure to monitor these services or our design and prototype services
adequately may harm our operating results.

Because our services sometimes involve the delivery of package designs and prototypes, we may be subject to
claims that we infringed or induced the infringement of patents and other intellectual property rights belonging to others. If such a claim were made, we may have to take a license or stop manufacturing the accused packages, which could cause our
services revenues to decrease. If we choose not to take a license, we may be sued for infringement, and may incur significant litigation costs in defending against the lawsuit. If we are found to infringe the intellectual property rights of others,
we may have to pay damages and could be subject to an injunction preventing us from continuing to provide the services. Any of these outcomes could harm our business.

If our prototypes, manufactured packages or products based on our designs are used in defective products, we may be subject to product liability or other claims.

Under our service contracts, we may, at times, manufacture packages on a limited basis, deliver prototypes or designs or help to design prototypes or products. If these
prototypes, packages or designs are used in defective or malfunctioning products, we could be sued for damages, especially if the defect or malfunction causes physical harm to people. The occurrence of a problem could result in product liability
claims and/or a recall of, or safety alert or advisory notice relating to, the product. While we believe the amount of product liability insurance maintained by us combined with the indemnities that we have been granted under these service contracts
are adequate, there can be no assurance that these will be adequate to satisfy claims made against us in the future or that we will be able to obtain insurance in the future at satisfactory rates or in adequate amounts. Product liability claims or
product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business, financial condition and reputation, and on our ability to attract and retain licensees and customers.

We intend to continue to expand our operations which may strain our resources and increase our operating expenses.



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We plan to continue the expansion of our operations, domestically and internationally, and may do so through both
internal growth and acquisitions. We expect that this expansion will strain our systems and operational and financial controls. In addition, we are likely to incur higher operating costs. To manage our growth effectively, we must continue to improve
and expand our systems and controls. If we do fail to do so, our growth would be limited. Our officers have limited experience in managing large or rapidly growing businesses through acquisitions. Further, our officers have limited experience
managing companies through acquisitions and technological changes. In addition, our management has limited experience in managing a public company.

We
have made and may continue to make acquisitions which could divert managements attention, cause ownership dilution to our stockholders, be difficult to integrate and adversely affect our financial results.

We have made several acquisitions and it is our current plan to acquire companies and technologies that we believe are strategic to our future business. Integrating newly
acquired businesses or technologies could put a strain on our resources, could be costly and time consuming, and might not be successful. Such acquisitions could divert our managements attention from other business concerns. In addition, we
might lose key employees while integrating new organizations. Acquisitions could also result in customer dissatisfaction, performance problems with an acquired company or technology, potentially dilutive issuances of equity securities or the
incurrence of debt, the assumption or incurrence of contingent liabilities, possible impairment charges related to goodwill or other intangible assets or other unanticipated events or circumstances, any of which could harm our business.
Consequently, we might not be successful in integrating any acquired businesses, products or technologies, and might not achieve anticipated revenues and cost benefits.

There are numerous risks with our recent acquisitions of Digital Optics Corporation and of certain assets from Shellcase Ltd.

In July 2006, we completed our acquisition of Digital Optics Corporation, a company based in Charlotte, North Carolina, and in December 2005, we completed our acquisition of certain equipment, intellectual property and other
intangible assets from Shellcase, Ltd., a company based in Israel. These acquisitions are subject to a number of risks, including the following:



| |  |  | Either acquisition could fail to produce anticipated benefits, or could have other adverse effects that we currently do not foresee. As a result, either acquisition could result in
a reduction of net income per share as compared to the net income per share we would have achieved if these acquisitions had not occurred.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Following completion of these acquisitions, we may uncover additional liabilities or unforeseen expenses not discovered during our diligence process. Any such additional liabilities
or expenses could result in significant unanticipated costs not originally estimated and may harm our financial results. Impairment charges of acquired assets and goodwill.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The integration of Digital Optics Corporation and of the Shellcase Ltd. assets will be a time consuming and expensive process that may disrupt our operations if it is not completed
in a timely and efficient manner. If our integration efforts are not successful, our results of operations could be harmed, employee morale could decline, key employees could leave, and customer relations could be damaged. In addition, we may not
achieve anticipated synergies or other benefits from either acquisition.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have incurred substantial direct transaction costs as a result of these acquisitions and anticipate incurring substantial additional costs to support the integration of Digital
Optics Corporation and the assets of Shellcase Ltd. The total cost of the integration may exceed our expectations.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If we lose any of our
key personnel or are unable to attract, train and retain qualified personnel, we may not be able to execute our business strategy effectively.

Our
success depends, in large part, on the continued contributions of our key management, engineering, sales and marketing, legal and finance personnel, many of whom are highly skilled and would be difficult to replace. In particular, the services of
Dr. McWilliams, our President, Chief Executive Officer and the Chairman of our Board of Directors, who has led our company since May 1999 and has been the Chairman of our board of directors since February 2002, are very important to our
business. None of our senior management, key technical personnel or key sales personnel are bound by written employment contracts to remain with us for a specified period. In addition, we do not currently maintain key person life insurance covering
our key personnel. The loss of any of our senior management or other key personnel could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

Moreover, some of the individuals on our management team have been in their current positions for a relatively short period of time. For example, our chief financial
officer has been with us for less than 12 months. Our future success will depend to a significant extent on the ability of our management team to work together effectively.

In addition, the initial stock options that were granted to many of our senior management and key employees are fully vested. Therefore, these employees may not have sufficient financial incentive to stay with us, we
may have to incur costs to replace key employees that leave, and our ability to execute our business model could be impaired if we cannot replace departing employees in a timely manner.

Many of our senior management personnel and other key employees have become, or will soon become, substantially vested in their initial stock options grants. While we often grant additional stock options to management
personnel and other key employees after their hire dates to provide additional incentives to remain employed by us, their initial grants are usually much larger than follow-on grants. Employees may be more likely to leave us after their initial
option grant fully vests, especially if the shares underlying the options have significantly appreciated in value relative to the option exercise price. If any members of our senior management team leave the company, our ability to successfully
operate our business could be impaired. We also may have to incur significant costs in identifying, hiring, training and retaining replacements for departing employees.



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Our success also depends on our ability to attract, train and retain highly skilled managerial, engineering, sales,
marketing, legal and finance personnel and on the abilities of new personnel to function effectively, both individually and as a group. Competition for qualified senior employees can be intense. For example, we have experienced, and we expect to
continue to experience, difficulty in hiring and retaining highly skilled engineers with appropriate qualifications to support our growth and expansion. Further, we must train our new personnel, especially our technical support personnel, to respond
to and support our licensees and customers. If we fail to do this, it could lead to dissatisfaction among our licensees or customers, which could slow our growth or result in a loss of business.

Decreased effectiveness of share-based compensation could adversely affect our ability to attract and retain employees.

We have historically used stock options and other forms of stock-based compensation as key components of our employee compensation program in order to align
employees interests with the interests of our stockholders, encourage employee retention and provide competitive compensation and benefit packages. In accordance with Financial Accounting Standards Board Statement 123R, Share-Based
Payment, we began recording charges to earnings for stock-based payments on January 1, 2006. As a result, we have incurred increased compensation costs associated with our stock-based compensation programs. Moreover, difficulties relating
to obtaining stockholder approval of equity compensation plans could make it harder or more expensive for us to grant stock-based payments to employees in the future. As a result, we may find it difficult to attract, retain and motivate employees,
and any such difficulty could materially adversely affect our business.

Failure to comply with environmental regulations could harm our business.

We use hazardous substances in the manufacturing and testing of prototype products and in the development of our technologies in our research and
development laboratories. We are subject to a variety of local, state, federal and foreign governmental regulations relating to the storage, discharge, handling, emission, generation, manufacture and disposal of toxic or other hazardous substances.
Our past, present or future failure to comply with environmental regulations could result in the imposition of substantial fines on us, suspension of production, alteration of our manufacturing processes or cessation of operations. Compliance with
such regulations could require us to acquire expensive remediation equipment or to incur other substantial expenses. Any failure by us to control the use, disposal, removal or storage of, or to adequately restrict the discharge of, or assist in the
cleanup of, hazardous or toxic substances, could subject us to significant liabilities, including joint and several liability under certain statues. The imposition of such liabilities could significantly harm our business.

Our corporate headquarters is located in California and, as a result, is subject to catastrophes and natural disasters.

Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel, which are located in or near our principal
headquarters in San Jose, California. San Jose exists on or near a known earthquake fault zone. Should an earthquake or other catastrophes, such as fires, floods, power loss, communication failure or similar events disable our facilities, we do not
have readily available alternative facilities from which we could conduct our business.

We have business operations located in North Carolina that are
subject natural disasters.

Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel, some
of which are located in Charlotte, North Carolina. Should a hurricane or other catastrophes, such as fires, floods, power loss, communication failure or similar events disable our facilities, we do not have readily available alternative facilities
from which we could conduct our business.

We have a research and development facility in Jerusalem, Israel that subjects us to risks that may
negatively affect our results of operations and financial condition.

Our research and development facility in Jerusalem, Israel may be subject to risks
that may limit our ability to design, develop, test or market certain technologies, which could in turn have an adverse effect on our results of operations and financial condition, including:



| |  |  | security concerns, including crime, political instability, terrorist activity, armed conflict and civil or military unrest;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | local business and cultural factors that differ from our normal standards and practices in the United States;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | regulatory requirements and prohibitions that differ between jurisdictions;
| | - |  | ---------------------------------------------------------------------------



| |  |  | differing employment practices and labor issues
| | - |  | -----------------------------------------------



| |  |  | limited infrastructure and disruptions, such as large-scale outages or interruptions of service from utilities or telecommunications providers; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | natural disasters.
| | - |  | ------------------

Compliance with changing regulation of corporate
governance and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and
public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, have created uncertainty for companies. These laws, regulations and standards are often subject to varying interpretations. As a
result, their application in practice may evolve as new guidance is provided by regulatory and governing bodies, which could result in higher costs necessitated by ongoing revisions to disclosure and governance practices. As a result of our efforts
to comply with evolving laws, regulations and standards, we have increased and will likely continue to increase general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance
activities. While we believe that we currently have adequate internal control procedures in place, we are still exposed to potential risks from recent legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley
Act of 2002. Our efforts to comply with Section 404 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors audit of that assessment has required the
commitment of significant financial and managerial resources. We expect these efforts to require the continued commitment of significant resources. Further, our Board members, Chief Executive Officer and Chief Financial Officer could face an
increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business.



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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Our initial public offering of 7,500,000 shares of
common stock was effected through a Registration Statement on Form S-1 (File No. 333-108518) that was declared effective by the Securities and Exchange Commission on November 12, 2003.

All of the net proceeds from the initial public offering remain invested in short-term, money market funds pending application of the funds to general corporate
purposes, as described in the Registration Statement on Form S-1.

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



|               |  |                                                                                                                                                                                                                                                                                                      
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibit Title                                                                                                                                                                                                                                                                                        
|               | 
|2.1            |  | Agreement and Plan of Merger dated as of July 7, 2006 among Tessera Technologies, Inc., Dalton Acquisition Corp., Digital Optics Corporation and Carolinas Capital Corp., (filed as Exhibit 2.1
to Tesseras Current Report on Form 8-K filed on July 10, 2006, and incorporated herein by reference)
|               | 
|3.1*           |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                                                
|               | 
|3.2*           |  | Restated Bylaws                                                                                                                                                                                                                                                                                      
|               | 
|10.1           |  | TCC License Agreement, dated July 21, 2006, among Tessera Technologies, Inc. and certain of its affiliates and Micron Technology, Inc and certain of its affiliates (filed as Exhibit 10.1 to
Tesseras Current Report on Form 8-K filed on July 21, 2006, and incorporated herein by reference)     
|               | 
|10.2           |  | Infineon TCC License Agreement, by and between Tessera Technologies, Inc. and Infineon Technologies AG, dated as of July 1, 2006 (filed as Exhibit 10.1 to Tesseras Current Report on
Form 8-K/A filed on August 7, 2006, and incorporated herein by reference)                                     
|               | 
|10.3           |  | Qimonda TCC License Agreement, by and between Tessera Technologies, Inc. and Qimonda AG, dated as of July 1, 2006 (filed as Exhibit 10.2 to Tesseras Current Report on Form 8-K/A filed
on August 7, 2006, and incorporated herein by reference)                                                    
|               | 
|10.4           |  | Employment Letter, by and between Tessera, Inc. and Charles A. Webster, dated August 7, 2006 (filed as Exhibit 10.1 to Tesseras Current Report on Form 8-K filed on August 29, 2006, and
incorporated herein by reference)                                                                          
|               | 
|31.1           |  | Section 302 Certification of the Chief Executive Officer                                                                                                                                                                                                                                             
|               | 
|31.2           |  | Section 302 Certification of the Chief Financial Officer                                                                                                                                                                                                                                             
|               | 
|32.1           |  | Section 906 Certification of the Chief Executive Officer and Chief Financial Officer                                                                                                                                                                                                                 

---

|* | Filed as exhibits to Tesseras Registration Statement on Form S-1 (SEC File No. 333-108518), effective November 12, 2003, and incorporated herein by reference.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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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.

Dated: November 10, 2006



Tessera Technologies, Inc.By:

/s/ Charles A. WebsterCharles A. WebsterChief Financial Officer and Executive Vice President




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EXHIBIT INDEX



|               |  |                                                                                                                                                                                                                                                                                                      
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibit Title                                                                                                                                                                                                                                                                                        
|               | 
|2.1            |  | Agreement and Plan of Merger dated as of July 7, 2006 among Tessera Technologies, Inc., Dalton Acquisition Corp., Digital Optics Corporation and Carolinas Capital Corp., (filed as Exhibit 2.1
to Tesseras Current Report on Form 8-K filed on July 10, 2006, and incorporated herein by reference)
|               | 
|3.1*           |  | Restated Certificate of Incorporation                                                                                                                                                                                                                                                                
|               | 
|3.2*           |  | Restated Bylaws                                                                                                                                                                                                                                                                                      
|               | 
|10.1           |  | TCC License Agreement, dated July 21, 2006, among Tessera Technologies, Inc. and certain of its affiliates and Micron Technology, Inc and certain of its affiliates (filed as Exhibit 10.1 to
Tesseras Current Report on Form 8-K filed on July 21, 2006, and incorporated herein by reference)     
|               | 
|10.2           |  | Infineon TCC License Agreement, by and between Tessera Technologies, Inc. and Infineon Technologies AG, dated as of July 1, 2006 (filed as Exhibit 10.1 to Tesseras Current Report on
Form 8-K/A filed on August 7, 2006, and incorporated herein by reference)                                     
|               | 
|10.3           |  | Qimonda TCC License Agreement, by and between Tessera Technologies, Inc. and Qimonda AG, dated as of July 1, 2006 (filed as Exhibit 10.2 to Tesseras Current Report on Form 8-K/A filed
on August 7, 2006, and incorporated herein by reference)                                                    
|               | 
|10.4           |  | Employment Letter, by and between Tessera, Inc. and Charles A. Webster, dated August 7, 2006 (filed as Exhibit 10.1 to Tesseras Current Report on Form 8-K filed on August 29, 2006, and
incorporated herein by reference)                                                                          
|               | 
|31.1           |  | Section 302 Certification of the Chief Executive Officer                                                                                                                                                                                                                                             
|               | 
|31.2           |  | Section 302 Certification of the Chief Financial Officer                                                                                                                                                                                                                                             
|               | 
|32.1           |  | Section 906 Certification of the Chief Executive Officer and Chief Financial Officer                                                                                                                                                                                                                 

---

|* | Filed as exhibits to Tesseras Registration Statement on Form S-1 (SEC File No. 333-108518), effective November 12, 2003, and incorporated herein by reference.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



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