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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

For the fiscal year ended December 31, 2005

OR

For the transition period from ______________ to ______________

Commission File Number: 000-50460

Tessera Technologies, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Securities registered pursuant to Section 12(b) of the Act:    None

Securities registered pursuant to Section 12(g) of the Act:    Common stock, par value $0.001 per share

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes ¨ No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing sale price of common stock as reported on the Nasdaq National Market, on March 13, 2006 was $1,448,501,196.

As of March 13, 2006 45,809,652 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Definitive Proxy Statement for registrant’s 2006 Annual Meeting of Stockholders to be held May 18, 2006 will be filed with the Commission within 120 days after the close of the registrant’s fiscal year and are incorporated by reference in Part III.

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ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005

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PART I

Corporate Information

This Annual Report (including the following section regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Annual Report. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, sales levels, expense levels and other statements regarding matters that are not historical are forward-looking statements.

Although forward-looking statements in this Annual Report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed under the heading “Risk Factors” below, as well as those discussed elsewhere in this Annual Report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report. Readers are urged to carefully review and consider the various disclosures made in this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

Our principal executive offices are located at 3099 Orchard Drive, San Jose, California 95134. Our telephone number is (408) 894-0700. We maintain a website at www.tessera.com. The reference to our website address does not constitute incorporation by reference of the information contained on this website.

We own or have rights to trademarks and trade names that we use in conjunction with the operation of our business, including Tessera and Tessera Technologies. This annual report also includes trademarks and trade names of other parties.

In this annual report, the “Company,” “Tessera,” “we,” “us” and “our” refer to Tessera Technologies, Inc. and, for periods prior to our corporate restructuring in January 2003 or if the context otherwise requires, Tessera, Inc., which is our wholly-owned subsidiary.

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 and mechanical properties of materials and interconnect. We develop and license technologies to the electronics industry. Our intellectual property includes more than 363 issued U.S. patents and 70 issued foreign patents, covering a broad range of advanced semiconductor packaging and interconnect 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. In addition, 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

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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.

We derive license fees and royalties based upon our intellectual property and generate fees for related services. Our technology has been widely adopted and is currently licensed to more than 50 companies, including Intel Corporation, Renesas Technology Co., Samsung Electronics Co., Ltd, Sharp Corporation, Texas Instruments, Inc. and Toshiba Corporation. We believe that more than 100 companies across the semiconductor supply chain have invested in the materials, equipment and assembly infrastructure needed to manufacture products that incorporate our technology. As a result, our technology has been incorporated into more than 8 billion semiconductors worldwide, including more than 2.9 billion semiconductors shipped in 2005. Based upon Gartner Dataquest, we anticipate that the market using Tessera CSP technology will grow to more than 14 billion units in 2008, representing a compound annual growth rate of 21%. The market for WLP technology includes image sensors for camera-equipped mobile phones, as well as micro electro-mechanical systems (“MEMS”) devices. According to Prismark, in 2005 approximately 115 million image sensors were packaged using our WLP technology. According to In-Stat, the MEMS market is expected to grow from 2.4 billion units in 2004 to nearly 6 billion units by 2009. We believe that we are well-positioned to take advantage of this expected significant growth in CSPs and WLPs.

Industry Background

Packaged semiconductor chips, which we refer to as semiconductors, are essential components in a broad range of communications, computing and consumer electronic products. According to the Semiconductor Industry Association, worldwide semiconductor sales totaled $227.5 billion in 2005 and are expected to grow to $309.0 billion in 2008. Many electronic products require increasingly complex semiconductors that are smaller and higher-performing, integrate more features and functions and are less expensive to produce than previous generations of semiconductors. Satisfying the demand for these complex semiconductors requires advances in semiconductor design, manufacturing and packaging technologies.

The disaggregation of the semiconductor industry and the emergence of intellectual property companies

Historically, most semiconductor companies were vertically integrated. They designed, fabricated, packaged and tested their semiconductors using internally developed software design tools and manufacturing processes and equipment. As the cost and skills required for designing and manufacturing complex semiconductors have increased, the semiconductor industry has become disaggregated, with companies concentrating on one or more individual stages of the semiconductor development and production process. This disaggregation has fueled the growth of fabless semiconductor companies, design tool vendors, semiconductor equipment manufacturers, third-party semiconductor manufacturers, or foundries, semiconductor assembly, package and test companies and intellectual property companies that develop and license technology to others.

While specialization has enabled greater development and manufacturing efficiency, it has also created an opportunity for intellectual property companies that develop and license technology to meet fundamental, industry-wide challenges. These intellectual property companies gain broad adoption of their technology throughout the industry by working with companies within the semiconductor supply chain to invest in the infrastructure needed to support their technology. This collaboration and investment benefit semiconductor companies by enabling them to bring new technology to market faster and more cost-effectively, without having to make the investment themselves.

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Demand for system-level miniaturization and increased performance

Miniaturization of electronic products, or system-level miniaturization, is a significant challenge for manufacturers of electronic products and their suppliers, including semiconductor companies. Digital cameras, digital audio players, personal computers, personal digital assistants, video game consoles, mobile phones and other electronic products are being made smaller with improved performance and an increasing number of advanced features. Semiconductor companies have traditionally responded to these challenges by shrinking the size of the basic semiconductor building block, or transistor, allowing for more transistors to be integrated on a single chip. For decades, the consistent reduction in transistor size has resulted in higher-performance, lower-cost chips that require less silicon area. In addition, transistors have become small enough to make it economical to combine multiple functions, such as logic, memory and analog, on a single chip, in what is commonly referred to as a system-on-a-chip.

Importance of semiconductor packaging

While the integration of increased functionality on a chip is critical to the miniaturization of electronic products, its impact has been limited by packaging technology, which has not kept pace with the advancements achieved by chip integration. Semiconductor chips are typically assembled in packages that act as the physical and electrical interface between the chip and the printed circuit board. The package protects the chip from breakage, contamination and stress. In addition, the package enables a chip to be easily tested prior to its incorporation into a system, enabling high system yields and lowering the total system cost. Traditional semiconductor packages are much larger than the chip itself and occupy significant circuit board and system area. Also, traditional packaging technologies are less capable of accommodating faster semiconductor speeds due to longer electrical connections. Due to these limitations, traditional semiconductor packages are not well suited to meet the increasing demand for product miniaturization, functionality and performance. As a result, in addition to continuing advancements in chip integration, advanced packaging technology is required to achieve further miniaturization and higher performance cost-effectively.

Our Solution

We are a leading provider of intellectual property for chip-scale and multi-chip packaging that meets the increasing demand for miniaturization and high performance in electronic products. We license a substantial portion of our intellectual property under our Tessera Compliant Chip, or TCC, license. This license primarily covers our core chip-scale and multi-chip packaging patents. We also offer an intellectual property license under our wafer level technologies license, which covers our wafer level optical packaging patents. In addition, we support the adoption of our technology by providing our customers with engineering services focused on addressing key issues related to the miniaturization and performance of electronics products. Our packaging technology provides the following benefits which are not provided by traditional packaging technologies:

Miniaturization.    Our CSP technology enables fully-packaged chips to be almost as small as the chip itself, which permits increased product miniaturization and functionality. Our multi-chip packaging technology extends this benefit by enabling multiple semiconductors to be stacked vertically, while occupying about the same circuit board area as a CSP. For example, our technology is broadly used to produce Flash memory and static random access memory, or SRAM, devices stacked in a multi-chip package utilized in mobile phones. As a result, we believe our multi-chip technology enables electronic products to achieve new levels of miniaturization. Our WLP technology enables chip packages in which the area of the package is the same size as the area of the chip itself.

High performance.    Our technology offers shorter electrical connections between the chip and circuit board and between adjacent chips. Shorter connections allow information to be more rapidly transferred between the semiconductors and the system, yielding better system performance. Our technology has been widely adopted for use in high-speed memory applications, such as high-performance personal computers, network switches and routers, set-top boxes, workstations and video game consoles, such as the Microsoft^® Xbox.

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High reliability.    The miniaturization of packaged semiconductors often presents reliability problems because the shorter connections are more vulnerable to breakage due to thermally-induced stress and mechanical shock. Overcoming these problems has been one of the most significant technical challenges in shrinking semiconductor packages to the size of the chip itself. Our technology alleviates these problems by allowing movement within the package. Our WLP technology provides the ability to protect an image sensor wafer from contamination at the wafer level and early in the packaging process. As a result, our technology provides high reliability without the increased package size or cost of competing technologies for a broad range of applications that require miniaturization.

Cost effectiveness.    The significant investment made by semiconductor chip makers, assemblers, and material and equipment providers in the manufacturing infrastructure that supports our technology enables high-volume production and broad availability of semiconductors that incorporate our technology. This in turn has reduced the cost of manufacturing products that incorporate our technology, allowing it to be used in cost-sensitive semiconductor applications such as dynamic random access memory, or DRAM, Flash memory, static random access memory, or SRAM, digital signal processors and image sensors. We believe that this broad adoption and high volume production of our technology will further increase its cost-effectiveness.

Our Strategy

Our objective is to be the leading provider of miniaturization technologies for the electronics industry by developing and licensing technologies that meet the increasing demand for miniaturization and performance in a broad range of communication, computing and consumer electronic products. The following are key elements of our strategy:

Expand the market penetration of our CSP technology.    Our patented CSP technology has been incorporated in over 8 billion semiconductors worldwide. As a result of the broad adoption of our technology and existing infrastructure that supports our technology, we believe that we are well positioned to benefit from the substantial growth projected for the CSP market. We intend to further increase our share of the CSP market by:

Accelerate the market acceptance of our three-dimensional multi-chip packaging technology.    Our three-dimensional multi-chip packaging technology extends our CSP technology by enabling multiple chips to be stacked vertically, while occupying about the same circuit board area as a CSP. This technology is designed for products in which miniaturization and feature integration are critical, including digital cameras, digital audio players, personal digital assistants and mobile phones. We intend to accelerate the adoption of our three-dimensional multi-chip packaging technology by:

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Accelerate the market acceptance of our wafer level packaging technology.    Our WLP technology permits the routing of device contacts either to the front or back side of the package, thereby enabling reduction in the overall size of the finished packaged chip relative to non-WLP packages. In addition, our technology has the ability to protect the image sensor wafer from contamination early in the packaging process, at the wafer level. This technology is designed for products in which miniaturization and manufacturing yield are critical, including camera-equipped mobile phones, digital cameras, and personal digital assistants. We intend to accelerate the adoption of our WLP technology by:

Provide engineering services to develop and promote the adoption of our technology.    We intend to continue to use our engineering services to accelerate the adoption of our technology, better understand our customers’ advanced packaging requirements, and develop and broaden our intellectual property portfolio. For example, we provide our customers with a broad range of services, such as package design, prototype manufacturing and reliability analysis, to help them develop products that incorporate our technology. This collaboration allows us to better understand our customers’ future product and packaging technology requirements. We have generated a substantial portion of our service revenues by providing our engineering services to various government agencies. These relationships contribute to the development of our advanced packaging technologies such as three-dimensional multi-chip packaging.

Utilize and enhance the infrastructure supporting our technology.    For more than a decade, we have collaborated with our infrastructure partners to help them develop and make widely available low-cost materials, equipment and assembly capacity to manufacture products that incorporate our technology. We design new technologies that are compatible with this existing infrastructure, which facilitates more rapid adoption of these new technologies. We plan to continue to work with our infrastructure partners to expand the adoption of our technology.

Broaden our intellectual property portfolio.    We intend to continue to broaden our intellectual property portfolio through internal development, strategic relationships and acquisitions, to enhance the competitiveness and size of our current businesses and diversify into markets and technologies that complement our current businesses. For example, we extended our intellectual property portfolio in the area of WLP by purchasing certain assets of Shellcase Ltd. We also intend to continue to utilize our core competency in aggregating and licensing intellectual property to grow and expand our business.

Create demand by collaborating with system manufacturers and electronic manufacturing service providers.    We work with leading system manufacturers and electronic manufacturing service providers to increase demand for our chip-scale, multi-chip and WLP technology. Through these relationships, we align our research and development efforts to better meet their needs.

Our Technology and Services

We derive the majority of our revenues from license fees and royalties associated with our TCC license. Our TCC license grants a worldwide right to develop, assemble, use and sell certain CSPs and multi-chip packages. The licensed technology primarily includes issued patents and pending patent applications during the term of the license. We also license components of our intellectual property portfolio outside of the TCC license, such as our wafer level packaging technology. In addition, we provide a broad range of engineering, assembly and infrastructure services to our customers.

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Our Technology

Our packaging technology is incorporated into packaged semiconductors for use in a broad range of communication, computing and consumer electronics applications. These semiconductors include:

Chip-Scale Package Technology Platforms

Although most of our licensees have developed their own proprietary packages incorporating our intellectual property, we have developed the following CSP platforms which are included in our TCC license:

Micro Ball Grid Array, or µBGA^®, Platform.    Our µBGA^® platform includes the lead-bonded µBGA^® package and the µBGA^®-W package, an alternative that uses wire-bonding as opposed to lead bonding as the package’s internal electrical interconnect. In the µBGA^® platform the chip is oriented face-down in the package with its contacts facing the circuit board. We believe this CSP platform offers the best combination of features to meet the requirements of high-performance DRAM semiconductors.

µBGA^®-F Platform.    The µBGA^®-F platform has the chip oriented face-up in the package, with its contacts facing away from the circuit board, and utilizes standard wire-bonding for the package’s internal electrical interconnect. The technology underlying this platform has been broadly adopted and incorporated into a large number of customer-developed proprietary packages for Flash memory, SRAM, DSP, ASIC and ASSP semiconductors used in wireless communication and consumer electronics products.

Multi-Chip Package Technology Platforms

Our technology is incorporated into a number of three-dimensional multi-chip packages used in wireless communication and digital consumer electronics products, such as digital cameras, digital audio players, personal digital assistants and mobile phones. These packages include various combinations of ASIC, ASSP, DSP, Flash memory and SRAM semiconductors. In addition, we have developed a family of three-dimensional multi-chip platforms, which are collectively referred to as the µZ^® Stacked Package family, to extend this innovative technology into new applications to meet the growing demand for higher levels of integration in computing, communications and consumer electronics. We also develop and design solutions which incorporate RF devices in three-dimensional platforms for a broad range of wireless handheld, computing and consumer electronic products.

We expect these platforms to build upon the existing CSP infrastructure and to enable further miniaturization and increased performance and functionality for a broad range of cost-sensitive, high volume applications. Each platform was developed to resolve complex, technical and business challenges inherent in the miniaturization of electronic products.

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We offer the following multi-chip platforms:

µZ^® Chip Stack Platform.    The µZ^® chip stack platform consists of two or more chips, stacked vertically on top of each other and wire-bonded to the package substrate. This is a cost-effective, versatile platform that is used in a broad range of semiconductors and product applications. The technology underlying this platform has been broadly adopted and incorporated into a large number of customer-developed proprietary stacked multi-chip packages for Flash memory, SRAM, DSP, ASIC and ASSP semiconductors, that are used in wireless communication and consumer electronics products.

µZ^® Fold-Over Stacked Platform.    We have introduced our µZ^® Fold-Over Stacked platform to solve an industry-wide problem associated with the integration of different types of functional blocks, such as processor, memory and various analog blocks, onto a single system-on-a-chip. For example, this package enables ASSP, ASIC and different memory semiconductors to be fully packaged, tested and then integrated, resulting in a high-yielding system-in-a-package. The µZ^® Fold-Over Stacked platform provides a cost-effective solution that meets mobile phone package height requirements and saves valuable circuit board space, enabling mobile products that are smaller and lighter with more functionality.

µZ^® Ball Stacked Platform.    We have also introduced our µZ^® Ball Stacked platform as a multi-chip solution that enables the integration of high-performance DRAM while occupying 25% less circuit board area with 60% of the height of a traditional DRAM package. Because each DRAM chip can be individually tested prior to being assembled in the multi-chip package, common yield problems associated with competing technologies can be overcome. Our µZ^® Ball Stacked platform can be used for cost-sensitive, high-volume applications, including DRAM modules for high-performance personal computers, workstations and network switches and routers.

Wafer Level Package Technology Platforms

Our WLP technologies are suitable for a variety of electronics products. The principal application to date is optical sensors; in particular complementary metal oxide semiconductor, or CMOS image sensors for camera-equipped mobile phones, charge-coupled device, or CCD area sensors and linear array image sensors. Our WLP technologies include the following platforms:

ShellcaseOP^TM.    The ShellcaseOP package utilizes an innovative glass-silicon-glass sandwich structure to enable image-sensing capabilities through the actual packaging structure. The end result is a true chip size package with horizontal and vertical dimensions identical to the original die size, and a total package thickness, which is in most cases similar to the original silicon thickness. The ShellcaseOP platform is offered in two configurations: “face up”, where the assembled die faces up towards the target image; or “face down” where the assembled die observes the target image through a port in the printed circuit board. ShellcaseOP packages offer significant advantages for CMOS and CCD linear and array image sensors, digital imaging and light detection applications. ShellcaseOP platforms have been in commercial production since 2000, and can be found in a wide variety of devices, including camera phones, digital cameras and medical devices.

ShellcaseOC^TM.    The ShellcaseOC package is a true chip size package that utilizes an innovative glass-silicon-glass sandwich to enable image-sensing capabilities through the actual packaging structure. ShellcaseOC provides an air cavity between the package and the die, making it the packaging solution of choice for image sensors with micro-lenses, such as those used in digital cameras and camera phones, fax machines and digital scanners, machine vision applications, and CD/DVD portable units, among others.

ShellcaseUT^TM.    The ShellcaseUT platform utilizes an innovative glass-silicon structure to enable image-sensing capabilities through the actual packaging structure. In a ShellcaseUT package, the bottom glass layer has been replaced with a polymer layer. That structure provides a true die-sized package with horizontal and vertical dimensions identical to the original chip size, and a total package thickness smaller than the original silicon thickness. The ShellcaseUT platform is available in both cavity and non-cavity formats.

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The following table provides a summary of the key features and semiconductor and system applications for each of our package technologies and the related platforms, all of which are included in our standard TCC license:

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Our Services

We provide our customers and partners with engineering, assembly and infrastructure services that we believe accelerate the adoption of our technology for a broad range of cost-sensitive, high-volume applications. We provide engineering services to semiconductor makers and assemblers, system manufacturers, electronic manufacturing service companies and government agencies and their contractors to enable the development of new packaging technologies. Most of our service revenues are derived from government-related engineering services.

Engineering services. Our engineering services include customized package design and prototyping, modeling, simulation, failure analysis and reliability testing and related training services. We provide these services to semiconductor makers and assemblers, system manufacturers, electronic manufacturing service companies and government agencies and their contractors. We believe that offering these services accelerates the incorporation of our intellectual property into our customers’ products and aids in our understanding of the electronic industry future packaging requirements.

Assembly services. We provide training and consulting services to assist semiconductor assemblers in designing, implementing, upgrading and maintaining their CSP and WLP assembly lines. We also offer services to help customers address process, equipment, materials and other manufacturing-related issues. This allows our assembly customers to bring their manufacturing lines incorporating our technology into production more rapidly and cost-effectively.

Infrastructure services. We offer evaluation, qualification, cost reduction and cost analysis services to companies that develop and manufacture equipment and materials to support the infrastructure needed to manufacture semiconductors that incorporate our technology. These services enable infrastructure customers to evaluate the impact of their specific materials and equipment on the manufacturability and reliability of our technology.

Operating Segments

Effective 2005, we organized our business operations into five operating groups, the Advanced Semiconductor Packaging Group, the Emerging Markets and Technologies Group, Tessera Interconnect Materials, Inc., (a wholly owned subsidiary formed in May 2005), the Wafer Level Technologies Division and the Product Miniaturization Division. These groups are reported in two segments; Intellectual Property and Services.

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Our Intellectual Property segment is composed of the following:

Advanced Semiconductor Packaging Group.    Our Advanced Semiconductor Packaging Group is focused on licensing technologies in our core markets, which include DRAM, Flash, SRAM, DSP, ASIC, ASSP, micro-controllers, general purpose logic and analog semiconductors. Key functions of this group include development, marketing and R&D. This group works closely with integrated device manufacturers (“IDMs”), which make semiconductors that use our technology.

Emerging Markets and Technologies Group.    Our Emerging Markets and Technologies Group is focused on expanding our technology portfolio into areas outside of our core markets that represent long-term growth opportunities through application of existing patents, products and technologies; internal development of new technologies for high growth markets; applications such as imaging, MEMs and RF; and new partnerships, ventures and acquisitions of complementary technology.

Tessera Interconnect Materials, Inc.    Tessera Interconnect Materials, Inc., our wholly-owned subsidiary formed in May 2005, is focused on acquiring patents, managing any associated licensing rights and further developing the technology acquired under such new patents. In May 2005, we entered into a number of new agreements with North Corporation (“North”), 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, for $5.9 million. The main technology acquired under the North patents is a substrate technology that gives us an entry into the materials technology for packaging and interconnects as well as establishing infrastructure for next-generation interconnect technology.

Wafer Level Technologies Division.    Our Wafer Level Technologies Division is focused on acquiring patents, managing any associated licensing rights and further developing the technology acquired under such new patents. In December 2005, we completed the acquisition of certain assets of Shellcase, Ltd., which included the acquisition of 100% ownership of all patents and applications filed by Shellcase, and certain research and development operations and facilities located in Israel, for $34.7 million. The technology acquired under the transaction with Shellcase includes wafer-level packaging for image sensors.

Our Services segment is composed of our Product Miniaturization Division, which drives our product development services revenues, while also providing a vehicle for transitioning our research efforts into fully developed technologies that can be licensed. This segment also addresses the challenges of electronic products miniaturization from a system perspective and through the dense interconnection of components by making extensive use of three-dimensional packaging technologies.

Beginning in 2006 management anticipates reorganizing its business units into three operating divisions: the Licensing Business, the Product Division and Emerging Markets and Technologies. We anticipate that the Product Division will incorporate operational functions that will be reported in both our Intellectual Property and Services segments.

Our segments were determined based upon the manner in which our management views and evaluates our operations. Segment information below in Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 9 of the Notes to Financial Statements is presented in accordance with the Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosure about Segments of an Enterprise and Related Information. For years prior to 2005, revenues were presented to management in the Intellectual Property and Services categories; however expenses were not allocated or presented to our management for these categories. It would be impractical to determine an allocation method for prior year expenses, therefore only revenues will be presented for these new segments. In addition to our reportable segments, we also have a Corporate 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.

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Customers

Our technology is currently licensed to more than 50 companies. The following table sets forth sales to customers comprising of 10% or more of total revenues for the periods indicated:

A significant portion of our revenues is derived from licensees headquartered outside of the United States, principally in Asia, and we expect these revenues will continue to account for a significant portion of total revenues in future periods. The table below lists the geographic regions of the headquarters of our customers and the percentage of revenues derived from each region for the periods indicated:

The international nature of our business exposes us to a number of risks, including but not limited to: 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; less effective protection of intellectual property than is afforded to us in the United States or other developed countries and international terrorism and anti-American sentiment, particularly in the emerging markets.

Most of our long-lived assets are located in the United States. In December 2005 we completed the acquisition of certain assets of Shellcase, Ltd. which included a research and development facility in Jerusalem, Israel and intellectual property that is owned by our subsidiary in Budapest, Hungary.

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The following is a list of our current licensees and, where indicated, our current sublicensees:

Most semiconductor material suppliers are licensed under our Tessera Compliant Mounting Tape (“TCMT”) license, which requires these licensees to pay us a license fee, but not royalties.

Sales and Marketing

Our sales activities focus primarily on developing strong, direct relationships at the technical, marketing and executive management levels with leading companies in the semiconductor industry to license our technologies and sell our services. We also sell our engineering services to system manufacturers and government agencies and their contractors. Marketing activities include identifying and promoting application-based technologies for specific, vertical market needs, such as wireless communications, consumer or computing needs, and identifying major business opportunities for current and future product development. Product marketing focuses on identifying the needs and product requirements of our customers. Product marketing also manages the development of all of our technology throughout the development cycle and creates the required marketing materials to assist with the adoption of the technology. Marketing communications focuses on advertising and communications that promote the adoption of our technology.

Research and Development

We believe that our success depends in part on our ability to achieve the following in a cost-effective and timely manner:

Our research and development employees work closely with our sales and marketing employees, as well as our customers and partners, to bring new products incorporating our technology to market in a timely, high quality and cost-

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efficient manner. We also work closely with material and equipment infrastructure providers to identify new technologies and improve existing technologies for use in the assembly and manufacture of semiconductor packages that incorporate our technology. Research, development and other related costs were $7.0 million in 2005, $7.1 million in 2004 and $7.6 million in 2003.

Our service contracts involve research and development for commercial entities and government agencies. For example, some of our development activities for the µZ^™ Fold-Over Stack package technology were partially funded through service contracts with one of our semiconductor company licensees. We also have collaborated with UTStarcom on the development of a MobileCard technology, which is an ultra-miniaturized mobile phone module that is equivalent to the size of two subscriber identity module, or SIM cards. Our µZ^™ multi-chip packaging technologies and system-level integration expertise were instrumental in the development of this highly innovative module. Our government contracts include terms required by the government that are not customary in commercial contracts, including a right of the government to terminate the contract at any time for convenience of the government. See Item 1A below – Risk Factors for a description of other risks involving government contracts.

Our research and development efforts currently focus on three major areas:

Chip-scale packaging.    Our CSP efforts focus on developing specific technologies for incorporation of existing or new CSP technology into new applications, developing prototypes and supporting customers or infrastructure providers with improvements to products for existing applications. We are developing next generation chip-scale packages that could offer higher off-chip wiring density and better signal performance.

Multi-chip packaging.    Our multi-chip packaging efforts focus on working with customers to incorporate our technology into their products and applications, developing prototypes and developing new, custom technologies to meet the needs of future applications.

Wafer level packaging.    Our WLP efforts focus on developing specific technologies for packaging of image sensors and other devices at the wafer level, developing prototypes and supporting customers with improvements to designs and process technologies.

We have additional research and development efforts underway in a number of areas related to the miniaturization of electronic products, including areas relating to materials, equipment, packaging, interconnect, assembly and testing of semiconductors and three-dimensional modules.

Intellectual Property

Our future success and competitive advantage depend upon our continued ability to develop and protect our intellectual property. To protect our intellectual property, we rely on a combination of patents, trade secrets and trademarks. We also attempt to protect our trade secrets and other proprietary information through confidentiality agreements with licensees, customers and potential customers and partners, and through proprietary information agreements with employees and consultants.

Our patents address advanced single and multi-chip and wafer level packaging, related processes, and complementary technologies. We have made and continue to make considerable investments in expanding and defending our patent portfolio. See Item 3 below—Legal Proceedings for a description of material legal proceedings in which we have recently been involved.

As of December 31, 2005, our intellectual property portfolio included 363 issued U.S. patents and 70 issued international patents. In 2005, 79 additional U.S. standard or provisional patent applications were filed, along with 30 additional international patent applications. Our patents have expiration dates ranging from January 25, 2009 to January 1, 2024. We continually file new patent applications for new developments in our technology.

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There are many countries in which we currently have no issued patents; however, products incorporating our technology that are sold in jurisdictions where patents have issued must be licensed, or stem from a licensed source, in order to avoid infringing our intellectual property.

Competition

As a developer and licensor of semiconductor packaging technology, we compete with other technologies, as opposed to other companies selling products. These competing technologies come principally from the internal design groups of a number of semiconductor and package assembly companies. Many of these companies are licensees, or potential licensees, of ours. In fact, many of our licensees consider packaging research and development to be one of their core competencies.

Semiconductor companies that have their own package design and manufacturing capabilities include, but are not limited to, Texas Instruments Inc., Intel Corporation and the semiconductor divisions of Sharp Corporation and Samsung Electronics Co., Ltd. Among the advanced packaging technologies developed by such companies are flip-chip and chip-on-board technologies that compete with our CSP, multi-chip and WLP technologies. Our technologies also compete with technologies developed by the internal design groups of package assembly companies, such as Advanced Semiconductor Engineering, Inc., Amkor Technology, Inc. and STATS ChipPAC, Inc.

We believe the principal competitive factors in the selection of semiconductor package technology by potential customers are:

We believe that our CSP, multi-chip and WLP technologies compete favorably in each of these factors with other advanced packaging technology solutions.

Employees

As of March 13, 2006, we had 162 employees, with 34 in sales, marketing and licensing, 91 in research and development (including employees who perform engineering, assembly and infrastructure services under our service agreements with third parties) and 37 in finance and administration. We have never had a work stoppage among our employees and no personnel are represented under collective bargaining agreements other than certain ordinary course agreements of an employers’ collective which may bind our Israeli subsidiary under Israel law. We consider our relations with our employees to be good.

Available Information

Our Internet address is www.tessera.com. There we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Our SEC reports can be accessed through the investor relations section of our Web site. The information found on our Web site is not part of this or any other report we file with or furnish to the SEC.

The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room located at 450 Fifth Street NW, Washington, DC 20549. The public may obtain information on the operation of

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the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains electronic versions of our reports on its website at www.sec.gov.

Item 1A.    Risk Factors

A court invalidation or limitation of our key patents 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.

We are currently in litigation involving some of our key patents.

On March 1, 2005, the Company filed a lawsuit against Micron Technology, Inc. and its subsidiary Micron Semiconductor Products, Inc. (collectively “Micron”) and against Infineon Technologies AG, Infineon Technologies Richmond LP and Infineon Technologies North America Corp. (collectively “Infineon”) in the U.S. District Court for the Eastern District of Texas, alleging infringement of the Company’s U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893 and 6,133,627 arising from Micron’s and Infineon’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 Micron and Infineon from continuing to infringe these patents and other relief. On April 13, 2005, the Company filed an amended complaint against Micron and Infineon alleging their violation of federal antitrust law, Texas antitrust law and Texas common law based on Micron’s and Infineon’s anticompetitive actions in markets related to synchronous DRAM. These new claims are in addition to the patent infringement claims in our original complaint, and we are seeking to recover additional damages for these new claims, including enhanced damages and/or punitive damages, depending upon the nature of the claim. We also seek other relief, including enjoining Micron and Infineon from continuing their anticompetitive actions. The Company cannot predict the outcome of this proceeding. Discovery has started, and trial is currently scheduled for August 14, 2006. An adverse decision in this proceeding could significantly harm our business.

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 has amended its complaint to add as defendants Spansion Inc., Spansion Technology, Inc., 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). This proceeding has just begun, and the Company cannot predict the outcome of this proceeding. Discovery has just begun. An adverse decision in this proceeding could significantly harm our business.

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. This proceeding has just begun, and the Company cannot predict its outcome. An adverse decision in this proceeding could significantly harm our business.

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

Our current lawsuit with Infineon and Micron (potential licensees), as described below in Part I, Item 3— Legal Proceedings, is an example. Any such dispute could cause the licensee or strategic partner to cease making

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royalty or other payments to us and could substantially damage our relationship with the company on both business and technical levels. Any litigation stemming from such a dispute could be very expensive and may cause us to cease being profitable. 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.

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 are 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 below in Part I, Item 3 – 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

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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.

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 relating to filing for 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.

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 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 year ended December 31, 2005 revenues from Samsung Electronics Co., Ltd. accounted for 20% of total revenues and Texas Instruments, Inc., accounted for 17% of total revenues. In the year ended December 31, 2004 revenues from Intel Corporation accounted for 18% of total revenues and Texas Instruments, Inc., accounted for 20% of total revenues. We expect that a significant portion of our revenues will continue to come from a few customers for the foreseeable future. If we lose any of these customers or if our revenues from them decline, our revenues may decrease substantially.

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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.

For example, the Financial Accounting Standards Board (“FASB”) issued its final standard on accounting for share-based payments (“SBP”), FASB Statement No. 123R (revised 2004), Share-Based Payment (FAS 123R), which will require us, starting January 1, 2006, to measure compensation costs for all stock-based compensation (including stock options) at fair value and to recognize these costs as expenses in our statements of operations The recognition of these expenses in our statements of operations could have a negative affect on our earnings per share, which could negatively impact our future stock price.

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.

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. We have had positive net income since the fourth quarter of 2001. 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:

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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 may fluctuate significantly from period to period based on manufacture or sales of products incorporating our licensed technology. We expect 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. 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.

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

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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:

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:

Failure by the semiconductor industry to adopt new 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 was designated by Rambus as the recommended package for its high performance Rambus DRAM chips. However, the DRAM designed by Rambus has not been widely adopted due to the use of competing technologies such as the first generation of Double Data Rate (“DDR”) DRAM, which does not widely utilize advanced packaging technologies. DRAM manufacturers are also currently developing new high performance DRAM chips such as the next generation of DDR, referred to as

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DDR2 and DDR3, to meet increasing speed and performance requirements of electronic products. We believe that these new high performance DRAM chips will require advanced packaging technologies such as CSP, and we currently have licensees, including Samsung, Electronics, Co., Ltd. who are paying royalties for DRAM chips in advanced packages.

We anticipate that royalties from shipments of these new, high performance DRAM chips packaged using our technology may account for a significant percentage of our future revenues. If semiconductor manufacturers do not adopt new, high performance DRAM as quickly as is currently being projected by industry sources or find an alternate viable packaging technology for use with their high performance DRAM chips, or if we do not receive royalties from new, high performance DRAM chips that use our technology, our future revenues could be adversely affected.

Our technology may be too expensive for certain new, high performance DRAM manufacturers, which could significantly reduce the adoption rate of our packaging technology in new, high performance DRAM chips. Even if our package technology is selected for at least some of these new, 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 new, 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.

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.

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 get their package technology adopted 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

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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 January 1, 2024. We need to develop and patent successful innovations before our current patents expire.

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. 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 develop or acquire new technologies 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.

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

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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.

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

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. For year ended December 31, 2005 these revenues accounted for 56% of our total revenues. For the year ended December 31, 2004 these revenues accounted for 43% of total revenues. International operations are subject to a number of risks, including the following:

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.

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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 expand our operations which may strain our resources and increase our operating expenses.

We plan to expand 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.

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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.

Acquisitions are commonplace in the semiconductor industry and we may acquire businesses or technologies. 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 acquisition of certain assets from Shellcase, Ltd.

In December 2005, we completed our acquisition of certain equipment, intellectual property and other intangible assets from Shellcase, Ltd., a company based in Israel. This acquisition is subject to a number of risks, including the following:

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 been Chairman 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.

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

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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.

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 share-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 will begin recording charges to earnings for share-based payments in the first quarter of fiscal 2006. As a result, we will incur increased compensation costs associated with our share-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 share-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 operations are primarily located in California and, as a result, are subject to catastrophes.

Our business operations depend on our ability to maintain and protect our facilities, computer systems and personnel, which are primarily 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,

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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:

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, are creating uncertainty for companies such as ours. These new or changed 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 of the Sarbanes-Oxley Act of 2002 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. In addition, director and officer liability insurance has become more expensive and we have purchased reduced coverage as compared to previous years. 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.

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

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,

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2011. 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.

Item 3.    Legal Proceedings

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

On March 1, 2005, the Company filed a lawsuit against Micron Technology, Inc. and its subsidiary Micron Semiconductor Products, Inc. (collectively “Micron”) and against Infineon Technologies AG, Infineon Technologies Richmond LP and Infineon Technologies North America Corp. (collectively “Infineon”) in the U.S. District Court for the Eastern District of Texas, alleging infringement of the Company’s U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893 and 6,133,627 arising from Micron’s and Infineon’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 Micron and Infineon from continuing to infringe these patents and other relief.

On April 13, 2005, the Company filed an amended complaint against Micron and Infineon alleging their violation of federal antitrust law, Texas antitrust law and Texas common law based on Micron’s and Infineon’s anticompetitive actions in markets related to synchronous DRAM. These new claims are in addition to the patent infringement claims in our original complaint, and we are seeking to recover additional damages for these new claims, including enhanced damages and/or punitive damages, depending upon the nature of the claim. We also seek other relief, including enjoining Micron and Infineon from continuing their anticompetitive actions.

On May 11, 2005, Micron and Infineon filed a motion to dismiss Tessera’s antitrust claims. On July 13, 2005, the Court granted in part and denied in part the motion to dismiss, allowing Tessera to go forward with its antitrust claims with respect to at least one of the markets alleged to be affected by Micron’s and Infineon’s anti-competitive conduct.

On June 22, 2005, Micron filed a motion requesting the Court’s permission to file a patent infringement counterclaim against Tessera as part of this lawsuit. On July 14, 2005, the Court denied Micron’s motion but allowed Micron to proceed with a separate patent infringement lawsuit in the Eastern District of Texas, which has been assigned Civil Action No. 2-05cv-319, which is discussed in more detail below.

On June 28, 2005, Micron and Infineon filed their answers to the Company’s amended complaint. Those answers deny most of the averments in the Company’s amended complaint, and also assert numerous affirmative defenses.

The Company cannot predict the outcome of this proceeding. Discovery has started, and trial is currently scheduled for August 14, 2006. An adverse decision in this proceeding could significantly harm our business.

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

This case began on July 14, 2005, as described above, as a result of the Court’s denial of Micron’s motion to add patent infringement claims to Case No. 2-05CV-94. Micron’s complaint asserts that the Company infringes, including by directly infringing, contributorily infringing and/or inducing infringement, the following Micron patents: 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. Micron’s complaint requests, among other things, that the Court enter judgment that the Company has infringed each of the above-identified Micron patents and permanently enjoin the Company (and its employees, agents and others acting in concert or participation) from infringement of those patents, that the Court award Micron damages in compensation for that alleged infringement, that the Court declare this an exceptional case

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and award Micron its costs, expenses and reasonable attorneys’ fees, and that the Court award Micron any and all other relief to which it may be entitled or which the Court deems just and proper.

The Company cannot predict the outcome of this proceeding. Discovery has begun, and trial is currently set for November 13, 2006. An adverse decision in this proceeding could significantly harm our business.

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. 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, 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 USA Inc., STMicroelectronics N.V., STMicroelectronics, Inc., STATS ChipPAC Ltd., STATS ChipPAC, Inc. and STATS ChipPAC Ltd. (BVI).

The Company cannot predict the outcome of this proceeding. Discovery has just begun, and no trial date has yet been set. An adverse decision in this proceeding could significantly harm our business.

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. This proceeding has just begun, and the Company cannot predict its outcome. An adverse decision in this proceeding could significantly harm our business.

Item 4.    Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

Our common stock began trading publicly on the Nasdaq National Market on November 13, 2003 and is traded under the symbol “TSRA.” Prior to that date, there was no public market for our common stock. The following table sets forth the high and low closing sales prices of the common stock during the prior two fiscal years.

As of December 31, 2005 there were outstanding 45,125,098 shares of common stock held by 56 stockholders of record, options to purchase 4,779,665 shares of common stock under our stock option plans and warrants to purchase 298 shares of common stock. We have not paid cash dividends on our common stock since our inception and we do not anticipate paying any in the foreseeable future.

Initial Public Offering

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.

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You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this annual report.

The consolidated statement of operations data for the fiscal years ended December 31, 2005, December 31, 2004 and December 31, 2003 and the consolidated balance sheet data as of December 31, 2005 and December 31, 2004 are derived from our audited consolidated financial statements appearing elsewhere in this annual report. The consolidated statement of operations data for the fiscal years ended December 31, 2002 and December 31, 2001 and the consolidated balance sheet data as of December 31, 2003, December 31, 2002 and December 31, 2001 are derived from our audited consolidated financial statements that are not included in this annual report. The historical results are not necessarily indicative of the results to be expected in any future period.

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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 and mechanical properties of materials and interconnect. We develop and license technologies to the electronics industry. Our intellectual property includes more than 363 issued patents, covering a broad range of advanced semiconductor packaging and interconnect 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. In addition, by using our technology, we believe that our customers are also able to reduce the time-to-market and development costs of their semiconductors.

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:

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. 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 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.

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From time to time, we receive payments through license negotiations or through the resolution of patent disputes. These license negotiations and dispute settlements generally include amounts for royalties related to previous periods based on historical production volumes. These amounts are reported as “past production payments revenues” (previously identified as “other intellectual property revenues”) in the statement of operations. In an effort to more specifically reflect the components of this revenue line, we changed the nomenclature as of the quarter ended June 30, 2005. Past production payments revenues will vary significantly on a quarterly basis.

Service revenues are primarily derived from engineering services, including related training services. Revenues from services related to training are recognized as the services are performed. Revenues from 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.

We derive a significant portion of our revenues from licensees headquartered outside of the United States, principally in Asia, and these revenues accounted for 56.0% of our total revenues for the year ended December 31, 2005. 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 year ended December 31, 2005, Samsung Electronics Co., Ltd. and Texas Instruments, Inc. each accounted for over 10% of revenue. For the year ended December 31, 2004, Intel Corporation and Texas Instruments, Inc. each account 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 2005, we organized our business operations into five operating groups, the Advanced Semiconductor Packaging Group, the Emerging Markets and Technologies Group, Tessera Interconnect Materials, Inc. (our wholly owned subsidiary formed in May 2005), the Wafer Level Technologies Division and the Product Miniaturization Division. These groups are reported into two segments; Intellectual Property, which consists of our Advanced Semiconductor Packaging Group, Emerging Markets and Technologies Group, Tessera Interconnect Materials, Inc. and our Wafer Level Technologies Division are consolidated; and Services, which consists of our Production Miniaturization Division. The segments were determined based upon how our management views and evaluates our operations. Segment information in this Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 9 of the Notes to Consolidated Financial Statements included in this report are presented in accordance with the Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosure about Segments of an Enterprise and Related Information. For years prior to 2005, revenues were presented to management in the Intellectual Property and Services categories; however, expenses were not allocated or presented to our management for these categories. Consequently, it would be impractical to determine an allocation method for prior year expenses, therefore only revenues will be presented for these new segments. In addition to our reportable segments, we also have a Corporate 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.

Beginning in 2006 management anticipates reorganizing its business units into three operating divisions: the Licensing Business, the Product Division and Emerging Markets and Technologies. We anticipate that the

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Product Division will incorporate operational functions that will be reported in both our Intellectual Property and Services segments.

Cost of revenues consists primarily of direct compensation, materials, supplies and equipment depreciation costs. Cost of revenues primarily relates to 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 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, materials, supplies and equipment depreciation. Our research and development is conducted primarily in-house and targets CSP, multi-chip and wafer level 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 research and development personnel to 86 at December 31, 2005 from 59 at December 31, 2004, and expect to continue to increase 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 litigation, as described above in Part I, Item 3 – 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.

In connection with the grant of stock options from 1996 through 2005, we recorded an aggregate of $33.3 million in deferred stock-based compensation within stockholders’ equity, due to the difference between the exercise price and the estimated fair value of common stock on the date of grant. The compensation expense is amortized over the vesting period of generally four years to five years. As of December 31, 2005, we had an aggregate of $2,244,844 of deferred stock-based compensation remaining to be amortized through 2010.

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Results of Operations

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

Fiscal Year 2005 and 2004

Revenues.    Revenues for the year ended December 31, 2005 were $94.7 million compared with $72.7 million for the year ended December 31, 2004, an increase of $22.0 million, or 30.2%. The $22.0 million increase was primarily due to a $17.3 million increase in royalties and license fees revenues, a $1.3 million increase in past production payments revenues and a $3.4 million increase in service revenues.

Cost of Revenues.    Cost of revenues for the year ended December 31, 2005 increased to $13.3 million, or 14.1% of revenues, from $9.6 million, or 13.2% of revenues, for the year ended December 31, 2004 primarily due to increased costs associated with an increase in service revenues. Cost of revenues primarily relates to service revenues as the cost of revenues associated with royalties and license fees revenues is not material. For the year ended December 31, 2005 and 2004, cost of revenues represented 80.7% and 73.3% respectively, of service revenues for each associated year. Cost of revenues as a percentage of total revenues will vary based on the service revenues component of total revenues. The majority of this increase in the year of 2005 was attributable to the allocation of more personnel to service-related projects and an increase in the number of these projects. Increased materials and subcontractor costs related to service-related projects also accounted for part of the increase in cost of revenues. For the year ended December 31, 2005 and 2004 materials and subcontractors costs totaled $3.6 million and $2.1 million, respectively, an increase of $1.5 million or 71.4%.

Research, Development and Other Related Costs.    Research, development and other related costs for the year ended December 31, 2005 decreased to $7.0 million, or 7.4% of revenues, from $7.1 million, or 9.8% of revenues, for the year ended December 31, 2004. This decrease of $94,000 in expenses is primarily due to the reassignment of more personnel resources to service revenues projects.

Selling, General and Administrative.    Selling, general and administrative (SG&A) expenses for the year ended December 31, 2005 increased to $27.6 million or 29.1% of revenues, from $20.1 million, or 27.7% of

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revenues, for the year ended December 31, 2004. The increase is primarily attributable to building an infrastructure to support our 2005 internal reorganization of personnel and departments that better aligns our resources to accommodate the needs of our business. In this effort we have increased our headcount by 21 in the following areas: business development, legal, finance and administration. The related compensation expense is included in SG&A. Total litigation expenses were $8.0 million for the year ended December 31, 2005, as compared to $7.2 million for the year ended December 31, 2004. We expect to continue to incur litigation expenses in upcoming quarters due to our ongoing litigation described in Part I, Item 3 – Legal Proceedings, above.

Stock-based Compensation.    Stock-based compensation increased to $1.2 million for the year ended December 31, 2005 as compared to $231,000 for the year ended December 31, 2004. The increase is primarily due to issuances of shares of restricted stock in 2005.

Interest and Other Income, Net.    Interest and other income, net was $3.6 million for the year ended December 31, 2005 as compared to $828,000 for the year ended December 31, 2004. The increase is directly related to income earned on higher cash balances as a result of positive cash flow generated from operations. Our cash balance was $127.6 million at December 31, 2005, compared to $108.3 million at December 31, 2004.

Benefit and Provision for Income Taxes.    Provision for income taxes was $17.7 million for the year ended December 31, 2005 of which $4.1 million was attributable to foreign withholding taxes. For the year ended December 31, 2004, we recorded a provision benefit of $22.6 million consisting of $343,000 of Alternative Minimum Tax (“AMT”), $1.7 million of foreign withholding taxes off-set by a benefit for the recognition of deferred tax assets of $24.7 million. The $24.7 million benefit is due to the reversal of the valuation allowance against our net operating losses (“NOL”). Due to historic and current income, prospects of future book income and the resolution of the litigation with Samsung Electronics Co., Ltd., management determined that a valuation allowance was no longer necessary, as it was more likely than not that the deferred tax assets would be fully realized. Foreign withholding taxes paid, relate to statutory withholding taxes on license and royalty revenues earned in foreign jurisdictions. We paid no federal or state income taxes in the years ended December 31, 2005 and 2004 primarily due to our NOL and tax benefits that resulted from employees that exercised their fully-vested non-qualified stock options, which reduced our income taxes currently payable for federal and state purposes.

Fiscal Year 2004 and 2003

Revenues.    Revenues for the year ended December 31, 2004 were $72.7 million compared with $37.3 million for the year ended December 31, 2003, an increase of $35.4 million, or 94.9%. The $35.4 million increase was primarily due to a $14.2 million increase in royalties and license fees revenues, a $16.8 million increase in past production payments revenues and a $4.4 million increase in service revenues.

Cost of Revenues.    Cost of revenues for the year ended December 31, 2004 increased to $9.6 million, or 13.2% of revenues, from $6.7 million, or 18.0% of revenues, for the year ended December 31, 2003 primarily due to increased costs associated with an increase in service revenues. Cost of revenues primarily relates to service revenues as the cost of revenues associated with royalties and license fees revenues is de minimis. For the year ended December 31, 2004 and 2003 cost of revenues represented 73.3% and 76.9% respectively, of service revenues for each associated year. Cost of revenues as a percentage of total revenues will vary based on the service revenues component of total revenues. The majority of this increase in the year of 2004 was attributable to the allocation of more personnel to service-related projects and an increase in the number of these projects. Increased materials and subcontractor costs related to service-related projects also accounted for part of the increase in cost of revenues.

Research, Development and Other Related Costs.    Research, development and other related costs for the year ended December 31, 2004 decreased to $7.1 million, or 9.8% of revenues, from $7.7 million, or 20.5% of revenues, for the year ended December 31, 2003. This decrease of $554,000 in expenses is primarily due to the reassignment of more personnel resources to service revenues projects.

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Selling, General and Administrative.    Selling, general and administrative expenses for the year ended December 31, 2004 increased to $20.1 million, or 27.7% of revenues, from $11.0 million, or 29.6% of revenues for the year ended December 31, 2003. The increase is attributable to the costs of being a public company and litigation expenses. The increased costs related to being a public company are primarily salaries, professional fees and insurance. For the year ended December 31, 2004 these costs were $3.2 million, which included $550,000 of professional charges for the Company’s secondary public offering that closed on March 31, 2004. Total litigation expenses were $7.2 million for the year ended December 31, 2004, as compared to $2.9 million for the year ended December 31, 2003. We expect to continue to incur litigation expenses in upcoming quarters. The addition of personnel and personnel-related expenses for the expansion of sales and marketing efforts also contributed to the increase in selling, general and administrative expenses.

Stock-based Compensation.    Stock-based compensation decreased to $231,000 for the year ended December 31, 2004 as compared to $1.1 million for the year ended December 31, 2003. The decrease is due to lower amortization of deferred compensation related to issuance of stock options in 1998 through 2000.

Interest and Other Income, Net.    Interest and other income, net was $828,000 for the year ended December 31, 2004, compared to $195,000 for the year ended December 31, 2003. The increase is directly related to income earned on higher cash balances as a result of the proceeds from the Company’s initial public offering in November 2003 and positive cash flow generated from operations.

Benefit and Provision for Income Taxes.    For the year ended December 31, 2004, we recorded a provision benefit of $22.6 million consisting of $343,000 of AMT, $1.7 million of foreign withholding taxes off-set by a benefit for the recognition of deferred tax assets of $24.7 million. The $24.7 million benefit is due to the reversal of the valuation allowance against our NOL. Due to historic and current income, prospects of future book income and the resolution of the Samsung Electronics Co., Ltd. litigation, management determined that a valuation allowance was no longer necessary; as it is more likely than not that the deferred tax assets will be fully realized. For the year ended December 31, 2003, the provision of $1.6 million consisted of $213,000 of AMT and $1.4 million of foreign withholding taxes. Foreign withholding taxes paid, relate to statutory withholding taxes on license and royalty revenues earned in Japan, Korea and Singapore. We paid no federal or state income taxes in the year ended December 31, 2004 primarily due to our operating NOL and allowable stock option deductions related to gains that our employees realized on the exercise and sale of their stock options. In the year ended December 31, 2003, we paid no state income taxes.

Segment Results

Effective 2005, we organized our business operations into five operating groups, the Advanced Semiconductor Packaging Group, the Emerging Markets and Technologies Group, Tessera Interconnect Materials, Inc., the Wafer Level Technologies Division and the Product Miniaturization Division. These groups are reported into two segments; Intellectual Property and Services.

Our Intellectual Property segment is composed of the following:

Advanced Semiconductor Packaging Group.    Our Advanced Semiconductor Packaging Group is focused on licensing technologies in our core markets, which include DRAM, Flash, SRAM, DSP, ASIC, ASSP, micro-controllers, general purpose logic and analog devices. Key functions of this group include development, marketing and R&D. This group works closely with IDMs, which make semiconductors that use our technology.

Emerging Markets and Technologies Group.    Our Emerging Markets and Technologies Group is focused on expanding our technology portfolio into areas outside of our core markets that represent long-term growth opportunities through application of existing patents, products and technologies; internal development of new technologies for high growth markets; applications such as imaging, MEMs and RF; and new partnerships, ventures and acquisitions of complementary technology.

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Tessera Interconnect Materials, Inc.    Tessera Interconnect Materials, Inc. is focused on acquiring patents, managing any associated licensing rights and further developing the technology acquired under such new patents. In May 2005, we entered into a number of new agreements with North, 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, for $5.9 million. The main technology acquired under the North patents is a substrate technology that gives us an entry into the materials technology for packaging and interconnects as well as establishing infrastructure for next-generation interconnect technology.

Wafer Level Technologies Division.    Our Wafer Level Technologies Division is focused on acquiring patents, managing any associated licensing rights and further developing the technology acquired under such new patents. In December 2005, we completed the acquisition of certain assets of Shellcase, Ltd., which included the acquisition of 100% ownership of all patents and applications filed by Shellcase, and certain research and development operations and facilities located in Israel, for $34.7 million. The technology acquired under the transaction with Shellcase includes wafer-level packaging for image sensors.

Our Services segment is composed of our Product Miniaturization Division, which drives our product development services revenues, while also providing a vehicle for transitioning our research efforts into fully developed technologies that can be licensed. This segment also addresses the challenges of electronic products miniaturization from a system perspective and through the dense interconnection of components through the extensive use of three-dimensional packaging technologies.

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

The revenues and operating income (loss) amounts in this section have been presented on a basis consistent with accounting principles generally accepted in the United States applied at the segment level. Corporate

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overhead expenses, which have been excluded, primarily include support services, human resources, legal, finance, IT, corporate development, procurement activities, insurance and board fees. For the year ended December 31, 2005, corporate overhead expenses were $15.7 million.

Intellectual Property Segment

Fiscal Year 2005 and 2004

Intellectual property revenues for the year ended December 31, 2005, were $78.2 million, as compared to $59.6 million for the year ended December 31, 2004, an increase of $18.6 million or 31.2%. The increase of $18.6 million consists of an increase in royalty and license fees revenues of $17.3 million and an increase in past production payments revenues of $1.3 million. For the year ended December 31, 2005, the $17.3 million increase was due to royalty and license fees revenues of $14.6 million from existing customers and $2.7 million from new customers. The increase of $1.3 million in past production payments revenues was primarily due to the resolution of license negotiations with new customers of $3.9 million and with existing customers of $17.4 million. The aggregate amount attributable to the resolution of license negotiations in the year ended December 31, 2005 was greater than the aggregate amount attributed to negotiations with new and existing customers in the year ended December 31, 2004, which totaled $20.0 million.

Operating expenses for the year ended December 31, 2005 were $18.7 million. These expenses consisted of $62,000 in cost of revenues, $6.7 million in research, development and other related costs, $11.4 million in SG&A and $540,000 in stock compensation costs. Included in the SG&A expenses for the year ended December 31, 2005 are litigation costs of $8.0 million. 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 lawsuits as described in Part I, Item 3 – 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.

Operating income for the year ended December 31, 2005 was $59.5 million.

Fiscal Year 2004 and 2003

Intellectual property revenues for the year ended December 31, 2004 were $39.6 million as compared to $25.4 million for the year ended December 31, 2003. This increase of $14.2 million or 56.0% consisted of $5.8 million from new customers and $8.4 million from existing customers. The increases are attributable to licenses executed by five new customers and an increase in royalties reported by existing customers.

Past production payments revenues for the year ended December 31, 2004 were $20.0 million as compared to $3.2 million for the year ended December 31, 2003. This increase of $16.8 million or 531.1% was primarily due to the resolution of license negotiations with NEC Electronics Corporation, OKI Electronic Industry Co. Ltd. and United Test and Assembly Center Ltd., totaling $4.8 million and with existing customers totaling $15.2 million, which includes a $6.0 million payment received from Samsung Electronics Co., Ltd. for royalties relating to past production. These aggregate amount attributable to the resolution of license negotiations in the year ended December 31, 2004 was greater than the aggregate amount attributed to negotiations with five new and existing customers in the year ended December 31, 2003, which totaled to approximately $3.2 million.

Services Segment

Fiscal Year 2005 and 2004

Service revenues for the year ended December 31, 2005 were $16.5 million as compared to $13.1 million for the year ended December 31, 2004, an increase of $3.4 million or 25.8%. The increase is due to the increase in service revenues from government related contracts. For the year ended December 31, 2005, total service

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revenues consisted of $15.8 million from government related contracts. For the year ended December 31, 2004, total service revenues of $13.1 million, consisted of $12.2 million from government related contracts.

Operating expenses for the year ended December 31, 2005 were $14.7 million. These expenses consisted of $13.3 million in cost of revenues, $178,000 in research, development and other related costs, $1.1 million in SG&A, and $215,000 in stock compensation cost.

Operating income for the year ended December 31, 2005 was $1.8 million.

Fiscal Year 2004 and 2003

Service revenues for the year ended December 31, 2004 were $13.1 million as compared to $8.8 million for the year ended December 31, 2003, an increase of $4.3 million or 48.9%. This increase is directly related to the increase in our number of government contracts. For the year ended December 31, 2004, revenues from government contracts increased by $4.6 million or 60.1% over the year ended December 31, 2003. Revenues from government contracts for the years ended December 31, 2004 and 2003 totaled $12.2 million and $7.6 million, respectively.

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Quarterly Results of Operations

The following table presents our unaudited quarterly results of operations for the eight quarters in the period ended December 31, 2005. You should read the following table in conjunction with the consolidated financial statements and related notes contained elsewhere in this annual report. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for fair presentation of our financial position and operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year.

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The following table presents our historical results for the periods indicated as percentage of revenues, except per share data.