TESSERA TECHNOLOGIES INC - 10-Q Quarterly Report

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ¨ No x

As of November 5, 2004, 41,735,449 shares of the registrant’s common stock were outstanding.

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

Tessera Technologies, Inc. (together with its subsidiaries, Tessera, Inc. and Tessera Global, Ltd., herein referred to as “Tessera” or the “Company”) develops semiconductor packaging technology that meets the demand for miniaturization and increased performance of electronic products. The Company licenses its technology to its customers, enabling them to produce semiconductors that are smaller and faster, and incorporate more features. These semiconductors are utilized in a broad range of electronics products including digital cameras, MP3 players, personal computers, personal digital assistants, video game consoles and wireless phones.

The Company was first incorporated in the state of Delaware in May 1990, as the entity Tessera, Inc. The Company was formed to develop proprietary semiconductor packaging technology and to promote the adoption of this technology in the semiconductor industry. In January 2003, in a corporate reorganization, each outstanding share of each class and series of Tessera Inc.’s capital stock was converted into a share of equivalent class and series of Tessera Technologies, Inc., a newly-formed Delaware corporation. Consequently, Tessera, Inc. became a wholly-owned subsidiary of Tessera Technologies, Inc. Tessera Technologies, Inc. is a non-operating holding company that has no assets other than its shares in Tessera, Inc. The financial position, results of operations and cash flows of Tessera, Inc. are the same as that of Tessera Technologies, Inc. when consolidated with Tessera, Inc. Since this was a reorganization of entities under common control, the financial statements are presented as if Tessera Technologies, Inc. was in existence for all periods presented.

The Company completed its initial public offering (“IPO”) of common stock in November 2003. In the IPO, the Company sold an aggregate of 3,000,000 shares of common stock. The underwriters of the Company’s IPO exercised their over-allotment option to purchase an additional 58,573 shares of common stock from the Company. Net proceeds from the IPO and the exercise of over-allotment option aggregated approximately, $34,590,000.

The accompanying interim unaudited condensed consolidated financial statements as of September 30, 2004 and 2003 and for the three and nine months then ended have been prepared by the Company in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). The amounts as of December 31, 2003 have been derived from the Company’s annual audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in accordance with such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company and its results of operations and cash flows as of and for the periods presented. These financial statements should be read in conjunction with the annual audited financial statements and notes thereto as of and for the year ended December 31, 2003, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any future period and the Company makes no representations related thereto.

The Company’s fiscal year ends on December 31. For quarterly reporting, the Company employs a 4-week, 4-week, 5-week reporting period. The current three-month period ended on Sunday, September 26, 2004. For presentation purposes, the financial statements and notes have been presented as ending on the last day of the nearest calendar month.

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

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Research and development costs consist primarily of compensation and related costs for personnel as well as costs related to patent prosecution, materials, supplies and equipment depreciation. All research and development costs are expensed as incurred.

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents and accounts receivable.

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

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

The Company’s accounts receivable are concentrated with two customers at September 30, 2004, representing 57%, and 12% of aggregate gross receivables, and four customers at December 31, 2003, representing 32%, 14%, 13%, and 13% of aggregate gross receivables.

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

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

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

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

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

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

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

The Company does not have guarantees required to be disclosed under Financial Accounting Standards Board Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” However, some of the Company’s technology license agreements provide certain types of indemnification for customers regarding intellectual property infringement claims. Also, the Company indemnifies its officers and directors under the terms of indemnity agreements entered into with them, as well as pursuant to its certificate of incorporation, bylaws, and applicable Delaware law. As of September 30, 2004, no such claims have been filed against the Company, and no liability has been accrued.

The Company’s employee stock option plans are accounted for in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and complies with the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.”

The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force Consensus (“EITF”) No. 96-18, “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Under SFAS No. 123 and EITF No. 96-18, stock option awards issued to non-employees are accounted for at fair value using the Black-Scholes option-pricing model. The Company believes that the fair value of the stock options are more reliably measured than the fair value of the services received. The fair value of each non-employee stock award is re-measured at each reporting date until a commitment date is reached, which is generally the vesting date. In connection with non-employee stock awards, the Company recorded compensation expense of $14,000 and $152,000 for the three and nine months ended September 30, 2004, and $469,000 and $512,000 for the three and nine months ended September 30, 2003, respectively.

Expense associated with stock-based compensation is amortized on an accelerated basis over the vesting period of the individual award, consistent with the method described in Financial Accounting Standards Board Interpretation No. (“FIN”) 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, an Interpretation of APB Opinion No. 15 and 25.”

The following table illustrates the effect on net income and net income per share if the Company had applied the fair value method as prescribed by SFAS No. 123. The estimated fair value of each Company option is calculated using the Black-Scholes option-pricing model (in thousands except per share data):

The weighted-average fair value, as defined by SFAS No. 123, options granted during the three and nine months ended September 30, 2004 were $11.10 and $11.00, and during the three and nine months ended September 30, 2003 were $0.78 and $0.85, respectively.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, and these assumptions differ significantly from the characteristics of Company stock option grants. Also, prior to the IPO, the Company has used the minimum value method as prescribed by SFAS No. 123. The Company included an expected volatility factor in the Black-Scholes model only after the IPO. The following weighted average assumptions are used to estimate the fair value of stock option grants in the three and nine months ended September 30, 2004 and 2003:

Using Black-Scholes, the per share weighted average estimated fair value of rights issued pursuant to the Company’s 2004 Employee Stock Purchase Plan (“ESPP”) during the three and nine months ended September 30, 2004 was $12.12 and $14.90. The following weighted average assumptions are used in the estimated grant date fair value calculations for rights to purchase stock under the ESPP:

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

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

The following outstanding mandatorily redeemable cumulative convertible preferred stock and warrants, common stock warrants, and common stock options were excluded from the computation of diluted net income per share as they had an antidilutive effect (in thousands):

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

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

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

In February 2003, the Board of Directors adopted, and the Company stockholders approved, the 2003 Equity Incentive Plan (the “2003 Plan”). The terms of the 2003 Plan are similar to the terms of the 1999 Plan. As of September 30, 2004, there were 1,868,000 shares reserved for grant under this plan.

Options to purchase 1,707,000 shares of common stock were granted to employees during the nine months ended September 30, 2004. As of September 30, 2004, options to purchase 7,629,000 shares of common stock were outstanding.

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

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

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

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

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

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

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

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

For the three and nine months ended September 30, 2004, the Company recorded a provision of $999,000 and $2.2 million consisting of $217,000 and $497,000 of federal Alternative Minimum Tax (“AMT”) and foreign withholding tax of $782,000 and $1.7 millions. For the three and nine months ended September 30, 2003, the Company recorded a provision of $370,000 and $1.3 million consisting of $14,000 and $149,000 of AMT and foreign withholding tax of $356,000 and $1.1 million.

On December 16, 2002, Samsung Electronics Company, Ltd. (“Samsung”) initiated a declaratory judgment action against the Company in the U.S. District Court for the Northern District of California seeking a declaratory judgment, alleging that: (1) it has not breached the license agreement it ente+red into with the Company in 1997 allegedly because its MWBGA, TBGA, FBGA, MCP and laminate based wBGA semiconductor chip packages are not covered by the license agreement and, therefore, it owes the Company no royalties for such packages; (2) the license agreement remains in effect because Samsung was not in breach for failing to pay royalties for such packages and, therefore, the Company’s termination of the license agreement was not effective; (3) its MWBGA, TBGA, FBGA, MCP and laminate based wBGA semiconductor chip packages do not infringe the Company’s U.S. Patents Nos. 5,852,326, 5,679,977, 6,433,419 and 6,465,893; and (4) these four Tessera patents are invalid and unenforceable. Samsung also seeks to recover its costs and attorney’s fees incurred in the action. Regarding the enforceability claim, Samsung has asserted that the Company is precluded from enforcing its patents on the grounds that: (1) the Company had a duty to disclose certain of its patents to JEDEC (a standards body); (2) the Company breached its duty of disclosure to JEDEC; and (3) as a result of the Company’s failure to disclose these patents, it may not allege in this lawsuit that they cover Samsung’s products. Samsung has also contended that the Tessera patents are unenforceable because of alleged “inequitable conduct” by Tessera before the United States Patent and Trademark Office during the prosecution of the patents in suit or related patent applications. The Company cannot predict the outcome of this proceeding. An adverse decision in this proceeding could significantly harm our business.

On February 18, 2003, the Company filed an answer in which the Company denies Samsung’s allegations, including its allegations that the Company’s patents are invalid or unenforceable. The Company also filed a counterclaim in which the Company alleges that: (1) Samsung has breached the license agreement by, among other things, failing to pay the Company royalties for the use of the Company’s U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893, 5,950,304 and 6,133,627; (2) the Company’s termination of the 1997 license agreement was effective and the 1997 license agreement is terminated; and (3) Samsung and its U.S. subsidiaries Samsung Electronics America and Samsung Semiconductor, Inc. have infringed these six Tessera patents. The Company has denied Samsung’s enforceability allegations on several grounds, including that (1) the Company has satisfied the duty of disclosure to JEDEC as that duty has been defined by the Courts in other cases; and (2) Samsung expressly agreed in its 1997 license agreement with the Company to pay royalties for any of its products that are covered by the Company’s patents, which expressly precludes Samsung from arguing that it believed the Company’s patents are unenforceable against Samsung’s products. The Company further seeks to recover damages, up to treble the amount of actual damages, together with attorney’s fees and costs. The Company also seeks to enjoin Samsung and its U.S. subsidiaries from continuing to infringe these patents in the future. Samsung has continued to make payments under the Company’s license agreement and has responded by moving to dismiss the Company’s patent infringement counterclaims on the grounds that they are barred by existence of the 1997 license agreement. On August 11, 2003, the Court granted Samsung’s motion to dismiss the Company’s patent infringement counterclaims on the grounds that, pending the outcome of the current litigation, Samsung does not infringe because its activities are covered by the 1997 license agreement. The Company is proceeding against Samsung with a breach of contract action with the Company’s infringement contentions being a central element of the action. On March 30, 2004, and then on July 16, 2004, Tessera notified Samsung that Tessera was terminating the 1997 license agreement in view of Samsung’s material breach thereof. Each notice of termination was based on a different alleged breach. Samsung disputes that either termination was proper and contends that the 1997 license agreement remains in full force and effect.

On November 12, 2003, the Court held a claim construction hearing at which the Company and Samsung each argued its interpretation of several claim terms of the patents at issue in the lawsuit. On January 8, 2004, the Court issued its Order Construing Disputed Claim and Terms.

On July 15, 2004, Samsung made a $6,000,000 one-time payment relating to production prior to the end of March 2004 of its TBGA and TBGA-MCP packages involved in this dispute. This amount was recognized as other intellectual property revenues in the quarter ended September 30, 2004. This payment does not resolve all of the issues between the parties with respect to the TBGA packages and does not resolve any of the issues between the parties with respect to the other package families at issue.

As part of the Court’s standard pretrial procedures, the Court heard argument on motions for summary judgment on August 27, 2004. Samsung moved for summary judgment on a subset of its defenses relating to both breach of contract and patent issues. On October 21, 2004, the Court granted Samsung’s motion that Tessera’s purported termination of the Agreement on March 30, 2004 was ineffective, and denied Samsung’s motions in all other respects.

On October 22, 2004, the Court held a final pretrial conference. The Court scheduled trial to commence on November 1, 2004, in exchange for Tessera’s agreement to drop its claim that the Agreement had been terminated as of July 16, 2004 and the contentions relating to that claim. The Court also bifurcated Samsung’s defenses of equitable estoppel and inequitable conduct for a separate non-jury trial to be held at a later date, not yet set.

Trial of the parties’ contentions of breach on contract and the underlying patent issues commenced on November 1, 2004, and is currently scheduled to end during the week of November 22, 2004.

The Company has adopted SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information.” Based on its operating management and financial reporting structure, the Company has determined that it has one reportable business segment: developing and licensing of advanced packaging technologies.

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

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

The following discussion should be read in conjunction with the attached condensed unaudited consolidated financial statements and notes thereto, and with our audited financial statements and notes thereto for the fiscal year ended December 31, 2003, found in our Annual Report on Form 10-K filed on March 8, 2004.

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

The forward-looking statements contained in this Quarterly Report involve a number of risks and uncertainties, many of which are outside of our control. Factors that could cause actual results to differ materially from projected results include, but are not limited to, risks associated with (1) our ability to protect and enforce our intellectual property rights, (2) costly legal proceedings that we may have to undertake to enforce or protect our intellectual property rights, (3) our inability to control risks that are inherent in a royalty-based business model, and (4) our ability to create and implement new designs to expand our licensable technology portfolio. Although we believe that the assumptions underlying the forward-looking statements contained in this Quarterly Report are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements will be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved. Furthermore, past performance in operations and share price is not necessarily indicative of future performance. Tessera disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

We develop semiconductor packaging technology that meets the demand for miniaturization and increased performance of electronic products. We license our technology to our customers, enabling them to produce packaged semiconductors that are smaller and faster, and incorporate more features. These semiconductors are utilized in a broad range of communications, computing and consumer electronics products. In addition, by utilizing 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, or CSPs, that are almost as small as the chip itself. Our technology also enables multiple chips to be stacked vertically in a single three-dimensional multi-chip package that occupies almost the same circuit board area as a CSP. 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.

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 products.

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 revenue 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 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 revenue when we receive a royalty report from our customer. We receive these reports the quarter after the semiconductors that incorporate our technology have been shipped.

From time to time, we receive payments through license negotiations or the resolution of patent disputes. These settlements generally include amounts for royalties related to previous periods based on historical production volumes. These amounts are reported as “other intellectual property revenues” in the statement of operations. Other intellectual property revenue 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 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. For the three and nine months ended September 30, 2004 these revenues accounted for 50% and 46% of our total revenues, respectively. In the three and nine months ended September 30, 2003 these revenues accounted for 37% and 39% of our total revenues, respectively. We expect that these revenues will continue to account for a significant portion of revenues in future periods. All of our revenues are denominated in U.S. dollars. For the three and nine months ended September 30, 2004, Texas Instruments, Intel and Samsung Electronics each accounted for over 10% of total revenues. For the three ended September 30, 2003 Texas Instruments and Intel each accounted for over 10% of total revenue and for the nine months ended September 30, 2003, Texas Instruments accounted for over 10% of total revenues.

We license most of our CSP and multi-chip packaging technology under a license that we refer to as a Tessera Compliant Chip, or TCC, license. The 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 Tessera Compliant Mounting Tape, or TCMT, license. The TCMT license calls for a one-time license fee and, unlike most of our other licenses, does not require ongoing royalty payments.

There have been no material changes in our critical accounting policies and estimates for the three-month period ended September 30, 2004 from our disclosure in our Annual Report on Form 10-K for the year ended December 31, 2003. For a discussion of our critical accounting policies, please see the discussion in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003.

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

Revenues for the three months ended September 30, 2004 were $23.6 million compared with $9.2 million for the three months ended September 30, 2003, an increase of $14.4 million, or 156.9%. Revenues for the nine months ended September 30, 2004 were $54.4 million compared with $26.6 million for the nine months ended September 30, 2003, an increase of $27.8 million or 104.2%. The overall increase for both the three months and nine months ended September 30, 2004 is primarily due to the increase to total intellectual property revenues.

Intellectual property revenues for the three months ended September 30, 2004 were $10.4 million compared to $6.0 million for the three months ended September 30, 2003. This consisted of an increase in royalty payments of $1.1 million from new customers and $3.3 million from existing customers, for a total increase of $4.4 million or 73.7%. Intellectual property revenues for the nine months ended September 30, 2004 were $27.4 million compared to $18.0 million for the nine months ended September 30, 2003. This consisted of an increase of $3.2 million from new customers and $6.2 million from existing customers, for a total increase of $9.4 million or 52.1%. This increase is attributable to the signing of two new licensees and an increase in royalties reported by existing customers.

Other intellectual property revenues for the three months ended September 30, 2004 increased by $8.1 million or 623.1% primarily due to the resolution of negotiations with four customers, totaling $9.4 million. These resolutions were greater than the aggregate amount negotiated with two customers in the three months ended September 30, 2003 which totaled approximately $1.3 million. The $9.4 million includes the $6.0 million payment received from Samsung Electronics for royalties relating to past production. Other intellectual property revenues for the nine months ended September 30, 2004 increased by $15.8 million or 726.4% due to the resolution of negotiations with ten customers, totaling $17.9 million. Of the $15.8 million increase, $5.6 million represented resolutions of negotiations with new customers and $10.2 million from existing customers, which includes the $6.0 million payment from Samsung Electronics. These resolutions were greater than the aggregate amount negotiated with three customers in the nine months ended September 30, 2003 which totaled to approximately $2.2 million.

Service revenue for the three months ended September 30, 2004 was $3.9 million as compared to $1.9 million for the three months ended September 30, 2003, an increase of $2.0 million or 102.5%. Service revenue for the nine months ended September 30, 2004 was $9.1 million as compared to $6.4 million for the nine months ended September 30, 2003, an increase of $2.6 million or 40.6%. These increases are directly related to the increase in number of government contracts. For the three months ended September 30, 2004, government contracts increased by $2.2 million or 143.2% over the three months ended September 30, 2003. Government contracts for the nine months ended September 30, 2004 increased by $2.9 million or 50.6% over the nine months ended September 30, 2003.

Cost of revenues primarily relates to service revenue as the cost of revenues associated with intellectual property revenues is de minimis. Cost of revenue as a percentage of total revenue will vary based on the service revenue component of total revenue.

Cost of revenues for the three months ended September 30, 2004 increased by $761,000 or 41.2% to $2.6 million as compared to $1.8 million for the three months ended September 30, 2003. Cost of revenues for the nine months ended September 30, 2004 increased by $1.6 million or 32.9% to $6.5 million as compared to $4.9 million for the nine months ended September 30, 2003. The majority of the increase was attributable to the number of service related projects. Increased materials and subcontractor costs related to service-related projects also accounted for part of the increase in cost of revenues.

Research and development expenses for the three months ended September 30, 2004 decreased by $507,000 or 25.4% to $1.5 million as compared to $2.0 million for the three months ended September 30, 2003. Research and development expenses for the nine months ended September 30, 2004 were $5.6 million as compared to $5.7 million for the nine months ended September 30, 2003, a decrease of $136,000 or 2.4%. This decrease in expenses is primarily due to the reassignment of more personnel resources to service revenue projects.

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

Selling, general and administrative expenses for the three months ended September 30, 2004 were $5.0 million as compared to $2.8 million for the three months ended September 30, 2003, an increase of $2.1 million, or 74.5%. Selling, general and administrative expenses for the nine months ended September 30, 2004 were $13.8 million as compared to $7.7 million for the nine months ended September 30, 2003, an increase of $6.1 million or 79.1%. The increase is primarily attributable to the costs of being a public company and our ongoing litigation with Samsung. The increased costs related to being a public company are primarily salaries, professional fees and insurance. For the three and nine months ended September 30, 2004, these costs were $511,000 and $2.3 million, respectively. For the nine months ended September 30, 2004, the costs included $550,000 of professional charges for the Company’s secondary public offering that closed on March 31, 2004. Total litigation expenses for the three and nine months ended September 30, 2004 were $1.7 million and $4.7 million, respectively, compared to the three and nine months ended September 30, 2003 of $859,000 and $1.7 million, respectively. We expect to continue to incur litigation expenses related to the Samsung legal proceeding in the upcoming quarter.

Excluding litigation expenses, we expect that as a percentage of revenues, our selling, general and administrative 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 with Samsung and because we expect that we will become involved in other litigation from time to time in the future in order to enforce and protect our intellectual property rights.

Stock-based compensation decreased to $20,000 for the three months ended September 30, 2004 compared to $612,000 for three months ended September 30, 2003. For the nine months ended September 30, 2004, stock-based compensation was $206,000 as compared to $1.0 million for the nine months ended September 30, 2003. Compensation expense directly related to non-employee stock awards for the three and nine months ended September 30, 2004 was $14,000 and $152,000, respectively. Compensation expense directly related to non-employee stock awards for the three and nine months ended September 30, 2003 was $469,000 and $512,000, respectively. The decrease in stock-based compensation is due to lower amortization of deferred compensation related to issuance of stock options in 1996 through 2003.

In connection with the grant of stock options from 1996 through 2003, we recorded an aggregate of $29.9 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. As of September 30, 2004, we had an aggregate of $51,000 of deferred stock-based compensation remaining to be amortized.

Interest and other income, net for the three and nine months ended September 30, 2004 was $233,000 and $475,000, respectively, compared to $69,000 and $202,000 for the three and nine months ended September 30, 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.

Income tax provision for the three and nine months ended September 30, 2004 was $999,000 and $2.2 million, respectively. For the three and nine months ended September 30, 2003 income tax provision was $370,000 and $1.3 million, respectively. The income tax provision is comprised of the alternative minimum tax and foreign withholding tax. The increase in the income tax provision for the three and nine months ended September 30, 2004 compared to the three and nine months ended September 30, 2003, is primarily attributable to the increase in foreign revenue for which we pay a statutory foreign withholding tax and an increase in net taxable income to which the alternative minimum tax rate is applied. For the year ended December 31, 2003, we recorded a full valuation allowance against our deferred tax assets, due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of certain net operating losses carried forward, before they expire.

Since our inception, we have financed our operations primarily through sales of equity securities and, more recently, through cash generated from operations. At September 30, 2004, we had $96.4 million in cash and cash equivalents.

Net cash provided by operating activities for the nine months ended September 30, 2004 of $26.6 million was primarily attributable to net income of $26.6 million, non-cash expenses primarily consisting of depreciation and amortization of deferred stock-based compensation of $932,000, an increase in accounts payable of $157,000 and an increase in accrued liabilities of $1.8 million. This was partially off-set by an increase in accounts receivable of $2.9 million, a decrease in prepaid and other current assets of $331,000 and a decrease in deferred revenue of $172,000.

Net cash provided by operating activities for the nine months ended September 30, 2003 of $7.7 million was primarily attributable to net income of $6.3 million, non-cash expenses primarily consisting of depreciation and amortization of deferred stock-based compensation of $1.7 million, an increase in accounts payable of $43,000, an increase in accrued liabilities of $1.2 million and an increase in deferred revenue of $463,000. This was partially off-set by an increase in accounts receivable of $1.2 million and an increase in prepaid and other current assets of $729,000.

Increases in accounts payable for 2004 and 2003 were primarily attributable to increased purchases of materials and supplies to accommodate our increases in service related-projects and expanded research and development activities. The increase of $1.8 million in accrued liabilities for 2004 was primarily due to the increase in litigation expense. Increases in accounts receivable for 2004 and 2003 were attributable to the timing of receipts from customers and amounts earned under our licenses and resolution of negotiations agreements. The increase in 2004 was primarily due to the resolution of negotiations with new and existing customers totaling $5.6 million and $12.4 million respectively. The decrease in prepaid and other current assets in 2004 of $331,000 is primarily due to prepaid insurance and expenses that are amortized over a period less than or equal to twelve months.

Net cash used in investing activities in the nine months ended September 30, 2004 of $976,000 was primarily attributable to the purchase of property and equipment. Net cash used in investing activities in the nine months ended September 30, 2003 of $7.4 million was primarily attributable to net purchases of short-term marketable securities of $6.2 million and purchases of property and equipment of $1.2 million.

Net cash provided by financing activities in the nine months ended September 30, 2004 was $6.3 million of which $5.9 million was attributable to proceeds for exercise of stock options and $431,000 was attributable to the proceeds from the employee stock purchase plan. Net cash used in financing activities in the nine months ended September 30, 2003 of $1.5 million was primarily attributable to the repurchase of preferred and common stock.

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

As of September 30, 2004 the following sets forth our minimum commitments under operating leases, most of which results from a facilities lease:

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

Our principal administrative, sales, marketing and research and development facilities occupy approximately 51,000 square feet in one building in San Jose, California, under a lease that expires on May 31, 2011. We believe our existing facilities are adequate for our current needs.

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. Moreover, our stock price may fluctuate based on developments in the course of ongoing litigation, including our litigation with Samsung Electronics Co. Ltd. described below and elsewhere in this quarterly report.

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

On December 16, 2002, Samsung initiated a declaratory judgment action against us in U.S. District Court. This action included the assertion of the defense of equitable estoppel, alleging that we are precluded from enforcing our patents on the grounds that: (1) we had a duty to disclose certain of our patents to JEDEC (a standards body); (2) we breached our duty of disclosure to JEDEC; and (3) as a result of our failure to disclose these patents, we may not allege that our patents cover Samsung’s products. On February 18, 2003, we filed our answer and counterclaim alleging patent infringement, termination of the license, and breach of the license by Samsung. In our answer and counterclaim we also denied Samsung’s allegations regarding JEDEC on several grounds, including that (1) we satisfied the duty of disclosure to JEDEC as that duty has previously been defined by the courts in other cases; and (2) Samsung expressly agreed in its 1997 license agreement with us to pay royalties for any of its products that are covered by our patents, which expressly precludes Samsung from arguing that it believes our patents are unenforceable against Samsung’s products. Samsung has continued to make payments under our license agreement and has responded by moving to dismiss our patent infringement counterclaims. On August 11, 2003, the court granted Samsung’s motion to dismiss our patent infringement counterclaims on the grounds that, pending the outcome of the current litigation, Samsung does not infringe because its activities are covered by the 1997 license agreement. On November 12, 2003, the court held a patent claim construction hearing, and a claim construction order was entered on January 8, 2004. On March 30, 2004, and then on July 16, 2004, Tessera notified Samsung that Tessera was terminating the 1997 license agreement in view of Samsung’s material breach thereof. Each notice of termination was based on a different alleged breach. Samsung disputes that either termination was proper and contends that the 1997 license agreement remains in full force and effect. Until the issue of whether the 1997 license agreement has been terminated is resolved, Tessera has refused to accept further royalty payments from Samsung for the period after March 30, 2004. We are proceeding against Samsung with a breach of contract action with our infringement contentions being a central element of the action. As part of the Court’s standard pretrial procedures, the Court heard argument on motions for summary judgment on August 27, 2004. Samsung moved for summary judgment on a subset of its defenses relating to both breach of contract and patent issues. On October 21, 2004, the Court granted Samsung’s motion that Tessera’s purported termination of the Agreement on March 30, 2004 was ineffective, and denied Samsung’s motions in all other respects. On October 22, 2004, the Court held a final pretrial conference. The Court scheduled trial to commence on November 1, 2004, in exchange for Tessera’s agreement to drop its claim that the Agreement had been terminated as of July 16, 2004 and the contentions relating to that claim. The Court also bifurcated Samsung’s defenses of equitable estoppel and inequitable conduct for a separate non-jury trial to be held at a later date, not yet set. Trial of the parties’ contentions of breach on contract and the underlying patent issues commenced on November 1, 2004, and is currently scheduled to end during the week of November 22, 2004. We cannot predict the outcome of this proceeding. An adverse decision in this proceeding could significantly harm our business.

We expect our quarterly operating results to fluctuate and these fluctuations may cause our stock price to be volatile and decline.

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 only 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:

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 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.

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 law 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 portfolio, and our license agreements typically include our 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 we asserted 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 law rather than patent law 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 contractual provisions with respect to these 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 be required 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 are currently involved in litigation with Samsung regarding our intellectual property rights, as described above, and expect to be involved in similar litigation in the future. Litigation is inherently uncertain and any adverse decision could result in a loss of our proprietary rights, subject us to significant liabilities, require us to seek licenses from others, limit the value of our licensed technology and 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.

We may become involved in litigation with our licensees, potential licensees or strategic partners, which could harm our business.

We may become involved in a dispute relating to our intellectual property or our contracts, which could include or be with a licensee, potential licensee or strategic partner. Our pending litigation with Samsung, as described above, is an example. Any such dispute could cause the licensee or strategic partner to cease making 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. We are unaware of any material harm or delay that the pending Samsung litigation has caused in our relationships with other licensees or potential customers. However, we believe that our previously-settled litigations with Sharp Corporation and Texas Instruments encouraged some potential licensees to postpone their licensing decisions until those litigations were settled.

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, then we may be forced to commence legal proceedings against them.

Our long-term success depends on future royalties paid to us by licensees. Royalty payments are primarily based upon the number of electrical connections to the semiconductor chip in a package covered by our licensed technology, although we do have royalty arrangements in which royalties are paid based upon a percent of the net sales price. 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, and potentially detrimental to our ongoing business relationship with our licensees. As a result, to date, we have primarily relied exclusively on the accuracy of the reports themselves without independently verifying the information in them. Our failure to audit our licensees’ books and records may result in us receiving less royalty revenues than we are entitled to under the terms of our license agreements.

Failure by our licensees to introduce products using our technology could limit our royalty revenue 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 dynamic random access memory, or DRAM, chips. For example, packaging using our technology was designated by Rambus as the reference design 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 DDR DRAM, which does not currently 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 DDR2, 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.

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.

Further, one of the issues in dispute in our current litigation with Samsung is whether our patents cover specific embodiments of packages used by Samsung for packaging DRAM. If Samsung prevails on the question of infringement of our patents upon certain of its packages or succeeds in proving that our patents relevant to the DRAM package are invalid, unenforceable or should be limited, revenues from DRAM chip manufacturers for our licensed technology will be adversely affected.

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, ASIC and memory. In addition, we derive substantial revenues from the incorporation of our technology into wireless 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. In the three and nine months ended September 30, 2004, Texas Instruments accounted for 16% and 20% of total revenue respectively, Intel accounted for 17% and 17% of total revenue respectively and Samsung accounted for 26% and 12% of total revenue respectively. For the three and nine months ended September 30, 2003, Texas Instruments accounted for 27% and 29% of total revenue respectively. 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.

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 that are also gaining popularity. The companies using these technologies are utilizing their current lead frame infrastructure to achieve cost-effective results.

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 electronic 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 September 19, 2021. We need to develop and patent successful innovations before our current patents expire.

We also may 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 and consumer electronics industries. Our failure to develop or acquire new technologies could significantly harm our business.

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 6 to 18 months. As such, we may incur significant losses in any particular period before any associated revenue stream begins.

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

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.

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

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

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

We provide certain other 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 offending 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 design or help design prototypes or products. If these prototypes, manufactured 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 significantly 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. Further, our officers have limited experience managing companies through acquisitions and technological changes. In addition, our management has limited experience in managing a public company.

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

While we have not acquired any significant businesses, products or technologies in the past, acquisitions are commonplace in the semiconductor industry and we may acquire complementary businesses or technologies in the future. Integrating newly acquired businesses or technologies could put a strain on our resources, could be costly and time consuming, and might not be successful. Future acquisitions could divert our management’s attention from other business concerns. In addition, we might lose key employees while integrating new organizations. Future 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.

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.

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.

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, 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.

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

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

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

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

As described below, we are currently involved in a material legal proceeding relating to our intellectual property and have been involved in others in the recent past. Given the importance of our intellectual property to our future success and competitive advantage, we expect to be involved in material legal proceedings relating to our intellectual property on a regular basis in the future.

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

On December 16, 2002, Samsung initiated a declaratory judgment action against us in the U.S. District Court for the Northern District of California seeking a declaratory judgment, alleging that: (1) it has not breached the license agreement it entered into with us in 1997 allegedly because its MWBGA, TBGA, FBGA, MCP and laminate based wBGA semiconductor chip packages are not covered by the license agreement and, therefore, it owes us no royalties for such packages; (2) the license agreement remains in effect because Samsung was not in breach for failing to pay royalties for such packages and, therefore, our termination of the license agreement was not effective; (3) its MWBGA, TBGA, FBGA, MCP and laminate based wBGA semiconductor chip packages do not infringe our U.S. Patents Nos. 5,852,326, 5,679,977, 6,433,419 and 6,465,893; and (4) these four Tessera patents are invalid and unenforceable. Samsung also seeks to recover its costs and attorney’s fees incurred in the action. Regarding the unenforceability claim, Samsung has asserted that we are precluded from enforcing our patents on the grounds that: (1) we had a duty to disclose certain of our patents to JEDEC (a standards body); (2) we breached our duty of disclosure to JEDEC; and (3) as a result of our failure to disclose these patents, we may not allege in this lawsuit that they cover Samsung’s products.

On February 18, 2003, the Company filed an answer in which the Company denies Samsung’s allegations, including its allegations that any of the Company’s patents are invalid or unenforceable. The Company also filed a counterclaim in which the Company alleges that: (1) Samsung has breached the license agreement by, among other things, failing to pay the Company royalties for the use of the Company’s U.S. Patents 5,852,326, 5,679,977, 6,433,419, 6,465,893, 5,950,304 and 6,133,627; (2) the Company’s termination of the 1997 license agreement was effective and the 1997 license agreement is terminated; and (3) Samsung and its U.S. subsidiaries Samsung Electronics America and Samsung Semiconductor, Inc. have infringed these six Tessera patents. The Company has denied Samsung’s enforceability allegations on several grounds, including that (1) the Company has satisfied the duty of disclosure to JEDEC as that duty has been defined by the courts in other cases; and (2) Samsung expressly agreed in its 1997 license agreement with the Company to pay royalties for any of its products that are covered by the Company’s patents, which expressly precludes Samsung from arguing that it believed the Company’s patents are unenforceable against Samsung’s products. The Company further seeks to recover damages, up to treble the amount of actual damages, together with attorney’s fees and costs. The Company also seeks to enjoin Samsung and its U.S. subsidiaries from continuing to infringe these patents in the future. Samsung has continued to make payments under the Company’s license agreement and has responded by moving to dismiss the Company’s patent infringement counterclaims on the grounds that they are barred by existence of the 1997 license agreement. On August 11, 2003, the Court granted Samsung’s motion to dismiss the Company’s patent infringement counterclaims on the grounds that, pending the outcome of the current litigation, Samsung does not infringe because its activities are covered by the 1997 license agreement. The Company is proceeding against Samsung with a breach of contract action with the Company’s infringement contentions being a central element of the action. On March 30, 2004, and then on July 16, 2004, Tessera notified Samsung that Tessera was terminating the 1997 license agreement in view of Samsung’s material breach thereof. Each notice of termination was based on a different alleged breach. Samsung disputes that either termination was proper and contends that the 1997 license agreement remains in full force and effect.

On July 15, 2004, Samsung made a $6,000,000 one-time payment relating to production prior to the end of March 2004 of its TBGA and TBGA-MCP packages involved in this dispute. This payment does not resolve all of the issues between the parties with respect to the TBGA packages and does not resolve any of the issues between the parties with respect to the other package families at issue.

Trial of the parties’ contentions of breach on contract and the underlying patent issues commenced on November 1, 2004, and is currently scheduled to end during the week of November 22, 2004.

From time to time, we may be involved in other litigation involving claims arising out of our operations in the normal course of business.

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.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Tessera Technologies, Inc.

By:		/s/ R. Douglas Norby
		R. Douglas Norby
		Chief Financial Officer and Senior Vice President


3099 Orchard Drive, San Jose, California		95134
(Address of Principal Executive Offices)		(Zip Code)


		Page
	PART I

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets (unaudited) – September 30, 2004 and December 31, 2003	3

	Condensed Consolidated Statements of Operations (unaudited) – Three and Nine Months Ended September 30, 2004 and 2003	4

	Condensed Consolidated Statements of Cash Flows (unaudited) – Nine Months Ended September 30, 2004 and 2003	5

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risks	26

Item 4.	Controls and Procedures	27

	PART II

Item 1.	Legal Proceedings	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29

Item 3.	Defaults Upon Senior Securities	29

Item 4.	Submission of Matters to a Vote of Security Holders	29

Item 5.	Other Information	29

Item 6.	Exhibits	30

Signatures		31

Exhibit Index		32


	September 30, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	96,376		$	64,379
Accounts receivable		5,482			2,540
Other current assets		961			1,335

Total current assets		102,819			68,254
Property and equipment, net		1,980			1,725
Other assets		145			102

Total assets	$	104,944		$	70,081

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,033		$	876
Accrued liabilities		4,782			3,014
Deferred revenue		30			202

Total current liabilities		5,845			4,092

Commitments and contingencies (Note 6)

Stockholders' equity:
Common stock: $0.001 par value; 54,686,666 shares authorized; 41,001,497 and 38,474,443 shares issued and outstanding		41			38
Additional paid-in capital		163,617			157,178
Deferred stock-based compensation		(51	)		(153	)
Accumulated deficit		(64,508	)		(91,074	)

Total stockholders’ equity		99,099			65,989

Total liabilities and stockholders' equity	$	104,944		$	70,081


	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Revenues:
Intellectual property revenues	$	10,399	$	5,987	$	27,431	$	18,037
Other intellectual property revenues		9,350		1,293		17,930		2,169
Service revenues		3,896		1,924		9,051		6,438

Total revenues		23,645		9,204		54,412		26,644

Operating expenses:
Cost of revenues (1)		2,610		1,849		6,497		4,890
Research and development (1)		1,490		1,997		5,566		5,702
Selling, general and administrative (1)		4,954		2,839		13,833		7,725
Stock-based compensation		20		612		206		1,008

Total operating expenses		9,074		7,297		26,102		19,325

Operating income		14,571		1,907		28,310		7,319
Other income, net		233		69		475		202

Income before taxes		14,804		1,976		28,785		7,521
Provision for income taxes		999		370		2,219		1,261

Net income		13,805		1,606		26,566		6,260
Cumulative preferred stock dividends in arrears		—		—		—		(6,187	)

Net income attributable to common stockholders	$	13,805	$	1,606	$	26,566	$	73

Basic and diluted net income per share attributable to common stockholders:
Net income per common share; basic	$	0.34	$	0.23	$	0.67	$	0.01

Net income per common share; diluted	$	0.30	$	0.04	$	0.57	$	0.01

Weighted average number of shares used in per share calculations; basic		40,448		6,870		39,482		6,851

Weighted average number of shares used in per share calculations; diluted		46,655		40,869		46,537		11,590

(1) Operating expense line item detail excludes stock-based compensation, as follows:

Cost of revenues	$	—	$	—	$	—	$	1
Research and development		5		223		52		373
Selling, general and administrative		15		389		154		634

Total	$	20	$	612	$	206	$	1,008


	Nine Months Ended September 30,
	2004			2003
Cash flows from operating activities:
Net income	$	26,566		$	6,260
Adjustments to reconcile income to net cash provided by operating activities:
Depreciation and amortization		726			654
Gain on disposal of fixed assets		(5	)		(7	)
Stock-based compensation, net		206			1,008
Unrealized gain and foreign translation		—			(36	)
Changes in operating assets and liabilities:
Accounts receivable		(2,942	)		(1,169	)
Other assets		331			(729	)
Accounts payable		157			43
Accrued liabilities		1,768			1,211
Deferred revenue		(172	)		463

Net cash provided by operating activities		26,635			7,698

Cash flows from investing activities:
Purchases of property and equipment		(982	)		(1,184	)
Proceeds from sale of fixed assets		6			14
Purchases of short-term investments, net		—			(6,230	)

Net cash used in investing activities		(976	)		(7,400	)

Cash flows from financing activities:
Proceeds from exercise of stock options and warrants, net		5,907			209
Proceeds from employee stock purchase program		431			—
Repurchase of common stock		—			(269	)
Repurchase of preferred stock		—			(1,447	)

Net cash provided by (used in) financing activities		6,338			(1,507	)

Net increase (decrease) in cash and cash equivalents		31,997			(1,209	)
Cash and cash equivalents at beginning of period		64,379			1,341

Cash and cash equivalents at end of period	$	96,376		$	132

Supplemental disclosure of non-cash investing and financing activities:
Deferred stock-based compensation	$	—		$	90

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	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Customer
Texas Instruments, Inc	16	%	27	%	20	%	29	%
Samsung Electronics	26	%	3	%	12	%	5	%
Intel Corporation	17	%	13	%	17	%	7	%


	September 30, 2004		December 31, 2003
Trade	$	1,833	$	1,500
Other		3,649		1,040

	$	5,482	$	2,540


	September 30, 2004			December 31, 2003
Furniture and equipment	$	9,788		$	8,786
Leasehold improvements		1,248			1,626

		11,036			10,412
Less: Accumulated depreciation and amortization		(9,056	)		(8,687	)

	$	1,980		$	1,725


	September 30, 2004		December 31, 2003
Employee compensation and benefits	$	1,774	$	1,439
Legal fees		1,844		1,246
Other		1,164		329

	$	4,782	$	3,014


	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Revenues:
License
Intellectual property revenues	44.0	%	65.0	%	50.4	%	67.7	%
Other intellectual property revenues	39.5		14.0		33.0		8.1
Service revenues	16.5		21.0		16.6		24.2

Total revenues	100.0		100.0		100.0		100.0

Operating expenses:
Cost of revenues	11.0		20.1		11.9		18.4
Research and development	6.3		21.7		10.2		21.4
Selling, general and administrative	21.0		30.8		25.4		29.0
Stock-based compensation	0.1		6.6		0.4		3.8

Total operating expenses	38.4		79.2		47.9		72.6

Operating income	61.6		20.8		52.1		27.4
Interest and other income, net	1.0		0.7		0.9		0.8

Income before taxes	62.6		21.5		53.0		28.2
Provision for income taxes	4.2		4.0		4.1		4.7

Net income	58.4	%	17.5	%	48.9	%	23.5	%


Year Ended December 31,	Amount
Year Ended December 31,	(in thousands)
Remainder of 2004	$	77
2005		322
2006		342
2007		360
2008		383
Thereafter		1,023

Total minimum lease commitments	$	2,507


Exhibit Number		Exhibit Title
10.1*		Forms of Stock Option Agreement under Second Amended and Restated 2003 Equity Incentive Plan

31.1		Section 302 Certification of the Chief Executive Officer

31.2		Section 302 Certification of the Chief Financial Officer

32.1		Section 906 Certification of the Chief Executive Officer and Chief Financial Officer


	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
United States	$	11,681	$	5,656	$	29,214	$	15,926
Japan		5,662		3,152		17,127		8,730
Korea		6,036		247		6,534		1,400
Singapore		36		—		709		—
Taiwan		188		7		485		241
Other		42		142		343		347

	$	23,645	$	9,204	$	54,412	$	26,644