The following discussion (presented in thousands, except for percentages) should be read in conjunction with our consolidated financial statements and notes thereto.

Business Overview

Tessera Technologies, Inc. is a holding company with operating subsidiaries in two segments: Intellectual Property and DigitalOptics.

Our Intellectual Property segment generates revenue from manufacturers and other implementers that use our technology. We pioneered chip-scale packaging solutions, which we license to the semiconductor industry. We also develop and acquire interconnect solutions and intellectual property in areas such as mobile computing and communications, memory and data storage, and 3DIC technologies.

Our DigitalOptics business designs and manufactures imaging systems for smartphones, generating revenue through product sales and software license fees and royalties. Our expertise in optics, camera modules, MEMS, and image processing enable us to deliver products that expand the boundaries of smartphone photography. We also offer customized micro-optic lenses, which may include DOEs, ROEs and/or IMOS.

Results of Operations

Acquisitions

We have grown our business partly through acquisitions. In 2010, we completed the acquisition of Siimpel Corporation ("Siimpel"), a developer and manufacturer of MEMS-based camera solutions for mobile imaging applications for $15.0 million. Siimpel's MEMS autofocus and MEMS autofocus + Shutter solutions complement our image enhancement solutions and enable us to offer a wider range of high-value IP-based imaging and optics solutions. The impact of this acquisition on our financial results has been included in our DigitalOptics segment as discussed below.

In June 2012, we completed the Zhuhai Transaction, which involved the acquisition of certain assets of Vista Point Technologies, a Tier One qualified camera module manufacturing business, from Flextronics International Ltd. for consideration of $29.0 million, net of $11.9 million cash acquired.
Approximately $7.6 million of the consideration has been placed in escrow at the initial closing, of which, approximately $4.0 million is subject to delivery of certain additional assets by Flextronics International Ltd. no later than March 31, 2013 and approximately $3.0 of which was released in connection with the delivery of certain additional assets in the fourth quarter of 2012. We intend to use the acquired assets to help build the DigitalOptics segment into a supplier of MEMS-based camera modules in the mobile phone market. In 2012, we generated approximately $13.4 million in revenues from the sale of fixed focus camera modules and incurred $20.0 million of operating expenses related to the manufacturing operations acquired in the Zhuhai Transaction. We expect our revenues from the production of the fixed focus camera modules to decrease during 2013 as compared to 2012, as we transition the Zhuhai manufacturing facility to the production of our MEMS-based camera modules, from which we have yet to generate meaningful revenue. The impact of the acquisition on our financial results has been included in the following discussion.

Revenues

Our revenues are generated from royalty and license fees, past production payments, and product and service revenues. Royalty and license fees include revenues from license fees and royalty payments generated from licensing the right to use our technologies or intellectual property. Licensees generally report shipment

information 30 to 60 days after the end of the quarter in which such activity takes place. Since there is no reliable basis on which we can estimate our royalty revenues prior to obtaining these reports from the licensees, we recognize royalty revenues on a one quarter lag. The timing of revenue recognition and the amount of revenue actually recognized for each type of revenues depends upon a variety of factors, including the specific terms of each arrangement, our ability to derive fair value of the element and the nature of our deliverables and obligations. In addition, our royalty revenues will fluctuate based on a number of factors such as: (a) the timing of receipt of royalty reports; (b) the rate of adoption and incorporation of our technology by licensees; (c) the demand for products incorporating semiconductors that use our licensed technology; (d) the cyclicality of supply and demand for products using our licensed technology; and (e) the impact of economic downturns.

From time to time we enter into license agreements that have fixed expiration dates. Upon expiration of such agreements, we need to renew or replace these agreements in order to maintain our revenue base. We may not be able to continue licensing customers on terms favorable to us, under the existing terms or at all, which would harm our results of operations. For example, our license agreement with Micron Technology, Inc. expired in May 2012. Micron Technology, Inc. accounted for 10% or more of total revenues for the year ended December 31, 2012 and has since entered into a definitive sponsor agreement to acquire and support Elpida Memory, Inc., a leading dynamic random access memory ("DRAM") manufacturer, which is expected to close in the first half of 2013 subject to numerous closing conditions and approvals. If we fail to replace the expired Micron Technology, Inc. license agreement, it will have a negative impact on our revenue and our results of operations.

We are in litigation with PTI, a material customer in 2012, and PTI has ceased making payments. See under the subheading "Contingencies" in Note 15-"Commitments and Contingencies" of the Notes to Consolidated Financial Statements. If we are not able to replace the revenue from PTI or if we receive an adverse determination in the litigation with PTI, it could have a substantial adverse impact on our royalty revenue in the near term.

In the past, we have engaged in litigation and arbitration proceedings to directly or indirectly enforce our intellectual property rights and the terms of our license agreements, including proceedings to ensure proper and full payment of royalties by our current licensees and by third parties whose products incorporate our intellectual property rights. For example, on February 20, 2013 the International Court of Arbitration of the International Chamber of Commerce issued an award in favor of Tessera, Inc. in its dispute with Amkor. Tessera, Inc. cannot predict the precise amount or the timing of Amkor's payment. We believe that the dispute with Amkor and similar future proceedings may result in fluctuations in our revenue and expenses.

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

                                                               Years Ended
                                                              December 31,
                                                      2012        2011        2010
      Revenues:
      Royalty and license fees                           78 %        93 %        93 %
      Past production payments                           11          -           -
      Product and service revenues                       11           7           7

      Total Revenues                                    100         100         100
      Operating expenses:
      Cost of revenues                                   17           9           7
      Research, development and other related costs      43          30          25
      Selling, general and administrative                42          33          26
      Litigation expense                                 15          12           7
      Restructuring and other charges                     1           2          -
      Impairment of long-lived assets                    -           (1 )         1
      Impairment of goodwill                             -           20          -

      Total operating expenses                          118         105          66

      Operating income (loss)                           (18 )        (5 )        34
      Other income and expense, net                       3           1           1

      Income (loss) before taxes                        (15 )        (4 )        35
      Provision for (benefit from) income taxes          (2 )         4          16

      Net income (loss)                                 (13 )%       (8 )%       19 %

Fiscal Year 2012 and 2011

The following table sets forth our revenues by type (in thousands, except for
percentages):



                                             Years Ended December 31,                     Increase/
                                         2012                        2011                 (Decrease)         Change
Royalty and license fees         $ 182,521          78 %     $ 237,201          93 %     $    (54,680 )          (23 )%
Past production payments            24,729          11              -           -              24,729            n/a
Product and service revenues        26,773          11          17,375           7              9,398             54

Total revenues                   $ 234,023         100 %     $ 254,576         100 %     $    (20,553 )           (8 )%

Total revenue for the year ended December 31, 2012 was $234.0 million compared to $254.6 million for the year ended December 31, 2011. See "Segment Operating Results" below for an explanation of the changes in revenue between the reporting periods.

Cost of Revenues

Cost of revenues primarily consists of materials and supplies, direct compensation, amortization of intangible assets related to acquired technologies, and depreciation expense. Amortization of certain acquired intangible assets and depreciation expense of property and equipment are generally classified as a component of cost of revenues from research, development and other related costs when an in-process development project reaches commercialization. Excluding amortization of acquired intangible assets, cost of revenues relates primarily to product and service revenues. For each associated period, cost of revenues as a percentage of total

revenues varies based on the rate of adoption of our technologies, the product and service revenues component of total revenues, the mix of product sales to semiconductor, optics and communications industries and the timing of property and equipment being placed in service. We anticipate our cost of revenues will increase as our product mix includes more products and services as we grow our DigitalOptics business through the manufacturing operations we acquired in June 2012 through the Zhuhai Transaction and from our manufacturing facility in Taiwan that we officially opened in January 2013.

Cost of revenues for the year ended December 31, 2012 was $40.4 million, as compared to $23.5 million for the year ended December 31, 2011, an increase of $16.9 million, or 72%. This increase resulted from increases in expensed equipment, materials and supplies, depreciation and amortization of acquired intangible assets, and personnel related expenses, which relate primarily to the increased product revenues driven by the operations acquired in the Zhuhai Transaction.

Research, Development and Other Related Costs

Research, development and other related costs consist primarily of compensation and related costs for personnel, as well as costs related to patent applications and examinations, product "tear downs" and reverse engineering, amortization of intangible assets, materials, supplies and equipment depreciation. Research and development is conducted primarily in-house and targets development of chip-scale, circuitry design, 3D architecture, wafer-level packaging technology, high-density substrate, thermal management technology, image sensor packaging, image enhancement technology, including MEMS-based products, and micro-optic lens solutions such as diffractive and refractive optical elements to integrated micro-optical subassemblies. All research, development and other related costs are expensed as incurred.

Research, development and other related costs for the year ended December 31, 2012 were $100.7 million, as compared to $76.0 million for the year ended December 31, 2011, an increase of $24.7 million, or 33%. The increase was primarily due to increases in personnel related expenses of $8.9 million, in material costs of $3.6 million, in consulting fees of $2.5 million, in masks and tooling expenses of $1.8 million, in patent prosecution, application and examination expenses of $1.9 million and in the amortization of intangible assets of $1.6 million. These increases were primarily the result of the expansion of the DigitalOptics business, including the Zhuhai acquisition, and were partially offset by a decrease in stock-based compensation expense of $1.8 million.

We believe that a significant level of research and development expenses will be required for us to remain competitive in the future.

Selling, General and Administrative

Selling expenses consist primarily of compensation and related costs for sales and marketing personnel, reverse engineering personnel and services, marketing programs, public relations, promotional materials, travel, trade show expenses, and stock-based compensation expense. General and administrative expenses consist primarily of compensation and related costs for general management, information technology, finance and accounting personnel, legal fees and expenses, facilities costs, stock-based compensation expense, and professional services. Our general and administrative expenses, other than facilities related expenses, are not allocated to other expense line items.

Selling, general and administrative expenses for the year ended December 31, 2012 were $97.3 million, as compared to $83.4 million for the year ended December 31, 2011, an increase of $13.9 million, or 17%. The increase was primarily attributable to increases in outside service of $4.3 million related to our acquisition activities, in amortization of intangible assets of $5.3 million resulting from approximately $64.0 million in purchases of intangible assets since the third quarter of 2011 and in personnel related expenses of $4.1 million, offset by a decrease in stock-based compensation expense of $6.9 million.

Litigation Expense

Litigation expense for the year ended December 31, 2012 was $34.0 million, as compared to $29.4 million for the year ended December 31, 2011, an increase of $4.6 million, or 16%. The increase was primarily attributable to the timing of case activities in our docket of legal proceedings.

We expect that litigation expense will continue to be a material portion of our operating expenses in future periods, and may fluctuate significantly in some periods, because of our ongoing litigation, as described Part I, Item 3-Legal Proceedings, and because of litigation initiated from time to time in the future in order to enforce and protect our intellectual property and contract rights.

Upon expiration of the current terms of our customers' licenses, if those licenses are not renewed, litigation may become a necessary element of a campaign to secure payment of reasonable royalties for the use of our patented technology. If we initiate such litigation, our future litigation expenses would significantly increase.

Restructuring and Other Charges

In November 2012, we announced further restructuring of our DigitalOptics segment to focus our efforts on our core MEMS camera module business. In connection with this effort, we are reducing our workforce and ceasing operations at our facility in Tel Aviv, Israel. In connection with these actions, we incurred total charges of $2.5 million in the fourth quarter of 2012 and expect to incur approximately $0.5 million of additional expenses in the first quarter of 2013.

Stock-based Compensation Expense

The following table sets forth our stock-based compensation expense for the
periods indicated (in thousands):



                                                             Years Ended
                                                            December 31,
                                                          2012         2011
        Cost of revenues                                $    641     $    458
        Research, development and other related costs      6,455        8,233
        Selling, general and administrative                9,940       16,879

        Total stock-based compensation expense          $ 17,036     $ 25,570

Stock-based compensation awards included employee stock options, restricted stock awards and units, and employee stock purchases. For the year ended December 31, 2012, stock-based compensation expense was $17.0 million, of which $10.3 million related to employee stock options, $4.8 million related to restricted stock awards and units and $1.9 million related to employee stock purchases. For the year ended December 31, 2011, stock-based compensation expense was $25.6 million, of which $16.5 million related to employee stock options, $7.0 million related to restricted stock awards and units and $2.1 million related to employee stock purchases. The $8.5 million decrease in stock-based compensation in 2012 when compared to 2011 was primarily the result of a $5.1 million decrease in expense related to modifications. Modifications typically occur when we enter into consulting agreements with departing employees. Some of these agreements may include continued vesting of the departing employees' stock awards and an extension of the exercise period from the standard 90 days from employment termination date to the termination of the consulting agreement. To a lesser extent, stock-based compensation expense was lower due to our declining stock price which affects the fair value of our grants.

As of December 31, 2012, the amount of unrecognized stock-based compensation expense after estimated forfeitures related to unvested stock options was $17.8 million to be recognized over an estimated weighted average amortization period of 2.9 years and $13.6 million related to restricted stock awards and units, including performance-based awards and units, to be recognized over an estimated weighted average amortization period of 2.5 years.

Future stock-based compensation expense and unrecognized stock-based compensation expense will fluctuate due to changes in our assumptions used to determine the fair value, fluctuations in our stock price and additional stock awards being granted.

Other Income and Expense, Net

Other income and expense, net, was $5.9 million for the year ended December 31, 2012 compared to $2.6 million for the year ended December 31, 2011. The increase was primarily due to the portion of the payment from Amkor related to the International Court of Arbitration of the International Chamber of Commerce interim award in favor of Tessera, Inc. that was recorded as interest income.

Provision for (benefit from) Income Taxes

The benefit from income taxes for the year ended December 31, 2012 of $4.8 million was largely comprised of domestic income tax benefit as offset by foreign income tax and withholding taxes. The provision for income taxes for the year ended December 31, 2011 was $10.0 million and was comprised of domestic income tax, foreign income and withholding taxes as offset by a tax benefit of the impairment of tax-deductible goodwill. The decrease in income tax expense for the year ended December 31, 2012 as compared to the prior year was largely attributable to the U.S. domestic loss incurred in the current year offset by an increase in valuation allowance related to state and foreign deferred tax assets.

Fiscal Year 2011 and 2010

The following table sets forth our revenues by type (in thousands, except for
percentages):



                                                Years Ended December 31,                 Increase/
                                             2011                     2010               (Decrease)        Change
Royalty and license fees              $ 237,201        93 %    $ 279,623        93 %    $    (42,422 )         (15 )%
Product and service revenues             17,375         7         21,770         7            (4,395 )         (20 )

Total revenues                        $ 254,576       100 %    $ 301,393       100 %    $    (46,817 )         (16 )%

Revenues

See "Segment Operating Results" below for an explanation of the changes in revenue as compared between the reporting periods.

Cost of Revenues

Cost of revenues for the year ended December 31, 2011 was $23.5 million, as compared to $21.8 million for the year ended December 31, 2010, an increase of $1.7 million, or 8%. The increase was primarily attributable to the increase in personnel related expenses and fees related to the renewal of our license agreements, offset by a decrease in materials and stock-based compensation expense.

Research, Development and Other Related Costs

Research, development and other related costs for the year ended December 31, 2011 were $76.0 million, as compared to $74.1 million for the year ended December 31, 2010, an increase of $1.9 million, or 3%. The increase was primarily due to $5.2 million of increased expenses incurred by Siimpel, acquired in May 2010, and an increase in patent prosecution, application and examination expenses of $3.0 million, outside service costs of $0.9 million, and amortization of intangible assets of $0.8 million, offset by decreases in stock-based compensation expense of $2.7 million, personnel related expenses of $2.0 million, depreciation expense of $1.6 million and material costs of $1.4 million.

Selling, General and Administrative

Selling, general and administrative expenses for the year ended December 31, 2011 were $83.4 million, as compared to $79.3 million for the year ended December 31, 2010, an increase of $4.1 million, or 5%. The increase was primarily attributable to the inclusion of $0.3 million of increased expenses in 2011 incurred by Siimpel, acquired in May 2010, and increases in amortization of intangible assets of $1.7 million, personnel related expenses of $1.3 million, office equipment and software of $0.5 million and stock-based compensation expense of $0.4 million.

Litigation Expense

Litigation expense for the year ended December 31, 2011 was $29.4 million, as compared to $21.9 million for the year ended December 31, 2010, an increase of $7.5 million, or 34%. The increase was primarily attributable to an increase in activities in our arbitration with Amkor Technology, Inc. Refer to Part I, Item 3-"Legal Proceedings" for additional details.

Restructuring and Other Charges

In January 2011, we announced a reorganization of our DigitalOptics (formerly Imaging and Optics) segment to focus on key growth opportunities including EDoF, Zoom and MEMS-based autofocus, and a reduction up to 15% of our worldwide employee base. In August 2011, we announced a commitment to undertake a workforce reduction at our Yokohama, Japan development facility and to close that facility in order to optimize our operations. Restructuring and other charges primarily consisted of severance, costs related to the continuation of employee benefits, expenses related to the closure of facilities, and other costs related to the closure of the leased facility in Japan that are not expected to be recurring. Restructuring and other charges were $5.2 million for the year ended December 31, 2011. No restructuring charges were incurred for the year ended December 31, 2010.

Impairment of long-lived assets

In 2010, in connection with the cessation of development activity of wafer-level optics technology, we concluded that certain equipment would be disposed of by sale. As a result, we recognized an impairment charge of $3.5 million, which represents the excess of the net carrying value of the equipment over the fair value less cost to sell. These assets were classified as assets-held-for-sale as of December 31, 2010. As of December 31, 2011, certain assets were reclassified as held-for-use and the remaining assets were disposed of, resulting in a gain of $0.6 million.

Impairment of Goodwill

In 2011, we recorded a goodwill impairment charge of $49.7 million due primarily to the low market price of our common stock, which resulted in our market capitalization being significantly lower than the book value of equity for an extended period of time. There was no impairment of goodwill for the year ended December 31, 2010.

Stock-based Compensation Expense

The following table sets forth our stock-based compensation expense for the
periods indicated (in thousands):



                                                             Years Ended
                                                            December 31,
                                                          2011         2010
        Cost of revenues                                $    458     $    579
        Research, development and other related costs      8,233       10,937
        Selling, general and administrative               16,879       16,479

        Total stock-based compensation expense          $ 25,570     $ 27,995

For the year ended December 31, 2011, stock-based compensation expense was $25.6 million, of which $16.5 million related to employee stock options, $7.0 million related to restricted stock awards and units and $2.1 million related to employee stock purchases. For the year ended December 31, 2010, stock-based compensation expense was $28.0 million, of which $14.6 million related to employee stock options, $11.0 million related to restricted stock awards and units and $2.4 million related to employee stock purchases. As of December 31, 2011, the amount of unrecognized stock-based compensation expense after estimated forfeitures related to unvested stock options was $21.3 million to be recognized over an estimated weighted average amortization period of 2.7 years and $13.9 million related to restricted stock awards and units, including performance-based awards and units, to be recognized over an estimated weighted average amortization period of 2.7 years.

Other Income and Expense, Net

Other income and expense, net, was $2.6 million for the year ended December 31, 2011 and 2010. The flat result from the earlier period was primarily attributable to a slight decrease in interest income on a higher average balance of cash equivalents and investments as compared to the same period in 2010.

Provision for Income Taxes

The provision for income taxes for the year ended December 31, 2011 was $10.0 million and was comprised of domestic income tax, foreign income and withholding taxes as offset by a tax benefit on the impairment of tax-deductible goodwill. . . .