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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER 0-26068
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ACACIA RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4405754
(State or other jurisdiction of (I.R.S. Employer
incorporation organization) Identification No.)
500 NEWPORT CENTER DRIVE, NEWPORT BEACH, CA 92660
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 480-8300
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
ACACIA RESEARCH - ACACIA TECHNOLOGIES COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
ACACIA RESEARCH - COMBIMATRIX COMMON STOCK, $0.001 PAR VALUE
(TITLE OF CLASS)
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Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark that disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [ ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, computed by reference to the last sales price
of such stock reported on The Nasdaq Stock Market, as of June 28, 2002, was
approximately $136,536,756. (All officers and directors of the registrant are
considered affiliates.)
As of March 21, 2003, 19,640,808 shares of Acacia Research-Acacia
Technologies common stock were issued and outstanding. As of March 21, 2003,
22,985,186 shares of Acacia Research-CombiMatrix common stock were issued and
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the close of its fiscal year are incorporated by reference into Part III.
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FORM 10-K ANNUAL REPORT
FISCAL YEAR ENDED DECEMBER 31, 2002
ACACIA RESEARCH CORPORATION
ITEM PAGE
- ---- ----
PART I
1. Business..................................................................1
2. Properties...............................................................20
3. Legal Proceedings........................................................20
4. Submission of Matters to a Vote of Security Holders......................21
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters....22
6. Selected Financial Data..................................................24
7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................29
7A. Quantitative and Qualitative Disclosures About Market Risk...............81
8. Financial Statements and Supplementary Data..............................81
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.....................................................81
PART III
10. Directors and Executive Officers of the Registrant.......................82
11. Executive Compensation...................................................82
12. Security Ownership of Certain Beneficial Owners and Management...........82
13. Certain Relationships and Related Transactions...........................82
14. Controls and Procedures..................................................82
PART IV
15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........83
PART I
CAUTIONARY STATEMENT
This report contains forward-looking statements within the meaning of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Reference is made in particular to the description of our plans and
objectives for future operations, assumptions underlying such plans and
objectives, and other forward-looking statements included in this report. Such
statements may be identified by the use of forward-looking terminology such as
"may," "will," "expect," "believe," "estimate," "anticipate," "intend,"
"continue," or similar terms, variations of such terms or the negative of such
terms. Such statements are based on management's current expectations and are
subject to a number of factors and uncertainties, which could cause actual
results to differ materially from those described in the forward-looking
statements. Such statements address future events and conditions concerning
product development, capital expenditures, earnings, litigation, regulatory
matters, markets for products and services, liquidity and capital resources and
accounting matters. Actual results in each case could differ materially from
those anticipated in such statements by reason of factors such as future
economic conditions, changes in consumer demand, legislative, regulatory and
competitive developments in markets in which we and our subsidiaries operate,
and other circumstances affecting anticipated revenues and costs. We expressly
disclaim any obligation or undertaking to release publicly any updates or
revisions to any forward-looking statements contained herein to reflect any
change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based. Additional
factors that could cause such results to differ materially from those described
in the forward-looking statements are set forth in connection with the
forward-looking statements.
As used in this Form 10-K, "we," "us" and "our" refer to Acacia
Research Corporation and its subsidiary companies.
ITEM 1. BUSINESS
Acacia Research Corporation develops, acquires and licenses enabling
technologies for the life sciences and media technologies sectors, which
comprise the two business groups of Acacia Research Corporation.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiaries, Advanced Material
Sciences, Inc., or Advanced Material Sciences, and CombiMatrix KK. Our core
technology opportunity in the life sciences sector has been developed by
CombiMatrix Corporation. CombiMatrix Corporation is a life sciences technology
company with a proprietary system for rapid, cost competitive creation of DNA
and other compounds on a programmable semiconductor chip. This proprietary
technology has significant applications relating to genomic and proteomic
research. Advanced Material Sciences, a development stage company, holds the
exclusive license for CombiMatrix Corporation's biological array processor
technology in certain fields of material sciences. CombiMatrix KK, a
majority-owned Japanese corporation located in Tokyo, is exploring opportunities
for CombiMatrix Corporation's active biochip system with academic,
pharmaceutical and biotechnology organizations in the Asian market.
Our media technologies business, collectively referred to as "Acacia
Technologies group," owns patented intellectual property in the media
technologies sector. The Acacia Technologies group owns patented digital media
transmission, or DMT, technology enabling the digitization, encryption, storage,
transmission, receipt and playback of digital content. The DMT technology is
protected by five U.S. and seventeen international patents. The DMT technology
is utilized by a variety of companies, including cable companies, hotel in-room
entertainment companies, Internet movie companies, Internet music companies,
on-line adult entertainment companies, on-line learning companies and other
companies that stream audio or audio/videos content. The Acacia Technologies
group also owns patented technology known as the V-chip. The V-chip was adopted
by manufacturers of televisions sold in the U.S. to provide blocking of certain
programming based upon its content rating code, in compliance with the
Telecommunications Act of 1996. The V-chip technology is protected by U.S.
Patent No. 4,554,584, which expires in July 2003.
1
Following is a summary of the principal wholly owned companies that
constitute our two business groups:
GROUP / COMPANY DESCRIPTION OF BUSINESS
- --------------- -----------------------
COMBIMATRIX GROUP:
CombiMatrix Corporation A life sciences technology company with a
proprietary system for rapid, cost
competitive creation of DNA and other
compounds on a programmable semiconductor
chip. This proprietary technology has
significant applications relating to genomic
and proteomic research, biological and
chemical detection and combinatorial
chemistry markets.
Advanced Material Sciences, a development
stage company and majority-owned subsidiary
of CombiMatrix Corporation, holds the
exclusive license for CombiMatrix
Corporation's biological array processor
technology in certain fields of material
sciences. CombiMatrix KK, a majority-owned
Japanese subsidiary of CombiMatrix
Corporation, is exploring opportunities for
CombiMatrix Corporation's active biochip
system with pharmaceutical and biotechnology
companies in the Asian market.
ACACIA TECHNOLOGIES GROUP:
Acacia Media Technologies A media technology company that owns
Corporation patented digital media transmission
technology used to digitize, encrypt, store,
transmit, receive and playback digitized
content sent via pathways such as cable,
satellite and the Internet, and covering a
variety of services such as those commonly
known as video-on-demand, audio-on-demand
and streaming media.
Soundview Technologies A media technology company that owns
Incorporated intellectual property related to the
telecommunications field, including a
television blanking system, also known as
"V-chip," which it licenses to television
manufacturers.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction whereby we created two new classes of common stock
called "Acacia Research-CombiMatrix stock," or AR-CombiMatrix stock, and "Acacia
Research-Acacia Technologies stock," or AR-Acacia Technologies stock, and
divided our existing Acacia Research Corporation common stock into shares of the
two new classes of common stock. AR-CombiMatrix stock is intended to reflect
separately the performance of Acacia Research Corporation's CombiMatrix group,
and to benefit from its licensing and research and development efforts.
AR-Acacia Technologies stock is intended to reflect separately the performance
of Acacia Research Corporation's Acacia Technologies group and to benefit from
the licensing of its technologies. In the recapitalization, which became
effective on December 13, 2002, Acacia Research Corporation stockholders
received 0.5582 of a share of AR-CombiMatrix stock, and one share of AR-Acacia
Technologies stock, for each share of common stock that they owned. Although the
AR-CombiMatrix stock and the AR-Acacia Technologies stock are intended to
reflect the performance of our different business groups, they are both classes
of common stock of Acacia Research Corporation and are not stock issued by the
respective groups. The AR-Acacia Technologies stock is listed on the Nasdaq
National Market System, and the AR-CombiMatrix stock is listed on the Nasdaq
SmallCap Market.
On December 11, 2002 Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which we acquired the stockholder interests in CombiMatrix
Corporation not already owned by us (52% of the total stockholder interests in
CombiMatrix Corporation). The acquisition was accomplished through a merger,
effective December 13, 2002, in which stockholders of CombiMatrix Corporation
other than Acacia Research Corporation received one share of the new
AR-CombiMatrix stock in exchange for each share of CombiMatrix Corporation
common stock that they owned immediately prior to the merger. On December 11,
2002, the stockholders of Acacia Research Corporation also approved the adoption
of two new stock incentive plans for the two business groups.
Ninety-eight percent of the Acacia Research Corporation stockholders
who voted in person or by proxy at the special meeting, voted in favor of the
recapitalization and merger transactions and for the approval of the adoption of
the new stock incentive plans.
2
COMPANY
Acacia Research Corporation, a Delaware corporation, was originally
incorporated in California in January 1993 and reincorporated in Delaware in
December 1999. Our website address is www.acaciaresearch.com. We make our
filings with the Securities and Exchange Commission, or SEC, including our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports, available free of charge on our
website as soon as reasonably practicable after we file these reports. The
public may read and copy any materials that Acacia Research Corporation files
with the SEC at the SEC's Public Reference Room at 450 Fifth Street N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC
maintains an Internet website that contains reports, proxy and information
statements, and other information regarding issuers, including the Acacia
Research Corporation, that file electronically with the SEC. The public can
obtain any documents that Acacia Research Corporation files with the SEC at
http://www.sec.gov.
BUSINESS GROUPS
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The CombiMatrix group is comprised of CombiMatrix Corporation, a wholly
owned subsidiary of Acacia Research Corporation, and its subsidiaries, Advanced
Material Sciences and CombiMatrix KK. The CombiMatrix group includes corporate
assets, liabilities and transactions of Acacia Research Corporation that relate
to its life sciences business. CombiMatrix Corporation is engaged in the
development of a proprietary universal biochip with applications in the
genomics, proteomics and combinatorial chemistry fields, and has emerged from
the development stage during the year ended December 31, 2002.
The CombiMatrix group is developing a technology to allow it, its
customers and any entities with which the CombiMatrix group has joint
development efforts to rapidly produce customizable biological array processors,
which are semiconductor-based tools for use in identifying and determining the
roles of genes, gene mutations and proteins. The CombiMatrix group is designing
its products principally to be responsive to the needs of pharmaceutical and
biotechnology researchers to analyze raw genomic data in the discovery and
development of pharmaceutical products. The CombiMatrix group's biological array
processor is a semiconductor coated with a three-dimensional layer of porous
material in which DNA, RNA, proteins, peptides or small molecules can be
synthesized or immobilized within discrete test sites. The CombiMatrix group
integrates a micro-fabricated semiconductor chip, proprietary software,
chemistry and hardware into a system that it believes will enable it, its
customers and any entities with which the CombiMatrix group has joint
development efforts, to design, customize and fabricate biological array
processors made to user's specifications, typically in less than a day. The
CombiMatrix group's system should enable researchers to conduct rapid, iterative
experiments to analyze the large amounts of genomic information generated by the
Human Genome Project and other genomic research efforts. The CombiMatrix group
believes that its customizable biological array processors will enable users to
reduce the time and costs associated with the discovery and development of
pharmaceutical products.
Advanced Material Sciences is a development stage company that holds an
exclusive license to CombiMatrix Corporation's biological processor technology
within the field of material science. Material science includes fuel cell
catalysts, battery materials, sensor arrays, electronic and electrochemical
materials and other materials relating to the use, storage, conversion and
delivery of energy other than those involving living or biologic systems. On
April 25, 2002, CombiMatrix Corporation purchased Acacia Research Corporation's
interest in Advanced Material Sciences. CombiMatrix Corporation currently owns
87% of Advanced Material Sciences and the remaining interests are owned by
unaffiliated third parties.
CombiMatrix KK, a Japanese corporation, was formed in 2001 for the
purpose of exploring opportunities for CombiMatrix Corporation's active biochip
system with academic, pharmaceutical and biotechnology organizations in the
Asian market. In October 2001, CombiMatrix KK entered into a joint venture with
Marubeni Japan, one of Japan's leading trading companies. The joint venture will
focus on further development and licensing opportunities for CombiMatrix
Corporation's biochip technology in Asia. Marubeni made a $1.1 million
investment in exchange for a 10% minority interest in CombiMatrix KK.
3
MARKET OVERVIEW AND TECHNOLOGY BACKGROUND
GENERAL OVERVIEW
The pharmaceutical and biotechnology industries are faced with
increasing costs and substantial risks of failure in the drug discovery,
development and commercialization process. The time required to successfully
commercialize a new proprietary drug now averages 15 years, and the direct and
indirect costs of the process average almost $800.0 million per drug. Less than
1% of all new chemical compounds that are developed by pharmaceutical companies
result in pharmaceutical products that are approved for patient use. The
pharmaceutical and biotechnology industries are attempting to reduce their costs
and risks of failure by turning to new technologies to help identify
deficiencies in drug candidates as early as possible in the process so that drug
discovery and development become more efficient and cost-effective.
Additionally, with vast amounts of genomic data becoming available for use in
the development of therapeutics and diagnostic tests, they are searching for
ways to expedite their analysis of available genomic data so that they can be
the first to bring new therapeutics and diagnostic tests to market.
DRUG DISCOVERY AND DEVELOPMENT
The discovery and development of new drugs for a particular disease
typically involve several steps. First, researchers identify a target for
therapeutic intervention, such as a protein, that is either directly involved in
the disease or lies in a biochemical pathway leading to the disease. The next
step is to identify chemical compounds that interact with the target and
modulate the target's activity in a manner that might help reverse, inhibit or
prevent the disease. The most promising compounds to emerge from this process
advance to the next stage, where synthetic derivatives of the compounds are
generated and tested to determine a lead compound. The interactions of these
lead compounds with the target and their activity in animal or cellular models
of the disease are then tested to determine which compounds might be developed
successfully into new drugs. The best new drug candidates then begin clinical
trials in humans.
Recent advances have led to the use of genomics in choosing targets for
drug development. This process begins with the discovery and identification of
genes within the genome and the functions of these genes in regulating
biological processes and disease. This information is used to assess the value
of a particular gene or its protein product as a target for drug discovery. Once
a target is chosen, high throughput chemistry and other drug discovery methods
are used to identify chemical compounds that interact with the target and might
help reverse, inhibit or prevent the disease. These compounds are then tested in
pre-clinical and clinical development programs.
According to industry statistics, pharmaceutical and biotechnology
companies world-wide spent approximately $50.0 billion on drug research and
development during 2000. Of this amount, approximately $13.0 billion was spent
on drug discovery and $7.0 billion on pre-clinical testing and clinical trials,
with the remainder on toxicology, post-marketing evaluations and other matters.
The CombiMatrix group believes that biological array processors,
whether they contain DNA, peptides or proteins, have potential applications in
all major phases of drug discovery and development. In the discovery phase, the
CombiMatrix group believes biological array processors can facilitate the
process of identifying and validating targets and lead compounds. In the
development phase, the CombiMatrix group believes biological array processors
can enhance the speed and accuracy of the toxicology, pre-clinical and clinical
development process. The CombiMatrix group believes that biological array
processors can also play a role in monitoring the therapeutic effectiveness of
drugs that have been approved for use.
GENES AND PROTEINS
The human body is composed of billions of cells each containing DNA
that encodes the basic instructions for cellular function. The complete set of
an individual's DNA is called the genome, and is organized into 23 pairs of
chromosomes, which are further divided into smaller regions called genes. Each
gene is composed of a strand of four types of nucleotide bases, referred to as
A, C, G and T. The bases of one DNA strand bind to the bases of the other strand
in a specific fashion to form base pairs: the base A always binds with the base
T and the base G always binds with the base C.
The human genome has approximately 3.0 billion nucleotides and their
precise order is known as the DNA sequence. When a gene is turned on, or
expressed, the genetic information encoded in the DNA is copied to a specific
type of RNA, called messenger RNA, or mRNA. The mRNA provides instructions for
the synthesis of proteins. Proteins direct cellular function, the development of
individual traits and are involved in many diseases. Variations in any part of
the sequence of DNA, called polymorphisms, can interfere with the normal
function of proteins and may result in a change in cell function leading to
disease, a predisposition to disease, an adverse response to drugs or other
unwanted effects.
4
GENE EXPRESSION PROFILING
Gene expression profiling is the process of determining which genes are
active in a specific cell or group of cells and is accomplished by measuring
mRNA, the intermediary between genes and proteins. By comparing gene expression
patterns between cells from normal tissue and cells from diseased tissue,
researchers may identify specific genes or groups of genes that play a role in
the presence of disease. Studies of this type, used in drug discovery, require
monitoring thousands, and preferably tens of thousands, of mRNAs in large
numbers of samples. As the correlation between gene expression patterns and
specific diseases is determined, the CombiMatrix group believes that gene
expression profiling will have an increasingly important role as a diagnostic
tool. Diagnostic use of expression profiling tools is anticipated to grow
rapidly with the combination of the sequencing of various genomes and the
availability of more cost-effective technologies.
GENETIC VARIATION AND FUNCTION
Genetic variation is mostly due to polymorphisms in genomes, although
functional variations may also arise from differences in the way genes are
expressed in a given cell, as well as the timing and levels of their expression.
Although most cells contain an individual's full set of genes, each cell
expresses only a small fraction of this set in different quantities and at
different times.
The most common form of genetic variation occurs as a result of a
difference in a single nucleotide in the DNA sequence, commonly referred to as a
single nucleotide polymorphism, or SNP. The human genome is estimated to contain
between three and six million SNPs. By screening for polymorphisms, researchers
seek to correlate variability in the sequence of genes with a specific disease.
SNPs are believed to be associated with a large number of human diseases,
although most SNPs are believed to be benign and not to be associated with
disease. Determining which SNPs may be related to a disease is a complex process
requiring investigation of a vast number of SNPs. An SNP association study might
require testing for 300,000 possible SNPs in 1,000 patients. Although only a few
hundred of these SNPs might be clinically relevant, 300.0 million genotyping
tests, or assays, might be required to complete a study. Using available
technologies, this scale of SNP genotyping is both impractical and prohibitively
expensive.
While in some cases one SNP will be responsible for medically important
effects, it is now believed that the genetic component of most major diseases is
associated with a combination of SNPs. As a result, the scientific community has
recognized the importance of investigating combinations of many SNPs in an
attempt to discover medically valuable information. In order to understand how
genetic variation causes disease, researchers must compare gene sequence
polymorphisms, or conduct SNP genotyping, from healthy and diseased individuals.
Researchers may also compare gene expression patterns, or perform gene
expression profiling, from healthy and diseased tissues.
SNP GENOTYPING
SNP genotyping is the process of comparing individuals' gene sequences
to identify variations in these sequences and determine the significance of
these variances. The CombiMatrix group believes that large-scale SNP genotyping,
when commercially feasible, has the potential to be used for a variety of
applications including: o genomics-based drug development; o clinical trial
design and analysis; o testing for predisposition to, and diagnosis of, disease;
o predicting the effectiveness of therapeutics; and o applications outside
healthcare.
PROTEOMICS
Proteomics is the process of determining which proteins are present in
cells, how they interact with one another and how they are correlated with
genomic variation. This process is useful in drug discovery and diagnostics
because most drugs target proteins that play a role in the existence or
development of a disease. Although the potential market for proteomic products
is uncertain, the CombiMatrix group believes that proteomics may have
applications in:
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o discovery of new drug targets and new biochemical pathways;
o measurement of protein expression and modification; and
o correlation of protein variation and function with genomic
variation and function.
CURRENT TECHNOLOGIES
There are currently a variety of traditional technologies available for
analyzing genetic variation and function. Traditional technologies generally
perform assays individually, or serially, and often require relatively large
sample volumes, adding significantly to the costs of assays. In addition, most
traditional technologies have limited flexibility to perform different
applications. Arrays were developed to overcome the limitations of traditional
technologies.
An array is a collection of miniaturized test sites arranged on a
surface that permits many tests to be performed simultaneously, or in parallel,
in order to achieve higher throughput. The average size of test sites in an
array and the spacing between them defines the array's density. Higher density
increases parallel processing throughput. In addition to increasing the
throughput, higher density reduces the required volume for the sample being
tested, and thereby lowers costs. Currently, the principal commercially
available ways to produce arrays include mechanical deposition, bead
immobilization, inkjet printing and photolithography.
While current array technologies have advantages over traditional
technologies, the CombiMatrix group believes the full market potential for
testing devices to study genetic variation and function has not been realized.
This is true for a number of reasons, including the following:
o HIGH COST. Many currently available array technologies require
relatively expensive capital equipment for manufacturing and
customizing arrays and reading test results.
o LOW THROUGHPUT. Some array technologies produce a relatively
low density of test sites, which results in low throughput.
o LIMITED APPLICATION. Many array technologies have limited
application outside of SNP genotyping and gene expression
profiling, for example in proteomics.
o INCONVENIENCE. Many array manufacturers do not offer
researchers all elements required to design arrays and to
complete and analyze their tests, such as test devices,
software, instrumentation and reagents.
o INABILITY TO FABRICATE IN-HOUSE. Most array manufacturers will
ship pre-fabricated arrays to customers, even though large
customers have a tremendous desire to fabricate their own
arrays in-house.
THE COMBIMATRIX GROUP SOLUTION
The CombiMatrix group believes that its integrated system has
advantages over other existing technologies because it will be a cost-effective,
fast, flexible, customizable alternative to existing analytical tools designed
for similar purposes. Researchers using the CombiMatrix group's system should be
able to design and order custom biological array processors or fabricate them
in-house, conduct their tests, analyze the results in the relatively inexpensive
hybridizer-reader supplied by the CombiMatrix group or any entities with which
the CombiMatrix group has joint development efforts, and reorder additional
custom biological array processors incorporating modified test parameters, all
within a few days. In addition, customers who wish to fabricate arrays
themselves will be able to utilize the CombiMatrix group's synthesizers and
blank chips to produce their own arrays.
The CombiMatrix group believes that its biological array processor
system will offer several advantages over competing products that are
commercially available. The principal scientific advantages of its system are
derived from the following three features:
o the CombiMatrix group's proprietary software, which directs
the individually controlled electrodes at the test sites on
the surface of its semiconductors and allows the CombiMatrix
group to synthesize or immobilize different sequences of DNA
or RNA, peptides or small molecules;
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o its virtual flask technology, which uses the chemistry of
carefully engineered liquid solutions instead of physical
walls around each electrode and avoids the problem of chemical
contamination between test sites; and
o its porous reaction layer, which coats one surface of the
semiconductor and may function as a three-dimensional
environment for the synthesis or immobilization of relatively
large quantities of DNA, RNA, peptides or small molecules so
that a stronger test signal is generated at each test site.
As a result of these scientific features, the CombiMatrix group
believes that the system it is designing will have the following
characteristics:
o RAPIDLY CUSTOMIZABLE. The CombiMatrix group believes its
proprietary software, chemistry and semiconductor system will
allow it or its partners to design, customize and ship
biological array processors for SNP genotyping and gene
expression profiling that are tailored to meet a customer's
specifications in a relatively short time, typically as little
as a day. The CombiMatrix group's customization time should be
short because it intends to rely on proprietary software and
chemical processes, rather than costly and often imprecise
mechanical methods, to produce its biological array
processors. The CombiMatrix group believes researchers will be
able to compress the time required to complete an iterative
series of genomic tests because of the short turnaround time
that should be required for the delivery of its customized
biological array processors.
o VERSATILE. The CombiMatrix group system can design and create
sequences of DNA, RNA, peptides or small molecules in the test
sites on its biological array processors, although its first
product will be limited to DNA sequences.
o HIGH THROUGHPUT. The CombiMatrix group's synthesizers will
enable its customers to fabricate from six to forty custom
designed biological array processors per day with a total of
up to several thousand test sites per processor.
o ACCURATE AND COST-EFFECTIVE. Relatively large amounts of DNA,
RNA, peptides or small molecules that can be synthesized or
immobilized in the porous reaction layer at each test site
generate strong assay signals that facilitate accurate
interpretation of test data. These strong assay signals will
enable the CombiMatrix group's customers to analyze the
results of their tests without investing in the relatively
expensive capital equipment needed to detect weak signals.
o CONVENIENT AND INTEGRATED. The CombiMatrix group plans to
offer its strategic partners and customers a complete system
including the software, biological array processors,
instrumentation and reagents necessary to design and perform
their assays and obtain an analysis of the results. Typically,
tests using the CombiMatrix group's biological array
processors should be able to be completed and analyzed within
hours by using the equipment, reagents and software supplied
by the CombiMatrix group.
o MANUFACTURING SCALABILITY. The CombiMatrix group believes it
will be able to increase production to respond to increased
demand because its semiconductors are manufactured by others
using conventional semiconductor fabrication methods and its
customization equipment can be rapidly assembled by the
CombiMatrix group or any entities with which the CombiMatrix
group has joint development efforts.
PRODUCTS AND SERVICES
The CombiMatrix group's technology potentially represents a significant
advance over existing biochip technologies and other platforms for combinatorial
chemistry. The first application of the technology that the CombiMatrix group is
pursuing is in the field of genomics, where it is developing a biochip for the
analysis of DNA. The CombiMatrix group believes that this technology may be
applied to the fields of genetic analysis and disease management. The
CombiMatrix group is also developing the chip in the emerging field of
proteomics, where analysis of DNA is correlated to the levels of proteins in
patient samples. Many researchers believe that the analysis of proteomic
information will lead to the development of new drugs and better disease
management. Once the CombiMatrix group demonstrates the feasibility of its
approach in each market, it intends to enter into strategic alliances with major
participants to speed commercialization in multiple applications. In addition,
the CombiMatrix group is exploring opportunities to utilize its technology for
the detection of the presence of chemical and biological warfare agents.
7
THE COMBIMATRIX GROUP'S STRATEGY
The CombiMatrix group's goal is to provide biotechnology and
pharmaceutical companies and academic researchers with the industry standard
solution for rapid evaluation of genetic function/variation, proteomic research
and bioinformatic tools.
FOCUSING ON HIGH-GROWTH MARKETS
The CombiMatrix group is initially focusing on the gene expression
profiling, SNP genotyping, proteomic and bioinformatics markets. Initial product
sales will be derived from the CombiMatrix group's DNA synthesizers, DNA
microarrays, hybridization-reader system and bioinformatic tools. The
CombiMatrix group believes the market for its rapid customization microarrays
and in-house synthesizers has the potential for high growth due to increasing
demand for therapeutics and diagnostics based on newly available genomic
information. To date, the lack of high-throughput and cost-effective
technologies and the slow turnaround of current technologies has limited the
growth of this market.
PARTNERING WITH MULTIPLE COMPANIES TO EXPAND MARKET OPPORTUNITY
The CombiMatrix group plans to pursue multiple relationships to
facilitate the expansion of its semiconductor based microarray technologies and
to exploit large and diverse markets. The CombiMatrix group expects to enter
into relationships and collaborations to gain access to complementary
technologies, distribution channels, manufacturing infrastructure and
information content. The CombiMatrix group intends to structure relationships
that maximize its research and development efforts with the strong distribution
and manufacturing capabilities of its customers and any entities with which the
CombiMatrix group has joint development efforts, enabling industry standard
solutions for pharmaceutical and biotechnology researchers. Such a strategy will
enable the CombiMatrix group to focus on its strength, which is research and
development, and leverage the strengths of any entities with which it has
entered into agreements to commercialize its products.
COMMERCIALIZING AND MANUFACTURING DESKTOP SYNTHESIZERS AND MICROARRAY
TECHNOLOGY FOR GENE EXPRESSION PROFILING AND MOLECULAR DIAGNOSTICS
The CombiMatrix group intends to rapidly commercialize its microarray
technology for gene expression profiling through agreements to jointly develop
technology. The CombiMatrix group has an agreement with Roche Diagnostics GmbH,
or Roche, to jointly develop technology. Roche contributes extensive expertise
in instrument and reagent development, as well as offers a large and experienced
worldwide sales and marketing team. The CombiMatrix group believes that the
combination of its microarray technology with Roche's leadership position in the
genetic analysis and diagnostic markets will enable it to capture a significant
portion of the gene expression profiling and molecular diagnostic markets.
In addition to Roche, the CombiMatrix group plans on establishing other
relationships for its DNA microarray technology. The CombiMatrix group also
intends on establishing alliances for its proteomic and bioinformatic products.
EXPANDING TECHNOLOGIES INTO MULTIPLE PRODUCT LINES
The CombiMatrix group intends to utilize the flexibility of its
semiconductor based microarray technologies to develop multiple product lines.
In addition to providing new sources of revenue, it believes these product lines
will further its goal of establishing its microarray technology as the industry
standard for array-based analysis.
STRENGTHENING TECHNOLOGICAL LEADERSHIP
The CombiMatrix group plans to continue advancing its proprietary
technologies through its internal research efforts, collaborations with industry
leaders and strategic licensing. The CombiMatrix group may also pursue
acquisitions of complementary technologies and leverage its technologies into
other value-added businesses. Its efforts to strengthen its technology include
the following:
o RAPIDLY COMMERCIALIZING ITS SNP GENOTYPING AND GENE EXPRESSION
PROFILING PRODUCTS. The CombiMatrix group is initially
focusing on the SNP genotyping and gene expression profiling
markets because it believes that there is substantial demand
for tools that help analyze newly available genomic
information and thereby assist pharmaceutical and
biotechnology companies in developing new drugs and diagnostic
tools. Typically, sales of products in these markets do not
require advance clearance by the U.S. Food and Drug
Administration, or FDA, and as a result, can be achieved more
quickly and with less cost than sales of regulated devices.
8
o DEVELOPING PRODUCT APPLICATIONS IN PROTEOMICS. Proteomic
research has not developed as rapidly as SNP genotyping and
gene expression profiling because of the absence of effective
technology and tools for conducting research. The CombiMatrix
group believes that its biological array processor system can
be developed to facilitate proteomic research. The CombiMatrix
group has developed chemical processes for the rapid
immobilization of proteins and small molecules within the test
sites on its biological array processors. The CombiMatrix
group believes its system may be particularly effective in
proteomic research because the proprietary materials that can
be used to form the three-dimensional porous reaction layer on
its biological array processors are a hospitable environment
for the immobilization and study of proteins. The CombiMatrix
group has produced customized test devices with peptides and
small molecules for possible use in proteomic research. The
CombiMatrix group is currently developing its technology for
proteomic applications.
o EXPANDING PROPOSED PRODUCT OFFERINGS. The CombiMatrix group is
engaged in several research and development initiatives to
expand its product offerings by increasing the density of its
biological array processors and by developing additional
applications of its technology for drug discovery and
development. The CombiMatrix group believes that the flexible,
parallel processing capabilities of its biological array
processor system may have potential applications related to:
o gene discovery and function characterization;
o specific targeting of drug discovery efforts;
o the development of customized drugs;
o high-throughput screening for pharmaceutical
candidates;
o the development of diagnostic methods for
identifying, classifying and staging diseases;
o the prediction of successful drug therapy for a
particular patient population;
o the identification of an individual patient's
tolerance for a particular drug so that previously
abandoned drugs can be selectively prescribed;
o early recognition of potential adverse response to
drug therapy;
o identification of predisposition to disease in order
to prescribe preventative therapies; and
o identification of the presence of chemical or
biological warfare agents.
However, the CombiMatrix group has not yet produced products to
address or access the potential of its technology in these areas.
o PROTECTING AND STRENGTHENING INTELLECTUAL PROPERTY. Through
the CombiMatrix Corporation's two issued patents in the United
States and one in Europe, its more than 44 patent applications
pending in the United States, Europe and elsewhere and its
trade secrets, the CombiMatrix group believes it has suitable
intellectual property protection for its proprietary
technologies. The CombiMatrix group plans to build its
intellectual property portfolio through internal research
efforts, collaborations with industry leaders, strategic
licensing and possible acquisitions of complementary
technologies. The CombiMatrix group also plans to pursue
patent protection for downstream products created using its
proprietary products.
THE COMBIMATRIX GROUP SYSTEM AND TECHNOLOGY
The CombiMatrix group anticipates that a customer wishing to use its
bioarray product will use its proprietary software to provide the CombiMatrix
group, or an entity with which the CombiMatrix group has joint development
efforts, with information relating to the sequences that the customer wishes to
evaluate. Array design software will design an initial array of DNA segments and
then instruct a synthesizer unit to customize one or more biological array
processors containing these selected DNA segments. This process will be entirely
automated. The completed biological array processor will be shipped to the
customer along with kits including specific instructions and reagents needed to
conduct these evaluations. The CombiMatrix group expects that the time interval
9
between receipt of the customer's order and shipment of the biological array
processors and reagent kits will typically be a few days or less. Alternatively
for a customer with an in-house synthesizer, the process will be completed
typically overnight. To use the processor, the customer will prepare a sample
and introduce it to the processor. The processor will then be inserted into a
hybridizer-reader unit that the CombiMatrix group, or an entity with which the
CombiMatrix group has joint development efforts, will have supplied to the
customer. Proprietary software will enable the customer to image the processor,
format the data and perform analysis.
In practical operation, the CombiMatrix group expects that a customer
will typically analyze the results of an initial experiment and choose to change
the composition of its biological array processors to further optimize its
performance. For example, a customer may choose to change the sequences of some
array elements, eliminate some sequences altogether or incorporate additional
sequences. The CombiMatrix group's biological array processor system will allow
a researcher to order or fabricate successive arrays with the desired changes.
THE COMBIMATRIX GROUP PROCESS
Each of the CombiMatrix group's biological array processors is made up
of a semiconductor chip on which the CombiMatrix group has installed electrical
conduits and applied a layer of porous material. It will have up to
approximately 10,000 test sites, one for each electrode site on the
semiconductor. The CombiMatrix group can synthesize or immobilize DNA, RNA,
peptides or small molecules within the porous reaction layer at each test site
on the surface of its semiconductor. The CombiMatrix group confines the chemical
synthesis within each test site using chemistry of carefully engineered liquid
solutions. This avoids the problem of chemical contamination between different
test sites. Because confinement is accomplished without physical walls, the
CombiMatrix group refers to this enabling technology as a virtual flask. This
virtual flask technology enables the CombiMatrix group to use semiconductor
devices that are fabricated by contractors using conventional semiconductor
processes.
In the case of the CombiMatrix group's DNA arrays, each test site, or
virtual flask, will contain a particular DNA segment, or capture probe, that is
made by putting nucleotide bases, A, G, C, or T, together one at a time. These
DNA probes typically contain between 16 and 60 nucleotide bases. The CombiMatrix
group's software selectively activates each electrode where a new nucleotide
base is to be added. Once activated, the electrode causes an electrochemical
reaction to occur that produces chemicals that react with the existing chains of
DNA at that site to activate them for bonding with the next nucleotide base.
These electrochemically-generated chemicals are confined by the CombiMatrix
group's virtual flask technology to the region of the porous reaction layer that
surrounds the electrode where they are produced. A fluidics delivery unit then
floods the semiconductor with a solution containing a nucleotide base, which
binds only to the capture probe at activated sites. This cycle is repeated over
and over to produce different DNA segments at each test site. Quality assurance
tests are performed following completion of the synthesis process. The
CombiMatrix group's laboratory tests have confirmed that other substances, such
as peptides, immobilized proteins and antibodies, small organic molecules and
enzymes, among others, can also be chemically isolated in the virtual flasks.
SEMICONDUCTOR COMPONENT
The CombiMatrix group's semiconductors are manufactured by others using
conventional semiconductor fabrication processes. The CombiMatrix group believes
that the total number of test sites on a semiconductor is limited only by the
degree of miniaturization of the semiconductor fabrication process. The
CombiMatrix group believes that its semiconductor architecture is scalable and,
as a result, that it can benefit directly from the substantial investments that
have been made by the semiconductor industry in miniaturizing chip fabrication
processes. At the present time, the CombiMatrix group is using devices made with
a 3.0 micron process size that yield 1,024 potential test sites within less than
a square centimeter. Each of the individual sites is 100 microns in diameter,
about the diameter of a human hair. The CombiMatrix group believes that by using
a standard 0.25 micron semiconductor fabrication process, it can produce a
biological array processor with over 1,000,000 sites per square centimeter,
although it has not yet made or tested a biological array processor with more
than 18,000 potential test sites.
HYBRIDIZER-READER
Hybridization is the binding of DNA sequences in a test sample with the
DNA material that has been created at specific test sites on its biological
array processors. In the case of DNA, segments bind together when the DNA
segments in a sample and the DNA segments on its test sites are complementary.
The CombiMatrix group is developing a combination hybridization chamber and
biological array processor reader that it calls the hybridizer-reader. The
hybridization chamber is being designed to help researchers standardize their
experimental conditions, such as temperature, so that consistent results may be
obtained from experiment to experiment. In the hybridization chamber, a solution
that the researcher wants to analyze will be washed over one or more of the
CombiMatrix group's biological array processors. DNA in the sample that is
10
complementary with the DNA on the capture probes of the CombiMatrix group's
biological array processors will bond. The hybridizer-reader will measure and
identify the presence or absence and relative strength of bonding in the test
sites on the biological array processors using conventional equipment. Because
the optical signals resulting from the tests are stronger than those obtained
from chips that contain a single molecular layer of test material, at its
current chip density the CombiMatrix group will be able to read test results
with a standard video camera system that should be substantially less expensive
than the typical optical reader system needed to read other chips on the market.
If the CombiMatrix group is able to increase substantially the density of its
biological array processor, researchers may be required to use more expensive
equipment to analyze the smaller volume of material bonded at each test site.
IN-HOUSE SYNTHESIZERS
The process of fabricating bioarray processors is performed using an
electrochemical technique, which takes advantage of the virtual flask
technology. This capability enables us to build synthesizers (desk top versions
as well as high-throughput industrial versions) that can be operated at the site
of use. Therefore, customers who choose to fabricate their own arrays can do so
by purchasing, leasing or licensing one of our synthesizers for operation in
their own facilities. This capability will enable customers to utilize array
processors quickly by eliminating the time necessary for shipping from a central
manufacturing facility. In addition, these customers will never be required to
disclose to any party, including the CombiMatrix group, the sequences or genes
in which they are investigating.
SOFTWARE
The CombiMatrix group has designed and is testing integrated, modular
software that will direct the design and customization of its biological array
processors for use in DNA applications. The software required to enable
proteomic research is in the early stages of development.
The CombiMatrix group's current software is being designed to:
o permit customers to access public databases for gene sequence
information;
o permit customers to transmit their research objectives to the
CombiMatrix group or partners over the Internet, or to their
own in-house synthesis lab behind their IT firewall;
o enable the CombiMatrix group to rapidly screen potential DNA
segments against large numbers of DNA targets during its
design process;
o enable the CombiMatrix group to direct its manufacturing
equipment to synthesize DNA segments designed by it on the
surface of its biological array processors; and
o permit the CombiMatrix group to quality check the finished
product.
REGULATORY MATTERS
The CombiMatrix group intends to sell products to the pharmaceutical,
biotechnology and academic communities for research applications. Therefore, its
initial products will not require approval from, or be regulated by, the FDA, as
a manufacturer nor will they be subject to the FDA's current good manufacturing
practice, or cGMP, regulations. Additionally, the CombiMatrix group's initial
products will not be subject to certain reagent regulations promulgated by the
FDA. However, the manufacture, marketing and sale of certain products and
services for any clinical or diagnostic applications will be subject to
extensive government regulation as medical devices in the United States by the
FDA and in other countries by corresponding foreign regulatory authorities.
The FDA requires that a manufacturer seeking to market a new or
modified medical device, or an existing medical device for a new indication,
obtain either a pre-market notification clearance under the Federal Food, Drug
and Cosmetic Act or a showing of substantial equivalence in function to an
existing regulated device. The CombiMatrix group anticipates that its products
will become subject to medical device regulations in the United States only when
they are marketed for clinical uses for any clinical or diagnostic purpose,
excluding pure research or product discovery research purposes. Material changes
to existing medical devices are also subject to FDA review and clearance or
approval prior to commercialization in the United States.
11
Should the CombiMatrix group market products for any clinical or
diagnostic purpose or act as a manufacturer or supplier of products for a
third-party customer to market for any clinical or diagnostic purpose, it will
be required to register as a medical device manufacturer with the FDA. As a
registered manufacturer, the CombiMatrix group would be subject to routine
inspection by the FDA for compliance with cGMP regulations and other applicable
regulations. In addition, the CombiMatrix group must currently comply with a
variety of other federal, state and local laws and regulations relating to safe
work conditions and manufacturing practices. The extent of government regulation
that might result from any future legislation or administration cannot be
predicted. Moreover, there can be no assurance that the CombiMatrix group or its
third-party customers will be able to obtain appropriate FDA regulatory
approvals on a timely basis, or at all, or that the CombiMatrix group will be
able to comply with cGMP regulations.
Sales of the CombiMatrix group's products outside the United States
will be subject to foreign regulatory requirements that vary from country to
country. Additional approvals from foreign regulatory authorities may be
required, and there can be no assurance that the CombiMatrix group will be able
to obtain foreign marketing approvals on a timely basis, or at all, or that it
will not be required to incur significant costs in obtaining or maintaining
foreign regulatory approvals. For example, if the CombiMatrix group products are
marketed for clinical or diagnostic purposes in the European Union, the
CombiMatrix group will have to obtain the certificates required for the "CE"
mark to be affixed to the CombiMatrix group products for sales in European Union
member countries. The "CE" mark is a European Union symbol of adherence to
quality assurance standards and compliance with applicable European Union
directives and regulations.
JOINT VENTURES
In October 2001, CombiMatrix KK, a majority-owned subsidiary of
CombiMatrix Corporation, formed a joint venture with Marubeni Japan, one of
Japan's leading trading companies. The joint venture will focus on development
and licensing opportunities for CombiMatrix Corporation's biochip technology
with academic, pharmaceutical and biotechnology organizations in the Japanese
market. Marubeni made an investment to acquire a 10% minority interest in the
joint venture.
Prior to April 25, 2002, CombiMatrix Corporation owned 28.5% of
Advanced Material Sciences, which in turn held an exclusive license for
CombiMatrix Corporation's microarray synthesis technology for the development
and discovery of advanced electronic materials for such purposes as fuel cell
catalysts. In consideration for this exclusive license, CombiMatrix Corporation
would share in the revenues earned by Advanced Material Sciences for
commercialization of these discoveries based on CombiMatrix Corporation's
microarray technology. The term of this arrangement was 20 years. As the
technology was being developed at Advanced Material Sciences, management
realized that it was inefficient to build redundant infrastructure to perform
this research. Rather than build and buy new equipment and facilities to conduct
materials discovery, it was decided to utilize the existing infrastructure at
CombiMatrix Corporation to more efficiently and quickly perform materials
discovery research. On April 25, 2002, CombiMatrix Corporation acquired Acacia
Research Corporation's majority interest in Advanced Material Sciences in
consideration of 180,982 shares of CombiMatrix Corporation's common stock.
MARKETING AND DISTRIBUTION
In July 2001, CombiMatrix Corporation entered into non-exclusive
worldwide license, supply, research and development agreements with Roche. These
agreements were amended in September 2002, primarily to grant Roche
manufacturing rights with respect to the products under development in return
for additional cash consideration under the agreements. The revised agreements
also make minor modifications to terms of the agreements involving matters such
as milestones, payments and technical specifications, none of which is
considered to be material. Such minor modifications are a standard part of the
research and development process and are routinely made in development
agreements. Since the inception of our relationship with Roche, CombiMatrix
Corporation has engaged in a continuous process of monitoring and reevaluating
the terms of our agreements, and have amended the agreements in several respects
to establish more meaningful goals, milestones and timelines. The agreements are
non-exclusive with respect to CombiMatrix Corporation's core technology, meaning
that CombiMatrix Corporation remains free to license its core technology to
third parties for applications in the genomics, proteomics and other fields. The
agreements contain exclusivity or co-exclusivity provisions only with respect to
the specific products being co-developed for, and partially funded by, Roche
pursuant to the agreements.
Under the terms of the revised agreements, it is contemplated that
Roche will co-develop, use, manufacture, market and distribute CombiMatrix
Corporation's biochips (microarrays) and related technology for rapid production
of customizable biochips. Additionally, CombiMatrix Corporation and Roche will
develop a platform technology, providing a range of standardized biochips for
use in important research applications. Roche has made and will continue to make
payments for the deliverables stipulated and for expanded license and
manufacturing rights.
The agreements provide for minimum payments by Roche to CombiMatrix
Corporation over the first three years, including milestone achievements,
payments for products, royalties and research and development projects.
Nevertheless, because our agreements with Roche contain provisions that would
allow Roche to terminate the agreements, the future payments by Roche to
12
CombiMatrix Corporation might never be realized. Since July 2001, CombiMatrix
Corporation has completed several milestones in its strategic alliance with
Roche including demonstration of several key performance metrics of its custom
in-situ microarray system, and has received approximately $16.8 million in cash
payments from Roche from July 2001 through December 31, 2002.
MANUFACTURING AND CUSTOMIZATION
The CombiMatrix group is developing automated, computer-directed
manufacturing processes for the synthesis of sequences of DNA, RNA, peptides or
small molecules in the virtual flasks on its biological array processors.
The CombiMatrix group's biological array processor manufacturing
process will involve:
o processing wafers of semiconductors manufactured by others
into individual devices and installing electrical contacts on
the semiconductor devices; and
o applying the porous reaction layer to the semiconductor
devices.
The CombiMatrix group, or any entities with which the CombiMatrix group
has joint development efforts, will then customize its biological array
processors in response to customer orders by:
o synthesizing test materials in the virtual flasks on the
biological array processors using its synthesis module; and
o checking the quality of the customized biological array
processors.
Initially, the CombiMatrix group plans to rely upon third-party
manufacturers to produce the semiconductors, chemical reagents and accessories
for its products. The CombiMatrix group intends to continue the outsourcing of
portions of its manufacturing process to subcontractors where the CombiMatrix
group determines it is in its best commercial interest.
Substantially all of the components and raw materials used in the
manufacture of the CombiMatrix group's products, including semiconductors and
reagents, are currently provided from a limited number of sources or in some
cases from a single source. Although the CombiMatrix group believes that
alternative sources for those components and raw materials are available, any
supply interruption in a sole-sourced component or raw material might result in
up to a several-month production delay and materially harm the CombiMatrix
group's ability to manufacture products until a new source of supply, if any,
could be located and qualified. In addition, an uncorrected impurity or
supplier's variation in a raw material, either unknown to the CombiMatrix group
or incompatible with its manufacturing process, could have a material adverse
effect on its ability to manufacture products. The CombiMatrix group may be
unable to find a sufficient alternative supply channel in a reasonable time
period, or on commercially reasonable terms, if at all. The CombiMatrix group
utilizes semiconductors made with a 3.0 micron fabrication process that is no
longer in wide use due to increased miniaturization of semiconductors. If the
CombiMatrix group is unable to achieve higher densities of test sites, it may
become difficult or more expensive for the CombiMatrix group to obtain
sufficient quantities of semiconductors as manufacturers phase out 3.0 micron
production capacity.
PATENTS, LICENSES AND FRANCHISES
The CombiMatrix group's primary patent strategy is to protect all
aspects of its biological array processor system, including the porous reaction
layer, the virtual flask technology, processes for designing capture probes,
unique properties of a protein-based biological array processor and business
methods for automating ordering, creating and manufacturing custom made
biological array processors. The CombiMatrix group's patent applications are
divided by subject matter into areas of its core biological array processor
technology, other hardware for detection and manufacturing, software for
designing experiments using biological array processors and chemical
compositions and processes.
CombiMatrix Corporation has 44 patent applications pending in the
United States and Europe. The CombiMatrix group's policy is to file patent
applications and to seek intellectual property protection for its proprietary
products and technology using patents, copyrights and trade secret protections,
as appropriate.
In July 2000, CombiMatrix Corporation was granted U.S. Patent No.
6,093,302, which expires in July 2017, for its biochip microarray processor
system. This system enables quick and economical turnaround of custom-designed
microarrays for use in biological research. A microarray consists of a chemical
13
"virtual flask" located on the surface of a semiconductor chip containing
thousands of microarrays, which are separated from each other using special
solutions instead of physical barriers. Each microarray has electronic circuitry
that may be directed by a computer to construct a specified compound. The patent
covers CombiMatrix Corporation's core technology, which is a method for
producing microarrays by synthesizing biological materials on a
three-dimensional, active surface.
The CombiMatrix group seeks to protect its corporate identity with
trademarks and service marks. In addition its trademark strategy includes
protecting the identity and goodwill associated with its biological array
processor products. The CombiMatrix group purchases chemical reagents from
suppliers who are licensed under appropriate patent rights. It is the
CombiMatrix group's policy to obtain licenses from patent holders if needed to
practice its chemical processes.
The CombiMatrix group's success will depend, in part, upon its ability
to obtain patents and maintain adequate protection of its intellectual property
in the United States and other countries. If it does not protect its
intellectual property adequately, competitors may be able to use its
technologies and thereby erode any competitive advantage that the CombiMatrix
group may have. The laws of some foreign countries do not protect proprietary
rights to the same extent as the laws of the United States, and many companies
have encountered significant problems in protecting their proprietary rights
abroad. These problems can be caused by the absence of rules and methods for
defending intellectual property rights.
The patent positions of companies developing tools for the
biotechnology and pharmaceutical industries, including the CombiMatrix group's
patent position, generally are uncertain and involve complex legal and factual
questions. The CombiMatrix group will be able to protect its proprietary rights
from unauthorized use by third parties only to the extent that its proprietary
technologies are covered by valid and enforceable patents or are effectively
maintained as trade secrets. The CombiMatrix group's existing patent and any
future patents it obtains may not be sufficiently broad to prevent others from
practicing its technologies or from developing competing products. There also is
risk that others may independently develop similar or alternative technologies
or design around its patented technologies. In addition, others may challenge or
invalidate the CombiMatrix group's patents, or its patents may fail to provide
it with any competitive advantage. Enforcing its intellectual property rights
may be difficult, costly and time consuming, and ultimately may not be
successful.
The CombiMatrix group also relies upon trade secret protection for its
confidential and proprietary information. It seeks to protect its proprietary
information by entering into confidentiality and invention disclosure and
transfer agreements with employees, collaborators and consultants. These
measures, however, may not provide adequate protection for the CombiMatrix
group's trade secrets or other proprietary information. Employees, collaborators
or consultants may still disclose its proprietary information, and the
CombiMatrix group may not be able to meaningfully protect its trade secrets. In
addition, others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
The CombiMatrix group cannot assure you that any of its patent
applications will result in the issuance of any additional patents, that its
patent applications will have priority of invention or filing date over similar
rights of others, or that, if issued, any of its patents will offer protection
against its competitors. Additionally, the CombiMatrix group cannot assure you
that any patent issued to it will not be challenged, invalidated or circumvented
in the future or that the intellectual property rights it has created will
provide a competitive advantage. Litigation may be necessary to enforce its
intellectual property rights or to determine the enforceability, scope of
protection or validity of the intellectual property rights of others.
COMPETITION
The CombiMatrix group expects to encounter competition in the area of
business opportunities from other entities having similar business objectives.
Many of these potential competitors possess financial, technical, human and
other resources greater than those of the CombiMatrix group. The CombiMatrix
group anticipates that it will face increased competition in the future as new
companies enter the market and advanced technologies become available. In the
life sciences industry, many competitors have more experience in research and
development than the CombiMatrix group. Technological advances or entirely
different approaches developed by one or more of its competitors could render
the CombiMatrix group's processes obsolete or uneconomical. The existing
approaches of competitors or new approaches or technology developed by
competitors may be more effective than those developed by the CombiMatrix group.
The CombiMatrix group is aware of other companies or companies with
divisions that have, or are developing, technologies for the SNP genotyping,
gene expression profiling and proteomic markets. The CombiMatrix group believes
that its primary competitors will be Abbott Laboratories, Affymetrix, Inc.,
Agilent Technologies, Inc., Bayer AG, Becton, Dickinson and Company, Ciphergen
Biosystems, Inc., Gene Logic Inc., Illumina, Inc., Johnson & Johnson, Nanogen,
Inc., Orchid Biosciences, Inc., Applera Corporation, Roche Diagnostics GmbH and
14
Sequenom, Inc. However, the CombiMatrix group's market is rapidly changing, and
the CombiMatrix group expects to face additional competition from new market
entrants, new product developments and consolidation of its existing
competitors. Many of the CombiMatrix group's competitors have existing strategic
relationships with major pharmaceutical and biotechnology companies, greater
commercial experience and substantially greater financial and personnel
resources than it does. The CombiMatrix group expects new competitors to emerge
and the intensity of competition to increase in the future.
The CombiMatrix group believes that the principal competitive factors
in selling its products will be:
o the time required to engineer, produce and ship products;
o the speed and accuracy with which test results can be read and
interpreted;
o the density of testing devices;
o the cost and pricing of the installed base of competing
products; and
o access to proprietary genetic databases.
The CombiMatrix group believes that it will be able to compete
favorably with regard to these factors even though it has competitors who
currently produce testing devices with higher densities than its proposed
initial products, and, initially, it will not offer its customers access to
proprietary genetic information.
RESEARCH, DEVELOPMENT AND ENGINEERING
The CombiMatrix group's research and development expenses excluding
non-cash stock compensation charges and acquired in-process research and
development charges were $18.2 million, $11.7 million and $5.9 million in 2002,
2001 and 2000, respectively. The CombiMatrix group intends to invest
aggressively in its proprietary technologies through internal development and,
to the extent available, licensing of third-party technologies to increase and
improve other characteristics of its products. The CombiMatrix group also plans
to continue to invest in improving the cost-effectiveness of its products
through further automation and improved information technologies. The
CombiMatrix group's future research and development efforts may involve research
conducted by the CombiMatrix group, collaborations with other researchers and
the acquisition of chemistries and other technologies developed by universities
and other academic institutions.
The CombiMatrix group is developing a variety of life sciences related
products and services. These industries are characterized by rapid technological
development. The CombiMatrix group believes that its future success will depend
in large part on its ability to continue to enhance its existing products and
services and to develop other products and services, which complement existing
ones. In order to respond to rapidly changing competitive and technological
conditions, the CombiMatrix group expects to continue to incur significant
research and development expenses during the initial development phase of new
products and services, as well as on an ongoing basis.
There are four major development hurdles to the CombiMatrix group's
core technology platform, three of which have been overcome, as described below:
o DESIGN AND FABRICATION OF SEMICONDUCTOR ARRAYS. The
CombiMatrix group has utilized common tools well known to the
semiconductor industry such as EDA (electronic design
automation) software, lithography fabrication techniques and
other semiconductor processing methods to fabricate a number
of array designs that are utilized as the base electronic
component of its products. The CombiMatrix group continues to
utilize these tools to advance their designs in a manner
similar to semiconductor companies. The core functional needs
of the devices have been achieved in designing and building
semiconductor arrays.
o DESIGN AND FABRICATION OF INSTRUMENTATION FOR SYNTHESIS OF DNA
ON ARRAYS AND THE ACTUAL SYNTHESIS OF DNA ON SUCH ARRAYS. In
order to produce bioarrays with in-situ synthesized DNA, the
CombiMatrix group designed and built unique instrumentation.
Such instrumentation incorporates standard electronic,
mechanical and fluidic components, as well as customized
firmware and user interface software. These prototype systems
operate in a manner that allows the synthesis of DNA, RNA and
other small molecules on multiple arrays.
o DESIGN AND FABRICATION OF INSTRUMENTATION TO PERFORM ASSAYS ON
ARRAYS AS WELL AS TO MEASURE SUCH PERFORMANCE. Instruments,
commonly known as Reader-Hybridizers, have been designed and
prototypes have been built to automate the process of
15
performing an assay on the CombiMatrix group's bioarrays as
well as to measure the performance of the assay. These
instruments incorporate standard, electronic, mechanical,
robotic and fluidic components, as well as firmware and
software to function.
o DEVELOPMENT OF A COST-EFFECTIVE, COMMERCIALLY VIABLE APPROACH
TO MANUFACTURE ARRAYS. As the CombiMatrix group moves forward
to broad commercialization of its technology platform,
advanced manufacturing techniques are being developed to
provide the most reliable and cost-effective approach to
manufacture bioarrays, as well as to develop products that are
commercially viable. These methods will utilize certain
protocols (many of which are well known in the manufacturing
sector), including robotic automation, as well as some
internally developed protocols. These processes are currently
in development.
GOVERNMENT GRANTS AND CONTRACTS
Government grants and contracts have allowed the CombiMatrix group to
fund certain internal scientific programs and exploratory research. The
CombiMatrix group retains ownership of all intellectual property and commercial
rights generated during these projects. The United States government, however,
retains a non-exclusive, non-transferable, paid-up license to practice the
inventions made with federal funds pursuant to applicable statutes and
regulations. The CombiMatrix group does not believe that the retained license
will have any impact on its ability to market its products. The CombiMatrix
group does not need government approval to enter into collaborations or other
relationships with third parties.
The CombiMatrix Corporation has been awarded two grants and two
contracts from the federal government in connection with its biological array
processor technology. In July 1999, the CombiMatrix Corporation was awarded a
$60,000 Phase I Small Business Innovative Research, or SBIR, contract from the
U.S. Department of Defense to develop nanode array sensor microchips to enable
simultaneous detection of numerous chemical and biological warfare agents. Also
in July 1999, the CombiMatrix Corporation was awarded a $100,000 Phase I SBIR
Department of Energy grant to use the CombiMatrix Corporation's proprietary
biochip technology to develop microarrays of affinity probes for the analysis of
gene products. In January 2000, the CombiMatrix Corporation was awarded a
$730,000 Phase II SBIR Department of Defense contract for the use of its biochip
technology to further develop nanode array sensor microchips. The term of the
Phase II SBIR Department of Defense contract ended July 2002 upon delivery of a
prototype electrochemical biological detection system to the Department of
Defense. As such, CombiMatrix Corporation will no longer receive grant revenues
under the Phase II SBIR Department of Defense contract beyond 2002. In February
2002, the CombiMatrix Corporation was awarded a six-month $100,000 Phase I
National Institutes of Health grant for the development of its protein biochip
technology, entitled "Self-Assembling Protein Microchips." This grant was
completed in August of 2002.
The CombiMatrix group will continue to pursue grants and contracts that
complement its research and development efforts.
EMPLOYEES
As of December 31, 2002, the CombiMatrix group had 99 full-time
employees, 18 of whom hold Ph.D. degrees and 71 of whom are engaged in full-time
research and development activities. The CombiMatrix group is not a party to any
collective bargaining agreement. The CombiMatrix group considers its employee
relations to be good.
ENVIRONMENTAL MATTERS
The operations of the CombiMatrix group involve the use,
transportation, storage and disposal of hazardous substances, and as a result,
these subsidiaries are subject to environmental and health and safety laws and
regulations. Although the CombiMatrix group currently uses fairly small
quantities of hazardous substances, as it expands its operations, its use of
hazardous substances will likely increase and lead to additional and more
stringent requirements. The cost of complying with these and any future
environmental regulations could be substantial. In addition, if the CombiMatrix
group fails to comply with environmental laws and regulations, or releases any
hazardous substance into the environment, the CombiMatrix group could be exposed
to substantial liability in the form of fines, penalties, remediation costs and
other damages, or could suffer a curtailment or shut down of its operations.
16
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BUSINESS
The Acacia Technologies group is principally comprised of Acacia Media
Technologies Corporation, or Acacia Media Technologies, formerly Greenwich
Information Technologies LLC, Soundview Technologies Incorporated, or Soundview
Technologies, and includes all corporate assets and liabilities and related
transactions of Acacia Research Corporation that relate to its media technology
businesses. Both Acacia Media Technologies and Soundview Technologies are wholly
owned subsidiaries of Acacia Research Corporation.
The Acacia Technologies group owns and is developing a portfolio of
U.S. and international pioneering patents covering the transmission and receipt
of digital content. These transmission and receiving systems are commonly
referred to as audio-on-demand, video-on-demand and audio/video streaming. The
Acacia Technologies group calls its proprietary technology Digital Media
Transmission, or DMT, technology.
The Acacia Technologies group also owns a patent for a system that
screens television content by content rating code, commonly referred to as
V-chip technology. The system, which uses the audio and video blanking interval
in conjunction with rating codes which are transmitted with television
programming, was approved by the Federal Communication Commission, or FCC, and
adopted by television manufacturers as the industry standard in response to the
U.S. Telecommunications Act of 1996.
The Acacia Technologies group is responsible for the development,
licensing and protection of its intellectual property and proprietary
technologies and continues to pursue both licensing and strategic business
alliances with leading companies in the rapidly growing media technologies
industry.
MARKET OVERVIEW
ACACIA MEDIA TECHNOLOGIES' MARKETS
The market for audio-on-demand, video-on-demand and audio/video
streaming utilizing the Acacia Technologies group's DMT technology continues to
grow both in the United States and internationally. It has recently been
reported that cable TV operators have rolled out video-on-demand services to
nearly 10.0 million homes. It has recently been reported that over 3.9 billion
video streams were served in 2002, a 52% increase over the previous year. The
Acacia Technologies group's DMT patents expire in 2011 and its international DMT
patents expire in 2012.
SOUNDVIEW TECHNOLOGIES' MARKETS
All televisions with screens 13 inches or larger sold in the U.S. after
July 10, 1999 are required to contain V-chip technology. Approximately 26.0
million new televisions are sold in the U.S. each year. The Acacia Technologies
group's V-chip patent expires in July 2003. To date, the Acacia Technologies
group has entered into licensing agreements with 13 television manufacturers
accounting for approximately 75% of the market.
MARKETING AND DISTRIBUTION
DIGITAL MEDIA TRANSMISSION TECHNOLOGY
The Acacia Technologies group has launched an extensive licensing
program for its DMT technology. Potential licensees include cable companies,
hotel in-room entertainment companies, content aggregators, Internet movie
companies, Internet music companies, on-line education services, on-line adult
entertainment companies, on-line news, sports and information services, hardware
and software manufacturers, and consumer electronics manufacturers.
As of March 31, 2003, the Acacia Technologies group has entered into 12
License Agreements for its DMT technology. The Acacia Technologies group has
also formed a joint venture with Grupo Pegasso to license its DMT technology
throughout Mexico. In addition, the Acacia Technologies group has initiated
patent infringement litigation in the Federal District Court for the Central
District of California against approximately 40 defendants who provide digital
content over the Internet. The Acacia Technologies group is in discussions with
several other potential licensees of its DMT technology.
17
V-CHIP TECHNOLOGY
During 2001, the Acacia Technologies group licensed 12 major television
manufacturers including Samsung Electronics, Hitachi America, Ltd., LG
Electronics, Inc., Funai Electric Co., Ltd., Daewoo Electronics Corporation of
America, Sanyo Manufacturing Corporation, Thomson Multimedia, Inc., JVC Americas
Corporation, Matsushita Electric Industrial Co., Ltd., Orion Electric Co. Ltd.,
Pioneer Electronics (USA) Incorporated and Philips Electronics North America
Corporation. In 2002, the Acacia Technologies group licensed one additional
television manufacturer. Litigation for patent infringement and anti-trust
violations is pending against Sony Corporation of America, Mitsubishi Digital
Electronics America, Inc., Sharp Electronics Corporation and Toshiba America
Consumer Products, Inc. These 13 licensees and 4 litigants manufacture most of
the television sets sold in the United States. The license agreements executed
contain provisions in some cases for lump sum payments, in other cases
provisions for ongoing royalty payments or a combination of both.
The Acacia Technologies group has identified several additional
companies that also manufacture televisions for sale in the U.S. and it intends
to continue to attempt to enter into licenses with these companies. The Acacia
Technologies group expects to enter into licenses with these companies, but may
initiate additional litigation against these companies if they use Acacia
Technologies group's V-chip technology without a license. The Acacia
Technologies group's success in entering into licenses or litigation with these
companies may, however, be impacted by developments in its existing litigation.
In pending litigation against Sony Corporation of America, Mitsubishi Digital
Electronics America, Inc., Sharp Electronics Corporation and Toshiba America
Consumer Products, Inc., the court in September 2002 ruled that the defendants
had not infringed the V-chip patent. While the Acacia Technologies group is
currently exploring strategies in connection with this ruling and intends to
appeal, litigation is inherently uncertain and there can be no assurance that
the Acacia Technologies group will be successful in any such appeal. As a result
of this ruling, in October 2002 Soundview Technologies voluntarily filed to
dismiss, without prejudice, its pending action for infringement of the V-chip
patent against seventeen television manufacturers. By voluntarily dismissing
this lawsuit at this time, Soundview Technologies will be able to refile the
action in the event that a favorable final decision is reached with respect to
the issue of infringement in the lawsuit against Sony, Mitsubishi, Sharp and
Toshiba. The Acacia Technologies group's V-chip patent expires in July 2003.
However, the Acacia Technologies group may continue to collect license fees on
televisions sold in the United States during the patent term, subsequent to the
July 2003 patent expiration date.
PATENTS, LICENSES AND FRANCHISES
The Acacia Technologies group owns five issued U.S. patents relating to
audio and video transmission and receiving systems, commonly known as
audio-on-demand and video-on-demand, used for distributing content via various
methods as follows: U.S. Patent No. 5,132,992, U.S. Patent No. 5,253,275, U.S.
Patent No. 5,550,863, U.S. Patent No. 6,002,720 and U.S. Patent No. 6,144,702.
In addition, the Acacia Technologies group owns seventeen foreign patents also
relating to audio and video transmission and receiving systems technology.
Foreign rights include a patent granted by the European Patent Office covering
Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy, Luxembourg,
Monaco, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom, and
patents in Japan, Taiwan and Mexico. Those patents that have already been issued
and granted were issued or granted during the past ten years, the earliest of
which will expire in 2011. The Acacia Technologies group is pursuing business
opportunities with possible providers of information-on-demand systems and
others involved in supplying related information-on-demand services.
The Acacia Technologies group's patent that describes a method for
implementing the V-chip system in parallel with the existing closed-captioning
circuits already in place in televisions was issued in November 1985 and expires
in July 2003. In April 1998, the U.S. Patent and Trademark Office issued a
reexamination certificate confirming the approval of all existing and newly
added claims of its issued patent. The reexamination was requested by Soundview
Technologies in August 1996 to confirm the strength of its patent in light of
other existing patents. Over 30 new prior art references were introduced and
examined during the process, which took more than eighteen months for the U.S.
Patent and Trademark Office to complete. As a result, patentability of all
original claims as issued was confirmed and 17 new claims more specific to the
V-chip implementation were granted.
REGULATORY MATTERS
The Acacia Technologies group markets and licenses technologies
relating to audio-on-demand and video-on-demand. These technologies can be used
to transmit content by several means including satellite, cable and
telecommunications systems. The satellite, cable and telecommunications
industries are subject to federal regulation, including FCC licensing and other
requirements. These industries are also often subject to extensive regulation by
18
local and state authorities. While most satellite, cable and telecommunication
industry regulations do not apply directly to the Acacia Technologies group,
they affect programming distributors, one of the large potential customers for
the technologies covered by the Acacia Technologies group patent portfolio. The
Acacia Technologies group monitors pending legislation and administrative
proceedings to ascertain relevance, analyze impact and develop strategies
regarding regulatory trends and developments within these industries.
Federal law requires cable operators to reserve up to one-third of a
system's channel capacity for local commercial television stations that have
elected must-carry status. In addition, a cable system is generally required to
carry local non-commercial television stations. The FCC has also implemented
comparable rules for satellite carriers requiring that if a satellite system
carries one local broadcast station in a local market pursuant to a royalty-free
license granted under the Satellite Home Viewer Improvement Act of 1999, then it
must carry all local broadcast stations in that market. To meet these
requirements, some cable and satellite systems must decide which programming
services to keep and which to remove in order to make space available for local
television stations. These must-carry requirements may impact the Acacia
Technologies group's information-on-demand and streaming media business by
causing cable and satellite systems operators to reduce the number of channels
on their systems that would have used technologies covered by Acacia
Technologies group's patent portfolio.
COMPETITION
The Acacia Technologies group expects to encounter competition in the
area of business opportunities from other entities having similar business
objectives. Many of these potential competitors may possess financial,
technical, human and other resources greater than those of the Acacia
Technologies group. The Acacia Technologies group anticipates that it will face
increased competition in the future as new companies enter the market and
advanced technologies become available.
Other companies may develop competing technologies that offer better or
less expensive alternatives to the V-chip technology and/or the Acacia
Technologies group's audio-on-demand and video-on-demand technologies. Many
potential competitors, including television manufacturers and other media
technology companies, have significantly greater resources. Technological
advances or entirely different approaches developed by one or more of its
competitors could render Acacia Technologies group's technologies obsolete or
uneconomical.
EMPLOYEES
As of December 31, 2002, the Acacia Technologies group had 14 full-time
employees. None of the companies included in the Acacia Technologies group is a
party to any collective bargaining agreement. The Acacia Technologies group
considers its employee relations to be good.
19
ITEM 2. PROPERTIES
Acacia Research Corporation leases approximately 7,143 square feet of
office space in Newport Beach, California, under a lease agreement that expires
in February 2007. We also lease approximately 7,019 square feet of office space
in Pasadena, California, under a lease agreement that expires in November 2003,
which is subleased through the remaining term of the lease agreement. Our
consolidated subsidiary, CombiMatrix Corporation, leases office and laboratory
space totaling approximately 90,111 square feet located north of Seattle,
Washington, under a lease agreement that expires in December 2008. Presently, we
are not seeking any additional facilities.
We are a guarantor under a lease agreement for office space in
Hollywood, California that expires in August 2005. The lease agreement was
entered into by Soundbreak.com Incorporated, or Soundbreak.com, which ceased
operations in February 2001. A portion of the leased premises is subleased
through the remaining term of the lease agreement, and we continue to pursue
opportunities to sublease the remaining space.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, we are the subject of, or party
to, various pending or threatened legal actions. We believe that any liability
arising from these actions will not have a material adverse effect on our
financial position, results of operations or cash flows.
COMBIMATRIX GROUP
On September 30, 2002, CombiMatrix Corporation and Dr. Montgomery
entered into a settlement agreement with Nanogen, Inc., or Nanogen, to settle
all pending litigation between the parties. Pursuant to the terms of the
settlement agreement, Nanogen dismissed with prejudice its lawsuit against
CombiMatrix Corporation and Dr. Montgomery. In return, CombiMatrix Corporation
agreed to pay Nanogen $0.5 ,million within 30 days of the settlement and an
additional $0.5 million within one year of the settlement. CombiMatrix
Corporation also agreed to make quarterly payments to Nanogen equal to 12.5% of
total sales of products developed by CombiMatrix Corporation and its affiliates
and based on the patents that had been in dispute in the litigation, up to an
annual maximum of $1.5 million. The minimum quarterly payments under the
settlement agreement will be $37,500 per quarter for the period from October 1,
2003 through October 1, 2004, and $25,000 per quarter thereafter until the
patents expire. Also, pursuant to the settlement agreement, CombiMatrix
Corporation issued to Nanogen 4,016,346 shares, or 17.5% of its outstanding
shares post issuance, subject to an antidilution provision related to the
exercise of CombiMatrix Corporation options and warrants that were outstanding
on the effective date of the agreement, for a period of up to three years.
ACACIA TECHNOLOGIES GROUP
In 2000, Soundview Technologies filed a federal patent infringement and
antitrust lawsuit against certain television manufacturers, the Consumer
Electronics Manufacturers Association and the Electronics Industries Alliance
d/b/a/ Consumer Electronics Association. In its lawsuit now pending before the
United States District Court for the District of Connecticut, Soundview
Technologies alleges that television sets fitted with V-chips and sold in the
United States infringe Soundview Technologies' patent. Additionally, Soundview
Technologies alleges that the Consumer Electronics Manufacturers Association has
induced infringement of Soundview Technologies' patent and that the defendants
have violated the federal Clayton and Sherman Antitrust Acts by engaging in
collusive attempts to prevent others in the electronics and television
broadcasting industries from entering into licensing agreements with Soundview
Technologies. Soundview Technologies is seeking monetary damages, an injunction
preventing unlicensed use of its patented technology and other remedies. In
September 2002, the court granted a motion for summary judgment filed by the
defendants, ruling that the defendants have not infringed on Soundview
Technologies' patent. While we are currently exploring strategies in response to
this ruling and intend to appeal it, litigation is inherently uncertain and we
can give no assurance that we will be successful in any such appeal.
The ruling has no effect on the revenues that the Acacia Technologies
group has received from current licensees of our patented V-chip technology.
Further, none of the revenues that we have received to date are contingent upon
any court rulings or the future outcome of any litigation with unlicensed
television manufacturers. Soundview Technologies continues to pursue its
antitrust claim against the defendants.
20
In August 2002, Soundview Technologies filed a federal patent
infringement lawsuit against seventeen television manufacturers in the United
States District Court for the District of Nevada. In this lawsuit, Soundview
alleges that television sets fitted with V-chips and sold in the United States
infringe Soundview Technologies' patent. As a result of the summary judgment
ruling in the case before the United States District Court for the District of
Connecticut, in October 2002, Soundview Technologies voluntarily filed to
dismiss, without prejudice, the Nevada infringement lawsuit. By voluntarily
dismissing this lawsuit at this time, Soundview Technologies will be able to
refile the action in the event that a favorable final decision is reached with
respect to the issue of infringement in the Connecticut lawsuit.
In February 2003, the Acacia Technologies group initiated DMT
technology patent infringement litigation in the Federal District Court for the
Central District of California against approximately 40 defendants who provide
digital content over the Internet. All of the defendants were previously
notified of their infringing activity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Acacia Research Corporation held a special meeting of stockholders, or
Special Meeting, on December 11, 2002. At the Special Meeting, the stockholders
voted on the following four items:
(a) A proposal to amend our certificate of incorporation to recapitalize
our company was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
11,248,369 279,282 165,310 0
(b) A proposal to approve and adopt an Agreement and Plan of Reorganization
and the transactions contemplated thereby was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
11,404,519 265,021 23,421 0
(c) A proposal to approve and adopt the Acacia Research Corporation 2002
CombiMatrix Stock Incentive Plan was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
9,481,771 2,063,218 147,972 0
(d) A proposal to approve and adopt the Acacia Research Corporation 2002
Acacia Technologies Stock Incentive Plan was approved as follows:
FOR AGAINST ABSTAIN BROKER NON-VOTES
- --- ------- ------- ----------------
9,454,823 2,087,439 150,699 0
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
RECENT MARKET PRICES
Acacia Research Corporation's two new classes of common stock, Acacia
Research-CombiMatrix common stock and Acacia Research-Acacia Technologies common
stock, commenced trading on the Nasdaq Stock Market on December 16, 2002. The
two new classes of common stock were created as a result of Acacia Research
Corporation's recapitalization that was approved by Acacia Research
Corporation's stockholders on December 11, 2002. The two new classes of stock
replace Acacia Research Corporation's common stock that formerly traded on the
Nasdaq stock market under the symbol ACRI. Acacia Research-Acacia Technologies
common stock is now listed on the Nasdaq National Market System and Acacia
Research-CombiMatrix common stock is now listed on the Nasdaq SmallCap Market.
Acacia Research-CombiMatrix common stock is intended to reflect the performance
of Acacia Research Corporation's CombiMatrix group, and Acacia Research-Acacia
Technologies stock is intended to reflect the performance of Acacia Research
Corporation's Acacia Technologies group.
Holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, holders of Acacia Research-Acacia Technologies stock and Acacia
Research-CombiMatrix stock continue to be subject to all of the risks of an
investment in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
The markets for securities such as the two classes of our common stock
have historically experienced extreme price and volume fluctuations during
certain periods. These broad market fluctuations and other factors, such as new
product developments and trends in our industry and the investment markets
generally, as well as economic conditions and quarterly variations in our
results of operations, may adversely affect the market price of our two classes
of common stock.
On October 22, 2001, our board of directors declared a 10% stock
dividend. The stock dividend, totaling 1,777,710 shares, was distributed on
December 5, 2001 for stockholders of record as of November 21, 2001. All share
and per share information presented herein is adjusted for the stock dividend.
The high and low bid prices for our two classes of common stock as
reported by NASDAQ for the periods indicated are as follows. Such prices are
inter-dealer prices without retail markups, markdowns or commissions and may not
necessarily represent actual transactions.
2002(1) 2001(1)
-------------------------------------- ---------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
Acacia Research Corporation
(through December 13, 2002):
High $5.61 $7.15 $11.50 $13.26 $13.42 $16.66 $16.14 $18.98
Low $3.65 $3.50 $5.90 $8.47 $8.29 $5.83 $4.69 $5.23
Acacia Research-Acacia Technologies stock:
High $3.40 - - - - - - -
Low $1.65 - - - - - - -
Acacia Research-CombiMatrix stock:
High $4.98 - - - - - - -
Low $2.70 - - - - - - -
- -------------------
(1) 2002 share and per share information gives effect to the recapitalization
transaction described elsewhere herein as of January 1, 2002. Historical share
and per share information for the new classes of securities is not presented as
these classes of securities were not part of Acacia Research Corporation's
capital structure during 2001 and prior periods.
On March 21, 2003, the closing bid and asked quotations for our Acacia
Research-Acacia Technologies stock were $1.16 and $1.17, respectively. On March
21, 2003, the closing bid and asked quotations for our Acacia
Research-CombiMatrix stock were $1.80 and $1.90, respectively.
22
On March 21, 2003, there were approximately 170 owners of record of
Acacia Research-Acacia Technologies stock and 280 owners of record of Acacia
Research-CombiMatrix stock. The majority of the outstanding shares of Acacia
Research-Acacia Technologies stock and Acacia Research-CombiMatrix stock are
held by a nominee holder on behalf of an indeterminable number of ultimate
beneficial owners.
DIVIDEND POLICY
To date, we have not declared or paid any cash dividends with respect
to our capital stock, and the current policy of the board of directors is to
retain earnings, if any, to provide for the growth of Acacia Research
Corporation. Consequently, we do not expect to pay any cash dividends in the
foreseeable future. Further, there can be no assurance that our proposed
operations will generate revenues and cash flow needed to declare a cash
dividend or that we will have legally available funds to pay dividends.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2002 with
respect to our common shares issuable under our equity compensation plans:
(c) NUMBER OF SECURITIES
(a) NUMBER OF REMAINING AVAILABLE FOR
SECURITIES TO BE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE (b) WEIGHTED AVERAGE EQUITY COMPENSATION PLANS
OF OUTSTANDING EXERCISE PRICE OF (EXCLUDING SECURITIES
PLAN CATEGORY OPTIONS OUTSTANDING OPTIONS REFLECTED IN COLUMN (a))
- ------------------------------------------------------ -------------------- -------------------- -------------------------
EQUITY COMPENSATION PLANS APPROVED BY SECURITY HOLDERS
2002 CombiMatrix Stock Incentive Plan(1) 5,620,000 $9.24 2,876,000
2002 Acacia Technologies Stock Incentive Plan(2) 4,295,000 $9.36 913,000
Subtotal(3) N/A N/A N/A
EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS(4)
- ------------------------------------------------------ -------------------- -------------------- -------------------------
TOTAL(3) N/A N/A N/A
- --------------------------------
(1) Our 2002 CombiMatrix Stock Incentive Plan, as amended, or the CombiMatrix
Plan, allows for the granting of stock options and other awards to
eligible individuals, which generally includes directors, officers,
employees and consultants. The CombiMatrix Plan does not segregate the
number of securities remaining available for future issuance among stock
options and other awards. The 2,876,000 shares authorized for future
issuance represents the total number of shares available through any
combination of stock options or other awards. The share reserve under the
CombiMatrix Plan automatically increases on the first trading day in
January each calendar year by an amount equal to three percent (3%) of the
total number of shares of our Acacia Research-CombiMatrix stock
outstanding on the last trading day of December in the prior calendar
year, but in no event will this annual increase exceed 600,000 shares and
in no event will the total number of common stock in the share reserve (as
adjusted for all such annual increases) exceed twenty million shares. See
Note 11 to our consolidated financial statements.
(2) Our 2002 Acacia Technologies Stock Incentive Plan, as amended, or the
Acacia Technologies Plan, allows for the granting of stock options and
other awards to eligible individuals, which generally includes directors,
officers, employees and consultants. The Acacia Technologies Plan does not
segregate the number of securities remaining available for future issuance
among stock options and other awards. The 913,000 shares authorized for
future issuance represents the total number of shares available through
any combination of stock options or other awards. The share reserve under
the Acacia Technologies Plan automatically increases on the first trading
day in January each calendar year by an amount equal to three percent (3%)
of the total number of shares of our Acacia Research-Acacia Technologies
stock outstanding on the last trading day of December in the prior
calendar year, but in no event will this annual increase exceed 500,000
shares and in no event will the total number of common stock in the share
reserve (as adjusted for all such annual increases) exceed twenty million
shares. See Note 11 to our consolidated financial statements.
23
(3) Subtotal and total information is not provided because the CombiMatrix
Plan and the Acacia Technologies Plan relate to two different classes of
our common stock.
(4) We have not authorized the issuance of equity securities under any plan
not approved by security holders.
ITEM 6. SELECTED FINANCIAL DATA
The consolidating selected balance sheet data as of December 31, 2002
and 2001 and the consolidating selected statement of operations data for the
years ended December 31, 2002, 2001 and 2000 set forth below have been derived
from our audited consolidated financial statements included elsewhere herein,
and should be read in conjunction with those financial statements (including
notes thereto). The consolidating selected financial data as of December 31,
2000, 1999 and 1998 and for the years ended December 31, 1999 and 1998 have been
derived from audited consolidated financial statements not included herein, but
which were previously filed with the SEC.
Acacia Research Corporation derived the Acacia Technologies group and
CombiMatrix group balance sheet data and statement of operations data from the
separate audited financial statements of the Acacia Technologies group and the
CombiMatrix group for the years ended December 31, 2002, 2001 and 2000 included
elsewhere herein, and the table should be read in conjunction with those
financial statements and related notes.
The AR-Acacia Technologies stock and the AR-CombiMatrix stock are
intended to reflect the separate performance of the respective divisions of
Acacia Research Corporation, rather than the performance of Acacia Research
Corporation as a whole. The chief mechanisms intended to cause the AR-Acacia
Technologies stock and the AR-CombiMatrix stock to reflect the financial
performance of the respective groups are provisions in our restated certificate
of incorporation and common stock policies governing dividends and distributions
to each class of stock, which specifically require the allocation of earnings to
each class based upon the performance of the two groups determined in accordance
with generally accepted accounting principles. Under these provisions, Acacia
Research Corporation factors the assets and liabilities and income or losses
attributable to the respective groups, determined as described under Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies," into the determination of the
amounts available to pay dividends, if any, on the shares issued for the
respective groups; and require Acacia Research Corporation to exchange, redeem
or distribute a dividend on the stock of a group if all or substantially all of
the assets allocated to the respective group are sold to a third party.
The Acacia Technologies group and the CombiMatrix group are not
separate legal entities. Holders of AR-Acacia Technologies stock and
AR-CombiMatrix stock are stockholders of Acacia Research Corporation. As a
result, stockholders continue to be subject to all of the risks of an investment
in Acacia Research Corporation and all of its businesses, assets and
liabilities. The assets that Acacia Research Corporation attributes to one group
could be subject to the liabilities of the other group.
24
CONSOLIDATING STATEMENT OF OPERATIONS DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
REVENUES:
Acacia Technologies group ...................... $ 43 $ 24,180 $ 40 $ 122 $ 382
CombiMatrix group .............................. 839 456 17 144 --
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ 882 $ 24,636 $ 57 $ 266 $ 382
============= ============= ============= ============= =============
OPERATING (LOSS) INCOME(5):
Acacia Technologies group ...................... $ (9,865) $ 5,858 $ (12,606) $ (4,955) $ (3,724)
CombiMatrix group .............................. (70,460) (49,056) (24,557) (2,625) (2,118)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (80,325) $ (43,198) $ (37,163) $ (7,580) $ (5,842)
============= ============= ============= ============= =============
OTHER (EXPENSE) INCOME, NET:
Acacia Technologies group ...................... $ (3,503) $ 2,111 $ (2,897) $ (818) $ (489)
CombiMatrix group .............................. 392 2,055 1,662 (224) (56)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (3,111) $ 4,166 $ (1,235) $ (1,042) $ (545)
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS
BEFORE MINORITY INTERESTS:
Acacia Technologies group ...................... $ (12,658) $ 7,034 $ (15,509) $ (5,791) $ (4,213)
CombiMatrix group .............................. (69,921) (46,846) (22,816) (2,851) (2,174)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (82,579) $ (39,812) $ (38,325) $ (8,642) $ (6,387)
============= ============= ============= ============= =============
MINORITY INTERESTS:
Acacia Technologies group ...................... $ 104 $ (1,277) $ 866 $ (27) $ 56
CombiMatrix group .............................. 23,702 18,817 8,300 1,248 142
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ 23,806 $ 17,540 $ 9,166 $ 1,221 $ 198
============= ============= ============= ============= =============
(LOSS) INCOME FROM CONTINUING OPERATIONS:
Acacia Technologies group ...................... $ (12,554) $ 5,757 $ (14,643) $ (5,818) $ (4,157)
CombiMatrix group .............................. (46,219) (28,029) (14,516) (1,603) (2,032)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (58,773) $ (22,272) $ (29,159) $ (7,421) $ (6,189)
============= ============= ============= ============= =============
LOSS FROM DISCONTINUED OPERATIONS (1):
Acacia Technologies group ...................... $ (200) $ -- $ (9,554) $ (776) $ --
CombiMatrix group .............................. -- -- -- -- --
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (200) $ -- $ (9,554) $ (776) $ --
============= ============= ============= ============= =============
(LOSS) INCOME BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE:
Acacia Technologies group ...................... $ (12,754) $ 5,757 $ (24,197) $ (6,594) $ (4,157)
CombiMatrix group .............................. (46,219) (28,029) (14,516) (1,603) (2,032)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (58,973) $ (22,272) $ (38,713) $ (8,197) $ (6,189)
============= ============= ============= ============= =============
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE DUE TO BENEFICIAL CONVERSION
FEATURE:
Acacia Technologies group ...................... $ -- $ -- $ -- $ -- $ --
CombiMatrix group .............................. -- -- (246) -- --
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ -- $ -- $ (246) $ -- $ --
============= ============= ============= ============= =============
NET (LOSS) INCOME:
Acacia Technologies group ...................... $ (12,754) $ 5,757 $ (24,197) $ (6,594) $ (4,157)
CombiMatrix group .............................. (46,219) (28,029) (14,762) (1,603) (2,032)
------------- ------------- ------------- ------------- -------------
Acacia Research Corporation .................... $ (58,973) $ (22,272) $ (38,959) $ (8,197) $ (6,189)
============= ============= ============= ============= =============
(CONTINUED ON NEXT PAGE)
25
CONSOLIDATING STATEMENT OF OPERATIONS DATA (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
LOSS PER COMMON SHARE(6):
BASIC AND DILUTED
LOSS FROM CONTINUING OPERATIONS
Acacia Research - Acacia Technologies stock .... $ (0.64) $ -- $ -- $ -- $ --
Acacia Research - CombiMatrix stock ............ (2.01) -- -- -- --
Acacia Research Corporation .................... -- (1.16) (1.78) (0.59) (0.58)
LOSS FROM DISCONTINUED OPERATIONS
Acacia Research - Acacia Technologies stock .... $ (0.01) $ -- $ -- $ -- $ --
Acacia Research - CombiMatrix stock ............ -- -- -- -- --
Acacia Research Corporation .................... -- -- (0.58) (0.06) --
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
Acacia Research - Acacia Technologies stock .... $ -- $ -- $ -- $ -- $ --
Acacia Research - CombiMatrix stock ............ -- -- -- -- --
Acacia Research Corporation .................... -- -- (0.02) -- --
NET LOSS
Acacia Research - Acacia Technologies stock .... $ (0.65) $ -- $ -- $ -- $ --
Acacia Research - CombiMatrix stock ............ (2.01) -- -- -- --
Acacia Research Corporation .................... -- (1.16) (2.38) (0.65) (0.58)
WEIGHTED AVERAGE NUMBER OF COMMON AND POTENTIAL
SHARES OUTSTANDING USED IN COMPUTATION OF LOSS
PER COMMON SHARE(2) (6):
BASIC
Acacia Research - Acacia Technologies stock .... 19,640,808 -- -- -- --
============= ============= ============= ============= =============
Acacia Research - CombiMatrix stock ............ 22,950,746 -- -- -- --
============= ============= ============= ============= =============
Acacia Research Corporation .................... -- 19,259,256 16,346,099 12,649,133 10,748,982
============= ============= ============= ============= =============
DILUTED
Acacia Research - Acacia Technologies stock .... 19,640,808 -- -- -- --
============= ============= ============= ============= =============
Acacia Research - CombiMatrix stock ............ 22,950,746 -- -- -- --
============= ============= ============= ============= =============
Acacia Research Corporation .................... -- 19,259,256 16,346,099 12,649,133 10,748,982
============= ============= ============= ============= =============
26
CONSOLIDATING BALANCE SHEET DATA
(IN THOUSANDS)
AT DECEMBER 31,
---------------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
TOTAL ASSETS(5):
Acacia Technologies group . $ 47,212 $ 62,926 $ 37,062 $ 49,788 $ 19,267
CombiMatrix group ......... 49,973 47,963 61,561 2,003 3,648
Eliminations(4) ........... (114) (30) (107) -- (3,146)
---------- ---------- ---------- ---------- ----------
Acacia Research Corporation $ 97,071 $ 110,859 $ 98,516 $ 51,791 $ 19,769
========== ========== ========== ========== ==========
LONG-TERM INDEBTEDNESS:
Acacia Technologies group . $ -- $ -- $ -- $ -- $ --
CombiMatrix group ......... -- 1,845 -- -- 1,222
---------- ---------- ---------- ---------- ----------
Acacia Research Corporation $ -- $ 1,845 $ -- $ -- $ 1,222
========== ========== ========== ========== ==========
TOTAL LIABILITIES(3)(5):
Acacia Technologies group . $ 5,183 $ 5,723 $ 5,075 $ 1,304 $ 436
CombiMatrix group ......... 13,972 14,131 15,880 229 4,538
Eliminations(4) ........... (114) (30) (107) 100 (3,146)
---------- ---------- ---------- ---------- ----------
Acacia Research Corporation $ 19,041 $ 19,824 $ 20,848 $ 1,633 $ 1,828
========== ========== ========== ========== ==========
MINORITY INTERESTS(3):
Acacia Technologies group . $ 1,487 $ 2,194 $ 2,012 $ 3,992 $ --
CombiMatrix group ......... 684 30,109 15,512 904 --
---------- ---------- ---------- ---------- ----------
Acacia Research Corporation $ 2,171 $ 32,303 $ 17,524 $ 4,896 $ --
========== ========== ========== ========== ==========
STOCKHOLDERS' EQUITY:
Acacia Technologies group . $ 40,542 $ 55,009 $ 29,975 $ 44,492 $ 18,845
CombiMatrix group ......... 35,317 3,723 30,169 770 (904)
---------- ---------- ---------- ---------- ----------
Acacia Research Corporation $ 75,859 $ 58,732 $ 60,144 $ 45,262 $ 17,941
========== ========== ========== ========== ==========
(1) On February 13, 2001, the board of directors of Soundbreak.com, one of
our majority-owned subsidiaries, resolved to cease operations as of
February 15, 2001 and liquidate the remaining assets and liabilities of
the company. Operating results in 1999 have been restated to present
Soundbreak.com as discontinued operations. See Note 10 to the 2002
consolidated financial statements.
(2) Potential common shares in 2002, 2001, 2000, 1999 and 1998 have been
excluded from the per share calculations because the effect of their
inclusion would be anti-dilutive. In addition, all share and per share
information has been adjusted as appropriate for all periods presented
to reflect a two-for-one stock split effected in March 1998 and a ten
percent (10%) stock dividend distributed on December 5, 2001 for
stockholders of record as of November 21, 2001.
(3) Effective January 1, 2001, we changed our accounting policy for balance
sheet classification of employee stock-based compensation resulting
from awards in consolidated subsidiaries. As a result, effective
January 1, 2001, amortized non-cash stock compensation charges related
to subsidiary stock options are included in minority interests in our
consolidated balance sheet. Prior to the change in accounting policy,
amortized non-cash stock compensation charges related to subsidiary
stock options were reflected as "accrued stock compensation" in
consolidated liabilities. There is no impact on previous consolidated
statements of operations as a result of this change in accounting
policy.
(4) Represents intercompany receivables/payables between the groups. In
1998, the intercompany receivable/payable was $3.1 million related to
funds advanced by Acacia Research Corporation to fund CombiMatrix
Corporation's operations. These amounts were repaid by CombiMatrix
Corporation in 1999.
27
(5) The management and allocation policies applicable to the preparation of
the financial statements of the Acacia Technologies group and the
CombiMatrix group and as a result, to the measurement by which
dividends or performance are determined for each group, may be modified
or rescinded, or additional policies may be adopted, at the sole
discretion of the Acacia Research Board at any time without approval of
the stockholders. The Acacia Technologies group's and the CombiMatrix
group's financial statements reflect the application of the management
and allocation policies adopted by the Acacia Research Corporation's
board of directors to various corporate activities. Management has no
plans to change allocation methods or the composition of the groups.
Refer to Item 7 "Management's Discussion and Analysis of Financial
Condition - Critical Accounting Policies" for a description of
allocation policies applied.
(6) The 2002 share and per share information gives effect to the
recapitalization transaction described elsewhere herein as of January
1, 2002. Historical share and per share information for the new classes
of securities is not presented as these classes of securities were not
part of Acacia Research Corporation's capital structure during 2001 and
prior periods.
FACTORS AFFECTING COMPARABILITY:
o The Acacia Technologies group revenues reflected in 1999 and
1998 primarily relate to capital management fee income,
including performance fee income, recorded by the Acacia
Capital Management division. During the fourth quarter of
1999, Acacia Research Corporation closed its Acacia Capital
Management division. Acacia Capital Management was a general
partner in two private investment partnerships and was an
investment advisor to two offshore private investment
corporations.
o In the fourth quarter of 2000, Acacia Research Corporation
recorded $1.0 million in write-offs of other early stage
investments and $2.6 million in write-offs of equity
investments, attributed to the Acacia Technologies group.
o During the year ended December 31, 2000, CombiMatrix
Corporation recorded deferred non-cash stock compensation
charges aggregating approximately $53.8 million in connection
with the granting of stock options. Deferred non-cash stock
compensation charges are being amortized by the CombiMatrix
group over the respective option grant vesting periods, which
range from one to four years. Non-cash stock compensation
charges totaled $6.4 million, $20.0 million and $10.0 million
in 2002, 2001 and 2000, respectively. Non-cash stock
compensation charges were not significant in prior periods.
o In connection with Acacia Research Corporation's increased
focus on the media technologies and life sciences sectors,
certain of Acacia Research Corporation's businesses allocated
to the Acacia Technologies group ceased operations and certain
investments were written off in 2000. As a result, marketing,
general and administrative costs related to salaries,
benefits, consulting, legal and other professional costs were
significantly reduced in 2001.
o In September 2002, Acacia Research Corporation recorded an
impairment charge of $2.7 million for an other-than-temporary
decline in the fair value of our cost method investment,
attributed to the Acacia Technologies group.
o On December 13, 2002, Acacia Research Corporation increased
its consolidated ownership interest in CombiMatrix Corporation
from 48% to 100% by acquiring from existing stockholders of
CombiMatrix Corporation 11,987,274 shares of CombiMatrix
Corporation common stock in exchange for 11,987,274 shares of
AR-CombiMatrix stock with a fair value of $46.0 million. The
total purchase price of $46.8 million was allocated to the
fair value of assets acquired and liabilities assumed,
including acquired in-process research and development, or
IPR&D. The amount attributable to CombiMatrix Corporation's
core technology and related patents was $5.3 million, which is
being amortized using the straight-line method over the
estimated remaining useful life of 7 years. The amount
attributable to IPR&D of $17.2 million was charged to expense
and is included in the consolidated statement of operations
and comprehensive loss for the year ended December 31, 2002.
The amount attributable to goodwill was $16.0 million. Amounts
allocated to patents, IPR&D and goodwill have been attributed
to the CombiMatrix group.
o On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix
Corporation, entered into a settlement agreement with Nanogen
to settle all pending litigation between the parties. In
addition to other terms of the settlement agreement as
described elsewhere herein, CombiMatrix Corporation agreed to
pay Nanogen $1.0 million and issued 4,016,346 shares, or 17.5%
of its outstanding shares post issuance, to Nanogen. The $1.0
million in payments have been expensed in the consolidated
statement of operations for the year ended December 31, 2002
under "legal settlement charges." The issuance of the
CombiMatrix Corporation common shares in settlement of the
litigation with Nanogen has been accounted for as a
nonmonetary transaction. Accordingly, included in "legal
settlement charges" in the consolidated statements of
operations for the year ended December 31, 2002 is a charge in
the amount of $17.5 million based on the fair value of the
CombiMatrix Corporation common shares issued to Nanogen.
Amounts related to the settlement have been attributed to the
CombiMatrix group.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS FORM 10-K. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS INCLUDING THOSE SET
FORTH UNDER "RISK FACTORS" HEREIN.
GENERAL
Acacia Research Corporation develops, acquires and licenses enabling
technologies for the life sciences and media technologies sectors, which
comprise the two business groups of Acacia Research Corporation. Acacia Research
Corporation's media technologies and life sciences businesses are referred to as
the "Acacia Technologies group" and the "CombiMatrix group," respectively. The
Acacia Technologies group owns and has licensed patented digital media
transmission, or DMT, technology enabling the digitization, encryption, storage,
transmission, receipt and playback of digital content, commonly known as
audio-on-demand, video-on-demand and streaming media and also owns and has
licensed technology, commonly known as the V-chip. To date, the Acacia
Technologies group has licensed its V-chip technology to 13 television
manufacturers representing approximately 75% of the industry. We will continue
to pursue both licensing and strategic business alliances with leading companies
in the rapidly growing media technologies industry. The CombiMatrix group's core
technology opportunity in the life sciences sector has been developed through
our wholly owned subsidiary, CombiMatrix Corporation, which is developing a
proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip.
In 2002, our results of operations were highlighted by CombiMatrix
Corporation's recognition of $0.5 million in grant and contract revenues,
including $0.3 million in grant revenue resulting from completion of its Phase
II SBIR Department of Defense contract, $141,000 in one-time contract research
and development revenues, $100,000 in revenue related to performance and
completion of its Phase I National Institutes of Health grant and $0.3 million
from the sale of a genomics microarray synthesizer system and related microarray
products to two institutions in Japan. Also during 2002, CombiMatrix Corporation
received $11.5 million in milestone payments pursuant to its license, research
and development agreements with Roche, which have been recorded as deferred
revenues.
In addition, during 2002, the Acacia Technologies group's operating
activities were highlighted by the execution of a license agreement for our
television V-chip technology for a cash payment of $43,000, the continued
building of its executive management team, including the hiring of key media
technology and intellectual property industry experts that will be responsible
for the development, licensing and protection of the Acacia Technologies group's
intellectual property and proprietary technologies, as well as the pursuit of
both licensing and strategic business alliances with leading companies in the
growing media technologies industry. In addition, in 2002, the Acacia
Technologies group increased legal and third-party consulting activities related
to its ongoing DMT patent marketing and commercialization efforts, including
patent claims construction, patent prosecution and related research and
engineering costs.
In 2001, our financial condition and results of operations were
highlighted by the receipt of $25.6 million in payments from the licensing of
our television V-chip technology, and $6.4 million received by CombiMatrix
Corporation pursuant to separate license, supply and research and development
agreements with Roche and the National Aeronautics and Space Administration, or
NASA, and continued performance by CombiMatrix Corporation under its Phase II
SBIR contract with the Department of Defense. In addition, CombiMatrix
Corporation continued its expansion of research and development activities in
2001. In 2000, our financial condition and results of operations were
highlighted primarily by the continued expansion of research and development and
the building of the management team at CombiMatrix Corporation.
During 2001, we began to receive significant payments from the
licensing of our television V-chip technology to television manufacturers. In
addition, CombiMatrix Corporation began to receive significant payments from its
strategic partners and licensees. However, to date, our subsidiary companies
have relied primarily upon selling equity securities, including sales to us, to
generate the funds needed to finance the implementation of their plans of
operation. Our subsidiary companies may be required to obtain additional
financing through bank borrowings, debt or equity financings or otherwise, which
would require us to make additional investments or face a dilution of our equity
interests.
We cannot assure that we will not encounter unforeseen difficulties
that may deplete our capital resources more rapidly than anticipated. Any
efforts to seek additional funds could be made through equity, debt or other
external financings; however, we cannot assure that additional funding will be
available on favorable terms, if at all. If we fail to obtain additional funding
when needed for our subsidiary companies, and ourselves, we may not be able to
execute our business plans and our business may suffer.
29
OPERATING AND ACQUISITION ACTIVITIES
During 2002, we continued to significantly increase operating
activities while receiving significant payments from our life sciences strategic
partners. We intend to continue to pursue both licensing and strategic business
alliances with leading companies in the rapidly growing media technologies
industry. Additionally, we intend to continue to invest in growing our life
sciences businesses by identifying and developing opportunities in the life
sciences sector that will be created by commercializing the new biochip
technology of CombiMatrix Corporation and other related investments in that
sector. Highlights of the acquisition and operating activities for the year
ended December 31, 2002 include the following:
ACACIA RESEARCH CORPORATION
o On December 13, 2002, Acacia Research Corporation increased
its consolidated ownership interest in CombiMatrix Corporation
from 48% to 100% by acquiring from existing stockholders of
CombiMatrix Corporation 11,987,274 shares of CombiMatrix
Corporation common stock in exchange for 11,987,274 shares of
AR-CombiMatrix stock with a fair value of $46.0 million. The
merger was designed to consolidate our ownership of
CombiMatrix Corporation and permit us to effectuate the
recapitalization transaction described elsewhere herein, by
creating the CombiMatrix group in a manner that reflects fully
the value of CombiMatrix Corporation.
COMBIMATRIX GROUP
o In February 2002, CombiMatrix Corporation was awarded a six
month $100,000 Phase I National Institutes of Health grant for
the development of its protein biochip technology, which was
completed in August 2002.
o In April 2002, CombiMatrix Corporation's Japanese subsidiary,
CombiMatrix KK, entered into a technology access and purchase
agreement in Japan with the Computational Biology Research
Center, or CBRC, a division of the Japanese National Institute
of Advanced Industrial Science and Technology. CBRC has
purchased and installed a CombiMatrix Corporation gene chip
synthesizer and entered into a multi-year agreement to
purchase blank chips that will be used to synthesize custom
gene chips. There are no minimum purchase requirements under
this agreement. The agreement also gives CBRC access to
CombiMatrix Corporation's set of informatics tools to help in
its efforts to expand biotechnology related businesses in
Japan.
o In April 2002, CombiMatrix Corporation purchased our interest
in Advanced Material Sciences. CombiMatrix Corporation issued
180,982 shares of its common stock to us in exchange for our
58% interest in Advanced Material Sciences. As a result of the
sale of our interest in Advanced Material Sciences,
CombiMatrix Corporation currently owns 87% of Advanced
Material Sciences and the remaining interests are owned by
unaffiliated third parties.
o In May 2002, CombiMatrix Corporation's Japanese subsidiary,
CombiMatrix KK, entered into a technology access collaboration
and purchasing agreement with the Genome Science Laboratory at
the Research Center for Advanced Science and Technology, or
RCAST, of the University of Tokyo. Under the terms of the
agreement, RCAST has installed a CombiMatrix Corporation gene
chip synthesizer and entered into a multi-year agreement to
purchase blank chips that will be used in the development of
diagnostic microarray applications, drug lead development and
target gene identification for the drug discovery industry.
There are no minimum purchase requirements under this
agreement. The agreement includes a memorandum of
understanding that in the event of the discovery or
development of novel and valuable content, candidates or
products, the parties will establish an agreement for the
commercialization of those discoveries.
o In July 2002, CombiMatrix Corporation completed a prototype
electrochemical detection system and delivered the system to
the Department of Defense. CombiMatrix Corporation developed
its sensor technology through grants from the Department of
Defense. The focus of the grants was aimed at developing an
ultrasensitive hand-held biochip system for detecting the
deployment of chemical and biological warfare agents.
o In September 2002, CombiMatrix Corporation and Roche amended
and restated their existing non-exclusive worldwide license
and supply and research and development agreements, pursuant
to which CombiMatrix Corporation and Roche seek to develop a
platform technology, providing a range of standardized
biochips for use in important research applications. Under the
30
agreements, Roche has made cash payments to CombiMatrix
Corporation of $11.5 million and $5.3 million during the years
ended December 31, 2002 and 2001, respectively, and will
continue to make payments for the deliverables stipulated and
for expanded license and manufacturing rights. Under the
agreements, it is contemplated that Roche will co-develop,
use, manufacture, market and distribute CombiMatrix
Corporation's active biochip system for rapid production of
both catalog and customizable biochips. The agreements provide
for minimum payments by Roche to CombiMatrix Corporation until
July 2004, including milestone achievement payments, payments
for products, royalties and payments for research and
development projects. All payments received under this
agreement to date have been recorded as deferred revenue.
o In September 2002, CombiMatrix Corporation and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix
Corporation, entered into a settlement agreement with Nanogen
to settle all pending litigation between the parties. Pursuant
to the terms of the settlement agreement, CombiMatrix
Corporation agreed to pay Nanogen $0.5 million within 30 days
of the settlement and an additional $0.5 million within one
year of the settlement. CombiMatrix Corporation also agreed to
make quarterly payments to Nanogen equal to 12.5% of total
sales of products developed by CombiMatrix Corporation and its
affiliates and based on the patents that had been in dispute
in the litigation, up to an annual maximum of $1.5 million.
The minimum quarterly payments under the settlement agreement
will be $37,500 per quarter for the period from October 1,
2003 through October 1, 2004, and $25,000 per quarter
thereafter until the patents expire. Also, pursuant to the
settlement agreement, CombiMatrix Corporation issued to
Nanogen 4,016,346 shares, or 17.5% of its outstanding shares
post-issuance, subject to an antidilution provision related to
the exercise of CombiMatrix Corporation options and warrants
that were outstanding on the effective date of the agreement,
for a period of up to three years.
ACACIA TECHNOLOGIES GROUP
o In July 2002, Acacia Media Technologies was granted a patent
for its DMT technology in Japan. The patent provides coverage
through January 2, 2012. The granting of the Japanese patent
strengthens the Acacia Technologies group's worldwide
intellectual property position, which includes five patents in
the United States and issued patents in 17 foreign countries.
o In July 2002, the Acacia Technologies group executed a license
agreement with Loewe Opta GmbH, whereby the Acacia
Technologies group will receive payment and grant a
non-exclusive license of its patented V-chip technology to
Loewe Opta GmbH, a manufacturer of televisions sold under the
Loewe brand name.
o To date, the Acacia Technologies group has entered into 12
license agreements for its DMT technology. The Acacia
Technologies group has also formed a joint venture with Grupo
Pegasso, a partner with Spain's Telefonica, in Mexico's second
largest mobile telephone company, Telefonica Moviles, to
license its DMT technology throughout Mexico. In addition, the
Acacia Technologies group has initiated patent infringement
litigation in the Federal District Court for the Central
District of California against approximately 40 defendants who
provide digital content over the Internet. The Acacia
Technologies group is in discussions with several other
potential licensees of its DMT technology.
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements and the separate group financial statements:
o revenue recognition;
o research and development expenses;
o litigation, claims and assessments;
o stock-based compensation;
o accounting for income taxes;
o valuation of long-lived and intangible assets and goodwill;
o accounting for business combinations;
o basis of presentation of separate group financial statements;
and
o management and allocation policies relating to AR-Acacia
Technologies stock and AR-CombiMatrix stock.
31
REVENUE RECOGNITION
ACACIA TECHNOLOGIES GROUP
To date, the Acacia Technologies group's revenues have consisted
primarily of fees from the licensing of its television V-chip technology to
television manufacturers.
As described below, significant management judgments must be made and
used in connection with the revenue recognized in any accounting period.
Material differences may result in the amount and timing of revenue recognized
for any period if management made different judgments.
The Acacia Technologies group's television V-chip technology settlement
and/or license agreements provide for the payment of contractually determined
license fees to us in consideration for the grant to certain television
manufacturers of a non-exclusive, retroactive and future license to manufacture
and/or sell products covered by Soundview Technologies' U.S. Patent No.
4,554,584 through July 2003. While payments recognized to date have been
one-time payments for the grant of V-chip patent licenses, certain of the
agreements also provide for future royalties or additional required payments
based on future television sales or the outcome of future litigation and
settlement activities. The agreements executed with the various television
manufacturers include certain release provisions with respect to Soundview
Technologies' ongoing patent infringement and anti-trust enforcement efforts.
Amounts received under the settlement and license agreements are recorded as
license fee income in the Acacia Technologies group's statement of operations.
License fee income is recognized as revenue when (i) persuasive
evidence of an arrangement exists, (ii) all obligations have been performed
pursuant to the terms of the license agreement, (iii) amounts are fixed or
determinable and (iv) collectibility of amounts is reasonably assured. Pursuant
to the terms of the agreements, the Acacia Technologies group has no further
obligation with respect to the sale of the non-exclusive retroactive and future
license, including no express or implied obligation on the Acacia Technologies
group's part to maintain or upgrade the technology or license, or provide future
support or services. Generally, the agreements provide for the grant of the
license upon receipt by Soundview Technologies of payment of the contractual
license fee. As such, the earnings process is generally complete upon the
receipt of payment from the television manufacturer, and revenue is recognized
when all of the criteria above are met.
License fee payments received by the Acacia Technologies group that do
not meet the revenue recognition criteria above are recorded as deferred
revenues, along with any related direct costs, until the criteria are met. In
the event that license fee amounts due from television manufacturers have been
accrued, the Acacia Technologies group assesses collection based on a number of
factors, including past transaction history and credit-worthiness. If it is
determined that collection of an accrued license fee is not reasonably assured,
the fee is deferred and is recognized as revenue upon receipt of cash.
COMBIMATRIX GROUP
The CombiMatrix group derives revenues and deferred revenues primarily
from two sources: (i) government grants and contract revenues and (ii)
multiple-element arrangements with strategic partners and licensees. As
described below, significant management judgments must be made and used in
connection with the revenue recognized or deferred in any accounting period.
Material differences may result in the amount and timing of revenues recognized
for any period if management made different judgments.
GOVERNMENT GRANTS: Revenues from government grants and contracts are
recognized as the related services are performed, when the services have been
accepted by the grantor and collectibility is reasonably assured. Amounts
recognized are limited to amounts due from the grantor based upon the contract
or grant terms.
REVENUES UNDER MULTIPLE-ELEMENT ARRANGEMENTS WITH STRATEGIC PARTNERS
AND LICENSEES: Pursuant to Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," or SAB No. 101, and related
pronouncements, an arrangement with multiple elements or deliverables should be
segmented into individual units of accounting based on the separate deliverables
only if there is objective and reliable evidence of fair value to allocate the
consideration received to the deliverables. Accordingly, revenues from
multiple-element arrangements involving license fees, up-front payments and
milestone payments, which are received or billable in connection with other
rights and services that represent continuing obligations of the CombiMatrix
group, are deferred until all of the multiple elements have been delivered or
until objective and verifiable evidence of the fair value of the undelivered
elements has been established. Upon establishing verifiable evidence of the fair
value of the elements in multiple-element arrangements, the fair value is
allocated to each element of the arrangement, such as license fees or research
32
and development projects, based on the relative fair values of the elements. The
CombiMatrix group determines the fair value of each element in multiple-element
arrangements based on objective and reliable evidence of fair value, which is
determined for each element based on the price charged when the same element is
sold separately to a third party. If evidence of fair value of all undelivered
elements exists but evidence does not exist for one or more delivered elements,
then revenue is recognized using the residual method. Under the residual method,
the fair value of the undelivered elements is deferred and the remaining portion
of the arrangement fee is recognized as revenue.
For the years ended December 31, 2002 and 2001, the CombiMatrix group
received cash consideration from Roche of $11.5 million and $5.3 million,
respectively, which has been classified as deferred revenue in the CombiMatrix
group's December 31, 2002 and 2001 consolidated balance sheets due to the
determination that the payments received related to elements for which objective
and reliable evidence of fair value does not currently exist. Pursuant to SAB
No. 101 and related guidance, the elements associated with the amounts received
to date and additional milestone payments will be treated as one accounting
unit. The up-front fees and cash payments received upon the accomplishment of
the contractual milestones will be deferred. Revenue will be recognized when all
of the related elements, for which objective and reliable evidence does not
exist, have been delivered and there is objective and reliable evidence to
support the fair value for all of the undelivered elements.
In connection with the step acquisition described below, and the
application of purchase accounting, Acacia Research Corporation was required to
fair value CombiMatrix Corporation's assets and liabilities including deferred
revenue. As a result, deferred revenue, primarily consisting of milestone
payments and other cash receipts from Roche and NASA, was reduced by $8.4
million to reflect the fair value of the continuing obligation related to the
52% interest acquired by Acacia Research Corporation.
In general, revenues from the sale of products and/or services are
recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery
has occurred or services have been rendered, (iii) the fees are fixed or
determinable and (iv) collectibility is reasonably assured.
RESEARCH AND DEVELOPMENT EXPENSES
The CombiMatrix group has been and continues to be engaged in a number
of research and development initiatives to improve and expand the active biochip
system, including increasing the number of test sites on active biochips from
currently 1,024 sites per square centimeter to over 10,000 sites per square
centimeter and by developing additional applications of CombiMatrix group's
technology for drug discovery.
Except for the amortization of non-cash deferred stock compensation
discussed below, research and development expenses have been the CombiMatrix
group's largest expense category to date and consist of costs to develop a
semiconductor-based, active biochip system. These costs include salaries,
benefits, recruiting and relocation expenses attributed to the CombiMatrix
group's research and development personnel, costs incurred in the development of
prototype products, contract engineering and development with third parties, the
consumption of laboratory materials and supplies and facilities costs. The
CombiMatrix group expects to continue to incur significant expenses for research
and development in order to commercialize an active biochip system. Once
commercialization for this platform technology has been achieved, the related
research and development spending will decrease. The CombiMatrix group expects
that new research and development efforts in collaboration with other strategic
partners will supplant existing collaboration efforts as they are completed. As
a result, the CombiMatrix group expects that the group's research and
development expenses will be volatile and could increase in the near term.
In addition to the amended license agreement with Roche, CombiMatrix
Corporation also entered into a 5-year research and development agreement with
Roche, which is subdivided into separate projects. As a result, a portion of the
research and development expenses incurred during 2002 and 2001 were driven by
obligations under these projects, which include continued development of
production microarray synthesis techniques, as well as higher density
microarrays. Research and development expenses required to complete these
projects are expected to continue into 2005, pursuant to the timelines outlined
in the related agreements.
The CombiMatrix group accounts for research and development expenses
pursuant to Statement of Financial Accounting Standards, or SFAS, No. 2,
"Accounting for Research and Development Costs," which requires that all
research and development costs be charged to expense as incurred. These would
include the costs described above as well as costs incurred to acquire
technologies, which are utilized in research and development and which have no
alternative future use. Also, costs related to filing and pursuing patent
33
applications are expensed as incurred, as recoverability of such expenditures is
uncertain. Research and development refers to a plan or design for a new product
or process or for a significant improvement to an existing product or process
whether intended for sale or use. Significant management estimates are required
with respect to the determination of which costs relate to plans or designs for
a new product or process or for a significant improvement to an existing
product. Had the CombiMatrix group determined that certain costs incurred were
not related to research and development activities, different accounting
treatment for such costs may have been required.
The costs of software developed or obtained for internal use is
expensed as incurred until certain capitalization criteria have been met, at
which time such costs are capitalized and reported as a component of property
and equipment. To date, these costs have been classified as research and
development expenses. Significant management estimates are required with respect
to the determination of when certain capitalization criteria have been met.
Typically this occurs upon completion of a prototype and design phase and a
functioning model exists. Thereafter, all software program costs are required to
be capitalized and amortized over the remaining estimated useful life of the
software. Had management made differing judgments regarding the capitalization
criteria, different accounting treatment of costs of software developed for
internal use may have been required.
For the years ended December 31, 2002 and 2000, Acacia Research
Corporation recorded charges for acquired in-process research and development of
$17.2 million and $2.5 million, respectively, in connection with certain step
acquisitions of additional ownership interests in CombiMatrix Corporation. The
value assigned to acquired in-process technology was determined by identifying
those acquired specific in-process research and development projects that would
be continued and for which (a) technological feasibility had not been
established at the acquisition date, (b) there was no alternative future use and
(c) the fair value was estimable with reasonable reliability. Charges for
acquired in-process research and development were attributed to the CombiMatrix
group. Refer to "Accounting for Business Combinations" for additional
disclosures regarding charges for acquired in-process research and development
in 2002.
LITIGATION, CLAIMS AND ASSESSMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Specifically, our management must make
estimates of whether (i) it is probable that an asset has been impaired or a
liability has been incurred at the date of the consolidated or separate group
financial statements and (ii) whether the amount of loss can be reasonably
estimated. In the event that in management's estimation it is probable that an
asset has been impaired or a liability has been incurred at the date of the
consolidated and separate group financial statements and amounts of loss can be
reasonably estimated, the estimated contingent loss from the loss contingency is
accrued by a charge to income.
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery, an officer and stockholder of CombiMatrix Corporation, entered into
a settlement agreement with Nanogen to settle all pending litigation between the
parties. In addition to other terms of the settlement agreement as described
elsewhere herein, CombiMatrix Corporation agreed to pay Nanogen $1.0 million and
issued 4,016,346 shares, or 17.5% of its outstanding shares post issuance, to
Nanogen. The $1.0 million in payments have been expensed in the consolidated
statement of operations for the year ended December 31, 2002 under "legal
settlement charges." The issuance of the CombiMatrix Corporation common shares
in settlement of the litigation with Nanogen has been accounted for as a
nonmonetary transaction. Accordingly, included in "legal settlement charges" in
the consolidated statements of operations for the year ended December 31, 2002
is a non-cash charge in the amount of $17.5 million based on the fair value of
the CombiMatrix Corporation common shares issued to Nanogen. The fair value of
the common shares issued and the related charge in the consolidated statement of
operations was based on an independent third-party valuation of CombiMatrix
Corporation as of September 30, 2002, the date of the settlement agreement.
Acacia Research Corporation is subject to claims and legal actions that
arise in the ordinary course of business. Management believes that the ultimate
liability with respect to these claims and legal actions, if any, will not have
a material effect on our consolidated or separate group financial position,
results of operations or cash flows. Because of the uncertainties related to
both probabilities of outcome and amounts and ranges of potential loss
associated with outstanding claims and pending litigation at December 31, 2002,
management is unable to make a reasonable estimate of the likelihood of outcome
or the liability that could result from an unfavorable outcome. As such, we have
not accrued for any loss contingencies as of December 31, 2002. As additional
information becomes available, we will assess the potential liability related to
our pending litigation and revise our estimates. Such revisions in our estimates
of the potential liability could materially impact our results of operations and
financial position.
34
STOCK-BASED COMPENSATION
Acacia Research Corporation's stock option policies provide for the
granting of stock options to employees, generally, at exercise prices equal to
the fair value of the underlying stock on the date of grant. The fair values of
Acacia Research Corporation stock option grants are determined by reference to
the quoted market prices of our stock as listed on the Nasdaq Stock Market on
the grant date.
Non-cash stock compensation cost related to stock options issued to
employees is accounted for in accordance with Accounting Principles Board, or
APB, Opinion No. 25, "Accounting for Stock Issued to Employees," or APB No. 25,
and related interpretations. Compensation cost attributable to such options is
recognized based on the difference, if any, between the closing market price of
the stock on the date of grant and the exercise price of the option.
Compensation cost is deferred and amortized on an accelerated basis over the
vesting period of the individual option awards using the amortization method
prescribed in Financial Accounting Standards Board, or FASB, Interpretation No.
28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans," or FIN No. 28. Non-cash compensation cost of stock options and
warrants issued to non-employee service providers, which has not been
significant, is accounted for under the fair value method required by SFAS No.
123, "Accounting for Stock-Based Compensation" and related interpretations.
During the year ended December 31, 2000, CombiMatrix Corporation
recorded deferred non-cash stock compensation charges aggregating approximately
$53.8 million in connection with the granting of stock options. Pursuant to
Acacia Research Corporation's policy, the stock options were originally granted
by CombiMatrix Corporation at exercise prices equal to the fair value of the
underlying CombiMatrix Corporation stock on the date of grant as determined by
its board of directors. However, such exercise prices were subsequently
determined to have been granted at exercise prices below fair value due to a
substantial step-up in the fair value of CombiMatrix Corporation pursuant to a
valuation provided by an investment banker in contemplation of a potential
CombiMatrix Corporation initial public offering in 2000. In connection with the
proposed CombiMatrix Corporation initial public offering and pursuant to SEC
rules and guidelines, we were required to reassess the value of stock options
issued during the one-year period preceding the potential initial public
offering and utilize the stepped-up fair value provided by the investment banker
for purposes of determining whether such stock option issuances were
compensatory, resulting in the calculation of the $53.8 million in deferred
non-cash stock compensation charges in 2000. Deferred non-cash stock
compensation charges are being amortized over the respective option grant
vesting periods, which range from one to four years. Non-cash stock compensation
charged to income during the years ended December 31, 2002, 2001 and 2000
totaled $6.4 million and $20.0 million and $10.0 million, respectively. Pursuant
to the vesting terms of CombiMatrix Corporation's stock options outstanding at
December 31, 2002, we will incur non-cash stock compensation amortization
expenses of $3.1 million in 2003 and $0.9 million in 2004. Amounts to be
amortized in future periods may be impacted by certain subsequent stock option
transactions including modification of terms, cancellations, forfeitures and
other activity.
During the years ended December 31, 2002 and 2001, certain CombiMatrix
Corporation unvested stock options were forfeited. Pursuant to the provisions of
APB No. 25 and related interpretations, the reversal of previously recognized
non-cash stock compensation expense on forfeited unvested stock options in the
amount of $1.2 million and $4.7 million has been reflected in the 2002 and 2001
consolidated statements of operations and comprehensive loss, respectively, as
reductions in non-cash stock compensation expense. In addition, the forfeiture
of certain unvested options during the years ended December 31, 2002 and 2001
resulted in a reduction of the remaining deferred non-cash stock compensation
expense scheduled to be amortized in future periods.
In connection with the acquisition of the stockholder interests in
CombiMatrix Corporation not already owned by Acacia Research Corporation, the
exchange of CombiMatrix Corporation Common Stock options for AR-CombiMatrix
stock options resulted in a new measurement date for those awards. Accordingly,
deferred stock-based compensation expense of approximately $116,000 was recorded
in the 2002 consolidated statement of operations of Acacia Research Corporation.
The additional stock compensation expense was allocated to the CombiMatrix
group.
35
ACCOUNTING FOR INCOME TAXES
As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves the estimating of our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as deferred revenue,
amortization of intangibles and asset depreciation for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our consolidated balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not likely, we must
establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the consolidated statement of operations and
comprehensive loss.
Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and our
valuation allowance. We have recorded a full valuation allowance against our
deferred tax assets of $71.7 million as of December 31, 2002, 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. In assessing the need for a valuation allowance, we have considered
our estimates of future taxable income, the period over which our deferred tax
assets may be recoverable, our history of losses and our assessment of the
probability of continuing losses in the foreseeable future. In management's
estimate, any positive indicators, including forecasts of potential future
profitability of our businesses, are outweighed by the uncertainties surrounding
our estimates and judgments of potential future taxable income. In the event
that actual results differ from these estimates or we adjust these estimates
should we believe we would be able to realize these deferred tax assets in the
future, an adjustment to the valuation allowance would increase income in the
period such determination was made. Any changes in the valuation allowance could
materially impact our financial position and results of operations.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and related goodwill and enterprise level goodwill whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
we consider important, which could trigger an impairment review include the
following:
o significant underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business;
o significant negative industry or economic trends;
o significant adverse changes in legal factors or in the
business climate, including adverse regulatory actions or
assessments; and
o significant decline in our stock price for a sustained period.
When we determine that the carrying value of intangibles, long-lived
assets and related goodwill and enterprise level goodwill may not be recoverable
based upon the existence of one or more of the above indicators of impairment,
we measure any impairment based on a projected discounted cash flow method using
a discount rate determined by our management to be commensurate with the risk
inherent in our current business model. Net intangible assets, long-lived assets
and goodwill amounted to $40.0 million as of December 31, 2002.
In September 2002, the court granted a motion for summary judgment
filed by the defendants in Soundview Technologies federal patent infringement
and antitrust lawsuit against certain television manufacturers, the Consumer
Electronics Manufacturers Association and the Electronics Industries Alliance
d/b/a/ Consumer Electronics Association, ruling that the defendants have not
infringed on Soundview Technologies' patent. While we are currently exploring
strategies in response to this ruling and intend to appeal it, litigation is
inherently uncertain and we can give no assurance that we will be successful in
any such appeal. Significant assumptions used in connection with our impairment
testing of the Acacia Technologies group's goodwill and intangibles give
consideration to the above. Near term potential for the recording of impairment
charges exist related to V-chip related intangibles totaling $1.7 million, in
the event that we experience any additional adverse rulings related to our
pending antitrust and or infringement actions.
In 2002, SFAS No. 142, "Goodwill and Other Intangible Assets," or SFAS
No. 142, became effective and as a result, we ceased to amortize approximately
$4.6 million of remaining goodwill effective January 1, 2002. Goodwill not
subject to amortization at December 31, 2002 totaled $20.7 million. We recorded
36
approximately $1.1 million of goodwill amortization during 2001. We performed an
initial impairment review of our goodwill in 2002 and will perform an annual
impairment review thereafter. As a result of our 2002 impairment reviews we did
not record any impairment charges. There can be no assurance that future
goodwill impairment tests will not result in a charge to earnings. See "Recent
Accounting Pronouncements."
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," or SFAS No. 144, which addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. SFAS No. 144 requires long-lived assets
to be tested for recoverability whenever events or changes in circumstances
indicate that its carrying amount may not be recoverable. In conjunction with
such tests, it may be necessary to review depreciation estimates and methods as
required by APB Opinion No. 20, "Accounting Changes," or the amortization period
as required by SFAS No. 142.
ACCOUNTING FOR BUSINESS COMBINATIONS
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,274
shares of CombiMatrix Corporation common stock in exchange for 11,987,274 shares
of AR-CombiMatrix stock with a fair value of $46.0 million. The transaction was
accounted for as a step acquisition using the purchase method of accounting. The
fair value of the AR-CombiMatrix stock issued in the transaction was based on
the quoted market price of AR-CombiMatrix stock averaged over a five-day period
(from December 16, 2002, the first day of trading for the new AR-CombiMatrix
stock through December 20, 2002). The total purchase price of $46.8 million,
including acquisition costs of $0.8 million, was allocated to the fair value of
assets acquired and liabilities assumed, including acquired in-process research
and development, or IPR&D. The amount attributable to CombiMatrix Corporation's
core technology and related patents was $5.3 million, which is being amortized
using the straight-line method over the estimated economic useful life of 7
years. The amount attributable to IPR&D of $17.2 million was charged to expense
and is included in the consolidated statement of operations and comprehensive
loss for the year ended December 31, 2002. The amount attributable to goodwill
was $16.0 million. Amounts allocated to patents, IPR&D and goodwill have been
attributed to the CombiMatrix group.
As described above, $17.2 million of the purchase price was allocated
to IPR&D projects that had not yet reached technological feasibility and had no
alternative future use. Accordingly, this amount was immediately expensed in the
2002 consolidated statement of operations and comprehensive loss as of the
acquisition date. The amounts attributed to acquired IPR&D were based on an
independent appraisal and were developed using an income approach. The
in-process technologies were valued using a discounted cash flow model on a
project-by-project basis, which estimated the cash flows expected to result from
each project once it has reached technological feasibility. A discount rate
consistent with the risks of each project was used to estimate the present value
of future cash flows. In estimating future cash flows, management considered the
contribution of its core technology (for which a United States patent was
obtained in July 2000) that would be required for successful exploitation of
purchased in-process technology, in order to value the core and in-process
technologies discretely. As a result, future cash flows relating to each
purchased IPR&D project were reduced in order to reflect the contribution of
core technology to each IPR&D project. The cash flows from these projects
attributable to core technology were then separately valued to determine the
intangible asset value of purchased core technology. In determining the
contribution of core technology to in-process projects, management used a profit
split approach which considered the estimated profit split between a licensor
and licensee of the core technology and management's assessment of how critical
the core technology was to the IPR&D projects.
The nature of the efforts to develop the purchased IPR&D into
commercially viable products principally relates to the completion and/or
acceleration of existing development programs. These efforts include testing
current and alternative materials used in microarray design, testing of existing
and alternative methods for microarray synthesis, developing prototype machinery
(including operating software) to synthesize, hybridize and read individual
microarrays, and to perform numerous experiments, or assays, with actual target
samples in order to determine customer protocols and procedures for using the
CombiMatrix group's microarray system. The costs of these efforts have been
included in the CombiMatrix group's projections to successfully launch the
purchased IPR&D projects. The resulting net cash flows from such projects are
based on management's estimates of revenues, cost of sales, research and
development expenses, sales and marketing expenses, general and administrative
expenses, the anticipated effect of income taxes, and required returns on
working capital, fixed assets and other assets necessary to support the
generation of these cash flows.
37
The discounting of net cash flows relating to core technology to their
present value is based on CombiMatrix Corporation's weighted average cost of
capital, or WACC. The WACC calculation produces the average required rate of
return of an investment in an operating enterprise, based on various required
rates of return from investments in various areas of that enterprise. The WACC
for CombiMatrix Corporation was approximately 20% at the time of the merger and
is the rate used in discounting the net cash flows attributable to purchased
core technology. Due to the additional inherent risks associated with the
purchased IPR&D projects, including if and when the technologies will ultimately
become commercially viable, market acceptance risks, and threats from competing
technologies, higher discount rates were used to value the projects. The
discount rates used for each project are described below.
The forecast data employed in the valuation analyses was based upon
product level forecast information obtained by Acacia Research Corporation from
numerous internal and external resources. These resources included publicly
available databases, external market research consultants, company-sponsored
focus groups and internal market experts. Management reviewed and challenged the
forecast data and related assumptions and utilized the information in analyzing
IPR&D. The forecast data and assumptions are inherently uncertain and
unpredictable. However, based upon the information available at this time,
Acacia Research Corporation management believes the forecast data and
assumptions to be reasonable. These assumptions may be incomplete or inaccurate
and no assurance can be given that unanticipated events and circumstances will
not occur. Accordingly, actual results may vary from the forecasted results. Any
such variance may result in a material adverse effect on Acacia Research
Corporation's financial condition and results of operations.
In the allocation of purchase price to the IPR&D, the concept of
alternative future use was specifically considered for each of the programs
under development. The acquired IPR&D consists of CombiMatrix Corporation's work
to complete each of the identified programs. The programs are very specific to
research market for which they are intended. There are no alternative uses for
the in-process programs in the event that the programs fail in their continued
development or are otherwise not feasible. The development effort for the
acquired IPR&D does not possess an alternative future use for Acacia Research
Corporation as defined by generally accepted accounting principles. Following is
a brief description of each IPR&D project.
GENOMICS BIOLOGICAL ARRAY SYSTEM: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The application of this system will be in
gene expression profiling and SNP genotyping, which could lead to the better
understanding of gene function and ultimately therapeutic discovery to fight
disease. CombiMatrix Corporation's projected cash flow models from
commercializing this system include servicing CombiMatrix Corporation's existing
relationship with Roche as well as other strategic partners, including
pharmaceutical, biotech and academic institutions. Although current research and
development efforts in commercializing this system have been positive, there can
be no assurance that the system will be successfully launched and broadly
accepted by the pharmaceutical, biotech and academic research fields. The value
assigned to the genomics biological array system IPR&D project was $14.0
million. A risk-adjusted discount rate of 32% was applied to the project's
estimated cash flows.
PROTEOMICS BIOLOGICAL ARRAY SYSTEM: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. However, the porous reaction layer coating
used in synthesis and manner in which the software used to design probes for
protein immobilization are significantly different from what is currently being
developed for the genomics application. Further, the proteomics biological array
system primarily uses electrochemical methods for detection of assay results,
which contrasts with the optical means that are the primary method used with the
CombiMatrix Corporation's genomics products. These differences arise largely due
to the inherent biological differences between DNA molecules and protein
molecules and how they interact with the CombiMatrix group's proprietary
technology. The proteomics biological array system is used for detection and
identification of bio-threat agents in CombiMatrix Corporation's biological and
chemical threat agent detector development programs that are currently in
process. Although current research and development efforts in commercializing
this system have been positive, there can be no assurance that the system will
be successfully launched and broadly accepted by the government, pharmaceutical,
biotech and academic research fields. The value assigned to the proteomics
biological array system IPR&D project was $3.2 million. A risk- adjusted
discount rate of 60% was applied to the project's estimated cash flows.
BASIS OF PRESENTATION OF SEPARATE GROUP FINANCIAL STATEMENTS
The CombiMatrix group and Acacia Technologies group financial
statements have been prepared in accordance with generally accepted accounting
principles and, taken together, comprise all the accounts included in the
corresponding consolidated financial statements of Acacia Research Corporation.
The financial statements of the CombiMatrix group and the Acacia Technologies
group reflect the financial condition, results of operations and cash flows of
38
the businesses included therein. The financial statements of each group include
the accounts or assets of Acacia Research Corporation specifically attributed to
the respective groups and give effect to the applicable accounting policies. The
group financial statements have been prepared on a basis that management
believes to be reasonable and appropriate and reflect the financial position,
results of operations and cash flows of businesses that comprise the separate
groups and all other corporate assets, liabilities and related transactions of
Acacia Research Corporation attributed to the respective groups, including
allocated portions of Acacia Research Corporation's general and administrative
costs. Intergroup transactions between the CombiMatrix group and the Acacia
Technologies group have not been eliminated in the separate group's financial
statements.
The preparation of the divisional 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, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from those estimates.
Significant management estimates and judgments are required related to the
implementation of the management and allocation policies applicable to the
preparation of the divisional financial statements of the CombiMatrix group and
the Acacia Technologies group. Individual group results may be significantly
impacted based on management's estimates and judgments.
MANAGEMENT AND ALLOCATION POLICIES RELATING TO AR-ACACIA TECHNOLOGIES STOCK AND
AR-COMBIMATRIX STOCK
The management and allocation policies applicable to the preparation of
the divisional financial statements of the CombiMatrix group and the Acacia
Technologies group (collectively, "the groups") may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation board of directors at any time without approval of the
stockholders. The group divisional financial statements reflect the application
of the management and allocation policies adopted by the Acacia Research
Corporation board of directors to various corporate activities, as described
below. The group's divisional financial statements should be read in conjunction
with Acacia Research Corporation's consolidated financial statements and related
notes.
TREASURY AND CASH MANAGEMENT POLICIES
Acacia Research Corporation manages most treasury and cash management
activities on a de-centralized basis, with each separate group separately
managing its own treasury activities. Pursuant to treasury and cash management
policies adopted by the Acacia Research Corporation board of directors, the
following policies apply:
o Acacia Research Corporation attributes each issuance of
AR-Acacia Technologies stock (and the proceeds thereof) to the
Acacia Technologies group and attributes each issuance of
AR-CombiMatrix stock (and the proceeds thereof) to the
CombiMatrix group;
o Acacia Research Corporation attributes each future incurrence
or issuance of external debt or preferred stock (and the
proceeds thereof) between the Acacia Technologies group and
the CombiMatrix group or entirely to one group as determined
by the Acacia Research Corporation board of directors, based
on the extent to which Acacia Research Corporation incurs or
issues the debt or preferred stock for the benefit of the
CombiMatrix group and the Acacia Technologies group;
o Dividends, if any, on AR-Acacia Technologies stock will be
charged against the Acacia Technologies group, and dividends,
if any, on AR-CombiMatrix stock will be charged against the
CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged
against the Acacia Technologies group and repurchases of
AR-CombiMatrix stock will be charged against the CombiMatrix
group;
o Acacia Research Corporation will account for any cash
transfers from Acacia Research Corporation to or for the
account of a group, from a group to or for the account of
Acacia Research Corporation, or from one group to or for the
account of the other group (other than transfers in return for
assets or services rendered) as short-term loans unless (A)
the Acacia Research Corporation board of directors determines
that a given transfer (or type of transfer) should be
accounted for as a long-term loan, (B) the Acacia Research
Corporation board of directors determines that a given
transfer (or type of transfer) should be accounted for as a
capital contribution or (C) the Acacia Research Corporation
board of directors determines that a given transfer (or type
of transfer) should be accounted for as a return of capital.
There are no specific criteria to determine when Acacia
Research Corporation will account for a cash transfer as a
long-term loan, a capital contribution or a return of capital
rather than an inter-group revolving credit advance; provided,
39
however, that cash advances from Acacia Research Corporation
to the Acacia Technologies group or to the CombiMatrix group
up to $25.0 million on a cumulative basis shall be accounted
for as short-term or long-term loans at interest rates at
which Acacia Research Corporation could borrow such funds and
shall not be accounted for as a capital contribution. The
Acacia Research Corporation board of directors will make such
a determination in the exercise of its business judgment at
the time of such transfer based upon all relevant
circumstances. Factors the Acacia Research Corporation board
of directors may consider include, without limitation: the
current and projected capital structure of each group; the
financing needs and objectives of the recipient group; the
availability, cost and time associated with alternative
financing sources; and prevailing interest rates and general
economic conditions; and
o Any cash transfers accounted for as short-term loans will bear
interest at the rate at which Acacia Research Corporation
could borrow such funds. In addition, any cash transfers
accounted for as a long-term loan will have interest rates,
amortization, maturity, redemption and other terms that
reflect the then-prevailing terms on which Acacia Research
Corporation could borrow such funds.
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES
Acacia Research Corporation allocates the cost of corporate general and
administrative services and facilities between the groups generally based upon
utilization. Where determinations based on utilization alone are impracticable,
Acacia Research Corporation uses other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials.
Except as may otherwise be specifically provided pursuant to the terms
of any agreements among Acacia Research Corporation and the groups or any
resolutions of the Acacia Research Corporation board of directors, the corporate
general and administrative services and facilities allocated between the groups
include, without limitation, legal services, accounting services (tax and
financial), insurance and deductibles payable in connection therewith, employee
benefit plans and administration thereof, investor relations, stockholder
services and services relating to the Acacia Research Corporation board of
directors.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES
Acacia Research Corporation determines its federal income taxes and the
federal income taxes of its subsidiaries that own assets allocated between the
groups on a consolidated basis. Acacia Research Corporation allocates
consolidated federal income tax provisions and related tax payments or refunds
between the groups based principally on the taxable income and tax credits
directly attributable to each group. Such allocations reflect each group's
contribution, whether positive or negative, to Acacia Research Corporation's
consolidated federal taxable income and consolidated federal tax liability and
tax credit position. Acacia Research Corporation credits tax benefits that
cannot be used by the group generating those benefits but can be used on a
consolidated basis to the group that generated such benefits. Inter-group
transactions will be treated as taxed on a separate return basis.
Had the groups filed separate tax returns, the provision (benefit) for
income taxes and net income (loss) for each group would not have differed from
the amounts reported in the groups' statements of operations for the years ended
December 31, 2002, 2001, and 2000.
Depending on the tax laws of the respective jurisdictions, state and
local income taxes are calculated on either a consolidated or combined basis
between the groups based on their respective contribution to such consolidated
or combined state taxable incomes. State and local income tax provisions and
related tax payments or refunds which are determined on a separate corporation
basis are allocated between the groups in a manner designed to reflect the
respective contributions of the groups to Acacia Research Corporation, separate
or local taxable income.
40
ACACIA RESEARCH CORPORATION CONSOLIDATED
RESULTS OF OPERATIONS (IN THOUSANDS) 2002 2001 2000
--------- --------- ---------
Net revenues .......................................... $ 882 $ 24,636 $ 57
Cost of sales ......................................... (263) -- --
Research and development expenses ..................... (18,187) (11,656) (5,959)
Charge for acquired in-process research and development (17,237) -- (2,508)
Non-cash stock compensation
expense - research and development .................. (1,868) (7,183) (3,397)
Marketing, general and administrative expenses ........ (18,632) (32,664) (14,782)
Non-cash stock compensation
expense - marketing, general and administrative ..... (4,559) (13,636) (7,307)
Amortization of patents and goodwill .................. (1,990) (2,695) (2,251)
Loss on disposal of consolidated subsidiaries ......... -- -- (1,016)
Legal settlement charges .............................. (18,471) -- --
Other (expense) income, net ........................... (3,111) 4,166 (1,235)
Benefit (provision) for income taxes .................. 857 (780) 73
Minority interests .................................... 23,806 17,540 9,166
Loss from discontinued operations of Soundbreak.com ... -- -- (7,443)
Loss from disposal of Soundbreak.com .................. (200) -- (2,111)
Cumulative effect of change in accounting principle ... -- -- (246)
--------- --------- ---------
Net loss .............................................. $(58,973) $(22,272) $(38,959)
========= ========= =========
2002 COMPARED TO 2001
REVENUES
LICENSE FEE INCOME. In 2002, license fee income was $43,000, as
compared to $24.2 million in 2001. During 2002, we executed one license
agreement with Loewe Opta GmbH, a manufacturer of televisions sold under the
Loewe brand name. License fee income for 2001 includes license fees received
from eleven television manufacturers with whom we executed separate settlement
and/or license agreements during 2001 and in December 2000. Pursuant to the
terms of the respective settlement and/or license agreements with each of the
television manufacturers, Soundview Technologies received one-time license fee
payments in exchange for the grant of non-exclusive licenses for its patented
V-chip technology to each of the respective manufacturers.
The Acacia Technologies group has generated substantially all of its
revenues from licensing the patented V-chip technology to television
manufacturers. Acacia Technologies group's patent on the V-chip technology
expires in July 2003. However, depending on the outcome of ongoing licensing
efforts and related infringement actions, the Acacia Technologies group may
continue to collect license fees on televisions sold in the United States during
the patent term, subsequent to the July 2003 patent expiration date. The Acacia
Technologies group is beginning to market its DMT technology and is looking to
acquire other technologies. Acacia Technologies group's digital media
transmission patent portfolio expires in 2011 in the U.S. and in 2012 in
international markets. If we do not succeed in acquiring such technologies or
are unable to commercially license our existing and future technologies, our
financial condition may be adversely impacted.
PRODUCT REVENUES AND COST OF SALES. In 2002, product revenues were $0.3
million, as compared to zero in 2001, with related cost of sales of $0.3 million
and zero for the same periods. Product revenues and cost of sales were
recognized by the CombiMatrix Corporation's Japanese subsidiary from the sale of
a genomics microarray synthesizer and related microarray products and services
to two Japanese institutions.
GRANT REVENUE. In each of 2002 and 2001, grant revenue was $0.5
million. Grant revenue in 2002 includes $0.3 million in grant revenue from
CombiMatrix Corporation's continuing performance under its Phase II SBIR
Department of Defense contract, $141,000 in one-time contract research and
development revenues and $100,000 in revenue related to performance under its
41
Phase I National Institutes of Health, or NIH, grant. Grant revenue for 2001
related to CombiMatrix Corporation's continued performance under its Phase II
SBIR contract. The Department of Defense and NIH grants were completed during
2002.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. In 2002, research and development
expenses were $18.2 million, as compared to $11.7 million in 2001. This increase
was primarily due to increased activities driven by the CombiMatrix group's
continuing performance obligations under the product commercialization phase of
its license and research and development agreements with Roche. These activities
include increases in labor, supplies and materials, development of prototype
microarrays and instruments, and the use of outside consultants for certain
engineering efforts. Since July 2001, most of the CombiMatrix Corporation's
research and development efforts have been driven by obligations under its
agreements with Roche. These projects include development of production
microarray synthesis techniques, development of higher density microarrays and
related instrumentation and software. These projects are expected to continue
into 2005 as determined by the timelines specified in the agreements with Roche.
CHARGE FOR ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Operating
expenses in 2002 include a non-cash charge for acquired in-process research and
development of $17.2 million, related to Acacia Research Corporation's purchase
of the stockholder interests in CombiMatrix Corporation that we did not already
own. See "Critical Accounting Policies" for a discussion of the allocation of
the purchase price and the accounting for acquired in-process research and
development.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. In 2002, marketing,
general and administrative expense was $18.6 million ($9.1 million related to
CombiMatrix Corporation), as compared to $32.7 million ($14.9 million related to
CombiMatrix Corporation) in 2001. The decrease in marketing, general and
administrative expenses for 2002, as compared to 2001, was primarily due to a
decrease in V-chip license fee revenues and related contingent legal fees
expense in 2002. Legal fees related to the license fee agreements executed with
television manufacturers are generally incurred on a contingency basis, based on
license fee payments received. Contingent legal fees incurred were not material
in 2002, as compared to $11.0 million in 2001. The decrease in marketing,
general and administrative expenses in 2002 was offset by a $2.0 million
increase in personnel, legal and consulting fees incurred in connection with
ongoing DMT patent marketing and commercialization efforts, including patent
claims construction, patent prosecution and related research and engineering
costs and $1.3 million in professional fees incurred in connection with the
preparation and filing of our registration statement with the SEC on Form S-4
related to the recapitalization and merger transactions discussed elsewhere
herein. This decrease was also due primarily to reductions in the CombiMatrix
group's sales and marketing staff and related expenses, decreased recruitment
and relocation expenses and reduced legal fees incurred during 2002 compared to
2001, primarily as a result of settling the litigation with Nanogen. This
overall decrease in general and administrative expenses was partially offset by
an increase in CombiMatrix Corporation's rent and utilities expenses as a result
of the increase in occupancy of its headquarters in Mukilteo, Washington.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. In 2002, research and development
related non-cash stock compensation charges, all of which relate to CombiMatrix
Corporation, were $1.9 million, as compared to $7.2 million in 2001.
MARKETING, GENERAL AND ADMINISTRATIVE. In 2002, marketing,
general and administrative non-cash stock compensation charges, primarily
related to CombiMatrix Corporation, were $4.6 million, as compared to $13.6
million in 2001.
The decrease in non-cash stock compensation charges related to research
and development and marketing, general and administrative expenses is primarily
due to the forfeiture and cancellation of certain options in the third and
fourth quarters of 2001 and a reduction in scheduled stock compensation
amortization related to the accelerated method of amortization utilized by us
pursuant to FIN No. 28, which results in higher amounts of amortization in the
early vesting periods, and lower amounts of amortization in subsequent vesting
periods. CombiMatrix Corporation non-cash stock compensation amortization
expense is net of $1.2 million and $4.7 million in stock compensation expense
reversals related to the forfeiture of certain unvested stock options during
2002 and 2001, respectively.
AMORTIZATION OF PATENTS AND GOODWILL. In 2002, amortization expense was
$2.0 million, as compared to $2.7 million in 2001. Amortization expense relating
to patents and goodwill in 2001 includes $1.1 million of goodwill amortization
expense. Effective January 1, 2002, pursuant to SFAS No. 142, goodwill is
required to be tested for impairment at least annually and written off when
determined to be impaired, rather than being amortized as previous standards
required. The reduction in goodwill amortization was offset by an increase in
patent amortization related to the increase in our ownership interest in Acacia
42
Media Technologies Corporation from 33% to 100% in November 2001. As a result of
the purchase, we will be recording additional patent amortization of
approximately $0.5 million on an annual basis (over the related patents'
economic useful life of approximately 10 years) related to the patent intangible
asset identified in connection with the application of the purchase method of
accounting. Patent amortization expense in future periods will also increase as
a result of the increase in our ownership interest in CombiMatrix Corporation
from 48% to 100% in December 2002. As a result of the step acquisition, we will
record additional amortization expense of approximately $0.8 million on an
annual basis (over the economic useful life of approximately 7 years), related
to the core technology patent intangible asset identified in connection with the
application of the purchase method of accounting.
LEGAL SETTLEMENT CHARGES. On September 30, 2002, CombiMatrix
Corporation and Dr. Donald Montgomery, an officer and stockholder of CombiMatrix
Corporation, entered into a settlement agreement with Nanogen to settle all
pending litigation between the parties. CombiMatrix Corporation agreed to pay
Nanogen $1.0 million and issued 4,016,346 shares, or 17.5% of its outstanding
shares post issuance, to Nanogen. The $1.0 million in payments have been
expensed in the consolidated statement of operations for the year ended December
31, 2002 under "legal settlement charges." The issuance of the CombiMatrix
Corporation common shares in settlement of the litigation with Nanogen has been
accounted for as a nonmonetary transaction. Accordingly, included in "legal
settlement charges" in the consolidated statements of operations for the year
ended December 31, 2002 is a non-cash charge in the amount of $17.5 million
based on the fair value of the CombiMatrix Corporation common shares issued to
Nanogen. The fair value of the common shares issued was based on an independent
third-party valuation of CombiMatrix Corporation as of September 30, 2002, the
date of the settlement agreement. Refer to Item 3 "Legal Proceedings," for a
description of additional settlement terms.
OTHER (EXPENSE) INCOME, NET
OTHER (EXPENSE) INCOME, NET. In 2002, other expense, net (primarily
comprised of an impairment charge on our cost method investment, interest
income, realized and unrealized gains and losses on trading securities, equity
in losses of affiliate and other) was $3.1 million, as compared to $4.2 million
in net other income in 2001.
IMPAIRMENT OF COST METHOD INVESTMENT. In September 2002, we
recorded an impairment charge of $2.7 million for an other-than-temporary
decline in the fair value of our cost method investment. Impairment indicators
included recurring losses, a decline in working capital and the completion of a
recent equity transaction with a shareholder at an amount below our carrying
value. The fair value of our cost method investment was determined by reference
to available financial and market information.
INTEREST INCOME. In 2002, interest income was $1.2 million, as
compared to $3.8 million in 2001. The decrease in interest income during 2002
was primarily due to a decrease in cash balances related to operating cash
outflows and the impact of a decrease in interest rates on our short-term
investments as a result of sharp interest rate cuts by the Federal Open Market
Committee and other external economic factors negatively impacting rates of
return on short-term investments occurring during late 2001 and continuing in
2002.
REALIZED (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. In 2002,
net realized losses on short-term investments was $1.2 million, as compared to
$0.4 million in net realized gains on short-term investments in 2001. The
increase in realized losses on short-term investments during 2002 was due to
realized losses recorded on certain trading securities during 2002.
UNREALIZED (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. In 2002,
net unrealized losses were $0.2 million, as compared to $0.2 million in net
unrealized gains in 2001. Net unrealized losses in 2002 are due to the sale of
the balance of our trading securities during 2002.
EQUITY IN LOSSES OF AFFILIATE. In 2002, equity in losses of
affiliate was zero, as compared to $0.2 million in 2001. Equity in losses of
affiliate during 2001 was comprised of losses recorded for our equity investment
in Acacia Media Technologies Corporation. As of December 31, 2001, we no longer
account for any of our investments under the equity method as we own 100% of our
principal operating subsidiaries.
BENEFIT (PROVISION) FOR INCOME TAXES. In 2002, the income tax benefit
was $0.9 million, as compared to a tax provision of $0.8 million in 2001. Acacia
Research Corporation had tax losses in 2002, as compared to 2001, which had
taxable income relating principally to license income generated by Soundview
Technologies. The 2002 income tax benefit relates principally to differences
between the 2001 provision and Acacia Research Corporation's final 2001 return
filed in September 2002, and is the result of additional deductions against
Soundview Technologies taxable income and the reversal of deferred tax
liabilities related to the amortization of identifiable intangible assets
related to certain of Acacia Research Corporation's step acquisitions during
2001 and 2000.
43
MINORITY INTERESTS. Minority interests in the losses of consolidated
subsidiaries was $23.8 million in 2002, as compared to $17.5 million in 2001.
Minority interests in the losses of consolidated subsidiaries in 2002 and 2001
were primarily comprised of minority interests in the net losses of CombiMatrix
Corporation totaling $23.6 million and $18.8 million, respectively. In 2001,
minority interests in the losses of consolidated subsidiaries was partially
offset by minority interests in the net income of Soundview Technologies
totaling $1.3 million. The increase in minority interests in the losses of
consolidated subsidiaries in 2002 is primarily due to the impact of a legal
settlement charge in the amount of $18.5 million recorded by CombiMatrix
Corporation in September 2002. Excluding the impact of the legal settlement
charge and the acquired IPR&D charge recorded subsequent to Acacia Research
Corporation's acquisition of the outstanding ownership interests in CombiMatrix
Corporation in December 2002, minority interests in the losses of the
CombiMatrix group decreased due to a reduction in the losses recorded by the
CombiMatrix group during 2002, as compared to 2001. As a result of our merger
with CombiMatrix Corporation, which increased our ownership interest to 100%
discussed elsewherein, we will no longer record minority interests related to
our investment in CombiMatrix Corporation in future periods.
DISCONTINUED OPERATIONS. On February 13, 2001, the board of directors
of Soundbreak.com resolved to cease operations as of February 15, 2001 and
liquidate the remaining assets and liabilities of the company. Accordingly, we
reported the results of operations and the estimated loss on disposal of
Soundbreak.com as results of discontinued operations in the consolidated
statements of operations and comprehensive loss in 2000. In September 2002, we
accrued an additional $0.5 million ($0.2 million after minority interests) in
estimated costs to be incurred in connection with the disposal of
Soundbreak.com. The additional accrual relates primarily to certain
non-cancelable lease obligations and the inability to sublease the related
office space at rates commensurate with our existing obligations.
2001 COMPARED TO 2000
REVENUES
LICENSE FEE INCOME. In 2001, license fee income was $24.2 million, as
compared to zero in 2000. The increase in license fee income for 2001 resulted
primarily from the settlement of patent infringement litigation brought by
Soundview Technologies and includes license fee amounts received from eleven of
the twelve television manufacturers with whom we have executed separate
settlement and/or license agreements. Pursuant to the terms of the respective
settlement and license agreements with each of the television manufacturers,
Soundview Technologies granted to such manufacturers non-exclusive licenses for
its U.S. Patent No. 4,554,584.
GRANT REVENUE. In 2001, grant revenue was $0.5 million, as compared to
$17,000 in 2000. The increase in grant revenue during 2001 resulted from
CombiMatrix Corporation's continuing performance under its Phase II SBIR
Department of Defense contract.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES. In 2001, research and development
expense was $11.7 million, all of which related to CombiMatrix Corporation, as
compared to $8.5 million in 2000, of which $5.9 million related to CombiMatrix
Corporation. The increase in research and development expense for 2001, as
compared to the same period in 2000 was primarily due to a general expansion of
CombiMatrix Corporation's research and development activities, including an
increase in personnel and amounts of supplies and materials used, increased
costs related to efforts to further develop and enhance its microarray
technology and increased costs related to significant engineering efforts
undertaken to productize its technology. Most of these efforts were driven by
CombiMatrix Corporation's obligations under the license and supply agreement
with Roche, executed in July 2001. These projects include development of
production microarray synthesis techniques, as well as higher density
microarrays. Research and development expenses for 2000 include a non-cash
charge for acquired IPR&D of $2.5 million.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and
administrative expenses were $32.7 million ($14.9 million related to CombiMatrix
Corporation) in 2001, as compared to $14.8 million ($4.6 million related to
CombiMatrix Corporation) in 2000. The increase in marketing, general and
administrative expenses for 2001, as compared to the same period in 2000 was
primarily due to the continued expansion of CombiMatrix Corporation's operations
including an increase in salaries and benefits due to an increase in the number
of CombiMatrix Corporation personnel, an increase in personnel recruitment and
relocation expenses, an increase in rent and utilities expenses relating to
CombiMatrix Corporation's move to larger office facilities during the first
quarter of 2001, the write-off of $1.4 million of deferred initial public
offering costs in the fourth quarter of 2001 by CombiMatrix Corporation and an
increase in legal fees related to Soundview Technologies' patent licensing and
related infringement settlements.
44
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. In 2001, research and development
related non-cash stock compensation charges, all of which relate to CombiMatrix
Corporation, were $7.2 million, as compared to $3.4 million in 2000. Research
and development related non-cash stock compensation charges for 2001 are net of
$0.8 million of non-cash stock compensation expense reversal related to the
forfeiture of certain unvested stock options during the third and fourth
quarters of 2001.
MARKETING, GENERAL AND ADMINISTRATIVE. In 2001, marketing,
general and administrative non-cash stock compensation charges, primarily
related to CombiMatrix Corporation, were $13.6 million, as compared to $7.3
million in 2000. Marketing, general and administrative non-cash stock
compensation charges for 2001 are net of $3.9 million of non-cash stock
compensation expense reversal related to the forfeiture of certain unvested
stock options during the third and fourth quarters of 2001.
Amortization of deferred stock compensation is amortized on an
accelerated basis over the vesting period of the individual option awards using
the amortization method prescribed in FIN No. 28. The increase in deferred stock
compensation amortization in 2001 was due to higher amounts of deferred stock
compensation charges scheduled to be amortized in 2001, as compared to 2000
related to $53.8 million of deferred stock compensation originally recorded in
the third and fourth quarters of 2000.
AMORTIZATION OF PATENTS AND GOODWILL. In 2001, amortization expense
relating to patents and goodwill was $2.7 million, as compared to $2.3 million
in 2000. As a result of the increase in our ownership interest in Acacia Media
Technologies, from 33% to 100% through the purchase of the ownership interest of
Acacia Media Technologies' other member in November 2001, and the purchase of
additional equity interests in CombiMatrix Corporation in July 2000, we incurred
additional amortization expense in 2001, as compared to 2000 relating to the
intangible assets acquired. See "Recent Accounting Pronouncements" for summary
of pronouncements affecting amortization of goodwill in future periods.
LOSS ON DISPOSAL OF CONSOLIDATED SUBSIDIARIES. In 2001, loss on
disposal of consolidated subsidiaries was zero, as compared to $1.0 million in
2000. In the fourth quarter of 2000, we recorded $1.0 million in write-offs of
early stage investments.
OTHER INCOME (EXPENSE), NET
OTHER INCOME (EXPENSE), NET. In 2001, other income, net (primarily
comprised of interest income, realized and unrealized gains and losses on
trading securities, equity in losses of affiliates and other) was $4.2 million,
as compared to $1.2 million in net other expense in 2000.
INTEREST INCOME. In 2001, interest income was $3.8 million, as
compared to $3.1 million in 2000. The increase in interest income during 2001
was due to higher cash balances during 2001, as compared to 2000, resulting from
various private equity financings and the receipt of significant license fee
payments by Soundview Technologies during the year. The increase in interest
income for 2001 was partially offset by the impact of a decrease in interest
rates on our short-term investments related to sharp interest rate cuts by the
Federal Open Market Committee and other external economic factors negatively
impacting rates of return on short-term investments occurring during the third
and fourth quarters of 2001.
REALIZED GAINS ON SHORT-TERM INVESTMENTS. In 2001, net realized
gains on short-term investments was $0.4 million, as compared to zero in 2000.
The increase in realized gains on short-term investments during 2001 was due to
realized gains recorded on our short-term investments classified as trading
securities during 2001.
UNREALIZED GAINS ON SHORT-TERM INVESTMENTS. In 2001, net
unrealized gains were $0.2 million, as compared to zero in 2000. The increase is
due to our investment in equity securities during 2001 classified as trading
securities under SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," or SFAS No. 115. Pursuant to SFAS No. 115, unrealized gains
and losses on trading securities are recorded in the consolidated statement of
operations. In 2000, all of our short-term investments were classified as
available-for-sale, and pursuant to SFAS No. 115, unrealized gains and losses
were recorded as a separate component of comprehensive income (loss) in
stockholders' equity until realized.
45
EQUITY IN LOSSES OF AFFILIATES. In 2001, equity in losses of
affiliates was $0.2 million, as compared to $1.7 million in 2000. Losses during
2001 were comprised of a loss of $0.2 million for our investment in Acacia Media
Technologies, as determined by the equity method of accounting through November
1, 2001. We increased our ownership percentage in Acacia Media Technologies to
100% on November 1, 2001. Losses during 2000 were comprised of a loss of $0.3
million for our investment in Signature-mail.com, a loss of $0.2 million for our
investment in Acacia Media Technologies, a loss of $143,000 for our investment
in Whitewing Labs and a loss of $1.1 million for our investment in Mediaconnex,
as determined by the equity method of accounting. We wrote-off our equity
investments in Signature-mail.com, Whitewing Labs and Mediaconnex as of December
31, 2000.
MINORITY INTERESTS. In 2001, minority interests in the losses of
consolidated subsidiaries were $17.5 million, as compared to $9.2 million in
2000. The increase in minority interests in 2001 was primarily due to the
increase in losses incurred by CombiMatrix Corporation as a result of increased
non-cash stock compensation amortization charges, its continued expansion of
research and development efforts and increased marketing, general and
administrative expenses. The increase in 2001 minority interests resulting from
CombiMatrix Corporation's increased losses was partially offset by minority
interests in the income of Soundview Technologies from January through June
2001. We increased our ownership percentage in Soundview Technologies to 100% in
June 2001.
(PROVISION) BENEFIT FOR INCOME TAXES. In 2001, the provision for income
taxes was $0.8 million, as compared to a benefit of $73,000 in 2000. The
increase in the provision for income taxes in 2001 was primarily due to a
significant increase in taxable income generated by Soundview Technologies
related to its patent infringement settlement and patent licensing activities,
as compared to the 2000 period.
DISCONTINUED OPERATIONS. On February 13, 2001, the board of directors
of Soundbreak.com resolved to cease operations as of February 15, 2001 and
liquidate the remaining assets and liabilities of the company. Accordingly, we
reported the results of operations and the estimated loss on disposal of
Soundbreak.com as results of discontinued operations in our 2000 consolidated
statement of operations and comprehensive loss. Discontinued operations of
Soundbreak.com included $7.4 million of loss from discontinued operations in
2000 and $2.1 million of accrued expenses in connection with its cessation of
operations.
INFLATION
Inflation has not had a significant impact on Acacia Research
Corporation.
LIQUIDITY AND CAPITAL RESOURCES
Acacia Research Corporation's consolidated cash and cash equivalents
along with short-term investments totaled $54.7 million at December 31, 2002
compared to $84.6 million at December 31, 2001. Working capital at December 31,
2002 was $41.0 million compared to $72.4 million at December 31, 2001.
Net cash used in continuing operating activities in 2002 was $19.7
million compared to $10.4 million in 2001. The increase was primarily
attributable to increased losses from continuing operations, partially offset by
an increase in working capital resulting principally from deferred revenues from
Roche of $11.6 million in 2002 compared to $7.5 million in 2001 and net sales of
trading securities in 2002 of $4.1million compared to net purchases of trading
securities of $4.1 million in 2001.
Net cash flows provided by continuing investing activities decreased to
$7.0 million in 2002 compared to $13.0 million in 2001 as a result of less cash
available from net sales of short-term investments of $9.0 million in 2002
compared to $19.6 million in 2001, which was partially offset by additional
investments in majority-owned subsidiaries in 2001 of $5.9 million.
Net cash used in financing activities was $2.9 million in 2002 compared
to net cash provided by financing activities of $23.2 million 2001. In 2002, net
cash used in financing activities primarily related to the repayment of a
capital lease obligation of $2.8 million. In 2001, net cash used in financing
activities primarily reflects $18.3 million in proceeds from the sale of our
securities, capital from minority shareholders in our subsidiary, Advanced
Material Sciences, of $3.3 million and proceeds from stock option exercises of
$1.8 million.
At December 31, 2000, Acacia Research Corporation's consolidated cash
and cash equivalents and short-term investments totaled $76.8 million and
working capital totaled $60.1 million. During 2000, cash used in continuing
operations of $17.9 million was offset by proceeds from issuance of our common
stock of $22.2 million, capital from minority shareholders in our subsidiaries,
CombiMatrix Corporation and Advanced Material Sciences, of $37.3 million and
proceeds from stock option and warrant exercises of $17.8 million, partially
offset by net purchases of available for sale securities of $39.6 million.
46
Outstanding warrant exercise prices and redemption provisions have been
adjusted to reflect the recapitalization discussed elsewhere herein. As a result
of the recapitalization, warrants issued by us in connection with our private
placement completed in January 2001 contain adjusted separate and independent
call and redemption provisions if the closing bid price of the AR-Acacia
Technologies stock or the AR-CombiMatrix stock exceeds $16.53 or $13.13,
respectively, per share for 20 or more consecutive trading days. The exercise
price per share for the AR-Acacia Technologies stock and the AR-CombiMatrix
stock underlying the warrants is $13.23 and $10.50, respectively. Warrants
issued by us in connection with our private placement completed in the third
quarter of 2000 contain separate and independent call and redemption provisions
if the closing bid price of the AR-Acacia Technologies stock or the
AR-CombiMatrix stock exceeds $24.94 or $19.81, respectively, per share for 20 or
more consecutive trading days. The exercise price per share for the AR-Acacia
Technologies stock and the AR-CombiMatrix stock underlying the warrants is
$20.79 and $16.51, respectively. In the event the requirements to call the
warrants are satisfied, we may call such warrants and we expect most, if not
all, of the holders to exercise such warrants in response. There can be no
assurance that the closing bid price of our common stock will exceed all such
thresholds or that, if it does, we will decide to call the warrants.
We have sustained losses since our inception contributing to an
accumulated deficit of $159.0 million on a consolidated basis, which includes
net losses of $59.0 million, $22.3 million and $39.0 million in 2002, 2001 and
2000, respectively. Net losses include significant non-cash acquired in-process
research and development, litigation and stock compensation charges reflected in
the accompanying Acacia Research Corporation consolidated results of operations
data for 2002, 2001 and 2000. The consolidated accumulated deficit of $159.0
million also includes an increase related to a reclassification of accumulated
deficit in the amount of $21.7 million to permanent capital representing the
fair value of the ten percent (10%) stock dividend distributed to stockholders
in 2001.
There can be no assurance that we will become profitable. If we do, we
may never be able to sustain profitability. We expect to incur significant
losses for the foreseeable future. We are making efforts to reduce expenses and
may take steps to raise additional capital.
We have no commitments for capital expenditures in 2002. Our minimum
rental commitments on operating leases related to continuing operations total
$10.6 million through December 2007. We have no committed lines of credit or
other committed funding or long-term debt. CombiMatrix Corporation paid the
remaining balance of its capital lease obligation on November 1, 2002.
Management believes that our cash and cash equivalent balances, anticipated cash
flow from operations and other external sources of available credit will be
sufficient to meet our cash requirements for the foreseeable future.
There can be no assurances that we will not encounter unforeseen
difficulties that may deplete our capital resources more rapidly than
anticipated. Any efforts to seek additional funding could be made through
equity, debt or other external financing and there can be no assurance that
additional funding will be available on favorable terms, if at all. Such
financing transactions may be dilutive to existing investors. If we fail to
obtain additional funding when needed, we may not be able to execute our
business plans and our business may suffer.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 to the Acacia Research Corporation consolidated
financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is limited primarily to interest income
sensitivity, which is affected by changes in the general level of United States
interest rates, particularly because a significant portion of our investments
are in short-term debt securities issued by the U.S. government, U.S.
corporations, institutional money market funds and other money market
instruments. The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income received without
significantly increasing risk. To minimize risk, we maintain a portfolio of
cash, cash equivalents and short-term investments in a variety of
investment-grade securities and with a variety of issuers, including corporate
notes, commercial paper and money market instruments. Due to the nature of our
short-term investments, we believe that we are not subject to any material
market risk exposure. We do not have any derivative financial instruments.
47
CHANGE IN ACCOUNTING POLICY
Effective January 1, 2001, we changed our accounting policy for balance
sheet classification of employee stock-based compensation resulting from awards
in consolidated subsidiaries. Historically, the consolidated financial
statements have accounted for cumulative earned employee stock-based
compensation related to subsidiaries as a liability, under the caption "accrued
stock compensation." Management believes a change to reflect these cumulative
charges as minority interests is preferable as it better reflects the underlying
economics of the stock-based compensation transaction. As a result of the
change, effective January 1, 2001, minority interests has been increased by
$10.4 million, and accrued stock compensation of $10.4 million has been
decreased. The change in accounting policy does not affect previously reported
consolidated net income.
48
DISCUSSION OF SEGMENTS' OPERATIONS, FINANCIAL RESOURCES AND LIQUIDITY
COMBIMATRIX GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE COMBIMATRIX
GROUP, A DIVISION OF ACACIA RESEARCH CORPORATION, FINANCIAL STATEMENTS AND
RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED FINANCIAL
STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS
AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE OF OPERATING RESULTS
FOR ANY FUTURE PERIODS.
GENERAL
The CombiMatrix group, a division of Acacia Research Corporation, is
comprised of CombiMatrix Corporation and its majority-owned subsidiaries,
CombiMatrix KK and Advanced Material Sciences, and includes all corporate
assets, liabilities and transactions related to Acacia Research Corporation's
life sciences businesses. The CombiMatrix group's core technology opportunity in
the life sciences sector has been primarily developed through CombiMatrix
Corporation, which was formed in October 1995. CombiMatrix Corporation is a life
sciences technology company with a proprietary system for rapid, cost
competitive creation of DNA and other compounds on a programmable semiconductor
chip. This proprietary technology has significant applications relating to
genomic and proteomic research. Advanced Material Sciences, a development stage
company, holds the exclusive license for CombiMatrix Corporation's biological
array processor technology in certain fields of material sciences. Advanced
Material Sciences has no operating history, and subsequent to April 2002 is a
majority-owned subsidiary of CombiMatrix Corporation. CombiMatrix KK, a
majority-owned Japanese corporation, is exploring opportunities for CombiMatrix
Corporation's active biochip system with academic, pharmaceutical and
biotechnology organizations in the Asian market.
Although AR-CombiMatrix stock is intended to reflect the separate
performance of the respective division of Acacia Research Corporation, rather
than the performance of Acacia Research Corporation as a whole, the CombiMatrix
group is not a separate legal entity. Holders of AR-CombiMatrix stock are
stockholders of Acacia Research Corporation. As a result, they continue to be
subject to all of the risks of an investment in Acacia Research Corporation and
all of its businesses, assets and liabilities. The assets Acacia Research
Corporation attributes to the CombiMatrix group could be subject to the
liabilities of the Acacia Technologies group.
The CombiMatrix group is developing technology that integrates a
semiconductor, proprietary materials, proprietary software, chemistry, and the
Internet into a system for use by pharmaceutical and biotechnology companies and
academic researchers in identifying and determining the roles of genes, gene
mutations and proteins. CombiMatrix Corporation's active biochip is a
semiconductor coated with a three-dimensional layer of porous material in which
DNA, RNA, peptides or small molecules can be synthesized or immobilized in
discrete test sites. Since inception, the CombiMatrix group's operating
activities have been devoted primarily to research and development of
technologies for its active biochip system, including the development of its
system, acquiring assets, recruiting personnel, business development and raising
capital.
During 2002, the CombiMatrix group's financial condition and results of
operations were highlighted by the receipt of $0.5 million in grant and contract
revenues, including $0.3 million in grant revenue resulting from completion of
its Phase II SBIR Department of Defense contract, $141,000 in one-time contract
research and development revenues and $100,000 in revenue related to performance
and completion of its Phase I NIH grant. The CombiMatrix group also recognized
$0.3 million from the sale of a genomics microarray synthesizer system and
related microarray products to two institutions in Japan. Also during 2002, the
CombiMatrix group received $11.5 million in milestone payments pursuant to its
license and supply and research and development agreements with Roche, which
have been recorded as deferred revenues. During the fourth quarter of 2002, the
CombiMatrix group repaid its remaining $2.1 million outstanding balance on a
capital lease obligation with a financial institution. During April 2002,
CombiMatrix Corporation acquired Acacia Research Corporation's majority
ownership interest in Advanced Material Sciences by issuing 180,982 shares of
CombiMatrix Corporation's common stock.
In 2001, the CombiMatrix group's financial condition and cash flows
were highlighted by the receipt of $6.4 million pursuant to separate license and
supply and research and development agreements with Roche and NASA, as well as
continued performance under CombiMatrix Corporation's Phase II SBIR grant with
the Department of Defense. Both the Roche and NASA agreements were executed
during the third quarter of 2001. During the second quarter of 2001, CombiMatrix
Corporation created a wholly owned subsidiary, CombiMatrix KK, which became a
majority-owned subsidiary during the fourth quarter of 2001 after selling 10% of
its common stock for $1.1 million as part of a joint venture agreement with
49
Marubeni Japan, one of Japan's leading trading companies. In addition, in the
third quarter of 2001 CombiMatrix Corporation raised $3.0 million through the
execution of a sale and leaseback transaction with a financial institution.
CombiMatrix Corporation also continued the expansion of its research and
development activities throughout 2001, including the relocation to its new
research facilities and corporate headquarters in January 2001 located in
Mukilteo, Washington. In addition, in May 2001, Advanced Material Sciences
completed a private equity financing raising gross proceeds of $2.0 million
through the issuance of 2,000,000 shares of common stock.
In 2000, the CombiMatrix group's financial condition and cash flows
were highlighted primarily by the continued expansion of research and
development activities, financing activities and the building of its core
management and scientific teams, as well as its relocation from California to
temporary research facilities and corporate headquarters in Snoqualmie,
Washington. In July 2000, CombiMatrix Corporation was granted U.S. Patent No.
6,093,302, which expires in July 2017, for its biochip microarray processor
system. In November 2000, Advanced Material Sciences was formed, raising initial
equity financing of $3.0 million. In 1999, the CombiMatrix group's financial
condition and cash flows were highlighted primarily by research and development
and financing activities. In the following discussion and analyses, the
period-to-period comparisons must be viewed in light of the impact that the
operating and financing activities have had on the CombiMatrix group's financial
condition and results of operations.
During 2002, the CombiMatrix group emerged from the development stage
as it began commencement of its planned principal operations and from which it
generated revenues.
Since inception, the CombiMatrix group has incurred significant net
losses. During the years ended December 31, 2002, 2001 and 2000, the CombiMatrix
group incurred net losses of approximately $46.2 million, $28.0 million and
$14.8 million, respectively. At December 31, 2002 and 2001, the CombiMatrix
group's accumulated deficit was approximately $94.0 million and $47.8 million,
respectively. The losses have resulted principally from costs incurred in
research and development and from marketing, general and administrative costs
associated with the CombiMatrix group's operations. Operating expenses including
non-cash stock-based compensation expense increased to $71.3 million for the
year ended December 31, 2002, from $49.5 million for 2001 and $24.6 million for
2000. Operating expenses for 2002 include one-time charges of $17.2 million and
$18.5 million relating to acquired in-process research and development and
litigation settlement charges, respectively. The CombiMatrix group expects to
continue to incur net losses and negative cash flow from operations for the
foreseeable future due to significant increases in research and development and
marketing, general and administrative expenses that will be necessary to further
develop CombiMatrix group's technologies towards commercialization. To date, the
CombiMatrix group has relied primarily upon selling equity securities, as well
as payments from strategic partners to generate the funds needed to finance the
implementation of the CombiMatrix group's business strategies. The CombiMatrix
group cannot assure that it will not encounter unforeseen difficulties that may
deplete capital resources more rapidly than anticipated. Any efforts to seek
additional funds could be made through equity, debt or other external
financings; however, the CombiMatrix group cannot assure that additional funding
will be available on favorable terms, if at all. If the CombiMatrix group fails
to obtain additional funding when needed, the CombiMatrix group may not be able
to execute its business strategies and its business may suffer.
STRATEGIC PARTNERSHIPS AND FINANCIAL HIGHLIGHTS
During 2002, the CombiMatrix group received significant payments from
its strategic partners and licensees. By continuing the CombiMatrix group's
efforts with these partners and by identifying new strategic relationships, the
CombiMatrix group intends to maximize the opportunities in the life sciences
sector that will be created by commercializing its biochip system. Highlights of
activities with the CombiMatrix group's strategic partners and other operating
activities for the year ended December 31, 2002 include:
50
o In September 2002, CombiMatrix Corporation amended and
restated its non-exclusive worldwide license and supply and
research and development agreements with Roche, pursuant to
which CombiMatrix Corporation and Roche will develop a
platform technology, providing a range of standardized
biochips for use in research applications. The agreements were
originally executed in July 2001. Under the agreements, Roche
has made cash payments to CombiMatrix Corporation of $11.5
million and $5.3 million during the years ended December 31,
2002 and 2001, respectively, and will continue to make
payments for the deliverables stipulated and for expanded
license and manufacturing rights. Under the terms of the
revised agreements, it is contemplated that Roche will
co-develop, use, manufacture, market and distribute
CombiMatrix Corporation's active biochip system for rapid
production of both catalog and customizable biochips.
CombiMatrix Corporation's goal is to develop a platform
technology, providing a range of standardized biochips for use
in important research applications. Roche has made and will
continue to make payments for the deliverables contemplated
and for expanded license rights. The agreements provide for
minimum payments by Roche to CombiMatrix Corporation over the
first three years, including milestone achievement payments,
payments for products, royalties and payments for research and
development projects. All payments received under this
agreement to date have been recorded as deferred revenue at
December 31, 2002. To date, CombiMatrix Corporation has
completed several strategic milestones in its strategic
alliance with Roche, by developing and delivering prototype
components of its microarray platform and by demonstrating
several key performance metrics of its custom in-situ
microarray system.
o In February 2002, CombiMatrix Corporation was awarded a
$100,000 Phase I National Institutes of Health grant for the
development of its protein biochip technology. The title of
the grant is "Self-Assembling Protein Microchips." This grant
was completed and all payments were received by August 2002.
During 2002 and 2001, CombiMatrix Corporation recognized $0.3
million and $0.5 million, respectively, of grant revenues from
its SBIR Phase II grant with the Department of Defense.
CombiMatrix Corporation's business relationship with the
Department of Defense began in July 1999 when CombiMatrix
Corporation was awarded an SBIR Phase I grant to use its
active biochip technology in connection with the development
of detection devices for chemical and biological warfare
agents. CombiMatrix Corporation was also awarded a $100,000
Department of Energy grant in July 1999, which was completed
in March 2000. In July 2000, CombiMatrix Corporation was
awarded a two-year $0.7 million SBIR Phase II grant to
continue its research for the Department of Defense. A
prototype electrochemical biological detection system
developed from this grant was demonstrated and delivered to
the Department of Defense in July 2002, thereby completing
this SBIR grant.
o In May 2001, CombiMatrix Corporation formed CombiMatrix KK, a
Japanese corporation located in Tokyo. In October 2001,
CombiMatrix KK entered into a joint venture agreement with
Marubeni Japan, the purpose of which is to focus on
development and licensing opportunities for CombiMatrix
Corporation's active biochip system with academic,
pharmaceutical and biotechnology organizations in the Asian
market. Marubeni Japan made a $1.1 million investment to
acquire a 10% minority interest in the joint venture. During
2002, CombiMatrix KK executed technology access and purchase
agreements with two government institutions in Japan, which
included the sale of a genomic microarray synthesizer system
and related microarray products and services totaling $0.3
million to these institutions.
51
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS (IN THOUSANDS) 2002 2001 2000
--------- --------- ---------
Product revenue .................................................. $ 306 $ -- $ --
Grant and contract revenue ....................................... 533 456 17
Cost of sales .................................................... (263) -- --
Research and development expenses ................................ (18,187) (11,656) (5,907)
Charge for acquired in-process research and development .......... (17,237) -- (2,508)
Non-cash stock compensation expenses - research and development .. (1,868) (7,183) (3,397)
Marketing, general and administrative expenses ................... (10,334) (16,690) (5,524)
Non-cash stock compensation expenses - marketing, general and
administrative ................................................. (4,540) (12,780) (6,598)
Amortization of patents and goodwill ............................. (399) (1,203) (640)
Legal settlement charges ......................................... (18,471) -- --
Other income, net ................................................ 392 2,055 1,662
Benefit for income taxes ......................................... 147 155 79
Minority interests ............................................... 23,702 18,817 8,300
Cumulative effect of change in accounting principle .............. -- -- (246)
--------- --------- ---------
Division net loss ................................................ $(46,219) $(28,029) $(14,762)
========= ========= =========
2002 COMPARED TO 2001
PRODUCT REVENUES AND COST OF SALES. In 2002, product revenues were $0.3
million, as compared to zero in 2001, with related cost of sales of $0.3 million
and zero for the same periods. Product revenues and cost of sales were
recognized by the CombiMatrix group's Japanese subsidiary from the sale of a
genomics microarray synthesizer and related microarray products and services to
two Japanese institutions.
GRANT AND CONTRACT REVENUE. In each of 2002 and 2001, grant revenue
was $0.5 million. Grant revenue in 2002 includes $0.3 million in grant revenue
from CombiMatrix Corporation's continuing performance under its Phase II SBIR
Department of Defense contract, $141,000 in one-time contract research and
development revenues and $100,000 in revenue related to performance under its
Phase I National Institutes of Health, or NIH, grant. Grant revenue for 2001
related to CombiMatrix Corporation's continued performance under its Phase II
SBIR contract. The Department of Defense and NIH grants were completed during
2002.
RESEARCH AND DEVELOPMENT EXPENSES. In 2002, research and development
expenses were $18.2 million, as compared to $11.7 million in 2001. This increase
was primarily due to increased activities driven by the CombiMatrix group's
continuing performance obligations under the product commercialization phase of
its license and supply and research and development agreements with Roche. These
activities include increases in labor, supplies and materials, development of
prototype microarrays and instruments, and the use of outside consultants for
certain engineering efforts. Since July 2001, most of the CombiMatrix group's
research and development efforts have been driven by obligations under its
agreements with Roche. These projects include development of production
microarray synthesis techniques, development of higher density microarrays and
related instrumentation and software. These projects are expected to continue
into 2005 as determined by the timelines specified in the agreements.
CHARGE FOR ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Operating
expenses in 2002 include a non-cash charge for acquired in-process research and
development of $17.2 million, related to Acacia Research Corporation's purchase
of the stockholder interests in CombiMatrix Corporation that Acacia Research
Corporation did not already own. See "Critical Accounting Policies" for a
discussion of the allocation of the purchase price and the accounting for
acquired in-process research and development.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. In 2002, marketing,
general and administrative expenses were $10.3 million, as compared to $16.7
million in 2001. This decrease was due primarily to reductions in the
CombiMatrix group's sales and marketing staff and related expenses, decreased
recruitment and relocation expenses and reduced legal fees incurred during 2002,
as compared to 2001, primarily as a result of settling the litigation with
52
Nanogen. This overall decrease in general and administrative expenses was
partially offset by an increase in CombiMatrix Corporation's rent and utilities
expenses as a result of the increase in occupancy of its headquarters in
Mukilteo, Washington. Included in marketing, general and administrative expenses
are allocated corporate charges of $1.2 million in 2002 and $1.4 million in
2001. See "Critical Accounting Policies" for a description of the management
allocation policies implemented.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. In 2002 and 2001, research and
development related non-cash stock compensation charges were $1.9 million and
$7.2 million, respectively.
MARKETING, GENERAL AND ADMINISTRATIVE. In 2002 and 2001,
marketing, general and administrative related non-cash stock compensation
charges were $4.5 million and $12.8 million, respectively.
The decrease in non-cash stock compensation charges related to
research and development and marketing, general and administrative expenses is
primarily due to the accelerated method of amortization utilized by the
CombiMatrix group pursuant to FIN No. 28, which results in higher amounts of
amortization in the early vesting periods. The CombiMatrix group's non-cash
stock compensation amortization expense is net of $1.2 million and $4.7 million
in stock compensation expense reversal related to the forfeiture of certain
unvested stock options during 2002 and 2001, respectively. The CombiMatrix group
is scheduled to incur deferred stock compensation amortization charges of
approximately $3.1 million and $0.9 million in 2003 and 2004, respectively.
AMORTIZATION OF PATENTS AND GOODWILL. In 2002, amortization of patents
and goodwill was $0.4 million, as compared to $1.2 million in 2001. Amortization
expense relating to patents and goodwill in 2001 includes $0.9 million of
goodwill amortization expense. Effective January 1, 2002, pursuant to SFAS No.
142, goodwill is required to be tested for impairment at least annually and
written off when determined to be impaired, rather than being amortized as
previous standards required. Patent amortization expense in future periods will
also increase as a result of the increase in Acacia Research Corporation's
ownership interest in CombiMatrix Corporation from 48% to 100% in December 2002.
As a result of the step acquisition, the CombiMatrix group will record
additional amortization expense of $0.8 million on an annual basis (over the
economic useful life of approximately 7 years), related to the core technology
patent intangible asset identified in connection with the application of the
purchase method of accounting.
LEGAL SETTLEMENT CHARGES. On September 30, 2002, CombiMatrix
Corporation and Dr. Donald Montgomery, an officer and stockholder of CombiMatrix
Corporation, entered into a settlement agreement with Nanogen to settle all
pending litigation between the parties. CombiMatrix Corporation agreed to pay
Nanogen $1.0 million and issued 4,016,346 shares, or 17.5% of CombiMatrix
Corporation outstanding shares post issuance, to Nanogen. The $1.0 million in
payments have been expensed in the CombiMatrix group statement of operations for
the year ended December 31, 2002 under "Legal Settlement Charges." The issuance
of the CombiMatrix Corporation common shares in settlement of the litigation
with Nanogen has been accounted for as a nonmonetary transaction. Accordingly,
included in "Legal Settlement Charges" in the CombiMatrix group statements of
operations for the year ended December 31, 2002 is a non-cash charge in the
amount of $17.5 million based on the fair value of the CombiMatrix Corporation
common shares issued to Nanogen. The fair value of the common shares issued was
based on an independent third-party valuation of CombiMatrix Corporation as of
September 30, 2002, the date of the settlement agreement. Refer to "Legal
Proceedings" for a description of additional settlement terms.
OTHER INCOME, NET. In 2002, other income (comprised of interest income
and interest expense), net was $0.4 million, as compared to $2.1 million in
2001.
INTEREST INCOME. In 2002, interest income was $0.6 million, as
compared to $2.1 million in 2001. The decrease was due primarily to lower
average cash and cash equivalents balances and short-term investments in 2002 as
compared to 2001, as well as lower market interest rates earned on the
CombiMatrix group's cash and investments.
INTEREST EXPENSE. In 2002, interest expense was $0.2 million,
as compared to $65,000 in 2001. Interest expense relates to CombiMatrix
Corporation's capital lease obligation with a financial institution, which was
executed in September 2001. In November 2002, the remaining balance of this
obligation was repaid in full. The change in interest expense during 2002 and
2001 relates directly to the period of time that the obligation was outstanding
during those periods.
MINORITY INTERESTS. In 2002, minority interests in the net losses of
the CombiMatrix group were $23.7 million, as compared to $18.8 million in 2001.
The increase in 2002 is primarily due to the impact of a legal settlement charge
in the amount of $18.5 million recorded by the CombiMatrix group in September
2002. Excluding the impact of the legal settlement charge and the acquired IPR&D
charge recorded subsequent to Acacia Research Corporation's acquisition of the
53
outstanding ownership interests in CombiMatrix Corporation in December 2002,
minority interests in the losses of the CombiMatrix group decreased due to a
reduction in the losses recorded by the CombiMatrix group during 2002, as
compared to 2001. As a result of Acacia Research Corporation's merger with
CombiMatrix Corporation, which increased Acacia Research Corporation's ownership
interest to 100%, the CombiMatrix group will no longer record minority interests
related to Acacia Research Corporation's investment in CombiMatrix Corporation
in future periods.
2001 COMPARED TO 2000
REVENUES. In 2001, revenues were $0.5 million, as compared to $17,000
in 2000. Revenues recognized in 2001 relate to the CombiMatrix group's
performance under its SBIR Phase II Department of Defense grant. The revenues
recognized in 2000 relate to the completion of CombiMatrix Corporation's
Department of Energy grant.
RESEARCH AND DEVELOPMENT EXPENSES. In 2001, research and development
expenses were $11.7 million, as compared to $8.4 million in 2000. The increase
in research and development expense was due primarily to the expansion of
research and development efforts, which resulted in the growth of research and
development personnel as well as the amount of supplies and materials consumed.
The CombiMatrix group's research and development activities were focused
primarily on efforts to further develop and enhance the active biochip system
towards commercialization. Most of these efforts were driven by CombiMatrix
Corporation's obligations under our agreements with Roche, which were executed
in July 2001. These projects include development of production microarray
synthesis techniques, as well as higher density microarrays. Research and
development expenses in 2000 includes a noncash charge for acquired IPR&D of
$2.5 million related to Acacia Research Corporation's acquisition of additional
ownership interests in CombiMatrix Corporation in July 2000.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. In 2001, marketing,
general and administrative expenses were $16.7 million, as compared to $5.5
million in 2000. These costs consist primarily of salaries and related expenses
for executive, financial and other administrative personnel, as well as expenses
associated with employee recruitment and relocation, professional services,
litigation costs, marketing activities, facilities costs and other corporate
expenses. The increase was primarily due to an increase in executive and
administrative personnel, an increase in personnel recruitment and relocation
expenses and an increase in rent and utilities expenses as a result of
CombiMatrix Corporation's January 2001 relocation to and occupancy of
approximately 64,000 square feet of office space in their new corporate and
research facilities located in Mukilteo, Washington. The CombiMatrix group's
legal fees increased significantly in 2001, as compared to 2000 as a result of
litigation with Nanogen. In addition, marketing, general and administrative
expenses include the write-off of approximately $1.4 million of deferred initial
public offering costs, which were charged to income in the fourth quarter of
2001 due to uncertainty related to the future recoverability of these deferred
costs, stemming from unfavorable market conditions in late 2001 and early 2002.
Included in marketing, general and administrative expenses of the CombiMatrix
group are allocated corporate charges of $1.4 million and $0.9 million in 2001
and 2000, respectively.
NON-CASH STOCK COMPENSATION EXPENSE.
RESEARCH AND DEVELOPMENT. In 2001, research and development
related non-cash stock compensation charges were $7.2 million, as compared to
$3.4 million in 2000.
MARKETING, GENERAL AND ADMINISTRATIVE. In 2001, marketing,
general and administrative related non-cash stock compensation charges were
$12.8 million, as compared to $6.6 million in 2000.
Amortization of deferred stock compensation is amortized on an
accelerated basis over the vesting period of the individual option awards using
the amortization method prescribed in FIN No. 28. The increase in deferred stock
compensation amortization in 2001 was due to higher amounts of deferred stock
compensation charges scheduled to be amortized in 2001, as compared to 2000
related to $53.8 million of deferred stock compensation originally recorded in
the third and fourth quarters of 2000. Amortization of deferred stock
compensation in 2001 was partially offset by $4.7 million due to forfeitures of
unvested stock options occurring in 2001.
AMORTIZATION OF PATENTS AND GOODWILL. In 2001, amortization of patents
and goodwill was $1.2 million, as compared to $0.6 million in 2000. The increase
in 2001 was due to a full year of amortization of goodwill and patent costs
allocated to the CombiMatrix group related to Acacia Research Corporations step
acquisition of additional ownership interests in CombiMatrix Corporation in the
third quarter of 2000.
54
OTHER INCOME, NET. In 2001, other income (comprised of interest income
and interest expense), net was $2.1 million, as compared to $1.7 million in
2000.
INTEREST INCOME. In 2001, interest income was $2.1 million, as
compared to $1.7 million in 2000. The increase in interest income was due
primarily to higher average balances of cash and cash equivalents and short-term
investments in 2001, as compared to 2000. The overall increase in the average
level of cash and investment balances in 2001 was primarily the result of a
private equity financing executed in August 2000 raising gross proceeds of $36.0
million through the sale of 4.0 million shares of CombiMatrix Corporation common
stock at $9 per share.
INTEREST EXPENSE. In 2001, interest expense was $65,000, as
compared to zero in 2000. Interest expense recorded in 2001 related to
CombiMatrix Corporation's capital lease obligation with a commercial bank, which
was entered into in September 2001. The CombiMatrix group had no similar
obligations in 2000.
MINORITY INTERESTS. In 2001, minority interests in the net losses of
the CombiMatrix group were $18.8 million, as compared to $8.3 million in 2000.
The increase in minority interests in 2001 was primarily due to the increase in
losses incurred by the CombiMatrix group as a result of increased non-cash stock
compensation amortization charges, its continued expansion of research and
development efforts and increased marketing, general and administrative
expenses.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE. In 2001, cumulative effect of
accounting change was zero, as compared to $0.2 million in 2000. During the
fourth quarter of 2000, Acacia Research Corporation adopted Emerging Issues Task
Force No. 98-15, "Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios." As a result,
the beneficial conversion feature of $1.5 million 6% unsecured promissory notes
that was valued at $0.2 million was charged to the December 31, 2000 statement
of operations with a corresponding increase to equity in accordance with APB
Opinion No. 20, "Accounting Changes."
INFLATION
Inflation has not had a significant impact on the CombiMatrix group in
the current or prior periods.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002, cash and cash equivalents and short-term
investments totaled $14.9 million compared to $33.3 million at December 31,
2001. Working capital at December 31, 2002 was $4.4 million compared to $24.8
million at December 31, 2001.
Net cash used in operations was $16.1 million in 2002 compared to $17.2
million in 2001. In 2002 and 2001, the CombiMatrix group's negative cash flow
from operations stemmed primarily from the continued expansion of the group's
research and development activities including its efforts under the Roche and
NASA agreements executed in 2001. Losses from operations were partially offset
by the receipt of milestone and advance payments of $11.6 million and $6.0
million in 2002 and 2001, respectively, primarily related to Roche in 2002 and
Roche and NASA in 2001, which have been recorded as deferred revenues.
Net cash provided by investing activities decreased to $7.6 million in
2002 compared to $18.8 million in 2001, as a result of less cash available from
net sales of short-term investments of $9.0 million in 2002 compared to $19.6
million in 2001.
Net cash (outflows) inflows attributed to the CombiMatrix group from
financing activities was ($0.8) million in 2002 compared to $4.5 million in
2001. The 2002 cash attributed to the CombiMatrix group from financing
activities includes the repayment of the CombiMatrix group's capital lease
obligation of $2.8 million, offset by $1.8 million in allocated corporate and
acquisition costs. In 2001, cash attributed to the CombiMatrix group from
financing activities primarily related to $3.1 million in proceeds from the sale
of CombiMatrix KK and Advance Material Sciences securities and $1.1 million in
corporate costs allocated to the CombiMatrix group.
At December 31, 2000, the CombiMatrix group's cash and cash equivalents
and short-term investments totaled $47.2 million and working capital totaled
$35.2 million. In 2000, cash used in continuing operations was $8.7 million and
cash used in investing activities was $42.6 million of net purchases of
short-term investments, which were offset by approximately $56.6 million in
proceeds from the sale of CombiMatrix and Advanced Material Sciences securities
and $0.8 million in corporate costs allocated to the CombiMatrix group.
55
CombiMatrix Corporation's rental expenses, including its share of the
common area maintenance and operating expenses are approximately $185,000 per
month (excluding any allocated rent expense) at its headquarters and research
facilities in Mukilteo, Washington. That amount increases over time, subject to
acceleration based on actual usage of the premises, to approximately $200,000
per month by mid 2006 through 2008. In November 2002, the CombiMatrix group paid
$2.1 million to a financial institution to repay the remaining balance of its
capital lease obligation. The CombiMatrix group has no other long-term debt. In
2003, the CombiMatrix group is required to pay Nanogen $0.5 million in September
2003, representing the second and final installment of the $1.0 million cash
payment due to Nanogen in accordance with the September 30, 2002 settlement
agreement entered into between CombiMatrix Corporation, Dr. Don Montgomery and
Nanogen. In addition, CombiMatrix Corporation will be required to pay 12.5% of
certain revenues, subject to minimum and maximum amounts not to exceed $1.5
million per year beginning in the fourth quarter of 2003, for the remaining life
of the CombiMatrix group's core patents. CombiMatrix Corporation also has
entered into a one-year commitment to purchase $1.1 million worth of
semiconductor wafers contingent upon successfully developing a next-generation
microarray.
The CombiMatrix group's long-term capital requirements will be
substantial and the adequacy of our available funds will depend upon many
factors, including:
o the CombiMatrix group's continued progress in research and
development programs;
o the costs involved in filing, prosecuting, enforcing and
defending any patents claims, should they arise;
o the CombiMatrix group's ability to license technology;
o competing technological developments;
o the creation and formation of strategic partnerships;
o the costs associated with leasing and improving our
headquarters in Mukilteo, Washington;
o the costs of commercialization activities; and
o other factors that may not be within the CombiMatrix group's
control.
The CombiMatrix group believes that its cash and cash equivalent and
short-term investment balances, anticipated cash flow from operations and other
external sources of available credit will be sufficient to meet its cash
requirements for the foreseeable future. However, changes may occur that would
cause the CombiMatrix group's available capital resources to be consumed
significantly sooner than it currently expects.
The CombiMatrix group may be unable to raise sufficient additional
capital on favorable terms or at all. If it fails to do so, it may have to
curtail or cease operations or enter into agreements requiring it to relinquish
rights to certain technologies, products or markets because it will not have the
capital necessary to exploit them.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 to the CombiMatrix group financial statements included
elsewhere herein.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The CombiMatrix group's exposure to market risk is limited to interest
income sensitivity, which is affected by changes in the general level of United
States interest rates, particularly because the majority of the group's
investments are in short-term debt securities issued by the U.S. treasury and by
U.S. corporations. The primary objective of the group's investment activities is
to preserve principal while at the same time maximizing the income the
CombiMatrix group receives without significantly increasing risk. To minimize
risk, the CombiMatrix group maintains its portfolio of cash, cash equivalents
and short-term investments in a variety of investment-grade securities and with
a variety of issuers, including corporate notes, commercial paper, government
securities and money market funds. Due to the nature of its short-term
investments, the CombiMatrix group believes that it is not subject to any
material market risk exposure.
At December 31, 2002, the CombiMatrix group had certain assets and
liabilities denominated in Japanese Yen as a result of forming CombiMatrix KK.
However, due to the relative insignificance of those amounts, the CombiMatrix
group does not believe that it has significant exposure to foreign currency
56
exchange rate risks. The CombiMatrix group currently does not use derivative
financial instruments to mitigate this exposure. The CombiMatrix group continues
to review this and may begin hedging certain foreign exchange risks through the
use of currency forwards or options in future periods.
57
ACACIA TECHNOLOGIES GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS
(A DIVISION OF ACACIA RESEARCH CORPORATION)
YOU SHOULD READ THIS DISCUSSION IN CONJUNCTION WITH THE ACACIA
TECHNOLOGIES GROUP, A DIVISION OF ACACIA RESEARCH CORPORATION, FINANCIAL
STATEMENTS AND RELATED NOTES AND THE ACACIA RESEARCH CORPORATION CONSOLIDATED
FINANCIAL STATEMENTS AND RELATED NOTES, BOTH INCLUDED ELSEWHERE HEREIN.
HISTORICAL RESULTS AND PERCENTAGE RELATIONSHIPS ARE NOT NECESSARILY INDICATIVE
OF OPERATING RESULTS FOR ANY FUTURE PERIODS.
GENERAL
The Acacia Technologies group, a division of Acacia Research
Corporation, is comprised primarily of Acacia Research Corporation's wholly
owned media technology subsidiaries Acacia Media Technologies and Soundview
Technologies and also includes all other related corporate assets and
liabilities and related transactions of Acacia Research Corporation that are
attributed to its media technology businesses.
Although the AR-Acacia Technologies stock is intended to reflect the
separate performance of the respective division of Acacia Research Corporation,
rather than the performance of Acacia Research Corporation as a whole, the
Acacia Technologies group is not a separate legal entity. Holders of the
AR-Acacia Technologies stock are stockholders of Acacia Research Corporation. As
a result, they continue to be subject to all of the risks of an investment in
Acacia Research Corporation and all of Acacia Research Corporation's businesses,
assets and liabilities. The assets Acacia Research Corporation attributes to the
Acacia Technologies group could be subject to the liabilities of the CombiMatrix
group.
The Acacia Technologies group owns and is developing a portfolio of
U.S. and international pioneering patents covering the transmission and receipt
of digital content. These transmission and receiving systems are commonly
referred to as audio-on-demand, video-on-demand, and audio/video streaming.
Acacia Media Technologies calls its proprietary technology Digital Media
Transmission, or "DMT" technology. The Acacia Technologies group also owns a
patent for a system that screens television content by content rating code,
commonly referred to as V-chip technology. The system, which uses the audio and
video blanking interval in conjunction with rating codes which are transmitted
with television programming, was approved by the Federal Communication
Commission or FCC and adopted by television manufacturers as the industry
standard in response to the U.S. Telecommunications Act of 1996. The Acacia
Technologies group is responsible for the development, licensing and protection
of its intellectual property and proprietary technologies. The Acacia
Technologies group continues to pursue both licensing and strategic business
alliances with leading companies in the rapidly growing media technologies
industry.
The Acacia Technologies group's operating activities were highlighted
by the execution of a license agreement for its television V-chip technology to
Loewe Opta GmbH for a payment of $43,000, the continued building of its
executive management team, including the hiring of key media technology and
intellectual property industry experts that will be responsible for the
development, licensing and protection of the Acacia Technologies group's
intellectual property and proprietary technologies, as well as the pursuit of
both licensing and strategic business alliances with leading companies in the
growing media technologies industry. In addition, in 2002, the Acacia
Technologies group increased legal and third party consulting activities related
to its ongoing DMT patent marketing and commercialization efforts, including
patent claims construction, patent prosecution and related research and
engineering costs.
In 2001, the Acacia Technologies group's financial condition and cash
flows were highlighted by the receipt of $25.6 million in payments from the
licensing of the Acacia Technologies group's television V-chip technology,
Acacia Research Corporation's completion of a private equity financing raising
gross proceeds of $19.0 million which was allocated to the Acacia Technologies
group and Acacia Research Corporation's acquisition of the minority interests in
Soundview Technologies in June 2001 and Acacia Media Technologies Corporation in
November 2001. In 2000, the Acacia Technologies group's financial condition and
cash flows were highlighted primarily by Acacia Research Corporation's
completion of a private equity financing raising gross proceeds of $23.7
million, the receipt of $14.8 million from the redemption of warrants issued in
connection with a December 1999 private equity financing, both of which were
allocated to the Acacia Technologies group, and the general expansion of
operations, including an increase in business development expenses as the Acacia
Technologies group explored new business opportunities. In the following
discussion and analysis, the period-to-period comparisons must be viewed in
light of the impact that the acquisition and disposition of securities of
various business interests has had on the Acacia Technologies group's financial
condition and results of operations.
58
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
RESULTS OF OPERATIONS (IN THOUSANDS) 2002 2001 2000
--------- --------- ---------
Net revenues ........................................ $ 43 $ 24,180 $ 40
Research and development expenses ................... -- -- (52)
Marketing, general and administrative expenses ...... (6,883) (4,853) (9,186)
Non-cash stock compensation expenses - marketing,
general and administrative ..................... (19) (856) (709)
Legal expenses-patents .............................. (1,415) (11,121) (72)
Amortization of patents and goodwill ................ (1,591) (1,492) (1,611)
Loss on disposal of subsidiaries .................... -- -- (1,016)
Other (expense) income, net ......................... (3,503) 2,111 (2,897)
Benefit (provision) for income taxes ................ 710 (935) (6)
Minority interests .................................. 104 (1,277) 866
Loss from discontinued operations of Soundbreak.com.. (200) -- (9,554)
--------- --------- ---------
Division net (loss) income .......................... $(12,754) $ 5,757 $(24,197)
========= ========= =========
2002 COMPARED TO 2001
LICENSE FEE INCOME. In 2002, license fee income was $43,000, as
compared to $24.2 million in 2001. During 2002, Soundview Technologies executed
a license agreement with Loewe Opta GmbH, a manufacturer of televisions sold
under the Loewe brand name. License fee income for 2001 includes license fees
received from eleven television manufacturers with whom we executed separate
settlement and/or license agreements during 2001 and in December 2000. Pursuant
to the terms of the respective settlement and/or license agreements with each of
the television manufacturers, Soundview Technologies received one-time license
fee payments in exchange for the grant of non-exclusive licenses for its
patented V-chip technology to each of the respective manufacturers.
The Acacia Technologies group has generated substantially all of its
revenues from licensing the patented V-chip technology to television
manufacturers. Acacia Technologies group's patent on the V-chip technology
expires in July 2003. However, depending on the outcome of ongoing licensing
efforts and related infringement actions, the Acacia Technologies group may
continue to collect license fees on televisions sold in the United States during
the patent term, subsequent to the July 2003 patent expiration date. The Acacia
Technologies group is beginning to market its digital media transmission
technology and is looking to acquire other technologies. Acacia Technologies
group's digital media transmission patent portfolio expires in 2011 in the U.S.
and in 2012 in international markets. The eventual licensing and sale of these
technologies is intended to replace the revenue generated by licensing the
V-chip technology. If we do not succeed in acquiring such technologies or are
unable to commercially license our existing and future technologies, our
financial condition may be adversely impacted.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. In 2002, marketing,
general and administrative expense was $6.9 million, as compared to $4.9 million
in 2001. The increase is primarily due to increased costs incurred related to
Acacia Technologies group's ongoing patent marketing and commercialization
efforts, including increased personnel costs relating to the hiring of key
executives, and consulting costs related to its ongoing DMT patent marketing and
commercialization efforts, including related research and engineering costs.
Included in marketing, general and administrative expenses are
allocated corporate charges of $4.9 million and $4.6 million for 2002 and 2001,
respectively. See "Critical Accounting Policies" for a description of the
management allocation policies implemented.
LEGAL EXPENSES - PATENTS. In 2002, patent related legal expenses were
$1.4 million, as compared to $11.1 million in 2001. The decrease is primarily
due to a decrease in legal expenses related to Soundview Technologies' V-chip
patent licensing and related infringement settlements. Legal fees related to the
license fee agreements executed with television manufacturers are generally
incurred on a contingency basis, based on license fee payments received. The
59
decrease in V-chip related legal fees was partially offset by $1.0 million in
legal fees incurred in connection with ongoing DMT patent marketing and
commercialization efforts, including patent claims construction, patent
prosecution and related research costs.
AMORTIZATION OF PATENTS AND GOODWILL. In 2002, amortization expense was
$1.6 million, as compared to $1.5 million in 2001. Amortization expense relating
to patents and goodwill in 2001 includes $0.2 million of goodwill amortization
expense. Effective January 1, 2002, pursuant to SFAS No. 142, goodwill is
required to be tested for impairment at least annually and written off when
determined to be impaired, rather than being amortized as previous standards
required. The reduction in goodwill amortization was offset by an increase in
patent amortization related to the increase in Acacia Research Corporation's
ownership interest in Acacia Media Technologies Corporation from 33% to 100%
through the purchase of the ownership interest of Acacia Media Technologies
Corporation's other member in November 2001. As a result of the purchase,
additional patent amortization of $0.5 million will be recorded on an annual
basis over the related patents' economic useful lives (approximately 10 years)
related to the intangibles identified in connection with the application of the
purchase method of accounting.
OTHER (EXPENSE) INCOME, NET. In 2002, other expense, net (primarily
comprised of an impairment charge on our cost method investment, interest
income, realized and unrealized gains and losses on trading securities, equity
in losses of affiliate and other) was $3.5 million, as compared to $2.1 million
in net other income in 2001.
IMPAIRMENT OF COST METHOD INVESTMENT. In September 2002, we
recorded an impairment charge of $2.7 million for an other-than-temporary
decline in the fair value of our cost method investment. Impairment indicators
included recurring losses, a decline in working capital and the completion of a
recent equity transaction with a shareholder at an amount below our carrying
value. The fair value of our cost method investment was determined by reference
to available financial and market information.
INTEREST INCOME. In 2002, interest income was $0.6 million, as
compared to $1.6 million in 2001. The decrease in interest income during 2002
was primarily due a decrease in cash balances related to net operating cash
outflows and the impact of a decrease in interest rates on our short-term
investments resulting from sharp interest rate cuts by the Federal Open Market
Committee and other external economic factors negatively impacting rates of
return on short-term investments occurring during late 2001 and continuing in
2002.
REALIZED (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. In 2002,
net realized losses on short-term investments was $1.2 million, as compared to
$0.4 million in net realized gains on short-term investments in 2001. The
increase in realized losses on short-term investments during 2002 was due to
realized losses recorded on certain trading securities during 2002.
UNREALIZED (LOSSES) GAINS ON SHORT-TERM INVESTMENTS. In 2002,
net unrealized losses were $0.2 million, as compared to $0.2 million in net
unrealized gains in 2001. Net unrealized losses in 2002 are due to the sale of
the balance of our trading securities during 2002.
EQUITY IN LOSSES OF AFFILIATE. In 2002, equity in losses of
affiliate was zero, as compared to $0.2 million in 2001. Equity in losses of
affiliate during 2001 was comprised of losses recorded for our equity investment
in Acacia Media Technologies Corporation. As of December 31, 2001, the Acacia
Technologies group no longer accounts for any investments under the equity
method.
(BENEFIT) PROVISION FOR INCOME TAXES. In 2002, the income tax benefit
was $0.7 million, as compared to a tax provision of $0.9 million in 2001. The
Acacia Technologies group had tax losses in 2002, as compared to 2001, which had
taxable income relating principally to license income generated by Soundview
Technologies. The 2002 income tax benefit relates principally to differences
between the 2001 provision and Acacia Research Corporation's final 2001 return
filed in September 2002, and is the result of additional deductions against
Soundview Technologies taxable income and the reversal of deferred tax
liabilities related to the amortization of identifiable intangible assets
related to Acacia Research Corporation's acquisition of 100% of Acacia Media
Technologies in 2001.
MINORITY INTERESTS. In 2002, minority interests in the losses of
consolidated subsidiaries was $104,000, as compared to $1.3 million in minority
interests in income of consolidated subsidiaries in 2001. Minority interests in
the losses of consolidated subsidiaries in 2002 was comprised of minority
interests in the net losses of the Acacia Technologies group's investment
limited partnership totaling $104,000. Minority interests in the net income of
consolidated subsidiaries in 2001 was comprised primarily of $1.3 million of
minority interests in the net income of Soundview Technologies recorded prior to
the increase in Acacia Research Corporation's ownership interest in Soundview
Technologies to 100% in June 2001.
60
DISCONTINUED OPERATIONS. On February 13, 2001, the board of directors
of Soundbreak.com resolved to cease operations as of February 15, 2001 and
liquidate the remaining assets and liabilities of the company. Accordingly, the
Acacia Technologies group reported the results of operations and the estimated
loss on disposal of Soundbreak.com as results of discontinued operations in the
statement of operations in 2000. In September 2002, the Acacia Technologies
group accrued an additional $0.5 million ($0.2 million after minority interests)
in estimated costs to be incurred in connection with the disposal of
Soundbreak.com. The additional accrual relates primarily to certain
non-cancelable lease obligations and the inability to sublease the related
office space at rates commensurate with existing obligations.
2001 COMPARED TO 2000
LICENSE FEE INCOME. In 2001, license fee income was $24.2 million, as
compared to zero in 2000. The increase for 2001 resulted primarily from the
settlement of patent infringement litigation brought by Soundview Technologies
and includes one-time license fees in exchange for the grant of V-chip patent
licenses, received from eleven of the twelve television manufacturers with whom
Soundview Technologies executed separate settlement and/or license agreements
during 2001 and 2000. Pursuant to the terms of the respective settlement and
license agreements with each of the television manufacturers, Soundview
Technologies granted to such manufacturers, non-exclusive licenses for its U.S.
Patent No. 4,554,584.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. The Acacia Technologies
group incurred marketing, general and administrative expenses of $5.7 million in
2001, as compared to $9.9 million in 2000. These costs consist primarily of
salaries and related expenses for executive, financial and other administrative
personnel, travel and meals, recruitment and relocation, professional services,
investor relations, insurance, facilities costs and other corporate expenses.
Management expects marketing, general and administrative expenses to increase in
the future to support the execution of the Acacia Technologies group's business
strategies.
Marketing, general and administrative expenses included $0.9 million
and $0.7 million of non-cash stock compensation charges for 2001 and 2000,
respectively. Included in the marketing, general and administrative expenses of
the Acacia Technologies group are allocated corporate charges of $4.6 million
and $7.7 million in 2001 and 2000, respectively. See "Critical Accounting
Policies" for a description of the management allocation policies implemented.
LEGAL EXPENSE - PATENTS. In 2001, legal expense was $11.1 million, as
compared to $72,000 in 2000. The increase in 2001 was due to approximately $11.0
million of legal costs incurred in connection with the execution of Soundview
Technologies' V-chip license and settlement agreements with eleven television
manufacturers during 2001. Legal fees incurred in connection with the Acacia
Technologies group's V-chip licensing arrangements are generally incurred on a
contingency basis and include legal costs incurred in connection with the
negotiation of license agreements, drafting of legal documents, discovery and
certain other legal expenses.
AMORTIZATION OF PATENTS AND GOODWILL. In 2001, amortization expense
relating to patents and goodwill was $1.5 million, as compared to $1.6 million
in 2000. As a result of the purchase of additional equity securities in various
subsidiaries, the Acacia Technologies group is incurring amortization expense
for periods ranging from three to five years relating to the intangible assets
acquired.
LOSS ON DISPOSAL OF CONSOLIDATED SUBSIDIARIES. In 2001, loss on
disposal of consolidated subsidiaries was zero, as compared to $1.0 million in
2000. In the fourth quarter of 2000, the Acacia Technologies group recorded $1.0
million in write-offs of early stage investments.
OTHER INCOME (EXPENSE), NET. In 2001, other income, net was $2.1
million (primarily comprised of interest income, realized and unrealized gains
and losses on trading securities, equity in losses of affiliates and other), as
compared to $2.9 million of net other expense in 2000.
INTEREST INCOME. In 2001, interest income was $1.6 million, as
compared to $1.4 million in 2000. The increase during 2001 was due to higher
cash balances during 2001 as compared to 2000, resulting from various private
equity financings and the receipt of significant license fee payments by
Soundview Technologies during the year. The increase was partially offset by the
impact of a decrease in interest rates on short-term investments related to
sharp interest rate cuts by the Federal Open Market Committee and other external
economic factors negatively impacting rates of return on short-term investments
occurring during the third and fourth quarters of 2001.
61
REALIZED GAINS ON SHORT-TERM INVESTMENTS. In 2001, net
realized gains on short-term investments were $0.4 million, as compared to zero
in 2000. The increase during 2001 was due to realized gains recorded on
short-term investments classified as trading securities during 2001. In 2000,
the Acacia Technologies group did not classify any investments as trading
securities.
UNREALIZED GAINS ON SHORT-TERM INVESTMENTS. In 2001, net
unrealized gains were $0.2 million, as compared to zero in 2000. The increase is
due to the investment in equity securities during 2001 classified as trading
securities under SFAS No. 115. Pursuant to SFAS No. 115, unrealized gains and
losses on trading securities are recorded in the statement of operations. In
2000, all of the Acacia Technologies group's short-term investments were
classified as available-for-sale.
EQUITY IN LOSSES OF AFFILIATES. In 2001, equity in losses of
affiliates was $0.2 million, as compared to $1.7 million in 2000. Losses during
2001 were comprised of a loss of $0.2 million for Acacia Research Corporation's
investment in Acacia Media Technologies, as determined by the equity method of
accounting through November 1, 2001. Acacia Research Corporation increased its
ownership percentage in Acacia Media Technologies to 100% on November 1, 2001.
Losses during 2000 were comprised of a loss of $0.3 million, $0.2 million,
$143,000 and $1.1 million for Acacia Research Corporation's investments in
Signature-mail.com, Acacia Media Technologies, Whitewing Labs and Mediaconnex,
respectively, as determined by the equity method of accounting. Acacia Research
Corporation wrote-off its equity investments in Signature-mail.com, Whitewing
Labs and Mediaconnex, as of December 31, 2000.
PROVISION FOR INCOME TAXES. In 2001, the provision for income taxes was
$0.9 million, as compared to $6,000 in 2000. The increase in 2001 was primarily
due to a significant increase in taxable income generated by Soundview
Technologies related to its patent infringement settlement and patent licensing
activities as compared to the 2000 period.
DISCONTINUED OPERATIONS. On February 13, 2001, the board of directors
of Soundbreak.com resolved to cease operations as of February 15, 2001 and
liquidate the remaining assets and liabilities of the company. Accordingly, the
Acacia Technologies group reported the results of operations and the estimated
loss on disposal of Soundbreak.com as results of discontinued operations in its
statement of operations. Discontinued operations of Soundbreak.com included $7.4
million of loss from discontinued operations in 2000 and $2.1 million of accrued
expenses in connection with its cessation of operations.
INFLATION
Inflation has not had a significant impact on the Acacia Technologies
group in the current or previous periods.
LIQUIDITY AND CAPITAL RESOURCES
The Acacia Technologies group's cash and cash equivalents and
short-term investments totaled $39.8 million at December 31, 2002 compared to
$51.2 million at December 31, 2001. Working capital at December 31, 2002 was
$36.5 million compared to $47.6 million at December 31, 2001.
Net cash (used in) provided by continuing operating activities in 2002
was ($3.5) million compared to $6.8 million in 2001. The decrease was primarily
due to a decrease in V-chip license fee income in 2002 compared to 2001, offset
by net sales of trading securities in 2002 of $4.1 million compared to net
purchases of trading securities of $4.1 million in 2001. The V-chip patent
expires in July 2003. The Acacia Technologies group will not be able to collect
royalties for televisions containing V-chip technology sold after the expiration
of the patent, but it may still collect revenues from the sale of such
televisions in the U.S. before the expiration date.
Net cash flows used in continuing investing activities decreased to
$0.6 million in 2002 compared to $5.9 million in 2001 as a result of a reduction
in investments in majority-owned subsidiaries of $0.4 million in 2002 compared
to $5.9 million in 2001.
Net cash (outflows) inflows attributed to the Acacia Technologies group
from financing activities was ($2.0) million in 2002 compared to $18.7 million
in 2001. Net cash outflows attributed to the Acacia Technologies group in 2002
primarily related to $1.8 million in allocated corporate and acquisition costs
to the CombiMatrix group as compared to $1.1 million in 2001. Net cash
attributed to the Acacia Technologies group in 2001 relates primarily to $19.6
million in proceeds from the sale of Acacia Research Corporation securities
allocated to the Acacia Technologies group.
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At December 31, 2000, the Acacia Technologies group's cash and cash
equivalents and short-term investments totaled $29.6 million and working capital
totaled $24.9 million. During 2000, cash used in continuing operations of $9.2
million was offset by approximately $20.9 million in proceeds from the sale of
Acacia Research Corporation securities allocated to the Acacia Technologies
group.
The Acacia Technologies group has no commitments for capital
expenditures in 2002. The Acacia Technologies group's minimum rental commitments
on operating leases related to continuing operations total $1.4 million through
February 2007 (excluding any allocated rent expenses). The Acacia Technologies
group has no committed lines of credit or other committed funding and no
long-term debt. The Acacia Technologies group believes that its cash and cash
equivalent balances, anticipated cash flow from operations and other external
sources of available credit will be sufficient to meet its cash requirements for
the foreseeable future.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 to the Acacia Technologies group financial statements
included elsewhere herein.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Acacia Technologies group's exposure to market risk is limited
primarily to interest income sensitivity, which is affected by changes in the
general level of United States interest rates, particularly because a
significant portion of our investments are in short-term debt securities issued
by United States corporations, institutional money market funds and other money
market instruments. The primary objective of our investment activities is to
preserve principal while at the same time maximizing the income received without
significantly increasing risk. To minimize risk, we maintain a portfolio of
cash, cash equivalents and short-term investments in a variety of
investment-grade securities and with a variety of issuers, including U.S.
government and corporate notes and bonds, commercial paper and money market
instruments. Due to the nature of our short-term investments, we believe that we
are not subject to any material market risk exposure. We do not have any
derivative financial instruments.
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RISK FACTORS
AN INVESTMENT IN OUR STOCK INVOLVES A NUMBER OF RISKS. BEFORE MAKING A
DECISION TO PURCHASE OUR SECURITIES, YOU SHOULD CAREFULLY CONSIDER ALL OF THE
RISKS DESCRIBED IN THIS ANNUAL REPORT. IF ANY OF THE RISKS DISCUSSED IN THIS
ANNUAL REPORT ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF
OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED. IF THIS WERE TO OCCUR, THE
TRADING PRICE OF OUR SECURITIES COULD DECLINE SIGNIFICANTLY AND YOU MAY LOSE ALL
OR PART OF YOUR INVESTMENT.
GENERAL RISKS
THE CONTINUING WORLDWIDE ECONOMIC SLOWDOWN AND RELATED UNCERTAINTIES MAY
CONTINUE TO ADVERSELY IMPACT OUR REVENUES AND OPERATING RESULTS.
Slower economic activity, concerns about inflation, decreased consumer
confidence, reduced corporate profits and capital spending, adverse business
conditions and liquidity concerns in the technology and biotechnology and
related industries, and recent international conflicts and terrorist and
military activity have resulted in a continuing downturn in worldwide economic
conditions. We cannot predict the timing, strength and duration of any economic
recovery in our industries. In addition, the events of September 11, 2001 and
subsequent international conflicts and terrorist acts can be expected to place
further pressure on economic conditions in the United States and worldwide.
These conditions make it extremely difficult for us to accurately forecast and
plan future business activities. If such conditions continue or worsen, our
business, financial condition and results of operations will likely be
materially and adversely affected.
BECAUSE OUR BUSINESS OPERATIONS ARE SUBJECT TO MANY INHERENT AND UNCONTROLLABLE
RISKS, WE MAY NOT SUCCEED.
We have significant economic interests in our subsidiary companies. Our
business operations are subject to numerous risks, challenges, expenses and
uncertainties inherent in the establishment of new business enterprises. Many of
these risks and challenges are subject to outside influences over which we have
no control, including:
o our subsidiary companies' products and services face uncertain
market acceptance;
o technological advances may make our subsidiary companies'
products and services obsolete or less competitive;
o competition;
o increases in operating costs, including costs for supplies,
personnel and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that excessively restricts our
subsidiary companies' businesses.
We cannot assure you that our subsidiary companies will be able to
market any product or service on a large commercial scale, that our subsidiary
companies will ever achieve or maintain profitable operations or that they, or
we, will be able to remain in business.
WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR ADDITIONAL LOSSES IN THE FUTURE.
We have sustained substantial losses since our inception resulting in
an accumulated deficit of $159.0 million (including a reclassification of
accumulated deficit in the amount of $21.7 million to permanent capital
representing the fair value of the ten percent (10%) stock dividend paid in
2001) on a consolidated basis, including operating losses of $80.3 million and
$43.2 million in 2002 and 2001, respectively. We may never become profitable or
if we do, we may never be able to sustain profitability. We expect to incur
significant research and development, marketing, general and administrative
expenses. As a result, we expect to incur significant losses for the foreseeable
future.
BECAUSE OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY AND MAY CONTINUE TO
DO SO IN THE FUTURE, OUR STOCK PRICE MAY BE VERY VOLATILE.
Our operating results may vary significantly from quarter to quarter
due to a variety of factors, including:
64
o the operating results of our current and future subsidiary
companies;
o the nature and timing of our investments in new subsidiary
companies;
o our decisions to acquire or divest interests in our current
and future subsidiaries, which may create changes in losses or
income and amortization of goodwill;
o changes in our methods of accounting for our current and
future subsidiaries, which may cause us to recognize gains or
losses under applicable accounting rules;
o the timing of the sales of equity interests in our current and
future subsidiary companies;
o our ability to effectively manage our growth and the growth of
our subsidiary companies;
o general economic conditions; and
o the cost of future acquisitions, which may increase due to
intense competition from other potential acquirers of
technology-related companies or ideas.
We have incurred and expect to continue to incur significant expenses
in pursuing and developing new business ventures. To date, we have lacked a
consistent source of recurring revenue. Each of the factors we have described
may cause our stock to be more volatile than the stock of other companies.
BECAUSE CERTAIN OF OUR SUBSIDIARY COMPANIES MAY NOT GENERATE ANY SIGNIFICANT
REVENUES, AND OPERATING RESULTS FROM OUR SUBSIDIARY COMPANIES MAY FLUCTUATE
SIGNIFICANTLY, OUR OWN OPERATING RESULTS MAY BE NEGATIVELY AFFECTED.
Our operating results may be materially impacted by the operating
results of our subsidiary companies. We cannot assure that these companies will
be able to meet their anticipated working capital needs to develop their
products and services. If they fail to properly develop these products and
services, they will be unable to generate meaningful product sales. We
anticipate that our operating results are likely to vary significantly as a
result of a number of factors, including:
o the timing of new product introductions by each subsidiary
company;
o the stage of development of the business of each subsidiary
company;
o the technical feasibility of each subsidiary company's
technologies and techniques;
o the novelty of the technology owned by our subsidiary
companies;
o the accuracy, effectiveness and reliability of products
developed by our subsidiary companies;
o the level of product acceptance;
o the strength of each subsidiary company's intellectual
property rights;
o the ability of each subsidiary company to avoid infringing the
intellectual property rights of others;
o each subsidiary company's ability to exploit and commercialize
its technology;
o the volume and timing of orders received and product line
maturation;
o the impact of price competition; and
o each subsidiary company's ability to access distribution
channels.
Many of these factors are beyond our subsidiary companies' control. We
cannot provide any assurance that any subsidiary company will experience growth
in the future or be profitable on an operating basis in any future period.
IF WE, OR OUR SUBSIDIARIES, ENCOUNTER UNFORESEEN DIFFICULTIES AND CANNOT OBTAIN
ADDITIONAL FUNDING ON FAVORABLE TERMS, OUR BUSINESS MAY SUFFER.
As of December 31, 2002, we had cash and short-term investments of
$54.7 million on our consolidated financial statements.
To date, our subsidiary companies have relied primarily upon selling
equity securities, including sales to and loans from us, to generate the funds
needed to finance implementing their plans of operations. Our subsidiary
companies may be required to obtain additional financing through bank
borrowings, debt or equity financings or otherwise, which would require us to
make additional investments or face a dilution of our equity interests.
We cannot assure that we will not encounter unforeseen difficulties
that may deplete our capital resources more rapidly than anticipated. Any
efforts to seek additional funds could be made through equity, debt or other
external financings. However, we cannot assure that additional funding will be
available on favorable terms, if at all. If we fail to obtain additional funding
when needed for our subsidiary companies and ourselves, we may not be able to
execute our business plans and our business may suffer.
65
OUR BUSINESS MAY BE HARMED IF MARKET AND OTHER CONDITIONS ADVERSELY AFFECT OUR
ABILITY TO DISPOSE OF CERTAIN ASSETS AT FAVORABLE PRICES.
An element of our business plan involves disposing of, in public
offerings or private transactions, our subsidiary companies and future partner
companies, or portions of assets thereof, to the extent such assets are no
longer consistent with our business plan. If we sell any such subsidiary
companies or assets, the price we receive will depend upon market and other
conditions. Therefore, we may not be able to sell at favorable prices. Market
and other conditions beyond our control affect:
o our ability to effect these sales;
o the timing of these sales; and
o the amount of proceeds from these sales.
In some instances, we may not be able to sell some or any of these
assets due to poor market and other conditions. As a result, we may be adversely
affected because we will be unable to dispose of assets or may receive a lesser
amount for our assets than we believe is favorable.
FAILURE TO EFFECTIVELY MANAGE OUR GROWTH COULD PLACE STRAINS ON OUR MANAGERIAL,
OPERATIONAL AND FINANCIAL RESOURCES AND COULD ADVERSELY AFFECT OUR BUSINESS AND
OPERATING RESULTS.
Our growth has placed, and is expected to continue to place, a
significant strain on our managerial, operational and financial resources.
Further, as the number of our subsidiary companies and their respective
businesses grow, we will be required to manage multiple relationships. Any
further growth by us or our subsidiary companies or an increase in the number of
our strategic relationships will increase this strain on our managerial,
operational and financial resources. This strain may inhibit our ability to
achieve the rapid execution necessary to successfully implement our business
plan. In addition, our future success depends on our ability to expand our
organization to match the growth of our business and our subsidiaries.
OUR FUTURE SUCCESS DEPENDS IN PART ON THE CONTINUED SERVICE OF OUR KEY
EXECUTIVES, AND THE LOSS OF ANY OF THESE KEY EXECUTIVES COULD ADVERSELY AFFECT
OUR BUSINESS AND OPERATING RESULTS.
Our success depends in part upon the continued service of our executive
officers, particularly Paul R. Ryan, our Chairman and Chief Executive Officer,
Robert L. Harris, II, our President and Dr. Amit Kumar, President and Chief
Executive Officer of CombiMatrix Corporation. Neither Mr. Ryan, Mr. Harris nor
Dr. Kumar has an employment or non-competition agreement with us. The loss of
any of these key individuals would be detrimental to our ongoing operations and
prospects.
OUR FUTURE SUCCESS AND THE SUCCESS OF OUR SUBSIDIARY COMPANIES DEPENDS ON OUR
AND THEIR ABILITIES TO ATTRACT AND RETAIN QUALIFIED TECHNICAL PERSONNEL AND
QUALIFIED MANAGEMENT AND MARKETING TEAMS. FAILURE TO DO SO WOULD HARM OUR
ONGOING OPERATIONS AND BUSINESS PROSPECTS.
We believe that our success will depend on continued employment by us
and our subsidiary companies of senior management and key technical personnel.
Our subsidiary companies will need to attract, retain and motivate qualified
management personnel to execute their current business plans and to successfully
develop commercially viable products and services. Competition for qualified
personnel is intense and we cannot assure you that we will successfully retain
our existing key employees or attract and retain any additional personnel we may
require.
Each of our subsidiary companies has key executives upon whom we
significantly depend, and the success of those subsidiary companies depends on
their ability to retain and motivate those individuals.
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, WE CANNOT ASSURE THAT OUR
OPERATIONS WILL BE PROFITABLE.
We commenced operations in 1993 and, accordingly, have a limited
operating history. In addition, certain of our subsidiary companies are in the
early stages of development and or operations and have limited operating
histories. You should consider our prospects in light of the risks, expenses and
difficulties frequently encountered by companies with such limited operating
histories. Since we have a limited operating history, we cannot assure you that
our operations will be profitable or that we will generate sufficient revenues
to meet our expenditures and support our activities.
During the fiscal year ended December 31, 2002, we had an operating
loss of approximately $80.3 million and a net loss of approximately $59.0
million. If we continue to incur operating losses, we may not have enough money
to expand our business and our subsidiary companies' businesses in the future.
66
THE AVAILABILITY OF SHARES FOR SALE IN THE FUTURE COULD REDUCE THE MARKET PRICE
OF OUR COMMON STOCK.
In the future, we may issue securities to raise cash for acquisitions.
We may also pay for interests in additional subsidiary companies by using a
combination of cash and our common stock or just our common stock. We may also
issue securities convertible into our common stock. Any of these events may
dilute your ownership interest in us and have an adverse impact on the price of
our common stock.
In addition, sales of a substantial amount of our common stock in the
public market, or the perception that these sales may occur, could reduce the
market price of our common stock. This could also impair our ability to raise
additional capital through the sale of our securities.
DELAWARE LAW AND OUR CHARTER DOCUMENTS CONTAIN PROVISIONS THAT COULD DISCOURAGE
OR PREVENT A POTENTIAL TAKEOVER OF ACACIA RESEARCH CORPORATION THAT MIGHT
OTHERWISE RESULT IN OUR STOCKHOLDERS RECEIVING A PREMIUM OVER THE MARKET PRICE
OF THEIR SHARES.
Provisions of Delaware law and our certificate of incorporation and
bylaws could make more difficult the acquisition of Acacia Research Corporation
by means of a tender offer, proxy contest or otherwise, and the removal of
incumbent officers and directors. These provisions include:
o Section 203 of the Delaware General Corporation Law, which
prohibits a merger with a 15%-or-greater stockholder, such as
a party that has completed a successful tender offer, until
three years after that party became a 15%-or-greater
stockholder;
o amendment of our bylaws by the stockholders requires a
two-thirds approval of the outstanding shares;
o the authorization in our certificate of incorporation of
undesignated preferred stock, which could be issued without
stockholder approval in a manner designed to prevent or
discourage a takeover;
o provisions in our bylaws eliminating stockholders' rights to
call a special meeting of stockholders, which could make it
more difficult for stockholders to wage a proxy contest for
control of our board of directors or to vote to repeal any of
the anti-takeover provisions contained in our certificate of
incorporation and bylaws; and
o the division of our board of directors into three classes with
staggered terms for each class, which could make it more
difficult for an outsider to gain control of our board of
directors.
Such potential obstacles to a takeover could adversely affect the
ability of our stockholders to receive a premium price for their stock in the
event another company wants to acquire us.
WE ARE AT RISK OF SECURITIES CLASS ACTION LITIGATION DUE TO STOCK PRICE
VOLATILITY.
In the past, securities class action litigation has often been brought
against a company following periods of volatility in the market price of its
securities. Due to the potential volatility of our stock price, we may be the
target of such litigation in the future. Securities litigation could result in
substantial costs and divert management's attention and resources, which could
seriously harm our business, financial condition and results of operations.
RISKS RELATING TO A CAPITAL STRUCTURE WITH TWO SEPARATE CLASSES OF COMMON STOCK
HOLDERS OF BOTH CLASSES OF STOCK ARE STOCKHOLDERS OF ONE COMPANY, AND THE
FINANCIAL PERFORMANCE OF ONE GROUP COULD AFFECT THE OTHER, THUS EXPOSING THE
HOLDERS OF EACH GROUP'S STOCK TO THE RISKS OF AN INVESTMENT IN THE ENTIRE
COMPANY.
Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock are
stockholders of a single company. The CombiMatrix group and the Acacia
Technologies group are not separate legal entities. As a result, stockholders
will continue to be subject to all of the risks of an investment in Acacia
Research Corporation and all of our businesses, assets and liabilities. The
issuance of the AR-CombiMatrix stock and the AR-Acacia Technologies stock and
the allocation of assets and liabilities and stockholders' equity between the
CombiMatrix group and the Acacia Technologies group did not result in a
distribution or spin-off to stockholders of any of our assets or liabilities and
did not affect ownership of our assets or responsibility for our liabilities or
those of our subsidiaries. The assets we attribute to one group could be subject
to the liabilities of the other group, whether such liabilities arise from
lawsuits, contracts or indebtedness that we attribute to the other group. If we
are unable to satisfy one group's liabilities out of the assets we attribute to
it, we may be required to satisfy those liabilities with assets we have
attributed to the other group.
67
Financial effects from one group that affect our consolidated results
of operations or financial condition could, if significant, affect the results
of operations or financial condition of the other group and the market price of
the common stock relating to the other group. In addition, net losses of either
group and dividends or distributions on, or repurchases of, either class of
common stock will reduce the funds we can pay as dividends on each class of
common stock under Delaware law. For these reasons, you should read our
consolidated financial information with the financial information we provide for
each group.
THE HOLDERS OF AR-COMBIMATRIX STOCK AND THE HOLDERS OF AR-ACACIA TECHNOLOGIES
STOCK HAVE ONLY LIMITED SEPARATE STOCKHOLDER RIGHTS.
Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock have
the rights customarily held by common stockholders. They also have these
specific rights related to their corresponding group:
o certain rights with regard to dividends and liquidation;
o requirements for a mandatory dividend, redemption or
conversion upon the disposition of all or substantially all of
the assets of their corresponding group; and
o a right to vote on matters as a separate voting class in the
limited circumstances provided under Delaware law, by stock
exchange rules or as determined by our board of directors
(such as an amendment of our certificate of incorporation that
changes the rights, privileges or preferences of the class of
stock held by such stockholder).
We will not hold separate stockholder meetings for holders of
AR-CombiMatrix stock and AR-Acacia Technologies stock.
THE HOLDERS OF AR-COMBIMATRIX STOCK AND THE HOLDERS OF AR-ACACIA TECHNOLOGIES
STOCK WILL HAVE CERTAIN LIMITS ON THEIR RESPECTIVE VOTING POWERS.
GROUP COMMON STOCK WITH A MAJORITY OF VOTING POWER CAN CONTROL VOTING
OUTCOMES.
The holders of AR-CombiMatrix stock and AR-Acacia Technologies stock
will vote together as a single class, except in limited circumstances. If a
separate vote on a matter by the holders of either the AR-CombiMatrix stock or
the AR-Acacia Technologies stock is not required under Delaware law or by stock
exchange rules, and if our board of directors does not require a separate vote,
either class of common stock that is entitled to more than the number of votes
required to approve such matter could control the outcome of such vote - even if
the matter involves a divergence or conflict of the interests between the
holders of the AR-CombiMatrix stock and the AR-Acacia Technologies stock. In
addition, if the holders of common stock having a majority of the voting power
of all shares of common stock outstanding approve a merger, the terms of which
did not require separate class voting under stock exchange rules, then the
merger could be consummated -- even if the holders of a majority of either class
of common stock were to vote against the merger.
GROUP COMMON STOCK WITH LESS THAN MAJORITY VOTING POWER CAN BLOCK
ACTION IF A CLASS VOTE IS REQUIRED.
If Delaware law, stock exchange rules or our board of directors
requires a separate vote on a matter by the holders of either the AR-CombiMatrix
stock or the AR-Acacia Technologies stock, such as a proposal to amend the terms
of one class of stock, those holders could prevent approval of the matter, even
if the holders of a majority of the total number of votes cast or entitled to be
cast, voting together as a class, were to vote in favor of it.
HOLDERS OF ONLY ONE CLASS OF COMMON STOCK CANNOT ENSURE THAT THEIR
VOTING POWER WILL BE SUFFICIENT TO PROTECT THEIR INTERESTS.
Since the relative voting power per share of AR-CombiMatrix stock and
AR-Acacia Technologies stock will fluctuate based on the market values of the
two classes of common stock, the relative voting power of a class of common
stock could decrease. As a result, holders of shares of only one of the two
classes of common stock cannot ensure that their voting power will be sufficient
to protect their interests.
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OUR RESTATED CERTIFICATE OF INCORPORATION MAY BE AMENDED TO INCREASE OR DECREASE
THE AUTHORIZED SHARES OF EITHER CLASS OF COMMON STOCK WITHOUT THE APPROVAL OF
EACH CLASS VOTING SEPARATELY.
Our restated certificate of incorporation provides that an amendment to
the restated certificate to increase or decrease the number of authorized shares
of either class of common stock will require the approval of the holders of a
majority of the voting power of all shares of common stock, voting together as a
single class, and will not require the approval of each class of stock voting as
a separate class. Accordingly, if the holders of one class of common stock hold
a majority of the voting power of all shares of common stock, then that majority
could approve an amendment to the restated articles to increase or decrease the
authorized shares of stock of either class without the approval of the holders
of the minority class of stock.
STOCKHOLDERS MAY NOT HAVE ANY REMEDIES FOR BREACH OF FIDUCIARY DUTIES IF ANY
ACTION BY OUR DIRECTORS OR OFFICERS HAS A DISADVANTAGEOUS EFFECT ON EITHER CLASS
OF COMMON STOCK.
Stockholders may not have any remedies if any action or decision of our
directors and officers has a disadvantageous effect on either class of common
stock compared to the other class of common stock. We are not aware of any legal
precedent under Delaware law involving the fiduciary duties of directors and
officers of corporations having two classes of common stock, or separate classes
or series of capital stock, the rights of which, like the AR-CombiMatrix stock
and AR-Acacia Technologies stock, are defined by reference to separate
businesses of the corporation.
Principles of Delaware law established in cases involving differing
treatment of two classes of capital stock or two groups of holders of the same
class of capital stock provide that a board of directors owes an equal duty to
all stockholders regardless of class or series. Under these principles of
Delaware law and the related principle known as the "business judgment rule,"
absent abuse of discretion, a good faith business decision made by a
disinterested and adequately informed board of directors, board of directors'
committee or officer with respect to any matter having different effects on
holders of AR-CombiMatrix stock and holders of AR-Acacia Technologies stock
would be a defense to any challenge to such determination made by or on behalf
of the holders of either class of common stock.
As of March 21, 2003, our executive officers, directors and their
affiliates beneficially owned approximately 5.1% of the outstanding
AR-CombiMatrix stock and 8.8% of the outstanding AR-Acacia Technologies stock.
NUMEROUS POTENTIAL CONFLICTS OF INTERESTS EXIST BETWEEN THE AR-COMBIMATRIX STOCK
AND THE AR-ACACIA TECHNOLOGIES STOCK WHICH MAY BE DIFFICULT TO RESOLVE BY OUR
BOARD OR WHICH MAY BE RESOLVED ADVERSELY TO ONE OF THE CLASSES.
The existence of separate classes of common stock could give rise to
occasions when the interests of the holders of AR-CombiMatrix stock and
AR-Acacia Technologies stock diverge or conflict. Examples include
determinations by our directors or officers to:
o pay or omit the payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock;
o allocate consideration to be received by holders of each of
the classes of common stock in connection with a merger or
consolidation involving Acacia Research Corporation;
o convert one class of common stock into shares of the other;
o approve certain dispositions of the assets of either group;
o allocate the proceeds of future issuances of our stock either
to the Acacia Technologies group or the CombiMatrix group;
o allocate corporate opportunities between the groups; and
o make other operational and financial decisions with respect to
one group that could be considered detrimental to the other
group.
When making decisions with regard to matters that create potential
diverging or conflicting interests, our directors and officers will act in
accordance with their fiduciary duties, the terms of the restated certificate of
incorporation, and, to the extent applicable, the management and allocation
policies described herein.
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THE PERFORMANCE OF ONE GROUP OR THE DIVIDENDS PAID TO ONE GROUP MAY
ADVERSELY AFFECT THE DIVIDENDS AVAILABLE FOR THE OTHER GROUP.
Our board of directors currently has no intention to pay dividends on
the AR-CombiMatrix stock or the AR-Acacia Technologies stock. Determinations as
to future dividends on the AR-CombiMatrix stock and the AR-Acacia Technologies
stock will be based primarily on the financial condition, results of operations
and business requirements of the relevant group and Acacia Research Corporation
as a whole. Subject to the limitations referred to below, our board of directors
has the authority to declare and pay dividends on the AR-CombiMatrix stock and
the AR-Acacia Technologies stock in any amount and could, in its sole
discretion, declare and pay dividends exclusively on the AR-CombiMatrix stock,
exclusively on the AR-Acacia Technologies stock, or on both, in equal or unequal
amounts. Our board of directors will not be required to consider the amount of
dividends previously declared on each class, the respective voting or
liquidation rights of each class or any other factor.
The performance of one group may cause our board of directors to pay
more or less dividends on the common stock relating to the other group than if
that other group was a stand-alone company. In addition, Delaware law and the
new certificate of incorporation impose limitations on the amount of dividends
which may be paid on each class of common stock.
PROCEEDS OF MERGERS OR CONSOLIDATIONS MAY BE ALLOCATED UNFAVORABLY.
Our restated certificate of incorporation does not contain any
provisions governing how consideration to be received by holders of common stock
in connection with a merger or consolidation involving Acacia Research
Corporation is to be allocated among holders of each class of common stock. Our
board of directors will determine the percentage of the consideration to be
allocated to holders of each class of common stock in any such transaction. Such
percentage may be materially more or less than that which might have been
allocated to such holders had our board of directors chosen a different method
of allocation.
HOLDERS OF EITHER CLASS OF COMMON STOCK MAY BE ADVERSELY AFFECTED BY A
CONVERSION OF GROUP COMMON STOCK.
Our board of directors could, in its sole discretion and without
stockholder approval, determine to convert shares of AR-Acacia Technologies
stock into shares of AR-CombiMatrix stock, or vice versa, at a time when either
or both classes of common stock may be considered to be overvalued or
undervalued. Any such conversion would dilute the interests in Acacia Research
Corporation of the holders of the class of common stock being issued in the
conversion. It could also give holders of shares of the class of common stock
converted a greater or lesser premium than any premium that might be paid by a
third-party buyer of all or substantially all of the assets of the group whose
stock is converted.
HOLDERS OF EITHER CLASS OF COMMON STOCK COULD BE ADVERSELY AFFECTED BY
A DISPOSITION OF THE ASSETS ALLOCATED TO THEIR RESPECTIVE GROUPS.
Our board of directors could, in its sole discretion and without
stockholder approval, determine to dispose of all or substantially all the
assets of a group. If a disposition of group assets occurs at a time when those
assets are considered undervalued, then holders of that group's stock would
receive less consideration than they could have received had the assets been
disposed of at a time when they had a higher value.
PROCEEDS OF FUTURE ISSUANCES OF OUR STOCK COULD BE ALLOCATED
UNFAVORABLY.
We may in the future issue a new class of stock, such as a class of
preferred stock, or additional shares of AR-CombiMatrix stock or AR-Acacia
Technologies stock. Proceeds from any future issuance of any class of stock
would be allocated among the CombiMatrix or the Acacia Technologies group as
determined by our board of directors. There is no requirement that the proceeds
from an issuance of AR-CombiMatrix stock or AR-Acacia Technologies stock be
allocated to the corresponding group. Such allocations might be materially more
or less for the respective groups than what might have been allocated had our
board of directors chosen a different allocation method. Also, any designated
preferred class may be designed to reflect the performance of Acacia Research
Corporation as a whole, rather than the performance of the CombiMatrix group or
the Acacia Technologies group.
ALLOCATION OF CORPORATE OPPORTUNITIES COULD FAVOR ONE GROUP OVER
ANOTHER.
Our board of directors may be required to allocate corporate
opportunities between the groups. In some cases, our directors could determine
that a corporate opportunity, such as a business that we are acquiring, should
be shared by the groups. Any such decisions could favor one group at the expense
of the other.
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OTHER OPERATIONAL AND FINANCIAL DECISIONS WHICH MAY FAVOR ONE GROUP
OVER THE OTHER.
Our board of directors or our senior officers will review other
operational and financial matters affecting the CombiMatrix group and the Acacia
Technologies group, including the allocation of financing resources and capital,
technology and know-how and corporate overhead, taxes, debt, interest and other
matters. Any decision of our board of directors or our senior officers in these
matters could favor one group at the expense of the other.
OUR BOARD OF DIRECTORS MAY CHANGE OUR MANAGEMENT AND ALLOCATION POLICIES WITHOUT
STOCKHOLDER APPROVAL TO THE DETRIMENT OF EITHER GROUP.
Our board of directors may modify or rescind our policies with respect
to the allocation of corporate overhead, taxes, debt, interest and other
matters, or may adopt additional policies, in its sole discretion without
stockholder approval. However, our board of directors has no present intention
to do so. A decision to modify or rescind these policies, or adopt additional
policies could have different effects on holders of either class of common stock
or could result in a benefit or detriment to one class of stockholders compared
to the other class. Our board of directors will make any such decision in
accordance with its good faith business judgment that the decision is in the
best interests of Acacia Research Corporation and all of our stockholders as a
whole.
EITHER GROUP MAY FINANCE THE OTHER GROUP ON TERMS UNFAVORABLE TO ONE OF THE
GROUPS.
We may transfer cash and other property between groups to finance their
business activities. The group providing the financing will be subject to the
risks relating to the group receiving the financing. We will account for those
transfers generally as a short-term or long-term loan between groups or as a
repayment of a previous borrowing.
THERE ARE LIMITS ON THE CONSIDERATION WHICH MAY BE RECEIVED BY THE STOCKHOLDERS
IN THE EVENT OF THE DISPOSITION OF ASSETS OF A GROUP.
Our restated certificate of incorporation provides that if a
disposition of all or substantially all of the properties and assets of either
group occurs, we must, subject to certain exceptions:
o distribute through a dividend or redemption to holders of the
class of common stock relating to such group an amount equal
to the net proceeds of such disposition; or
o convert at a 10% premium such common stock into shares of the
class of common stock relating to the other group.
If the group subject to the disposition were a separate, independent
company and its shares were acquired by another person, certain costs of that
disposition, including corporate level taxes, might not be payable in connection
with that acquisition. As a result, stockholders of the separate, independent
company might receive a greater amount than the net proceeds that would be
received by holders of the class of common stock relating to that group if the
assets of such group were sold. In addition, we cannot assure you that the net
proceeds per share of the common stock relating to that group will be equal to
or more than the market value per share of such common stock prior to or after
announcement of a disposition.
The term "substantially all of the properties and assets" of a group is
subject to potentially conflicting interpretations. Resolution of such a dispute
could adversely impact the holders of either the class of common stock related
to the assets being disposed or the holders of the other class because the
consideration, if any, to be received by the holders of the class related to the
disposed assets may depend on whether the disposition involved "substantially
all" of the properties and assets of that class.
HOLDERS OF EITHER CLASS OF COMMON STOCK MAY BE ADVERSELY AFFECTED BY A
REDEMPTION OF THEIR COMMON STOCK.
We are entitled to redeem the outstanding common stock relating to a
group when all or substantially all of that group's assets are sold. We can
redeem the assets for cash, securities, a combination of cash and securities or
other property at fair value. A disposition-related redemption could occur when
the assets being disposed of are considered undervalued. If that is the case,
the holders of our common stock related to that group would receive less
consideration for their shares than they may deem reasonable.
We can also redeem on a pro rata basis all of the outstanding shares of
a group's common stock for shares of the common stock of one or more of our
wholly owned subsidiaries. If this were to occur, the holders of the redeemed
class of common stock would no longer have stockholder voting rights in Acacia
71
Research Corporation or any other benefits to be derived from holding a class of
stock in Acacia Research Corporation. In addition, if the outstanding shares of
a class of our common stock are redeemed for shares that are not publicly
traded, the holders of such redeemed stock will no longer be able to publicly
trade their shares and accordingly their investment will be substantially less
liquid.
OUR CAPITAL STRUCTURE AND THE VARIABLE VOTE PER SHARE COULD ENABLE A POTENTIAL
ACQUIRER TO TAKE CONTROL OF ACACIA RESEARCH CORPORATION THROUGH THE ACQUISITION
OF ONLY ONE OF THE CLASSES OF OUR COMMON STOCK.
A potential acquirer could acquire control of Acacia Research
Corporation by acquiring shares of common stock having a majority of the voting
power of all shares of common stock outstanding. Such a majority could be
obtained by acquiring a sufficient number of shares of both classes of common
stock or, if one class of common stock has a majority of such voting power, only
shares of that class. Currently, the AR-CombiMatrix stock has a majority of the
voting power. As a result, currently, it might be possible for an acquiror to
obtain control of Acacia Research Corporation by purchasing only shares of
AR-CombiMatrix stock.
DECISIONS BY DIRECTORS AND OFFICERS THAT AFFECT DIFFERENTLY ONE CLASS OF OUR
COMMON STOCK COMPARED TO THE OTHER COULD ADVERSELY AFFECT THE MARKET VALUE OF
EITHER OR BOTH OF THE CLASSES OF OUR COMMON STOCK.
The relative voting power per share of the AR-CombiMatrix stock and the
AR-Acacia Technologies stock and the number of shares of one class of common
stock issuable upon the conversion of the other class of common stock will vary
depending upon the relative market values of the AR-CombiMatrix stock and the
AR-Acacia Technologies stock. The market value of either or both classes of
common stock could be affected by market reaction to decisions by our board of
directors or our management that investors perceive to affect differently one
class of common stock compared to the other. These decisions could involve
changes to our management and allocation policies, allocations of corporate
opportunities and financing resources between groups, and changes in dividend
policies.
INVESTORS MAY NOT VALUE THE AR-COMBIMATRIX STOCK AND THE AR-ACACIA TECHNOLOGIES
STOCK BASED ON GROUP FINANCIAL INFORMATION AND POLICIES.
We cannot assure you that investors will value the AR-CombiMatrix stock
and the AR-Acacia Technologies stock based on the reported financial results and
prospects of the separate groups or the dividend policies established by our
board of directors with respect to those groups. Holders of AR-CombiMatrix stock
and AR-Acacia Technologies stock will continue to be common stockholders of
Acacia Research Corporation subject to all the risks associated with an
investment in Acacia Research Corporation as a whole. Additionally, the separate
stockholder rights related to each group are limited and relate to events that
may never occur such as dividend and liquidation rights and the disposition of
all or substantially all of the assets of a group. Accordingly, investors may
discount the value of AR-CombiMatrix stock and AR-Acacia Technologies stock
because both groups are part of a common enterprise rather than a stand-alone
entity and each class of stock has limited separate stockholder rights.
HOLDERS OF AR-COMBIMATRIX STOCK AND AR-ACACIA TECHNOLOGIES STOCK MAY NOT RECEIVE
A PREMIUM FROM AN INVESTOR ACQUIRING CONTROL OF THEIR RESPECTIVE CLASSES OF
STOCK.
Control of AR-CombiMatrix stock or AR-Acacia Technologies stock may not
provide control of Acacia Research Corporation as a whole. Accordingly, unlike
many acquisition transactions, holders of AR-CombiMatrix stock and
AR-Technologies stock may not receive a controlling interest premium from an
investor acquiring control of their respective classes of stock.
THERE ARE CERTAIN PROVISIONS IN OUR TWO-CLASS CAPITAL STRUCTURE THAT COULD HAVE
ANTITAKEOVER EFFECTS.
The existence of the two classes of common stock could, under certain
circumstances, prevent stockholders from profiting from an increase in the
market value of their shares as a result of a change in control of Acacia
Research Corporation by delaying or preventing such change in control. The
existence of two classes of common stock could present complexities and could,
in certain circumstances, pose obstacles, financial and otherwise, to an
acquiring person. We could, in the sole discretion of our board of directors and
without stockholder approval, exercise the right to convert the shares of one
class of common stock into shares of the other at a 10% premium over their
respective average market values. This conversion could result in additional
dilution to persons seeking control of Acacia Research Corporation.
Our board of directors could issue shares of preferred stock or common
stock that could be used to create voting or other impediments to discourage
persons seeking to gain control of Acacia Research Corporation, and preferred
stock could also be privately placed with purchasers favorable to our board of
directors in opposing such action.
72
RISKS RELATING TO THE COMBIMATRIX GROUP
The risk factors beginning on this page discuss risks relating to the
CombiMatrix group. Because each holder of AR-CombiMatrix stock is a holder of
the common stock of one company, Acacia Research Corporation, the risks
associated with the Acacia Technologies group could affect the AR-CombiMatrix
stock. As such, we also urge you to read carefully the section "Risks Relating
to the Acacia Technologies Group" beginning on page 78.
THE COMBIMATRIX GROUP HAS A HISTORY OF LOSSES AND EXPECTS TO INCUR ADDITIONAL
LOSSES IN THE FUTURE.
The CombiMatrix group has sustained substantial losses since its
inception. The CombiMatrix group may never become profitable or if it does, it
may never be able to sustain profitability. We expect the CombiMatrix group to
incur significant research and development, marketing, general and
administrative expenses. As a result, we expect the CombiMatrix group to incur
significant losses for the foreseeable future.
THE COMBIMATRIX GROUP MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF
FLUCTUATIONS IN ITS QUARTERLY OPERATING RESULTS, WHICH COULD CAUSE ITS STOCK
PRICE TO DECLINE.
The CombiMatrix group's revenues and operating results have fluctuated
in the past and may continue to fluctuate significantly from quarter to quarter
in the future. It is possible that in future periods the CombiMatrix group's
revenues could fall below the expectations of securities analysts or investors,
which could cause the market price of the AR-CombiMatrix stock to decline. The
following are among the factors that could cause the CombiMatrix group's
operating results to fluctuate significantly from period to period:
o its unpredictable revenue sources, as described below;
o the nature, pricing and timing of the CombiMatrix group's and
its competitors' products;
o changes in the CombiMatrix group's and its competitors'
research and development budgets;
o expenses related to, and the CombiMatrix group's ability to
comply with, governmental regulations of its products and
processes; and
o expenses related to, and the results of, patent filings and
other proceedings relating to intellectual property rights.
The CombiMatrix group anticipates significant fixed expenses due in
part to its need to continue to invest in product development. It may be unable
to adjust its expenditures if revenues in a particular period fail to meet its
expectations, which would harm its operating results for that period. As a
result of these fluctuations, the CombiMatrix group believes that
period-to-period comparisons of the CombiMatrix group's financial results will
not necessarily be meaningful, and you should not rely on these comparisons as
an indication of its future performance.
THE COMBIMATRIX GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY HARM ITS
FINANCIAL CONDITION.
The amount and timing of revenues that the CombiMatrix group may
realize from its business will be unpredictable because:
o whether products are commercialized and generate revenues
depends, in part, on the efforts and timing of its potential
customers;
o its sales cycles may be lengthy; and
o it cannot be sure as to the timing of receipt of payment for
its products.
As a result, the CombiMatrix group's revenues may vary significantly
from quarter to quarter, which could make its business difficult to manage and
cause its quarterly results to be below market expectations. If this happens,
the price of the CombiMatrix group's common stock may decline significantly.
73
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS THE PRICE OF THE AR-COMBIMATRIX STOCK.
The stock market has experienced significant price and volume
fluctuations, and the market prices of technology companies, particularly
biotechnology companies, has been highly volatile. We believe that various
factors may cause the market price of the AR-CombiMatrix stock to fluctuate,
perhaps substantially, including, among others, announcements of:
o its or its competitors' technological innovations;
o developments or disputes concerning patents or proprietary
rights;
o supply, manufacturing or distribution disruptions or other
similar problems;
o proposed laws regulating participants in the biotechnology
industry;
o developments in relationships with collaborative partners or
customers;
o its failure to meet or exceed securities analysts'
expectations of its financial results; or
o a change in financial estimates or securities analysts'
recommendations.
In the past, companies that have experienced volatility in the market
price of their stock have been the objects of securities class action
litigation. If the AR-CombiMatrix stock was the object of securities class
action litigation, it could result in substantial costs and a diversion of
management's attention and resources, which could materially harm the business
and financial results of the CombiMatrix group.
THE COMBIMATRIX GROUP IS DEPLOYING NEW AND UNPROVEN TECHNOLOGIES WHICH MAKES
EVALUATION OF ITS BUSINESS AND PROSPECTS DIFFICULT AND IT MAY BE FORCED TO CEASE
OPERATIONS IF IT DOES NOT DEVELOP COMMERCIALLY SUCCESSFUL PRODUCTS.
The CombiMatrix group has not proven its ability to commercialize
products on a large scale. In order to successfully commercialize products on a
large scale, it will have to make significant investments, including investments
in research and development and testing, to demonstrate their technical benefits
and cost-effectiveness. Problems frequently encountered in connection with the
commercialization of products using new and unproven technologies might limit
its ability to develop and commercialize its products. For example, the
CombiMatrix group's products may be found to be ineffective, unreliable or
otherwise unsatisfactory to potential customers. The CombiMatrix group may
experience unforeseen technical complications in the processes it uses to
develop, manufacture, customize or receive orders for its products. These
complications could materially delay or limit the use of products the
CombiMatrix group attempts to commercialize, substantially increase the
anticipated cost of its products or prevent it from implementing its processes
at appropriate quality and scale levels, thereby causing its business to suffer.
THE COMBIMATRIX GROUP MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, AND IF
ADDITIONAL CAPITAL IS NOT AVAILABLE ON ACCEPTABLE TERMS, THE COMBIMATRIX GROUP
MAY HAVE TO CURTAIL OR CEASE OPERATIONS.
The CombiMatrix group's future capital requirements will be substantial
and will depend on many factors including how quickly it commercializes its
products, the progress and scope of its collaborative and independent research
and development projects, the filing, prosecution, enforcement and defense of
patent claims and the need to obtain regulatory approval for certain products in
the United States or elsewhere. Changes may occur that would cause the
CombiMatrix group's available capital resources to be consumed significantly
sooner than it expects.
The CombiMatrix group may be unable to raise sufficient additional
capital on favorable terms or at all. If it fails to do so, it may have to
curtail or cease operations or enter into agreements requiring it to relinquish
rights to certain technologies, products or markets because it will not have the
capital necessary to exploit them.
IF THE COMBIMATRIX GROUP DOES NOT ENTER INTO SUCCESSFUL PARTNERSHIPS AND
COLLABORATIONS WITH OTHER COMPANIES, IT MAY NOT BE ABLE TO FULLY DEVELOP ITS
TECHNOLOGIES OR PRODUCTS, AND ITS BUSINESS WOULD BE HARMED.
Since the CombiMatrix group does not possess all of the resources
necessary to develop and commercialize products that may result from its
technologies on a mass scale, it will need either to grow its sales, marketing
and support group or make appropriate arrangements with strategic partners to
74
market, sell and support its products. The CombiMatrix group believes that it
will have to enter into additional strategic partnerships to develop and
commercialize future products. If it does not enter into adequate agreements, or
if its existing arrangements or future agreements are not successful, its
ability to develop and commercialize products will be impacted negatively, and
its revenues will be adversely affected.
The current business of the CombiMatrix group is substantially
dependent on its existing arrangement with Roche. The CombiMatrix group
currently relies upon payments by Roche for a majority of its future revenues
and expends a majority of its resources toward fulfilling its contractual
obligations to Roche. Roche's primary service to the CombiMatrix group is to
distribute and proliferate its technology platform. If the CombiMatrix group
were to lose its relationship with Roche, the CombiMatrix group would be
required to establish a distribution agreement with another partner or
distribute its technology platform itself. This could prove difficult,
time-consuming and expensive, and the CombiMatrix group may not be successful in
achieving this objective.
THE COMBIMATRIX GROUP HAS LIMITED EXPERIENCE COMMERCIALLY MANUFACTURING,
MARKETING OR SELLING ANY OF ITS POTENTIAL PRODUCTS, AND UNLESS IT DEVELOPS THESE
CAPABILITIES, IT MAY NOT BE SUCCESSFUL.
Even if the CombiMatrix group is able to develop its products for
commercial release on a large-scale, it has limited experience in manufacturing
its products in the volumes that will be necessary for it to achieve commercial
sales and in marketing or selling its products to potential customers. We cannot
assure you that the CombiMatrix group will be able to commercially produce its
products on a timely basis, in sufficient quantities or on commercially
reasonable terms.
THE COMBIMATRIX GROUP FACES INTENSE COMPETITION AND WE CANNOT ASSURE YOU THAT IT
WILL BE SUCCESSFUL.
The CombiMatrix group expects to compete with companies that design,
manufacture and market instruments for analysis of genetic variation and
function and other applications using established sequential and parallel
testing technologies. The CombiMatrix group is also aware of other biotechnology
companies that have or are developing testing technologies for the SNP
genotyping, gene expression profiling and proteomic markets. The CombiMatrix
group anticipates that it will face increased competition in the future as new
companies enter the market with new technologies and its competitors improve
their current products.
The markets for the CombiMatrix group's products are characterized by
rapidly changing technology, evolving industry standards, changes in customer
needs, emerging competition and new product introductions. One or more of the
CombiMatrix group's competitors may offer technology superior to those of the
CombiMatrix group and render its technology obsolete or uneconomical. Many of
its competitors have greater financial and personnel resources and more
experience in marketing, sales and research and development than it has. Some of
its competitors currently offer arrays with greater density than it does and
have rights to intellectual property, such as genomic information or proprietary
technology, which provides them with a competitive advantage. If the CombiMatrix
group is not able to compete successfully, its business and financial condition
would be materially harmed.
IF THE COMBIMATRIX GROUP'S NEW AND UNPROVEN TECHNOLOGY IS NOT USED BY
RESEARCHERS IN THE PHARMACEUTICAL, BIOTECHNOLOGY AND ACADEMIC COMMUNITIES, ITS
BUSINESS WILL SUFFER.
The CombiMatrix group's products may not gain market acceptance. In
that event, it is unlikely that its business will succeed. Biotechnology and
pharmaceutical companies and academic research centers have historically
analyzed genetic variation and function using a variety of technologies, and
many of them have made significant capital investments in existing technologies.
Compared to existing technologies, the CombiMatrix group's technologies are new
and unproven. In order to be successful, its products must meet the commercial
requirements of the biotechnology, pharmaceutical and academic communities as
tools for the large-scale analysis of genetic variation and function. Market
acceptance will depend on many factors, including:
o the development of a market for its tools for the analysis of
genetic variation and function, the study of proteins and
other purposes;
o the benefits and cost-effectiveness of its products relative
to others available in the market;
o its ability to manufacture products in sufficient quantities
with acceptable quality and reliability and at an acceptable
cost;
75
o its ability to develop and market additional products and
enhancements to existing products that are responsive to the
changing needs of its customers;
o the willingness and ability of customers to adopt new
technologies requiring capital investments or the reluctance
of customers to change technologies in which they have made a
significant investment; and
o the willingness of customers to transmit test data and permit
the CombiMatrix group to transmit test results over the
Internet, which will be a necessary component of its product
and services packages unless customers purchase or license its
equipment for use in their own facilities.
IF THE MARKET FOR ANALYSIS OF GENOMIC INFORMATION DOES NOT DEVELOP OR IF GENOMIC
INFORMATION IS NOT AVAILABLE TO THE COMBIMATRIX GROUP'S POTENTIAL CUSTOMERS, ITS
BUSINESS WILL NOT SUCCEED.
The CombiMatrix group is designing its technology primarily for
applications in the biotechnology, pharmaceutical and academic communities. The
usefulness of the CombiMatrix group's technology depends in part upon the
availability of genomic data. The CombiMatrix group is initially focusing on
markets for analysis of genetic variation and function, namely SNP genotyping
and gene expression profiling. These markets are new and emerging, and they may
not develop as the CombiMatrix group anticipates, or at all. Also, researchers
may not seek or be able to convert raw genomic data into medically valuable
information through the analysis of genetic variation and function. If genomic
data is not available for use by the CombiMatrix group's customers or if its
target markets do not emerge in a timely manner, or at all, demand for its
products will not develop as it expects, and it may never become profitable.
THE COMBIMATRIX GROUP'S FUTURE SUCCESS DEPENDS ON THE CONTINUED SERVICE OF ITS
ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL AND ITS ABILITY TO IDENTIFY,
HIRE AND RETAIN ADDITIONAL ENGINEERING, TECHNICAL AND KEY MANAGEMENT PERSONNEL.
There is intense competition for qualified personnel in the CombiMatrix
group's industry, particularly for engineers and senior level management. Loss
of the services of, or failure to recruit, engineers or other technical and key
management personnel could be significantly detrimental to the group and could
adversely affect its business and operating results. The CombiMatrix group may
not be able to continue to attract and retain engineers or other qualified
personnel necessary for the development of its products and business or to
replace engineers or other qualified personnel who may leave the group in the
future. The CombiMatrix group's anticipated growth is expected to place
increased demands on its resources and likely will require the addition of new
management personnel.
THE EXPANSION OF THE COMBIMATRIX GROUP'S PRODUCT LINES MAY SUBJECT IT TO
REGULATION BY THE UNITED STATES FOOD AND DRUG ADMINISTRATION AND FOREIGN
REGULATORY AUTHORITIES, WHICH COULD PREVENT OR DELAY ITS INTRODUCTION OF NEW
PRODUCTS.
If the CombiMatrix group manufactures, markets or sells any products
for any regulated clinical or diagnostic applications, those products will be
subject to extensive governmental regulation as medical devices in the United
States by the FDA and in other countries by corresponding foreign regulatory
authorities. The process of obtaining and maintaining required regulatory
clearances and approvals is lengthy, expensive and uncertain. Products that
CombiMatrix Corporation manufactures, markets or sells for research purposes
only are not subject to governmental regulations as medical devices or as
analyte specific reagents to aid in disease diagnosis. We believe that the
CombiMatrix group's success will depend upon commercial sales of improved
versions of products, certain of which cannot be marketed in the United States
and other regulated markets unless and until the CombiMatrix group obtains
clearance or approval from the FDA and its foreign counterparts, as the case may
be. Delays or failures in receiving these approvals may limit our ability to
benefit from new CombiMatrix group products.
AS THE COMBIMATRIX GROUP'S OPERATIONS EXPAND, ITS COSTS TO COMPLY WITH
ENVIRONMENTAL LAWS AND REGULATIONS WILL INCREASE, AND FAILURE TO COMPLY WITH
THESE LAWS AND REGULATIONS COULD HARM ITS FINANCIAL RESULTS.
The CombiMatrix group's operations involve the use, transportation,
storage and disposal of hazardous substances, and as a result it is subject to
environmental and health and safety laws and regulations. As the CombiMatrix
group expands its operations, its use of hazardous substances will increase and
lead to additional and more stringent requirements. The cost to comply with
these and any future environmental and health and safety regulations could be
substantial. In addition, the CombiMatrix group's failure to comply with laws
and regulations, and any releases of hazardous substances into the environment
or at its disposal sites, could expose the CombiMatrix group to substantial
liability in the form of fines, penalties, remediation costs and other damages,
or could lead to a curtailment or shut down of its operations. These types of
events, if they occur, would adversely impact the group's financial results.
76
THE COMBIMATRIX GROUP'S BUSINESS DEPENDS ON ISSUED AND PENDING PATENTS, AND THE
LOSS OF ANY PATENTS OR THE GROUP'S FAILURE TO SECURE THE ISSUANCE OF PATENTS
COVERING ELEMENTS OF ITS BUSINESS PROCESSES WOULD MATERIALLY HARM ITS BUSINESS
AND FINANCIAL CONDITION.
The CombiMatrix group's success depends on its ability to protect and
exploit its intellectual property. The CombiMatrix group currently has two
patents issued in the United States, one patent issued in Europe and more than
44 patent applications pending in the United States, Europe and elsewhere. The
patent application process before the Unites States Patent and Trademark Office
and other similar agencies in other countries is initially confidential in
nature. Patents that are filed outside the United States, however, are published
approximately eighteen months after filing. The CombiMatrix group cannot
determine in a timely manner whether patent applications covering technology
that competes with its technology have been filed in the United States or other
foreign countries or which, if any, will ultimately issue or be granted as
enforceable patents. Some of the CombiMatrix group's patent applications may
claim compositions, methods or uses that may also be claimed in patent
applications filed by others. In some or all of these applications, a
determination of priority of inventorship may need to be decided in a proceeding
before the United States Patent and Trademark Office or a foreign regulatory
body or a court. If the CombiMatrix group is unsuccessful in these proceedings,
it could be blocked from further developing, commercializing or selling
products. Regardless of the ultimate outcome, this process is time-consuming and
expensive.
ANY INABILITY TO ADEQUATELY PROTECT THE COMBIMATRIX GROUP'S PROPRIETARY
TECHNOLOGIES COULD MATERIALLY HARM THE COMBIMATRIX GROUP'S COMPETITIVE POSITION
AND FINANCIAL RESULTS.
If the CombiMatrix group does not protect its intellectual property
adequately, competitors may be able to use its technologies and erode any
competitive advantage that it may have. The laws of some foreign countries do
not protect proprietary rights to the same extent as the laws of the United
States, and many companies have encountered significant problems in protecting
their proprietary rights abroad. These problems can be caused by the absence of
rules and methods for defending intellectual property rights.
The patent positions of companies developing tools for the
biotechnology, pharmaceutical and academic communities, including the
CombiMatrix group's patent position, generally are uncertain and involve complex
legal and factual questions. The CombiMatrix group will be able to protect its
proprietary rights from unauthorized use by third parties only to the extent
that its proprietary technologies are covered by valid and enforceable patents
or are effectively maintained as trade secrets. The CombiMatrix group's existing
patents and any future issued or granted patents it obtains may not be
sufficiently broad in scope to prevent others from practicing its technologies
or from developing competing products. There also is a risk that others may
independently develop similar or alternative technologies or designs around the
CombiMatrix group's patented technologies. In addition, others may oppose or
invalidate its patents, or its patents may fail to provide it with any
competitive advantage. Enforcing the CombiMatrix group's intellectual property
rights may be difficult, costly and time-consuming and ultimately may not be
successful.
The CombiMatrix group also relies upon trade secret protection for its
confidential and proprietary information. While it has taken security measures
to protect its proprietary information, these measures may not provide adequate
protection for its trade secrets or other proprietary information. The
CombiMatrix group seeks to protect its proprietary information by entering into
confidentiality and invention disclosure and transfer agreements with employees,
collaborators and consultants. Nevertheless, employees, collaborators or
consultants may still disclose its proprietary information, and the CombiMatrix
group may not be able to meaningfully protect its trade secrets. In addition,
others may independently develop substantially equivalent proprietary
information or techniques or otherwise gain access to its trade secrets.
ANY LITIGATION TO PROTECT THE COMBIMATRIX GROUP'S INTELLECTUAL PROPERTY OR ANY
THIRD-PARTY CLAIMS OF INFRINGEMENT, COULD DIVERT SUBSTANTIAL TIME AND MONEY FROM
THE COMBIMATRIX GROUP'S BUSINESS AND COULD SHUT DOWN SOME OF ITS OPERATIONS.
The CombiMatrix group's commercial success depends in part on its
non-infringement of the patents or proprietary rights of third parties. Many
companies developing tools for the biotechnology and pharmaceutical industries
use litigation aggressively as a strategy to protect and expand the scope of
their intellectual property rights. Accordingly, third parties may assert that
the CombiMatrix group is employing their proprietary technology without
authorization. In addition, third parties may claim that use of the CombiMatrix
group's technologies infringes their current or future patents. The CombiMatrix
group could incur substantial costs and the attention of its management and
technical personnel could be diverted while defending ourselves against any of
these claims. The CombiMatrix group may incur the same liabilities in enforcing
its patents against others. The CombiMatrix group has not made any provision in
its financial plans for potential intellectual property related litigation, and
it may not be able to pursue litigation as aggressively as competitors with
substantially greater financial resources.
77
If parties making infringement claims against the CombiMatrix group are
successful, they may be able to obtain injunctive or other equitable relief,
which effectively could block the CombiMatrix group's ability to further
develop, commercialize and sell products, and could result in the award of
substantial damages against it. If the CombiMatrix group is unsuccessful in
protecting and expanding the scope of its intellectual property rights, its
competitors may be able to develop, commercialize and sell products that compete
with it using similar technologies or obtain patents that could effectively
block its ability to further develop, commercialize and sell its products. In
the event of a successful claim of infringement against it, the CombiMatrix
group may be required to pay substantial damages and either discontinue those
aspects of its business involving the technology upon which it infringed or
obtain one or more licenses from third parties. While the CombiMatrix group may
license additional technology in the future, it may not be able to obtain these
licenses at a reasonable cost, or at all. In that event, it could encounter
delays in product introductions while it attempts to develop alternative methods
or products, which may not be successful. Defense of any lawsuit or failure to
obtain any of these licenses could prevent it from commercializing available
products.
RISKS RELATING TO THE ACACIA TECHNOLOGIES GROUP
The risk factors beginning on this page discuss risks relating to the
Acacia Technologies group. Because each holder of AR-Acacia Technologies stock
is a holder of the common stock of one company, Acacia Research Corporation, and
the risks associated with the CombiMatrix group could affect the AR-Acacia
Technologies stock. As such, we also urge you to read carefully the section
"Risks Relating to the CombiMatrix Group" beginning on page 73.
THE V-CHIP TECHNOLOGY PATENT HELD BY THE ACACIA TECHNOLOGIES GROUP WILL EXPIRE
IN JULY 2003, AND IF THE GROUP DOES NOT DEVELOP OTHER RECURRING SOURCES OF
REVENUE, ITS FINANCIAL CONDITION WILL BE ADVERSELY IMPACTED.
The Acacia Technologies group, and Acacia Research Corporation as a
whole, has generated substantially all of its revenues from licensing the
patented V-chip technology to television manufacturers. The Acacia Technologies
group's patent on the V-chip technology will expire in July 2003. The Acacia
Technologies group will not be able to collect royalties for televisions
containing V-chip technology sold after the expiration of that patent, but it
may still collect revenues from the sale of such televisions in the U.S. before
that date. The Acacia Technologies group is beginning to market its digital
media transmission technology and is developing other technologies and products.
The eventual licensing and sale of these technologies is intended to replace the
revenue currently being generated by licensing its V-chip technology. If the
Acacia Technologies group does not succeed in developing such technologies or is
unable to commercially license its existing and future technologies, its
financial condition will be adversely impacted.
THE ACACIA TECHNOLOGIES GROUP MAY FAIL TO MEET MARKET EXPECTATIONS BECAUSE OF
FLUCTUATIONS IN ITS QUARTERLY OPERATING RESULTS, WHICH COULD CAUSE THE PRICE OF
AR-ACACIA TECHNOLOGIES STOCK TO DECLINE.
The Acacia Technologies group revenues and operating results have
fluctuated in the past and may continue to fluctuate significantly from quarter
to quarter in the future. It is possible that in future periods the Acacia
Technologies group's revenues could fall below the expectations of securities
analysts or investors, which could cause the market price of the AR-Acacia
Technologies stock to decline. The following are among the factors that could
cause the Acacia Technologies group's operating results to fluctuate
significantly from period to period:
o its unpredictable revenue sources, as described below;
o costs related to acquisitions, alliances, licenses and other
efforts to expand its operations;
o the timing of payments under the terms of any customer or
license agreements into which the Acacia Technologies group
may enter; and
o expenses related to, and the results of, patent filings and
other proceedings relating to intellectual property rights.
THE ACACIA TECHNOLOGIES GROUP'S REVENUES WILL BE UNPREDICTABLE, AND THIS MAY
HARM ITS FINANCIAL CONDITION.
The amount and timing of revenues that the Acacia Technologies group
may realize from its business will be unpredictable because:
o whether the Acacia Technologies group generates revenues
depends, in part, on the success of its licensing efforts;
78
o its cycle of obtaining licensees may be lengthy; and
o it cannot be sure as to the timing of receipt of payment.
As a result, the Acacia Technologies group's revenues may vary
significantly from quarter to quarter, which could make its business difficult
to manage and cause its quarterly results to be below market expectations. If
this happens, the price of the AR-Acacia Technologies stock may decline
significantly.
TECHNOLOGY COMPANY STOCK PRICES ARE ESPECIALLY VOLATILE, AND THIS VOLATILITY MAY
DEPRESS THE PRICE OF AR-ACACIA TECHNOLOGIES STOCK.
The stock market has experienced significant price and volume
fluctuations, and the market prices of technology companies have been highly
volatile. We believe that various factors may cause the market price of the
AR-Acacia Technologies stock to fluctuate, perhaps substantially, including,
among others, announcements of:
o its or its competitors' technological innovations;
o developments or disputes concerning patents or proprietary
rights;
o developments in relationships with licensees;
o its failure to meet or exceed securities analysts'
expectations of its financial results; or
o a change in financial estimates or securities analysts'
recommendations.
In the past, companies that have experienced volatility in the market
price of their stock have been the objects of securities class action
litigation. If the AR-Acacia Technologies stock was the object of securities
class action litigation, it could result in substantial costs and a diversion of
management's attention and resources, which could materially harm the business
and financial results of the Acacia Technologies group.
THE ACACIA TECHNOLOGIES GROUP FACES INTENSE COMPETITION, AND WE CANNOT ASSURE
YOU THAT IT WILL BE SUCCESSFUL.
The Acacia Technologies group believes that Soundview Technologies'
V-chip technology is protected by enforceable patent rights. Other companies,
however, may develop competing technologies that offer better or less expensive
alternatives to those offered by Soundview Technologies. Many potential
competitors, including television manufacturers, have significantly greater
resources.
Although the Acacia Technologies group believes that Acacia Media
Technologies has marketing and licensing rights to enforceable patents and other
intellectual property relating to video and audio on demand, the Acacia
Technologies group cannot assure you that other companies will not develop
competing technologies that offer better or less expensive alternatives to those
offered by Acacia Media Technologies. In the event a competing technology
emerges, Acacia Media Technologies would expect substantial additional
competition.
THE MARKETS SERVED BY THE ACACIA TECHNOLOGIES GROUP ARE SUBJECT TO RAPID
TECHNOLOGICAL CHANGE, AND IF THE ACACIA TECHNOLOGIES GROUP IS UNABLE TO DEVELOP
AND INTRODUCE NEW PRODUCTS, ITS REVENUES COULD STOP GROWING OR COULD DECLINE.
The markets served by the Acacia Technologies group frequently undergo
transitions in which products rapidly incorporate new features and performance
standards on an industry-wide basis. Products for communications applications,
as well as for high-speed computing applications, are based on continually
evolving industry standards. A significant portion of the Acacia Technologies
group's revenues in recent periods has been, and is expected to continue to be,
derived from sales of products based on existing transmission standards.
However, the Acacia Technologies group's ability to compete in the future will
depend on its ability to identify and ensure compliance with evolving industry
standards.
79
THE ACACIA TECHNOLOGIES GROUP'S SUCCESS IS BASED ON ITS ABILITY TO PROTECT ITS
PROPRIETARY TECHNOLOGY AND ITS ABILITY TO DEFEND ITSELF AGAINST INFRINGEMENT
CLAIMS.
The success of the Acacia Technologies group relies, to varying
degrees, on its proprietary rights and their protection or exclusivity. Although
reasonable efforts will be taken to protect the Acacia Technologies group's
proprietary rights, the complexity of international trade secret, copyright,
trademark and patent law, and common law, coupled with limited resources and the
demands of quick delivery of products and services to market, create risk that
these efforts will prove inadequate. For example, in our pending litigation
against certain television manufacturers alleging their infringement of
Soundview Technologies' V-chip patent, a motion for summary judgment filed by
the defendants was granted in September 2002. The court ruled that the
defendants have not infringed on Soundview Technologies' patent. If we are
unsuccessful in our intended appeal of this ruling, legal principles would
preclude us from claiming infringement of our patents by other parties.
Accordingly, if we are unsuccessful in this or other litigation to protect our
intellectual property rights, the future revenues of the Acacia Technologies
group could be adversely affected.
From time to time, the Acacia Technologies group may be subject to
third-party claims in the ordinary course of business, including claims of
alleged infringement of proprietary rights. Any such claims may harm the Acacia
Technologies group by subjecting it to significant liability for damage and
invalidating its proprietary rights. These types of claims, with or without
merit, could subject the Acacia Technologies group to costly litigation and
diversion of its technical and management personnel. The Acacia Technologies
group depends largely on the protection of enforceable patent rights. The Acacia
Technologies group has applications on file with the U.S. Patent and Trademark
Office seeking patents on its core technologies and has patents or rights to
patents that have been issued. We cannot assure you that the pending patent
applications of the Acacia Technologies group will be issued, that third parties
will not violate, or attempt to invalidate these intellectual property rights,
or that certain aspects of those intellectual property will not be
reverse-engineered by third parties without violating the patent rights of the
Acacia Technologies group.
For Acacia Media Technologies and Soundview Technologies, proprietary
rights constitute their only significant assets. The Acacia Technologies group
also owns licenses from third parties and it is possible that it could become
subject to infringement actions based upon such licenses. The Acacia
Technologies group generally obtains representations as to the origin and
ownership of such licensed content. However, this may not adequately protect the
Acacia Technologies group. The Acacia Technologies group enters into
confidentiality agreements with third parties and generally limits access to
information relating to its proprietary rights. Despite these precautions, third
parties may be able to gain access to and use the Acacia Technologies group's
proprietary rights to develop competing technologies and products with similar
or better features and prices. Any substantial unauthorized use of the Acacia
Technologies group's proprietary rights could materially and adversely affect
its business and operational results.
80
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the caption "Quantitative and Qualitative Disclosures About
Market Risk" on pages 47, 56 and 62.
The primary objective of our investment activities is to preserve
principal while concurrently maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we may invest in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the current value of the principal amount of our investment will decline.
To minimize this risk in the future, we intend to maintain our portfolio of cash
equivalents and short-term investments in a variety of securities, including
commercial paper, money market funds, high-grade corporate bonds, government and
non-government debt securities and certificates of deposit. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate. As of December 31, 2002, all
of our investments were in money market funds, high-grade corporate bonds, and
U.S. government debt securities. A hypothetical 100 basis point increase in
interest rates would result in an approximate $61,000 decrease in the fair value
of our available-for-sale securities as of December 31, 2002. See Note 3 to the
Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and related financial information required to
be filed hereunder are indexed under Item 15 of this report and are incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
81
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated by reference from
the information under the captions entitled "Election of Directors-Nominees,"
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in our definitive proxy statement to be filed with the SEC no later
than April 30, 2003.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from
the information under the caption entitled "Executive Officer Compensation" in
our definitive proxy statement to be filed with the SEC no later than April 30,
2003.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from
the information under the caption entitled "Security Ownership of Certain
Beneficial Owners and Management" in our definitive proxy statement to be filed
with the SEC no later than April 30, 2003.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference from
the information under the caption entitled "Transactions with Management and
Others" in our definitive proxy statement to be filed with the SEC no later than
April 30, 2003.
ITEM 14. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, we carried out
an evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information relating to us (including our consolidated subsidiaries)
required to be included in our periodic SEC filings.
(b) There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of the evaluation referred to above. There were no significant deficiencies
or material weaknesses, and therefore there were no corrective actions taken.
82
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report.
(1) Financial Statements
Acacia Research Corporation Consolidated Financial Statements PAGE
----
Report of Independent Accountants.......................................F-1
Consolidated Balance Sheets as of December 31, 2002 and 2001............F-2
Consolidated Statements of Operations and Comprehensive Loss
for the Years Ended December 31, 2002, 2001 and 2000..................F-3
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 2002, 2001 and 2000................................F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000......................................F-6
Notes to Consolidated Financial Statements..............................F-7
*Acacia Technologies Group Financial Statements PAGE
(A Division of Acacia Research Corporation) ----
Report of Independent Accountants......................................F-53
Balance Sheets as of December 31, 2002 and 2001........................F-54
Statements of Operations
for the Years Ended December 31, 2002, 2001 and 2000.................F-55
Statements of Allocated Net Worth for the Years
Ended December 31, 2002, 2001 and 2000...............................F-56
Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000.....................................F-57
Notes to Financial Statements..........................................F-58
*CombiMatrix Group Financial Statements PAGE
(A Division of Acacia Research Corporation) ----
Report of Independent Accountants......................................F-74
Balance Sheets as of December 31, 2002 and 2001........................F-75
Statements of Operations
for the Years Ended December 31, 2002, 2001 and 2000.................F-76
Statements of Allocated Net Worth for the Years
Ended December 31, 2002, 2001 and 2000...............................F-77
Statements of Cash Flows for the Years Ended
December 31, 2002, 2001 and 2000.....................................F-78
Notes to Financial Statements..........................................F-79
*NOTE: We are presenting, the Acacia Research Corporation consolidated financial
statements and the separate financial statements for the CombiMatrix group and
the Acacia Technologies group. The separate financial statements and
accompanying notes of the two groups are being provided as additional disclosure
regarding the financial performance of the two divisions and to provide
investors with information regarding the potential value and operating results
of the respective businesses, which may affect the respective share values. The
separate financial statements should be reviewed in conjunction with Acacia
Research Corporation's consolidated financial statements and accompanying notes.
The presentation of separate financial statements is not intended to indicate
that we have changed the title to any of our assets or changed the
responsibility for any of our liabilities, nor is it intended to indicate that
the rights of our creditors have been changed. Acacia Research Corporation, and
not the individual groups, is the issuer of the securities. Holders of the two
securities are stockholders of Acacia Research Corporation and do not have a
separate and exclusive interest in the respective groups.
83
(2) Financial Statement Schedules
Financial statement schedules are omitted because they are not applicable
or the required information is shown in the Financial Statements or the Notes
thereto.
(3) Exhibits. The following exhibits are either filed herewith or incorporated
herein by reference:
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement and Plan of Merger of Acacia Research Corporation, a
California corporation, and Acacia Research Corporation, a
Delaware corporation, dated as of December 23, 1999 (1)
2.2 Agreement and Plan of Reorganization by and among Acacia Research
Corporation, Combi Acquisition Corp. and CombiMatrix Corporation
dated as of March 20, 2002 (attached as Annex A to the
Prospectus/Proxy Statement included in this Registration
Statement)
3.1 Restated Certificate of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.1 Form of Specimen Certificate of Acacia's Common Stock (4)
10.1 Acacia Research Corporation1993 Stock Option Plan (5)
10.2 Form of Stock Option Agreement for Acacia Research Corporation1993
Stock Option Plan (5)
10.3 Acacia Research Corporation1996 Stock Option Plan, as amended (6)
10.4 Form of Option Agreement constituting the Acacia Research
Corporation1996 Executive Stock Bonus Plan (7)
10.5 CombiMatrix Corporation 1995 Stock Option Plan (8)
10.6 CombiMatrix Corporation 1998 Stock Option Plan (8)
10.7 CombiMatrix Corporation 2000 Stock Awards Plan (8)
10.8 2002 CombiMatrix Stock Incentive Plan (9)
10.9 2002 Acacia Technologies Stock Incentive Plan (10)
10.10 Agreement between Acacia Research Corporation and Paul Ryan (11)
10.11 Lease Agreement dated April 30, 1998, between Acacia Research
Corporation and EOP-Pasadena Towers, L.L.C., a Delaware limited
liability company doing business as EOP-Pasadena, LLC (12)
10.12 Lease Agreement between Soundbreak.com Incorporated and 8730
Sunset Towers and related Guaranty (13)
10.13 First Amendment dated June 26, 2000, to Lease Agreement between
Acacia Research Corporation and Pasadena Towers, L.L.C. (14)
10.14 Sublease dated November 30, 2001, between and Jenkens & Gilchrist
(14)
10.15 Lease Agreement dated January 28, 2002, between Acacia Research
Corporation and The Irvine Company (14)
10.16 Settlement Agreement dated September 30, 2002, by and among Acacia
Research Corporation, CombiMatrix Corporation, Donald D.
Montgomery, Ph.D. and Nanogen, Inc.(8)
10.17+ Research & Development Agreement dated September 25, 2002, between
CombiMatrix Corporation and Roche Diagnostics GmbH(8)
10.18+ License Agreement dated September 25, 2002 between CombiMatrix
Corporation and Roche Diagnostics GmbH(8)
10.19 Form of Indemnification Agreement
21.1 List of Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of Acacia Research Corporation)
23.2 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of CombiMatrix Corporation)
23.3 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of the Acacia Technologies Group and the CombiMatrix
Group)
99.1 Certifications of the Chief Executive Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certifications of the Chief Financial Officer provided pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
- ---------------------------
84
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with the United
States Securities and Exchange Commission.
(1) Incorporated by reference from Acacia Research Corporation's Report on
Form 8-K filed on December 30, 1999 (SEC File No. 000-26068).
(2) Incorporated by reference as Appendix B to the Proxy
Statement/Prospectus which formed part of Acacia Research Corporation's
Registration Statement on Form S-4 (SEC File No. 333-87654) which
became effective on November 8, 2002.
(3) Incorporated by reference from Acacia Research Corporation's Quarterly
Report on Form 10-Q filed on August 10, 2001 (SEC File No. 000-26068).
(4) Incorporated by reference from Amendment No. 2 on Form 8-A/A filed on
December 30, 1999 (SEC File No. 000-26068).
(5) Incorporated by reference from Acacia Research Corporation's
Registration Statement on Form SB-2 (33-87368-L.A.), which became
effective under the Securities Act of 1933, as amended, on June 15,
1995.
(6) Incorporated by reference as Appendix A to the Definitive Proxy
Statement on Schedule 14A filed on April 10, 2000 (SEC File No.
000-26068).
(7) Incorporated by reference from Acacia Research Corporation's Definitive
Proxy as Appendix A Statement on Schedule 14A filed on April 26, 1996
(SEC File No. 000-26068).
(8) Incorporated by reference to Acacia Research Corporation's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective
on November 8, 2002.
(9) Incorporated by reference as Appendix D to the Proxy
Statement/Prospectus which formed part of Acacia Research Corporation's
Registration Statement on Form S-4 (SEC File No. 333-87654) which
became effective on November 8, 2002.
(10) Incorporated by reference as Appendix E to the Proxy
Statement/Prospectus which formed part of Acacia Research Corporation's
Registration Statement on Form S-4 (SEC File No. 333-87654) which
became effective on November 8, 2002.
(11) Incorporated by reference from Acacia Research Corporation's Annual
Report on Form 10-K for the year ended December 31, 1997, filed on
March 30, 1998 (SEC File No. 000-26068).
(12) Incorporated by reference to Acacia Research Corporation's Quarterly
Report on Form 10-Q filed on August 14, 1998 (SEC File No. 000-26068).
(13) Incorporated by reference to Acacia Research Corporation's Quarterly
Report on Form 10-Q filed on November 15, 1999 (SEC File No.
000-26068).
(14) Incorporated by reference from Acacia Research Corporation's Annual
Report on Form 10-K for the year ended December 31, 2001 filed on March
27, 2002 (SEC File No. 000-26068). (b) Reports on Form 8-K filed during
the quarter ended December 31, 2002.
On November 14, 2002, Acacia Research Corporation filed a Current
Report on Form 8-K to report results for the quarter ended September 30, 2002
(Item 9).
On December 12, 2002, Acacia Research Corporation filed a Current
Report on Form 8-K to report the approval by its stockholders of its
recapitalization and merger proposals (Item 9).
On December 24, 2002, Acacia Research Corporation filed a Current
Report on Form 8-K to report that its Acacia Research--CombiMatrix common stock
would trade on the Nasdaq SmallCap Market, rather than the Nasdaq National
Market (Item 9).
85
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
DATED: March 26, 2003 ACACIA RESEARCH CORPORATION
/s/ Paul R. Ryan
----------------------------------
Paul R. Ryan
CHAIRMAN OF THE BOARD
AND CHIEF EXECUTIVE OFFICER
(AUTHORIZED SIGNATORY)
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Paul R. Ryan Chairman of the Board and March 26, 2003
- ----------------------------------- Chief Executive Officer
Paul R. Ryan (Principal Chief Executive)
/s/ Robert L. Harris, II Director and President March 26, 2003
- -----------------------------------
Robert L. Harris, II
/s/ Clayton J. Haynes Chief Financial Officer March 26, 2003
- ----------------------------------- (Principal Financial Officer)
Clayton J. Haynes
/s/ Thomas B. Akin Director March 26, 2003
- -----------------------------------
Thomas B. Akin
/s/ Fred A. de Boom Director March 26, 2003
- -----------------------------------
Fred A. de Boom
/s/ Edward W. Frykman Director March 26, 2003
- -----------------------------------
Edward W. Frykman
/s/ G. Louis Graziadio, III Director March 26, 2003
- -----------------------------------
G. Louis Graziadio, III
/s/ Amit Kumar, Ph.D. Director March 26, 2003
- -----------------------------------
Amit Kumar, Ph.D.
/s/ Rigdon Currie Director March 26, 2003
- -----------------------------------
Rigdon Currie
86
CERTIFICATION
-------------
I, Paul R. Ryan, certify that:
1. I have reviewed this annual report on Form 10-K of Acacia Research
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/ Paul R. Ryan
---------------------------
Paul R. Ryan
CHAIRMAN OF THE BOARD AND
CHIEF EXECUTIVE OFFICER
87
CERTIFICATION
-------------
I, Clayton J. Haynes, certify that:
1. I have reviewed this annual report on Form 10-K of Acacia Research
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/ Clayton J. Haynes
---------------------------
Clayton J. Haynes
CHIEF FINANCIAL OFFICER
88
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the consolidated financial statements listed in the
index appearing under Item 15(a)(1) on page 83 present fairly, in all material
respects, the financial position of Acacia Research Corporation and its
subsidiaries at December 31, 2002 and December 31, 2001, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of Acacia Research Corporation's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements,
effective January 1, 2001, Acacia Research Corporation changed its balance sheet
classification for accrued subsidiary employee stock-based compensation charges,
resulting in no cumulative effect on income.
As discussed in Note 2 to the consolidated financial statements,
effective October 1, 2000, Acacia Research Corporation adopted Emerging Issues
Task Force Consensus on Issue No. 00-27, "Application of Issue No. 98-5 to
Certain Convertible Instruments," resulting in a charge of $246,000 in the year
ended December 31, 2000 for cumulative effect of change in accounting principle
due to beneficial conversion feature of debt.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 26, 2003
F-1
ACACIA RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2002 2001
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents .............................................................. $ 43,083 $ 59,451
Short-term investments ................................................................. 11,605 25,110
Accounts receivable .................................................................... 578 143
Prepaid expenses, other receivables and other assets ................................... 1,221 1,470
---------- ----------
Total current assets ........................................................... 56,487 86,174
Property and equipment, net of accumulated depreciation ................................... 4,075 4,906
Investment in affiliate, at cost .......................................................... 252 3,000
Patents, net of accumulated amortization .................................................. 15,280 11,855
Goodwill, net of accumulated amortization ................................................. 20,693 4,627
Other assets .............................................................................. 284 297
---------- ----------
$ 97,071 $ 110,859
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ........................................... $ 4,826 $ 5,756
Current portion of deferred revenues ................................................... 10,675 7,088
Current portion of capital lease obligation ............................................ -- 934
---------- ----------
Total current liabilities ........................................................ 15,501 13,778
Deferred income taxes ..................................................................... 3,540 3,829
Deferred revenues, net of current portion ................................................. -- 372
Capital lease obligation, net of current portion .......................................... -- 1,845
---------- ----------
Total liabilities ................................................................ 19,041 19,824
---------- ----------
Commitments and contingencies (Note 13)
Minority interests ........................................................................ 2,171 32,303
---------- ----------
Stockholders' equity:
Preferred stock (Note 8)
Acacia Research Corporation, par value $0.001 per share; 10,000,000 shares authorized;
no shares issued or outstanding .................................................... -- --
Acacia Research Corporation (predecessor), par value $0.001 per share; 20,000,000
shares authorized; no shares issued or outstanding ................................ -- --
Common stock (Note 8)
Acacia Research - Acacia Technologies stock, par value $0.001 per share;
50,000,000 shares authorized; 19,640,808 and zero shares issued and
outstanding as of December 31, 2002 and 2001, respectively ......................... 20 --
Acacia Research - CombiMatrix stock, par value $0.001 per share; 50,000,000 shares
authorized; 22,964,779 and zero shares issued and outstanding as of December 31,
2002 and 2001, respectively ........................................................ 23 --
Acacia Research Corporation common stock (predecessor), par value $0.001 per share;
60,000,000 shares authorized; 19,592,459 shares issued and outstanding as of
December 31, 2001 .................................................................. -- 20
Additional paid-in capital ............................................................. 238,627 158,529
Deferred stock compensation ............................................................ (4,023) --
Warrants to purchase common stock ...................................................... 199 199
Comprehensive loss ..................................................................... (2) (4)
Accumulated deficit .................................................................... (158,985) (100,012)
---------- ----------
Total stockholders' equity ....................................................... 75,859 58,732
---------- ----------
$ 97,071 $ 110,859
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-2
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2002 2001 2000
--------- --------- ---------
Revenues:
License fee income ........................................... $ 43 $ 24,180 $ --
Product revenue .............................................. 306 -- --
Grant and contract revenue ................................... 533 456 17
Other income ................................................. -- -- 40
--------- --------- ---------
Total revenues ........................................... 882 24,636 57
--------- --------- ---------
Operating expenses:
Cost of sales ................................................ 263 -- --
Research and development expenses ............................ 18,187 11,656 5,959
Charge for acquired in-process research and development ...... 17,237 -- 2,508
Non-cash stock compensation
expense - research and development ......................... 1,868 7,183 3,397
Marketing, general and administrative expenses ............... 18,632 32,664 14,782
Non-cash stock compensation
expense - marketing, general and administrative ............ 4,559 13,636 7,307
Amortization of patents and goodwill ......................... 1,990 2,695 2,251
Legal settlement charges ..................................... 18,471 -- --
Loss on disposal of consolidated subsidiaries ................ -- -- 1,016
--------- --------- ---------
Total operating expenses ................................. 81,207 67,834 37,220
--------- --------- ---------
Operating loss ........................................... (80,325) (43,198) (37,163)
--------- --------- ---------
Other (expense) income:
Impairment of cost method investment ......................... (2,748) -- --
Write-off of equity investments .............................. -- -- (2,603)
Interest income .............................................. 1,209 3,762 3,086
Realized (losses) gains on short-term investments ............ (1,184) 350 --
Unrealized (losses) gains on short-term investments .......... (249) 237 --
Interest expense ............................................. (203) (65) --
Equity in losses of affiliate ................................ -- (195) (1,746)
Other income ................................................. 64 77 28
--------- --------- ---------
Total other (expense) income ............................. (3,111) 4,166 (1,235)
--------- --------- ---------
Loss from continuing operations
before income taxes and minority interests .................... (83,436) (39,032) (38,398)
Benefit (provision) for income taxes ............................ 857 (780) 73
--------- --------- ---------
Loss from continuing operations before minority interests ....... (82,579) (39,812) (38,325)
Minority interests .............................................. 23,806 17,540 9,166
--------- --------- ---------
Loss from continuing operations ................................. (58,773) (22,272) (29,159)
Discontinued operations:
Loss from discontinued operations of Soundbreak.com .......... -- -- (7,443)
Estimated loss on disposal of Soundbreak.com ................. (200) -- (2,111)
--------- --------- ---------
Loss before cumulative effect of change in accounting principle . (58,973) (22,272) (38,713)
Cumulative effect of change in accounting principle due to
beneficial conversion feature of debt ......................... -- -- (246)
--------- --------- ---------
Net loss ........................................................ (58,973) (22,272) (38,959)
Unrealized (losses) gains on short-term investments ........... (38) (9) 77
Unrealized gains (losses) on foreign currency translation ..... 40 (72) --
--------- --------- ---------
Comprehensive loss .............................................. $(58,971) $(22,353) $(38,882)
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-3
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
2002 2001 2000
------------- ------------- -------------
LOSS PER SHARE:
ATTRIBUTABLE TO THE ACACIA TECHNOLOGIES GROUP:
Loss from continuing operations ................... $ (12,554) $ -- $ --
Basic and diluted per share ..................... (0.64) -- --
Loss from discontinued operations ................. (200) -- --
Basic and diluted per share ..................... (0.01) -- --
Net loss .......................................... (12,754) -- --
Basic and diluted per share ....................... (0.65) -- --
ATTRIBUTABLE TO THE COMBIMATRIX GROUP:
Loss from continuing operations ................... $ (46,219) $ -- $ --
Basic and diluted per share ..................... (2.01) -- --
Net loss .......................................... (46,219) -- --
Basic and diluted per share ..................... (2.01) -- --
ACACIA RESEARCH CORPORATION:
Loss from continuing operations ................... $ -- $ (22,272) $ (29,159)
Basic and diluted per share ..................... -- (1.16) (1.78)
Loss from discontinued operations ................. -- -- (9,554)
Basic and diluted per share ..................... -- -- (0.58)
Cumulative effect of change in accounting principle -- -- (246)
Basic and diluted per share ..................... -- -- (0.02)
Net loss .......................................... -- (22,272) (38,959)
Basic and diluted per share ..................... -- (1.16) (2.38)
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED:
Acacia Research - Acacia Technologies stock ....... 19,640,808 -- --
============= ============= =============
Acacia Research - CombiMatrix stock ............... 22,950,746 -- --
============= ============= =============
Acacia Research Corporation ....................... -- 19,259,256 16,346,099
============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-4
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
ACACIA
ACACIA RESEARCH AR-ACACIA AR- RESEARCH AR-ACACIA AR-
CORPORATION TECHNOLOGIES COMBIMATRIX CORPORATION TECHNOLOGIES COMBIMATRIX ADDITIONAL
COMMON SHARES COMMON COMMON COMMON STOCK COMMON COMMON PAID-IN
(PREDECESSOR) SHARES SHARES (PREDECESSOR) STOCK STOCK CAPITAL
------------ ------------ ------------ ------------ ------------ ------------ ------------
2000
Balance at December 31, 1999 ........ 13,607,193 -- -- $ 14 $ -- $ -- $ 62,283
Net loss ............................
Units issued in private
placements, net ................... 872,638 1 22,199
Stock options exercised ............. 543,961 1 2,131
Stock issuance related to
acquisition of additional
CombiMatrix Corporation shares .... 488,557 11,634
Warrants exercised .................. 578,238 14,878
Increase in capital due to
issuance of stock by subsidiaries.. 2,293
Compensation expense relating to
stock options and warrants......... 599
Unrealized gain on short-term
investments........................
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2000 ........ 16,090,587 -- -- 16 -- -- 116,017
2001
Net loss ............................
Units issued in private
placement, net .................... 1,127,274 1 18,247
Stock options exercised ............. 596,888 1 1,251
Increase in capital due to
issuance of stock by
subsidiaries ...................... 1,283
Compensation expense relating
to stock options and warrants ..... 47
Stock dividend (Note 1 and 8) ....... 1,777,710 2 21,684
Unrealized loss on short-term
investments .......................
Unrealized loss on foreign
currency translation ..............
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 ........ 19,592,459 -- -- 20 -- -- 158,529
2002
Net loss ............................
Stock options exercised ............. 48,349 136
Decrease in capital due to
issuance of stock by
subsidiaries ...................... (550)
Compensation expense relating
to stock options .................. 19
Unrealized loss on short-term
investments .......................
Unrealized gain on foreign
currency translation ..............
Dividends paid by subsidiary ........ (11)
Stock cancellation due to
recapitalization .................. (19,640,808) (20) 20
Stock issuance due to
recapitalization .................. 19,640,808 10,963,499 20 11 (31)
Stock issuance related to
acquisition of additional
CombiMatrix Corporation shares .... 11,987,052 12 80,370
Stock options exercised ............. 14,228 29
Compensation expense relating to
stock options ..................... 116
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 ........ -- 19,640,808 22,964,779 $ -- $ 20 $ 23 $ 238,627
============ ============ ============ ============ ============ ============ ============
(CONTINUED ON NEXT PAGE)
F-5a
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
WARRANTS TO
PURCHASE
DEFERRED STOCK COMMON ACCUMULATED COMPREHENSIVE
COMPENSATION STOCK DEFICIT INCOME(LOSS) TOTAL
------------ ------------ ------------ ------------ ------------
2000
Balance at December 31, 1999 .................. $ -- $ 58 $ (17,093) $ -- $ 45,262
Net loss ...................................... (38,959) (38,959)
Units issued in private placements, net ....... 86 22,286
Stock options exercised ....................... 2,132
Stock issuance related to acquisition of
additional CombiMatrix Corporation shares ... 11,634
Warrants exercised ............................ (58) 14,820
Increase in capital due to issuance of stock
by subsidiaries ............................. 2,293
Compensation expense relating to stock
options and warrants ........................ 599
Unrealized gain on short-term investments ..... 77 77
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2000 .................. -- 86 (56,052) 77 60,144
2001
Net loss ...................................... (22,272) (22,272)
Units issued in private placement, net ........ 113 18,361
Stock options exercised ....................... 1,252
Increase in capital due to issuance of stock
by subsidiaries ............................. 1,283
Compensation expense relating to stock
options and warrants ........................ 47
Stock dividend (Note 1 and 8) ................. (21,688) (2)
Unrealized loss on short-term investments ..... (9) (9)
Unrealized loss on foreign currency translation (72) (72)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2001 .................. -- 199 (100,012) (4) 58,732
2002
Net loss ...................................... (58,973) (58,973)
Stock options exercised ....................... 136
Decrease in capital due to issuance of stock
by subsidiaries ............................. (550)
Compensation expense relating to stock options 19
Unrealized loss on short-term investments ..... (38) (38)
Unrealized gain on foreign currency translation 40 40
Dividends paid by subsidiary .................. (11)
Stock cancellation due to recapitalization .... --
Stock issuance due to recapitalization ........ --
Stock issuance related to acquisition of
additional CombiMatrix Corporation shares ... (4,207) 76,175
Stock options exercised ....................... 29
Compensation expense relating to stock options 184 300
------------ ------------ ------------ ------------ ------------
Balance at December 31, 2002 .................. $ (4,023) $ 199 $ (158,985) $ (2) $ 75,859
============ ============ ============ ============ ============
F-5b
ACACIA RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
2002 2001 2000
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations: ........................................................ $(58,773) $(22,272) $(29,159)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ........................................................... 3,533 3,869 2,657
Equity in losses of affiliate ........................................................... -- 195 1,746
Minority interests ...................................................................... (23,806) (17,540) (9,166)
Non-cash stock compensation ............................................................. 6,427 20,819 10,704
Charge for acquired in-process research and development ................................. 17,237 -- 2,508
Deferred tax benefit .................................................................... (289) (182) (81)
Write-off of equity investments ......................................................... -- -- 2,603
Write-off of other assets ............................................................... -- 918 --
Net sales (purchases) of trading securities ............................................. 4,124 (4,135) --
Unrealized losses (gains) on short-term investments ..................................... 249 (237) --
Issuance of common stock by subsidiary - legal settlement charge ........................ 17,471 -- --
Impairment of cost method investment .................................................... 2,748 -- --
Other ................................................................................... 99 354 293
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other receivables and other assets ............... (178) (713) (2,029)
Accounts payable, accrued expenses and other ............................................ (143) 1,085 2,040
Deferred revenues ....................................................................... 11,640 7,460 --
--------- --------- ---------
Net cash used in operating activities from continuing operations ........................ (19,661) (10,379) (17,884)
Net cash used in operating activities from discontinued operations ...................... (905) (2,182) (16,600)
--------- --------- ---------
Net cash used in operating activities ................................................... (20,566) (12,561) (34,484)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equity investments .......................................................... -- -- (54)
Purchase of additional equity in consolidated subsidiaries .............................. (200) (3,304) (970)
Purchase of property and equipment ...................................................... (1,080) (3,775) (2,476)
Proceeds from sale of property and equipment ............................................ 361 -- --
Proceeds from sale and leaseback arrangement ............................................ -- 3,000 --
Purchase of available-for-sale investments .............................................. (11,338) (56,686) (43,606)
Sale of available-for-sale investments .................................................. 20,383 76,275 3,975
Purchase of common stock from minority stockholders of subsidiaries ..................... (217) (2,550) --
Acquisition costs ....................................................................... (834) -- --
Other ................................................................................... (100) -- --
--------- --------- ---------
Net cash provided by (used in) investing activities from continuing operations .......... 6,975 12,960 (43,131)
Net cash used in investing activities from discontinued operations ...................... (3) (145) (1,173)
--------- --------- ---------
Net cash provided by (used in) investing activities ..................................... 6,972 12,815 (44,304)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options and warrants ................................ 242 1,774 17,771
Capital contributions from minority shareholders of subsidiaries, net of issuance costs . 300 3,257 37,322
Capital distributions to minority shareholders of subsidiaries .......................... (618) -- --
Proceeds from sale of common stock, net of issuance costs ............................... -- 18,349 22,199
Repayment of capital lease obligation ................................................... (2,779) (221) --
Other ................................................................................... (11) -- 28
--------- --------- ---------
Net cash (used in) provided by financing activities ..................................... (2,866) 23,159 77,320
--------- --------- ---------
(Decrease) increase in cash and cash equivalents ............................................ (16,460) 23,413 (1,468)
--------- --------- ---------
Cash and cash equivalents, beginning ........................................................ 59,451 36,163 37,631
Effect of exchange rate on cash ............................................................. 92 (125) --
--------- --------- ---------
Cash and cash equivalents, ending ........................................................... $ 43,083 $ 59,451 $ 36,163
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
F-6
ACACIA RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation ("we," "us" and "our") develops, acquires
and licenses enabling technologies for the life sciences and media technologies
sectors, which comprise the two business groups of Acacia Research Corporation.
Our life sciences business, referred to as the "CombiMatrix group," is
comprised of our wholly owned subsidiary, CombiMatrix Corporation and
CombiMatrix Corporation's majority-owned subsidiaries, Advanced Material
Sciences, Inc. ("Advanced Material Sciences") and CombiMatrix KK. Our core
technology in the life sciences sector has been developed by CombiMatrix
Corporation. CombiMatrix Corporation is a life sciences technology company with
a proprietary system for rapid, cost competitive creation of DNA and other
compounds on a programmable semiconductor chip. This proprietary technology has
significant applications relating to genomic and proteomic research. Advanced
Material Sciences, a development stage company, holds the exclusive license for
CombiMatrix Corporation's biological array processor technology in certain
fields of material sciences. CombiMatrix KK, a majority-owned Japanese
corporation located in Tokyo, is exploring opportunities for CombiMatrix
Corporation's active biochip system with pharmaceutical and biotechnology
companies in the Asian market.
Our media technologies business, referred to as "Acacia Technologies
group," is comprised primarily of Acacia Research Corporation's wholly owned
media technology subsidiaries, Acacia Media Technologies and Soundview
Technologies. The Acacia Technologies group owns patented intellectual property
in the media technologies sector. The Acacia Technologies group owns a digital
media transmission ("DMT") technology enabling the digitization, encryption,
storage, transmission, receipt and playback of digital content. The DMT
technology is protected by five U.S. and seventeen international patents. The
DMT technology is utilized by a variety of companies, including cable companies,
hotel in-room entertainment companies, Internet movie companies, Internet music
companies, on-line adult entertainment companies, on-line learning companies and
other companies that stream audio or audio/video content. The Acacia
Technologies group also owns a technology commonly known as the V-chip. The
V-chip was adopted by manufacturers of televisions sold in the U.S. to provide
blocking of certain programming based upon its content rating code, in
compliance with the Telecommunications Act of 1996. The V-chip technology is
protected by U.S. Patent No. 4,554,584.
Following is a summary of the principal wholly owned companies that
constitute our two business groups:
GROUP / COMPANY DESCRIPTION OF BUSINESS
- --------------- -----------------------
COMBIMATRIX GROUP:
CombiMatrix Corporation A life sciences technology company with
a proprietary system for rapid, cost
competitive creation of DNA and other
compounds on a programmable
semiconductor chip. This proprietary
technology has significant applications
relating to genomic and proteomic
research, biological and chemical
detection and combinatorial chemistry
markets.
Advanced Material Sciences, a
development stage company and
majority-owned subsidiary of CombiMatrix
Corporation, holds the exclusive license
for CombiMatrix Corporation's biological
array processor technology in certain
fields of material sciences. CombiMatrix
KK, a majority-owned Japanese subsidiary
of CombiMatrix Corporation, is exploring
opportunities for CombiMatrix
Corporation's active biochip system with
pharmaceutical and biotechnology
companies in the Asian market.
F-7
ACACIA TECHNOLOGIES GROUP:
Acacia Media Technologies Corporation A media technology company that owns a
digital media transmission technology
used to digitize, encrypt, store,
transmit, receive and playback digitized
content sent via pathways such as cable,
satellite and the Internet, and covering
a variety of services such as those
commonly known as video-on-demand,
audio-on-demand and streaming media.
Soundview Technologies Incorporated A media technology company that owns
intellectual property related to the
telecommunications field, including a
television blanking system, also known
as "V-chip," which it licenses to
television manufacturers.
We were incorporated on January 25, 1993 under the laws of the State of
California. In December 1999, we changed our state of incorporation from
California to Delaware. Acacia Research Corporation owns and operates emerging
corporations with intellectual property rights, certain of which are involved in
developing new or unproven technologies. There is no assurance that any or all
such technologies will be successful, and even if successful, that the
development of such technologies can be commercialized.
LIQUIDITY AND RISKS
To date, we and our subsidiaries have relied primarily upon selling
equity securities to generate the funds needed to finance the implementation of
our plans of operation for our subsidiaries. Our subsidiaries may be required to
obtain additional financing, which would require us to make additional
investments or face a dilution of our equity interests. We cannot assure that
additional funding will be available on favorable terms, if at all. If we fail
to obtain additional funding when needed, we may not be able to execute our
business plans and our businesses may suffer. Our business operations are also
subject to certain risks and uncertainties, including:
o market acceptance of products and services;
o technological advances that may make our products and services
obsolete or less competitive;
o increases in operating costs, including costs for supplies,
personnel and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiaries
businesses.
Acacia Research Corporation has generated substantially all of its
revenues from licensing the Acacia Technologies group's patented V-chip
technology to television manufacturers. The V-chip patent expires in July 2003.
The Acacia Technologies group will not be able to collect royalties for
televisions containing V-chip technology sold after the expiration of the
patent, but it may still collect revenues from the sale of such televisions in
the U.S. before the expiration date. The Acacia Technologies group is beginning
to market and commercially license its DMT technology and is currently
developing additional technologies. However, there can be no assurance that the
Acacia Technologies group will be able to implement its future plans. Failure by
management to achieve its plans would have a material adverse effect on the
Acacia Technologies group and on Acacia Research Corporation's ability to
achieve its intended business objectives. The Acacia Technologies group's
success also depends on its ability to enforce and protect its intellectual
property.
The CombiMatrix group is deploying unproven technologies and continues
to develop its commercial products. The CombiMatrix group is currently
substantially dependent on its existing arrangement(s) with Roche Diagnostics
GmbH ("Roche"), and relies upon payments by Roche for a majority of its future
revenues. The CombiMatrix group expends a majority of its resources toward
fulfilling its contractual obligations under the Roche agreements. Roche's
primary service to the CombiMatrix group is to distribute and proliferate its
technology platform. The CombiMatrix group will need to enter into additional
strategic partnerships to develop and commercialize future products. However,
there can be no assurance that the CombiMatrix group will be able to implement
its future plans. Failure by management to achieve its plans would have a
F-8
material adverse effect on the CombiMatrix group's and Acacia Research
Corporation's ability to achieve its intended business objectives. The
CombiMatrix group's success also depends on its ability to protect its
intellectual property.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, our stockholders voted in favor of a
recapitalization transaction whereby we created two new classes of common stock
called "Acacia Research-CombiMatrix stock," or AR-CombiMatrix stock, and "Acacia
Research-Acacia Technologies stock," or AR-Acacia Technologies stock, and
divided our existing Acacia Research Corporation common stock into shares of the
two new classes of common stock. AR-CombiMatrix stock is intended to reflect
separately the performance of Acacia Research Corporation's CombiMatrix group,
and to benefit from its research and development efforts. AR-Acacia Technologies
stock is intended to reflect separately the performance of Acacia Research
Corporation's Acacia Technologies group and to benefit from the licensing of its
technologies. In the recapitalization, which became effective on December 13,
2002, Acacia Research Corporation stockholders received 0.5582 of a share of
AR-CombiMatrix stock, and one share of AR-Acacia Technologies stock, for each
share of common stock that they owned. Although the AR-CombiMatrix stock and the
AR-Acacia Technologies stock are intended to reflect the performance of our
different business groups, they are both classes of common stock of Acacia
Research Corporation and are not stock issued by the respective groups. The
AR-Acacia Technologies stock is listed on the Nasdaq National Market System, and
the AR-CombiMatrix stock is listed on the Nasdaq SmallCap Market.
On December 11, 2002, Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which we acquired the stockholder interests in CombiMatrix
Corporation not already owned by us (52% of the total stockholder interests in
CombiMatrix Corporation). The acquisition was accomplished through a merger,
effective December 13, 2002, in which stockholders of CombiMatrix Corporation
other than Acacia Research Corporation received one share of the new
AR-CombiMatrix stock in exchange for each share of CombiMatrix Corporation
common stock that they owned immediately prior to the merger. On December 11,
2002, the stockholders of Acacia Research Corporation also approved the adoption
of two new stock incentive plans for the two business groups.
All share and per share information in the consolidated financial
statements and accompanying notes to the consolidated financial statements,
unless otherwise noted, give effect to the recapitalization as of January 1,
2002. Share and per share information is excluded for the AR-CombiMatrix stock
and the AR-Acacia Technologies stock for all periods prior to 2002 as the two
new securities were not part of Acacia Research Corporation's capital structure
prior to 2002.
GENERAL
In January 2001, we completed an institutional private equity financing
raising gross proceeds of $19.0 million ($17.9 million, net of issuance costs)
through the issuance of 1,107,274 units. Each unit consists of one share of our
common stock and one three-year callable common stock purchase warrant. Each
common stock purchase warrant entitles the holder to purchase, a share of
AR-Acacia Technologies stock and a fraction of a share of AR-CombiMatrix stock
at a price of $13.23 and $10.50 per share, respectively. The separate warrants
are callable by us once the closing bid price of our AR-Acacia Technologies
stock averages $16.53 and our AR-CombiMatrix stock averages $13.13, or above for
20 or more consecutive trading days on the Nasdaq Stock Market. We issued an
additional 20,000 units in lieu of cash payments for finders' fees in
conjunction with the private placement. Proceeds from this equity financing were
attributed to the Acacia Technologies group.
In June 2001, our ownership interest in Soundview Technologies
Incorporated ("Soundview Technologies") increased from 67% to 100%, following
Soundview Technologies' completion of a stock repurchase transaction with its
former minority stockholders. Soundview Technologies repurchased the stock of
its former minority stockholders in exchange for a cash payment and the grant to
such stockholders of the right to receive 26% of future net revenues generated
by Soundview Technologies' current patent portfolio, which includes its V-chip
patent.
On October 22, 2001, our board of directors declared a ten percent
(10%) stock dividend. The stock dividend totaling 1,777,710 shares of our common
F-9
stock was distributed on December 5, 2001 to stockholders of record as of
November 21, 2001. All references to the number of shares (other than common
stock issued or outstanding on the 2001 and 2000 consolidated statements of
stockholders' equity), per share amounts and any other reference to shares in
the 2001 and 2000 consolidated financial statements and accompanying notes to
the consolidated financial statements, unless otherwise noted, have been
adjusted to reflect the stock dividend on a retroactive basis.
In November 2001, we increased our ownership interest in Acacia Media
Technologies Corporation ("Acacia Media Technologies"), formerly Greenwich
Information Technologies LLC, from 33% to 100% through the purchase of the
ownership interest of the former limited liability company's other member. In
December 2001, we converted the company from a limited liability company to a
corporation and changed the name of the company to Acacia Media Technologies
(see Note 6).
In the third quarter of 2000, we completed a private offering of
861,638 units at $27.50 per unit for gross proceeds of approximately $23.7
million ($22.0 million, net of issuance costs). Each unit consists of one share
of common stock and one common stock purchase warrant entitling the holder to
purchase a share of AR-Acacia Technologies stock and a fraction of a share of
AR-CombiMatrix stock at an exercise price of $20.79 and $16.51 per share,
respectively, subject to adjustment, expiring in three years. The separate
warrants are callable by us once the closing bid price of our AR-Acacia
Technologies stock averages $24.94 and our AR-CombiMatrix stock averages $19.81,
or above for 20 consecutive trading days on the Nasdaq Stock Market. We issued
an additional 11,000 units in lieu of cash payments for finders' fees in
conjunction with the private placement. Proceeds from this equity financing were
attributed to the Acacia Technologies group.
In the fourth quarter of 1999, we completed a private placement
consisting of the sale of units, each composed of one share of Acacia Research
Corporation's common stock and one-half of a common stock purchase warrant. We
issued 974,771 units at an offering price of $21.50 per unit. Approximately
$21.0 million ($19.1 million, net of issuance costs) was raised from this
financing. During the first quarter of 2000, we issued a 30-day redemption
notice for these warrants. As a result, all of these warrants were exercised
prior to the redemption date with Acacia Research Corporation receiving proceeds
of approximately $14.8 million.
ACACIA TECHNOLOGIES GROUP
ACACIA MEDIA TECHNOLOGIES
In July 2002, Acacia Media Technologies was granted a patent for its
digital media transmission technology in Japan. The patent provides coverage
through January 2, 2012.
SOUNDVIEW TECHNOLOGIES
In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending patent infringement and antitrust lawsuit,
alleging that television sets utilizing certain content blocking technology
(commonly known as the "V-chip") and sold in the United States infringe
Soundview Technologies' U.S. Patent No. 4,554,584. In granting the motion, the
court ruled that the defendants have not infringed on Soundview Technologies'
patent. See Note 13 for additional information related to the motion granted.
In June 2001, Soundview Technologies repurchased the stock of the
former minority stockholders of Soundview Technologies in exchange for a cash
payment and the grant to the former stockholders of the right to receive 26% of
future net revenues generated by Soundview Technologies' current patent
portfolio, which includes its V-chip patent. As of December 31, 2002, total
consideration paid combined with amounts accrued pursuant to the stock
repurchase agreements totaled $2,825,000. Acacia Research Corporation accounts
for contingent purchase consideration as an additional cost of the acquired
enterprise. As a result of the stock repurchase transaction our ownership
interest in Soundview Technologies increased from 67% to 100%.
During 2001, Soundview Technologies executed separate settlement and/or
license agreements with Samsung Electronics, Hitachi America, Ltd., LG
Electronics, Inc., Funai Electric Co. Ltd., Daewoo Electronics Corporation of
America, Sanyo Manufacturing Corporation, Thomson Multimedia, Inc., JVC Americas
F-10
Corporation, Matsushita Electric Industrial Co., Ltd. and Orion Electric Co.,
Ltd. In addition, Soundview Technologies settled its lawsuits with Pioneer
Electronics (USA) Incorporated, an affiliate of Pioneer Corporation, and
received payments from Philips Electronics pursuant to a settlement and license
agreement signed in December 2000. Certain of these license agreements
constitute settlements of patent infringement litigation brought by Soundview
Technologies. As of December 31, 2002, we have received license fee payments
totaling $25,673,000 from the settlement and license agreements and have granted
non-exclusive, retroactive and future licenses of Soundview Technologies' U.S.
Patent No. 4,554,584 to the respective television manufacturers. Certain of the
settlement and license agreements provide for future royalty payments to
Soundview Technologies. License fee payments received during 2001 totaling
$1,500,000 are included in deferred revenues pursuant to the terms of the
respective agreements.
COMBIMATRIX GROUP
COMBIMATRIX CORPORATION
In February 2002, CombiMatrix Corporation was awarded a six month
$100,000 Phase I National Institutes of Health grant for the development of its
protein biochip technology. This grant was completed in August of 2002.
In April 2002, CombiMatrix Corporation's Japanese subsidiary entered
into a technology access and purchase agreement in Japan with the Computational
Biology Research Center ("CBRC"), a division of the Japanese National Institute
of Advanced Industrial Science and Technology. CBRC has purchased a CombiMatrix
Corporation gene chip synthesizer and entered into a multi-year agreement to
purchase blank chips. The agreement also gives CBRC access to CombiMatrix
Corporation's set of informatics tools to help in its efforts to expand
biotechnology related businesses in Japan.
On April 25, 2002, CombiMatrix Corporation purchased our interest in
Advanced Material Sciences. CombiMatrix Corporation issued 180,982 shares of its
common stock to us in exchange for our 58% interest in Advanced Material
Sciences. As a result of the sale of our interest in Advanced Material Sciences,
CombiMatrix Corporation currently owns 87% of Advanced Material Sciences and the
remaining interests are owned by unaffiliated third parties (see Note 6).
In May 2002, CombiMatrix Corporation's Japanese subsidiary entered into
a technology access collaboration and purchasing agreement with the Genome
Science Laboratory at the Research Center for Advanced Science and Technology
("RCAST") of the University of Tokyo. Under the terms of the agreement, RCAST
has installed a CombiMatrix Corporation gene chip synthesizer and entered into a
multi-year agreement to purchase blank chips. The agreement includes a
memorandum of understanding that in the event of the discovery or development of
novel and valuable content, candidates or products, the parties will establish
an agreement for the commercialization of those discoveries.
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. ("Nanogen") to
settle all pending litigation between the parties. See Note 13 for a description
of the settlement and related terms.
In September 2002, CombiMatrix Corporation amended and restated its
non-exclusive worldwide license and supply and research and development
agreements with Roche, pursuant to which CombiMatrix Corporation and Roche will
develop a platform technology, providing a range of standardized biochips for
use in research applications. These agreements were originally entered into in
July 2001. Under the agreements, Roche has made cash payments to CombiMatrix
Corporation of $11.5 million and $5.3 million during the years ended December
31, 2002 and 2001, respectively, and will continue to make payments for the
deliverables stipulated and for expanded license and manufacturing rights. Under
the terms of the revised agreements, it is contemplated that Roche will
co-develop, use, manufacture, market and distribute CombiMatrix Corporation's
active biochip system for rapid production of both catalog and customizable
biochips. CombiMatrix Corporation's goal is to develop a platform technology,
providing a range of standardized biochips for use in research applications. The
agreements provide for minimum payments by Roche to CombiMatrix Corporation over
the first three years, including milestone achievement payments, payments for
products, royalties and payments for research and development projects. As of
December 31, 2002, all payments received under this agreement have been recorded
as deferred revenue. To date, CombiMatrix Corporation has completed several
F-11
strategic milestones in its strategic alliance with Roche, by developing and
delivering prototype components of its microarray platform and by demonstrating
several key performance metrics of its custom in-situ microarray system.
In August 2001, CombiMatrix Corporation entered into a license and
supply agreement with the National Aeronautics and Space Administration
("NASA"). The agreement has a two-year term and provides for the license,
purchase and use by the NASA Ames Research Center of CombiMatrix Corporation's
active biochips (microarrays) and related technology to conduct biological
research in terrestrial laboratories and in space.
In October 2001, CombiMatrix KK formed a joint venture with Marubeni
Japan, one of Japan's leading trading companies. The joint venture, based in
Tokyo, is focusing on development and licensing opportunities for CombiMatrix
Corporation's biochip technology with pharmaceutical and biotechnology companies
in the Japanese market. Marubeni made an investment of $1.1 million to acquire a
ten percent (10%) minority interest in the joint venture.
ADVANCED MATERIAL SCIENCES
In May 2001, Advanced Material Sciences completed a private equity
financing raising gross proceeds of $2.0 million through the issuance of
2,000,000 shares of common stock. Acacia Research Corporation invested $155,000
in this private placement to acquire 155,000 shares. As a result of the
transaction, our equity ownership in Advanced Material Sciences decreased from
66.7% to 58.1%. We accounted for the purchase of 155,000 shares of Advanced
Material Sciences as a step acquisition using the purchase method of accounting.
The total purchase price was allocated to the fair value of assets acquired and
liabilities assumed. As a result of the decrease in our ownership interest due
to our disproportionate purchase of additional shares in Advanced Material
Sciences, we recorded a gain reflected in the statement of stockholders' equity
as a direct increase to capital in excess of par. Advanced Material Sciences
issued an additional 29,750 shares of common stock, in lieu of cash payments,
and warrants to purchase approximately 54,000 shares of common stock, for
finders' fees in connection with the private placement. Each common stock
purchase warrant entitles the holder to purchase shares of Advanced Material
Sciences common stock at a price of $1.10 per share. Proceeds from this equity
financing were attributed to the CombiMatrix group.
Advanced Material Sciences was formed in November 2000 and holds an
exclusive license to CombiMatrix Corporation's biological processor technology
within the field of material science. Initial investments for Advanced Material
Sciences consisted of $2.0 million from us and $1.0 million from CombiMatrix
Corporation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES AND FISCAL YEAR END. The consolidated financial
statements and accompanying notes are prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles in the
United States of America. We have a December 31 year end.
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial
statements include the accounts of Acacia Research Corporation and its wholly
owned and majority-owned subsidiaries. Investments for which Acacia Research
Corporation possesses the power to direct or cause the direction of the
management and policies, either through majority ownership or other means, are
accounted for under the consolidation method. Material intercompany transactions
and balances have been eliminated in consolidation. Investments in companies in
which we maintain an ownership interest of 20% to 50% or exercise significant
influence over operating and financial policies are accounted for under the
equity method. The cost method is used where we maintain ownership interests of
less than 20% and do not exercise significant influence over the investee.
REVENUE RECOGNITION. We recognize revenue in accordance with Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
No. 101") and related authoritative pronouncements. License fee income is
recognized as revenue when (i) persuasive evidence of an arrangement exists,
(ii) all obligations have been performed pursuant to the terms of the license
F-12
agreement, (iii) amounts are fixed or determinable and (iv) collectibility of
amounts is reasonably assured. Revenues from government grants and contracts are
recognized as the related services are performed, when the services have been
accepted by the grantor and collectibility is reasonably assured. Amounts
recognized are limited to amounts due from the grantor based upon the contract
or grant terms
Revenue from the sale of products and services is recognized when (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred or
services have been rendered, (iii) the fees are fixed or determinable and (iv)
collectibility is reasonably assured.
Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received or billable by us
in connection with other rights and services that represent continuing
obligations of ours, are deferred until all of the elements have been delivered
or until we have established objective and verifiable evidence of the fair value
of the undelivered elements.
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. During the
years ended December 31, 2002 and 2001, we recorded a total of $19,100,000 as
deferred revenues related to payments received under multiple-element
arrangements and other advances. See Note 7 regarding adjustments to CombiMatrix
Corporation's deferred revenues in connection with Acacia Research Corporation's
acquisition of the ownership interests in CombiMatrix Corporation not already
owned by us in December 2002 and the application of the purchase method of
accounting. Deferred revenues, as adjusted, will be recognized as revenue in
future periods when the applicable revenue recognition criteria as describe
above are met.
CASH AND CASH EQUIVALENTS. We consider all highly liquid, short-term
investments with original maturities of three months or less when purchased to
be cash equivalents.
SHORT-TERM INVESTMENTS. Our short-term investments are held in a
variety of interest bearing instruments including high-grade corporate bonds,
commercial paper, money market accounts and other marketable securities.
Investments in securities with original maturities of greater than three months
and less than one year are classified as short-term investments. Investments are
classified into categories in accordance with the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS No. 115"). Certain of our
investments are classified as available-for-sale, which are reported at fair
value with related unrealized gains and losses in the value of such securities
recorded as a separate component of comprehensive income (loss) in stockholders'
equity until realized. At December 31, 2001, certain of our investments were
classified as trading securities, which have been reported at fair value. At
December 31, 2002, there were no investments classified as trading securities.
Realized and unrealized gains and losses in the value of trading securities are
included in net income (loss) in the consolidated statements of operations and
comprehensive loss.
The fair value of our investments is primarily determined by quoted
market prices. Realized and unrealized gains and losses are recorded based on
the specific identification method. For investments classified as
available-for-sale, unrealized losses that are other than temporary are
recognized in net income.
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. We have not experienced any losses on our deposits of
cash and cash equivalents.
PROPERTY AND EQUIPMENT. Property and equipment are recorded at cost.
Major additions and improvements that materially extend useful lives of property
and equipment are capitalized. Maintenance and repairs are charged against the
results of operations as incurred. When these assets are sold or otherwise
disposed of, the asset and related depreciation are relieved, and any gain or
loss is included in the statement of operations and comprehensive loss for the
period of sale or disposal. Depreciation is computed on a straight-line basis
over the following estimated useful lives of the assets:
F-13
Machine shop and laboratory equipment......... 5 years
Furniture and fixtures........................ 3 to 7 years
Computer hardware and software................ 3 to 5 years
Leasehold improvements........................ Lesser of lease term or
useful life of
improvement
Construction in progress includes direct costs incurred related to
internally constructed assets which are depreciated once the asset is placed
into service. Equipment held under capital lease is included in property, plant
and equipment and amortized using the straight-line method over the lease term.
At December 31, 2001, the related capital lease obligation is recorded as a
liability in the consolidated balance sheet. Capital lease amortization is
included in depreciation expense in the consolidated statement of operations and
comprehensive loss. In November 2002, the capital lease obligation was repaid.
PREPAID PUBLIC OFFERING COSTS. As of September 30, 2001, CombiMatrix
Corporation capitalized $1,353,000 of costs incurred in connection with the
filing of a registration statement with the SEC in November 2000. Deferred costs
totaling $918,000 are included in current assets in our December 31, 2000
consolidated balance sheet. In the fourth quarter of 2001, all of these deferred
costs were charged to operations.
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued, and
goodwill (pursuant to SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002, goodwill is no longer amortized, see "Recent
Accounting Pronouncements") are amortized on the straight-line method over their
economic remaining useful lives, ranging from three to twenty years.
POTENTIAL IMPAIRMENT OF LONG-LIVED ASSETS. We review long-lived assets
and intangible assets for potential impairment annually and when events or
changes in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded. If an asset is determined to be impaired, the loss
is measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, other receivables, accounts payable and accrued expenses
approximate fair value due to their short-term maturity. The carrying value of
our capital lease obligation approximates its fair value based on the current
interest rate for similar type instruments.
FOREIGN CURRENCY TRANSLATION. The functional currency of our foreign
entity is the local currency. Foreign currency translation is reported pursuant
to SFAS No. 52, "Foreign Currency Translation" ("SFAS No. 52"). Assets and
liabilities recorded in foreign currencies are translated at the exchange rate
on the balance sheet date. Translation adjustments resulting from this process
are charged or credited to other comprehensive income. Revenue and expenses are
translated at average rates of exchange prevailing during the year.
STOCK-BASED COMPENSATION. At December 31, 2002, Acacia Research
Corporation has two stock-based employee compensation plans, which are described
more fully in Note 11. Compensation cost of stock options issued to employees is
accounted for in accordance with Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations. Compensation cost attributable to such options is recognized
based on the difference, if any, between the closing market price of the stock
on the date of grant and the exercise price of the option. Compensation cost is
generally deferred and amortized on an accelerated basis over the vesting period
of the individual option awards using the amortization method prescribed in
Financial Accounting Standards Board ("FASB") Interpretation No. 28, "Accounting
for Stock Appreciation Rights and Other Variable Stock Option or Award Plans"
("FIN No. 28"). We have adopted the disclosure only requirements of SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") with respect to
options issued to employees. Compensation cost of stock options and warrants
issued to non-employee service providers is accounted for under the fair value
method required by SFAS No. 123 and related interpretations.
F-14
The following table illustrate the effect on net loss and loss per
share if Acacia Research Corporation had applied the fair value recognition
provisions of SFAS No. 123 (in thousands, except per share data):
AR-ACACIA
TECHNOLOGIES AR-COMBIMATRIX
STOCK STOCK ACACIA RESEARCH CORPORATION
---------- ---------- ----------------------------
2002 2002 2001 2000
---------- ---------- --------- ---------
Loss from continuing operations as reported.................... $ (12,554) $ (46,219) $(22,272) $(29,159)
Stock-based compensation, intrinsic value method, net of tax... 19 3,660 12,335 6,408
Pro forma stock based compensation fair value method,
net of tax .................................................. (5,034) (7,198) (4,907) (4,928)
Loss from continuing operations, pro forma..................... (17,569) (49,757) (14,844) (27,679)
Basic loss per share from continuing operations as reported.... (0.64) (2.01) (1.16) (1.78)
Basic loss per share from continuing operations, pro forma..... (0.89) (2.17) (0.77) (1.69)
Diluted loss per share from continuing operations as reported.. (0.64) (2.01) (1.16) (1.78)
Diluted loss per share from continuing operations, pro forma... (0.89) (2.17) (0.77) (1.69)
- --------------------------------------------------------------------------------
Note: The stock-based compensation information above gives effect to the
recapitalization as of January 1, 2002. As a result, stock-based compensation
information related to Acacia Research Corporation common stock in 2002 has been
omitted from the table above. Further, stock-based compensation information
related to the AR-Acacia Technologies stock and the AR-CombiMatrix stock has
been omitted for all periods prior to 2002 as the two new securities were not
part of Acacia Research Corporation's capital structure prior to 2002.
The fair value of Acacia Research Corporation stock options was
determined using the Black-Scholes option-pricing model, assuming weighted
average risk free annual interest of 4.52% and 6.31% in 2001 and 2000,
respectively, volatility of approximately 75%, with expected lives of
approximately four years and no expected dividends.
The fair value of AR-Acacia Technologies stock options was determined
using the Black-Scholes option-pricing model, assuming weighted average risk
free annual interest rate of 3.43%, volatility of approximately 100%, with
expected lives of approximately five years and no expected dividends.
The fair value of AR-CombiMatrix stock options was determined using the
Black-Scholes option-pricing model, assuming weighted average risk free annual
interest rate of 4.38%, volatility of approximately 100%, with expected lives of
approximately five years and no expected dividends.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist of costs incurred for direct and overhead-related research expenses and
are expensed as incurred. Costs to acquire technologies, which are utilized in
research and development and which have no alternative future use are expensed
when incurred. Costs related to filing and pursuing patent applications are
expensed as incurred, as recoverability of such expenditures is uncertain.
Software developed for use in our products is expensed as incurred until both
(i) technological feasibility for the software has been established and (ii) all
research and development activities for the other components of the system have
been completed. We believe these criteria are met after we have received
evaluations from third-party test sites and completed any resulting
modifications to the products. Expenditures to date have been classified as
research and development expense.
Acacia Research Corporation recorded charges for acquired in-process
research and development ("IPR&D") of $17,237,000 in 2002 and $2,508,000 in
2000, in connection with certain step acquisitions of additional ownership
interests in CombiMatrix Corporation. The value assigned to acquired in-process
technology was determined by identifying those acquired specific in-process
research and development projects that would be continued and for which (a)
technological feasibility had not been established at the acquisition date, (b)
there was no alternative future use and (c) the fair value was estimable with
reasonable reliability. Charges for acquired in-process research and development
were attributed to the CombiMatrix group. See Note 7 for description of 2002
IPR&D projects.
F-15
INCOME TAXES. Income taxes are accounted for using an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in Acacia Research Corporation's financial statements or tax returns.
A valuation allowance is established to reduce deferred tax assets if all, or
some portion, of such assets will more than likely not be realized.
ACCOUNTING FOR SALES OF STOCK BY A SUBSIDIARY. Gains or losses
resulting from a subsidiary's sale of stock to third parties at a price per
share in excess of or below Acacia Research Corporation's average carrying
amount per share are generally reflected in stockholders' equity as a direct
increase or decrease to capital in excess of par or stated value. See Note 8 for
description of gains and losses reflected in stockholders' equity as a result of
our subsidiaries' sales and other issuances of stock to third parties.
COMPREHENSIVE (LOSS) INCOME. Comprehensive (loss) income is the change
in equity from transactions and other events and circumstances other than those
resulting from investments by owners and distributions to owners.
SEGMENT REPORTING. We use the management approach, which designates the
internal organization that is used by management for making operating decisions
and assessing performance as the basis of Acacia Research Corporation's
reportable segments. At December 31, 2002 our reporting segments were modified
to reflect the attribution of assets and liabilities and the allocation of
expenditures consistent with the management and allocation policies used in the
preparation of the separate Acacia Technologies group and CombiMatrix group
financial statements. Segment information has been adjusted for all periods
presented.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
LOSS PER SHARE. Basic loss per share for each class of common stock is
computed by dividing the earnings allocated to each class of common stock by the
weighted average number of outstanding shares of that class of common stock.
Diluted earnings per share is computed by dividing the loss allocated to each
class of common stock by the weighted average number of outstanding shares of
that class of common stock including the dilutive effect of common stock
equivalents. Potentially dilutive common stock equivalents primarily consist of
employee stock options.
The earnings or losses allocated to each class of common stock are
determined by Acacia Research Corporation's board of directors. This
determination is generally based on the net income or loss amounts of the
corresponding group determined in accordance with accounting principles
generally accepted in the United States of America, consistently applied. Acacia
Research Corporation believes this method of allocation is systematic and
reasonable. The Acacia Research Corporation board of directors can, at its
discretion, change the method of allocating earnings or losses to each class of
common stock at any time.
F-16
The following table presents a reconciliation of basic and diluted loss
per share:
FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
----------- ----------- -----------
ACACIA RESEARCH CORPORATION COMMON STOCK
Weighted Average Number of Common Shares Outstanding
Used in Computation of Basic Loss per Share ................. -- 19,259,256 16,346,099
Dilutive Effect of Outstanding Stock Options and Warrants (a).. -- -- --
----------- ----------- -----------
Weighted Average Number of Common and Potential Common
Shares Outstanding Used in Computation of Diluted Loss
per Share ................................................... -- 19,259,256 16,346,099
=========== =========== ===========
ACACIA RESEARCH-ACACIA TECHNOLOGIES STOCK
Weighted Average Number of Common Shares Outstanding
Used in Computation of Basic Loss per Share ................. 19,640,808 -- --
Dilutive Effect of Outstanding Stock Options and Warrants (b).. -- -- --
----------- ----------- -----------
Weighted Average Number of Common and Potential Common
Shares Outstanding Used in Computation of Diluted Loss
per Share ................................................... 19,640,808 -- --
=========== =========== ===========
ACACIA RESEARCH-COMBIMATRIX STOCK
Weighted Average Number of Common Shares Outstanding
Used in Computation of Basic Loss per Share ................. 22,950,746 -- --
Dilutive Effect of Outstanding Stock Options and Warrants (c).. -- -- --
----------- ----------- -----------
Weighted Average Number of Common and Potential Common
Shares Outstanding Used in Computation of Diluted Loss
per Share ................................................... 22,950,746 -- --
=========== =========== ===========
---------------------------
(a) Potential Acacia Research Corporation (predecessor) common shares of
719,471 and 1,046,072 at December 31, 2001 and 2000, respectively, have
been excluded from the per share calculation because the effect of
their inclusion would be anti-dilutive.
(b) Potential AR - Acacia Technologies common shares of 46,857 at December
31, 2002 have been excluded from the per share calculation because the
effect of their inclusion would be anti-dilutive.
(c) Potential AR - CombiMatrix common shares of 305,256 at December 31,
2002 have been excluded from the per share calculation because the
effect of their inclusion would be anti-dilutive.
RECLASSIFICATIONS. Certain immaterial reclassifications of prior year
amounts have been made to conform to the 2002 presentation.
ACCOUNTING CHANGES. Effective January 1, 2001, we changed our
accounting policy for balance sheet classification of employee stock-based
compensation resulting from awards in consolidated subsidiaries. Historically,
the consolidated financial statements have accounted for cumulative earned
employee stock-based compensation related to subsidiaries as a liability, under
the caption "accrued stock compensation." Management believes a change to
reflect these cumulative charges as minority interests is preferable as it
better reflects the underlying economics of the stock-based compensation
transaction. As a result of the change, effective January 1, 2001, minority
interests has been increased by $10,392,000, and accrued stock compensation of
$10,392,000 has been decreased. The change in accounting policy does not affect
previously reported consolidated net income (loss).
During March 1998, CombiMatrix Corporation issued $1,450,000 principal
amount of 6% unsecured subordinated convertible promissory notes due in 2001.
The notes had a contingent beneficial conversion feature with intrinsic value of
$246,000. We adopted Emerging Issues Task Force ("EITF") No. 00-27, "Application
of Issue No. 98-5 to Certain Convertible Instruments" ("EITF 00-27"), in the
fourth quarter of 2000. The adoption of EITF 00-27 resulted in a charge of
$246,000 in the year ended December 31, 2000 for the cumulative effect of a
change in accounting principle in accordance with APB Opinion No. 20,
"Accounting Changes."
F-17
RECENT ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued SFAS
No. 141, "Business Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill
and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 addresses financial
accounting and reporting for business combinations and supersedes APB Opinion
No. 16, "Business Combinations." Changes made by SFAS No. 141 include (1)
requiring the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and (2) establishing specific
criteria for the recognition of intangible assets separately from goodwill.
These provisions are effective for business combinations for which the date of
acquisition is subsequent to June 30, 2001.
We adopted SFAS No. 142 effective January 1, 2002 and ceased amortizing
goodwill on that date. SFAS No. 142 addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in the
financial statements. This standard provides that goodwill is not subject to
amortization. Instead, it is subject to a periodic review that must occur at
least annually at a reporting unit level for possible impairment. This review is
known as the "two-step" impairment test and provides that the initial
"first-step" reviews of each reporting unit must be completed within six months
of the adoption of the standard. The "first-step" of the goodwill impairment
test, used to identify potential impairment, compares the fair value of each
reporting unit with its carrying amount, including goodwill. If upon completion
of these initial reviews an impairment of goodwill is indicated, the
"second-step" is required to be performed, which will compare the implied fair
value of each reporting unit goodwill with the carrying amount of goodwill. In
connection with the adoption of SFAS No. 142, we performed a transitional
goodwill impairment assessment and a year end goodwill impairment assessment and
determined that there was no impairment of goodwill. The fair value of our two
reporting units was estimated using a discounted cash flow analysis. There can
be no assurance that future goodwill impairment tests will not result in a
charge to earnings.
The Acacia Technologies group had $1,834,000 and $1,776,000 of goodwill
at December 31, 2002 and 2001 (net of $2,258,000 of accumulated amortization),
respectively, and recorded $216,000 and $451,000 of goodwill amortization
expense in 2001 and 2000, respectively. The CombiMatrix group had $18,859,000
and $2,851,000 of goodwill at December 31, 2002 and 2001 (net of $1,312,000 of
accumulated amortization), respectively, and recorded $862,000 and $470,000 of
goodwill amortization expense in 2001 and 2000, respectively.
Our net loss and loss per share, adjusted to exclude goodwill
amortization expense for 2002, 2001 and 2000 are as follows (in thousands,
except earnings per share amounts):
F-18
ACACIA RESEARCH CORPORATION
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
--------------- -------------- -------------
Reported net loss ................. $ (58,973) $ (22,272) $ (38,959)
Add back: goodwill amortization ... -- 1,078 921
--------------- -------------- -------------
Adjusted net loss ................. $ (58,973) $ (21,194) $ (38,038)
=============== ============== =============
LOSS PER SHARE (BASIC AND DILUTED):
Reported net loss ................. -- $ (1.16) $ (2.38)
Goodwill amortization ............. -- $ 0.06 $ 0.06
--------------- -------------- -------------
Adjusted net loss ................. -- $ (1.10) $ (2.32)
=============== ============== =============
ACACIA TECHNOLOGIES GROUP
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
--------------- -------------- -------------
Reported net (loss) income ........ $ (12,754) $ 5,757 $ (24,197)
Add back: goodwill amortization ... -- 216 451
--------------- -------------- -------------
Adjusted net (loss) income ........ $ (12,754) $ 5,973 $ (23,746)
=============== ============== =============
LOSS PER SHARE (BASIC AND DILUTED):
Reported net loss ................. $ (0.65) -- --
Goodwill amortization ............. $ -- -- --
--------------- -------------- -------------
Adjusted net loss ................. $ (0.65) -- --
=============== ============== =============
COMBIMATRIX GROUP
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
--------------- -------------- -------------
Reported net loss ................. $ (46,219) $ (28,029) $ (14,762)
Add back: goodwill amortization ... -- 862 470
--------------- -------------- -------------
Adjusted net loss ................. $ (46,219) $ (27,167) $ (14,292)
=============== ============== =============
LOSS PER SHARE (BASIC AND DILUTED):
Reported net loss ................. $ (2.01) -- --
Goodwill amortization ............. $ -- -- --
--------------- -------------- -------------
Adjusted net loss ................. $ (2.01) -- --
=============== ============== =============
- --------------------------------------------------------------------------------
(1) The recapitalization transaction discussed elsewhere herein has been
given effect as of January 1, 2002 for all share and per share
information included in the notes to the consolidated financial
statements. As such, per share information for Acacia Research
Corporation common stock (predecessor) in 2002 has been excluded from
the presentation above.
(2) The earnings (loss) per share information for 2001 and 2000 (prior to
the recapitalization) for AR-CombiMatrix stock and AR-Acacia
Technologies stock is omitted from the presentation above as the
AR-CombiMatrix stock and the AR-Acacia Technologies stock were not part
of the capital structure of Acacia Research Corporation prior to fiscal
2002.
F-19
Acacia Research Corporation's only identifiable intangible assets are
patents totaling $15,280,000 and $11,855,000 at December 31, 2002 and 2001,
respectively (net of $7,613,000 and $5,655,000 of accumulated amortization,
respectively). The gross carrying amounts and accumulated amortization related
to acquired intangible assets, all related to patents, by segment, as of
December 31, 2002 and 2001 are as follows (in thousands):
ACACIA TECHNOLOGIES GROUP COMBIMATRIX GROUP
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
Gross carrying amount - patents.. $ 10,798 $ 10,698 $ 12,095 $ 6,812
Accumulated amortization ........ (6,730) (5,144) (883) (511)
------------- ------------- ------------- -------------
Patents, net .................... $ 4,068 $ 5,554 $ 11,212 $ 6,301
============= ============= ============= =============
Aggregate patent amortization expense was $1,990,000 ($1,591,000 and
$399,000 for the Acacia Technologies group and the CombiMatrix group,
respectively), $1,618,000 ($1,277,000 and $341,000 for the Acacia Technologies
group and CombiMatrix group, respectively) and $1,330,000 ($1,159,000 and
$170,000 for the Acacia Technologies group and the CombiMatrix group,
respectively) in 2002, 2001 and 2000, respectively.
The estimated aggregate amortization expense for the years ended
December 31, 2003 through 2007 is as follows (in thousands):
ACACIA
YEAR ENDED TECHNOLOGIES COMBIMATRIX
DECEMBER 31, GROUP GROUP TOTAL
------------- ------------- ------------- -------------
2003........ $ 500 $ 1,095 $ 1,595
2004........ 500 1,095 1,595
2005........ 500 1,095 1,595
2006........ 500 1,095 1,595
2007........ 500 1,095 1,595
Refer to Note 7, "Step Acquisitions of CombiMatrix Corporation," for
additions to goodwill and intangibles during the year ended December 31, 2002.
At December 31, 2002 and December 31, 2001, all of our acquired
intangible assets other than goodwill were subject to amortization.
On January 1, 2002, we adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." SFAS No. 144 also supersedes the accounting and reporting
provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," for segments of a
business to be disposed of. SFAS No. 144 also amends Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a temporarily controlled subsidiary. SFAS No. 144 requires
long-lived assets to be tested for recoverability whenever events or changes in
circumstances indicate that its carrying amount may not be recoverable. In
conjunction with such tests, it may be necessary to review depreciation
estimates and methods as required by APB Opinion No. 20, "Accounting Changes,"
or the amortization period as required by SFAS No. 142. The adoption of SFAS No.
144 did not have a material effect on our consolidated results of operations or
financial position.
F-20
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections," ("SFAS No. 145"), which is effective for transactions occurring
after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64, which
addressed the accounting for gains and losses from extinguishment of debt. SFAS
No. 44 set forth industry-specific transitional guidance that did not apply to
us. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications
that have economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale-leaseback transactions. SFAS No. 145 also makes
technical corrections to certain existing pronouncements that are not
substantive in nature. The adoption of SFAS No. 145 did not have a significant
impact on our financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity," under which a liability for an exit cost was recognized at the date
of an entity's commitment to an exit plan. SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
at fair value when the liability is incurred. The provisions of this statement
are effective for exit or disposal activities that are initiated after December
31, 2002. We do not expect the adoption of SFAS No. 146 to have a significant
impact on our financial position or results of operations.
In December 2002, we adopted SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure--an amendment of SFAS No. 123" ("SFAS
No. 148"). This statement amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. Acacia
Research Corporation has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in APB Opinion No. 25
and related interpretations. Accordingly, compensation expense for stock options
is measured as the excess, if any, of the estimate of the market value of our
stock at the date of the grant over the amount an employee must pay to acquire
the stock. We will adopt the interim disclosure provisions for our financial
reports for the quarter ended March 31, 2003. The adoption of SFAS No. 148 did
not have a material effect on our consolidated results of operations or
financial position.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB
Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN
45 elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 are applicable to
guarantees issued or modified after December 31, 2002 and are not expected to
have a material effect on Acacia Research Corporation's consolidated financial
statements. The disclosure requirements are effective for financial statements
of interim and annual periods ending after December 31, 2002.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires
consolidation of variable interest entities by the entity's primary beneficiary
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. FIN 46 must be applied beginning
July 1, 2003 to variable entities existing prior to February 1, 2003. The
adoption of FIN 46 will not have a material impact on Acacia Research
Corporation's results of operations or financial condition.
F-21
3. SHORT-TERM INVESTMENTS
Short-term investments consists of the following at December 31, 2002
and 2001 (in thousands):
2002 AMORTIZED FAIR
COST VALUE
-------- --------
Available-for-sale-securities:
Corporate bonds and notes ................ $ 5,718 $ 5,808
U.S. government securities ............... 5,698 5,797
-------- --------
$11,416 $11,605
======== ========
2001 AMORTIZED FAIR
COST VALUE
-------- --------
Trading securities ........................... $ -- $ 4,372
Available-for-sale-securities:
Corporate bonds and notes ................ 14,427 14,869
U.S. government securities ............... 5,643 5,869
-------- --------
$20,070 $25,110
======== ========
Gross unrealized gains and losses related to available-for-sale
securities were not material for 2002 and 2001.
Contractual maturities for investments in debt securities classified as
available-for-sale as of December 31, 2002 are as follows (in thousands):
FAIR
COST VALUE
-------- --------
Due within one year .......................... $ 8,630 $ 8,772
Due after one year through two years ......... 2,786 2,833
-------- --------
$11,416 $11,605
======== ========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2002
and 2001 (in thousands):
2002 2001
-------- --------
Machine shop and laboratory equipment ............. $ 3,272 $ 844
Furniture and fixtures ............................ 345 445
Computer hardware and software .................... 1,444 1,203
Leasehold improvements ............................ 1,200 565
Facilities and equipment held under capital lease.. -- 3,000
Construction in progress .......................... 352 84
-------- --------
6,613 6,141
Less: accumulated depreciation and amortization .. (2,538) (1,235)
-------- --------
$ 4,075 $ 4,906
======== ========
Depreciation expense was $1,573,000, $1,174,000 and $471,000 for the
years ended December 31, 2002, 2001 and 2000, respectively. Amortization of
assets held under capital lease included in depreciation expense was $590,000
and $161,000 for the years ended December 31, 2002 and 2001, respectively.
F-22
5. BALANCE SHEET COMPONENTS
Accounts payable, accrued expenses and other consists of the following
at December 31, 2002 and 2001 (in thousands):
2002 2001
--------- ---------
Accounts payable ................................... $ 413 $ 837
Payroll, vacation and other employee benefits ...... 1,348 1,740
Accrued liabilities of discontinued operations ..... 915 1,342
Taxes payable ...................................... 2 356
Accrued subsidiary shareholder redemption payments.. 58 217
Accrued legal expenses ............................. 1,307 505
Other accrued liabilities .......................... 783 759
--------- ---------
$ 4,826 $ 5,756
========= =========
Deferred revenues consist of the following at December 31, 2002 and
2001 (in thousands):
2002 2001
--------- ---------
Milestone and up-front payments .................... $ 9,172 $ 5,960
License fee payments ............................... 1,503 1,500
--------- ---------
10,675 7,460
Less: current portion .............................. (10,675) (7,088)
--------- ---------
$ -- $ 372
========= =========
6. INVESTMENTS
On April 25, 2002, CombiMatrix Corporation purchased our interest in
Advanced Material Sciences. CombiMatrix Corporation issued 180,982 shares of its
common stock in exchange for our 58% interest in Advanced Material Sciences. As
a result of the sale of our interest in Advanced Material Sciences, CombiMatrix
Corporation currently owns 87% of Advanced Material Sciences and the remaining
interests are owned by unaffiliated entities. The purchase was accounted for
pursuant to APB Opinion No. 16, "Business Combinations," and related
interpretations and EITF 90-5, "Exchanges of Ownership Interests between
Entities under Common Control." Accordingly, the transaction was accounted for
using Acacia Research Corporation's basis in the net assets of Advanced Material
Sciences and as a result, Acacia Research Corporation's consolidated financial
statements continue to reflect the assets and liabilities of Advanced Material
Sciences at historical cost.
In November 2001, we increased our ownership interest in Acacia Media
Technologies from 33% to 100% through the purchase of the ownership interest of
the former limited liability company's other member. In December 2001, Acacia
Media Technologies was incorporated under the laws of the State of Delaware and
we changed the name from Greenwich Information Technologies LLC to Acacia Media
Technologies Corporation. The ownership interest purchase has been accounted for
as a purchase transaction in accordance with SFAS No. 141. The excess purchase
price was allocated to Acacia Media Technologies' patent portfolio and is being
amortized over the remaining life of the respective patents, which is
approximately 10 years. The results of operations have been included in the
consolidated statement of operations and comprehensive loss from the date of
acquisition. Pro forma results of operations have not been presented because the
effects of these acquisitions were not material on either an individual or
aggregate basis.
In September 2002, we recorded an impairment charge of $2,748,000 for
an other-than-temporary decline in the fair value of our investment in Advanced
Data Exchange ("ADX"). Impairment indicators included recurring losses, a
decline in working capital and the completion of a recent equity transaction
with a shareholder at an amount below our carrying value. The fair value of our
cost method investment was determined by reference to available financial and
market information.
F-23
In 2000, Acacia Research Corporation purchased "non-voting" Series B
preferred stock and a 7.6% interest in ADX for $3,000,000. ADX is a corporation
engaged in business-to-business Internet exchange transactions that allow
mid-sized companies to exchange its purchase orders, purchase order
acknowledgments, advance ship notices, invoices and other business documents
over the Internet with supply chain partners and emerging digital marketplaces.
At December 31, 2002, Acacia Research Corporation owned a 6.8% interest in ADX
and has no board of directors representation. Additional rounds of financing may
further dilute our interest. We do not have the ability to control decision
making at ADX.
In the fourth quarter of 2000, we recorded $1,016,000 in write-offs of
early stage investments. In addition, we recorded $2,603,000 in write-offs of
certain equity investments.
7. STEP ACQUISITIONS OF COMBIMATRIX CORPORATION
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,274
shares of CombiMatrix Corporation common stock in exchange for 11,987,274 shares
of AR-CombiMatrix stock with a fair value of $46,007,000. The merger was
designed to consolidate our ownership of CombiMatrix Corporation and permit us
to effectuate the recapitalization transaction described elsewhere herein, by
creating the CombiMatrix group.
The transaction was accounted for as a step acquisition using the
purchase method of accounting. The fair value of the AR-CombiMatrix stock issued
in the transaction was based on the quoted market price of AR-CombiMatrix stock
averaged over a five-day period (from December 16, 2002, the first day of
trading for the new AR-CombiMatrix stock, through December 20, 2002).
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed and the allocation of the purchase price at the
date of acquisition (in thousands):
Acquisition costs:
Exchange of AR-CombiMatrix stock for CombiMatrix
Corporation common stock ............................ $ 46,007
Acquisition expenses .................................. 834
---------
Total acquisition cost ............................ $ 46,841
=========
Purchase price allocation:
Fair value of 52% of CombiMatrix Corporation net
tangible assets at December 13, 2002................. $ 8,313
Intangible assets acquired:
Core technology/patent ............................ 5,283
Acquired in-process research and development ...... 17,237
Goodwill (non-deductible for tax purposes) ........ 16,008
---------
Total ............................................ $ 46,841
=========
The total purchase price of $46,841,000 was allocated to the fair value
of assets acquired and liabilities assumed, including acquired IPR&D. The amount
attributable to CombiMatrix Corporation's core technology and related patents
was $5,283,000, which is being amortized using the straight-line method over the
estimated economic useful life of 7 years. The amount attributable to goodwill
was $16,008,000. Amounts allocated to patents, IPR&D and goodwill have been
attributed to the CombiMatrix group.
The amount attributable to IPR&D projects (comprised of two projects:
Genomics and Proteomics biological array systems) that had not yet reached
technological feasibility and had no alternative future use of
F-24
$17,237,000 was charged to expense on the acquisition date and is included in
the consolidated statement of operations and comprehensive loss for the year
ended December 31, 2002. Following is a brief description of the two IPR&D
projects identified.
Genomics Biological Array System: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The value assigned to the genomics
biological array system IPR&D project was $13,978,000. A risk-adjusted discount
rate of 32% was applied to the project's estimated cash flows.
Proteomics Biological Array System: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. The proteomics biological array system is used
for detection and identification of bio-threat agents in CombiMatrix
Corporation's biological and chemical threat agent detector development programs
that are currently in process. The value assigned to the proteomics biological
array system IPR&D project was $3,259,000. A risk-adjusted discount rate of 60%
was applied to the project's estimated cash flows.
DEFERRED REVENUE PURCHASE ACCOUNTING ADJUSTMENT
In connection with the step acquisition described above, and the
application of purchase accounting pursuant to SFAS No. 142, Acacia Research
Corporation was required to adjust CombiMatrix Corporation's assets and
liabilities, including deferred revenue, to fair value. As a result, deferred
revenue, primarily consisting of milestone payments and other cash receipts from
Roche and NASA, was reduced by $8,425,000 to reflect the fair value of the
continuing obligation related to the 52% interest in CombiMatrix Corporation
acquired by Acacia Research Corporation. A reconciliation of 2002 activity
related CombiMatrix Corporation's deferred revenue balances including the impact
of the fair value adjustment is as follows (in thousands):
CombiMatrix Corporation deferred revenue balance at December 31, 2001...... $ 5,960
Cash payments and accruals recorded as deferred revenues during 2002....... 11,637
Less: purchase accounting adjustment...................................... (8,425)
--------
CombiMatrix Corporation deferred revenue balance at December 31, 2002...... $ 9,172
========
In the first quarter of 2000, CombiMatrix Corporation completed a
private equity financing raising gross proceeds of approximately $17,500,000
through the sale of 3,500,000 shares of CombiMatrix Corporation common stock.
Acacia Research Corporation invested approximately $10,000,000 in this private
placement to acquire 2,000,000 shares of CombiMatrix Corporation common stock.
The transaction was accounted for as a step acquisition using the purchase
method of accounting. The total purchase price was allocated to the fair value
of assets acquired and liabilities assumed. As a result of the transaction, we
increased our consolidated ownership interest in CombiMatrix Corporation from
50.01% to 51.8%. Proceeds from this equity financing were attributed to the
CombiMatrix group.
In the third quarter of 2000, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 51.8% to 61.4%
by acquiring from existing stockholders of CombiMatrix Corporation 1,163,850
shares of CombiMatrix Corporation common stock in exchange for 488,557 shares of
Acacia Research Corporation's common stock. The transaction was accounted for as
a step acquisition using the purchase method of accounting. The fair value of
the Acacia Research Corporation shares issued in the transaction was based on
the quoted market price of Acacia Research Corporation's stock averaged over a
five-day period (including two days before and after the June 28, 2000
announcement date). The total purchase price of $11,634,000 was allocated to the
fair value of assets acquired and liabilities assumed, including acquired
in-process research and development. The amount attributable to goodwill was
$2,928,000, which is amortized using the straight-line method over the economic
remaining useful life of five years (see "Recent Accounting Pronouncements"
F-25
regarding implementation of Statement of Financial Accounting Standards No. 142
and ceased amortization of goodwill effective January 1, 2002). The amount
attributable to in-process research and development of $2,508,000 was charged to
expense and is included in the consolidated statement of operations and
comprehensive loss for the year ended December 31, 2000.
In the third quarter of 2000, CombiMatrix Corporation completed a
private equity financing raising gross proceeds of approximately $36,000,000
through the sale of 4,000,000 shares of CombiMatrix Corporation common stock.
Acacia Research Corporation invested approximately $17,500,000 in this private
placement to acquire 1,944,445 shares. The transaction was accounted for as a
step acquisition using the purchase method of accounting. As a result of the
transaction, our consolidated interest in CombiMatrix Corporation decreased from
61.4% to 58.4%, and we recognized a gain, which has been reflected in
stockholders' equity as a direct increase to capital in excess of par. Proceeds
from this equity financing were attributed to the CombiMatrix group.
8. STOCKHOLDERS' EQUITY
CAPITAL STRUCTURE
The authorized capital stock of Acacia Research Corporation consists of
110,000,000 shares, of which 50,000,000 shares is a class of common stock
designated as "AR-CombiMatrix stock," having a par value of $0.001 per share,
50,000,000 shares is a class of common stock designated as "AR-Acacia
Technologies stock," having a par value of $0.001 per share, and 10,000,000 is a
class of preferred stock having a par value of $0.001 per share (the "Preferred
Stock") and issuable in one or more series as determined by the board of
directors pursuant to Acacia Research Corporation's restated certificate of
incorporation. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock
vote together as a single class (except in certain limited circumstances). Each
share of AR-CombiMatrix stock entitles the holder to one vote. Each share of
AR-Acacia Technologies stock entitles the holder, for any particular vote, to a
number of votes equal to the average market value of a share of AR-Acacia
Technologies stock divided by the average market value of a share of
AR-CombiMatrix stock over a specified 20-trading day period ending on the tenth
trading day prior to the record date for determining the stockholders entitled
to vote.
Holders of each class of common stock are entitled to receive ratably
such dividends, if any, as may be declared by the board of directors out of
funds legally available therefore.
Under our restated certificate of incorporation, in the event of our
dissolution, liquidation or winding up, after payment or provision for payment
of the debts and other liabilities and full preferential amounts to which
holders of any preferred stock are entitled, regardless of the group to which
such shares of preferred stock were attributed, the holders of AR-CombiMatrix
stock and AR-Acacia Technologies stock will be entitled to receive our assets
remaining for distribution to holders of common stock on a per share basis in
proportion to the liquidation units per share of such class. Each share of
AR-CombiMatrix stock will have one liquidation unit. Each share of AR-Acacia
Technologies stock will have a number of liquidation units equal to the quotient
of the average market value of a share of AR-Acacia Technologies stock over the
20-trading day period ending on the 40th trading day after the effective date of
the recapitalization, divided by the average market value of a share of
AR-CombiMatrix stock over the same period.
Holders of each class of common stock have no preemptive, subscription,
redemption or conversion rights. Management, at its discretion may, at any time,
convert each share of AR-CombiMatrix stock into a number of shares of AR-Acacia
Technologies stock at a 10% premium over the average market price.
Each new class of stock is designed to reflect the financial
performance of the respective group, rather than the performance of Acacia
Research Corporation as a whole. The chief mechanisms intended to cause the
AR-CombiMatrix stock and the AR-Acacia Technologies stock to reflect the
financial performance of the respective group are provisions in Acacia Research
Corporation's restated certificate of incorporation governing dividends and
distributions. Under these provisions, Acacia Research Corporation will:
F-26
o factor the assets and liabilities and income or losses
attributable to the respective group into the determination of the
amount available to pay dividends on the shares issued for the
respective group; and
o require Acacia Research Corporation to exchange, redeem or
distribute a dividend on the stock of a group if all or
substantially all of the assets allocated to the respective group
are sold to a third party.
Management of Acacia Research Corporation cannot assure the holders of
AR-CombiMatrix stock or AR-Acacia Technologies stock that the market values of
the two share classes will in fact reflect the separate performance of each
class of stock. Holders of AR-CombiMatrix stock and AR-Acacia Technologies stock
are stockholders of Acacia Research Corporation and as a result, are subject to
all of the risks of an investment in Acacia Research Corporation and all of its
businesses, assets and liabilities. Financial effects from one group that affect
Acacia Research Corporation's consolidated results of operations or financial
condition could, if significant, affect the results of operations or financial
condition of the other group.
Acacia Research Corporation's board of directors, subject to state laws
and limits in our restated certificate of incorporation, including those
discussed above, will be able to declare dividends on AR-CombiMatrix stock and
AR-Acacia Technologies stock in its discretion. To date, Acacia Research
Corporation has never paid or declared cash dividends on shares of our stock,
nor do we anticipate paying cash dividends on either of the two new classes of
stock in the foreseeable future.
The allocation of corporate expenses is generally based on utilization
and is in accordance with Acacia Research Corporation's restated certificate of
incorporation, for the purpose of measuring earnings available to stockholders
of AR-CombiMatrix stock and AR-Acacia Technologies stock and does not
necessarily reflect the financial condition, cash flows and operating results of
each division as if it were a stand-alone entity. The management and allocation
policies applicable to the determination of the assets and liabilities and
income or losses attributable to the respective group may be modified or
rescinded, or additional policies may be adopted, at the sole discretion of
Acacia Research Corporation's board of directors at any time without approval of
the stockholders. Acacia Research Corporation's management and board of
directors have the ability to: transfer funds between the groups at the
discretion of management and the board of directors; allocate financing costs
between groups that may not reflect the separate borrowing costs of the groups;
and charge a greater or lesser portion of the total corporate tax liability to
the groups than that which would have been charged if the groups were
stand-alone entities. Acacia Research Corporation's management and board of
directors do not presently intend to modify or rescind the methodologies and
assumptions underlying the allocations in the pro forma financial statements.
See Note 16 for a description of applicable management allocation policies.
OTHER
In September 2002, CombiMatrix Corporation issued 4,016,346 shares of
its common stock to Nanogen in settlement of all outstanding litigation between
the parties (see Note 13). As a result of the transaction, our equity ownership
in CombiMatrix Corporation decreased from 58% to 48%. A loss totaling $550,000,
resulting from CombiMatrix Corporation's issuance of stock to a third party at a
value per share below our carrying amount per share has been reflected as a
direct reduction to additional paid-in capital in consolidated stockholders'
equity.
On October 22, 2001, our board of directors declared a ten percent
(10%) stock dividend. The stock dividend totaling 1,777,710 shares of our common
stock was distributed on December 5, 2001 to stockholders of record as of
November 21, 2001. The fair value of the stock dividend paid, based on the
market value of our common stock on the date of declaration as adjusted for the
dilutive effect of the stock dividend declared, is reflected as a
reclassification of accumulated deficit in the amount of $21,688,000, to
permanent capital, represented by our common stock and additional paid-in
capital accounts. All references to the number of shares (other than common
stock issued or outstanding on the 2001 and 2000 consolidated statements of
stockholders' equity), per share amounts and any other reference to shares in
the consolidated financial statements and accompanying notes to the consolidated
financial statements, unless otherwise noted, have been adjusted to reflect the
stock dividend on a retroactive basis.
F-27
In May 2001, Advanced Material Sciences completed a private equity
financing raising gross proceeds of $2.0 million through the issuance of
2,000,000 shares of common stock. Acacia Research Corporation invested $155,000
in this private placement to acquire 155,000 shares. As a result of the
transaction, our equity ownership in Advanced Material Sciences decreased from
66.7% to 58.1%. Additionally, in October 2001, a subsidiary of CombiMatrix
Corporation sold 10% of its voting common stock to a joint venture partner in
Japan. The gain, totaling $1,283,000, resulting from our subsidiaries sale of
stock to third-parties at a price per share in excess of our carrying amount per
share has been reflected as a direct increase to additional paid-in capital in
consolidated stockholders' equity.
9. PROVISIONS FOR INCOME TAXES
(Benefit) provision for income taxes consists of the following (in
thousands):
2002 2001 2000
------ ------ ------
Current:
U.S. Federal tax .................... $(572) $ 776 $ 2
State taxes ......................... 4 186 4
------ ------ ------
(568) 962 6
------ ------ ------
Deferred:
U.S. Federal tax .................... (289) (182) (79)
State taxes ......................... -- -- --
------ ------ ------
(289) (182) (79)
------ ------ ------
$(857) $ 780 $ (73)
====== ====== ======
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2002 and 2001 (in thousands):
2002 2001
--------- ---------
Deferred tax assets:
Basis of investments in affiliates ................ $ 18,265 $ 16,789
Deferred revenue .................................. 3,116 --
Stock compensation ................................ 8,656 6,993
Accrued liabilities ............................... 2,558 1,061
Net operating loss carryforwards and credits ...... 39,142 25,080
--------- ---------
Total deferred tax assets .......................... 71,737 49,923
Less: valuation allowance ............................ (71,737) (49,923)
--------- ---------
Deferred tax assets, net of valuation allowance .... -- --
--------- ---------
Deferred tax liabilities:
Intangibles ........................................ (3,540) (3,829)
--------- ---------
Net deferred tax liability ....................... $ (3,540) $ (3,829)
========= =========
insert
F-28
A reconciliation of the federal statutory income tax rate and the
effective income tax rate is as follows:
2002 2001 2000
----- ----- -----
Statutory federal tax rate..................... (34%) (34%) (34%)
State income taxes, net of federal benefit..... -- (3%) (3%)
Amortization of intangible assets.............. 1% 2% 1%
Stock compensation............................. 1% 7% 3%
Non deductible permanent items................. 9% -- --
Intangibles.................................... 3% -- --
Valuation allowance............................ 21% 30% 33%
----- ----- -----
1% 2% --
===== ===== =====
At December 31, 2002, Acacia Research Corporation has deferred tax
assets totaling approximately $71,737,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
In December 2002, Acacia Research Corporation increased its ownership
interest in CombiMatrix Corporation from 48% to 100%. As a result of the
increase in ownership, Acacia Research Corporation will file consolidated
federal income tax returns, including CombiMatrix Corporation, beginning
December 13, 2002, the step acquisition date.
At December 31, 2002, consolidated U.S. Federal and California state
income tax net operating loss carry forwards ("NOLs"), excluding NOLs related to
subsidiaries for which we do not file a consolidated tax return, were
approximately $109,971,000 and $27,953,000, expiring between 2003 and 2022. In
addition, we had consolidated tax credit carryforwards of approximately
$2,051,000. The amount of the CombiMatrix Corporation NOLs and tax credits
acquired, totaling approximately $66,360,000 (expiring between 2010 and 2022)
and $1,989,000, respectively, that can be utilized annually to offset future
taxable income or tax liability has been limited under the Internal Revenue Code
due to the ownership change resulting from our December 2002 increase in
ownership interest in CombiMatrix Corporation to 100%.
The aggregate tax NOLs at other subsidiaries are approximately
$16,629,000 and $8,859,000 for federal and state income tax purposes,
respectively, expiring between 2003 and 2022. However, the use of these NOLs are
limited to the separate earnings of the respective subsidiaries. In addition,
ownership changes may also restrict the use of NOLs and tax credits.
As of December 31, 2002, approximately $9,618,000 of the valuation
allowance related to the tax benefits of stock option deductions included in
Acacia Research Corporation's NOLs. At such time as the valuation allowance is
released, the benefit will be credited to additional paid-in capital.
10. DISCONTINUED OPERATIONS
On February 13, 2001, the board of directors of Soundbreak.com
Incorporated ("Soundbreak.com"), a majority-owned subsidiary of Acacia Research
Corporation, resolved to cease operations as of February 15, 2001 and liquidate
the remaining assets and liabilities of the subsidiary. Accordingly, we reported
the results of operations and the estimated loss on disposal of Soundbreak.com
as results of discontinued operations in the 2000 consolidated statements of
operations and comprehensive loss. In September 2002, we accrued an additional
$480,000 ($200,000 net of minority interests) in estimated costs to be incurred
in connection with the discontinued operations of Soundbreak.com. The additional
accrual relates primarily to certain noncancellable lease obligations and the
inability to sublease the related office space at rates commensurate with our
existing obligations.
F-29
Following is summary financial information for the discontinued
operations (in thousands):
2002 2001 2000
--------- --------- ---------
Net sales ................................. $ -- $ -- $ 4
========= ========= =========
Loss from discontinued operations:
Before minority interests .............. $ -- $ -- $ 16,437
Minority interests ..................... -- -- (8,994)
--------- --------- ---------
Net .................................... $ -- $ -- $ 7,443
========= ========= =========
Estimated loss on disposal:
Before minority interests .............. $ 480 $ -- $ 5,066
Minority interests ..................... (280) -- (2,955)
--------- --------- ---------
Net .................................... $ 200 $ -- $ 2,111
========= ========= =========
Discontinued operations did not have an impact on the December 31, 2001
consolidated statement of operations and comprehensive loss.
The assets and liabilities of the discontinued operations at December
31, 2002 consist primarily of $3,109,000 of cash and cash equivalents and
$918,000 of accounts payable and accrued expenses. The assets and liabilities of
the discontinued operations at December 31, 2001 consist primarily of $4,014,000
of cash and cash equivalents and $1,342,000 of accounts payable and accrued
expenses.
11. STOCK OPTIONS AND WARRANTS
The 2002 Acacia Technologies Stock Incentive Plan (the "AR-Acacia
Technologies Group Plan") and the 2002 CombiMatrix Stock Incentive Plan (the
"AR-CombiMatrix Group Plan") were approved by the stockholders of Acacia
Research Corporation in December 2002 (see Note 1). The AR-Acacia Technologies
Group Plan authorizes grants of stock options, stock awards and performance
shares with respect to AR-Acacia Technologies stock. The AR-CombiMatrix Group
Plan authorizes grants of stock options, stock awards and performance shares
with respect to AR-CombiMatrix stock. Directors and certain officers and key
employees with responsibilities involving both the Acacia Technologies group and
the CombiMatrix group may be granted awards under both incentive plans in a
manner which reflects their responsibilities. The board of directors believes
that granting participants awards tied to performance of the group in which the
participants work and, in certain cases the other group, is in the best interest
of the Acacia Research Corporation and its stockholders.
As a result of the recapitalization of Acacia Research Corporation in
December 2002 (see Note 1), each outstanding option and warrant to acquire a
share of Acacia Research Corporation common stock under the existing stock
option plans or warrants was converted into separately exercisable options or
warrants, as the case may be, to acquire 0.5582 of a share of AR-CombiMatrix
stock and one share of AR-Acacia Technologies stock. The conversion ratio for
shares of AR-CombiMatrix stock is equal to the quotient obtained by dividing (a)
the number of shares of CombiMatrix Corporation common stock owned by Acacia
Research Corporation immediately prior to the effective time of the merger by
(b) the total number of shares of Acacia Research Corporation common stock
issued and outstanding immediately prior to the effective time. The exercise
price for the resulting AR-Acacia Technologies stock options and warrants and
AR-CombiMatrix stock options and warrants was calculated by multiplying the
exercise price under such existing stock option or warrant by a fraction, the
numerator of which is the result obtained by multiplying the opening price of
the applicable class of common stock underlying such option on the first date
such stocks are traded after the recapitalization times the applicable
conversion ratio and the denominator of which is the sum of such amounts for the
AR-CombiMatrix stock and the AR-Acacia Technologies stock. However, the
aggregate intrinsic value of the options was not increased, and the ratio of the
exercise price per option to the market value per share was not reduced. The
converted options continue to be governed by the terms and conditions of the
original option plans.
F-30
As a result of the merger transaction with CombiMatrix Corporation, in
December 2002 (see Note 1), each outstanding option to purchase shares of
CombiMatrix Corporation common stock under CombiMatrix Corporation's 1995 Stock
Option Plan, 1998 Stock Option Plan and 2000 Stock Awards Plan, whether or not
exercisable, was assumed by Acacia Research Corporation. Each assumed option
continues to be governed by the same terms and conditions that governed it under
the applicable CombiMatrix Corporation plan immediately before the effective
time of the merger except that the option is exercisable for shares of
AR-CombiMatrix stock rather than CombiMatrix Corporation common stock. The
number of shares of AR-CombiMatrix stock issuable upon exercise of the assumed
option, as well as the exercise price, is the same as the number of shares of
CombiMatrix Corporation common stock issuable and exercise price prior to the
merger. The exchange of AR-CombiMatrix stock options for CombiMatrix Common
stock options is considered a modification (or settlement) of a stock-based
compensation arrangement resulting in a new measurement date for the respective
awards. The new measurement date for the award modifications was December 13,
2002, the effective date of the merger, and resulted in additional stock-based
compensation of $116,000.
STOCK OPTION PLANS
The terms of the AR-Acacia Technologies Group Plan and the
AR-CombiMatrix Group Plan are identical except that AR-Acacia Technologies stock
may be issued only under the AR-Acacia Technologies Group Plan and
AR-CombiMatrix stock may be issued only under the AR-CombiMatrix Group Plan.
Acacia Research Corporation's compensation committee administers the
discretionary option grant and stock issuance programs. This committee
determines which eligible individuals are to receive option grants or stock
issuances under those programs, the time or times when the grants or issuances
are to be made, the number of shares subject to each grant or issuance, the
status of any granted option as either an incentive stock option or a
non-statutory stock option under the federal tax laws, the vesting schedule to
be in effect for the option grant or stock issuance and the maximum term for
which any granted option is to remain outstanding.
PROGRAMS
Each of the incentive plans has four separate programs:
o DISCRETIONARY OPTION GRANT PROGRAM. Under the discretionary option
grant program, our compensation committee may grant (1) non-statutory
options to purchase shares of AR-Acacia Technologies stock and
AR-CombiMatrix stock, as applicable, to eligible individuals in the
employ or service of Acacia Research Corporation or our subsidiaries
(including employees, non-employee board members and consultants) at an
exercise price not less than 85% of the fair market value of those
shares on the grant date and (2) incentive stock options to purchase
shares of AR-Acacia Technologies stock and AR-CombiMatrix stock, as
applicable, to eligible employees at an exercise price not less than
100% of the fair market value of those shares on the grant date (not
less than 110% of fair market value if such employee actually or
constructively owns more than 10% of our voting stock or the voting
stock of any of our subsidiaries).
o STOCK ISSUANCE PROGRAM. Under the stock issuance program, eligible
individuals may be issued shares of AR-Acacia Technologies stock and
AR-CombiMatrix stock, as applicable, directly, upon the attainment of
performance milestones or the completion of a specified period of
service or as a bonus for past services. Under this program, the
purchase price for the shares shall not be less than 100% of the fair
market value of the shares on the date of issuance, and payment may be
in the form of cash or past services rendered.
o AUTOMATIC OPTION GRANT PROGRAM. Under the automatic option grant
program, option grants will automatically be made at periodic intervals
to eligible non-employee members of our board of directors to purchase
shares of AR-Acacia Technologies stock and AR-CombiMatrix stock, as
applicable, at an exercise price equal to 100% of the fair market value
of those shares on the grant date. Each individual who first becomes a
non-employee board member at any time after the date of the adoption of
the incentive plans by our board of directors will automatically
receive an option to purchase 20,000 shares of AR-Acacia Technologies
stock and 20,000 shares of AR-CombiMatrix stock on the date the
F-31
individual joins the board of directors. In addition, on the first
business day in each calendar year following the adoption of the
incentive plans by our board of directors, each non-employee board
member then in office, including each of our current non-employee board
members who is then in office, will automatically be granted an option
to purchase 15,000 shares of AR-Acacia Technologies stock and 15,000
shares of AR-CombiMatrix stock, provided that the individual has served
on the board of directors for at least six months.
o DIRECTOR FEE OPTION GRANT PROGRAM. If this program is put into effect
in the future, it will allow non-employee members of our board of
directors the opportunity to apply a portion of any retainer fee
otherwise payable to them in cash each year to the acquisition of
special below-market option grants.
Limited stock appreciation rights will automatically be included as
part of each grant made under the automatic and director fee option grant
programs, and these rights may also be granted to one or more of our officers as
part of their option grants under the discretionary option grant program.
Our board of directors may amend or modify the incentive plans at any
time, subject to any required stockholder approval. The incentive plans will
terminate no later than the tenth anniversary of the approval of the incentive
plans by our stockholders.
Options are generally exercisable six months to one year after grant
and expire five years after grant for directors or up to ten years after grant
for key employees. The authorized number of shares of common stock subject to
the AR-Acacia Technologies Group Plan is 5,207,855 shares. The authorized number
of shares of common stock subject to the AR-CombiMatrix Group Plan is 8,496,087
shares. At December 31, 2002, shares available for grant are 912,888 and
2,875,925 under the AR-Acacia Technologies Group Plan and the AR-CombiMatrix
Group Plan, respectively.
The following is a summary of common stock option activities:
ACACIA RESEARCH CORPORATION COMMON STOCK (THROUGH DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
----------- ----------------- -------------
Balance at December 31, 1999.......................... 2,218,000 $ 0.91 - $21.59 $6.38
Options Granted....................................... 2,709,000 $ 14.55 - $50.28 $27.90
Options Exercised..................................... (585,000) $ 2.39 - $14.55 $3.41
Options Cancelled..................................... (717,000) $ 1.82 - $46.79 $19.48
-----------
Balance at December 31, 2000.......................... 3,625,000 $ 2.77 - $50.28 $20.51
Options Granted....................................... 1,390,000 $ 5.65 - $16.08 $7.14
Options Exercised..................................... (790,000) $ 2.77 - $14.55 $3.48
Options Cancelled..................................... (743,000) $ 3.18 - $48.69 $30.48
-----------
Balance at December 31, 2001.......................... 3,482,000 $ 3.47 - $50.28 $16.94
Options Granted....................................... 441,000 $ 6.68 - $11.67 $8.48
Options Exercised..................................... (56,000) $ 3.47 - $ 7.16 $3.63
Options Cancelled..................................... (370,000) $ 3.52 - $43.18 $16.94
-----------
Balance at December 13, 2002 (pre-recapitalization)... 3,497,000 $ 3.59 - $50.28 $16.09
Exchange in recapitalization transaction.............. (3,497,000) $ 3.59 - $50.28 $16.09
Balance at December 13, 2002 (post-recapitalization).. -- -- --
===========
Exercisable at December 31, 2001...................... 1,315,000 $ 3.47 - $50.28 $18.47
Exercisable at December 13, 2002
(pre-recapitalization)............................. 2,088,000 $ 3.59 - $50.28 $17.17
F-32
AR-ACACIA TECHNOLOGIES STOCK (FROM DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
----------- ----------------- -------------
Balance at December 13, 2002.......................... 3,497,000 $ 2.49 - $34.84 $11.14
Options Granted....................................... 822,000 $ 1.85 - $ 1.85 $1.85
Options Exercised..................................... -- -- --
Options Cancelled..................................... (24,000) $ 9.45 - $ 15.31 $12.65
-----------
Balance at December 31, 2002.......................... 4,295,000 $ 1.85 - $34.84 $9.36
===========
Exercisable at December 31, 2002...................... 2,401,000 $ 1.85 - $34.84 $11.91
AR-COMBIMATRIX STOCK (FROM DECEMBER 13, 2002):
EXERCISE WEIGHTED
SHARES PRICES AVERAGE PRICE
----------- ----------------- -------------
Balance at December 13, 2002...................... 5,648,000 $ 1.50 - $27.67 $9.22
Options Granted................................... -- -- --
Options Exercised................................. (14,000) $ 1.98 - $ 2.00 $2.00
Options Cancelled................................. (14,000) $ 7.50 - $12.16 $10.04
-----------
Balance at December 31, 2002...................... 5,620,000 $ 1.50 - $27.67 $9.24
===========
Exercisable at December 31, 2002.................. 3,736,000 $ 1.50 - $27.67 $8.37
Options outstanding at December 31, 2002 are summarized as follows:
AR-ACACIA TECHNOLOGIES STOCK (FROM DECEMBER 13, 2002):
WEIGHTED OUTSTANDING EXERCISABLE
NUMBER OF AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------------------- ----------- ---------------- -------------- ----------- --------------
$ 0.00 - $ 5.00........... 2,176,000 8.6 $ 3.24 868,000 $ 4.14
$ 5.01 - $10.00........... 403,000 8.5 $ 6.89 205,000 $ 6.88
$ 10.01 - $15.00........... 288,000 7.1 $12.68 230,000 $12.65
$ 15.01 - $20.00........... 1,102,000 7.4 $17.16 782,000 $16.85
$ 20.01 - $25.00........... 209,000 6.1 $20.86 209,000 $20.86
$ 25.01 - $30.00........... 110,000 7.2 $29.09 101,000 $29.09
$ 30.01 - $35.00........... 7,000 7.2 $34.84 6,000 $34.84
----------- -----------
4,295,000 2,401,000
=========== ===========
AR-COMBIMATRIX STOCK (FROM DECEMBER 13, 2002):
WEIGHTED OUTSTANDING EXERCISABLE
NUMBER OF AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------------------- ----------- ---------------- -------------- ----------- --------------
$ 0.00 - $ 5.00........... 2,292,000 6.9 $ 3.78 1,843,000 $ 3.76
$ 5.01 - $10.00........... 985,000 7.9 $ 8.35 668,000 $ 8.49
$ 10.01 - $15.00........... 1,413,000 8.6 $12.28 638,000 $12.05
$ 15.01 - $20.00........... 597,000 7.3 $16.27 402,000 $16.32
$ 20.01 - $25.00........... 329,000 8.1 $23.83 182,000 $23.72
$ 25.01 - $30.00........... 4,000 7.2 $27.67 3,000 $27.67
----------- -----------
5,620,000 3,736,000
=========== ===========
F-33
At December 31, 2002, the total number of warrants outstanding
represent rights to purchase 960,000 and 1,240,000 shares of AR-Acacia
Technologies common stock at a per share exercise price of $20.79 and $13.23,
respectively. At year ended December 31, 2002, the total number of warrants
outstanding also represent rights to purchase 536,000 and 692,000 shares of
AR-CombiMatrix's common stock at a per share exercise price of $16.51 and
$10.50, respectively. At December 31, 2001, the total number of warrants
outstanding represented rights to purchase 960,000 and 1,240,000 shares of
Acacia Research Corporation's common stock at a per share exercise price of
$30.00 and $19.09.
We have adopted the disclosure only requirements of SFAS No. 123 with
respect to options issued to employees. The weighted average fair value of
options granted during 2002, 2001 and 2000 are as follows:
OPTIONS GRANTED WEIGHTED AVERAGE FAIR VALUE OF OPTIONS
- --------------- --------------------------------------
2002 2001 2000
-------- -------- --------
Acacia Research Corporation stock options
(January 1, 2002 - December 13, 2002)...... $ 5.43 $ 4.19 $ 20.17
AR-Acacia Technologies stock options............ $ 1.16
AR-CombiMatrix stock options.................... $ --
There were no options granted during 2002, 2001 or 2000 with exercise
prices less than or greater than the market value on the date of grant.
12. DEFERRED NON-CASH STOCK COMPENSATION CHARGES
During the year ended December 31, 2000, CombiMatrix Corporation
recorded deferred non-cash stock compensation charges aggregating approximately
$53,773,000 in connection with the granting of stock options. Pursuant to Acacia
Research Corporation's policy, the stock options were originally granted by
CombiMatrix Corporation at exercise prices equal to the fair value of the
underlying CombiMatrix Corporation stock on the date of grant as determined by
its board of directors. However, such exercise prices were subsequently
determined to have been granted at exercise prices below fair value due to a
substantial step-up in the fair value of CombiMatrix Corporation pursuant to a
valuation provided by an investment banker in contemplation of a potential
CombiMatrix Corporation initial public offering in 2000. In connection with the
proposed CombiMatrix Corporation initial public offering and pursuant to SEC
rules and guidelines, we were required to reassess the value of stock options
issued during the one-year period preceding the potential initial public
offering and utilize the stepped-up fair value provided by the investment banker
for purposes of determining whether such stock option issuances were
compensatory, resulting in the calculation of the $53,773,000 in deferred
non-cash stock compensation charges in 2000. Deferred non-cash stock
compensation charges are being amortized over the respective option grant
vesting periods, which range from one to four years. Non-cash stock compensation
charged to income during 2002, 2001 and 2000 totaled $6,408,000, $19,963,000 and
$9,995,000, respectively. Pursuant to the vesting terms of CombiMatrix
Corporation's stock options outstanding at December 31, 2002, we will record
non-cash stock compensation amortization expenses of $3,142,000 in 2003 and
$881,000 in 2004.
During 2002 and 2001, certain CombiMatrix Corporation unvested stock
options were forfeited. Pursuant to the provisions of APB Opinion No. 25 and
related interpretations, the reversal of previously recognized non-cash stock
compensation expense on forfeited unvested stock options in the amount of
$1,204,000 and $4,698,000 has been reflected in the 2002 and 2001 consolidated
statements of operations and comprehensive loss, respectively, as reductions in
non-cash stock compensation expense. In addition, the forfeiture of certain
unvested options during 2002 and 2001 resulted in a reduction of the remaining
deferred non-cash stock compensation expense scheduled to be amortized in future
periods.
In connection with our acquisition of the stockholder interests in
CombiMatrix Corporation not already owned by us, the exchange of CombiMatrix
Corporation common stock options for AR-CombiMatrix stock options resulted in a
new measurement date for those awards. Accordingly, additional stock-based
compensation expense of approximately $116,000 was recorded in the 2002
consolidated statement of operations of Acacia Research Corporation related to
F-34
the incremental increase in compensation expense for certain options exchanged
on the new measurement date. The additional stock compensation expense has been
allocated to the CombiMatrix group.
Amounts to be amortized in future periods reflected above may be
impacted by certain subsequent stock option transactions including modification
of terms, cancellations, forfeitures and other activity.
13. COMMITMENTS AND CONTINGENCIES
SALE AND LEASEBACK ARRANGEMENT
In September 2001, CombiMatrix Corporation entered into a sale and
leaseback arrangement with a bank, providing up to $7,000,000 in financing for
equipment and other capital purchases. Pursuant to the terms of the agreement,
certain equipment and leasehold improvements, totaling $2,557,000 in net book
value were sold to the bank at a purchase price of $3,000,000, resulting in a
deferred gain on the sale of assets of $443,000. The deferred gain is being
amortized over 4 years, the life of the related property and equipment. In
addition, CombiMatrix Corporation entered into a capital lease arrangement to
lease the fixed assets from the bank.
In October 2002, CombiMatrix Corporation was in non-compliance with one
of its covenants under its capital lease obligation with a commercial bank.
CombiMatrix Corporation repaid the entire remaining balance of the obligation in
the amount of $2,116,000 on November 1, 2002.
OPERATING LEASES
We lease certain office furniture and equipment and laboratory and
office space under various operating lease agreements expiring over the next 7
years. Minimum annual rental commitments on operating leases of continuing
operations having initial or remaining non-cancelable lease terms in excess of
one year are as follows (in thousands):
YEAR
----
2003....................................................... $ 2,281
2004....................................................... 2,035
2005....................................................... 2,118
2006....................................................... 2,148
2007....................................................... 1,976
Thereafter................................................. 1,614
---------
Total minimum lease payments............................... $ 12,172
=========
Rent expenses of continuing operations at year ended December 31, 2002,
2001 and 2000 approximated $2,063,000, $1,979,000 and $1,032,000, respectively.
LITIGATION
CombiMatrix Corporation
On November 28, 2000, Nanogen filed a complaint in the United States
District Court for the Southern District of California against CombiMatrix
Corporation and Donald D. Montgomery, Ph.D., an officer, director and
stockholder of CombiMatrix Corporation. Dr. Montgomery was employed by Nanogen
as a senior research scientist between May 1994 and August 1995. The Nanogen
complaint alleged, among other things, breach of contract, trade secret
misappropriation and that U.S. Patent No. 6,093,302 and other proprietary
information belonging to CombiMatrix Corporation are instead the property of
Nanogen. The complaint sought, among other things, correction of inventorship on
the patent, the assignment of rights in the patent and pending patent
applications to Nanogen, an injunction preventing disclosure of trade secrets,
damages for trade secret misappropriation and the imposition of a constructive
trust.
F-35
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, Nanogen dismissed with prejudice its lawsuit against CombiMatrix
Corporation and Dr. Montgomery. In return, CombiMatrix Corporation agreed to pay
Nanogen $500,000 within 30 days of the settlement and an additional $500,000
within one year of the settlement. CombiMatrix Corporation also agreed to make
quarterly payments to Nanogen equal to 12.5% of payments to CombiMatrix
Corporation from sales of products developed by CombiMatrix Corporation and its
affiliates and based on the patents that had been in dispute in the litigation,
up to an annual maximum of $1,500,000. The minimum quarterly payments under the
settlement agreement will be $37,500 per quarter for the period from October 1,
2003 through October 1, 2004, and $25,000 per quarter thereafter until the
patents expire in 2018. Also, pursuant to the settlement agreement, CombiMatrix
Corporation issued to Nanogen 4,016,346 shares, or 17.5% of its outstanding
shares post-issuance, subject to an antidilution provision related to the
exercise of CombiMatrix Corporation options and warrants that were outstanding
on the effective date of the agreement, for a period of up to three years.
The issuance of shares by CombiMatrix Corporation to Nanogen decreased
our consolidated ownership interest in CombiMatrix Corporation from 58% to 48%.
We continued to possess the ability to direct or cause the direction of the
management and policies of CombiMatrix Corporation, primarily through Acacia
Research Corporation's ability to elect the majority of the board of directors
of CombiMatrix Corporation, pursuant to a shareholder agreement with Dr. Donald
Montgomery. This shareholder agreement stipulated that, collectively, Acacia
Research Corporation and the officer who is party to the stockholder agreement
would vote their shares such that the board will be comprised of the directors
nominated by Acacia Research Corporation and Dr. Donald Montgomery. Dr. Donald
Montgomery was generally prohibited from selling his shares and Acacia Research
Corporation has a right of first refusal should Dr. Donald Montgomery wish to
sell his shares. Accordingly, Acacia Research Corporation continued to account
for its investment in CombiMatrix Corporation under the consolidation method of
accounting subsequent to the settlement with Nanogen.
The issuance of the CombiMatrix Corporation common shares in settlement
of the litigation with Nanogen was accounted for as a nonmonetary transaction.
Accordingly, CombiMatrix Corporation recorded a non-cash litigation settlement
charge in the consolidated statements of operations for the year ended December
31, 2002 of approximately $17,471,000, which was based on the fair value of the
CombiMatrix Corporation common shares issued to Nanogen. The fair value of the
common shares issued and the related litigation charge was based on an
independent third-party valuation of CombiMatrix Corporation as of September 30,
2002.
Total legal settlement charges recorded in the consolidated statements
of operations for the year ended December 31, 2002 include the fair value of the
common shares issued to Nanogen in the amount of $17,471,000 and a charge in the
amount of $1,000,000 related to the cash payments due to Nanogen discussed
above.
Soundview Technologies
On April 5, 2000, Soundview Technologies filed a federal patent
infringement and antitrust lawsuit against Sony Corporation of America, Philips
Electronics North America Corporation, the Consumer Electronics Manufacturers
Association and the Electronics Industries Alliance d/b/a Consumer Electronics
Association in the United States District Court for the Eastern District of
Virginia, alleging that television sets utilizing certain content blocking
technology (commonly known as the "V-chip") and sold in the United States
infringe Soundview Technologies' U.S. Patent No. 4,554,584. In September 2002,
the United States District Court for the District of Connecticut granted a
motion for summary judgment filed by the defendants. In granting the motion, the
court ruled that the defendants have not infringed on Soundview Technologies'
patent. While we are currently exploring strategies in response to this ruling
and intend to appeal it, litigation is inherently uncertain and we can give no
assurance that we will be successful in any such appeal.
The ruling has no effect on the revenues that we have received from
current licensees of our patented V-chip technology. Further, none of the
revenues that we have received to date are contingent upon any court rulings or
F-36
the future outcome of any litigation with unlicensed television manufacturers.
Soundview continues to pursue its antitrust claim against the defendants.
Acacia Research Corporation is subject to other claims and legal
actions that arise in the ordinary course of business. Management believes that
the ultimate liability with respect to these claims and legal actions, if any,
will not have a material effect on our financial position, results of operations
or cash flows.
14. SEGMENT INFORMATION
Acacia Research Corporation has adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Our chief
operating decision maker is considered to be Acacia Research Corporation's CEO.
The CEO reviews and evaluates financial information presented on a group basis
as described below. Management evaluates performance based on the profit or loss
from continuing operations and financial position of its segments. Acacia
Research Corporation has two reportable segments as follows:
ACACIA TECHNOLOGIES GROUP - The Acacia Technologies group is primarily
comprised of Acacia Research Corporation's interests in two wholly owned media
technologies subsidiaries: (1) Acacia Media Technologies and (2) Soundview
Technologies, and also includes all corporate assets, liabilities, and related
transactions of Acacia Research Corporation attributed to the Acacia
Technologies group. Acacia Technologies group owns intellectual property related
to the telecommunications field, including a television blanking system, also
known as the "V-chip," which it licenses to television manufacturers. In
addition, our media technologies group owns a worldwide portfolio of pioneering
patents relating to audio and video transmission and receiving systems, commonly
known as audio-on-demand and video-on-demand, used for distributing content via
various methods including computer networks, cable television systems and direct
broadcasting satellite systems.
COMBIMATRIX GROUP - The CombiMatrix group is comprised of our wholly
owned subsidiary, CombiMatrix Corporation, CombiMatrix Corporation's
majority-owned subsidiaries, Advanced Material Sciences and CombiMatrix KK and
also includes all corporate assets, liabilities, and related transactions of
Acacia Research Corporation attributed to the CombiMatrix group. CombiMatrix
Corporation is a life sciences technology company with a proprietary system for
rapid, cost competitive creation of DNA and other compounds on a programmable
semiconductor chip. Advanced Material Sciences, a development stage company,
holds the exclusive license for CombiMatrix Corporation's biological array
processor technology in certain fields of material sciences. CombiMatrix KK, a
majority-owned Japanese corporation located in Tokyo, is exploring opportunities
for CombiMatrix Corporation's active biochip system with pharmaceutical and
biotechnology companies in the Asian market.
Material intercompany transactions and transfers have been eliminated
in consolidation. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. On December 13,
2002, our reporting segments were modified to reflect the attribution of assets
and liabilities and the allocation of expenditures consistent with the
management and allocation policies used in the preparation of the separate
Acacia Technologies group and CombiMatrix group financial statements. Segment
information has been adjusted for all periods presented.
The tables below present information about our reportable segments in
continuing operations for the years ended December 31, 2002, 2001 and 2000 (in
thousands):
F-37
ACACIA
TECHNOLOGIES COMBIMATRIX
2002 GROUP GROUP TOTAL
------------- ------------- -------------
Revenue ............................... $ 43 $ 839 $ 882
Amortization of patents ............... 1,591 399 1,990
Other income .......................... 64 -- 64
Interest income ....................... 620 589 1,209
Interest expense ...................... 6 197 203
Realized losses on investments ........ 1,184 -- 1,184
Unrealized losses on investments ...... 249 -- 249
Impairment of cost method investment .. 2,748 -- 2,748
Loss from operations before
income taxes and minority interests.. 13,368 70,068 83,436
Non-cash stock compensation charges ... 19 6,408 6,427
Segment assets ........................ 43,816 49,973 93,789
Investment in affiliate, at cost ...... 252 -- 252
Purchase of property and equipment .... 78 1,002 1,080
ACACIA
TECHNOLOGIES COMBIMATRIX
2001 GROUP GROUP TOTAL
------------- ------------- -------------
Revenue ............................... $ 24,180 $ 456 $ 24,636
Amortization of patents and goodwill .. 1,492 1,203 2,695
Other income .......................... 77 -- 77
Interest income ....................... 1,642 2,120 3,762
Interest expense ...................... -- 65 65
Realized gains on investments ......... 350 -- 350
Unrealized gains on investments ....... 237 -- 237
Equity in losses of affiliate ......... 195 -- 195
(Income) loss from operations before
income taxes and minority interests.. (7,969) 47,001 39,032
Non-cash stock compensation charges ... 856 19,963 20,819
Segment assets ........................ 58,705 47,963 106,668
Investment in affiliate, at cost ...... 3,000 -- 3,000
Purchase of property and equipment .... 19 3,756 3,775
F-38
ACACIA
TECHNOLOGIES COMBIMATRIX
2000 GROUP GROUP TOTAL
------------- ------------- -------------
Revenue ............................... $ 40 $ 17 $ 57
Amortization of patents ............... 1,611 640 2,251
Other income .......................... 28 -- 28
Interest income ....................... 1,424 1,662 3,086
Equity in losses of affiliates ........ 1,746 -- 1,746
Loss from operations before
income taxes and minority interests.. 15,503 22,895 38,398
Non-cash stock compensation charges ... 709 9,995 10,704
Segment assets ........................ 29,879 61,561 91,440
Investment in affiliate, at equity .... 346 -- 346
Investment in affiliate, at cost ...... 3,000 -- 3,000
Purchase of property and equipment .... 472 2,921 3,393
Segment information excludes amounts related to the discontinued
operations of Soundbreak.com for the years ended December 31, 2002, 2001 and
2000. See Note 10 to consolidated financial statements.
15. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS):
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest .......................................................... $ 192 $ 42 $ 79
Cash paid for income taxes ...................................................... -- 597 --
Supplemental schedule of non-cash operating, investing and financing activities:
Issuance of common stock for additional equity in consolidated subsidiary ....... (46,007) -- (11,634)
Purchase price allocated to goodwill - step acquisitions ........................ 16,008 -- 2,928
Purchase price allocated to patents - step acquisitions ......................... 5,283 -- 6,812
Liabilities assumed in acquisition of minority ownership interest in subsidiary.. -- 200 --
Fixed assets purchased with accounts payable .................................... 70 -- 917
Purchase of equipment under capital lease agreement ............................. -- (3,000) --
Capital lease obligation incurred ............................................... -- 3,000 --
Accrued payments for purchase of common stock from former minority
stockholders of subsidiary ...................................................... 58 217 --
Loss from discontinued operations of Soundbreak.com ............................. 480 -- 3,072
Deferred revenue purchase accounting adjustment ................................. 8,425 -- --
F-39
16. CONSOLIDATING FINANCIAL INFORMATION
Presented below is consolidating financial information reflecting the
businesses of the Acacia Technologies group and the CombiMatrix group. Earnings
attributable to each group has been determined in accordance with accounting
principles generally accepted in the United States.
AR-CombiMatrix stock and AR-Acacia Technologies stock are intended to
reflect the separate performance of the respective division of Acacia Research
Corporation. The CombiMatrix group and the Acacia Technologies group are not
separate legal entities. Holders of AR-CombiMatrix stock and AR-Acacia
Technologies stock are stockholders of Acacia Research Corporation. As a result,
holders of AR-CombiMatrix stock and AR-Acacia Technologies stock continue to be
subject to all of the risks of an investment in Acacia Research Corporation and
all of its businesses, assets and liabilities. The assets Acacia Research
Corporation attributes to one of the groups could be subject to the liabilities
of the other group. The group financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America, and taken together, comprise all the accounts included in the
corresponding consolidated financial statements of Acacia Research Corporation.
The financial statements of the groups reflect the financial condition, results
of operations, and cash flows of the businesses included therein. The financial
statements of the groups include the accounts or assets of Acacia Research
Corporation specifically attributed to the groups and were prepared using
amounts included in Acacia Research Corporation's consolidated financial
statements.
Minority interests represent participation of other stockholders in the
net equity and in the division earnings and losses of the groups and are
reflected in the caption "Minority interests" in the group financial statements.
Minority interests adjust group net results of operations to reflect only the
group's share of the division earnings or losses of non-wholly owned investees.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or of the Acacia
Technologies group, and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock, will reduce the assets of
Acacia Research Corporation legally available for payment of dividends on
AR-CombiMatrix stock or AR-Acacia Technologies stock.
MANAGEMENT ALLOCATION POLICIES. The management and allocation policies
applicable to the preparation of the financial statements of the CombiMatrix
group and the Acacia Technologies group may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation board of directors at any time without approval of the
stockholders. The group's financial statements reflect the application of the
management and allocation policies adopted by the Acacia Research Corporation
board of directors to various corporate activities, as described below.
Management has no plans to change allocation methods or the composition of the
groups. The group financial statements should be read in conjunction with the
Acacia Research Corporation consolidated financial statements and related notes.
TREASURY AND CASH MANAGEMENT POLICIES. Cash and short-term investments
are attributed to the groups based on the respective cash and short term
investments balances of the entities comprising each group. Corporate cash
balances have been attributed to the Acacia Technologies group. All cash raised
by CombiMatrix Corporation and Advanced Material Sciences have been attributed
to the CombiMatrix group. Acacia Research Corporation will manage most treasury
activities on a decentralized basis, with each separate group separately
managing its own treasury activities. Pursuant to treasury and cash management
policies adopted by the Acacia Research Corporation board of directors, the
following applies:
o Acacia Research Corporation will attribute each future issuance of
AR-Acacia Technologies stock (and the proceeds thereof) to the Acacia
Technologies group and will attribute each future issuance of
AR-CombiMatrix stock (and the proceeds thereof) to the CombiMatrix
group;
F-40
o Acacia Research Corporation will attribute each future incurrence or
issuance of external debt or preferred stock (and the proceeds thereof)
between the groups or entirely to one group as determined by the Acacia
Research Corporation board of directors, based on the extent to which
Acacia Research Corporation incurs or issues the debt or preferred
stock for the benefit of the CombiMatrix group or the Acacia
Technologies group;
o Dividends on AR-Acacia Technologies stock will be charged against the
AR-Acacia Technologies group, and dividends on AR-CombiMatrix stock
will be charged against the CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged against the
Acacia Technologies group and Repurchases of AR-CombiMatrix stock will
be charged against the CombiMatrix group;
o Acacia Research Corporation accounts for any cash transfers from Acacia
Research Corporation to or for the account of a group, from a group to
or for the account of Acacia Research Corporation, or from one group to
or for the account of the other group (other than transfers in return
for assets or services rendered) as short-term loans unless (A) the
Acacia Research Corporation board of directors determines that a given
transfer (or type of transfer) should be accounted for as a long-term
loan, (B) the Acacia Research Corporation board of directors determines
that a given transfer (or type of transfer) should be accounted for as
a capital contribution or (iii) the Acacia Research Corporation board
of directors determines that a given transfer (or type of transfer)
should be accounted for as a return of capital. There are no specific
criteria to determine when Acacia Research Corporation will account for
a cash transfer as a long-term loan, a capital contribution or a return
of capital rather than an inter-group revolving credit advance;
provided, however, that cash advances from Acacia Research Corporation
to the Acacia Technologies group or to the CombiMatrix group up to
$25.0 million on a cumulative basis shall be accounted for as
short-term or long-term loans at interest rates at which Acacia
Research Corporation could borrow such funds and shall not be accounted
for as a capital contribution. The Acacia Research Corporation board of
directors will make such a determination in the exercise of its
business judgment at the time of such transfer based upon all relevant
circumstances. Factors the Acacia Research Corporation board of
directors may consider include, without limitation, the current and
projected capital structure of each group; the financing needs and
objectives of the recipient group; the availability, cost and time
associated with alternative financing sources; and prevailing interest
rates and general economic conditions; and
o Any cash transfers accounted for as short-term loans will bear interest
at the rate at which Acacia Research Corporation could borrow such
funds. In addition, any cash transfers accounted for as a long-term
loan will have interest rates, amortization, maturity, redemption and
other terms that reflect the then-prevailing terms on which Acacia
Research Corporation could borrow such funds.
ASSETS AND LIABILITIES. In general, Acacia Research Corporation's
assets and liabilities have been attributed to the Acacia Technologies group and
the CombiMatrix group based on the respective asset and liabilities of the
business comprising each group. Net intangible assets recorded at the Acacia
Research Corporation level, primarily consisting of acquired patents and
goodwill balances, have been attributed to the respective businesses comprising
each group to which the intangibles and goodwill relate.
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES. Acacia
Research Corporation allocates the cost of corporate general and administrative
services and facilities between the groups generally based upon utilization.
Where determinations based on utilization alone are impracticable, Acacia
Research Corporation utilizes other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials. Except as may otherwise be specifically provided
pursuant to the terms of any agreements among Acacia Research Corporation and
F-41
the groups or any resolutions of the Acacia Research Corporation board of
directors, the corporate general and administrative services and facilities to
be allocated between the groups include, without limitation, legal services,
accounting services (tax and financial), insurance and deductibles payable in
connection therewith, employee benefit plans and administration thereof,
investor relations, stockholder services, and services relating to the board of
directors.
Management believes that the methods and criteria used to allocate
costs are equitable and provide a reasonable estimate of the cost attributable
to the groups. Based on the allocation methods used, Acacia Research Corporation
believes that the allocation of expenses as presented in the accompanying
consolidating financial information reflects a reasonable estimation of expenses
that would be recognized if the groups were separate stand alone registrants.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES. Acacia Research
Corporation determines its federal income taxes and the federal income taxes of
its subsidiaries that own assets allocated between the groups on a consolidated
basis. Acacia Research Corporation allocates consolidated federal income tax
provisions and related tax payments or refunds between the Acacia Technologies'
group and CombiMatrix group based principally on the taxable income and tax
credits directly attributable to each group. Such allocations reflect each
group's contribution, whether positive or negative, to Acacia Research
Corporation's consolidated federal taxable income and consolidated federal tax
liability and tax credit position. Acacia Research Corporation will credit tax
benefits that cannot be used by the group generating those benefits but can be
used on a consolidated tax return basis to the group that generated such
benefits.
Inter-group transactions are treated as taxed as if each group was a
stand-alone company. Depending on the tax laws of the respective jurisdictions,
state and local income taxes are calculated on either a consolidated or combined
basis between the groups based on their respective contribution to such
consolidated or combined state taxable incomes. State and local income tax
provisions and related tax payments or refunds which are determined on a
separate corporation basis are allocated between the groups in a manner designed
to reflect the respective contributions of the groups to Acacia Research
Corporation's separate or local taxable income.
F-42
CONSOLIDATING STATEMENT OF FINANCIAL POSITION AT DECEMBER 31, 2002 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
---------- ---------- ---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ............................ $ 39,792 $ 3,291 $ -- $ 43,083
Short-term investments ............................... -- 11,605 -- 11,605
Accounts receivable .................................. -- 578 -- 578
Prepaid expenses, other receivables and other assets.. 775 446 -- 1,221
---------- ---------- ---------- ----------
Total current assets .................... 40,567 15,920 -- 56,487
Property and equipment, net of accumulated depreciation... 180 3,895 -- 4,075
Receivable from CombiMatrix group ........................ 114 -- (114) --
Investment in affiliate, at cost ......................... 252 -- -- 252
Patents, net of accumulated amortization ................. 4,068 11,212 -- 15,280
Goodwill, net of accumulated amortization ................ 1,834 18,859 -- 20,693
Other assets ............................................. 197 87 -- 284
---------- ---------- ---------- ----------
$ 47,212 $ 49,973 $ (114) $ 97,071
========== ========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other ......... $ 2,524 $ 2,302 $ -- $ 4,826
Current portion of deferred revenues ................. 1,503 9,172 -- 10,675
Current portion of capital lease obligation .......... -- -- -- --
---------- ---------- ---------- ----------
Total current liabilities ............... 4,027 11,474 -- 15,501
Payable to Acacia Technologies group ..................... -- 114 (114) --
Deferred income taxes .................................... 1,156 2,384 -- 3,540
Deferred revenues, net of current portion ................ -- -- -- --
Capital lease obligation, net of current portion ......... -- -- -- --
---------- ---------- ---------- ----------
Total liabilities ....................... 5,183 13,972 (114) 19,041
---------- ---------- ---------- ----------
Minority interests ....................................... 1,487 684 -- 2,171
---------- ---------- ---------- ----------
Stockholders' equity:
AR - Acacia Technologies stock ....................... 105,557 129,286 1 234,844
AR - CombiMatrix stock ............................... (65,015) (93,969) (1) (158,985)
---------- ---------- ---------- ----------
Total stockholders' equity .............. 40,542 35,317 -- 75,859
---------- ---------- ---------- ----------
$ 47,212 $ 49,973 $ (114) $ 97,071
========== ========== ========== ==========
F-43
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2002 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINATIONS/
GROUP GROUP RECLASSIFICATIONS CONSOLIDATED
------------- ------------- ------------- -------------
Revenues:
License fee income ..................................... $ 43 $ -- $ -- $ 43
Product revenue ........................................ -- 306 -- 306
Grant revenue .......................................... -- 533 -- 533
------------- ------------- ------------- -------------
Total revenues .................................... 43 839 -- 882
------------- ------------- ------------- -------------
Operating expenses:
Cost of sales .......................................... -- 263 -- 263
Research and development expenses ...................... -- 18,187 -- 18,187
Charge for acquired in-process research and development. -- 17,237 -- 17,237
Non-cash stock compensation
expense - research and development ................... -- 1,868 -- 1,868
Marketing, general and administrative expenses ......... 6,883 10,334 1,415 18,632
Non-cash stock compensation
expense - marketing, general and administrative ...... 19 4,540 -- 4,559
Legal expenses ......................................... 1,415 -- (1,415) --
Amortization of patents and goodwill ................... 1,591 399 -- 1,990
Legal settlement charges ............................... -- 18,471 -- 18,471
------------- ------------- ------------- -------------
Total operating expenses .......................... 9,908 71,299 -- 81,207
------------- ------------- ------------- -------------
Operating loss ......................................... (9,865) (70,460) -- (80,325)
------------- ------------- ------------- -------------
Other (expense) income:
Impairment of cost method investment ................... (2,748) -- -- (2,748)
Interest income ........................................ 620 589 -- 1,209
Realized (losses) gains on short-term investments ...... (1,184) -- -- (1,184)
Unrealized (losses) gains on short-term investments .... (249) -- -- (249)
Interest expense ....................................... (6) (197) -- (203)
Other income (expense) ................................. 64 -- -- 64
------------- ------------- ------------- -------------
Total other (expense) income ...................... (3,503) 392 -- (3,111)
------------- ------------- ------------- -------------
Loss from continuing operations
before income taxes and minority interests ............... (13,368) (70,068) -- (83,436)
Benefit (provision) for income taxes ....................... 710 147 -- 857
------------- ------------- ------------- -------------
Loss from continuing operations before minority interests... (12,658) (69,921) -- (82,579)
Minority interests ......................................... 104 23,702 -- 23,806
------------- ------------- ------------- -------------
Loss from continuing operations ............................ (12,554) (46,219) -- (58,773)
Discontinued operations:
Estimated loss on disposal of Soundbreak.com ........... (200) -- -- (200)
------------- ------------- ------------- -------------
Net loss ................................................... $ (12,754) $ (46,219) $ -- $ (58,973)
============= ============= ============= =============
F-44
CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2002 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX ELIMINA- CONSOLI-
GROUP GROUP TIONS DATED
--------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations: ............................................... $(12,554) $(46,219) $ -- $(58,773)
Adjustments to reconcile net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization ............................................. 1,797 1,736 -- 3,533
Minority interests ........................................................ (104) (23,702) -- (23,806)
Stock-based compensation .................................................. 19 6,408 -- 6,427
Charge for acquired in-process research and development ................... -- 17,237 -- 17,237
Deferred tax benefit ...................................................... (142) (147) -- (289)
Net sales (purchases) of trading securities ............................... 4,124 -- -- 4,124
Unrealized losses (gains) on short-term investments ....................... 249 -- -- 249
Issuance of common stock by subsidiary - legal settlement ................. -- 17,471 -- 17,471
Impairment of cost method investment ...................................... 2,748 -- -- 2,748
Other ..................................................................... (30) 129 -- 99
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other receivables and other assets.. (1) (177) -- (178)
Accounts payable, accrued expenses and other .............................. 372 (515) -- (143)
Deferred revenue .......................................................... 3 11,637 -- 11,640
--------- --------- --------- ---------
Net cash used in operating activities from continuing operations .......... (3,519) (16,142) -- (19,661)
Net cash used in operating activities from discontinued operations ........ (905) -- -- (905)
--------- --------- --------- ---------
Net cash used in operating activities ..................................... (4,424) (16,142) -- (20,566)
--------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of additional equity in consolidated subsidiaries ................ (200) -- -- (200)
Purchase of property and equipment ........................................ (78) (1,002) -- (1,080)
Proceeds from sale of property and equipment .............................. 3 358 -- 361
Purchase of available-for-sale investments ................................ -- (11,338) -- (11,338)
Sale of available-for-sale investments .................................... -- 20,383 -- 20,383
Purchase of common stock from minority stockholders of subsidiaries ....... (217) -- -- (217)
Acquisition costs ......................................................... -- (834) -- (834)
Other ..................................................................... (100) -- -- (100)
--------- --------- --------- ---------
Net cash provided by investing activities from continuing operations ...... (592) 7,567 -- 6,975
Net cash used in investing activities from discontinued operations ........ (3) -- -- (3)
--------- --------- --------- ---------
Net cash provided by investing activities ................................. (595) 7,567 -- 6,972
--------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash attributed to the Acacia Technologies group ...................... (2,048) -- -- (2,048)
Net cash attributed to the CombiMatrix group .............................. -- (818) -- (818)
--------- --------- --------- ---------
Net cash (used in) provided by financing activities ....................... (2,048) (818) -- (2,866)
--------- --------- --------- ---------
(Decrease) increase in cash and cash equivalents ................................... (7,067) (9,393) -- (16,460)
--------- --------- --------- ---------
Cash and cash equivalents, beginning ............................................... 46,859 12,592 -- 59,451
Effect of exchange rate on cash .................................................... -- 92 -- 92
--------- --------- --------- ---------
Cash and cash equivalents, ending .................................................. $ 39,792 $ 3,291 $ -- $ 43,083
========= ========= ========= =========
F-45
CONSOLIDATING STATEMENT OF FINANCIAL POSITION AT DECEMBER 31, 2001 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
ASSETS GROUP GROUP ELIMINATIONS CONSOLIDATED
---------- ---------- ---------- ----------
Current assets:
Cash and cash equivalents ............................. $ 46,859 $ 12,592 $ -- $ 59,451
Short-term investments ................................ 4,372 20,738 -- 25,110
Prepaid expenses, other receivables and other assets .. 800 813 -- 1,613
---------- ---------- ---------- ----------
Total current assets ............................. 52,031 34,143 -- 86,174
Property and equipment, net of accumulated depreciation ... 358 4,548 -- 4,906
Receivable from CombiMatrix group ......................... 30 -- (30) --
Investment in affiliate, at cost .......................... 3,000 -- -- 3,000
Patents, net of accumulated amortization .................. 5,554 6,301 -- 11,855
Goodwill, net of accumulated amortization ................. 1,776 2,851 -- 4,627
Other assets .............................................. 177 120 -- 297
---------- ---------- ---------- ----------
$ 62,926 $ 47,963 $ (30) $ 110,859
========== ========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable, accrued expenses and other .............. $ 2,925 $ 2,831 $ -- $ 5,756
Current portion of deferred revenues ...................... 1,500 5,588 -- 7,088
Current portion of capital lease obligation ............... -- 934 -- 934
---------- ---------- ---------- ----------
Total current liabilities ........................ 4,425 9,353 -- 13,778
---------- ---------- ---------- ----------
Payable to Acacia Technologies group ...................... -- 30 (30) --
Deferred income taxes ..................................... 1,298 2,531 -- 3,829
Deferred revenues, net of current portion ................. -- 372 -- 372
Capital lease obligation, net of current portion .......... -- 1,845 -- 1,845
---------- ---------- ---------- ----------
Total liabilities ................................ 5,723 14,131 (30) 19,824
---------- ---------- ---------- ----------
Minority interests ........................................ 2,194 30,109 -- 32,303
---------- ---------- ---------- ----------
Stockholders' equity:
AR-Acacia Technologies stock .......................... 55,009 -- -- 55,009
AR-CombiMatrix stock .................................. -- 3,723 -- 3,723
---------- ---------- ---------- ----------
Total stockholders' equity ................................ 55,009 3,723 -- 58,732
---------- ---------- ---------- ----------
$ 62,926 $ 47,963 $ (30) $ 110,859
========== ========== ========== ==========
F-46
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
--------- --------- ------------ -----------
Revenues:
License fee income ............................. $ 24,180 $ -- $ -- $ 24,180
Grant revenue .................................. -- 456 -- 456
--------- --------- ------------ -----------
Total revenues ............................ 24,180 456 -- 24,636
Operating expenses:
Research and development expenses .............. -- 18,839 -- 18,839
Marketing, general and administrative expenses.. 5,258 29,470 -- 34,728
Legal expenses ................................. 11,572 -- -- 11,572
Amortization of patents and goodwill ........... 1,492 1,203 -- 2,695
--------- --------- ------------ -----------
Total operating expenses .................. 18,322 49,512 -- 67,834
--------- --------- ------------ -----------
Operating income (loss) ........................ 5,858 (49,056) -- (43,198)
--------- --------- ------------ -----------
Other income (expense):
Write-off of equity investments ................ -- -- -- --
Interest income ................................ 1,642 2,120 -- 3,762
Realized gains on short-term investments ....... 350 -- -- 350
Unrealized gains on short-term investments ..... 237 -- -- 237
Interest expense ............................... -- (65) -- (65)
Equity in losses of affiliates ................. (195) -- -- (195)
Other income ................................... 77 -- -- 77
--------- --------- ------------ -----------
Total other income (expense) .............. 2,111 2,055 -- 4,166
--------- --------- ------------ -----------
Income (loss) from continuing operations before
income taxes and minority interests ............. 7,969 (47,001) -- (39,032)
(Provision) benefit for income taxes ............... (935) 155 -- (780)
--------- --------- ------------ -----------
Income (loss) from continuing operations before
minority interests .............................. 7,034 (46,846) -- (39,812)
Minority interests ................................. (1,277) 18,817 -- 17,540
--------- --------- ------------ -----------
Net income (loss) .................................. $ 5,757 $(28,029) $ -- $ (22,272)
========= ========= ============ ===========
F-47
CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2001 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
----------- ----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations ......................... $ 5,757 $ (28,029) $ -- $ (22,272)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation and amortization ................................ 1,710 2,159 -- 3,869
Equity in losses of affiliates ............................... 195 -- -- 195
Minority interests ........................................... 1,277 (18,817) -- (17,540)
Compensation expense relating to stock options and
warrants ................................................... 856 19,963 -- 20,819
Deferred tax benefit ......................................... (27) (155) -- (182)
Write-off of other assets .................................... -- 918 -- 918
Net purchases of trading securities .......................... (4,135) -- -- (4,135)
Unrealized gain on short-term investments .................... (237) -- -- (237)
Other ........................................................ 40 314 -- 354
Changes in assets and liabilities, net of effects of acquisitions:
Prepaid expenses, other receivables and other assets ......... (378) (258) (77) (713)
Accounts payable, accrued expenses and other ................. 233 775 77 1,085
Deferred revenues ............................................ 1,500 5,960 -- 7,460
Net cash provided by (used in) operating activities of
continuing operations ...................................... 6,791 (17,170) -- (10,379)
Net cash used in operating activities of discontinued
operations ................................................. (2,182) -- -- (2,182)
----------- ----------- ----------- -----------
Net cash provided by (used in) operating activities .......... 4,609 (17,170) -- (12,561)
----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of additional equity in consolidated subsidiaries ... (3,304) -- -- (3,304)
Purchase of property and equipment ........................... (19) (3,756) -- (3,775)
Proceeds from sale and leaseback arrangement ................. -- 3,000 -- 3,000
Sale of available-for-sale investments ....................... 25,921 50,354 -- 76,275
Purchase of available-for-sale investments ................... (25,921) (30,765) -- (56,686)
Purchase of common stock from minority stockholders
of subsidiaries ............................................ (2,550) -- -- (2,550)
----------- ----------- ----------- -----------
Net cash (used in) provided by investing activities
of continuing operations ................................... (5,873) 18,833 -- 12,960
Net cash used in investing activities of discontinued
operations ................................................. (145) -- -- (145)
----------- ----------- ----------- -----------
Net cash (used in) provided by investing activities .......... (6,018) 18,833 -- 12,815
----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash attributed to the Acacia Technologies group ......... 18,663 -- -- 18,663
Net cash attributed to the CombiMatrix group ................. -- 4,496 -- 4,496
----------- ----------- ----------- -----------
Net cash provided by financing activities .................... 18,663 4,496 -- 23,159
----------- ----------- ----------- -----------
Increase in cash and cash equivalents ........................ 17,254 6,159 -- 23,413
Cash and cash equivalents, beginning ......................... 29,605 6,558 -- 36,163
Effect of exchange rate on cash .............................. -- (125) -- (125)
----------- ----------- ----------- -----------
Cash and cash equivalents, ending ............................ $ 46,859 $ 12,592 $ -- $ 59,451
=========== =========== =========== ===========
F-48
CONSOLIDATING STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- -------------- --------------
Revenues:
Grant revenue ........................................... $ -- $ 17 $ -- $ 17
Other income ............................................ 40 -- -- 40
-------------- -------------- -------------- --------------
Total revenues ....................................... 40 17 -- 57
-------------- -------------- -------------- --------------
Operating expenses:
Research and development expenses ....................... 52 11,812 -- 11,864
Marketing, general and administrative expenses .......... 8,983 12,122 -- 21,105
Legal expenses .......................................... 984 -- -- 984
Amortization of patents and goodwill .................... 1,611 640 -- 2,251
Loss on disposal of consolidated subsidiaries ........... 1,016 -- -- 1,016
-------------- -------------- -------------- --------------
Total operating expenses ............................. 12,646 24,574 -- 37,220
-------------- -------------- -------------- --------------
Operating loss .......................................... (12,606) (24,557) -- (37,163)
-------------- -------------- -------------- --------------
Other income (expense):
Write-off of equity investments ......................... (2,603) -- -- (2,603)
Interest income ......................................... 1,424 1,662 -- 3,086
Equity in losses of affiliates .......................... (1,746) -- -- (1,746)
Other income ............................................ 28 -- -- 28
-------------- -------------- -------------- --------------
Total other income (expense) ......................... (2,897) 1,662 -- (1,235)
-------------- -------------- -------------- --------------
Loss from continuing operations before income taxes and
minority interests ...................................... (15,503) (22,895) -- (38,398)
(Provision) benefit for income taxes ....................... (6) 79 -- 73
-------------- -------------- -------------- --------------
Loss from continuing operations before minority interests .. (15,509) (22,816) -- (38,325)
Minority interests ......................................... 866 8,300 -- 9,166
-------------- -------------- -------------- --------------
Loss from continuing operations ............................ (14,643) (14,516) -- (29,159)
Discontinued operations:
Loss from discontinued operations of Soundbreak.com ..... (7,443) -- -- (7,443)
Estimated loss on disposal of Soundbreak.com ............ (2,111) -- -- (2,111)
-------------- -------------- -------------- --------------
Loss before cumulative effect of change in accounting
principle ............................................... (24,197) (14,516) -- (38,713)
Cumulative effect of change in accounting principle due
to beneficial conversion feature of debt ................ -- (246) -- (246)
-------------- -------------- -------------- --------------
Net loss ................................................... $ (24,197) $ (14,762) $ -- $ (38,959)
============== ============== ============== ==============
F-49
CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2000 (IN THOUSANDS)
ACACIA
TECHNOLOGIES COMBIMATRIX
GROUP GROUP ELIMINATIONS CONSOLIDATED
-------------- -------------- ------------ --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations .................................. $ (14,643) $ (14,516) $ -- $ (29,159)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ................................. 1,751 906 -- 2,657
Equity in losses of affiliates ................................ 1,746 -- -- 1,746
Minority interests ............................................ (866) (8,300) -- (9,166)
Compensation expense relating to stock options and warrants.... 709 9,995 -- 10,704
Charge for acquired in-process research and development ....... -- 2,508 -- 2,508
Deferred tax benefit .......................................... (2) (79) -- (81)
Write-off of other assets ..................................... 2,603 -- -- 2,603
Other ......................................................... 398 (105) -- 293
Changes in assets and liabilities, net of effects of acquisitions:
Prepaid expenses, other receivables and other assets .......... (1,053) (989) 13 (2,029)
Accounts payable, accrued expenses and other .................. 162 1,891 (13) 2,040
-------------- -------------- ------------ --------------
Net cash used in operating activities of continuing
operations ................................................. (9,195) (8,689) -- (17,884)
Net cash used in operating activities of discontinued
operations ................................................. (16,600) -- -- (16,600)
-------------- -------------- ------------ --------------
Net cash used in operating activities ......................... (25,795) (8,689) -- (34,484)
-------------- -------------- ------------ --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contribution to equity investments .................... 1,000 -- -- 1,000
Purchase of additional equity in consolidated subsidiaries .... (970) -- -- (970)
Purchase of property and equipment ............................ (472) (2,004) -- (2,476)
Sale of available-for-sale investments ........................ -- 3,975 -- 3,975
Purchase of available-for-sale investments .................... -- (44,606) -- (44,606)
Other ......................................................... (54) -- -- (54)
-------------- -------------- ------------ --------------
Net cash used in investing activities of continuing
operations ................................................. (496) (42,635) -- (43,131)
Net cash used in investing activities of discontinued
operations ................................................. (1,173) -- -- (1,173)
-------------- -------------- ------------ --------------
Net cash used in investing activities ......................... (1,669) (42,635) -- (44,304)
-------------- -------------- ------------ --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash attributed to the Acacia Technologies group .......... 20,897 -- -- 20,897
Net cash attributed to the CombiMatrix group .................. -- 56,423 -- 56,423
-------------- -------------- ------------ --------------
Net cash provided by financing activities ..................... 20,897 56,423 -- 77,320
-------------- -------------- ------------ --------------
(Decrease) Increase in cash and cash equivalents .............. (6,567) 5,099 -- (1,468)
Cash and cash equivalents, beginning .......................... 36,172 1,459 -- 37,631
Effect of exchange rate on cash ............................... -- -- -- --
-------------- -------------- ------------ --------------
Cash and cash equivalents, ending ............................. $ 29,605 $ 6,558 $ -- $ 36,163
============== ============== ============ ==============
F-50
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth unaudited consolidated statement of
operations data for the eight quarters in the period ended December 31, 2002.
This information has been derived from our unaudited condensed consolidated
financial statements that have been prepared on the same basis as the audited
consolidated financial statements and, in the opinion of management, include all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the information when read in conjunction with the audited
consolidated financial statements and related notes thereto. Our quarterly
results have been in the past and may in the future be subject to significant
fluctuations. As a result, we believe that results of operations for interim
periods should not be relied upon as any indication of the results to be
expected in any future periods.
F-51
QUARTER ENDED
MAR. 31, JUN. 30, SEP. 30, DEC. 31, MAR. 31, JUN. 30, SEP. 30, DEC. 31,
2002 2002 2002 2002 2001 2001 2001 2001
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE INFORMATION)
Revenues:
License fee
income .......... $ -- $ -- $ 43 $ -- $ 2,440 $ 10,000 $ 10,740 $ 1,000
Product
revenue ......... -- 274 23 9 -- -- -- --
Grant
revenue ......... 249 164 113 7 183 91 91 91
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Total revenues ...... 249 438 179 16 2,623 10,091 10,831 1,091
Operating
expenses .......... 8,694 13,473 32,219 26,820 18,424 20,028 18,527 10,855
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Operating loss ...... (8,445) (13,035) (32,040) (26,804) (15,801) (9,937) (7,696) (9,764)
Other (expenses)
income ............ (486) (845) (2,749) 968 1,144 1,031 796 1,195
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Loss from continuing
operations before
income taxes and
minority interests. (8,931) (13,880) (34,789) (25,836) (14,657) (8,906) (6,900) (8,569)
Benefit (provision)
for income taxes .. 69 75 287 426 (13) (228) (778) 239
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Loss from continuing
operations before
minority interests. (8,862) (13,805) (34,502) (25,410) (14,670) (9,134) (7,678) (8,330)
Minority interests .. 2,435 4,104 14,080 3,187 5,191 4,362 4,851 3,136
------------- ------------- ------------- ------------- ------------- ------------- ------------- -----------
Loss from
continuing
operations ........ (6,427) (9,701) (20,422) (22,223) (9,479) (4,772) (2,827) (5,194)
Loss from
discontinued
operations ........ -- -- (200) -- -- -- -- --
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Net loss ............ $ (6,427) $ (9,701) $ (20,622) $ (22,223) $ (9,479) $ (4,772) $ (2,827) $ (5,194)
============= ============= ============= ============= ============= ============= ============= ============
Loss per common share
basic and diluted:
Attributable to the
Acacia Technologies
group:
Loss from
continuing
operations .... $ (0.14) $ (0.19) $ (0.26) $ (0.04) $ -- $ -- $ -- $ --
Loss from
discontinued
operations .... $ -- $ -- $ (0.01) $ -- $ -- $ -- $ -- $ --
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Net loss ............ $ (0.14) $ (0.19) $ (0.27) $ (0.04) $ -- $ -- $ -- $ --
============= ============= ============= ============= ============= ============= ============= ============
Attributable to the
CombiMatrix group:
Loss from
continuing
operations .... $ (0.16) $ (0.26) $ (0.67) $ (0.93) $ -- $ -- $ -- $ --
Loss from
discontinued
operations .... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Net loss ............ $ (0.16) $ (0.26) $ (0.67) $ (0.93) $ -- $ -- $ -- $ --
============= ============= ============= ============= ============= ============= ============= ============
Acacia Research
Corporation:
Loss from
continuing
operations .... $ -- $ -- $ -- $ -- $ (0.50) $ (0.25) $ (0.15) $ (0.27)
Loss from
discontinued
operations .... $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ --
------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------
Net loss ............ $ -- $ -- $ -- $ -- $ (0.50) $ (0.25) $ (0.15) $ (0.27)
============= ============= ============= ============= ============= ============= ============= ============
Weighted average
shares - basic
and diluted:
Acacia Research
- Acacia
Technologies
stock ............. 19,640,808 19,640,808 19,640,808 19,640,808 -- -- -- --
Acacia Research
- CombiMatrix
stock ............. 22,950,551 22,950,551 22,950,551 22,951,324 -- -- -- --
Acacia Research
Corporation ...... -- -- -- -- 18,985,864 19,503,645 19,525,807 19,558,572
Market price
per share -
Acacia Research
Corporation
(through
December 13,
2002):
High ............ $ 13.26 $ 11.50 $ 7.15 $ 5.61 $ 18.98 $ 16.14 $ 16.66 $ 13.42
Low ............. $ 8.47 $ 5.90 $ 3.50 $ 3.65 $ 5.23 $ 4.69 $ 5.83 $ 8.29
Market price
per share -
Acacia
Technologies
stock:
High ............ $ -- $ -- $ -- $ 3.40 $ -- $ -- $ -- $ --
Low ............. $ -- $ -- $ -- $ 1.65 $ -- $ -- $ -- $ --
Market price
per share -
CombiMatrix
stock:
High ............ $ -- $ -- $ -- $ 4.98 $ -- $ -- $ -- $ --
Low ............. $ -- $ -- $ -- $ 2.70 $ -- $ -- $ -- $ --
F-52
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the financial statements listed in the index appearing
under Item 15(a)(1) on page 83 present fairly, in all material respects, the
financial position of Acacia Technologies Group (a division of Acacia Research
Corporation as described in Note 1) at December 31, 2002 and December 31, 2001,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of Acacia Research Corporation's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As more fully described in Note 1 to the financial statements, Acacia
Technologies Group is a division of Acacia Research Corporation; accordingly,
the financial statements of Acacia Technologies group should be read in
conjunction with the consolidated financial statements of Acacia Research
Corporation.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 26, 2003
F-53
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
AT DECEMBER 31,
-----------------------
2002 2001
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ............................ $ 39,792 $ 46,859
Short-term investments ............................... -- 4,372
Prepaid expenses, other receivables and other assets.. 775 800
---------- ----------
Total current assets ............................ 40,567 52,031
Property and equipment, net of accumulated depreciation ... 180 358
Receivable from CombiMatrix group ......................... 114 30
Investment in affiliate, at cost .......................... 252 3,000
Patents, net of accumulated amortization .................. 4,068 5,554
Goodwill, net of accumulated amortization ................. 1,834 1,776
Other assets .............................................. 197 177
---------- ----------
$ 47,212 $ 62,926
========== ==========
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other ......... $ 2,524 $ 2,925
Deferred revenues .................................... 1,503 1,500
---------- ----------
Total current liabilities ....................... 4,027 4,425
Deferred income taxes ..................................... 1,156 1,298
---------- ----------
Total liabilities ............................... 5,183 5,723
---------- ----------
Commitments and contingencies (Note 8)
Minority interests ........................................ 1,487 2,194
---------- ----------
Allocated net worth:
Funds allocated by Acacia Research Corporation ....... 105,557 107,270
Accumulated net losses ............................... (65,015) (52,261)
---------- ----------
Total allocated net worth ....................... 40,542 55,009
---------- ----------
$ 47,212 $ 62,926
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-54
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
Revenues:
License fee income ....................................... $ 43 $ 24,180 $ --
Other income ............................................. -- -- 40
--------- --------- ---------
Total revenues ...................................... 43 24,180 40
--------- --------- ---------
Operating expenses:
Research and development expenses ........................ -- -- 52
Marketing, general and administrative expenses ........... 6,883 4,853 9,186
Non-cash stock compensation - marketing, general and
administrative ...................................... 19 856 709
Legal expenses - patents ................................. 1,415 11,121 72
Amortization of patents and goodwill ..................... 1,591 1,492 1,611
Loss on disposal of subsidiaries ......................... -- -- 1,016
--------- --------- ---------
Total operating expenses ............................ 9,908 18,322 12,646
--------- --------- ---------
Operating (loss) income ....................................... (9,865) 5,858 (12,606)
--------- --------- ---------
Other (expense) income:
Write-off of equity investments .......................... -- -- (2,603)
Impairment of cost method investment ..................... (2,748) -- --
Interest income .......................................... 620 1,642 1,424
Realized (losses) gains on short-term investments ........ (1,184) 350 --
Unrealized (losses) gains on short-term investments ...... (249) 237 --
Interest expense ......................................... (6) -- --
Equity in losses of affiliate ............................ -- (195) (1,746)
Other income ............................................. 64 77 28
--------- --------- ---------
Total other (expenses) income ....................... (3,503) 2,111 (2,897)
--------- --------- ---------
(Loss) income from continuing operations before
income taxes and minority interests ...................... (13,368) 7,969 (15,503)
Benefit (provision) for income taxes .......................... 710 (935) (6)
--------- --------- ---------
(Loss) income from continuing operations before
minority interests ....................................... (12,658) 7,034 (15,509)
Minority interests ............................................ 104 (1,277) 866
--------- --------- ---------
(Loss) income from continuing operations....................... (12,554) 5,757 (14,643)
Discontinued operations
Loss from discontinued operations of Soundbreak.com ...... -- -- (7,443)
Estimated loss on disposal of Soundbreak.com ............. (200) -- (2,111)
--------- --------- ---------
Division net (loss) income .................................... $(12,754) $ 5,757 $(24,197)
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-55
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF ALLOCATED NET WORTH
(IN THOUSANDS)
Balance at December 31, 1999..................................... $ 44,492
Net assets attributed to the Acacia Technologies group........... 9,680
Division net loss................................................ (24,197)
------------
Balance at December 31, 2000..................................... 29,975
Net assets attributed to the Acacia Technologies group........... 19,277
Division net income.............................................. 5,757
------------
Balance at December 31, 2001..................................... 55,009
Net assets attributed to the Acacia Technologies group........... (1,713)
Division net loss................................................ (12,754)
------------
Balance at December 31, 2002..................................... $ 40,542
============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-56
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Division net (loss) income from continuing operations: .................... $(12,554) $ 5,757 $(14,643)
Adjustments to reconcile division net (loss) income from
continuing operations to net cash (used in) provided
by operating activities:
Depreciation and amortization ........................................ 1,797 1,710 1,751
Equity in losses of affiliate ........................................ -- 195 1,746
Minority interests ................................................... (104) 1,277 (866)
Non-cash stock compensation .......................................... 19 856 709
Deferred tax benefit ................................................. (142) (27) (2)
Write-off of other assets ............................................ -- -- 2,603
Net sales (purchases) of trading securities .......................... 4,124 (4,135) --
Unrealized losses (gains) on short-term investments .................. 249 (237) --
Impairment of cost method investment ................................. 2,748 -- --
Other ................................................................ (30) 40 398
Changes in assets and liabilities:
Prepaid expenses, other receivables and other assets ................. (1) (455) (1,040)
Accounts payable, accrued expenses and other ......................... 372 310 149
Deferred revenues .................................................... 3 1,500 --
--------- --------- ---------
Net cash (used in) provided by operating activities from
continuing operations .............................................. (3,519) 6,791 (9,195)
Net cash used in operating activities from discontinued operations ... (905) (2,182) (16,600)
--------- --------- ---------
Net cash (used in) provided by operating activities .................. (4,424) 4,609 (25,795)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to equity investments .......................... -- -- 1,000
Purchase of additional equity in consolidated subsidiaries ........... (200) (3,304) (970)
Purchase of property and equipment ................................... (78) (19) (472)
Proceeds from sale of property and equipment ......................... 3 -- --
Purchase of available-for-sale investments ........................... -- (25,921) --
Sale of available-for-sale investments ............................... -- 25,921 --
Purchase of common stock from minority stockholders of subsidiaries .. (217) (2,550) --
Other ................................................................ (100) -- (54)
--------- --------- ---------
Net cash used in investing activities from continuing operations ..... (592) (5,873) (496)
Net cash used in investing activities from discontinued operations ... (3) (145) (1,173)
--------- --------- ---------
Net cash used in investing activities ................................ (595) (6,018) (1,669)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash flows attributed to the Acacia Technologies group ........... (2,048) 18,663 20,897
--------- --------- ---------
(Decrease) increase in cash and cash equivalents .......................... (7,067) 17,254 (6,567)
--------- --------- ---------
Cash and cash equivalents, beginning ...................................... 46,859 29,605 36,172
--------- --------- ---------
Cash and cash equivalents, ending ......................................... $ 39,792 $ 46,859 $ 29,605
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-57
ACACIA TECHNOLOGIES GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation's continuing operations are comprised of
two separate divisions: the Acacia Technologies group and the CombiMatrix group
( the "groups").
The Acacia Technologies group, a division of Acacia Research
Corporation, is primarily comprised of Acacia Research Corporation's interests
in two wholly owned media technologies subsidiaries: (1) Acacia Media
Technologies Corporation, ("Acacia Media Technologies") a Delaware corporation
and (2) Soundview Technologies, Inc., ("Soundview Technologies") a Delaware
corporation, and also includes all corporate assets, liabilities, and related
transactions of Acacia Research Corporation attributed to the Acacia
Technologies group.
The Acacia Technologies group owns patented digital media transmission,
or DMT, technology enabling the digitization, encryption, storage, transmission,
receipt and playback of digital content. The DMT technology is protected by five
U.S. and seventeen international patents. The DMT technology is utilized by a
variety of companies, including cable companies, hotel in-room entertainment
companies, Internet movie companies, Internet music companies, on-line adult
entertainment companies, on-line learning companies and other companies that
stream audio or audio/videos content. The Acacia Technologies group also owns
patented technology known as the V-chip. The V-chip was adopted by the
manufacturers of televisions sold in the U.S. to provide blocking of certain
programming based upon its content rating code, in compliance with the
Telecommunications Act of 1996. The V-chip technology is protected by U.S.
Patent No. 4,554,584, which expires in July 2003.
LIQUIDITY AND RISKS
The Acacia Technologies group's business operations are subject to
certain risks and uncertainties, including:
o market acceptance of products and services;
o technological advances that may make our products and services obsolete
or less competitive;
o increases in operating costs, including costs for supplies, personnel
and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiary companies'
businesses.
Acacia Research Corporation has generated substantially all of its
revenues from licensing the Acacia Technologies group's patented V-chip
technology to television manufacturers. The V-chip patent expires in July 2003.
The Acacia Technologies group will not be able to collect royalties for
televisions containing V-chip technology sold after the expiration of that
patent, but it may still collect revenues from the sale of such televisions in
the U.S. before the expiration date. The Acacia Technologies group is beginning
to market and commercially license its DMT technology and is currently
developing additional technologies. However, there can be no assurance that the
Acacia Technologies group will be able to implement its future plans. Failure by
management to achieve its plans would have a material adverse effect on the
Acacia Technologies group and on Acacia Research Corporation's ability to
achieve its intended business objectives. The Acacia Technologies group's
success also depends on its ability to protect its intellectual property.
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction whereby Acacia Research Corporation
created two new classes of common stock called "Acacia Research-CombiMatrix
stock" ("AR-CombiMatrix stock"), and "Acacia Research-Acacia Technologies stock"
F-58
("AR-Acacia Technologies stock"), and divided Acacia Research Corporation's
existing Acacia Research Corporation common stock into shares of the two new
classes of common stock. AR-CombiMatrix stock is intended to reflect separately
the performance of Acacia Research Corporation's CombiMatrix group, and to
benefit from its research and development efforts. AR-Acacia Technologies stock
is intended to reflect separately the performance of Acacia Research
Corporation's Acacia Technologies group and to benefit from the licensing of its
technologies. In the recapitalization, which became effective on December 13,
2002, Acacia Research Corporation stockholders received 0.5582 of a share of
AR-CombiMatrix stock, and one share of AR-Acacia Technologies stock, for each
share of common stock that they owned. Although the AR-CombiMatrix stock and the
AR-Acacia Technologies stock are intended to reflect the performance of Acacia
Research Corporation's different business groups, they are both classes of
common stock of Acacia Research Corporation and are not stock issued by the
respective groups. The AR-Acacia Technologies stock is listed on the Nasdaq
National Market System, and the AR-CombiMatrix stock is listed on the Nasdaq
SmallCap Market.
On December 11, 2002, Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which Acacia Research Corporation acquired the stockholder interests
in CombiMatrix Corporation not already owned by Acacia Research Corporation (52%
of the total stockholder interests in CombiMatrix Corporation). The acquisition
was accomplished through a merger, effective December 13, 2002, in which
stockholders of CombiMatrix Corporation other than Acacia Research Corporation
received one share of the new AR-CombiMatrix stock in exchange for each share of
CombiMatrix Corporation common stock that they owned immediately prior to the
merger.
On December 11, 2002, the stockholders of Acacia Research Corporation
also approved the adoption of two new stock incentive plans for the two business
groups.
GENERAL
In January 2001, Acacia Research Corporation completed an institutional
private equity financing raising gross proceeds of $19.0 million ($17.9 million,
net of issuance costs) through the issuance of 1,107,274 units. Proceeds from
this equity financing were attributed to the Acacia Technologies group.
In the third quarter of 2000, Acacia Research Corporation completed a
private offering of 861,638 units at $27.50 per unit for gross proceeds of
approximately $23.7 million ($22.0 million, net of issuance costs). Proceeds
from this equity financing were attributed to the Acacia Technologies group.
In the fourth quarter of 1999, Acacia Research Corporation completed an
institutional private equity financing raising gross proceeds of $21.0 million
($19.1 million, net of issuance costs) through the issuance of 974,771 units,
consisting of one share of Acacia Research Corporation's common stock and
one-half of a common stock purchase warrant. During the first quarter of 2000,
Acacia Research Corporation issued a 30-day redemption notice for these
warrants. As a result, all of these warrants were exercised prior to the
redemption date with Acacia Research Corporation receiving proceeds of
approximately $14.8 million. Proceeds from this equity financing were attributed
to the Acacia Technologies group.
Acacia Research Corporation's cash and the cash held by its media
technology businesses, including all cash raised through Acacia Research
Corporation's previous offerings has been attributed to the Acacia Technologies
group as these funds are intended to support the media technology businesses of
Acacia Research Corporation.
ACACIA MEDIA TECHNOLOGIES
In July 2002, Acacia Media Technologies was granted a patent for its
digital media transmission technology in Japan. The patent provides coverage
through January 2, 2012.
In November 2001, Acacia Research Corporation increased its ownership
interest in Acacia Media Technologies Corporation ("Acacia Media Technologies"),
formerly Greenwich Information Technologies LLC ("Greenwich"), from 33% to 100%
through the purchase of the ownership interest of the former limited liability
company's other member. In December 2001, Acacia Research Corporation converted
Greenwich from a limited liability company to a corporation and changed its name
F-59
to Acacia Media Technologies. The ownership interest purchase has been accounted
for under the purchase method of accounting. The excess purchase price was
allocated to Acacia Media Technologies' patent portfolio and is being amortized
over the remaining economic life of the respective patents, which is
approximately 10 years. The results of operations have been included in the
statement of operations from the date of acquisition. Pro forma results of
operations have not been presented because the effects of these acquisitions
were not material on either an individual or aggregate basis.
SOUNDVIEW TECHNOLOGIES
In July 2002, Soundview Technologies executed a license agreement with
Loewe Opta GmbH, whereby Soundview Technologies received a one-time license fee
payment of $43,000 and granted a non-exclusive license of its patented V-chip
technology to Loewe Opta GmbH, a manufacturer of televisions sold under the
Loewe brand name.
In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending patent infringement and antitrust lawsuit against
Sony Corporation of America, Philips Electronics North America Corporation, the
Consumer Electronics Manufacturers Association and the Electronics Industries
Alliance d/b/a Consumer Electronics Association in the United States District
Court for the Eastern District of Virginia (filed on April 5, 2000), alleging
that television sets utilizing certain content blocking technology (commonly
known as the "V-chip") and sold in the United States infringe Soundview
Technologies' U.S. Patent No. 4,554,584. In granting the motion, the court ruled
that the defendants have not infringed on Soundview Technologies' patent. See
Note 8 for additional information related to the motion granted.
In June 2001, Acacia Research Corporation's ownership interest in
Soundview Technologies, Incorporated ("Soundview Technologies") increased from
67% to 100%, following Soundview Technologies' completion of a stock repurchase
transaction with its former minority stockholders. Soundview Technologies
repurchased the stock of its former minority stockholders in exchange for a cash
payment and the grant to such stockholders of the right to receive 26% of future
net revenues generated by Soundview Technologies' current patent portfolio,
which includes its V-chip patent. As of December 31, 2002, total consideration
paid combined with amounts accrued pursuant to the stock repurchase agreements
totaled $2,825,000. The increase in Acacia Research Corporation's interest in
Soundview Technologies from 67% to 100% was accounted for as a step acquisition
in accordance with the purchase method of accounting. Accordingly, the purchase
price paid to date was allocated to the fair value of assets acquired and
liabilities assumed. The excess of the purchase price paid over the fair market
value of the net assets acquired of $1,543,000 was assigned to goodwill.
Contingent purchase consideration is accounted for as an additional cost of the
acquired enterprise.
During 2001, Soundview Technologies executed separate settlement and/or
license agreements with Samsung Electronics, Hitachi America, Ltd., LG
Electronics, Inc., Funai Electric Co. Ltd., Daewoo Electronics Corporation of
America, Sanyo Manufacturing Corporation, Thomson Multimedia, Inc., JVC Americas
Corporation, Matsushita Electric Industrial Co., Ltd. and Orion Electric Co.,
Ltd. In addition, Soundview Technologies settled its lawsuits with Pioneer
F-60
Electronics (USA) Incorporated, an affiliate of Pioneer Corporation, and
received payments from Philips Electronics pursuant to a settlement and license
agreement signed in December 2000. Certain of these license agreements
constitute settlements of patent infringement litigation brought by Soundview
Technologies. As of December 31, 2002, the Acacia Technologies group has
received and recognized as revenue, one-time license fee payments totaling
$25,673,000 from the settlement and license agreements and have granted
non-exclusive, retroactive and future licenses of Soundview Technologies' U.S.
Patent No. 4,554,584 to the respective television manufacturers. Certain of the
settlement and license agreements provide for future royalty payments to
Soundview Technologies. License fee payments received during 2001 totaling
$1,500,000 are included in deferred revenues pursuant to the terms of the
respective agreements.
OTHER
The Acacia Technologies group includes the assets and liabilities of
Soundbreak.com, a 66.9% held subsidiary of Acacia Research Corporation, which
ceased operations as of February 15, 2001. Accordingly, the Acacia Technologies
group has reported the results of operations and the estimated loss on disposal
of Soundbreak.com as results of discontinued operations in the 2002 and 2000
statements of operations (see Note 7).
The Acacia Technologies group conducted a portion of its investing
activity through a limited partnership, of which a wholly owned subsidiary of
Acacia Research Corporation is the general partner. The limited partnership
ceased trading activity in May 2002. As a result of the significant control that
Acacia Research Corporation exercised over the limited partnership, the assets
and liabilities and results of operations have been consolidated by Acacia
Research Corporation during 2002 and 2001. As of December 31, 2002, the limited
partnership had distributed all limited partner capital account balances and as
a result has no net assets as of December 31, 2002. Prior to cessation of
operations, the net assets, liabilities and results of operations of the limited
partnership, which included certain health sciences securities, have been
attributed to the Acacia Technologies group.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. AR-Acacia Technologies stock is intended to
reflect the separate performance of the respective division of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock are stockholders of Acacia Research
Corporation. As a result, holders of AR-Acacia Technologies stock are subject to
all of the risks of an investment in Acacia Research Corporation and all of its
businesses, assets and liabilities. The assets Acacia Research Corporation
attributes to Acacia Technologies could be subject to the liabilities of the
CombiMatrix group.
The Acacia Technologies group financial statements have been prepared
in accordance with generally accepted accounting principles in the United States
of America, and taken together with the CombiMatrix group financial statements,
comprise all the accounts included in the corresponding consolidated financial
statements of Acacia Research Corporation. The financial statements of Acacia
Technologies group reflect the financial condition, results of operations, and
cash flows of the businesses included therein. The financial statements of the
Acacia Technologies group include the accounts or assets of Acacia Research
Corporation specifically attributed to the Acacia Technologies group and were
prepared using amounts included in Acacia Research Corporation's consolidated
financial statements.
Minority interests represents participation of other stockholders in
the allocated net assets and in the division earnings and losses of the Acacia
Technologies group and is reflected in the caption "Minority interests" in the
Acacia Technologies group financial statements. Minority interests adjust the
Acacia Technologies group's share of the division's earnings or loss of
non-wholly owned subsidiaries of Acacia Research Corporation that have been
attributed to the Acacia Technologies group.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.
F-61
MANAGEMENT ALLOCATION POLICIES. The management and allocation policies
applicable to the preparation of the financial statements of the CombiMatrix
group and the Acacia Technologies group may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation Board at any time without approval of the stockholders. The
Acacia Technologies group financial statements reflect the application of the
management and allocation policies adopted by the Acacia Research Corporation
Board to various corporate activities, as described below. Management has no
plans to change allocation methods or the composition of the groups. The Acacia
Technologies group financial statements should be read in conjunction with the
Acacia Research Corporation consolidated financial statements and related notes.
TREASURY AND CASH MANAGEMENT POLICIES. Cash and short-term investments
were allocated to the groups based on the respective cash and short term
investments balances of the entities comprising each group. Corporate cash
balances have been attributed to the Acacia Technologies group. All cash raised
by CombiMatrix Corporation and Advanced Material Sciences has been allocated to
the CombiMatrix group. Acacia Research Corporation manages most treasury and
cash management activities on a de-centralized basis, with each separate group
separately managing its own treasury activities. Pursuant to treasury and cash
management policies adopted by the Acacia Research Corporation Board, the
following applies:
o Acacia Research Corporation will attribute each future issuance of
AR-Acacia Technologies stock (and the proceeds thereof) to the Acacia
Technologies group and will attribute each future issuance of
AR-CombiMatrix stock (and the proceeds thereof) to the CombiMatrix
group;
o Acacia Research Corporation will attribute each future incurrence or
issuance of external debt or preferred stock (and the proceeds
thereof), if any, between the Acacia Research Corporation or entirely
to one group as determined by the Acacia Research Corporation Board,
based on the extent to which Acacia Research Corporation incurs or
issues the debt or preferred stock for the benefit of the CombiMatrix
group or the Acacia Technologies group;
o Dividends, if any, on AR-Acacia Technologies stock will be charged
against the Acacia Technologies group, and dividends, if any, on
AR-CombiMatrix stock will be charged against the CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged against the
Acacia Technologies group and repurchases of AR-CombiMatrix stock will
be charged against the CombiMatrix group;
o Acacia Research Corporation will account for any cash transfers from
Acacia Research Corporation to or for the account of a group, from a
group to or for the account of Acacia Research Corporation, or from one
group to or for the account of the other group (other than transfers in
return for assets or services rendered) as short-term loans unless (A)
the Acacia Research Corporation Board determines that a given transfer
(or type of transfer) should be accounted for as a long-term loan, (B)
the Acacia Research Corporation Board determines that a given transfer
(or type of transfer) should be accounted for as a capital contribution
or (iii) the Acacia Research Corporation Board determines that a given
transfer (or type of transfer) should be accounted for as a return of
capital. There are no specific criteria to determine when Acacia
Research Corporation will account for a cash transfer as a long-term
loan, a capital contribution or a return of capital rather than an
inter-group revolving credit advance; provided, however, that cash
advances from Acacia Research Corporation to the Acacia Technologies
group or to the CombiMatrix group up to $25.0 million on a cumulative
basis shall be accounted for as short-term or long-term loans at
interest rates at which Acacia Research Corporation could borrow such
funds and shall not be accounted for as a capital contribution. The
Acacia Research Corporation Board will make such a determination in the
exercise of its business judgment at the time of such transfer based
upon all relevant circumstances. Factors the Acacia Research
Corporation Board may consider include, without limitation, the current
and projected capital structure of each group; the financing needs and
objectives of the recipient group; the availability, cost and time
associated with alternative financing sources; and prevailing interest
rates and general economic conditions; and
o Any cash transfers accounted for as short-term loans will bear interest
at the rate at which Acacia Research Corporation could borrow such
F-62
funds. In addition, any cash transfers accounted for as a long-term
loan will have interest rates, amortization, maturity, redemption and
other terms that reflect the then-prevailing terms on which Acacia
Research Corporation could borrow such funds.
ASSETS AND LIABILITIES. Acacia Research Corporation's assets and
liabilities have been attributed to the Acacia Technologies group and the
CombiMatrix group based on the respective asset and liabilities balances of the
entities comprising each group. Intangible assets recorded at the Acacia
Research Corporation level, primarily consisting of acquired patents and
goodwill balances, have been attributed to the respective groups to which the
intangibles and goodwill relate.
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES. Acacia
Research Corporation allocates the cost of corporate general and administrative
services and facilities between the groups generally based upon utilization.
Where determinations based on utilization alone are impracticable, Acacia
Research Corporation utilizes other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials.
Except as may otherwise be specifically provided pursuant to the terms
of any agreements among Acacia Research Corporation and the groups or any
resolutions of the Acacia Research Corporation Board, the corporate general and
administrative services and facilities to be allocated between the groups
include, without limitation, legal services, accounting services (tax and
financial), insurance and deductibles payable in connection therewith, employee
benefit plans and administration thereof, investor relations, stockholder
services, and services relating to the Acacia Research Corporation Board.
Direct salaries, payroll taxes and fringe benefits are allocated to the
groups based on the percentage of actual time incurred by specific employees to
total annual time available and direct costs including, postage, insurance,
legal fees, accounting and tax and other are allocated to the groups based on
specific identification of costs incurred on behalf of each group. Other direct
costs, including direct depreciation expense, computer costs, general office
supplies and rent are allocated to the groups based on the ratio of direct
salaries to total salaries. Indirect costs, including indirect salaries and
benefits, investor relations, rent, general office supplies and indirect
depreciation are allocated to the groups based on the ratio of direct salaries
for each group to total direct salaries. Included in the marketing, general and
administrative expenses of the Acacia Technologies group are allocated corporate
charges of $4,906,000, $4,591,000 and $7,692,000 relating to the periods ending
December 31, 2002, 2001 and 2000, respectively.
Management believes that the methods and criteria used to allocate
costs are equitable and provide a reasonable approximation of the cost
attributable to the groups. Based on the allocation methods used, the Acacia
Research Corporation believes that the allocation of expenses as presented in
the accompanying financial statements for the groups reflects a reasonable
estimation of expenses that would be recognized if the groups were separate
stand alone registrants.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES. Acacia Research
Corporation determines its federal income taxes and the federal income taxes of
its subsidiaries that own assets allocated between the groups on a consolidated
basis. Acacia Research Corporation allocates consolidated federal income tax
provisions and related tax payments or refunds between the Acacia Technologies
group and the CombiMatrix group based principally on the taxable income and tax
credits directly attributable to each group. Such allocations reflect each
group's contribution, whether positive or negative, to Acacia Research
Corporation's consolidated federal taxable income and consolidated federal tax
liability and tax credit position. Acacia Research Corporation will credit tax
benefits that cannot be used by the group generating those benefits but can be
used on a consolidated tax return basis to the group that generated such
benefits. Inter-group transactions will be treated as taxed as if each group was
a stand-alone company.
F-63
Depending on the tax laws of the respective jurisdictions, state and
local income taxes are calculated on either a consolidated or combined basis
between the groups based on their respective contribution to such consolidated
or combined state taxable incomes. State and local income tax provisions and
related tax payments or refunds which are determined on a separate corporation
basis will be allocated between the groups in a manner designed to reflect the
respective contributions of the groups to Acacia Research Corporation's separate
or local taxable income.
REVENUE RECOGNITION. The Acacia Technologies group recognizes revenue
in accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101") and related authoritative pronouncements.
License fee income is recognized as revenue when (i) persuasive evidence of an
arrangement exists, (ii) all obligations have been performed pursuant to the
terms of the license agreement, (iii) amounts are fixed or determinable and (iv)
collectibility of amounts is reasonably assured.
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. At December
31, 2002 and 2001, the Acacia Technologies group balance sheets include
$1,503,000 and $1,500,000, respectively, as deferred revenues related to
payments received in advance of the culmination of the earnings process, which
will be recognized as revenue in future periods when the applicable revenue
recognition criteria as described above are met. Direct costs related to the
deferred revenues totaling $668,000 have been deferred at December 31, 2002 and
2001 and will be charged to income when the related revenues are recognized.
CASH AND CASH EQUIVALENTS. The Acacia Technologies group considers all
highly liquid, short-term investments with original maturities of three months
or less when purchased to be cash equivalents.
SHORT-TERM INVESTMENTS. The Acacia Technologies group's short-term
investments are held in a variety of interest bearing instruments including
high-grade corporate bonds, commercial paper, money market accounts and other
high-credit quality marketable securities. Investments in securities with
original maturities of greater than three months and less than one year are
classified as short-term investments. Investments are classified into categories
in accordance with the provisions of Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
("SFAS No. 115"). At December 31, 2001, certain of the Acacia Technologies
group's investments are classified as trading securities, which are reported at
fair value. Realized and unrealized gains and losses in the value of trading
securities are included in division net income (loss) in the statements of
operations. At December 31, 2002, there were no investments classified as
trading securities. At December 31, 2001, short-term investments consist of
trading securities with a fair value of $4,372,000.
The fair value of the Acacia Technologies group's investments is
primarily determined by quoted market prices. Realized and unrealized gains and
losses are recorded based on the specific identification method. For investments
classified as available-for-sale, unrealized losses that are other than
temporary are recognized in division net income (loss).
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. The Acacia Technologies group' has not experienced any
losses on its deposits of cash and cash equivalents.
PROPERTY AND EQUIPMENT. Property and equipment are recorded at cost.
Major additions and improvements that materially extend useful lives of property
and equipment are capitalized. Maintenance and repairs are charged against the
results of operations as incurred. When these assets are sold or otherwise
disposed of, the asset and related depreciation are relieved, and any gain or
loss is included in the statement of operations for the period of sale or
disposal. Depreciation is computed on a straight-line basis over the following
estimated useful lives of the assets:
Furniture and fixtures.................. 3 to 5 years
Computer hardware and software.......... 3 to 5 years
Leasehold improvements.................. Lesser of lease term or
useful life of improvement
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
F-64
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued, and
goodwill (pursuant to SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002, goodwill is no longer amortized, see "Recent
Accounting Pronouncements") are amortized on the straight-line method over their
economic remaining useful lives, ranging from three to twenty years.
IMPAIRMENT OF LONG-LIVED ASSETS. Long-lived assets and intangible
assets are reviewed for potential impairment when events or changes in
circumstances indicate the carrying amount of an asset may not be recoverable.
In the event the sum of the expected undiscounted future cash flows resulting
from the use of the asset is less than the carrying amount of the asset, an
impairment loss equal to the excess of the asset's carrying value over its fair
value is recorded. If an asset is determined to be impaired, the loss is
measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, other receivables, accounts payable and accrued expenses
approximate fair value due to their short-term maturity.
STOCK-BASED COMPENSATION. Compensation cost of stock options issued to
employees is accounted for in accordance with Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No.
25") and related interpretations. Compensation cost attributable to such options
is recognized based on the difference, if any, between the closing market price
of the stock on the date of grant and the exercise price of the option.
Compensation cost is deferred and amortized on an accelerated basis over the
vesting period of the individual option awards using the amortization method
prescribed in Financial Accounting Standards Board ("FASB") Interpretation No.
28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans" ("FIN No. 28"). Compensation cost of stock options and warrants
issued to non-employee service providers is accounted for under the fair value
method required by SFAS No. 123 and related interpretations. In 2001 and earlier
periods, stock compensation expense recorded related to Acacia Technologies
group employees was allocated to the Acacia Technologies group. As a result of
the recapitalization transaction discussed earlier, in future periods, stock
compensation expense, if any, resulting from the issuance of AR-Acacia
Technologies stock will generally be allocated to the Acacia Technologies group.
Stock option and related option plan information is omitted from the
Acacia Technologies group footnotes because AR-Acacia Technologies stock is part
of the capital structure of Acacia Research Corporation. The Acacia Technologies
group is not a separate legal entity. Holders of AR-Acacia Technologies stock
continue to be stockholders of Acacia Research Corporation. This presentation
reflects the fact that the Acacia Technologies group does not have legally
issued common or preferred stock, nor are warrant issuances or employee stock
transactions legal transactions of the Acacia Technologies group. Refer to the
Acacia Research Corporation consolidated financial statements for disclosures
regarding Acacia Research Corporation's stock option plans.
SEGMENTS. The Acacia Technologies group follows SFAS No. 131,
"Disclosure about Segments of an Enterprise and Related Information," which
establishes annual and interim reporting standards for an enterprise's operating
segments and related disclosures about its products, services, geographic areas
and major customers. Management has determined that the Acacia Technologies
group operates in one segment.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure 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 these estimates.
EARNINGS PER SHARE. Earnings per share information is omitted from the
Acacia Technologies group statements of operations because AR-Acacia
Technologies stock is part of the capital structure of Acacia Research
Corporation. The Acacia Technologies group is not a separate legal entity.
Holders of AR-Acacia Technologies stock continue to be stockholders of Acacia
Research Corporation. This presentation reflects the fact that the Acacia
F-65
Technologies group does not have legally issued common or preferred stock, nor
are warrant issuances or employee stock transactions legal transactions of the
Acacia Technologies group. Refer to the Acacia Research Corporation consolidated
financial statements for earnings per share information for Acacia Research
Corporation's classes of stock, computed using the two-class method in
accordance with SFAS No. 128 "Earnings per Share."
RECENT ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"). SFAS No. 141 addresses financial accounting and
reporting for business combinations and supersedes Accounting Principles Board
("APB") Opinion No. 16, "Business Combinations." Changes made by SFAS No. 141
include (1) requiring the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and (2) establishing specific
criteria for the recognition of intangible assets separately from goodwill.
These provisions are effective for business combinations for which the date of
acquisition is subsequent to June 30, 2001.
The Acacia Technologies group adopted SFAS No. 142 effective January 1,
2002 and ceased amortizing goodwill on that date. SFAS No. 142 addresses how
goodwill and other intangible assets should be accounted for after they have
been initially recognized in the financial statements. This standard provides
that goodwill is not subject to amortization. Instead, it is subject to a
periodic review that must occur at least annually at a reporting unit level for
possible impairment. This review is known as the "two-step" impairment test and
provides that the initial "first-step" reviews of each reporting unit must be
completed within six months of the adoption of the standard. The "first-step" of
the goodwill impairment test, used to identify potential impairment, compares
the fair value of each reporting unit with its carrying amount, including
goodwill. If upon completion of these initial reviews an impairment of goodwill
is indicated, the "second-step" is required to be performed, which will compare
the implied fair value of each reporting unit goodwill with the carrying amount
of goodwill. In connection with the adoption of SFAS No. 142, the Acacia
Technologies group performed a transitional goodwill impairment assessment and a
year end impairment assessment and determined that there was no impairment of
goodwill. The fair value of the Acacia Technologies group's one reporting unit
was estimated using a discounted cash flow analysis. There can be no assurance
that future goodwill impairment tests will not result in a charge to earnings.
The Acacia Technologies group had $1,834,000 and $1,776,000 of goodwill
at December 31, 2002 and 2001 (net of $2,258,000 of accumulated amortization),
respectively, and recorded approximately $216,000 and $451,000 of goodwill
amortization expense during 2001 and 2000, respectively.
The Acacia Technologies group's net (loss) income, adjusted to exclude
goodwill amortization expense, for the years ended December 31, 2002, 2001 and
2000 are as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
--------- --------- ---------
Reported net (loss) income ............ $(12,754) $ 5,757 $(24,197)
Add back: goodwill amortization ....... -- 216 451
--------- --------- ---------
Adjusted net (loss) income ............ $(12,754) $ 5,973 $(23,746)
========= ========= =========
The Acacia Technologies group's only identifiable intangible assets are
patents. The gross carrying amounts and accumulated amortization related to
acquired intangible assets as of December 31, 2002 and 2001 are as follows (in
thousands):
2002 2001
------------- -------------
Gross carrying amount - patents.. $ 10,798 $ 10,698
Accumulated amortization ........ (6,730) (5,144)
------------- -------------
Patents, net .................... $ 4,068 $ 5,554
============= =============
F-66
Aggregate patent amortization expense was $1,591,000, $1,277,000 and
$1,159,000 in 2002, 2001 and 2000, respectively. The estimated aggregate
amortization expense for the years ended December 31, 2003 through 2007 is as
follows (in thousands):
YEAR ENDED
DECEMBER 31,
------------
2003....................................... $ 500
2004....................................... 500
2005....................................... 500
2006....................................... 500
2007....................................... 500
At December 31, 2002 and 2001, all of the Acacia Technologies group's
acquired intangible assets other than goodwill were subject to amortization.
On January 1, 2002, the Acacia Technologies group adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"), which addresses financial accounting and reporting for the impairment of
long-lived assets and for long-lived assets to be disposed of. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of." SFAS No. 144 also supersedes the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for segments of a business to be disposed of. SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements,"
to eliminate the exception to consolidation for a temporarily controlled
subsidiary. SFAS No. 144 requires long-lived assets to be tested for
recoverability whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable. In conjunction with such tests, it may
be necessary to review depreciation estimates and methods as required by APB
Opinion No. 20, "Accounting Changes," or the amortization period as required by
SFAS No. 142. The adoption of SFAS No. 144 did not have a material effect on the
Acacia Technologies group's consolidated results of operations or financial
position.
In April 2002, the Acacia Technologies group adopted SFAS No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections," ("SFAS No. 145"), which is effective for
transactions occurring after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 and
SFAS No. 64, which addressed the accounting for gains and losses from
extinguishment of debt. SFAS No. 44 set forth industry-specific transitional
guidance that did not apply to us. SFAS No. 145 amends SFAS No. 13 to require
that certain lease modifications that have economic effects similar to
sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. SFAS No. 145 also makes technical corrections to
certain existing pronouncements that are not substantive in nature. The adoption
of SFAS No. 145 did not have a significant impact on the Acacia Technologies
group's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity," under which a liability for an exit cost was recognized at the date
of an entity's commitment to an exit plan. SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
at fair value when the liability is incurred. The provisions of this statement
are effective for exit or disposal activities that are initiated after December
31, 2002. The Acacia Technologies group does not expect the adoption of SFAS No.
146 to have a significant impact on its financial position or results of
operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB
F-67
Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN
45 elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 are applicable to
guarantees issued or modified after December 31, 2002 and are not expected to
have a material effect on the Acacia Technologies group's financial statements.
The disclosure requirements are effective for financial statements of interim
and annual periods ending after December 31, 2002.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires
consolidation of variable interest entities by the entity's primary beneficiary
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. FIN 46 must be applied beginning
July 1, 2003 to variable entities existing prior to February 1, 2003. The
adoption of FIN 46 will not have a material impact on the Acacia Technologies
group's results of operations or financial condition.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2002
and 2001 (in thousands):
2002 2001
--------- ---------
Furniture and fixtures.................................... $ 189 $ 320
Computer hardware and software............................ 287 320
Leasehold improvements.................................... 208 185
--------- ---------
684 825
Less: accumulated depreciation........................... (504) (467)
--------- ---------
$ 180 $ 358
========= =========
Depreciation expense was $209,000, $218,000 and $206,000 for the years
ended December 31, 2002, 2001 and 2000, respectively.
4. ACCOUNTS PAYABLE, ACCRUED EXPENSES AND OTHER
Accounts payable, accrued expenses and other consists of the following
at December 31, 2002 and December 31, 2001 (in thousands):
2002 2001
--------- ---------
Accounts payable.......................................... $ 234 $ 210
Payroll, vacation and other employee benefits............. 455 415
Accrued liabilities of discontinued operations............ 915 1,342
Taxes payable............................................. 2 356
Accrued subsidiary shareholder redemption payments........ 58 217
Accrued legal expenses.................................... 626 --
Other accrued liabilities................................. 234 385
--------- ---------
$ 2,524 $ 2,925
========= =========
5. INVESTMENTS IN AFFILIATES
In September 2002, the Acacia Technologies group recorded an impairment
charge of $2,748,000 for an other-than-temporary decline in the fair value of
F-68
Acacia Research Corporation's investment in Advanced Data Exchange ("ADX").
Impairment indicators included recurring losses, a decline in working capital
and the completion of a recent equity transaction with a shareholder at an
amount below Acacia Research Corporation's carrying value. The fair value of the
investment in ADX was determined by reference to available financial and market
information.
In 2000, Acacia Research Corporation purchased "non-voting" Series B
preferred stock and a 7.6% interest in ADX for $3,000,000. ADX is a corporation
engaged in business-to-business Internet exchange transactions that allow
mid-sized companies to exchange its purchase orders, purchase order
acknowledgments, advance ship notices, invoices and other business documents
over the Internet with supply chain partners and emerging digital marketplaces.
At December 31, 2002, Acacia Research Corporation owned a 6.8% interest in ADX.
The investment in ADX is accounted for under the cost method. Additional rounds
of financing may further dilute Acacia Research Corporation's ownership
interest.
In the fourth quarter of 2000, in connection with a review of the
carrying value of Acacia Research Corporation's investment portfolio, it was
determined that certain Acacia Research Corporation early stage investments
accounted for under the equity method and certain consolidated subsidiaries had
experienced significant losses in value that were determined to be other than
temporary. The decline in value of these investments, which were primarily start
up phase businesses, was attributed to the existence of continuing operating
losses, management's determination that the associated business models were no
longer viable and in some cases the cessation of operations of the respective
entities, and management's assessment that such investments were not
recoverable. Acacia Technologies group recorded $1,016,000 in write-offs of
early stage investments and $2,603,000 in write-offs of certain equity
investments. The investments written-off were not individually material.
6. INCOME TAXES
Acacia Technologies group's allocated provision (benefit) for income
taxes consists of the following (in thousands):
2002 2001 2000
------- ------- -------
Current:
U.S. Federal tax ............. $ (572) $ 776 $ 3
State taxes .................. 4 183 3
------- ------- -------
(568) 959 6
------- ------- -------
Deferred:
U.S. Federal tax ............. (142) (24) --
State taxes .................. -- -- --
------- ------- -------
(142) (24) --
------- ------- -------
$ (710) $ 935 $ 6
======= ======= =======
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2002 and 2001 (in thousands):
2002 2001
--------- ---------
Deferred tax assets:
Basis of investments in affiliates ................... $ 18,265 $ 16,920
Depreciation and amortization ........................ 4 37
Stock compensation ................................... 740 733
Accrued liabilities .................................. 2,574 545
Net operating loss carryforwards and credits ......... 16,529 11,222
--------- ---------
Total deferred tax assets .......................... 38,112 29,457
Less: valuation allowance ............................. (38,112) (29,457)
--------- ---------
Deferred tax assets, net of valuation allowance .... -- --
--------- ---------
Deferred tax liabilities:
Intangibles ......................................... (1,156) (1,298)
--------- ---------
Net deferred tax liability ........................ $ (1,156) $ (1,298)
========= =========
F-69
A reconciliation of the federal statutory income
tax rate and the effective income tax rate is as follows:
2002 2001 2000
----- ----- -----
Statutory federal tax rate......................... (34%) (34%) (34%)
State income taxes, net of federal benefit......... -- (2%) (3%)
Amortization of intangible assets.................. 5% (13%) 1%
Non deductible permanent items..................... (4%) -- --
Valuation allowance................................ 28% 37% 36%
----- ----- -----
(5%) (12%) --
===== ===== =====
At December 31, 2002, the Acacia Technologies group has deferred tax
assets totaling approximately $38,112,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
At December 31, 2002, the Acacia Technologies group had U.S. Federal
and California state income tax net operating loss carry forwards ("NOLs") of
approximately $43,619,000 and $27,957,000, expiring between 2002 and 2021. In
addition, the Acacia Technologies group had tax credit carryforwards of
approximately $62,000.
As of December 31, 2002, the aggregate tax NOLs at subsidiaries not
consolidated for tax purposes are $16,719,000 and $8,908,000 for federal and
state income tax purposes, respectively, expiring between 2002 and 2022.
However, the use of these NOLs are limited to the separate earnings of the
respective subsidiaries. In addition, ownership changes may also restrict the
use of NOLs.
Had the Acacia Technologies group filed separate tax returns, the
provision (benefit) for income taxes and division net income (loss) would not
have differed from the amounts reported in the Acacia Technologies group's
statements of operations for the years ended December 31, 2002, 2001, and 2000.
7. DISCONTINUED OPERATIONS
On February 13, 2001, the board of directors of Soundbreak.com
Incorporated ("Soundbreak.com"), a majority-owned subsidiary of Acacia Research
Corporation, resolved to cease operations as of February 15, 2001 and liquidate
the remaining assets and liabilities of the subsidiary. Accordingly, the Acacia
Technologies group has reported the results of operations and the estimated loss
on disposal of Soundbreak.com as discontinued operations in the 2000 statements
of operations. In September 2002, the Acacia Technologies group accrued an
additional $480,000 ($200,000 net of minority interests) in estimated costs to
be incurred in connection with the discontinued operations of Soundbreak.com.
The additional accrual relates primarily to certain noncancellable lease
obligations and the inability to sublease the related office space at rates
commensurate with our existing obligations.
F-70
Following is summary financial information for discontinued operations
included in the Acacia Technologies group financial statements (in thousands):
2002 2001 2000
--------- ------ ---------
Net sales .............................. $ -- $ -- $ 4
========= ====== =========
Loss from discontinued operations:
Before minority interests ........... $ -- $ -- $ 16,437
Minority interests .................. -- -- (8,994)
--------- ------ ---------
Net ................................. $ -- $ -- $ 7,443
========= ====== =========
Estimated loss on disposal:
Before minority interests ........... $ 480 $ -- $ 5,066
Minority interests .................. (280) -- (2,955)
--------- ------ ---------
Net ................................. $ 200 $ -- $ 2,111
========= ====== =========
Discontinued operations did not have an impact on the December 31, 2001
Acacia Technologies group statement of operations.
The assets and liabilities of the discontinued operations at December
31, 2002 consist primarily of $3,109,000 of cash and cash equivalents and
$918,000 of accounts payable and accrued expenses. The assets and liabilities of
the discontinued operations at December 31, 2001 consist primarily of $4,014,000
of cash and cash equivalents and $1,342,000 of accounts payable and accrued
expenses.
8. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Acacia Technologies group leases certain office furniture and equipment
and office space under various operating lease agreements expiring over the next
5 years. Minimum annual rental commitments for Acacia Technologies group
operating leases of continuing operations having initial or remaining
noncancellable lease terms in excess of one year are as follows (in thousands):
YEAR
----
2003........................................................... $ 472
2004........................................................... 295
2005........................................................... 303
2006........................................................... 312
2007........................................................... 39
----------
Total minimum lease payments................................... $ 1,421
==========
Rent expense of continuing operations for the years ended December 31,
2002, 2001 and 2000 approximated $445,000, $529,000 and $621,000, respectively.
LITIGATION
In September 2002, the United States District Court for the District of
Connecticut granted a motion for summary judgment filed by the defendants in
Soundview Technologies pending patent infringement and antitrust lawsuit against
Sony Corporation of America, Philips Electronics North America Corporation, the
Consumer Electronics Manufacturers Association and the Electronics Industries
Alliance d/b/a Consumer Electronics Association in the United States District
Court for the Eastern District of Virginia (filed on April 5, 2000), alleging
F-71
that television sets utilizing certain content blocking technology (commonly
known as the "V-chip") and sold in the United States infringe Soundview
Technologies' U.S. Patent No. 4,554,584. In granting the motion, the court ruled
that the defendants have not infringed on Soundview Technologies' patent. While
the Acacia Technologies group is currently exploring strategies in response to
this ruling and intend to appeal it, litigation is inherently uncertain and
there can be no assurance that the Acacia Technologies group will be successful
in any such appeal.
The ruling has no effect on the revenues that the Acacia Technologies
group has received from current licensees of its patented V-chip technology.
Further, none of the revenues received are contingent upon any court rulings or
the future outcome of any litigation with unlicensed television manufacturers.
Soundview Technologies continues to pursue its antitrust claim against the
defendants.
Acacia Technologies group is subject to other claims and legal actions
that arise in the ordinary course of business. Management believes that the
ultimate liability with respect to these claims and legal actions, if any, will
not have a material effect on the Acacia Technologies group's financial
position, results of operations or cash flows. However, the Acacia Technologies
group could be subject to claims and legal actions relating to the CombiMatrix
group.
9. ALLOCATED NET WORTH
The Acacia Technologies group statement of allocated net worth presents
the equity transactions of Acacia Research Corporation, which are attributed to
the Acacia Technologies group as "Net assets attributed to the Acacia
Technologies group." This presentation reflects the fact that the Acacia
Technologies group does not have legally issued common or preferred stock, nor
are warrant issuances or employee stock transactions legal transactions of the
Acacia Technologies group. Presented below is a detail of the equity
transactions of Acacia Research Corporation which relate to the businesses of
the Acacia Technologies group and which therefore comprise the balances
reflected in the group's Net assets attributed to Acacia Technologies group (in
thousands):
ACACIA
TECHNOLOGIES
GROUP
---------
2000
Units issued in private placements, net ........................ $ 2,786
Allocated corporate charges .................................... (783)
Stock options exercised ........................................ 2,132
Warrants exercised ............................................. 4,820
Change in capital due to issuance of stock by subsidiaries ..... 126
Compensation expense relating to stock options and warrants .... 599
---------
Net assets attributed to the Acacia Technologies group - 2000 .. $ 9,680
=========
2001
Allocated corporate charges .................................... $ (1,118)
Units issued in private placement, net ......................... 18,361
Stock options exercised ........................................ 1,252
Change in capital due to issuance of stock by subsidiaries ..... 737
Compensation expense relating to stock options and warrants .... 47
Stock dividend ................................................. (2)
---------
Net assets attributed to the Acacia Technologies group - 2001 .. $ 19,277
=========
F-72
2002
Allocated corporate charges ..................................... $ (1,032)
Stock options exercised ......................................... 136
Compensation expense relating to stock options and warrants ..... 19
Acquisition costs allocated to the CombiMatrix group ............ (834)
Other ........................................................... (2)
---------
Net assets attributed to the Acacia Technologies group - 2002 ... $ (1,713)
=========
10. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
--------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid for income taxes .................................. $ -- $ 597 $ --
Supplemental schedule of non-cash, operating,
investing and financing activities:
Liabilities assumed in acquisition of minority ownership
interest in subsidiary .................................... -- 200 --
Accrued payments for purchase of common stock from former
minority stockholders of subsidiary ....................... 58 217 --
Loss from discontinued operations of Soundbreak.com ......... 480 -- 3,072
F-73
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Acacia Research Corporation
In our opinion, the financial statements listed in the index appearing
under Item 15(a)(1) on page 83 present fairly, in all material respects, the
financial position of CombiMatrix Group (a division of Acacia Research
Corporation as described in Note 1) at December 31, 2002 and December 31, 2001,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of Acacia Research Corporation's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 2 to the financial statements, effective October
1, 2000, Acacia Research Corporation adopted Emerging Issues Task Force
Consensus on Issue No. 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," resulting in a charge of $246,000 in the year ended
December 31, 2000 for cumulative effect of change in accounting principle due to
beneficial conversion feature of debt.
As more fully described in Note 1 to the financial statements,
CombiMatrix Group is a division of Acacia Research Corporation; accordingly, the
financial statements of Acacia Technologies group should be read in conjunction
with the consolidated financial statements of Acacia Research Corporation.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 26, 2003
F-74
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
BALANCE SHEETS
(IN THOUSANDS)
AT DECEMBER 31,
-----------------------
2002 2001
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 3,291 $ 12,592
Short-term investments ................................................ 11,605 20,738
Accounts receivable ................................................... 578 143
Inventories, prepaid expenses and other assets ........................ 446 670
---------- ----------
Total current assets ............................................. 15,920 34,143
Property and equipment, net of accumulated depreciation and amortization ... 3,895 4,548
Patents, net of accumulated amortization ................................... 11,212 6,301
Goodwill, net of accumulated amortization .................................. 18,859 2,851
Other assets ............................................................... 87 120
---------- ----------
$ 49,973 $ 47,963
========== ==========
LIABILITIES AND ALLOCATED NET WORTH
Current liabilities:
Accounts payable, accrued expenses and other .......................... $ 2,302 $ 2,831
Current portion of deferred revenues .................................. 9,172 5,588
Current portion of capital lease obligation ........................... -- 934
---------- ----------
Total current liabilities ........................................ 11,474 9,353
---------- ----------
Payable to Acacia Technologies group ....................................... 114 30
Deferred income taxes ...................................................... 2,384 2,531
Deferred revenues, net of current portion .................................. -- 372
Capital lease obligation, net of current portion ........................... -- 1,845
---------- ----------
Total liabilities ................................................ 13,972 14,131
---------- ----------
Commitments and contingencies (Note 7)
Minority interests ......................................................... 684 30,109
---------- ----------
Allocated net worth:
Funds allocated by Acacia Research Corporation ........................ 129,286 51,473
Accumulated net losses ................................................ (93,969) (47,750)
---------- ----------
Total allocated net worth ........................................ 35,317 3,723
---------- ----------
$ 49,973 $ 47,963
========== ==========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-75
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
Revenues:
Product revenue ....................................................... $ 306 $ -- $ --
Grant and contract revenue ............................................ 533 456 17
--------- --------- ---------
Total revenues.................................................... 839 456 17
--------- --------- ---------
Operating expenses:
Cost of sales ......................................................... 263 -- --
Research and development expenses ..................................... 18,187 11,656 5,907
Charge for acquired in-process research and development ............... 17,237 -- 2,508
Non-cash compensation expense - research and development .............. 1,868 7,183 3,397
Marketing, general and administrative expenses ........................ 10,334 16,690 5,524
Non-cash compensation expense - marketing, general and
administrative ..................................................... 4,540 12,780 6,598
Amortization of patents and goodwill .................................. 399 1,203 640
Legal settlement charges .............................................. 18,471 -- --
--------- --------- ---------
Total operating expenses ......................................... 71,299 49,512 24,574
--------- --------- ---------
Operating loss ............................................................. (70,460) (49,056) (24,557)
--------- --------- ---------
Other income (expense):
Interest income ....................................................... 589 2,120 1,662
Interest expense ...................................................... (197) (65) --
--------- --------- ---------
Total other income ............................................... 392 2,055 1,662
--------- --------- ---------
Loss from operations before income taxes and minority interests ............ (70,068) (47,001) (22,895)
Benefit for income taxes ................................................... 147 155 79
--------- --------- ---------
Loss from operations before minority interests ............................. (69,921) (46,846) (22,816)
Minority interests ......................................................... 23,702 18,817 8,300
--------- --------- ---------
Loss from operations before cumulative
effect of change in accounting principle ................................ (46,219) (28,029) (14,516)
--------- --------- ---------
Cumulative effect of change in accounting principle due to
beneficial conversion feature of debt ................................... -- -- (246)
--------- --------- ---------
Division net loss .......................................................... $(46,219) $(28,029) $(14,762)
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-76
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF ALLOCATED NET WORTH
(IN THOUSANDS)
Balance at December 31, 1999 .................................. $ 770
Net assets attributed to the CombiMatrix group ................ 44,161
Division net loss ............................................. (14,762)
---------
Balance at December 31, 2000 .................................. 30,169
Net assets attributed to the CombiMatrix group ................ 1,583
Division net loss ............................................. (28,029)
---------
Balance at December 31, 2001 .................................. 3,723
Net assets attributed to the CombiMatrix group ................ 77,813
Division net loss ............................................. (46,219)
---------
Balance at December 31, 2002 .................................. $ 35,317
=========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-77
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Division net loss from continuing operations: ......................... $(46,219) $(28,029) $(14,516)
Adjustments to reconcile division net loss from continuing
operations to net cash used in operating activities:
Depreciation and amortization .................................... 1,736 2,159 906
Minority interests ............................................... (23,702) (18,817) (8,300)
Stock-based compensation ......................................... 6,408 19,963 9,995
Charge for acquired in-process research and development .......... 17,237 -- 2,508
Deferred tax benefit ............................................. (147) (155) (79)
Write-off of other assets ........................................ -- 918 --
Issuance of common stock by subsidiary - legal settlement ........ 17,471 -- --
Other ............................................................ 129 314 (105)
Changes in assets and liabilities:
Accounts receivable, prepaid expenses, other receivables and
other assets ................................................... (177) (258) (989)
Accounts payable, accrued expenses and other ..................... (515) 775 1,891
Deferred revenues ................................................ 11,637 5,960 --
--------- --------- ---------
Net cash used in operating activities of continuing operations ... (16,142) (17,170) (8,689)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............................... (1,002) (3,756) (2,004)
Proceeds from sale of property and equipment ..................... 358 -- --
Proceeds from sale and leaseback arrangement ..................... -- 3,000 --
Purchase of available-for-sale investments ....................... (11,338) (30,765) (44,606)
Sale of available-for-sale investments ........................... 20,383 50,354 3,975
Acquisition costs ................................................ (834) -- --
--------- --------- ---------
Net cash provided by (used in) investing activities .............. 7,567 18,833 (42,635)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash flows attributed to the CombiMatrix group ............... (818) 4,496 56,423
--------- --------- ---------
(Decrease) increase in cash and cash equivalents ...................... (9,393) 6,159 5,099
--------- --------- ---------
Cash and cash equivalents, beginning .................................. 12,592 6,558 1,459
Effect of exchange rate on cash ....................................... 92 (125) --
--------- --------- ---------
Cash and cash equivalents, ending ..................................... $ 3,291 $ 12,592 $ 6,558
========= ========= =========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-78
COMBIMATRIX GROUP
(A DIVISION OF ACACIA RESEARCH CORPORATION)
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Acacia Research Corporation is comprised of two separate divisions: the
CombiMatrix group and the Acacia Technologies group (the "groups").
The CombiMatrix group, a division of Acacia Research Corporation, is
intended to reflect the performance of Acacia Research Corporation's wholly
owned subsidiary, CombiMatrix Corporation, and CombiMatrix Corporation's
majority-owned subsidiaries, Advanced Material Sciences, Inc. ("Advanced
Material Sciences") and CombiMatrix K.K. (the "KK"), as well as the assets,
liabilities and related transactions of Acacia Research Corporation attributed
to the CombiMatrix group. The CombiMatrix group's core technology opportunity in
the life sciences sector has been primarily developed through CombiMatrix
Corporation which is a life sciences technology company with a proprietary
system for rapid, cost competitive creation of DNA and other compounds on a
programmable semiconductor chip (referred to as active biochips or microarrays).
This proprietary technology has applications relating to genomic and proteomic
research, biological and chemical detection and combinatorial chemistry markets.
CombiMatrix Corporation's majority-owned subsidiary, Advanced Material Sciences,
holds the exclusive license for CombiMatrix Corporation's biological array
processor technology in certain fields of material sciences.
During 2002, the CombiMatrix group emerged from the development stage
as it began commencement of its planned principal operations and from which it
generated revenues.
LIQUIDITY AND RISKS
The CombiMatrix group is deploying new and unproven technologies and
continues to develop its commercial products. The CombiMatrix group has several
ongoing long-term development projects that involve experimental technology and
may require several years and substantial expenditures to complete. Management
believes that existing cash and cash equivalents and short-term investments are
adequate to fund operations through December 31, 2003. However, the ability to
meet business objectives is dependent upon the CombiMatrix group's ability to
raise additional financing, substantiate its technology and ultimately to fund
itself from continuing operations. There can be no assurance that such funding
will be available at acceptable terms or at all.
The CombiMatrix group's business operations are also subject to certain
risks and uncertainties, including:
o market acceptance of products and services;
o technological advances that may make our products and services obsolete
or less competitive;
o increases in operating costs, including costs for supplies, personnel
and equipment;
o the availability and cost of capital;
o general economic conditions; and
o governmental regulation that may restrict our subsidiary companies'
businesses.
The CombiMatrix group is currently substantially dependent on its
existing arrangement(s) with Roche Diagnostics GmbH ("Roche"), and relies upon
payments by Roche for a majority of its future revenues. The CombiMatrix group
expends a majority of its resources toward fulfilling its contractual
obligations under the Roche agreements. Roche's primary service to the
CombiMatrix group is to distribute and proliferate its technology platform. The
CombiMatrix group will need to enter into additional strategic partnerships to
develop and commercialize future products. However, there can be no assurance
that the CombiMatrix group will be able to implement its future plans. Failure
by management to achieve its plans would have a material adverse effect on the
CombiMatrix group's ability to achieve its intended business objectives. The
CombiMatrix group's success also depends on its ability to protect its
intellectual property.
F-79
RECAPITALIZATION AND MERGER TRANSACTIONS
On December 11, 2002, Acacia Research Corporation's stockholders voted
in favor of a recapitalization transaction whereby Acacia Research Corporation
created two new classes of common stock called "Acacia Research-CombiMatrix
stock" ("AR-CombiMatrix stock"), and "Acacia Research-Acacia Technologies stock"
("AR-Acacia Technologies stock"), and divided Acacia Research Corporation's
existing Acacia Research Corporation common stock into shares of the two new
classes of common stock. AR-CombiMatrix stock is intended to reflect separately
the performance of Acacia Research Corporation's CombiMatrix group, and to
benefit from its research and development efforts. AR-Acacia Technologies stock
is intended to reflect separately the performance of Acacia Research
Corporation's Acacia Technologies group and to benefit from the licensing of its
technologies. In the recapitalization, which became effective on December 13,
2002, Acacia Research Corporation stockholders received 0.5582 of a share of
AR-CombiMatrix stock, and one share of AR-Acacia Technologies stock, for each
share of common stock that they owned. Although the AR-CombiMatrix stock and the
AR-Acacia Technologies stock are intended to reflect the performance of Acacia
Research Corporation's different business groups, they are both classes of
common stock of Acacia Research Corporation and are not stock issued by the
respective groups. The AR-Acacia Technologies stock is listed on the Nasdaq
National Market System, and the AR-CombiMatrix stock is listed on the Nasdaq
SmallCap Market.
On December 11, 2002, Acacia Research Corporation stockholders and
CombiMatrix Corporation stockholders voted in favor of a merger transaction
pursuant to which Acacia Research Corporation acquired the stockholder interests
in CombiMatrix Corporation not already owned by Acacia Research Corporation (52%
of the total stockholder interests in CombiMatrix Corporation). The acquisition
was accomplished through a merger, effective December 13, 2002, in which
stockholders of CombiMatrix Corporation other than Acacia Research Corporation
received one share of the new AR-CombiMatrix stock in exchange for each share of
CombiMatrix Corporation common stock that they owned immediately prior to the
merger.
On December 11, 2002, the stockholders of Acacia Research Corporation
also approved the adoption of two new stock incentive plans for the two business
groups.
GENERAL
In April 2002, CombiMatrix Corporation purchased Acacia Research
Corporation's majority interest in Advanced Material Sciences. CombiMatrix
Corporation issued 180,982 shares of its common stock to Acacia Research
Corporation in exchange for Acacia Research Corporation's 58% interest in
Advanced Material Sciences. As a result of this transaction, CombiMatrix
Corporation currently owns 87% of Advanced Material Sciences, with the remaining
interests owned by unaffiliated parties. The transaction was accounted for using
Acacia Research Corporation's basis in the net assets of Advanced Material
Sciences and as a result, the CombiMatrix group's financial statements reflect
the assets and liabilities of Advanced Material Sciences at historical cost.
Advanced Material Sciences was formed in November 2000 and holds an
exclusive license to CombiMatrix Corporation's biological processor technology
within the field of material science. Initial investments for Advanced Material
Sciences consisted of $2.0 million from Acacia Research Corporation and $1.0
million from CombiMatrix Corporation. Acacia Research Corporation's ownership
interest in Advanced Material Sciences has been attributed to the CombiMatrix
group.
In May 2001, Advanced Material Sciences completed a private equity
financing raising gross proceeds of $2.0 million through the issuance of
2,000,000 shares of common stock. Acacia Research Corporation invested $155,000
in this private placement to acquire 155,000 shares. As a result of the
transaction, Acacia Research Corporation's equity ownership in Advanced Material
Sciences decreased from 66.7% to 58.1%. Acacia Research Corporation accounted
for its purchase of 155,000 shares of Advanced Material Sciences as a step
acquisition using the purchase method of accounting. The total purchase price
was allocated to the fair value of assets acquired and liabilities assumed. As a
F-80
result of the decrease in ownership interest due to the disproportionate
purchase of additional shares in Advanced Material Sciences, a gain was
reflected in Acacia Research Corporation's statement of stockholders' equity as
a direct increase to capital in excess of par. Advanced Material Sciences issued
an additional 29,750 shares of common stock, in lieu of cash payments, and
warrants to purchase approximately 54,000 shares of common stock, for finders'
fees in connection with the private placement. Each common stock purchase
warrant entitles the holder to purchase shares of Advanced Material Sciences
common stock at a price of $1.10 per share. The value of such warrants is not
material.
In May 2001, CombiMatrix Corporation formed CombiMatrix International
Holdings Corporation ("Holdings"), a Delaware corporation and a wholly owned
subsidiary of CombiMatrix Corporation. Additionally, CombiMatrix Corporation
formed the KK, a Japanese corporation, which was a wholly owned subsidiary of
Holdings at formation. In October 2001, the KK sold 10% of its voting common
stock to Marubeni Japan. Marubeni Japan made a $1.1 million investment to
acquire a 10% minority interest in the KK. The KK, which is based in Tokyo,
Japan, will focus on development and licensing opportunities for CombiMatrix
Corporation's microarray technology with pharmaceutical and biotechnology
companies throughout the Asian market.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. AR-CombiMatrix stock is intended to reflect the
separate performance of the respective division of Acacia Research Corporation.
The CombiMatrix group is not a separate legal entity. Holders of AR-CombiMatrix
stock are stockholders of Acacia Research Corporation. As a result, holders of
AR-CombiMatrix stock are subject to all of the risks of an investment in Acacia
Research Corporation and all of its businesses, assets and liabilities. The
assets Acacia Research Corporation attributes to the CombiMatrix group could be
subject to the liabilities of the Acacia Technologies group.
The CombiMatrix group financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America, and taken together with the Acacia Technologies group financial
statements, comprise all the accounts included in the corresponding consolidated
financial statements of Acacia Research Corporation. The financial statements of
CombiMatrix group reflect the financial condition, results of operations, and
cash flows of the businesses included therein. The financial statements of the
CombiMatrix group include the accounts or assets of Acacia Research Corporation
specifically attributed to the CombiMatrix group and were prepared using amounts
included in Acacia Research Corporation's consolidated financial statements.
Minority interests represent participation of other stockholders in the
allocated net assets and in the division earnings and losses of the CombiMatrix
group and are reflected in the caption "Minority interests" in CombiMatrix
group's financial statements. Minority interests adjust CombiMatrix group's net
results of operations to reflect only CombiMatrix group's share of the division
earnings or losses of non wholly owned investees of Acacia Research Corporation
that have been attributed to the CombiMatrix group.
Financial effects arising from one group that affect Acacia Research
Corporation's results of operations or financial condition could, if
significant, affect the results of operations or financial condition of the
other group and the market price of the class of common stock relating to the
other group. Any division net losses of the CombiMatrix group or the Acacia
Technologies group and dividends or distributions on, or repurchases of,
AR-CombiMatrix stock or AR-Acacia Technologies stock or repurchases of preferred
stock of Acacia Research Corporation will reduce the assets of Acacia Research
Corporation legally available for payment of dividends on AR-CombiMatrix stock
or AR-Acacia Technologies stock.
MANAGEMENT ALLOCATION POLICIES. The management and allocation policies
applicable to the preparation of the financial statements of the CombiMatrix
group and the Acacia Technologies group may be modified or rescinded, or
additional policies may be adopted, at the sole discretion of the Acacia
Research Corporation Board at any time without approval of the stockholders. The
CombiMatrix group's financial statements reflect the application of the
management and allocation policies adopted by the Acacia Research Corporation
Board to various corporate activities, as described below. Management has no
plans to change allocation methods or the composition of the groups. The
CombiMatrix group financial statements should be read in conjunction with the
Acacia Research Corporation consolidated financial statements and related notes.
F-81
TREASURY AND CASH MANAGEMENT POLICIES. Cash and short-term investments
were attributed to the groups based on the respective cash and short term
investments balances of the entities comprising each group. Corporate cash
balances have been attributed to the Acacia Technologies group. All cash raised
by CombiMatrix Corporation and Advanced Material Sciences has been attributed to
the CombiMatrix group. Acacia Research Corporation manages most treasury
activities on a de-centralized basis, with each separate group separately
managing its own treasury activities. Pursuant to treasury and cash management
policies adopted by the Acacia Research Corporation Board, the following
applies:
o Acacia Research Corporation will attribute each future issuance of
AR-Acacia Technologies stock (and the proceeds thereof) to the Acacia
Technologies group and will attribute each future issuance of
AR-CombiMatrix stock (and the proceeds thereof) to the CombiMatrix
group;
o Acacia Research Corporation will attribute each future incurrence or
issuance of external debt or preferred stock (and the proceeds thereof)
between the groups or entirely to one group as determined by the Board,
based on the extent to which Acacia Research Corporation incurs or
issues the debt or preferred stock for the benefit of the CombiMatrix
group or the Acacia Technologies group;
o Dividends on AR-Acacia Technologies stock will be charged against the
AR-Acacia Technologies group, and dividends on AR-CombiMatrix stock
will be charged against the CombiMatrix group;
o Repurchases of AR-Acacia Technologies stock will be charged against the
Acacia Technologies group and Repurchases of AR-CombiMatrix stock will
be charged against the CombiMatrix group;
o Acacia Research Corporation will account for any cash transfers from
Acacia Research Corporation to or for the account of a group, from a
group to or for the account of Acacia Research Corporation, or from one
group to or for the account of the other group (other than transfers in
return for assets or services rendered) as short-term loans unless (A)
the Acacia Research Corporation Board determines that a given transfer
(or type of transfer) should be accounted for as a long-term loan, (B)
the Acacia Research Corporation Board determines that a given transfer
(or type of transfer) should be accounted for as a capital contribution
or (iii) the Acacia Research Corporation Board determines that a given
transfer (or type of transfer) should be accounted for as a return of
capital. There are no specific criteria to determine when Acacia
Research Corporation will account for a cash transfer as a long-term
loan, a capital contribution or a return of capital rather than an
inter-group revolving credit advance; provided, however, that cash
advances from Acacia Research Corporation to the Acacia Technologies
group or to the CombiMatrix group up to $25.0 million on a cumulative
basis shall be accounted for as short-term or long-term loans at
interest rates at which Acacia Research Corporation could borrow such
funds and shall not be accounted for as a capital contribution. The
Acacia Research Corporation Board will make such a determination in the
exercise of its business judgment at the time of such transfer based
upon all relevant circumstances. Factors the Acacia Research
Corporation Board may consider include, without limitation, the current
and projected capital structure of each group; the financing needs and
objectives of the recipient group; the availability, cost and time
associated with alternative financing sources; and prevailing interest
rates and general economic conditions; and
o Any cash transfers accounted for as short-term loans will bear interest
at the rate at which Acacia Research Corporation could borrow such
funds. In addition, any cash transfers accounted for as a long-term
loan will have interest rates, amortization, maturity, redemption and
other terms that reflect the then-prevailing terms on which Acacia
Research Corporation could borrow such funds.
ASSETS AND LIABILITIES. Acacia Research Corporation's assets and
liabilities have been attributed to the Acacia Technologies group and the
CombiMatrix group based on the respective asset and liabilities of the
businesses comprising each group. Intangible assets recorded at the Acacia
Research Corporation level, primarily consisting of acquired patents and
goodwill balances, have been attributed to the respective businesses to which
the intangibles and goodwill relate.
F-82
CORPORATE GENERAL AND ADMINISTRATIVE SERVICES AND FACILITIES. Acacia
Research Corporation allocates the cost of corporate general and administrative
services and facilities between the groups generally based upon utilization.
Where determinations based on utilization alone are impracticable, Acacia
Research Corporation will use other methods and criteria that management
believes to be equitable and to provide a reasonable estimate of the cost
attributable to each group. Except as otherwise determined by management, the
allocated costs of providing such services and facilities include, without
limitation, all costs and expenses of personnel employed in connection with such
services and facilities, including, without limitation, all direct costs of such
personnel, such as payroll, payroll taxes and fringe benefit costs (calculated
at the appropriate annual composite rate therefor) and all overhead costs and
expenses directly related to such personnel and the services or facilities
provided by them. In addition, allocated costs include all materials used in
connection with such services or facilities, billed at their net cost to the
provider of the services or facilities plus all overhead costs and expenses
related to such materials.
Except as may otherwise be specifically provided pursuant to the terms
of any agreements among Acacia Research Corporation and the groups or any
resolutions of the Board, the corporate general and administrative services and
facilities to be allocated between the groups include, without limitation, legal
services, accounting services (tax and financial), insurance and deductibles
payable in connection therewith, employee benefit plans and administration
thereof, investor relations, stockholder services, and services relating to the
board of directors.
Direct salaries, payroll taxes and fringe benefits are allocated to the
groups based on the percentage of actual time incurred by specific employees to
total annual time available and direct costs including postage, insurance, legal
fees, accounting and tax are attributed to the groups based on specific
identification of costs incurred on behalf of each group. Other direct costs,
including direct depreciation expense, computer costs, general office supplies
and rent are attributed to the groups based on the ratio of direct salaries to
total salaries. Indirect costs, including indirect salaries and benefits,
investor relations, rent, general office supplies and indirect depreciation are
allocated to the groups based on the ratio of direct salaries for each group to
total direct salaries. Included in marketing, general and administrative
expenses of the CombiMatrix group are allocated corporate charges of $1,161,000,
$1,361,000 and $883,000 relating to the periods ending December 31, 2002, 2001
and 2000, respectively.
Management believes that the methods and criteria used to allocate
costs are equitable and provide a reasonable approximation of the cost
attributable to the groups. Based on the allocation methods used, Acacia
Research Corporation believes that the allocation of expenses as presented in
the accompanying financial statements for the groups reflects a reasonable
estimation of expenses that would be recognized if the groups were separate
stand alone registrants.
ALLOCATION OF FEDERAL AND STATE INCOME TAXES. Acacia Research
Corporation determines its federal income taxes and the federal income taxes of
its subsidiaries that own assets allocated between the groups on a consolidated
basis. Acacia Research Corporation allocates consolidated federal income tax
provisions and related tax payments or refunds between the Acacia Technologies'
group and CombiMatrix group based principally on the taxable income and tax
credits directly attributable to each group. Such allocations reflect each
group's contribution, whether positive or negative, to Acacia Research
Corporation's consolidated federal taxable income and consolidated federal tax
liability and tax credit position. Acacia Research Corporation will credit tax
benefits that cannot be used by the group generating those benefits but can be
used on a consolidated tax return basis to the group that generated such
benefits. Inter-group transactions will be treated as taxed as if each group was
a stand-alone company.
Depending on the tax laws of the respective jurisdictions, state and
local income taxes are calculated on either a consolidated or combined basis
between the groups based on their respective contribution to such consolidated
or combined state taxable incomes. State and local income tax provisions and
related tax payments or refunds which are determined on a separate corporation
basis will be allocated between the groups in a manner designed to reflect the
respective contributions of the groups to Acacia Research Corporation's separate
or local taxable income.
F-83
REVENUE RECOGNITION. The CombiMatrix group recognizes revenue in
accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB No. 101") and related authoritative pronouncements.
Revenue from government grant and contract activities are recognized as the
related services are performed and when the services have been approved by the
grantor and collectibility is reasonably assured. Amounts recognized are limited
to amounts due from customers based on contract or grant terms.
Revenue from the sale of products and services is recognized when (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred or
services have been rendered, (iii) the fees are fixed or determinable, and (iv)
collectibility is reasonably assured.
Revenues from multiple-element arrangements involving license fees,
up-front payments and milestone payments, which are received or billable by the
CombiMatrix group in connection with other rights and services that represent
continuing obligations are deferred until all of the elements have been
delivered or until the CombiMatrix group has established objective and
verifiable evidence of the fair value of the undelivered elements.
Deferred revenue arises from payments received in advance of the
culmination of the earnings process. Deferred revenue expected to be recognized
within the next twelve months is classified as a current liability. At December
31, 2002, the CombiMatrix group recorded $11,637,000 as deferred revenues
related to payments received under multiple-element arrangements and other
advances. See Note 5 regarding adjustments to the CombiMatrix group's deferred
revenues in connection with Acacia Research Corporation's acquisition of the
ownership interests in CombiMatrix Corporation not already owned by Acacia
Research Corporation in December 2002 and the application of the purchase method
of accounting. Deferred revenue balances, as adjusted, will be recognized as
revenue in future periods when the applicable revenue recognition criteria as
describe above are met.
CASH AND CASH EQUIVALENTS. The CombiMatrix group considers all highly
liquid, short-term investments with original maturities of three months or less
when purchased to be cash equivalents.
SHORT-TERM INVESTMENTS. The CombiMatrix group's short-term investments
are held in a variety of interest bearing instruments including high-grade
corporate bonds, money market accounts and other high-credit quality marketable
securities. Investments in securities with original maturities of greater than
three months and less than one year are classified as short-term investments.
Investments are classified into categories in accordance with the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS No. 115"). Investments are
classified as available-for-sale, which are reported at fair value with related
unrealized gains and losses in the value of such securities recorded as a
separate component of comprehensive income (loss) in the CombiMatrix group
allocated net worth until realized.
The fair value of the CombiMatrix group's investments is primarily
determined by quoted market prices. Realized and unrealized gains and losses are
recorded based on the specific identification method. For investments classified
as available-for-sale, unrealized losses that are other than temporary are
recognized in division net income (loss).
The cost of debt securities is adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income (expense). Interest and dividends on all securities are included
in interest income.
CONCENTRATION OF CREDIT RISKS. Cash and cash equivalents are invested
in deposits with certain financial institutions and may, at times, exceed
federally insured limits. The CombiMatrix group has not experienced any losses
on its deposits of cash and cash equivalents.
INVENTORY. Inventory, which consists primarily of raw materials to be
used in the production of our microarray products, is stated at the lower of
cost or market using the first-in, first-out method.
PROPERTY AND EQUIPMENT. Property and equipment is recorded at cost.
Additions and improvements that increase the value or extend the life of an
asset are capitalized. Maintenance and repairs are expensed as incurred.
Disposals are removed at cost less accumulated depreciation or amortization and
any gain or loss from disposition is reflected in the statement of operations in
the year of disposition. Depreciation is computed on a straight-line basis over
the following estimated useful lives of the assets:
F-84
Machine shop and laboratory equipment........ 5 years
Furniture and fixtures....................... 5 to 7 years
Computer hardware and software............... 3 years
Leasehold improvements....................... Lesser of lease term
or useful life of
improvement
Construction in progress includes direct costs incurred related to
internally constructed assets which are depreciated once the asset is placed
into service. Certain leasehold improvements, furniture and equipment held under
capital leases are classified as property and equipment and are amortized over
their useful lives using the straight-line method. Lease amortization is
included in depreciation expense.
PREPAID PUBLIC OFFERING COSTS. During 2000 and 2001, CombiMatrix
Corporation capitalized $1,353,000 of costs incurred in connection with the
filing of a registration statement with the Securities and Exchange Commission
in November 2000. During 2001, all of these deferred costs were charged to
operations and are included as a component of marketing, general and
administrative expense in the accompanying statements of operations.
ORGANIZATION COSTS. Costs of start-up activities, including
organization costs, are expensed as incurred.
PATENTS AND GOODWILL. Goodwill and identifiable intangibles, including
patents, are recorded when the consideration paid for acquisitions exceeds the
fair value of the net tangible assets acquired. Patents, once issued, and
goodwill (pursuant to SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002, goodwill is no longer amortized, see "Recent
Accounting Pronouncements") are amortized on the straight-line method over their
economic remaining useful lives, ranging from three to twenty years.
IMPAIRMENT OF LONG-LIVED ASSETS. Long-lived assets and intangible
assets are reviewed for potential impairment when events or changes in
circumstances indicate the carrying amount of an asset may not be recoverable.
In the event the sum of the expected undiscounted future cash flows resulting
from the use of the asset is less than the carrying amount of the asset, an
impairment loss equal to the excess of the asset's carrying value over its fair
value is recorded. If an asset is determined to be impaired, the loss is
measured based on quoted market prices in active markets, if available. If
quoted market prices are not available, the estimate of fair value is based on
various valuation techniques, including a discounted value of estimated future
cash flows.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying value of cash and
cash equivalents, other receivables, accounts payable, deferred revenues and
accrued expenses approximate fair value due to their short-term maturity. The
carrying value of the capital lease obligation approximates its fair value based
on the current interest rate for similar type of instruments.
FOREIGN CURRENCY TRANSLATION. The functional currency of the KK is the
local currency. Foreign currency translation is reported pursuant to SFAS No.
52, "Foreign Currency Translation" ("SFAS No. 52"). Assets and liabilities
recorded in foreign currencies are translated at the exchange rate on the
balance sheet date. Translation adjustments resulting from this process are
charged or credited to other comprehensive income. Revenue and expenses are
translated at average rates of exchange prevailing during the year. Foreign
currency transactions gains and losses were insignificant for the years ended
December 31, 2002, 2001 and 2000.
STOCK-BASED COMPENSATION. Compensation cost of stock options issued to
employees is accounted for in accordance with Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No.
25") and related interpretations. Compensation cost attributable to such options
is recognized based on the difference, if any, between the closing market price
of the stock on the date of grant and the exercise price of the option.
Compensation cost is deferred and amortized on an accelerated basis over the
vesting period of the individual option awards using the amortization method
prescribed in Financial Accounting Standards Board ("FASB") Interpretation No.
28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or
Award Plans" ("FIN No. 28"). Compensation cost of stock options and warrants
issued to non-employee service providers is accounted for under the fair value
method required by SFAS No. 123 and related interpretations. In 2001 and earlier
periods, stock compensation expense recorded related to the CombiMatrix group
employees has been allocated to the CombiMatrix group. As a result of the
F-85
recapitalization transaction discussed earlier, in future periods, stock
compensation expense, if any, resulting from the issuance of AR-CombiMatrix
stock will generally be allocated to the CombiMatrix group.
Stock option and related option plan information is omitted from the
CombiMatrix group footnotes because AR- CombiMatrix stock is part of the capital
structure of Acacia Research Corporation. The CombiMatrix group is not a
separate legal entity. Holders of AR-CombiMatrix stock continue to be
stockholders of Acacia Research Corporation. This presentation reflects the fact
that the CombiMatrix group does not have legally issued common or preferred
stock, nor are warrant issuances or employee stock transactions legal
transactions of the CombiMatrix group. Refer to the Acacia Research Corporation
consolidated financial statements for disclosures regarding Acacia Research
Corporation's stock option plans.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist of costs incurred for direct and overhead-related research expenses and
are expensed as incurred. Costs to acquire technologies which are utilized in
research and development and which have no alternative future use are expensed
when incurred. Costs related to filing and pursuing patent applications are
expensed as incurred, as recoverability of such expenditures is uncertain.
Software developed for use in our products is expensed as incurred until both
(i) technological feasibility for the software has been established and (ii) all
research and development activities for the other components of the system have
been completed. Management believes these criteria are met after the CombiMatrix
group has received evaluations from third-party test sites and completed any
resulting modifications to the products. Expenditures to date have been
classified as research and development expense.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT. Excluding non-cash stock
based compensation related to research and development, the CombiMatrix group
incurred research and development expenses of $35,424,000, $11,656,000 and
$8,415,000 in 2002, 2001, and 2000, respectively, including amounts assigned to
acquired in-process technology of $17,237,000 and $2,508,000 in 2002 and 2000,
respectively. The value assigned to acquired in-process technology was
determined by identifying those acquired specific in-process research and
development projects that would be continued and for which (a) technological
feasibility had not been established at the acquisition date, (b) there was no
alternative future use and (c) the fair value was estimable with reasonable
reliability.
SEGMENTS. The CombiMatrix group follows SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" ("SFAS No. 131"), which
establishes annual and interim reporting standards for an enterprise's operating
segments and related disclosures about its products, services, geographic areas
and major customers. Management has determined that the CombiMatrix group
operates in one segment.
USE OF ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the combined financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
EARNINGS PER SHARE. Earnings per share information is omitted from the
CombiMatrix group statements of operations because AR-CombiMatrix stock is part
of the capital structure of Acacia Research Corporation. The CombiMatrix group
is not a separate legal entity. Holders of AR-CombiMatrix stock continue to be
stockholders of Acacia Research Corporation. This presentation reflects the fact
that the CombiMatrix group does not have legally issued common or preferred
stock, nor are warrant issuances or employee stock transactions legal
transactions of the CombiMatrix group. Refer to the Acacia Research Corporation
consolidated financial statements for earnings per share information for Acacia
Research Corporation's classes of stock, computed using the two-class method in
accordance with SFAS No. 128 "Earnings per Share."
During March 1998, CombiMatrix Corporation issued $1,450,000 principal
amount of 6% unsecured subordinated convertible promissory notes due in 2001.
The notes had a contingent beneficial conversion feature with intrinsic value of
$246,000. The CombiMatrix group adopted Emerging Issues Task Force Consensus of
Issues No. 00-27, "Application of Issue No. 98-5 to Certain Convertible
F-86
Instruments" ("EITF 00-27"), in the fourth quarter of 2000. The adoption of EITF
00-27 resulted in a charge of $246,000 in the year ended December 31, 2000 for
the cumulative effect of a change in accounting principle in accordance with APB
Opinion No. 20, "Accounting Changes."
CERTAIN RISKS AND UNCERTAINTIES. The CombiMatrix group's products and
services will be concentrated in a highly competitive market that is
characterized by rapid technological advances, frequent changes in customer
requirements and evolving regulatory requirements and industry standards.
Failure to anticipate or respond adequately to technological advances, changes
in customer requirements, changes in regulatory requirements or industry
standards, or any significant delays in the development or introduction of
planned products or services, could have a material adverse effect on the
CombiMatrix group's business and operating results.
RECENT ACCOUNTING PRONOUNCEMENTS. In June 2001, the FASB issued SFAS
No. 141, "Business Combinations" ("SFAS No. 141"), and SFAS No. 142, "Goodwill
and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 addresses financial
accounting and reporting for business combinations and supersedes APB Opinion
No. 16, "Business Combinations." Changes made by SFAS No. 141 include (1)
requiring the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and (2) established specific criteria
for the recognition of intangible assets separately from goodwill. These
provisions are effective for business combinations for which the date of
acquisition is subsequent to June 30, 2001.
The CombiMatrix group adopted SFAS No. 142 effective January 1, 2002
and ceased amortizing goodwill on that date. SFAS No. 142 addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. This standard provides that
goodwill is not subject to amortization. Instead, it is subject to a periodic
review that must occur at least annually at a reporting unit level for possible
impairment. This review is known as the "two-step" impairment test and provides
that the initial "first-step" reviews of each reporting unit must be completed
within six months of the adoption of the standard. The "first-step" of the
goodwill impairment test, used to identify potential impairment, compares the
fair value of each reporting unit with its carrying amount, including goodwill.
If upon completion of these initial reviews an impairment of goodwill is
indicated, the "second-step" is required to be performed, which will compare the
implied fair value of each reporting unit goodwill with the carrying amount of
goodwill. In connection with the adoption of SFAS No. 142, the CombiMatrix group
performed a transitional goodwill impairment assessment and a year end
impairment assessment and determined that there was no impairment of goodwill.
The fair value of the CombiMatrix group's one reporting unit was estimated using
a discounted cash flow analysis. There can be no assurance that future goodwill
impairment tests will not result in a charge to earnings.
The CombiMatrix group has $18,859,000 and $2,851,000 of goodwill at
December 31, 2002 and 2001 (net of $1,312,000 of accumulated amortization),
respectively and recorded approximately $862,000 and $470,000 of goodwill
amortization expense during 2001 and 2000, respectively.
F-87
The CombiMatrix group adopted SFAS No. 142 effective January 1, 2002
and ceased amortizing goodwill on that date. Division net loss, adjusted to
exclude goodwill amortization expense, for the years ended December 31, 2002,
2001 and 2000, are as follows (in thousands):
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
Reported net loss .................... $(46,219) $(28,029) $(14,762)
Add back: goodwill amortization ...... -- 862 470
--------- --------- ---------
Adjusted net loss .................... $(46,219) $(27,167) $(14,292)
========= ========= =========
The gross carrying amounts and accumulated amortization related to
acquired intangible assets, all related to patents, as of December 31, 2002 and
2001, are as follows (in thousands):
2002 2001
------------- -------------
Gross carrying amount - patents.. $ 12,095 $ 6,812
Accumulated amortization ........ (883) (511)
------------- -------------
Patents, net .................... $ 11,212 $ 6,301
============= =============
Aggregate patent amortization expense was $399,000, $341,000 and
$170,000 in 2002, 2001 and 2000, respectively.
The estimated aggregate amortization expense for each of the five
succeeding years is as follows (in thousands):
YEAR ENDED
DECEMBER 31,
----------------
2003............................................. $ 1,095
2004............................................. 1,095
2005............................................. 1,095
2006............................................. 1,095
2007............................................. 1,095
Refer to Note 10, "Step Acquisitions Allocated to the CombiMatrix
Group," for additions to goodwill and intangibles during the year ended December
31, 2002.
At December 31, 2002, all of the CombiMatrix group's acquired
intangible assets other than goodwill were subject to amortization.
OTHER PRONOUNCEMENTS
On January 1, 2002, the CombiMatrix group adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"), which addresses financial accounting and reporting for the impairment of
long-lived assets and for long-lived assets to be disposed of. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of." SFAS No. 144 also supersedes the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
F-88
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for segments of a business to be disposed of. SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements,"
to eliminate the exception to consolidation for a temporarily controlled
subsidiary. SFAS No. 144 requires long-lived assets to be tested for
recoverability whenever events or changes in circumstances indicate that its
carrying amount may not be recoverable. In conjunction with such tests, it may
be necessary to review depreciation estimates and methods as required by APB
Opinion No. 20, "Accounting Changes," or the amortization period as required by
SFAS No. 142. The adoption of SFAS No. 144 did not have a material effect on the
CombiMatrix group's results of operations or financial position.
In April 2002, the CombiMatrix group adopted SFAS No. 145, "Rescission
of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections," ("SFAS No. 145"), which is effective for transactions
occurring after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4 and SFAS No. 64,
which addressed the accounting for gains and losses from extinguishment of debt.
SFAS No. 44 set forth industry-specific transitional guidance that did not apply
to us. SFAS No. 145 amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. SFAS No. 145
also makes technical corrections to certain existing pronouncements that are not
substantive in nature. The adoption of SFAS No. 145 did not have a significant
impact on the CombiMatrix group's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). SFAS No. 146
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity," under which a liability for an exit cost was recognized at the date
of an entity's commitment to an exit plan. SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
at fair value when the liability is incurred. The provisions of this statement
are effective for exit or disposal activities that are initiated after December
31, 2002. The CombiMatrix group does not expect the adoption of SFAS No. 146 to
have a significant impact on its financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others," ("FIN 45") an interpretation of FASB
Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34. FIN
45 elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 are applicable to
guarantees issued or modified after December 31, 2002 and are not expected to
have a material effect on the CombiMatrix group's financial statements. The
disclosure requirements are effective for financial statements of interim and
annual periods ending after December 31, 2002.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 requires
consolidation of variable interest entities by the entity's primary beneficiary
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective for all new variable interest entities
created or acquired after January 31, 2003. FIN 46 must be applied beginning
July 1, 2003 to variable entities existing prior to February 1, 2003. The
adoption of FIN 46 will not have a material impact on the CombiMatrix group's
results of operations or financial condition.
F-89
3. SHORT-TERM INVESTMENTS
Short-term investments consists of the following at December 31, 2002
and 2001 (in thousands):
AMORTIZED FAIR
2002 COST VALUE
--------- ---------
Available-for-sale-securities:
Corporate bonds and notes .................. $ 5,718 $ 5,808
U.S. government securities ................. 5,698 5,797
--------- ---------
$ 11,416 $ 11,605
========= =========
AMORTIZED FAIR
2001 COST VALUE
--------- ---------
Available-for-sale-securities:
Corporate bonds and notes................... $ 14,427 $ 14,869
U.S. government securities.................. 5,643 5,869
--------- ---------
$ 20,070 $ 20,738
========= =========
Gross unrealized gains and losses related to available-for-sale
securities were not material for 2002 and 2001.
Contractual maturities for investments in debt securities classified as
available-for-sale as of December 31, 2002 are as follows (in thousands):
FAIR
COST VALUE
--------- ---------
Due within one year......................... $ 8,630 $ 8,772
Due after one year through two years........ 2,786 2,833
--------- ---------
$ 11,416 $ 11,605
========= =========
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 2002
and 2001 (in thousands):
2002 2001
-------- --------
Machine shop and laboratory equipment ................ $ 3,272 $ 844
Furniture and fixtures ............................... 156 125
Computer hardware and software ....................... 1,157 883
Leasehold improvements ............................... 992 380
Facilities and equipment held under capital lease .... -- 3,000
Construction in progress ............................. 352 84
-------- --------
5,929 5,316
Less: accumulated depreciation and amortization ...... (2,034) (768)
-------- --------
$ 3,895 $ 4,548
======== ========
Depreciation and amortization expense was $1,364,000, $955,000 and
$266,000 for the years ended December 31, 2002, 2001 and 2000. Amortization of
assets held under capital lease included in depreciation and amortization
expense was $590,000 and $161,000 for the years ended December 31, 2002 and
2001, respectively.
F-90
During 2001, CombiMatrix Corporation entered into a sale and leaseback
transaction with a commercial bank. Approximately $3,000,000 of property and
equipment was financed, resulting in a deferred gain of approximately $443,000
(see Note 7). In November 2002, the lease obligation was repaid and title to the
assets previously under capital lease was transferred back to the CombiMatrix
group.
5. BALANCE SHEET COMPONENTS
Accounts payable, accrued expenses and other consists of the following
at December 31, 2002 and December 31, 2001 (in thousands):
2002 2001
------- -------
Accounts payable ................................. $ 179 $ 627
Payroll and other employee benefits .............. 481 1,014
Accrued vacation ................................. 412 311
Legal settlement (see Note 7) .................... 500 --
Other accrued liabilities ........................ 730 879
------- -------
$2,302 $2,831
======= =======
Deferred revenues consist of the following at December 31, 2002 and
December 31, 2001 (in thousands):
2002 2001
--------- ---------
Milestone and up-front payments................... $ 9,172 $ 5,960
Less: current portion............................ (9,172) (5,588)
--------- ---------
$ -- $ 372
========= =========
DEFERRED REVENUE PURCHASE ACCOUNTING ADJUSTMENT
In connection with the December 2002 step acquisition described
elsewhere herein, and the application of purchase accounting pursuant to SFAS
No. 142, Acacia Research Corporation was required to adjust CombiMatrix
Corporation's assets and liabilities, including deferred revenues attributed to
the CombiMatrix group to fair value. As a result, deferred revenue, primarily
consisting of milestone payments and other cash receipts from Roche and the
National Aeronautics and Space Administration, was reduced by $8,425,000 to
reflect the fair value of the continuing obligation related to the 52% interest
in CombiMatrix Corporation acquired by Acacia Research Corporation. A
reconciliation of 2002 activity related to the CombiMatrix group's deferred
revenue balances including the impact of the fair value adjustment is as follows
(in thousands):
Deferred revenue balance at December 31, 2001........................... $ 5,960
Cash payments and accruals recorded as deferred revenues during 2002.... 11,637
Less: purchase accounting adjustment................................... (8,425)
---------
Deferred revenue balance at December 31, 2002........................... $ 9,172
=========
F-91
6. INCOME TAXES
CombiMatrix group's allocated benefit for income taxes consists of the
following (in thousands):
2002 2001 2000
------ ------ ------
Current:
U.S. Federal tax ............. $ -- $ -- $ --
State taxes .................. -- 3 --
------ ------ ------
-- 3 --
------ ------ ------
Deferred:
U.S. Federal tax ............. (147) (158) (79)
State taxes .................. -- -- --
------ ------ ------
(147) (158) (79)
------ ------ ------
$(147) $(155) $ (79)
====== ====== ======
The tax effects of temporary differences and carryforwards that give
rise to significant portions of deferred assets and liabilities consist of the
following at December 31, 2002 and 2001 (in thousands):
2002 2001
--------- ---------
Deferred tax assets:
Deferred revenues .................................... $ 3,116 $ --
Stock compensation ................................... 7,916 6,260
Other ................................................ 23 386
Net operating loss carryforwards and credits ......... 22,571 13,820
--------- ---------
Total deferred tax assets .......................... 33,626 20,466
Less: valuation allowance ............................. (33,626) (20,466)
--------- ---------
Deferred tax assets, net of valuation allowance .... -- --
--------- ---------
Deferred tax liabilities:
Intangibles ......................................... (2,384) (2,531)
--------- ---------
Net deferred tax liability ........................ $ (2,384) $ (2,531)
========= =========
A reconciliation of the federal statutory income tax rate and the
effective income tax rate is as follows
2002 2001 2000
------ ------ ------
Statutory federal tax rate.................... (34%) (34%) (34%)
State income taxes, net of federal benefit.... -- -- (3%)
Amortization of intangible assets............. 3% -- 1%
Stock compensation............................ 1% 6% 3%
Non deductible permanent items................ 13% (1%) --
Valuation allowance........................... 19% 29% 33%
Other......................................... (2%) -- --
------ ------ ------
-- -- --
====== ====== ======
F-92
At December 31, 2002, the CombiMatrix group has deferred tax assets
totaling approximately $36,626,000, which are fully offset by a valuation
allowance due to management's determination that the criteria for recognition
have not been met.
At December 31, 2002, the CombiMatrix group had federal net operating
loss carryforwards of approximately $66,360,000, which will begin to expire in
2010 through 2022. In addition, the CombiMatrix group has tax credit
carryforwards of approximately $1,989,000. Utilization of net operating loss
carryforwards and tax credit carryforwards are subject to the "change of
ownership" provisions under Section 382 of the Internal Revenue Code. The amount
of such limitations, if any, has not been determined.
Had the CombiMatrix group filed separate tax returns, the benefit for
income taxes and division net loss would not have differed from the amounts
reported in the CombiMatrix group's statements of operations for the years ended
December 31, 2002, 2001, and 2000.
7. COMMITMENTS AND CONTINGENCIES
SALE AND LEASEBACK ARRANGEMENT
In September 2001, CombiMatrix Corporation entered into a sale and
leaseback arrangement with a bank, providing up to $7,000,000 in financing for
equipment and other capital purchases. Pursuant to the terms of the agreement,
certain equipment and leasehold improvements, totaling $2.6 million in net book
value were sold to the bank at a purchase price of $3,000,000, resulting in a
deferred gain on the sale of assets of $443,000. The deferred gain is being
amortized over 4 years, representing the weighted average remaining useful life
of the leased assets. In addition, CombiMatrix Corporation entered into a
capital lease arrangement to lease the fixed assets from the bank. The term of
the lease obligation was three years, over which monthly principal and interest
payments of approximately $95,000 were paid. The capital lease obligation was
collateralized by the property and equipment under lease. At December 31, 2001,
the fair value of the capital lease obligation was approximately $2,779,000. The
capital lease agreement provided CombiMatrix Corporation with the option to
purchase the equipment for a nominal amount at the end of the lease term, which
expired in September 2004, and allowed for early pre-payment of the lease
obligation. In October 2002, CombiMatrix Corporation was in non-compliance with
one of its covenants under the lease. In November 2002, CombiMatrix Corporation
exercised its pre-payment option and repaid its remaining obligation of
$2,116,000 to the bank. There is no remaining capital lease or other long-term
debt obligations outstanding as of December 31, 2002.
OPERATING LEASES
In October 2000, CombiMatrix Corporation entered into a non-cancelable
operating lease for office space. A security deposit in the form of a $783,000
letter of credit was issued November 1, 2000, which was increased to $1.2
million during 2001 and to $1.5 million during 2002. Future minimum operating
lease payments as of December 31, 2002 are as follows (in thousands):
YEAR
----
2003............................................ $ 1,809
2004............................................ 1,740
2005............................................ 1,815
2006............................................ 1,836
2007............................................ 1,937
Thereafter...................................... 1,614
---------
Total minimum lease payments.................... $ 10,751
=========
Rent expense for the years ended December 31, 2002, 2001 and 2000 was
$1,618,000, $1,450,000 and $411,000, respectively.
F-93
COLLABORATIVE AND RESEARCH AGREEMENTS
In July 2001, CombiMatrix Corporation entered into a non-exclusive
worldwide license, supply, research and development agreement with Roche
Diagnostics GmbH ("Roche"). Under the terms of the agreement, Roche will
purchase, use and resell CombiMatrix Corporation's microarray and related
technologies for rapid production of customizable biochips. Additionally,
CombiMatrix Corporation and Roche will develop a platform technology, providing
a range of standardized biochips for use in research applications. The agreement
has a 15-year term and provides for minimum payments by Roche to CombiMatrix
Corporation over the first three years, including payments upon the achievement
of certain milestone and payments for products, royalties and research and
development projects. This agreement was amended in September 2002 in order to
grant Roche additional manufacturing rights in exchange for greater cash
compensation to CombiMatrix Corporation, among other changes and modifications.
For the years ended December 31, 2002 and 2001, CombiMatrix Corporation received
$11,435,000 and $5,321,000 in milestone payments, respectively, which have been
classified as deferred revenue in the CombiMatrix group balance sheets.
RESEARCH AND DEVELOPMENT
In January 2001, CombiMatrix Corporation entered into a design
commitment to develop a next generation microarray. If this design project is
successful pursuant to the terms of the agreement, CombiMatrix Corporation will
be obligated to a one-year commitment to purchase a specific number of
semiconductor wafers at a total cost of $1,100,000.
HUMAN RESOURCES
In October 2001, CombiMatrix Corporation's Board of Directors amended
its existing general severance plan for executive officers, which provides that
if CombiMatrix Corporation terminates an executive who is a vice president or
higher for other than cause, death or disability, the executive will receive
payments equal to three months' base salary and target bonus and other benefits
on a bi-weekly basis over a three-month period. If termination occurs as a
result of a change in control transaction, these benefits will be extended by
three months.
CombiMatrix Corporation also offers a general severance plan providing
all employees with certain benefits upon their termination of employment due to
lack of work. Under this plan, terminated employees will be provided with either
four-weeks notice or four-weeks' salary in lieu of notice, and paid a lump-sum
amount based on the employee's length of service, plus accrued benefits. The
terminated employees will also be provided continuing medical and dental
benefits, as well as continuation of life insurance, for a period ranging from
two to 26 weeks subsequent to the date of termination, depending upon the
employee's length of service.
LITIGATION
On November 28, 2000, Nanogen, Inc. ("Nanogen") filed suit against
CombiMatrix Corporation and Dr. Donald Montgomery, an officer, director and
stockholder of CombiMatrix Corporation. The Nanogen suit alleged, among other
things, that CombiMatrix Corporation's issued patent and certain pending patent
applications, trade secrets and related technologies that were inappropriately
obtained by CombiMatrix Corporation and that Nanogen was the legal owner of the
patents, trade secrets and related technologies. The suit sought, among other
things, correction of inventorship on CombiMatrix Corporation's issued patent,
the assignment of rights in the issued patent and pending patent applications to
Nanogen, an injunction preventing disclosure of trade secrets, damages for trade
secret misappropriation and the imposition of a constructive trust.
F-94
On September 30, 2002, CombiMatrix Corporation and Dr. Donald
Montgomery entered into a settlement agreement with Nanogen, Inc. to settle all
pending litigation between the parties. Pursuant to the terms of the settlement
agreement, CombiMatrix Corporation agreed to pay Nanogen $500,000 within 30 days
of the settlement, which was paid, and an additional $500,000 within one year of
the settlement. CombiMatrix Corporation also agreed to make quarterly payments
to Nanogen equal to 12.5% of total sales of products developed by CombiMatrix
Corporation and its affiliates and based on the patents that had been in dispute
in the litigation, up to an annual maximum of $1,500,000. The minimum quarterly
payments under the settlement agreement will be $37,500 per quarter for the
period from October 1, 2003 through October 1, 2004, and $25,000 per quarter
thereafter until the patents expire. Also, pursuant to the settlement agreement,
CombiMatrix Corporation issued to Nanogen 4,016,346 shares, or 17.5% of its
outstanding shares post-issuance, subject to an antidilution provision related
to the exercise of CombiMatrix Corporation options and warrants that were
outstanding on the effective date of the agreement, for a period of up to three
years.
CombiMatrix Corporation accounted for the issuance of the CombiMatrix
Corporation common shares in settlement of the litigation with Nanogen as a
nonmonetary transaction. Accordingly, in the third quarter of 2002, CombiMatrix
Corporation recorded a litigation settlement charge in its statement of
operations of approximately $17,471,000, which was based on the fair value of
the CombiMatrix Corporation common shares issued to Nanogen. The fair value of
the common shares issued and the related litigation charge was based on a
third-party valuation of CombiMatrix Corporation. Including the $1,000,000 cash
settlement stipulated in the agreement, the CombiMatrix group has recognized
$18,471,000 of litigation settlement charges in its December 31, 2002 statement
of operations.
The CombiMatrix group is subject to other claims and legal actions that
arise in the ordinary course of business. Management believes that the ultimate
liability with respect to these claims and legal actions, if any, will not have
a material effect on CombiMatrix group's financial position, results of
operations or cash flows.
8. RETIREMENT SAVINGS PLAN
CombiMatrix Corporation has an employee savings and retirement plan
under section 401(k) of the Internal Revenue Code (the "Plan"). The Plan is a
defined contribution plan in which eligible employees may elect to have a
percentage of their compensation contributed to the Plan, subject to certain
guidelines issued by the Internal Revenue Service. CombiMatrix Corporation may
contribute to the Plan at the discretion of the board of directors. There were
no contributions made by the CombiMatrix group during the years ended December
31, 2002, 2001 and 2000.
9. ALLOCATED NET WORTH
The CombiMatrix group statement of allocated net worth presents the
equity transactions of Acacia Research Corporation, which are attributed to the
CombiMatrix group as "Net assets attributed to the CombiMatrix group." This
presentation reflects the fact that the CombiMatrix group does not have legally
issued common or preferred stock, nor are warrant issuances or employee stock
transactions legal transactions of the CombiMatrix group. Presented below is a
detail of the equity transactions of Acacia Research Corporation which relate to
the businesses of the CombiMatrix group and which therefore comprise the
balances reflected in the group's net assets attributed to CombiMatrix group (in
thousands):
F-95
COMBIMATRIX
GROUP
-----------
2000
Units issued in private placements, net .................................. $ 19,500
Allocated corporate charges .............................................. 783
Stock issuance related to acquisition of additional CombiMatrix shares ... 11,634
Warrants exercised ....................................................... 10,000
Change in capital due to issuance of stock by subsidiaries ............... 2,167
Unrealized gain on short-term investments ................................ 77
-----------
Net assets attributed to the CombiMatrix group - 2000 .................... $ 44,161
===========
2001
Allocated corporate charges .............................................. $ 1,118
Change in capital due to issuance of stock by subsidiaries ............... 546
Unrealized loss on short-term investments ................................ (9)
Unrealized loss on foreign currency translation .......................... (72)
-----------
Net assets attributed to the CombiMatrix group - 2001 .................... $ 1,583
===========
2002
Allocated corporate charges .............................................. $ 1,032
Stock options exercised .................................................. 29
Change in capital due to issuance of stock by subsidiaries ............... (550)
Compensation expense relating to stock options and warrants .............. 300
Unrealized gain on short-term investments ................................ (38)
Unrealized loss on foreign currency translation .......................... 40
Dividends paid ........................................................... (11)
Stock issuance related to acquisition of additional CombiMatrix shares ... 76,175
Acquisition costs allocated .............................................. 834
Other .................................................................... 2
-----------
Net assets attributed to the CombiMatrix group - 2002 .................... $ 77,813
===========
During February 2000, an officer of the CombiMatrix Corporation entered
into an employment agreement with the CombiMatrix Corporation. Among other
items, the agreement required the officer to purchase 125,000 shares of
CombiMatrix Corporation common stock at $2.00 per share. The shares were
purchased in June 2000 resulting in cash proceeds to the CombiMatrix group of
$250,000.
During October 2001, the KK issued 10% of its common stock to an
unrelated company for $1,108,000. The per-share price paid for these shares
exceeded the price per share paid by Holdings to capitalize the KK. As a result,
CombiMatrix group recognized a change of interest gain of approximately
$951,000. The gain, net of minority interests, has been recorded as an increase
to allocated net worth.
WARRANTS
Pursuant to the issuance of convertible promissory notes in March 1998
as discussed in Note 2, CombiMatrix Corporation issued warrants to purchase
145,000 shares of its common stock at a price of $2.00 per share. These warrants
were exercised in 2000 and 2001, resulting in proceeds to the CombiMatrix group
of $33,000 and $257,000, respectively, which were allocated to the CombiMatrix
group.
F-96
10. STEP ACQUISITIONS ALLOCATED TO THE COMBIMATRIX GROUP
On December 13, 2002, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 48% to 100% by
acquiring from existing stockholders of CombiMatrix Corporation 11,987,274
shares of CombiMatrix Corporation common stock in exchange for 11,987,274 shares
of AR-CombiMatrix stock with a fair value of $46,007,000. The merger was
designed to consolidate Acacia Research Corporation's ownership of CombiMatrix
Corporation and permit Acacia Research Corporation to effectuate the
recapitalization transaction described elsewhere herein, by creating the
CombiMatrix group.
The transaction was accounted for as a step acquisition using the
purchase method of accounting. The fair value of the AR-CombiMatrix stock issued
in the transaction was based on the quoted market price of AR-CombiMatrix stock
averaged over a five-day period (from December 16, 2002, the first day of
trading for the new AR-CombiMatrix stock, through December 20, 2002).
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed and the allocation of the purchase price at the
date of acquisition (in thousands):
Acquisition costs:
Exchange of AR-CombiMatrix stock for CombiMatrix
Corporation common stock ............................ $46,007
Acquisition expenses .................................. 834
--------
Total acquisition cost ............................ $46,841
========
Purchase price allocation:
Fair value of 52% of CombiMatrix Corporation net
tangible assets at December 13, 2002 ................ $ 8,313
Intangible assets acquired:
Core technology/patent ............................ 5,283
Acquired in-process research and development ...... 17,237
Goodwill (non-deductible for tax purposes) ........ 16,008
--------
Total ............................................ $46,841
========
The total purchase price of $46,841,000 was allocated to the fair value
of assets acquired and liabilities assumed, including acquired IPR&D. The amount
attributable to CombiMatrix Corporation's core technology and related patents
was $5,283,000, which is being amortized using the straight-line method over the
estimated economic useful life of 7 years. The amount attributable to goodwill
was $16,008,000. Amounts allocated to patents, IPR&D and goodwill have been
attributed to the CombiMatrix group.
The amount attributable to IPR&D projects (comprised of two projects:
Genomics and Proteomics biological array systems) that had not yet reached
technological feasibility and had no alternative future use of $17,237,000 was
charged to expense on the acquisition date and is included in the accompanying
statement of operations for the year ended December 31, 2002.
The nature of the efforts to develop the purchased IPR&D into
commercially viable products principally relates to the completion and/or
acceleration of existing development programs. These efforts include testing
current and alternative materials used in microarray design, testing of existing
and alternative methods for microarray synthesis, developing prototype machinery
(including operating software) to synthesize, hybridize and read individual
microarrays, and to perform numerous experiments, or assays, with actual target
samples in order to determine customer protocols and procedures for using the
CombiMatrix group's microarray system. Following is a brief description of the
two IPR&D projects identified.
F-97
Genomics Biological Array System: CombiMatrix Corporation's genomics
biological array processor system is being developed to discretely immobilize
sequences of DNA or RNA within individual test sites on a modified semiconductor
chip coated with a three-dimensional layer of porous material. The system also
includes proprietary hardware units and related software applications to be able
to synthesize materials onto the chips, apply target samples of genetic
materials and interpret the results. The value assigned to the genomics
biological array system IPR&D project was $13,978,000. A risk-adjusted discount
rate of 32% was applied to the project's estimated cash flows.
Proteomics Biological Array System: CombiMatrix Corporation's
proteomics biological array processor system is being developed to discretely
immobilize proteins and other small molecules within individual test sites on a
modified semiconductor chip in a similar fashion as described above for the
genomics biological array system. The proteomics biological array system is used
for detection and identification of bio-threat agents in CombiMatrix
Corporation's biological and chemical threat agent detector development programs
that are currently in process. The value assigned to the proteomics biological
array system IPR&D project was $3,259,000. A risk-adjusted discount rate of 60%
was applied to the project's estimated cash flows.
In the first quarter of 2000, CombiMatrix Corporation completed a
private equity financing raising gross proceeds of $17.5 million through the
sale of 3,500,000 shares of CombiMatrix Corporation common stock. Acacia
Research Corporation invested $10.0 million in this private placement to acquire
2,000,000 shares of CombiMatrix Corporation common stock. The transaction was
accounted for as a step acquisition using the purchase method of accounting. The
total purchase price was allocated to the fair value of assets acquired and
liabilities assumed. As a result of the transaction, Acacia Research Corporation
increased its consolidated ownership interest in CombiMatrix Corporation from
50.01% to 51.8%. Proceeds from this equity financing were attributed to the
CombiMatrix group.
In the third quarter of 2000, Acacia Research Corporation increased its
consolidated ownership interest in CombiMatrix Corporation from 51.8% to 61.4%
by acquiring from existing stockholders of CombiMatrix Corporation 1,163,850
shares of CombiMatrix Corporation common stock in exchange for 488,557 shares of
Acacia Research Corporation's common stock. The transaction was accounted for as
a step acquisition using the purchase method of accounting. The fair value of
the Acacia Research Corporation shares issued in the transaction was based on
the quoted market price of Acacia Research Corporation's stock averaged over a
five-day period (including two days before and after the June 28, 2000
announcement date). The total purchase price of $11.6 million was allocated to
the fair value of assets acquired and liabilities assumed, including acquired
in-process research and development. The amount attributable to goodwill was
$2.9 million, which is amortized using the straight-line method over the
estimated remaining useful life of five years. The amount attributable to
in-process research and development of $2.5 million was charged to expense and
is included in the CombiMatrix group's statement of operations for the year
ended December 31, 2000. Related goodwill and intangibles were attributed to the
CombiMatrix group.
In the third quarter of 2000, CombiMatrix Corporation completed a
private equity financing raising gross proceeds of $36.0 million through the
sale of 4,000,000 shares of CombiMatrix Corporation common stock. Acacia
Research Corporation invested $17.5 million in this private placement to acquire
1,944,445 shares. The transaction was accounted for as a step acquisition using
the purchase method of accounting. As a result of the transaction, Acacia
Research Corporation's consolidated interest in CombiMatrix Corporation
decreased from 61.4% to 58.4%, and we recognized a gain, which is reflected in
Acacia Research Corporation's statement of stockholders' equity as a direct
increase to capital in excess of par. Proceeds from this equity financing were
attributed to the CombiMatrix group.
F-98
11. SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
--------- --------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest .................................................. $ 192 $ 42 $ --
Supplemental schedule of non-cash operating, investing and financing activities:
Intangibles attributed to the CombiMatrix group.......................... (46,007) -- (11,634)
Purchase price allocated to goodwill - step acquisitions ................ 16,008 -- 2,928
Purchase price allocated to patents - step acquisitions ................. 5,283 -- 6,812
Fixed assets purchased with accounts payable ............................ 70 -- 917
Purchase of equipment under capital lease agreement ..................... -- (3,000) --
Capital lease obligation incurred ....................................... -- 3,000 --
Fair value of options and warrants issued for services .................. -- -- 1,239
Deferred revenue purchase accounting adjustment ......................... 8,425 -- --
F-99
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
2.1 Agreement and Plan of Merger of Acacia Research Corporation, a
California corporation, and Acacia Research Corporation, a Delaware
corporation, dated as of December 23, 1999 (1)
2.2 Agreement and Plan of Reorganization by and among Acacia Research
Corporation, Combi Acquisition Corp. and CombiMatrix Corporation dated
as of March 20, 2002 (attached as Annex A to the Prospectus/Proxy
Statement included in this Registration Statement)
3.1 Restated Certificate of Incorporation (2)
3.2 Amended and Restated Bylaws (3)
4.1 Form of Specimen Certificate of Acacia's Common Stock (4)
10.1 Acacia 1993 Stock Option Plan (5)
10.2 Form of Stock Option Agreement for Acacia 1993 Stock Option Plan (5)
10.3 Acacia 1996 Stock Option Plan, as amended (6)
10.4 Form of Option Agreement constituting the Acacia 1996 Executive Stock
Bonus Plan (7)
10.5 CombiMatrix Corporation 1995 Stock Option Plan (8)
10.6 CombiMatrix Corporation 1998 Stock Option Plan (8)
10.7 CombiMatrix Corporation 2000 Stock Awards Plan (8)
10.8 2002 CombiMatrix Stock Incentive Plan (9)
10.9 2002 Acacia Technologies Stock Incentive Plan (10)
10.10 Agreement between Acacia Research and Paul Ryan (11)
10.11 Lease Agreement dated April 30, 1998, between Acacia and EOP-Pasadena
Towers, L.L.C., a Delaware limited liability company doing business as
EOP-Pasadena, LLC (12)
10.12 Lease Agreement between Soundbreak.com Incorporated and 8730 Sunset
Towers and related Guaranty (13)
10.13 First Amendment dated June 26, 2000, to Lease Agreement between Acacia
and Pasadena Towers, L.L.C. (14)
10.14 Sublease dated November 30, 2001, between Acacia and Jenkens &
Gilchrist (14)
10.15 Lease Agreement dated January 28, 2002, between Acacia and The Irvine
Company (14)
10.16 Settlement Agreement dated September 30, 2002, by and among Acacia,
CombiMatrix Corporation, Donald D. Montgomery, Ph.D. and Nanogen,
Inc.(8)
10.17+ Research & Development Agreement dated September 25, 2002, between
CombiMatrix Corporation and Roche Diagnostics GmbH(8)
10.18+ License Agreement dated September 25, 2002 between CombiMatrix
Corporation and Roche Diagnostics GmbH(8)
10.19 Form of Indemnification Agreement
21.1 List of Subsidiaries
23.1 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of Acacia Research Corporation)
23.2 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of CombiMatrix Corporation)
23.3 Consent of PricewaterhouseCoopers LLP (relating to the financial
statements of the Acacia Technologies Group and the CombiMatrix Group)
99.1 Certifications of the Chief Executive Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certifications of the Chief Financial Officer provided pursuant to 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
___________________________
+ Portions of this exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with the United
States Securities and Exchange Commission.
(1) Incorporated by reference from Acacia's Report on Form 8-K filed on
December 30, 1999 (SEC File No. 000-26068).
(2) Incorporated by reference as Appendix B to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective
on November 8, 2002.
(3) Incorporated by reference from Acacia's Quarterly Report on Form 10-Q
filed on August 10, 2001 (SEC File No. 000-26068).
(4) Incorporated by reference from Amendment No. 2 on Form 8-A/A filed on
December 30, 1999 (SEC File No. 000-26068).
(5) Incorporated by reference from Acacia's Registration Statement on Form
SB-2 (33-87368-L.A.), which became effective under the Securities Act
of 1933, as amended, on June 15, 1995.
(6) Incorporated by reference as Appendix A to the Definitive Proxy
Statement on Schedule 14A filed on April 10, 2000 (SEC File No.
000-26068).
(7) Incorporated by reference from Acacia's Definitive Proxy as Appendix A
Statement on Schedule 14A filed on April 26, 1996 (SEC File No.
000-26068).
(8) Incorporated by reference to Acacia's Registration Statement on Form
S-4 (SEC File No. 333-87654) which became effective on November 8,
2002.
(9) Incorporated by reference as Appendix D to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective
on November 8, 2002.
(10) Incorporated by reference as Appendix E to the Proxy
Statement/Prospectus which formed part of Acacia's Registration
Statement on Form S-4 (SEC File No. 333-87654) which became effective
on November 8, 2002.
(11) Incorporated by reference from Acacia's Annual Report on Form 10-K for
the year ended December 31, 1997, filed on March 30, 1998 (SEC File No.
000-26068).
(12) Incorporated by reference to Acacia's Quarterly Report on Form 10-Q
filed on August 14, 1998 (SEC File No. 000-26068).
(13) Incorporated by reference to Acacia's Quarterly Report on Form 10-Q
filed on November 15, 1999 (SEC File No. 000-26068).
(14) Incorporated by reference from Acacia's Annual Report on Form 10-K for
the year ended December 31, 2001 filed on March 27, 2002 (SEC File No.
000-26068).